[Federal Register Volume 59, Number 208 (Friday, October 28, 1994)]
[Unknown Section]
[Page ]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 94-26726]


[Federal Register: October 28, 1994]


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COMMODITY FUTURES TRADING COMMISSION

17 CFR Parts 35 and 36


Section 4(c) Contract Market Transactions; Swap Agreements

AGENCY: Commodity Futures Trading Commission.

ACTION: Proposed rules.

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SUMMARY: On August 16, 1993, the Commodity Futures Trading Commission 
(``Commission'') published a notice of petitions for exemptive relief 
submitted by the Chicago Mercantile Exchange (``CME'') and the Board of 
Trade of the City of Chicago (``CBOT'') and request for comment. The 
petitions requested exemptions from most of the requirements of the 
Commodity Exchange Act (``CEA'' or ``Act'') and Commission regulations 
for certain exchange-traded futures and option contracts pursuant to 
Section 4(c) of the Act, added October 28, 1992.
    The comment period closed December 15, 1993, and the Commission has 
carefully considered the comments received. Based upon its review of 
the comments and its own consideration of the exemption requests, the 
Commission is proposing rules which will permit certain contract market 
transactions (as defined herein) meeting specified criteria to trade 
pursuant to exemption from certain requirements under the Act and 
Commission regulations on a section 4(c) contract market. The 
Commission is also seeking comment on whether Part 35 (exemption of 
swap agreements) should be amended to include stand-alone prohibitions 
on fraud and price manipulation.

DATES: Written comments must be received by the Commission by the close 
of business on December 12, 1994. Reference should be made to section 
4(c) contract market transactions.

ADDRESSES: Interested persons should submit their written views and 
comments to Jean A. Webb, Secretary, Commodity Futures Trading 
Commission, 2033 K Street, N.W., Washington, D.C. 20581.

FOR FURTHER INFORMATION CONTACT: Pat G. Nicolette, Acting General 
Counsel, David R. Merrill, Deputy General Counsel, or Ellyn S. Roth, 
Attorney, Office of the General Counsel, Commodity Futures Trading 
Commission, 2033 K Street, N.W., Washington, D.C. 20581. Telephone: 
(202) 254-9880.

SUPPLEMENTARY INFORMATION:

I. Statutory Background

    Section 2(a)(1)(A) of the Act grants the Commission exclusive 
jurisdiction over ``accounts, agreements (including any transaction 
which is of the character of * * * an 'option' * * *), and transactions 
involving contracts of sale of a commodity for future delivery traded 
or executed on a contract market * * * or any other board of trade, 
exchange, or market * * *'' 7 U.S.C. 2. The CEA and Commission 
regulations require that transactions in commodity futures contracts 
and commodity option contracts, with narrowly defined exceptions, occur 
on or subject to the rules of contract markets designated by the 
Commission.1
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    \1\Sections 4(a), 4c(b) and 4c(c) of the Act, 7 U.S.C. 6(a), 
6c(b), and 6c(c). Section 4(a) of the CEA specifically provides, 
inter alia, that it is unlawful to enter into a commodity futures 
contract that is not made ``on or subject to the rules of a board of 
trade which has been designated by the Commission as a `contract 
market' for such commodity.'' 7 U.S.C. 6(a). This prohibition does 
not apply to futures contracts made on or subject to the rules of a 
foreign board of trade, exchange or market. 7 U.S.C. 6(a).
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    On October 28, 1992, the Futures Trading Practices Act of 1992 
(``1992 Act'') was signed into law. P.L. No. 102-546. This legislation 
added new subsections (c) and (d) to Section 4 of the Act. New Section 
4(c)(1) authorizes the Commission, by rule, regulation, or order, to 
exempt any agreement, contract or transaction, or class thereof, from 
the exchange-trading requirements of Section 4(a) or any other 
requirement of the Act other than Section 2(a)(1)(B), 7 U.S.C. 2.2 
New Section 4(c)(2) provides that the Commission may not grant an 
exemption from the exchange-trading requirement of the Act unless, 
inter alia, the agreement, contract or transaction being exempted will 
be entered into solely between ``appropriate persons'' as defined in 
new Section 4(c)(3)3 subject to such limitations as may be deemed 
appropriate by the Commission, in the public interest.4 In 
granting such an exemption, the Commission must also determine that the 
agreement, contract or transaction in question will not have a material 
adverse effect on the ability of the Commission or any contract market 
to discharge its regulatory or self-regulatory duties under the Act and 
that the exemption would be consistent with the public interest and the 
purposes of the Act.5 In vesting the Commission with this new 
exemptive authority, Congress recognized the need to create legal 
certainty for instruments that may contain some features similar to 
those of regulated exchange-traded products but that are sufficiently 
different in their purpose, function or design, or other 
characteristics such that traditional futures regulation may be 
unnecessary.6
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    \2\Specifically, Section 4(c)(1), 7 U.S.C. 6(c)(1), provides:
    In order to promote responsible economic or financial innovation 
and fair competition, the Commission by rule, regulation, or order, 
after notice and opportunity for hearing, may (on its own initiative 
or on application of any person, including any board of trade 
designated as a contract market for transactions for future delivery 
in any commodity under section 5 of this Act) exempt any agreement, 
contract, or transaction (or class thereof) that is otherwise 
subject to subsection (a) (including any person or class of persons 
offering, entering into, rendering advice or rendering other 
services with respect to, the agreement, contract, or transaction), 
either unconditionally or on stated terms or conditions or for 
stated periods and either retroactively or prospectively, or both, 
from any of the requirements of subsection (a), or from any other 
provision of this Act (except section 2(a)(1)(B)), if the Commission 
determines that the exemption would be consistent with the public 
interest.
    \3\Section 4(c)(3), 7 U.S.C. 6(c)(3), provides that the term 
``appropriate person'' shall be limited to the following persons or 
classes thereof:
    (A) A bank or trust company (acting in an individual or 
fiduciary capacity).
    (B) A savings association.
    (C) An insurance company.
    (D) An investment company subject to regulation under the 
Investment Company Act of 1940 (15 U.S.C. 80a-1 et seq.).
    (E) A commodity pool formed or operated by a person subject to 
regulation under this Act.
    (F) A corporation, partnership, proprietorship, organization, 
trust, or other business entity with a net worth exceeding 
$1,000,000 or total assets exceeding $5,000,000, or the obligations 
of which under the agreement, contract or transaction are guaranteed 
or otherwise supported by a letter of credit or keepwell, support, 
or other agreement by any such entity or by an entity referred to in 
subparagraph (A), (B), (C), (H), (I), or (K) of this paragraph.
    (G) An employee benefit plan with assets exceeding $1,000,000, 
or whose investment decisions are made by a bank, trust company, 
insurance company, investment adviser registered under the 
Investment Advisers Act of 1940 (15 U.S.C. 80a-1 et seq.), or a 
commodity trading advisor subject to regulation under this Act.
    (H) Any governmental entity (including the United States, any 
state, or any foreign government) or political subdivision thereof, 
or any multinational or supranational entity or any instrumentality, 
agency, or department of any of the foregoing.
    (I) A broker-dealer subject to regulation under the Securities 
Exchange Act of 1934 (15 U.S.C. 78a et seq.) acting on its own 
behalf or on behalf of another appropriate person.
    (J) A futures commission merchant, floor broker, or floor trader 
subject to regulation under this Act acting on its own behalf or on 
behalf of another appropriate person.
    (K) Such other persons that the Commission determines to be 
appropriate in light of their financial or other qualifications, or 
the applicability of appropriate regulatory protections.
    \4\See H.R. Rep. No. 978, 102d Cong., 2d Sess. 79 (1992).
    \5\Specifically, Section 4(c)(2), 7 U.S.C. 6(c)(2), states:
    The Commission shall not grant any exemption under paragraph (1) 
from any of the requirements of subsection (a) unless the Commission 
determines that--
    (A) The requirement should not be applied to the agreement, 
contract, or transaction for which the exemption is sought and that 
the exemption would be consistent with the public interest and the 
purposes of this Act; and
    (B) the agreement, contract, or transaction--
    (i) will be entered into solely between appropriate persons; and
    (ii) will not have a material adverse effect on the ability of 
the Commission or any contract market to discharge its regulatory or 
self-regulatory duties under this Act.
    \6\See H.R. Rep. No. 978, 102d Cong., 2d Sess. 80 (1992).
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II. The Petitions for Exemptive Relief

    On August 16, 1993, the Commission published in the Federal 
Register a notice of petitions for exemption submitted by the CME and 
CBOT pursuant to Section 4(c) of the Act, 7 U.S.C. 6(c), and a request 
for comment.7 In its petition, submitted on April 8, 1993 (and 
supplemented June 18, 1993), the CME sought an exemption from most of 
the provisions of the Act and Commission regulations with regard to the 
purchase and sale of certain contracts denominated by the CME as 
Rolling SpotTM futures and options contracts (``Rolling Spot 
Contracts''). The CBOT's petition, submitted on June 30, 1993, 
requested that the Commission establish a ``professional trading market 
exemption'' from most of the provisions of the Act and regulations for 
trading in any instrument of the CBOT and other boards of trade, 
including those designated previously as contract markets by the 
Commission. Under both petitions, trading in exempted instruments would 
have been limited to certain participants, and trades would have been 
cleared through an exchange clearing system approved by the Commission.
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    \7\58 FR 43414 (Aug. 16, 1993); 58 FR 44402 (Aug. 20, 1993) 
(correction); 58 FR 52948 (Oct. 13, 1993) (extension of comment 
period to Dec. 15, 1993).
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    In the Federal Register notice, the Commission requested comment 
concerning the appropriate disposition, pursuant to Section 4(c) of the 
Act, 7 U.S.C. 6(c), of the applications submitted by the CME and the 
CBOT. Specifically, the Commission requested comment on approximately 
100 issues under the following general headings, corresponding to the 
determinations that the Commission must make in order to grant an 
exemption under Section 4(c), 7 U.S.C. 6(c): (1) Whether the exemption 
is consistent with the public interest and purposes of the Act; (2) 
whether the contracts to be exempted will be entered into solely 
between ``appropriate persons'' as defined in Section 4(c)(3) of the 
Act, 7 U.S.C. 6(c)(3); and (3) whether the exemption will have a 
material adverse effect on the ability of the Commission or any 
contract market to discharge its regulatory or self-regulatory duties 
under the Act.

III. Comments Received

    The Commission received 36 comment letters on the proposal: seven 
from futures exchanges;\8\ two from securities exchanges; one from the 
National Futures Association; six from trade associations;\9\ three 
from foreign regulatory bodies; two from university professors; four 
from federal regulatory agencies; one from a member of Congress; one 
from a publisher of a futures publication; five from futures traders; 
one from a bar association; two from investment companies; and one from 
a futures lawyer.\10\
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    \8\The seven comment letters consist of an interim letter signed 
by the presidents of eight exchanges, a 134-page letter signed by 
the presidents of seven exchanges, a letter from the New York 
Mercantile Exchange (``NYMEX''), a letter from the CME responding to 
a comment letter, and three joint letters from the CME and CBOT 
supplementing the record and responding to other comment letters. In 
addition, by letter dated September 20, 1994, the NYMEX sought to 
join in the CBOT's petition.
    \9\The six include an extension of time request.
    \10\In addition, on November 23, 1993, the Commission held a 
roundtable discussion, during which industry experts, including 
representatives of end users and dealers in over-the-counter 
(``OTC'') and exchange-traded derivatives, presented their views on 
the exchange petitions. A number of concerns were expressed 
regarding the way in which the exchanges' ``professional trading 
market'' would operate.
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    There were three general sets of commenters: those who expressed 
unqualified support in favor of the petitions; those who were generally 
in favor of the petitions but who thought they should be modified 
somewhat, either by limiting the scope of the exemptions and/or by 
granting the exemptions on a trial basis; and those who were generally 
against the petitions. The CME and the CBOT were joined by six other 
exchanges in expressing their support for the proposals. The group in 
favor of the exemptions also included certain futures professionals and 
academics. The industry's views, however, were not uniform. Futures 
trade associations as well as other futures professionals comprised the 
group giving their qualified support to the CME and CBOT petitions. 
Those opposing the petitions largely consisted of regulatory agencies, 
both foreign and domestic. In addition, portions of the petitions were 
criticized by some investment professionals.
    Those supporting the petitions generally believed that the 
exchanges are operating at a handicap in competing with the OTC markets 
because of what they characterized as burdensome, costly, and 
unnecessary federal regulation. Removing such regulation would, 
according to supporters, enhance the competitive posture of the U.S. 
exchanges in the world marketplace. Supporters further asserted that 
professional and institutional traders do not require the same level of 
regulatory protection as the small retail speculator. They argued that 
the Commission should treat transactions occurring in centralized 
``professional trading markets'' the same way that it did swaps, 
hybrids, and certain energy transactions, all previously exempted from 
most or all of the provisions of the Act and Commission regulations.
    Some supporters commented that the exemptions would allow flexible 
product development, the hallmark of the OTC market, but in a far more 
structured regulatory environment. According to these commenters, 
exchange self-regulation over derivatives is preferable to no market 
regulation, the present situation in connection with OTC transactions.
    Those giving the petitions qualified support generally also 
endorsed permitting more flexible approaches than the current 
designation process as well as enhancing the exchanges' ability to 
respond to the needs of sophisticated and institutional market 
participants and competitive demands of the international marketplace. 
Nonetheless, commenters in this category expressed concerns with the 
petitions, and highlighted the need to ensure the integrity of both the 
non-exempt as well as the exempt markets, particularly with regard to 
financial requirements, customer funds protections, trade practice 
rules, market surveillance, exchange governance, and the integrity of 
the clearing system. In addition, some of these commenters were not 
thoroughly convinced that the rules for preventing fraud and 
manipulation proposed by the CME and CBOT would be as effective as the 
current procedures.\11\ The commenters further noted the importance of 
maintaining public confidence in the integrity of the futures markets. 
Some emphasized that public markets like the CME and CBOT imply a 
comprehensive regulatory environment, including the imposition of 
fitness standards for commodity professionals.
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    \11\In addition, two commenters suggested that the CBOT's 
proposed antifraud rule might exceed the Commission's jurisdictional 
scope.
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    Finally, some commenters giving the petitions qualified support 
believed that the absence of defining criteria for the proposed 
transactions made their evaluation of the potential consequences of the 
exchanges' petitions difficult. Accordingly, commenters in this group 
generally recommended caution--either by limiting the commodities which 
could be traded on a ``professional trading market'' or by granting the 
exemptions on a trial basis, or both.
    Commenters opposing the petitions, in particular other financial 
regulatory agencies, essentially contended that the exemption proposals 
were too broad and lack sufficient justification. Specifically, 
according to some commenters, the exchanges failed to make their case 
that approval of their proposals would be in the public interest. They 
further argued that the exchanges have not presented evidence showing 
that the existing regulatory structure is so harmful to competition 
that such broad relief is necessary in order for exchanges to compete 
effectively. Commenters against the petitions contended that granting 
such broad exemptions may have unintended effects on market integrity, 
in particular, unexpected consequences for the non-exempt markets and 
the safety of the clearing system.\12\
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    \12\Some commenters stated that although the exchanges have 
indicated that they do not intend to trade identical exempt and non-
exempt contracts, the theoretical possibility of allowing such two-
tier trading would raise a number of concerns, including the drain 
of liquidity from the non-exempt market and the resulting 
implications for price discovery, the potential for manipulation, 
trading ahead, and other issues relating to the integrity of both 
the exempt and non-exempt markets.
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    Some commenters further noted that Congress warned the Commission 
to use its new exemptive authority sparingly, and not as a means of 
effecting wholesale deregulation of the futures markets. Commenters 
stated that, contrary to the exchanges' assertions, there are 
distinctions between the OTC derivative markets (including the 
instruments previously exempted by the Commission) and the contracts 
traded on the CME, CBOT, and other exchange markets. Whereas swaps and 
other OTC derivatives are primarily dispersed, non-fungible, privately-
negotiated, principal-to-principal transactions in which individual 
credit determinations have been made about disclosed counterparties, 
exchange-traded futures contracts are traded among anonymous 
counterparties and on an agency basis in a public market established by 
a third party. Commenters in this category emphasized that an 
appropriate level of federal regulatory oversight of exchange markets 
is necessary to maintain market integrity, and, moreover, that the need 
for such oversight is not diminished by the exclusion of certain market 
participants since exchange regulation is designed to address the 
characteristics of that market and many regulatory provisions are 
designed to protect the market itself.
    Moreover, according to some commenters, the ultimate and the 
appropriate regulatory structure for OTC derivatives is not settled; 
rather, Congress and financial regulators are reviewing the need for 
OTC derivatives regulation. Some commenters asserted that the entire 
derivatives market requires more, not less, regulation.

IV. The Proposed Rules

    In granting the Commission exemptive authority, Congress cautioned 
the Commission to use its authority ``sparingly'' and not as a way of 
prompting a ``wide-scale deregulation of markets falling within the 
ambit of the Act.''\13\ In light of this admonition as well as the 
advice of commenters, in particular that of other financial regulators, 
the Commission believes that the scope of the exchanges' petitions, 
which requested exemptive relief from most of the provisions of the Act 
and regulations for all instruments traded by sophisticated 
participants, is too broad. Notwithstanding the exchanges' assertions 
to the contrary, the Commission's previous exemptions for swaps, 
hybrids, and certain energy contracts, granted shortly after the 
Commission was provided with exemptive authority,\14\ cannot be equated 
with the exchanges' requests for exemptive relief. The previous 
exemptions, which followed extensive periods of consideration of the 
issues raised by such instruments,\15\ arose out of a need specifically 
recognized by Congress to enhance the legal certainty as to the 
regulatory status of those instruments. Each such exemption related to 
types of transactions that the Commission had previously found to be 
beyond the scope of the CEA or unsuitable for regulation thereunder 
because of the nature of the transaction, the parties, the 
applicability of other regulatory regimes or otherwise.\16\
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    \13\H.R. Rep. No. 978, 102d Cong., 2d Sess. 81 (1992).
    \14\The Commission exempted from most provisions of the Act and 
regulations the following: (1) hybrid instruments that are not 
predominantly composed of a commodity interest (17 CFR Part 34; 58 
FR 5580 (Jan. 22, 1993)), (2) swap transactions meeting certain 
criteria (17 CFR Part 35; 58 FR 5587 (Jan. 22, 1993)), and (3) 
certain contracts between commercial participants for the deferred 
purchase or sale of energy products (58 FR 21286 (April 20, 1993)).
    \15\Each of the Commission's exemptions for swaps, hybrids, and 
energy products was a culmination of a deliberate and cautious 
exercise by the Commission of its regulatory authority that spanned 
several years. Specifically, the Commission's consideration of an 
appropriate regulatory approach for swaps began in December 1987 
with the publication of an Advanced Notice of Proposed Rulemaking 
which addressed a number of types of off-exchange instruments and 
which solicited public comments on a wide range of issues. 
Subsequently, in July 1989, after a second notice-and-comment 
period, the Commission issued a policy statement which established a 
safe harbor for swap agreements meeting certain specified criteria. 
This was the foundation upon which the Commission ultimately adopted 
final rules in January 1993.
    The Commission's examination of a regulatory approach with 
regard to hybrid instruments also began with the same December 1987 
Advanced Notice of Proposed Rulemaking and request for comments. 
Based upon the comments received and its subsequent experience, the 
Commission in January 1989 proposed rules to exempt certain types of 
hybrid instruments meeting specified criteria, and adopted a 
statutory interpretation which recognized an exclusion from 
regulation for other types of hybrids. Following an extensive 
comment period on its proposed rules, the Commission adopted final 
rules in July 1989. These rules and the statutory interpretation, 
together with the experience gained by the Commission in 
administering them, served as the basis for the proposal and 
ultimate adoption by the Commission in January 1993, pursuant to its 
new authority, of rules exempting certain hybrid instruments.
    Finally, with respect to commercial contracts involving energy 
products, the Commission received inquiries concerning the 
applicability of the Act to transactions of this type following the 
issuance of the judicial decision in Transnor (Bermuda) Limited v. 
BP North American Petroleum, et al., 738 F. Supp. 1472 (S.D.N.Y. 
1990). In response, the Commission in September 1990 issued a 
statutory interpretation taking the position that commercial 
transactions of this type which met certain criteria were excluded 
from regulation under the Act as ``cash forward'' contracts. 
Following the enactment of the 1992 Act, the Commission in November 
1992 received a petition for exemptive relief concerning similar 
transactions. In response, the Commission published a proposed order 
which would provide exemptive relief to certain persons engaged in 
contracts involving energy products that meet certain criteria and, 
following a public comment period, adopted a final order in this 
regard in April 1993.
    \16\In granting exemptive authority to the Commission under new 
Section 4(c), the Conferees on the 1992 Act recognized the need to 
create legal certainty for a number of existing categories of 
instruments which traded outside the forum of a designated contract 
market. These instruments were noted to contain some features 
similar to those of regulated exchange-traded products but are 
sufficiently different in their purpose, function, design or other 
characteristics that, as a matter of policy, traditional futures 
regulation and the limitation of trading to the floor of an exchange 
may be unnecessary to protect the public interest and may create an 
inappropriate burden on commerce. H.R. Rep. No. 978, 102d Cong., 2d 
Sess. 80 (1992).
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    Moreover, the Commission does not subscribe to the exchanges' 
apparent view that there are no significant distinctions between 
dispersed dealer and central auction markets that would be reflected in 
assessing the appropriate level and manner of regulation of 
transactions undertaken in either forum or that should cause the 
Commission, in applying the exemptive criteria of the Act, to treat OTC 
and central exchange products identically. This is true irrespective of 
whether further regulation of the dealer market may be found, as a 
result of ongoing inquiries, to be desirable. The federal regulation of 
futures exchange markets dates from 1922. In 1974, Congress expressly 
expanded coverage of the CEA to ``all services, rights and interests in 
which contracts for future delivery are presently or in the future 
dealt in,'' to assure that the prices generally quoted and disseminated 
from those contracts could be used as a fair basis for determining 
consumer and producer prices.\17\ To reflect the public interest in the 
appropriate functioning of price discovery markets and to assure market 
integrity and customer protection, a number of regulatory protections 
are currently required. These requirements reflect the fact that 
exchange transactions are conducted between anonymous counterparties 
and support the financial integrity of such transactions with marking-
to-market, daily or more frequent cash settlement, segregation of 
customer funds, capital requirements, margin, recordkeeping and 
inspection rules, and clearing guarantees.
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    \17\Sections 1a and 3 of the Act, 7 U.S.C. 1 and 5. In 1974, 
Congress described a ``fundamental purpose'' of the Act as follows:
    ``* * * to insure fair practice and honest dealing on the 
commodity exchanges and to provide a measure of control over those 
forms of speculative activity which too often demoralize the markets 
to the injury of producers and consumers and the exchanges 
themselves.''
    Report of the Senate Committee on Agriculture and Forestry, S. 
Rep. No. 1131, 93d Cong., 2d Sess. 14 (1974).
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    Thus, the fact that a centralized market is composed solely of 
institutional or ``sophisticated'' participants does not obviate the 
need to ensure market integrity, price dissemination, and adequate 
protections against fraud, manipulation, and other trading abuses by 
continued Commission regulation and oversight. In this regard, the term 
``institutional'' may encompass customers with a wide range of 
financial experience, acumen and resources. The Commission believes, 
moreover, that the Act and Commission regulations serve a vital 
function, even where such a market includes only sophisticated 
participants, in that the regulatory requirements substitute for 
individualized credit determinations and permit increased access to the 
markets by secondary participants and customers. Further, a premise of 
the CEA for over 70 years has been that all traders require not only an 
efficient, but also a fair marketplace in which to trade, which 
Congress has previously determined to be best effectuated by a 
regulatory framework in which federal regulation is paramount.
    Moreover, notwithstanding the exchanges' arguments to the contrary, 
since the enactment of the CEA the exchanges have grown and thrived, 
not despite, but at least in part, because of the regulatory scheme 
under which they operate and the resulting public confidence in the 
fairness of the markets. The Commission agrees with the commenters who 
stated that regulatory safeguards promote public confidence in the 
integrity of the markets, confidence likely to be eroded without 
federal oversight. Accordingly, the Commission is not convinced that a 
broad exemption of the kind requested by the exchanges is in the public 
interest.
    Nevertheless, the Commission has in the past taken into account in 
fashioning its regulations, granting exemptions, and establishing 
policies, whether the general public is excluded from a market or 
transaction or is permitted to participate. The Commission considers 
the exclusion of non-sophisticated market participants as the single 
most important rationale supporting the various forms of relief 
proposed herein. The proposed relief from certain aspects of exchange 
regulation should enhance the exchanges' ability to innovate and their 
competitive posture. Indeed, the Commission is cognizant, as the 
exchanges and other commenters noted, that its exemptive authority is 
``intended to promote responsible economic and financial innovation and 
fair competition.''18 In issuing its study on U.S. market 
competitiveness, the Commission stated that it was committed to keeping 
its regulatory programs under continuous review to assure that 
``consistent with our responsibilities for market integrity and 
customer protection, they: (1) keep pace with changes in the 
marketplace; and (2) do not unnecessarily impede domestic exchanges 
from evolving to remain competitive, especially with regard to the cost 
of compliance relative to non-U.S. exchanges.''19
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    \1\8H.R. Rep. No. 978, 102d Cong., 2d Sess. 78 (1992).
    \1\9Commodity Futures Trading Commission, A Study of the Global 
Competitiveness of U.S. Futures Markets 2 (April 1994).
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    To that end, the Commission recognizes that some regulatory 
controls, such as certain procedures for Commission review and approval 
of new instruments, could be streamlined in order to facilitate the 
introduction of products and the on-exchange offering of more varied 
contract designs. More flexibility to permit some customizing of 
exchange-traded products also may attract certain institutional 
participants for which the efficiency of exchange markets and other 
protections they afford may be preferable to off-exchange transactions 
where prices are often opaque and credit risk is a more profound issue. 
The Commission also believes that exchange transactions traded by 
professional traders may not require the full panoply of regulatory 
requirements. In that regard, the Commission believes that a more 
flexible approach to risk disclosure for products offered to 
sophisticated market participants may be preferable to existing 
requirements. In addition, the Commission preliminarily agrees with the 
commenters who suggested that certain registration requirements could 
be streamlined for professional traders licensed with other financial 
regulators to facilitate new entrants to the exchange markets by 
persons currently selling OTC products to sophisticated customers. 
Finally, the Commission preliminarily believes that the long-standing 
traditional requirements of open and competitive trading could be 
relaxed for sophisticated, eligible participants in order to facilitate 
the execution of large orders, as long as appropriate post-trade 
transparency, customer, and other market protections from trading 
abuses are maintained.
    For these reasons, after reviewing the exchanges' petitions and the 
general comments, the Commission is proposing to test some ways of 
giving the exchanges flexibility and greater latitude in order to 
enhance their ability to devise innovative responses both to other 
centralized and to less regulated, non-centralized markets. The 
Commission believes that the exemptive relief that it is proposing 
preserves regulatory safeguards but also acknowledges that non-
centralized markets have a far lower regulatory burden and that several 
comparable markets of other jurisdictions provide certain trading 
mechanism concessions not currently afforded the U.S. futures markets. 
In that regard, the Commission proposes a new Part 36, which exempts 
contracts termed ``section 4(c) contract market transactions'' meeting 
specified criteria from certain specific requirements and regulations 
under the Act. There are four main proposed limitations on the 
exemption: (1) The duration, (2) the scope, (3) the persons who are 
eligible to enter into the transactions, and (4) the transactions which 
may trade as section 4(c) contract market transactions. The Commission 
believes that this proposal strikes the appropriate balance between the 
need to detect and deter abuses and the need for an innovative central 
market tailored to the needs of sophisticated and institutional market 
participants. The Commission requests comments concerning the specifics 
of the proposed criteria for the transactions as well as the proposed 
provisions from which the transactions will be exempt.

A. Duration and Scope of Exemption

    In Sec. 36.1(a), the Commission proposes to implement the exemption 
under a three-year pilot program. The pilot program is designed to give 
the exchanges and the Commission a trial period to test the operation 
of the exemption. More importantly, it affords the Commission an 
opportunity to determine the effect of section 4(c) contract market 
transactions on the integrity of the marketplace as a whole and whether 
continued trading under the exemption would be in the public interest. 
The trial nature of the program reflects the Commission's belief that 
the exemption constitutes a significant departure from the regulatory 
scheme under which futures and option contracts have been trading for 
over 70 years. The Commission believes that the pilot program will 
enable the Commission to obtain sufficient data on which to base a 
permanent program. In this regard, at the conclusion of the pilot 
program, the Commission intends to evaluate section 4(c) contract 
market transactions exempted by this Part in order to determine whether 
to extend the exemptive relief granted herein, and whether it would be 
appropriate to alter the requirements of this Part or expand the 
exemptive relief provided to other transactions or markets. The 
Commission requests comment specifically addressed to whether a pilot 
program is feasible and appropriate.
    Proposed Sec. 36.1(b) sets forth the scope of the exemption. It 
states that each board of trade on which section 4(c) contract market 
transactions are traded is deemed to be a contract market and must 
comply with all provisions of the Act and Commission regulations, 
including the requirement of a clearing facility subject to Commission 
oversight,20 except for those provisions which are ``specifically 
inconsistent'' with Part 36. Moreover, new markets that seek to use 
this exemption must submit all rules relative to governance, 
disciplinary proceedings, financial requirements, et cetera, under the 
current provisions of Section 5a(a)(12) of the Act, 7 U.S.C. 7a(12). 
Therefore, the Commission intends that section 4(c) contract market 
transactions trade pursuant to the following provisions: 36.3 (trading 
rules), 36.4 (listing of transactions), 36.5 (reporting requirements), 
36.6 (registration requirements), 36.7 (risk disclosure), and 36.9 
(fraud and manipulation). Except where specifically indicated in Part 
36, the provisions of Part 36 govern in lieu of the provisions of the 
Act and Commission regulations that would otherwise apply to futures 
and option transactions. Thus, these provisions of Part 36, explained 
in detail below, constitute the scope of the exemption for section 4(c) 
contract market transactions; all other provisions of the Act and 
Commission rules, including, among other things, segregation, net 
capital, supervision, bankruptcy, exchange emergency actions, 
availability of reparations, and private rights of action, would 
continue to apply. In any submission under proposed Part 36, a contract 
market should specify those provisions of the Act and Commission rules 
which the contract market deems to be specifically inconsistent with 
the contract market rules being submitted. The Commission requests 
comments concerning the scope of the exemption.
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    \2\01.41(a)(3), 17 CFR 1.41(a)(3) (1994). The term ``contract 
market'' includes a clearing organization that clears trades for the 
contract market. The Commission does not intend to alter this aspect 
of the markets it regulates by virtue of this proposal.
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    In proposed Sec. 36.1(b), the Commission does not intend to limit 
contract markets in section 4(c) contract market transactions to 
current contract markets or exchanges. In order to qualify, such an 
entity would be treated similarly to a board of trade seeking an 
initial designation as a contract market. In addition, under the 
structure of the Act, the Commission's regulations, and this exemption, 
any entity wishing to offer a facility for trading section 4(c) 
contract market transactions would be required to become a contract 
market in these transactions.

B. Appropriate Persons

    In considering the persons that may enter into section 4(c) 
contract market transactions, that is, ``eligible participants,'' the 
Commission is proposing to use a list of ``appropriate persons'' 
modeled on the list set forth in Section 4(c)(3) (A) through (J) of the 
Act, 7 U.S.C. 6(c)(3) (A) through (J), with revisions tailored to this 
particular market and reflecting the Commission's experience in 
applying similar concepts in other exemptions. In this regard, the 
Commission is requesting comment whether these proposed requirements 
should be applied to the Commission's previously-granted exemptions as 
well.
    Of note is that under proposed Sec. 36.1(c)(1), all eligible 
participants may enter into section 4(c) contract market transactions 
for their own accounts; in addition, futures commission merchants 
(``FCMs'') and floor brokers may trade section 4(c) contract market 
transactions on behalf of other eligible participants. In addition, 
under proposed Sec. 36.1(c)(2)(vii), the Commission is intending to 
limit eligible employee benefit plans to those with total assets 
exceeding $5 million and (rather than the ``or'' provided in Section 
4(c)(3)(G) of the Act, 7 U.S.C. 6(c)(3)(G)) whose investment decisions 
are made by a bank, trust company, insurance company, investment 
adviser under the Investment Advisers Act of 1940, or a commodity 
trading advisor under the CEA. In this regard, the Commission 
specifically seeks comment concerning whether there is an asset level 
for such employee benefit plans which should qualify them as an 
eligible participant irrespective of whether their investment decisions 
are made by a bank, trust company, insurance company, investment 
adviser or commodity trading advisor. In addition, in the context of 
proposed Sec. 36.1(c)(2)(viii), the Commission seeks comment on whether 
municipalities should be included as ``eligible participants,'' and, if 
so, what, if any, limitations would be appropriate in this context. 
Finally, the Commission is interested in comments addressing whether 
the list of appropriate persons as proposed would exclude any 
individuals, entities, collective investment vehicles or others who 
should be considered suitable to engage in section 4(c) contract market 
transactions, and in particular whether Part 36 should be conformed to 
Part 35 in this regard.
    Section 4(c)(3)(K) of the Act, 7 U.S.C. 6(c)(3)(K), also authorizes 
the Commission to determine other persons to be ``appropriate persons'' 
for section 4(c) contract market transactions in light of their 
financial or other qualifications, or if appropriate regulatory 
protections are applicable. The Commission is therefore proposing under 
Sec. 36.1(c)(2)(xi) to permit persons, including natural persons, to 
enter into section 4(c) contract market transactions provided their 
total assets exceed $10 million. The Commission requests comments 
specifically addressed to whether these thresholds are appropriate and 
whether any additional or different financial criteria (such as net 
worth standards) should be added to any other category of ``eligible 
participants'' and, if so, whether part 36 should be conformed to part 
35.
    The Commission is proposing, in Rule 36.1(c)(2)(x), to include 
floor brokers and floor traders within the class of ``appropriate 
persons'' that may participate in section 4(c) contract market 
transactions. Furthermore, proposed Rule 36.1(c)(1) would permit floor 
brokers to enter into section 4(c) contract market transactions on 
behalf of other eligible participants. The Commission is not proposing 
separate financial standards for eligible floor brokers and floor 
traders at this time based upon its understanding that each such 
participant would, by necessity, be a member in good standing of the 
section 4(c) contract market whose transactions thereon would be 
guaranteed by an exchange clearing member. The Commission seeks comment 
on whether it should make a requirement of a clearing member guarantee 
explicit in the rule and whether it should impose separate financial 
requirements on floor brokers and floor traders.

C. Transactions Eligible to Trade

    Proposed Sec. 36.2 establishes the breadth of the exemption, 
delineating those transactions eligible to trade as section 4(c) 
contract market transactions. In that sense, proposed Sec. 36.2 
modifies the broad definition of section 4(c) contract market 
transactions set forth in proposed Sec. 36.1(c)(1). Proposed 
Sec. 36.2(a)(1) provides that except for a major foreign currency, the 
transaction must be settled either in cash, at a price that meets the 
existing Commission requirements for cash-settled contracts set forth 
in Guideline No. 1, 17 CFR part 5, Appendix A, ``or by means other than 
the transfer or receipt of any commodity.'' The phrase ``or by means 
other than the transfer or receipt of any commodity'' would permit the 
delivery of a subsequent contractual agreement, such as a subsequent 
position in a swaps agreement.
    Proposed Sec. 36.2(a)(2) states that the transaction must be 
cleared through a clearing organization subject to Commission 
oversight, a provision originally part of the CME and CBOT's petition 
for exemptive relief. The rules of clearing organizations subject to 
Commission oversight as adjuncts to contract markets must be submitted 
to the Commission pursuant to section 5a(a)(12) of the Act, 7 U.S.C. 
7a(12).21 Additionally, as the result of section 4d(2) of the Act, 
7 U.S.C. 6d(2), such organizations must settle accounts or positions 
daily. The rules would require section 4(c) contract market 
transactions to be separately identified on the books of the 
participant in clearing records to facilitate surveillance of these 
transactions.
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    \2\1See Board of Trade Clearing Corporation, et al. v. United 
States of America, et al., [1977-1980 Transfer Binder] Comm. Fut. L. 
Rep. (CCH)  20,534 (D.D.C. Jan. 11, 1978).
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    Proposed Sec. 36.2(a)(3) prohibits section 4(c) contract market 
transactions on the agricultural commodities enumerated in section 1a 
of the Act, except for contracts on a broad-based index thereof. In 
this regard, the Commission notes that it did not provide specifically 
for an exemption from Commission rules concerning speculative position 
limits. Under Rule 150.2, 17 CFR 150.2 (1994), the Commission directly 
administers position limits for futures contracts on those agricultural 
commodities. Commission Rule 1.61, 17 CFR 1.61 (1994), requires 
contract markets to adopt speculative position limits for futures and 
option contracts which do not have Commission-set speculative limits. 
While in theory Rule 1.61 would apply to section 4(c) contract market 
transactions, the exemption from that requirement, 1.61(e), 17 CFR 
1.61(e) (1994), has been interpreted flexibly to permit the exchanges 
to substitute for speculative position limits various position 
accountability rules for certain futures and option contracts.22 
Therefore, the exchanges have already been afforded substantial 
flexibility in this area. In addition, additional flexibility in this 
regard would be afforded by proposed Rule 36.3 which should permit 
exempt contract markets to implement trading rules more expeditiously 
and without formal approval by the Commission. The Commission requests 
comment on whether any further relief is appropriate for section 4(c) 
contract market transactions.
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    \2\2See 57 FR 29064 (June 30, 1992).
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    In Sec. 36.2(a)(4), the Commission is proposing to limit section 
4(c) contract market transactions to those transactions which can 
``reasonably be distinguished'' from futures or option contracts 
designated by the Commission for trading on a traditional contract 
market at the time of application to trade a section 4(c) contract 
market transaction. The distinguishing factors are described in 
relation to the contract's hedging function and/or pricing basis. The 
Commission will base determinations as to whether section 4(c) contract 
market transactions are ``reasonably distinguished'' from traditional 
designated futures and option contracts on the same considerations that 
it now applies in deciding whether proposed new futures and options 
contracts shall be treated as separate designation applications. 
Proposed Sec. 36.2(a)(4) is intended to address, among other things, 
the concerns expressed by some commenters regarding the problems of a 
two-tier marketplace. Although the CME and CBOT have indicated that 
they do not intend to trade the same contract on both a section 4(c) 
contract market and a traditional contract market, this provision would 
prevent a section 4(c) contract market transaction from trading if a 
traditional contract were already trading on any existing contract 
market. A section 4(c) contract market transaction could potentially be 
submitted for designation for traditional trading. If so, the full 
5a(a)(12) process, including publication for comment, would be followed 
and further attention directed to whether delisting as a section 4(c) 
contract market transaction would be required. As a consequence, the 
concern of side-by-side trading of identical contracts subject to 
different trading regimes without further review is addressed by this 
proposal. General disclosure obligations nonetheless would require 
purveyors of section 4(c) contract market transactions to clarify that 
different rules are applicable to those transactions than for 
transactions traded pursuant to traditional requirements.
    Under proposed Sec. 36.2(a)(4), the Commission contemplates that a 
broad array of contracts would be eligible for section 4(c) contract 
market transactions. Thus, the following are examples of potentially 
permissible section 4(c) contract market transactions in that they are 
cash-settled and can reasonably be distinguished from currently 
designated futures and options contracts: (1) Newly-issued 30-year U.S. 
Treasury bonds, which are cash-settled based on either cash transaction 
prices or firm quotes obtained from electronic information vendors; (2) 
six-month London interbank offered rates (LIBOR), which are cash-
settled based on a survey of British Bankers Association rates; and (3) 
two-year interest rate swaps, which are cash-settled based on a survey 
of swap dealers to obtain the rates they are willing to pay or to 
receive for fixed-rate payments on generic two-year swaps, given a 
specified notional amount.23
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    \2\3The Commission notes that while these specific, hypothetical 
contracts can reasonably be distinguished from currently designated 
futures and option contracts and therefore permitted to trade under 
these proposed rules, that may not necessarily be true at the time a 
board of trade applies to trade a specific section 4(c) contract 
market transaction.
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    In addition, proposed Sec. 36.2(a)(4) provides for certain specific 
contracts to be eligible section 4(c) contract market transactions. 
First, flexible commodity options, which trade under contract market 
option rules, but are not separately designated, may trade as section 
4(c) contract market transactions.24 In addition, contracts in 
foreign currency known as Rolling SpotTM Contracts, the subject of 
the CME's petition for exemptive relief, as well as five- and ten-year 
interest rate swaps contracts, and foreign currency forward futures 
contracts and options thereon are specifically eligible to trade as 
section 4(c) contract market transactions.25
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    \2\4Under the proposal, when such options become regular 
options, they would no longer qualify to trade as section 4(c) 
contract market transactions, and the full panoply of the 
Commission's regulatory requirements would apply.
    \2\5Eligible swaps contracts include the contract markets of the 
CBOT which the Commission designated in cash-settled three- and 
five-year interest rate SWAP (IR-SWAP) futures contracts on January 
29, 1991. Options based on those futures contracts were approved by 
the Commission on February 26, 1991. On September 4, 1992, the 
Commission approved amendments submitted by the CBOT to convert the 
three-year IR-SWAP contracts to 10-year IR-SWAP contracts.
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    Finally, proposed Sec. 36.2(a)(5) provides that any transaction 
subject to Section 2(a)(1)(B) of the Act, 7 U.S.C. 2, including stock 
index futures contracts, is not within the scope of the exemptive 
rules. Because of special considerations applicable to such 
transactions, including the approval procedures of Section 2(a)(1)(B), 
the Commission believes that such contracts may not be appropriate for 
exemption under the proposed rules.
    The Commission requests comment on whether the proposed 
restrictions on section 4(c) contract market transactions are 
appropriate.

D. Section 4(c) Contract Market Trading Rules

    Proposed Section 36.3, which permits a board of trade to submit for 
Commission approval trading procedures for section 4(c) contract market 
transactions, is intended to facilitate trading in section 4(c) 
contract market transactions which do not comply in all respects with 
certain Commission regulations setting forth trading standards and 
related recordkeeping requirements for an open outcry double auction 
trading environment. In general, Section 36.3 is intended to permit, 
subject to certain conditions, section 4(c) contract market 
transactions to trade pursuant to innovative trading strategies which 
may not satisfy existing competitive trading requirements and other 
trading standards relative to the exposure of orders and trades. In 
proposing Sec. 36.3 the Commission intends to provide the flexibility 
for transactions in a section 4(c) contract market to occur either on 
the exchange floor, off the floor, or in both locales subject to 
immediate post-trade reporting and clearing requirements. The 
Commission regulations for which exchange alternatives could be 
submitted include Regulations 1.35, 1.38(a), 1.39, 155.2, 155.3, and 
155.4, 17 CFR 1.35, 1.38(a), 1.39, 155.2, 155.3 and 155.4 (1994).
    Proposed Section 36.3 represents a substantial change in the 
assumptions underlying the method of trading futures and options 
contracts. Section 4c(a) of the Act, 7 U.S.C. 6c(a), enumerates certain 
trading practices which are prohibited, namely, wash sales, cross 
trades, accommodation trades, and fictitious sales.26 The 
Commission has viewed the ``common denominator'' of the abuses 
prohibited by Section 4c(a) of the Act, 7 U.S.C. 6c(a), as the ``use of 
trading techniques that give the appearance of submitting trades to the 
open market'' while in reality ``negating the risk or price competition 
incident to such a market.''27 Commission Regulation 1.38 
explicitly requires open and competitive execution.28 The primary 
purpose of Rule 1.38 was summarized as follows in a Senate Report 
issued in connection with the Commodity Futures Trading Commission Act 
of 1974:

    \2\6Section 4c(a) of the Act, 7 U.S.C. 6c(a), provides that:
    (a) It shall be unlawful for any person to offer to enter into, 
enter into or confirm the execution of, any transaction involving 
any commodity * * *
    (A) if such transaction is, is of the character of, or is 
commonly known to the trade as, a ``wash sale'', ``cross trade'', or 
``accommodation trade'', or is a fictitious sale; or
    (B) if such transaction is used to cause any price to be 
reported, registered, or recorded which is not a true and bona fide 
price.
    \2\7In re Collins, [1986-1987 Transfer Binder] Comm. Fut. L. 
Rep. (CCH) 22,982 at 31,902 (CFTC Apr. 4, 1986), reversed on other 
grounds sub nom. Stoller v. Commodity Futures Trading Commission, 
834 F.2d 262 (2d Cir. 1987). See also, e.g., In re Bear Stearns & 
Co., [1990-1992 Transfer Binder] Comm. Fut. L. Rep. (CCH) 24,994 
(CFTC Jan. 25, 1991); In re Gimbel, [1987-1990 Transfer Binder] 
Comm. Fut. L. Rep. (CCH) 24,213 (CFTC Apr. 14, 1988).
    \2\8Rule 1.38, 17 CFR 1.38 (1994), provides:
    All purchases and sales of any commodity for future delivery, 
and of any commodity option, on or subject to the rules of a 
contract market shall be executed openly and competitively by open 
outcry or posting of bids and offers or by other equally open and 
competitive methods, in the trading pit or ring or similar place 
provided by the contract market, during the regular hours prescribed 
by the contract market * * *
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    The purpose of this requirement [Regulation 1.38] is to ensure 
that all trades are executed at competitive prices and that all 
trades are focused into the centralized marketplace to participate 
in the competitive determination of the price of futures contracts. 
This system also provides reasonable access to the market for all 
orders and results in a continuous flow of price information to the 
public.29
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    \2\9Report of the Senate Committee on Agriculture and Forestry, 
S. Rep. 93-1131, 93d Cong., 2d Sess. 16 (1974).

Thus, a long-standing fundamental premise of the Commission's 
regulatory scheme has been that trades must be executed competitively.
    The Commission has shown some flexibility in the methods it has 
permitted to implement this competitive execution requirement. 
Historically, execution of orders in the futures industry has been 
conducted by open outcry on the floor of an exchange. The Commission 
has indicated, however, that other methods are acceptable under the 
Act. In this regard, in 1989, the Commission approved trading on 
GLOBEX, an electronic computerized trading system for trading futures 
and options contracts after regular hours. Under GLOBEX, trading is 
generally conducted on computer terminals through a competitive auction 
process pursuant to an algorithm, under which orders at the best prices 
would be executed first. Each terminal provides an equal opportunity 
for obtaining order execution.30 Despite the fact that trading in 
GLOBEX is not conducted on the floor of the exchange, the Commission 
has viewed this order execution procedure as competitive and consistent 
with the Act and regulations.31
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    \3\0See, e.g., CME's Proposed Amendments Relating to the 
Implementation of the GLOBEX System, 53 FR 25528 (July 7, 1988).
    \3\1See also, the rules applicable to the NYMEX ACCESS System, 
and the CBOT's Project A, which have been approved by the 
Commission.
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    Notwithstanding the fact that the Commission has afforded market 
participants some flexibility in this area, until recently the 
Commission has not permitted any procedures that provide for off-floor 
discussion of trades.32 In 1991, however, the Commission amended 
Rule 1.39 to permit large order execution (``LOX'') procedures and the 
crossing of orders, procedures which contemplate some off-floor 
discussion prior to executing the orders in the pit.33 In the 
Federal Register release approving LOX, the Commission emphasized that 
although off-floor discussions are permitted in LOX transactions, LOX 
procedures nonetheless ultimately ``allow participation by the entire 
pit'' when the trade is executed.34 The Commission further noted 
that ``LOX transactions would be conducted only pursuant to exchange 
rules approved by the CFTC, and enforced through a contract market 
surveillance program, including measures specifically tailored to LOX 
procedures, designed to ensure compliance with the Commodity Exchange 
Act.''35 Accordingly, the Commission determined that LOX could be 
consistent with the Act.36
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    \3\2Although prearranged trading is not expressly prohibited by 
the CEA, the Commission has held it to be a form of anticompetitive 
trading in violation of Regulation 1.38 as well as a form of 
fictitious sale under Section 4c(a) of the Act. See Collins, 22,982 
at 31,903; Gimbel, 24,213 at 35,003.
    \3\3See 56 FR 12336 (March 25, 1991).
    \3\456 FR at 12341. In contrast, the Commission has held illegal 
trading activities which do not provide real opportunities for the 
entire pit to participate in the trades. See, e.g., In re Murphy and 
Rudman, [1984-1986 Transfer Binder] Comm. Fut. L. Rep. (CCH) 22,798 
(CFTC Sept. 25, 1985).
    \3\556 FR at 12341.
    \3\6The principal statutory basis for Regulation 1.39 is Section 
4b(b) of the Act, 7 U.S.C. 6b (as amended 1992), which addresses 
simultaneous buying and selling orders of different principals. The 
provision states that such orders can be executed ``at the market 
price,'' but requires that the orders be executed ``on the floor of 
the exchange'' and ``at public outcry across the ring.'' The 
Commission stated that the legislative history of this provision 
indicates that its purpose was to ensure that one order was not 
disadvantaged to the benefit of the other order or that both orders 
were not disadvantaged to the benefit of the broker. According to 
the Commission, since the statute did not prescribe the way in which 
this was to be accomplished, the Commission had the discretion to 
craft an appropriate method or methods ``to provide for the 
protection of customers in this area,'' including the discretion to 
amend Rule 1.39. 56 FR at 12338.
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    Proposed Sec. 36.3 goes beyond LOX in that it not only allows off-
floor discussion prior to execution but also allows execution without 
exposing the trades to the pit. In proposing a means of permitting 
these procedures, it is the Commission's intention to provide a way for 
exchanges to develop new trading procedures and standards intended to 
address the needs of their increasingly institutional market 
participants. The Commission did not attempt to describe whether there 
should be other limits on the procedures as it had no specific 
proposals to change pending methodologies before it and wanted to leave 
the exchanges free to develop designs consistent with the parameters 
set forth herein.37 This also reflects the Commission's 
willingness to experiment through a pilot program with rules that 
relax, for certain market participants, the traditional Commission 
requirements for competitive trading. Specifically, the approach taken 
affords those participants the opportunity to execute large 
transactions with greater immediacy than might be available under 
existing contract market trading procedures. The Commission 
preliminarily believes that by permitting section 4(c) contract market 
participants to trade in this manner, the futures exchanges' ability to 
draw institutional participants to the more transparent exchange (as 
opposed to OTC) markets will be enhanced.
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    \3\7Compare, however, New York Stock Exchange (``NYSE'') Rule 
76, which governs block trading and requires that a member who has 
set up a block trade and is bringing it to the floor to be crossed 
must first announce the proposed bid, offer, and transaction size to 
the floor. The member must then wait a reasonable amount of time to 
allow the ``crowd'' (including specialists) to trade against either 
side before completing the transaction. See also NYSE Rule 72, which 
provides priority to an agency cross transaction where both orders 
consist of 25,000 shares or more.
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    At the same time, however, the Commission is concerned with 
maintaining essential market and appropriate customer protections. 
Therefore, it is proposing regulatory safeguards with which the 
exchanges must comply in formulating any innovative trading procedures. 
Proposed Sec. 36.3(b) lists those requirements which must be satisfied 
by a contract market seeking to establish such rules for section 4(c) 
contract market transactions. In this connection, the Commission 
requests comment as to whether additional or different requirements 
should apply.
    First, transactions generally must satisfy Commission recordkeeping 
and audit trail requirements. Proposed paragraph (b)(1) of Rule 36.3 
requires the contract market to provide for record maintenance and 
retention consistent with Regulation 1.31, 17 CFR 1.31 (1994). Under 
proposed Sec. 36.3(b)(2), the audit trail for such transactions must 
meet the trade register, trade timing, and contract market oversight 
requirements in Regulations 1.35(e), (g), and (i), 17 CFR 1.35(e), (g), 
and (i) (1994), respectively. In addition, the recordkeeping 
requirements set forth in Regulation 1.38(b), 17 CFR 1.38(b) (1994), 
for noncompetitive trades and the audit trail documentation required 
under the other provisions of Regulation 1.35, 17 CFR 1.35 (1994), must 
be satisfied to the extent they are applicable to the subject trading 
procedures.38 A contract market must demonstrate in a clear and 
convincing manner that these and any other regulations referenced in 
paragraph (b) that it believes are inapplicable to its proposed trading 
procedures are, in fact, inapplicable.
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    \3\8For example, Regulation 1.35, 17 CFR 1.35 (1994), provides 
for two orders, an office order (1.35(a-1)(1)) and a floor order 
(1.35(a-1)(2)(i)). A contract market's proposed procedures may 
render the requirement for a floor order inapplicable.
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    Second, the Commission is proposing to maintain customer protection 
standards. Commission Regulations 155.2, 155.3, and 155.4, 17 CFR 
155.2, 155.3 and 155.4 (1994), set forth customer protection trading 
standards for floor brokers, FCMs, and introducing brokers (``IBs'') 
respectively. Under proposed Sec. 36.3(b)(3), the contract market's 
proposed procedures must comply with these provisions to the extent 
they are applicable.39
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    \3\9For example, Regulation 155.2, 17 CFR 155.2 (1994), sets 
forth standards for floor brokers. If, however, under proposed 
section 4(c) contract market trading rules, a function analogous to 
that of a floor broker does not exist, that rule would not apply.
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    Third, the transactions must be transparent. The Commission is 
proposing in paragraphs (b)(4) and (b)(5) of Rule 36.3 certain 
requirements for the reporting and identifying of section 4(c) market 
transactions after they are executed. Specifically, in addition to the 
trade recordation requirements listed above, the transactions are to be 
reported immediately to the floor of the exchange and are to be 
disseminated immediately on the relevant market floor, trading screen, 
and/or vendor services through the exchange's market quotation system. 
Records must be maintained of the time of execution to this end.40 
The information to be so reported must include, at a minimum, price, 
quantity, and contract. To the extent that a proposal for section 4(c) 
contract market transactions might provide for trading when the 
exchange floor is closed, the Commission would still require the 
immediate report and dissemination of that transaction information. 
Brokers engaging in such transactions will need to have supervisory 
procedures in place reasonably designed to achieve such post-trade 
transparency. The Commission believes that these proposed requirements 
to report and specifically identify section 4(c) contract market 
transactions will provide the public with notice of the way in which 
the prices in this market have been reached. As such, persons relying 
on these prices for price basing purposes will have the opportunity to 
take that information into account. The Commission requests comment on 
these requirements.
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    \4\0To the extent applicable, all Regulation 1.35 audit trail 
requirements will apply to the production of upstairs trading 
records.
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    Fourth, the Commission is proposing requirements intended to ensure 
the financial integrity of the transactions. Proposed paragraph (b)(5) 
of Rule 36.3 requires section 4(c) contract market trading rules to 
provide that section 4(c) contract market transactions be reported to 
clearing and be cleared by the contract market on the same schedule as 
required for trades subject to Regulations 1.38 and 1.39. Should there 
be no such schedule, then the report to clearing must be immediate. The 
Commission requests comment as to whether clearing procedures should be 
further articulated in that case. In this connection, the Commission 
notes that the clearing arrangements would be subject to Commission 
oversight and that proposed clearing rules would require prior 
Commission review under Section 5a(a)(12)(A) of the Act, 7 U.S.C. 
7a(12), and Regulation 1.41, 17 CFR 1.41 (1994). The section 4(c) 
contract market clearing organization would have an affirmative duty 
under the Act and Commission regulations to enforce its rules, and 
would be subject to recordkeeping, document retention, and other 
applicable requirements.
    According to NYSE market surveillance staff, block trades are not 
separately identified as such on the exchange's audit trail/time and 
sales register. However, NYSE would be able to ascertain whether a 
trade is a block trade by contacting the transacting members, each of 
whom must keep a record reflecting which of its trades are blocks. 
Interestingly, while not separately identifying block trades in its 
audit trail, NYSE and its vendors do have a separate ``block trade'' 
ticker which runs throughout the day reflecting size and price of block 
trades alone. The Commission requests comment on whether to require the 
dissemination of separate pricing information for block trades.
    Pursuant to proposed paragraph (c), any submission made hereunder 
for proposed section 4(c) contract market transactions must describe 
fully the contract market procedures and systems that will assure 
compliance with Sections 4b and 4c(a) of the Act, 7 U.S.C. 6b and 
6c(a), with respect to prohibitions on abuse of customer orders, 
including frontrunning of such orders, misuse of information, and wash 
sales and fictitious trades. This provision reflects, among other 
things, the Commission's continuing concern that customer orders 
receive appropriate priority and that trading between markets or 
locations does not cause distortions in prices or provide advantages to 
one class or user of the markets over others.
    In this connection, proposed paragraph (g) of Rule 36.3 states that 
trades entered into in compliance with section 4(c) contract market 
trading rules shall not be in violation of Sections 4b(a)(iv), 4b(b) or 
4c(a) of the Act, 7 U.S.C. 6b(D), 6b or 6c(a), ``based solely on having 
been executed noncompetitively.'' Failure to comply explicitly with 
such contract market rules will render the conduct involved subject to 
Commission action under Sections 4b and 4c(a) of the Act, 7 U.S.C. 6b 
and 6c(a), and Regulations 1.38 and 1.39, 17 CFR 1.38 and 1.39 (1994), 
in addition to any other applicable provisions of the Act and 
Regulations.
    Pursuant to proposed paragraphs (d) and (e) of Rule 36.3, section 
4(c) contract market trading rules must be submitted to the Commission 
for review prior to being put into effect.41 Such submitted rules 
may become effective ten days after receipt by the Commission unless 
the Commission, within that ten-day period, notifies the submitter that 
the proposal does not meet the conditions of this section. In the event 
the trading rules are not permitted to go into effect, they shall be 
subject to the usual rule approval procedures under Section 
5a(a)(12)(A) of the Act, 7 U.S.C. 7a(12), and Regulation 1.41(b), 17 
CFR 1.41(b) (1994). In accordance with paragraph (f) of Rule 36.3, any 
subsequent proposed modifications of such rules shall be subject to the 
same Commission review procedures.
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    \4\1Section 4(c) contract market trading rules may be submitted 
prior to trading of section 4(c) contract market transactions or at 
any time after the transactions begin trading under Commission 
regulations.
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E. Listing of Section 4(c) Contract Market Transactions

    Proposed Sec. 36.4 provides that a board of trade which meets other 
requirements of the Act seeking an exemption for section 4(c) contract 
market transactions shall furnish to the Commission the terms and 
conditions of the transaction at least ten days prior to the proposed 
effective date.42 Section 4(c) contract market transactions 
meeting the requirements of Sec. 36.2 may be traded or executed ten 
days after receipt of the submission unless, within the ten-day period, 
the Commission notifies the board of trade in writing that the 
submission does not meet the conditions of this section.43 In that 
event, the terms and conditions of the transaction shall be subject to 
the usual rule approval procedures under Section 5a(a)(12)(A) of the 
Act, 7 U.S.C. 7a(12), and Regulation 1.41(b), 17 CFR 1.41(b) (1994). 
The proposed rule further provides that any modification to the terms 
and conditions of a section 4(c) contract market transaction shall be 
submitted to the Commission. Such modification shall be subject to the 
same procedures applicable to the initial listing of section 4(c) 
contract market transactions.
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    \4\2As noted above, a board of trade which is not currently an 
exchange must first get initial designation as a contract market 
pursuant to Sections 5 and 5a of the Act (other than Section 
5a(a)(12), which sets forth the procedures for Commission approval 
of terms and conditions of contracts and contract market rules). An 
initial designation generally requires the Commission to review and 
approve the applicant's core rules regarding, among other things, 
clearing, governance, and discipline.
    \4\3Section 2(a)(8)(B)(ii) of the Act, 7 U.S.C. 4a(g), allows 
forty-five days for the Department of the Treasury and the Board of 
Governors of the Federal Reserve System to comment on any 
application by a board of trade for designation as a contract market 
involving transactions for the future delivery of any security 
issued or guaranteed by the United States or any agency thereof. In 
light of the ten-day time frame for new filings and amendments, the 
Commission intends to waive Section 2(a)(8)(B)(ii) for section 4(c) 
contract market transactions. The Commission requests comment on 
waiving this provision.
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    This limited, ten-day advance notice period for new filings and for 
amendments to existing terms and conditions is designed to remove 
potential impediments to the development of new products which are 
eligible for the proposed section 4(c) contract market transactions. 
The Commission believes that a streamlined approach will not only give 
the exchanges flexibility but also will permit them to launch new 
products rapidly to meet the competitive demands of the marketplace and 
to take advantage of opportunities in a fast-changing market. This 
procedure is limited to certain cash-settled contracts in order to 
avoid issues related to delivery.
    Although the proposed ten-day notification requirement for section 
4(c) contract market transactions does not contemplate the same level 
of prior Commission review and approval of terms and conditions as is 
required by Commission Rule 1.41(b), 17 CFR 1.41(b) (1994), for 
contracts traded on traditional contract markets, the Commission has 
continuing authority to ensure that section 4(c) contract market 
transactions remain consistent with the public interest and the 
purposes of the Act. In this regard, proposed Sec. 36.8 provides that 
the Commission can suspend or revoke an exemption if it fails to meet 
these requirements.44
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    \4\4Furthermore, under Rule 1.50, 17 CFR 1.50 (1994), at any 
time the Commission can request from a contract market demonstration 
of continued compliance with the requirements of contract market 
designation. In addition, the Commission retains its authority under 
Section 8a(7) of the Act, 7 U.S.C. 12a(7), to alter or supplement 
contract market rules.
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    The Commission requests comment on the ten-day advance notification 
period for the terms and conditions of section 4(c) contract market 
transactions.

F. Reporting Requirements

    The Commission is proposing that contract markets, FCMs, and large 
traders who conduct section 4(c) contract market transactions comply 
with certain reporting requirements similar to those currently in 
effect for persons trading in non-exempt commodity futures and/or 
options. These requirements are being proposed in lieu of the 
requirements set forth in Parts 16, 17, 18, and 19 of the Commission 
regulations, 17 CFR Parts 16, 17, 18, and 19 (1994).
1. Reporting Requirements for Contract Markets
    The Commission is proposing in Secs. 36.5 (c)(1) and (e) that 
contract markets operating pursuant to this section provide information 
daily to the Commission and to the public concerning total open 
interest, transactions, and prices for each commodity or type of 
contract similar to that required under Rule 16.01 for non-exempt 
futures and options. This information is intended to give the 
Commission an overview of the size and development of these markets and 
provide potential participants with important information concerning 
the depth and breadth of the markets as well as the opportunity to 
compare transaction prices against other markets trading the same 
commodity. In addition, in Sec. 36.5(c)(2), the Commission is proposing 
that contract markets provide open interest and transaction information 
for each clearing member similar to that required under Rule 16.00, 17 
CFR 16.00 (1994). This information is necessary for market 
surveillance, providing needed input into the Commission's financial 
monitoring system for clearing member FCMs.
    Last, in Sec. 36.5(c)(3), the Commission is proposing that contract 
markets supply information concerning large traders conducting section 
4(c) contract market transactions, but only on call by the Commission. 
In order to ensure that the financial integrity protections currently 
provided by using such reports are maintained, the Commission 
anticipates that contract markets trading section 4(c) contract market 
transactions will by rule require members to file daily reports 
concerning accounts carried by large traders similar to the information 
now provided by FCMs, clearing members, and foreign brokers under Rules 
16.02, 17.00, and 17.02, 17 CFR 16.02, 17.00, and 17.02 (1994), for 
large traders in non-exempt futures and options. The Commission will 
rely on contract markets to define, subject to Commission approval, 
position levels at which a trader is considered large. Under this 
proposal, the Commission would monitor the development of the markets 
to determine if and when it would require that the contract markets 
submit large trader reports. If these exempt contract markets develop 
rapidly, the Commission may require large trader reports on a daily 
basis to augment the information it currently receives.
    The Commission is proposing that all information, with the 
exception of account identification forms, be provided in machine-
readable form using a format and coding structure approved in writing 
by the Commission or its designee. Contract markets currently provide 
option and futures data pursuant to similar requirements.
2. Reporting Requirements for FCMs, Introducing Brokers and Traders
    The Commission is proposing to incorporate into Sec. 36.5 the 
provisions of Commission Rules 15.05 and Part 21, 17 CFR 15.05 and Part 
21 (1994). Section 15.05 states that any FCM who makes or causes to be 
made any futures or option contract for the account of any foreign 
broker or foreign trader, and any IB who introduces such an account to 
an FCM is deemed to be the agent of the foreign broker or the foreign 
trader for purposes of accepting delivery and service of any 
communication issued by or on behalf of the Commission to the foreign 
broker or the foreign trader with respect to any futures or option 
contracts maintained in such accounts carried by the FCM.45 This 
provision is used routinely for traditional futures and options, and 
has proven to be effective in obtaining information from foreign 
traders for market surveillance purposes.
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    \4\5The FCM or IB is considered an agent only if the foreign 
broker or trader has not duly executed or does not maintain a 
written agency agreement with a person domiciled in the United 
States. 17 CFR 15.05(d) (1994).
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    The provisions of Part 21 provide that FCMs, IBs, foreign brokers, 
and foreign traders must furnish on call by the Commission certain 
information concerning their futures and options trading. Special calls 
under Part 21 may be made to obtain market-wide summary information on 
demographics and market uses of participants (Secs. 21.02 and 21.02a, 
17 CFR 21.02 and 21.02a (1994)) or, in the case of special market 
situations (Sec. 21.03, 17 CFR 21.03 (1994)), when information is 
needed about all, rather than only reportable, traders in a market. The 
Commission believes that it is important to retain this authority with 
respect to participants operating under Part 36 so that the Commission 
can make informed decisions and take appropriate action as special 
situations warrant.
    The Commission is also proposing that eligible participants in 
section 4(c) contract market transactions be subject to requirements 
similar to those contained in Secs. 18.00, 18.04, and 18.05, 17 CFR 
18.00, 18.04, and 18.05 (1994), for large futures and options traders 
trading in the non-exempt market. The requirements proposed in 
Sec. 36.5(f) paragraphs (2) (i) and (ii) would require large traders to 
file, on call by the Commission, information concerning their positions 
and transactions in the subject market as well as identifying and other 
information contained on CFTC Form 40. Proposed Sec. 36.5(f)(1) would 
require large traders to maintain books and records concerning section 
4(c) contract market transactions and commercial activities that the 
trader hedges in the commodity underlying such transactions. Reports 
concerning these transactions and activities would have to be furnished 
on request to the Commission or the U.S. Department of Justice.

G. Special Temporary License, Registration or Principal Listing 
Procedures

    The Commission is also proposing, in Sec. 36.6, to allow special 
procedures that would be available to a person associated with an FCM 
or IB who limits his or her activities to certain specified 
instruments. If this rule were to be adopted, the Commission would 
expect to set forth in an Appendix A to Part 36 those instruments to 
which the special registration procedures would apply. An instrument 
would be included in such an Appendix A only upon petition by a 
contract market demonstrating that it is not contrary to the purpose of 
the Act and the registration rules promulgated thereunder or to the 
public interest to permit special temporary license, registration or 
principal listing procedures for persons licensed with another federal 
financial regulatory authority and involved only with that instrument. 
Although to obtain a temporary license, such persons would have to 
certify that they are not subject to statutory disqualification under 
Section 8a(2) of the Act, 7 U.S.C. 12a(2), the National Futures 
Association (``NFA'') could, for example, waive the fingerprint 
requirement. Further, the Commission notes that although proficiency 
testing requirements are governed by NFA Rules 401 and 402 and 
interpretive notices related thereto, such a contract market petition 
could also address whether alternative proficiency testing requirements 
would be appropriate. Registration, of course, could continue to be 
denied under Sections 8a(3) or 8a(4) of the Act, 7 U.S.C. 12a(3) or 
12a(4). If the Commission were to approve the contract market petition, 
NFA could then adopt and submit for Commission approval special 
registration procedures to govern those persons involved only with the 
particular instrument that is the subject of the petition. The 
Commission, nonetheless, wishes to make clear that a contract market 
seeking special registration procedures with respect to persons 
limiting their activities to a particular new instrument may consult 
with NFA and develop such procedures to be submitted in conjunction 
with the contract market application for simultaneous consideration by 
the Commission. Such NFA rules could vary depending upon the instrument 
involved and would be considered by the Commission on a case-by-case 
basis. The Commission would expect to include in Appendix A to Part 36 
those instruments covered by the pending petitions of the CBOT and the 
CME to which Part 36 applies. This authority would be comparable to 
that already established under Part 3 of the Commission's regulations. 
See Commission Rule 3.12(j), 17 CFR 3.12(j) (1994). The Commission 
requests comment on these special registration procedures, in 
particular their practicability.

H. Risk Disclosure

    The Commission is proposing, in Sec. 36.7, to permit accounts to be 
opened for section 4(c) contract market transactions without furnishing 
an eligible participant with the basic risk disclosure statements 
applicable generally to non-exempt futures and option contracts under 
Commission Rules 1.55, 1.65, 33.7, and 190.10, 17 CFR 1.55, 1.65, 33.7, 
and 190.10 (1994), or the Commission's newly-adopted generic risk 
disclosure statement.46 These basic risk disclosure statements are 
intended to provide a brief description of some of the risks attendant 
to futures and options trading and are designed to be understood by all 
customers. Since section 4(c) contract market transactions would be 
entered into only by sophisticated or high net worth persons or those 
engaged in the futures industry, and since the products themselves may 
be different from traditional futures and option contracts, the 
Commission believes that it may be appropriate to substitute for 
standard disclosure statements such disclosure as may be appropriate to 
the customer's expertise and financial capacity, tailored to the 
particular product. Therefore, in lieu of requiring a specific 
statement or format, the proviso to proposed Sec. 36.7(a) would require 
an FCM or, in the case of an introduced account, an IB, to furnish an 
eligible participant with disclosure appropriate to the particular 
instrument and the eligible participant prior to the eligible 
participant's entry into the first section 4(c) contract market 
transaction involving a particular instrument.
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    \4\659 FR 34376 (July 5, 1994). This statement currently can be 
used in the U.S., in the United Kingdom, in Ireland and in Belgium. 
Several other jurisdictions are considering its adoption.
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    In this regard, the Commission notes that Rule 1.55(f), 17 CFR 
1.55(f) (1994), currently states that furnishing the required 
disclosure statement under that rule does not relieve an FCM or IB from 
any other disclosure obligation it may have under applicable 
law.47 The Commission further notes that exchanges with non-
traditional trading systems have required, on their own initiative, 
special risk disclosures applicable to such systems.48 The 
Commission further notes that in order to qualify for the exemption of 
swap agreements under Part 35 of its rules, an agreement must be 
entered into by an eligible swap participant, the definition of which 
is closely followed by proposed Rule 36.1(c)(2), and there are no 
specific disclosure requirements under Part 35 of the Commission's 
rules, 17 CFR Part 35 (1994).49 The Commission therefore 
preliminarily believes that it is striking the appropriate balance in 
proposed Rule 36.7 with respect to disclosure in light of the eligible 
participants and products involved. The Commission requests comment 
concerning the risk disclosure requirements for section 4(c) contract 
market transactions.
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    \4\7The Commission notes that proposed Sec. 36.7(b), which 
provides that ``[t]his section does not relieve a futures commission 
merchant or introducing broker from any other disclosure obligations 
it may have under applicable law,'' is included as a reminder that 
Section 4b of the Act requires all material information to be 
disclosed. The fact that other proposed sections of Part 36 do not 
have a similar ``catch-all'' provision should not be interpreted to 
mean that the Act or Commission regulations do not apply to those 
sections.
    \4\8See CME Rule 577 and New York Mercantile Exchange Rule 6.22, 
which address the risk disclosure requirements applicable to the 
users of the GLOBEX and ACCESS electronic trading systems, 
respectively. See also Commission Rules 4.7 and 4.8, 17 CFR 4.7 and 
4.8 (1994), wherein the Commission has provided exemptions from 
disclosure, reporting and recordkeeping requirements for CPOs 
privately offering commodity pools to certain highly-accredited 
investors and for CTAs providing commodity interest trading advice 
to such persons.
    \4\9See also Part 34 of the Commission's rules, 17 CFR Part 34 
(1994), regarding regulation of hybrid instruments.
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I. Suspension or Revocation of Section 4(c) Contract Market Transaction 
Exemption

    Proposed Sec. 36.8 mirrors the requirements for exemptive relief 
under Section 4(c) of the Act, namely that any exemption must be 
consistent with the public interest and the purposes of the Act. If the 
Commission determines otherwise, Sec. 36.8 provides that, after notice 
and opportunity for a hearing, the exemption may be suspended or 
revoked.

J. Fraud and Manipulation in Connection With Section 4(c) Market 
Transactions

    Proposed Sec. 36.9 applies to section 4(c) contract market 
transactions the antifraud proscriptions of Sections 4b(a) and 4o of 
the Act, 7 U.S.C. 6b and 6o, those provisions of Sections 6(c), 6(d), 
and 9(a) of the Act, 7 U.S.C. 9, 15, 13b and 13(a), that prohibit price 
manipulation, and Commission Rules 33.9 and 33.10, 17 CFR 33.9 and 
33.10 (1994), which prohibit fraudulent conduct and price manipulation 
in connection with commodity option transactions.
    In its petition for exemption, the CBOT included a rule 
specifically prohibiting fraud and manipulation relating to 
professional market transactions. The CBOT petition explains:

    Fraud and manipulation are the core proscriptions of the 
Commodity Exchange Act* * *. Rather than engage in a hyper-technical 
legal effort to mesh certain exempt transactions with the 
requirements of the CEA's existing fraud and manipulation 
provisions, the proposal contains a special antifraud and 
antimanipulation provision. That approach will make certain that any 
party committing fraud or engaging in manipulative practices in 
connection with an otherwise exempt transaction * * * would not be 
able to wriggle out of liability under the CEA under some legal 
technicality.

58 FR 43414, 43433 (August 16, 1993). The CME did not suggest the 
adoption of a specific fraud and manipulation rule; nonetheless, it did 
not request an exemption from the antifraud and antimanipulation 
provisions of the Act and Commission regulations.
    In its consideration of the petitions and the comments received 
thereon, the Commission is also considering whether to adopt specific 
stand-alone rules prohibiting fraud and manipulation to supplement 
proposed Sec. 36.9. In this regard and as noted above, the exemption 
being proposed would relieve the exchanges and their members from some 
provisions of the Act and regulations that are intended to provide 
prophylactic protection for customers. In the absence of these 
protections, it may be appropriate to apply broader antifraud and 
antimanipulation prohibitions to effectively control certain abusive 
conduct, such as trading ahead of customer orders in any form and 
failure to disclose material information. As a result, the Commission 
is proposing, in Sec. 36.9(a), a free-standing antifraud rule for 
section 4(c) contract market transactions modeled after Commission Rule 
33.10, 17 CFR 33.10 (1994). The Commission specifically requests 
comments concerning whether it should adopt such a rule.
    The Commission is also requesting comment concerning whether those 
provisions of the Act and rules thereunder reserved in the manipulation 
provision, Sec. 36.9(b), are adequate in this regard or whether the 
Commission should also adopt an additional free-standing 
antimanipulation rule. Should commenters believe that a free-standing 
antimanipulation rule is warranted, comment is requested concerning 
whether a rule prohibiting manipulation or attempted manipulation of 
the price of any section 4(c) contract market transaction or of any 
commodity in interstate commerce or any contract of sale of a commodity 
for future delivery on or subject to the rules of any contract market, 
would be appropriate.
    In a related matter, the Commission is also seeking comment on 
whether Part 35 of its rules, 17 CFR Part 35 (1994), which provides an 
exemption for certain swap transactions, should be amended to include 
specific stand-alone prohibitions of fraud and price manipulation like 
those discussed above.\50\ While Section 4b of the Act has provided an 
adequate tool to address fraud in traditional futures contract trading, 
and Section 4o (which is also reserved in Part 35) addresses the giving 
of advice, questions have been raised about the efficacy of these 
provisions as applied to certain of the transactions included in the 
ambit of Part 35. An amendment to Part 35 in this regard would 
eliminate any such questions and could also provide desirable 
consistency in the legal standards applicable to both section 4(c) 
contract market transactions and exempt swap transactions. Comment is 
requested concerning the type of antifraud and antimanipulation rules 
that the Commission should adopt if it determines to do so.
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    \50\Currently, Rule 35.2, 17 CFR 35.2 (1994), applies the 
proscriptions of Sections 4b, 4o, 6(c), and 9(a)(2) of the Act, 7 
U.S.C. 6b, 6o, 9, 15, and 13(a)(2), and Commission Rule 32.9, 17 CFR 
32.9 (1994), to swap agreements.
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V. Related Matters

A. Regulatory Flexibility Act

    The Regulatory Flexibility Act (``RFA''), Public Law No. 96-354, 94 
Stat. 1164 (1980), 5 U.S.C. 601 et seq., requires each federal agency 
to consider, in the course of proposing substantive rules, the effect 
of those rules on small entities. A small entity is defined to include, 
inter alia, a ``small business'' and a ``small organization.'' 5 U.S.C. 
601(6).\51\ The Commission previously has formulated its own standards 
of what constitutes a small business with respect to the types of 
entities regulated by it. The Commission has determined that contract 
markets,\52\ futures commission merchants,\53\ registered commodity 
pool operators,\54\ and large traders\55\ should not be considered 
small entities for purposes of the RFA.
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    \5\1``Small organizations,'' as used in the RFA, means ``any 
not-for-profit enterprise which is independently owned and operated 
and is not dominant in its field * * *'' 5 U.S.C. 601(4). The RFA 
does not incorporate the size standards of the Small Business 
Administration (``SBA'') for small organizations. Agencies are 
expressly authorized to establish their own definition of small 
organization. Id.
    \5\247 FR 18618 (April 30, 1982).
    \5\3Id. at 18619.
    \5\4Id.
    \5\5Id. at 18620.
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    The Commission believes that to the extent that firms defined as 
small businesses under section 3 of the Small Business Act could offer 
or be offered section 4(c) contract market transactions, the proposed 
rules would not add any legal, accounting, consulting or expert costs. 
No one is required to trade section 4(c) contract market transactions. 
The proposed rules would merely provide exemptive relief for those 
trading such transactions. The determination of whether a section 4(c) 
contract market transaction would qualify for the proposed exemption 
requires minimal analysis of data that will be readily accessible to 
the offeror.
    Accordingly, the Chairman, on behalf of the Commission, certifies 
pursuant to section 3(a) of the RFA, 5 U.S.C. 605(b), that the proposed 
rules will not have a significant economic impact on a substantial 
number of small entities. Nonetheless, the Commission invites comment 
from any firm which believes that these proposed rules would have a 
significant economic impact on its operations.

B. Paperwork Reduction Act

    The Paperwork Reduction Act of 1980, (``PRA'') 44 U.S.C. 3501 et 
seq., 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. In compliance with the 
PRA, the Commission has submitted these proposed rules and its 
associated information collection requirements to the Office of 
Management and Budget. The burden associated with these proposed rules, 
is as follows:

Average burden hours per response
2.88
Number of respondents
300
Frequency of response
on occasion

    Persons wishing to comment on the information which would be 
required by these proposed rules should contact Gary Waxman, Office of 
Management and Budget, Room 3228, NEOB, Washington, D.C. 20503, (202) 
395-7340. Copies of the information collection submission to OMB are 
available from Joe F. Mink, CFTC Clearance Officer, 2033 K Street, 
N.W., Washington, D.C. 20581, (202) 254-9735.

List of Subjects in 17 CFR Part 36

    Commodity futures, Commodity options, Prohibited transactions.

    In consideration of the foregoing, and pursuant to the authority 
contained in the Commodity Exchange Act, and in particular, Sections 2, 
4, 4c, and 8a, 7 U.S.C. 2, 6, 6c, and 12a, as amended, the Commission 
hereby proposes to add Part 36 to Chapter I of Title 17 of the Code of 
Federal Regulations as follows:

PART 36--EXEMPTION OF SECTION 4(c) CONTRACT MARKET TRANSACTIONS

Sec.
36.1  Exemption and definitions.
36.2  Trading of section 4(c) contract market transactions.
36.3 Section 4(c) contract market trading rules.
36.4  Listing of section 4(c) contract market transactions.
36.5  Reporting requirements.
36.6  Special procedures relating to temporary licensing, 
registration, and listing of principals.
36.7  Risk disclosure.
36.8  Suspension or revocation of section 4(c) contract market 
transaction exemption.
36.9  Fraud and manipulation in connection with section 4(c) 
contract market transactions.

    Authority: 7 U.S.C. 2, 6, 6c, and 12a.


Sec. 36.1  Exemption and definitions.

    (a) Duration of exemption. The provisions of this part apply to any 
section 4(c) contract market transaction entered into on or after 
[EFFECTIVE DATE OF FINAL RULES]. The provisions of this part expire, 
and are no longer valid as to any such transaction entered into on or 
after three years following the date the first contract trades pursuant 
to this part.
    (b) Scope of exemption. Each board of trade on which section 4(c) 
contract market transactions are permitted to be traded pursuant to 
this part shall be deemed for such purposes to be a contract market 
within the meaning of the Act and, with respect to section 4(c) 
contract market transactions, shall comply with and be subject to all 
of the provisions of the Act and the Commission's regulations 
applicable to a contract market other than those provisions which are 
specifically inconsistent with this part, in which case the provisions 
of this part shall govern.
    (c) Definitions. As used in this part:
    (1) Section 4(c) contract market transaction means: Any agreement, 
contract, or transaction (or class thereof) entered into on or subject 
to the rules of a contract market in accordance with the provisions of 
this part, and that is executed by a member of the section 4(c) 
contract market that is an eligible participant for its own account, or 
a futures commission merchant or floor broker for its own account or on 
behalf of an eligible participant.
    (2) Eligible participant means:
    (i) A bank or trust company;
    (ii) A savings association or credit union;
    (iii) An insurance company;
    (iv) An investment company regulated under the Investment Company 
Act of 1940 (15 U.S.C. 80a-1, et seq.) or an investment company 
performing a similar role or function subject as such to foreign 
regulation, provided that such investment company is not formed solely 
for the purpose of constituting an eligible participant and has total 
assets exceeding $5,000,000;
    (v) A commodity pool formed and operated by a person regulated 
under the Act or a foreign person performing a similar role or function 
subject as such to foreign regulation, provided that such commodity 
pool or foreign person is not formed solely for the purpose of 
constituting an eligible participant and has total assets exceeding 
$5,000,000;
    (vi) A corporation, partnership, proprietorship, organization, 
trust, or other entity, other than a commodity pool or other collective 
investment vehicle, not formed solely for the purpose of constituting 
an eligible participant (A) which has total assets exceeding 
$10,000,000; or (B) which has a net worth of $1,000,000 and enters into 
a section 4(c) contract market transaction in connection with the 
conduct of its business; or (C) which has a net worth of $1,000,000 and 
enters into a section 4(c) contract market transaction to manage the 
risk of an asset or liability owned or incurred in the conduct of its 
business or reasonably likely to be owned or incurred in the conduct of 
its business;
    (vii) An employee benefit plan subject to the Employee Retirement 
Income Security Act of 1974 or a foreign person performing a similar 
role or function subject as such to foreign regulation with total 
assets exceeding $5,000,000 and whose investment decisions are made by 
a bank, trust company, insurance company, investment adviser subject to 
regulation under the Investment Advisers Act of 1940 (15 U.S.C. 80b-1, 
et seq.), or a commodity trading advisor subject to regulation under 
the Act;
    (viii) Any governmental entity (including the United States, any 
state, or any foreign government) or political subdivision thereof, or 
any multinational or supranational entity or any instrumentality, 
agency, or department of any of the foregoing;
    (ix) A broker-dealer subject to regulation under the Securities 
Exchange Act of 1934 (15 U.S.C. 78a, et seq.) or a foreign person 
performing a similar role or function subject as such to foreign 
regulation, acting on its own behalf: Provided, however, that if such 
broker-dealer is a natural person or proprietorship, the broker-dealer 
must also meet the requirements of paragraph (c)(2) (vi) or (xi) of 
this section;
    (x) A futures commission merchant, floor broker, or floor trader 
subject to regulation under the Act or a foreign person performing a 
similar role or function subject as such to foreign regulation; or
    (xi) Any natural person with total assets exceeding at least 
$10,000,000.
    (3) Section 4(c) contract market trading rules means:
    Contract market rules prescribing trading procedures applicable 
only to section 4(c) contract market transactions.
    (4) Terms and conditions has the same meaning as in Sec. 1.41(a)(2) 
of this chapter.


Sec. 36.2  Trading of section 4(c) contract market transactions.

    A section 4(c) contract market transaction may be traded pursuant 
to the provisions of this part provided the following conditions are 
met:
    (a) The section 4(c) market transaction:
    (1) Provides that settlement or delivery shall be in cash (at a 
cash settlement price that reflects the cash market for the underlying 
commodity and is based on a price series that is reliable, publicly 
available, and timely) or by means other than the transfer or receipt 
of any commodity, except a major foreign currency; provided however, 
that the terms and conditions of such transaction are in conformity 
with the underlying cash market (or, in the absence of conformity, are 
necessary or appropriate) and that trading is not readily susceptible 
to price manipulation, nor to causing or being used in the manipulation 
of the price of any underlying commodity;
    (2) Is cleared through a clearing organization subject to 
Commission oversight;
    (3) Except with respect to a broad-based index, does not involve 
any, or the price of any, wheat, cotton, rice, corn, oats, barley, rye, 
flaxseed, grain sorghums, millfeed, butter, eggs, onions, solanum 
tuberous (Irish potatoes), wool, wool tops, fats and oils (including 
lard, tallow, cottonseed oil, peanut oil, soybean oil, and all other 
fats and oils), cottonseed meal, cottonseed, peanuts, soybeans, soybean 
meal, livestock, livestock products, or frozen concentrated orange 
juice;
    (4) Does not involve any commodity futures contract or commodity 
option for which any board of trade has been designated by the 
Commission as a contract market prior to its application to trade as a 
section 4(c) contract market transaction, unless it can reasonably be 
distinguished from any such futures contract or commodity option based 
on its hedging function and/or pricing basis; provided however, that 
(i) the five- and ten-year interest rate swaps futures contracts, the 
Rolling Spot Contracts in foreign currency, and foreign currency 
forward futures contracts and options thereon may be traded as section 
4(c) contract market transactions, and (ii) a flexible commodity option 
may be listed as a section 4(c) contract market transaction prior to 
listing such option for trading otherwise; and
    (5) Does not involve any contracts of sale (or options on such 
contracts) subject to the provisions of Section 2(a)(1)(B) of the Act, 
including contracts for future delivery of a group or index of 
securities (or any interest therein or based upon the value thereof).
    (b) The contract market on which the section 4(c) contract market 
transaction is traded or executed complies with the provisions of this 
part.


Sec. 36.3  Section 4(c) contract market trading rules.

    (a) A board of trade may, subject to the terms and conditions 
stated herein, submit for Commission approval, section 4(c) contract 
market trading rules to permit an on-floor and/or off-floor trading 
procedure for section 4(c) contract market transactions that do not 
satisfy all of the requirements of Secs. 1.38(a), 1.39, 155.2, 155.3, 
and 155.4 of this chapter.
    (b) Section 4(c) contract market trading rules submitted pursuant 
to this section must provide for the following:
    (1) Record maintenance and retention in accordance with Sec. 1.31 
of this chapter;
    (2) An audit trail that meets the requirements of Sec. 1.35(e), 
(g), and (i) [trade register, trade timing, and contract market 
oversight] and 1.38(b) of this chapter [identification of certain 
transactions], and that otherwise complies with the provisions of 
Sec. 1.35 of this chapter to the extent applicable;
    (3) Compliance with Secs. 155.2, 155.3, and 155.4 of this chapter 
[trading standards for floor brokers, futures commission merchants, and 
introducing brokers] to the extent applicable;
    (4) The immediate post-execution report of each purchase and each 
sale transaction to and dissemination on the relevant market floor, 
trading screen, and/or vendor service through the board of trade's 
market quotation system of the price, quantity, and contract traded 
pursuant to this section;
    (5) The report to clearing, and clearing, of transactions concluded 
pursuant to this section on the same schedule as trades subject to 
Secs. 1.38 and 1.39 of this chapter and, otherwise, the immediate 
report to clearing; and
    (c) Any rules submitted pursuant to this section must describe the 
manner in which such rules or contract market procedures and systems 
will assure compliance with the provisions of Sections 4b and 4c(a) of 
the Act prohibiting false reports, frontrunning, misuse of information, 
fictitious sales, wash sales, and abuse of customer orders.
    (d) A board of trade seeking approval of a section 4(c) contract 
market trading rule shall furnish one copy of the information set forth 
in paragraph (b) of this section to the Commission at its Washington, 
D.C. headquarters. One copy shall also be transmitted by the board of 
trade to the regional office of the Commission having local 
jurisdiction over the board of trade. Each submission shall be labeled 
as being submitted pursuant to this section.
    (e) Rules submitted by a contract market pursuant to this section 
shall become effective ten days after receipt of the submission (or 
such earlier time as may be determined by the Commission or its 
delegee) unless, within the ten-day period, the Commission or its 
delegee notifies the board of trade in writing that the submission does 
not meet the conditions of this section. Upon such notification by the 
Commission or its delegee, the submission will be subject to the usual 
procedures for rule approval under Section 5a(a)(12)(A) of the Act and 
Sec. 1.41(b) of this chapter.
    (f) Once trading in a section 4(c) contract market transaction has 
commenced, any modification to any approved section 4(c) contract 
market trading rule must be submitted to the Commission for review 
pursuant to the standards and procedures for section 4(c) contract 
market trading rules set forth in this section.
    (g) Trades entered into in compliance with the section 4(c) 
contract market trading rules in effect shall not be in violation of 
Sections 4b(a)(iv), 4b(b) or 4c(a) of the Act based solely on having 
been executed noncompetitively. Failure to comply with such contract 
market rules shall render the conduct involved subject to Commission 
action for noncompetitive trading under Sections 4b and 4c(a) of the 
Act and Secs. 1.38, 1.39, and, if applicable, Secs. 155.2, 155.3, and 
155.4 of this chapter in addition to any other applicable provisions of 
the Act and rules of this chapter.


Sec. 36.4  Listing of section 4(c) contract market transactions.

    (a) A board of trade which has been initially designated as a 
contract market and has otherwise met the requirements of Sections 5 
and 5a of the Act (other than Section 5a(a)(12)(A)) seeking to permit 
trading in a section 4(c) contract market transaction shall furnish to 
the Commission at least ten days prior to its proposed effective date, 
the rules setting forth the terms and conditions of the proposed 
section 4(c) contract market transaction.
    (b) The board of trade shall furnish one copy of the information 
set forth in paragraph (a) of this section to the Commission at its 
Washington, D.C. headquarters. One copy shall also be transmitted by 
the board of trade to the regional office of the Commission having 
local jurisdiction over the board of trade. Each submission shall be 
labeled as being submitted pursuant to this Part.
    (c) A board of trade which has been initially designated as a 
contract market and has otherwise met the requirements of Sections 5 
and 5a of the Act (other than Section 5a(a)(12)(A)) and which meets the 
requirements of Sec. 36.2 of this part shall be deemed to be designated 
as a contract market in section 4(c) contract market transactions, the 
rules submitted shall be deemed to be approved, and section 4(c) 
contract market transactions may be traded or executed thereon ten days 
after receipt of the submission pursuant to this section unless, within 
the ten-day period, the Commission or its delegee notifies the board of 
trade in writing that the proposed transactions do not meet the 
requirements of Sec. 36.2 of this part. Upon such notification by the 
Commission or its delegee, the submission will be subject to the usual 
procedures for rule approval under Section 5a(a)(12)(A) of the Act and 
Sec. 1.41(b) of this chapter.
    (d) Any modification to the rules setting forth the terms and 
conditions of a section 4(c) contract market transaction shall be 
submitted to the Commission pursuant to the procedure set forth in this 
section.


Sec. 36.5  Reporting requirements.

    (a) The reporting requirements set forth in this section shall 
govern section 4(c) market transactions in lieu of the requirements of 
parts 16, 17, 18, and 19 of this chapter.
    (b) The provisions of Sec. 15.05 and part 21 of this chapter shall 
apply to section 4(c) contract market transactions as though they were 
set forth herein and included specific references to eligible 
participants.
    (c) Reports by contract markets to the Commission. Each contract 
market shall submit to the Commission in accordance with paragraph (d) 
of this section the following information with respect to section 4(c) 
market transactions by commodity or type of contract as specified by 
the Commission:
    (1) For each commodity or type of contract,
    (i) The total gross open contracts at the end of the day covered by 
the report,
    (ii) Total transactions, by type of transaction, as specified by 
the Commission, which occurred during the day covered by the report, 
and
    (iii) Prices, as specified by the Commission.
    (2) For each clearing member by proprietary and customer account,
    (i) The total of all long open contracts and the total of all short 
open contracts carried at the end of the day covered by the report, and
    (ii) The quantity of contracts transacted during the day covered by 
the report, by type of transaction, as specified by the Commission.
    (3) Large trader reports.
    (i) Reportable positions. Reportable long and short positions of 
traders as defined by contract market rules and approved by the 
Commission, separately for each futures commission merchant or member 
of the contract market.
    (ii) Identification information. For each reportable position, the 
information specified in Sec. 17.01(b)(1) through (b)(8) of this 
chapter.
    (d) Form and manner of reporting; time and place of filing reports. 
Unless otherwise approved by the Commission or its designee, each 
contract market operating pursuant to this part shall submit the 
information required by paragraph (c) of this section as follows:
    (1) Using a format and coding structure approved in writing by the 
Commission or its designee on compatible data processing media as 
defined in part 15 of this chapter;
    (2) The information contained in paragraphs (c)(1) and (c)(2) of 
this section must be filed daily when the data are first available, but 
not later than 3:00 p.m. on the business day following the day to which 
the information pertains. The information contained in paragraph (c)(3) 
must be filed on call by the Commission or its designee, at such times 
as specified in the call.
    (3) Except for dial-up transmissions, at the regional office of the 
Commission having local jurisdiction with respect to such contract 
market.
    (e) Reports by contract markets to the public. Each contract market 
operating pursuant to this part shall publish for each business day the 
following information for section 4(c) contract market transactions by 
commodity or type of contract as specified by the Commission:
    (1) The total gross open contracts;
    (2) The total number of transactions by transaction type as 
specified by the Commission; and
    (3) Prices, as specified by the Commission.
    (f) Reports and maintenance of books and records by traders. Every 
trader who owns, holds, or controls, or has held, owned, or controlled 
a reportable position, as defined by contract market rules, in 
contracts traded as section 4(c) market transactions shall:
    (1) Keep books and records showing all details concerning all 
positions and transactions with respect to section 4(c) market 
transactions, all positions and transactions in any options traded 
thereon, and all positions and transactions in the underlying 
commodity, its products, and by-products and, in addition, commercial 
activities that the trader hedges in the underlying commodity, and 
shall upon request furnish to the Commission or the U.S. Department of 
Justice any pertinent information concerning such positions, 
transactions, or activities.
    (2) File within one business day after a special call upon such 
trader by the Commission or its designee the following:
    (i) Reports showing positions and transactions on such contract 
markets for the period of time that the trader held or controlled a 
reportable position, and in a form and manner as instructed in the 
call; and
    (ii) The information specified in Sec. 18.04 of this chapter as 
though it pertains to section 4(c) market transactions.


Sec. 36.6  Special procedures relating to temporary licensing, 
registration, and listing of principals.

    Notwithstanding any other provision of law, any person associated 
with a futures commission merchant or an introducing broker shall be 
granted a temporary license to act in the capacity of an associated 
person of such sponsor or listed as a principal of such futures 
commission merchant or introducing broker if such person certifies that 
he is licensed, or otherwise authorized to do business and in good 
standing with another federal financial regulatory authority, or a 
foreign financial regulatory authority with which the Commission has 
comparability arrangements under part 30 of this chapter, is not 
subject to a statutory disqualification from registration under Section 
8a(2) of the Act and restricts his activities to section 4(c) market 
transactions, and if such person and his sponsor comply with special 
temporary license, registration, or principal listing procedures 
applicable to persons involved solely with such transactions that have 
been adopted by the National Futures Association and approved by the 
Commission.


Sec. 36.7  Risk disclosure.

    (a) A futures commission merchant or, in the case of an introduced 
account, an introducing broker, may open an account for a customer with 
respect to an instrument governed by this part without furnishing such 
customer the disclosure statements required under Secs. 1.55, 1.65, 
33.7, and 190.10 of this chapter: Provided, however, that the futures 
commission merchant or, in the case of an introduced account, the 
introducing broker, does furnish the customer, prior to the customer's 
entry into the first section 4(c) contract market transaction with 
respect to a particular instrument, with disclosure appropriate to the 
particular instrument and the customer.
    (b) This section does not relieve a futures commission merchant or 
introducing broker from any other disclosure obligation it may have 
under applicable law.


Sec. 36.8  Suspension or revocation of section 4(c) contract market 
transaction exemption.

    The Commission may, after notice and opportunity for a hearing, 
suspend or revoke the exemption of any section 4(c) contract market 
transaction if the Commission determines that the exemption is no 
longer consistent with the public interest and the purposes of the Act.


Sec. 36.9  Fraud and manipulation in connection with section 4(c) 
contract market transactions.

    (a) Fraud. The requirements of sections 4b(a) and 4o of the Act and 
Sec. 33.10 of this chapter shall apply to section 4(c) contract market 
transactions. In addition, it shall be unlawful for any person, 
directly or indirectly, in or in connection with an offer to enter 
into, the entry into, the confirmation of the execution of, or the 
maintenance of any transaction entered into pursuant to this part--
    (1) To cheat or defraud or attempt to cheat or defraud any other 
person;
    (2) To make or cause to be made to any other person any false 
report or statement thereof or cause to be entered for any person any 
false record thereof;
    (3) To deceive or attempt to deceive any other person by any means 
whatsoever.
    (b) Manipulation. The requirements of sections 6(c), 6(d), and 9(a) 
of the Act and Sec. 33.9(d) of this chapter shall apply to section 4(c) 
contract market transactions.

    Issued in Washington, D.C. on October 24, 1994, by the 
Commission.
Jean A. Webb,
Secretary of the Commission.
[FR Doc. 94-26726 Filed 10-27-94; 8:45 am]
BILLING CODE 6351-01-P