[Federal Register Volume 59, Number 7 (Tuesday, January 11, 1994)]
[Unknown Section]
[Page 0]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 94-608]


[[Page Unknown]]

[Federal Register: January 11, 1994]


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COMMODITY FUTURES TRADING COMMISSION

17 CFR Parts 1, 30, 33, and 190

 

Risk Disclosure by Futures Commission Merchants, Introducing 
Brokers, Commodity Pool Operators and Commodity Trading Advisors to 
Customers; Bankruptcy Disclosure

AGENCY: Commodity Futures Trading Commission.

ACTION: Advance notice of proposed rulemaking.

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SUMMARY: The Commodity Futures Trading Commission (Commission or CFTC) 
is requesting public comment on the text of a draft two page generic 
risk disclosure statement currently being discussed among various 
international futures regulators that potentially could be used to meet 
the risk disclosure requirements for both domestic and foreign 
commodity futures and commodity option products subject to regulation 
by the CFTC. As contemplated by Commission rule 1.55(c), the text of 
the generic risk disclosure statement is being published, in part, to 
further these discussions relative to the development of one document 
to satisfy the risk disclosure requirements of the CFTC and such 
foreign jurisdictions as may choose to adopt its language for use in 
their jurisdictions. Based on the comments received, the CFTC may be 
better able to provide input to these discussions and to consider rule 
amendments to permit the substitution of this statement under rule 
1.55(c) and certain other rules for firms doing cross-border business.

DATES: Comments must be submitted on or before February 10, 1994.

ADDRESSES: Comments should be sent to the Secretariat, Commodity 
Futures Trading Commission, 2033 K Street, NW., Washington, DC 20581. 
Reference should be made to ``Generic Risk Disclosure--Advance 
Notice.''

FOR FURTHER INFORMATION CONTACT: Jane C. Kang, Esq., or Robert H. 
Rosenfeld, Esq., Division of Trading and Markets, Commodity Futures 
Trading Commission, 2033 K Street, NW., Washington, DC 20581; telephone 
(202) 254-8955.

SUPPLEMENTARY INFORMATION:

Background

    On March 30, 1993, the Commission, among other things, adopted 
final rule amendments to Commission rule 1.55(b) which simplified the 
risk disclosure process by consolidating the risk disclosure statements 
applicable to domestic futures transactions and foreign futures and 
foreign commodity options transactions in rules 1.55 and 30.6, 
respectively.\1\ The use of such a statement was intended to greatly 
simplify the risk disclosure process for U.S. firms conducting cross-
border business.
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    \1\58 FR 17496 (April 5, 1993). These amendments also:
    --eliminated the requirement that the rule 190.10 disclosure 
regarding treatment of non-cash margin be acknowledged by the 
customer;
    --clarified that the rule 1.55 risk disclosure statement may be 
included in a booklet of account opening documents, provided it 
appears on the cover page or following the cover page of such 
booklet;
    --provided that the Commission may approve a risk disclosure 
statement that has been approved by a foreign jurisdiction or 
foreign SRO for use in lieu of the Commission-required statement;
    --permitted the use of a single acknowledgement for rule 1.55 
and 33.7 statements and other elections, subject to specified 
conditions; and
    --simplified the disclosure requirements regarding the bulk 
transfer of accounts.
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    In response to Commission suggestions in the notice of proposed 
rulemaking concerning rule 1.55 that it also was considering the 
development of a ``plain language'' options disclosure statement,\2\ 
some commenters supported that course of action and further suggested 
that the Commission not only shorten the rule 33.7 disclosure statement 
applicable to exchange-traded commodity option transactions but also 
consolidate it with the new combined domestic futures and foreign 
futures and foreign commodity options statement. In response, the 
Commission noted that certain international regulators were endeavoring 
to develop a single risk disclosure statement that could be used in 
multiple jurisdictions to satisfy the risk disclosure requirements 
applicable to domestic and cross-border transactions in futures and 
options. The Commission stated that if a universal statement were to be 
developed, it would consider permitting the use of such a statement in 
lieu of the new consolidated rule 1.55 risk disclosure statement as 
well as the options risk disclosure statement required by current rule 
33.7.\3\ Under amended rule 1.55(c), the Commission may permit the 
substituted use of a risk disclosure statement approved by a foreign 
regulatory or self-regulatory organization if the Commission determines 
that such statement reasonably is calculated to provide the disclosure 
required by Commission rule 1.55(b).\4\
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    \2\See 57 FR 46101, 46108 (October 7, 1992).
    \3\58 FR at 17497 and 17502 (April 5, 1993).
    \4\58 FR at 17503-17504 (April 5, 1993).
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    For some time, a working group\5\ of international regulators 
worked towards developing a single risk disclosure statement which 
could satisfy the risk disclosure requirements applicable, in the 
multiple participating jurisdictions, to domestic and cross-border 
transactions in futures and options (``generic disclosure 
statement'').\6\ Following extensive discussions, the draft generic 
disclosure statement set forth herein was developed and the draft text 
was passed to those regulatory authorities (including the CFTC) who 
were interested in taking the work forward. The text remains subject to 
final discussion and approval by the regulatory authorities of the 
participating jurisdictions.
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    \5\The working group was composed of representatives from Canada 
(Ontario Securities Commission), France (the French Conseil du 
Marche a Terme), Switzerland (the Swiss Ministry of Finance), the 
United Kingdom (the U.K. Securities and Investments Board, which 
chaired the working group), and the United States (the CFTC).
    \6\See 58 FR at 17496, 17497 and 17502 (April 5, 1993).
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    It is intended that the generic disclosure statement would specify, 
in an addendum on a third page, the participating jurisdictions and the 
specific products for which it could be used. The addendum would be 
updated periodically as new jurisdictions adopted the text. In the 
United States, it is contemplated that such risk disclosure statement, 
if ultimately proposed and adopted after further public comment, would 
satisfy only those risk disclosure obligations set forth in Commission 
rules 1.55 (which incorporates the risk-disclosure contained in 
Commission rule 30.6),\7\ the special disclosures related to futures-
style margining of options permitted on certain foreign exchanges,\8\ 
and the special bankruptcy disclosures of Commission rule 190.10(c) 
related to the acceptance of non-cash margin.
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    \7\The Commission notes in this regard that pending resolution 
of the Commission's determination on this draft generic risk 
disclosure statement, firms operating pursuant to Commission rule 
30.10 relief should continue to comply with the risk disclosure 
requirements set forth in the relevant Commission orders and that 
for these purposes may continue to use the text of rule 30.6 as 
published prior to the 1993 revisions to Commission rules 1.55 and 
30.6 (which incorporated the rule 30.6 disclosures for foreign 
futures into the rule 1.55 disclosures for domestic futures) (see 58 
FR 17496 (April 5, 1993)).
    \8\See, e.g., CFTC Advisory No. 90-1 [1987-1990 Transfer Binder] 
Comm. Fut. L. Rep. (CCH) 24,597 (disclosure statement relating to 
the deferred payment of option premiums for options, superseding 
separate disclosure addenda required by orders concerning the London 
International Financial Futures Exchange (54 FR 37636 (September 12, 
1989)), the International Petroleum Exchange (54 FR 50356 (December 
6, 1989)), and the London Futures and Options Exchange (renamed as 
the London Commodity Exchange) (54 FR 50348 (December 6, 1989)); and 
55 FR 14238 (April 17, 1990) (Sydney Futures Exchange).
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Approach Taken By Working Group

    The approach taken by the international working group with respect 
to risk disclosure has been to develop a draft generic statement which 
focuses on the major risks of trading and contains the basic generic 
disclosures required by most jurisdictions.
    Thus, the approach of the working group was to eliminate much of 
the definitional and educational material which currently is required 
to be disclosed by Commission rule 33.7 and to treat options disclosure 
in a manner equivalent to disclosure for futures. As such, the 
statement is intended to focus customer attention on the risks of 
trading, as currently is the practice with futures risk disclosure. 
Further, the statement would highlight the importance of obtaining 
sufficient information as to the specifics of trading without 
attempting to address the differences from market to market.
    The elimination of a Commission mandated description of options 
trading and other educational material from the mandated risk 
disclosure statement does not mean, however, that firms do not have the 
obligation to provide all material disclosures in compliance with 
Commission and National Futures Association (NFA) rules.\9\
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    \9\See, e.g., Commission rule 1.55(d), which provides that: This 
section [requiring distribution of a risk disclosure statement] does 
not relieve a futures commission merchant or introducing broker from 
any other disclosure obligation it may have under applicable law.
    See also, NFA Compliance Rule 2-30 (customer information and 
risk disclosure).
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Additional Topics

    As the working group's objective was not only to create a risk 
disclosure statement that categorized existing disclosure requirements 
in most jurisdictions but also to incorporate new matters deemed 
relevant in an evolving marketplace, the generic statement also 
contains the following additional topics.

1. Supporting Systems

    The current draft generic disclosure statement would briefly 
disclose the fact that most open-outcry and electronic trading 
facilities are supported by computer-based component systems, which are 
vulnerable to temporary disruption or failure.

2. Electronic Trading

    Differences in electronic trading systems are such that a common 
disclosure appropriate to the specifics of each such system may not be 
feasible and, in the case of domestic contract market electronic 
systems, the draft generic disclosure statement would not substitute 
for disclosure requirements that currently are required by individual 
contract markets for such systems. However, as the purpose of the draft 
generic disclosure statement is to articulate general risks common to 
futures and options trading, it is possible in the case of electronic 
systems to identify the risks common to any such system, such as the 
possibility of system failure and that the liability of the system 
provider may be limited. No attempt has been made to describe in detail 
the specifics of any one system. On the contrary, the proposed 
disclosure text encourages the customer to ask the firm with which it 
is dealing for details in this respect.

3. Off-Exchange Trading

    The draft generic disclosure statement also contains a reference to 
the risks of off-exchange trading. The international working group 
drafting the consolidated disclosure statement concluded that such a 
provision, if worded appropriately, would not mislead or confuse 
customers in those jurisdictions which, for example, do not permit 
retail customers to participate in off-exchange markets.

Request For Comment

    The Commission is inviting public comment and suggestions generally 
on the draft text of the generic risk disclosure statement so that any 
material public concerns can be considered by the Commission. The 
Commission also requests public comment on whether the use of a generic 
disclosure statement to substitute for current disclosures contained in 
rules 1.55, 33.7, 190.10 and Commission orders and Advisories regarding 
disclosures related to futures-style margining of option premiums 
allowed by certain foreign exchanges would be most useful if made 
mandatory for certain categories of registrants, and if so, which 
categories should be included, and whether use should be limited to 
firms doing cross-border business or more broadly available.

Text of Draft Generic Risk Disclosure Statement

Risk Disclosure Statement for Futures and Options

    This brief statement does not disclose all of the risks and other 
significant aspects of trading in futures and options. In light of the 
risks, you should undertake such transactions only if you understand 
the nature of the contracts (and contractual relationships) into which 
you are entering and the extent of your exposure to risk. Trading in 
futures and options is not suitable for many members of the public. You 
should carefully consider whether trading is appropriate for you in 
light of your experience, objectives, financial resources and other 
relevant circumstances.

Futures

1. Effect of ``Leverage'' or ``Gearing''
    Transactions in futures carry a high degree of risk. The amount of 
initial margin is small relative to the value of the futures contract 
so that transactions are ``leveraged'' or ``geared.'' A relatively 
small market movement will have a proportionately larger impact on the 
funds you have deposited or will have to deposit: this may work against 
you as well as for you. You may sustain a total loss of initial margin 
funds and any additional funds deposited with the firm to maintain your 
position. If the market moves against your position or margin levels 
are increased, you may be called upon to pay substantial additional 
funds on short notice to maintain your position. If you fail to comply 
with a request for additional funds within the time prescribed, your 
position may be liquidated at a loss and you will be liable for any 
resulting deficit.
2. Risk-reducing Orders or Strategies
    The placing of certain orders (e.g. ``stop-loss'' orders, where 
permitted under local law, or ``stop-limit'' orders) which are intended 
to limit losses to certain amounts may not be effective because market 
conditions may make it impossible to execute such orders. Strategies 
using combinations of positions, such as ``spread'' and ``straddle'' 
positions may be as risky as taking simple ``long'' or ``short'' 
positions.

Options

3. Variable Degree of Risk
    Transactions in options carry a high degree of risk. Purchasers and 
sellers of options should familiarize themselves with the type of 
option (i.e. put or call) which they contemplate trading and the 
associated risks. You should calculate the extent to which the value of 
the options must increase for your position to become profitable, 
taking into account the premium and all transaction costs.
    The purchaser of options may offset or exercise the options or 
allow the options to expire. The exercise of an option results either 
in a cash settlement or in the purchaser acquiring or delivering the 
underlying interest. If the option is on a future, the purchaser will 
acquire a futures position with associated liabilities for margin (see 
the section on Futures above). If the purchased options expire 
worthless, you will suffer a total loss of your investment which will 
consist of the option premium plus transaction costs. If you are 
contemplating purchasing deep-out-of-the-money options, you should be 
aware that the chance of such options becoming profitable ordinarily is 
remote.
    Selling (``writing'' or ``granting'') an option generally entails 
considerably greater risk than purchasing options. Although the premium 
received by the seller is fixed, the seller may sustain a loss well in 
excess of that amount. The seller will be liable for additional margin 
to maintain the position if the market moves unfavorably. The seller 
will also be exposed to the risk of the purchaser exercising the option 
and the seller will be obligated to either settle the option in cash or 
to acquire or deliver the underlying interest. If the option is on a 
future, the seller will acquire a position in a future with associated 
liabilities for margin (see the section on Futures above). If the 
option is ``covered'' by the seller holding a corresponding position in 
the underlying interest or a future or another option, the risk may be 
reduced. If the option is not covered, the risk of loss can be 
unlimited.
    Certain exchanges in some jurisdictions permit deferred payment of 
the option premium, exposing the purchaser to liability for margin 
payments not exceeding the amount of the premium. The purchaser is 
still subject to the risk of losing the premium and transaction costs. 
When the option is exercised or expires, the purchaser is responsible 
for any unpaid premium outstanding at that time.

Additional Risks Common to Futures and Options

4. Terms and Conditions of Contracts
    You should ask the firm with which you deal about the terms and 
conditions of the specific futures or options which you are trading and 
associated obligations (e.g. the circumstances under which you may 
become obligated to make or take delivery of the underlying interest of 
a futures contract and, in respect of options, expiration dates and 
restrictions on the time for exercise). Under certain circumstances the 
specifications of outstanding contracts (including the exercise price 
of an option) may be modified by the exchange or clearing house to 
reflect changes in the underlying interest.
5. Suspension or Restriction of Trading and Pricing Relationships
    Market conditions (e.g. illiquidity) and/or the operation of the 
rules of certain markets (e.g. the suspension of trading in any 
contract or contract month because of price limits or ``circuit 
breakers'') may increase the risk of loss by making it difficult or 
impossible to effect transactions or liquidate/offset positions. If you 
have sold options, this may increase the risk of loss.
    Further, normal pricing relationships between the underlying 
interest and the future, and the underlying interest and the option may 
not exist. This can occur when, for example, the futures contract 
underlying the option is subject to price limits while the option is 
not. The absence of an underlying reference price may make it difficult 
to judge ``fair'' value.
6. Deposited Cash and Property
    You should familiarize yourself with the protections accorded money 
or other property you deposit for domestic and foreign transactions, 
particularly in the event of a firm insolvency or bankruptcy. The 
extent to which you may recover your money or property may be governed 
by specific legislation or local rules. In some jurisdictions, property 
which had been specifically identifiable as your own will be pro-rated 
in the same manner as cash for purposes of distribution in the event of 
a shortfall.
7. Commission and Other Charges
    Before you begin to trade, you should obtain a clear explanation of 
all commission, fees and other charges for which you will be liable. 
These charges will affect your net profit (if any) or increase your 
loss.
8. Transactions in Other Jurisdictions
    Transactions on markets in other jurisdictions, including markets 
formally linked to a domestic market, may expose you to additional 
risk. Such markets may be subject to regulation which may offer 
different or diminished investor protection. Before you trade you 
should enquire about any rules relevant to your particular 
transactions. Your local regulatory authority will be unable to compel 
the enforcement of the rules of regulatory authorities or markets in 
other jurisdictions where your transactions have been effected. You 
should ask the firm with which you deal for details about the types of 
redress available in both your home jurisdiction and other relevant 
jurisdictions before you start to trade.
9. Currency Risks
    The profit or loss in transactions in foreign currency-denominated 
contracts (whether they are traded in your own or another jurisdiction) 
will be affected by fluctuations in currency rates where there is a 
need to convert from the currency denomination of the contract to 
another currency.
10. Trading Facilities
    Most open-outcry and electronic trading facilities are supported by 
computer-based component systems for the order-routing, execution, 
matching, registration or clearing of trades. As with all facilities 
and systems, they are vulnerable to temporary disruption or failure.
11. Electronic Trading
    Trading on an electronic trading system may differ not only from 
trading in an open-outcry market but also from trading on other 
electronic trading systems. If you undertake transactions on an 
electronic trading system, you will be exposed to risks associated with 
the system including the failure of hardware and software. The result 
of any system failure may be that your order is either not executed 
according to your instructions or is not executed at all. Your ability 
to recover certain losses which are particularly attributable to 
trading on a market using an electronic trading system may be limited 
to less than the amount of your total loss. Limits on liability may be 
imposed by the system provider, the market, the clearing house and/or 
member firms. Such limits may vary: You should ask the firm with which 
you deal for details in this respect.
12. Off-exchange Transactions
    In some jurisdictions, and only then in restricted circumstances, 
firms are permitted to effect off-exchange transactions. The firm with 
which you deal may be acting as your counterparty to the transaction. 
It may be difficult or impossible to liquidate an existing position, to 
assess the value, to determine a fair price or to assess the exposure 
to risk. For these reasons, these transactions may involve increased 
risks.
    Off-exchange transactions may be less regulated or subject to a 
separate regulatory regime. Before you undertake such transactions, you 
should familiarize yourself with applicable rules.
    This disclosure document meets the risk disclosure requirements in 
the jurisdictions identified below ONLY for those instruments which are 
specified:

Jurisdiction ``A'':
    futures
    options on futures
Jurisdiction ``B'':
    futures
    options on futures
    options on commodities
Jurisdiction ``C'':
    futures
    options on futures
    options on equities
etc.

    Issued in Washington, DC. on January 5, 1994 by the Commission.
Jean A. Webb,
Secretary of the Commission.
[FR Doc. 94-608 Filed 1-10-94; 8:45 am]
BILLING CODE 6351-01-P