[Federal Register Volume 61, Number 85 (Wednesday, May 1, 1996)]
[Rules and Regulations]
[Pages 19177-19187]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 96-10714]



=======================================================================
-----------------------------------------------------------------------

COMMODITY FUTURES TRADING COMMISSION

17 CFR Part 1


Early Warning Reporting Requirements, Minimum Financial 
Requirements, Prepayment of Subordinated Debt, Gross Collection of 
Exchange-Set Margin for Omnibus Accounts and Capital Charge on 
Receivables From Foreign Brokers

AGENCY: Commodity Futures Trading Commission.

ACTION: Final rules.

-----------------------------------------------------------------------

SUMMARY: Rule 1.12 of the Commodity Futures Trading Commission 
(Commission or CFTC) sets forth the financial early warning reporting 
requirements for futures commission merchants (FCMs) and introducing 
brokers (IBs), which are designed to afford the Commission and industry 
self-regulatory organizations (SROs) sufficient advance notice of a 
firm's financial or operational problems to take such protective or 
remedial action as may be needed to assure the safety of customer funds 
and the integrity of the marketplace. The Commission has determined to 
adopt amendments to Commission Rule 1.12, applicable to FCMs only, that 
will: amend paragraph (g) to require the reporting of a reduction in 
net capital of 20 percent or more within two business days and a 
planned reduction in excess adjusted net capital of 30 percent or more 
two business days prior thereto, and to make that paragraph applicable 
to all FCMs, rather than just those FCMs subject to the risk assessment 
reporting requirements of Commission Rule 1.15; require reporting of a 
margin call that exceeds an FCM's excess adjusted net capital which 
remains unanswered by the close of business on the day following the 
issuance of the call; and require reporting by an FCM when-ever its 
excess adjusted net capital is less than six percent of the maintenance 
margin required to support positions of noncustomers carried by the 
FCM, unless the noncustomer is itself subject to the Commission's 
minimum financial requirements for an FCM or the Securities and 
Exchange Commission's (SEC's) minimum financial requirements for a 
securities broker-dealer (BD).
    The Commission has also determined to adopt amendments to: Rules 
1.17(a)(1)(i) and (ii) to (a) increase the minimum required dollar 
amount of adjusted net capital for FCMs from $50,000 to $250,000, (b) 
increase the minimum required dollar amount of adjusted net capital for 
IBs from $20,000 to $30,000, and (c) make the amount of adjusted net 
capital required by a registered futures association for its member 
FCMs and IBs an element of the Commission's minimum financial 
requirements for FCMs and IBs; Rule 1.17(h)(2)(vii) with respect to the 
procedure to obtain approval for prepayment of subordinated debt; and 
Rule 1.58, which governs gross collection of exchange-set margins for 
omnibus accounts, to make it applicable to omnibus accounts carried by 
FCMs for foreign brokers. The Commission believes that these amendments 
will conform the Commission's rules with those of SROs and therefore 
should not require changes in the operations of most firms. In 
addition, the Commission has determined that the five percent capital 
charge for unsecured receivables from a foreign broker will not apply 
where the receivables represent deposits required to maintain futures 
or options positions, the foreign broker has been granted comparability 
relief under Commission Rule 30.10, and the asset is held in accordance 
with the relevant grant of relief under Rule 30.10 at the foreign 
broker, with another foreign broker that has been granted comparability 
relief under Commission Rule 30.10, or at a depository in the same 
jurisdiction as either foreign broker in accordance with Commission 
Rule 30.7.

EFFECTIVE DATE: May 31, 1996.

FOR FURTHER INFORMATION CONTACT: Paul H. Bjarnason, Jr., Chief 
Accountant, or Lawrence B. Patent, Associate Chief Counsel, Division of 
Trading and Markets, Commodity Futures Trading Commission, 1155 21st 
Street, N.W., Washington, D.C. 20581; telephone (202) 418-5459 or 418-
5439.

[[Page 19178]]

SUPPLEMENTARY INFORMATION:

I. Early Warning Rules

A. Reportable Events in General

    The Commission has required each FCM 1 to report to the 
Commission and to the FCM's designated self-regulatory organization 
(DSRO) certain events pertaining to the FCM's financial condition, the 
FCM's procedures for safeguarding customer and firm assets, and its 
ability to monitor its financial condition through an appropriate 
system of records and reports. The purpose of such reporting is to make 
the Commission and the FCM's DSRO aware of circumstances that have or 
potentially could have a negative impact on the FCM's ability to carry 
on normal business operations consistent with the Commission's 
prudential requirements and pose a potential threat to customer funds 
or the FCM's financial integrity. Receipt of such notices results in a 
heightened degree of surveillance over the FCM by the Commission and 
the DSRO. The events to be reported include undercapitalization, the 
FCM's adjusted net capital being below its early warning level (i.e., 
150 percent of the minimum required), failure to maintain current books 
and records, the existence of material inadequacies in the FCM's 
accounting systems or internal controls, and the issuance of a margin 
call exceeding the FCM's adjusted net capital. Collectively, these are 
known as the Commission's early warning reporting requirements and are 
set forth in Rule 1.12. With respect to notices relative to reductions 
in capital, one purpose of this rulemaking has been to harmonize 
required notices to the SEC and relevant futures and securities SROs.
---------------------------------------------------------------------------

    \1\ Rule 1.12 also requires certain reports from FCMs, IBs, and 
exchange clearing organizations. The rule amendments that have been 
adopted relate only to reporting by FCMs. No changes have been made 
with respect to reporting requirements imposed on FCM applicants, 
IBs or IB applicants, or clearing organizations.
---------------------------------------------------------------------------

B. Background of This Rulemaking

    On March 1, 1994, the Commission published proposed Risk Assessment 
Rules for Holding Company Systems, 59 FR 9689. Certain portions of 
these proposals were adopted as final rules by the Commission. 59 FR 
66674 (Dec. 28, 1994). The proposed risk assessment rules generally 
would have required, inter alia, an FCM to notify the Commission of 
certain events or transactions that would reduce or potentially reduce 
the FCM's net capital. These ``triggering'' events were originally 
proposed to be included in a new Rule 1.15 as part of the risk 
assessment reporting rules. However, several of the commenters on the 
risk assessment proposals suggested that the reporting of certain of 
these triggering events should more appropriately be part of the 
Commission's early warning reporting system set forth in Rule 1.12, and 
the Commission agreed. Therefore, when the Commission adopted as part 
of the risk assessment rulemaking one of the triggering provisions 
relating to declines in an FCM's adjusted net capital, that provision 
was adopted as Rule 1.12(g) instead of as a provision of Rule 1.15, and 
was made applicable only to those FCMs which are required to file 
reports under Rule 1.15.2
---------------------------------------------------------------------------

    \2\ The balance of the proposed trigger event provisions remains 
under consideration by the Commission.
---------------------------------------------------------------------------

    Certain commenters on the risk assessment proposals had suggested 
that the notice provision relating to declines in capital should be 
applicable to all FCMs, not just those subject to the risk assessment 
rules. The Commission agreed, but was concerned that FCMs which 
believed that they were not subject to the risk assessment rules may 
not have availed themselves of the opportunity to comment upon the 
Commission's March 1994 risk assessment proposals, including the 
provision adopted as Rule 1.12(g). Therefore, the Commission adopted 
Rule 1.12(g) in December 1994 as applicable only to those FCMs subject 
to the risk assessment rules and at the same time proposed to amend 
Rule 1.12(g) to make the reporting of capital declines applicable to 
all FCMs. 59 FR 66822 (Dec. 28, 1994). In the same Federal Register 
release which announced the proposed amendment to Rule 1.12(g), the 
Commission also proposed to make certain other changes to the early 
warning system as an adjunct to its risk assessment initiative and in 
response to comments received on the March 1994 risk assessment rule 
proposals which would: (1) require an FCM to report a margin call that 
exceeds its excess adjusted net capital and remains unanswered by the 
close of business on the day following the issuance of the call 
(proposed Rule 1.12(f)(4)); and (2) require an FCM to report whenever 
its excess adjusted net capital is less than six percent of the 
maintenance margin required to support proprietary and noncustomer 
positions carried by the FCM (proposed Rule 1.12(f)(5)).
    The Commission originally permitted 30 days for public comment on 
the proposed amendments to Rule 1.12 and it extended the comment period 
for an additional 30 days in response to a request from the Securities 
Industry Association (SIA). 60 FR 7925 (Feb. 10, 1995). The Commission 
received six written comments on these proposals, including two from 
contract markets (Chicago Board of Trade (CBT) and Chicago Mercantile 
Exchange (CME)), two from trade associations (Futures Industry 
Association (FIA) and SIA), one from an FCM, Bielfeldt & Company 
(Bielfeldt), and one from an associated person, Alvin L. Goldberg. The 
Commission's Division of Trading and Markets (Division) also received 
two letters from the Intermarket Financial Surveillance Group 
(IFSG),3 dated February 22 and April 8, 1996, respectively, which 
bear directly upon one of these proposals and have been considered 
along with the other comment letters.
---------------------------------------------------------------------------

    \3\ The IFSG was formed in 1988 to provide a coordinating body 
to address financial surveillance issues relevant to both futures 
and securities markets. It includes representatives of most of the 
principal commodity and securities exchanges as well as the National 
Futures Association (NFA) and the National Association of Securities 
Dealers, Inc. Staff members of the CFTC and of the SEC frequently 
attend IFSG meetings as observers.
---------------------------------------------------------------------------

    The Commission has carefully considered the comments received. The 
Commission has determined to adopt the proposed amendment concerning 
unanswered margin calls as proposed. The Commission has also 
determined, based upon a review of the comments and its own 
reconsideration of the proposal, that the provision of the early 
warning system for FCMs requiring a comparison of excess adjusted net 
capital to six percent of the maintenance margin level will only apply 
to those positions carried by an FCM on behalf of a noncustomer that is 
not itself subject to the Commission's minimum financial requirements 
for an FCM or the minimum financial requirements of the SEC for a BD. 
The Commission is therefore not adopting Rule 1.12(f)(5) as proposed, 
which would have applied six percent of the maintenance margin level to 
all positions held in noncustomer and proprietary accounts. The 
Commission has further determined to modify slightly the standards in 
Rule 1.12(g) concerning notice of substantial declines in capital in 
light of the comments received, particularly the IFSG letters, and its 
own reconsideration of the issue. The Commission has also clarified 
certain matters in response to issues raised in the comment letters, as 
discussed more fully below.

C. Reductions in Capital

    As noted above, the Commission in December 1994 added to the list 
of

[[Page 19179]]

reportable events under Rule 1.12 a new paragraph (g), requiring that 
certain FCMs (i.e., those FCMs required to file risk assessment 
reports) report capital declines which may not necessarily result in 
the FCM being undercapitalized or its capital declining below early 
warning levels, but which are sufficiently material to the FCM's 
regulatory capital to warrant enhanced monitoring by the Commission and 
the FCM's DSRO.4
---------------------------------------------------------------------------

    \4\ There are approximately 190 FCMs required to file risk 
assessment reports, and the extension of Rule 1.12(g) would cover 
the remaining FCMs, approximately 70 firms.
---------------------------------------------------------------------------

    The event currently required to be reported under Rule 1.12(g) is 
the occurrence of any transaction or condition that results in a 
reduction of more than 20 percent in the adjusted net capital of an FCM 
from that reported in the most recent financial report filed with the 
Commission pursuant to Commission Rule 1.10.5 The rule draws a 
distinction, with respect to when the event must be reported, between 
those events occurring in the normal course of business and those which 
are extraordinary. If the decline in adjusted net capital is due to 
activities in the normal course of an FCM's business, the reduction is 
to be reported within two business days following the event. These 
events are not normally planned for in advance, such as operating 
losses, proprietary trading losses or increased charges against net 
capital. However, where a transaction or series of transactions is 
planned to be taken which will reduce adjusted net capital by more than 
20 percent, the notice must be filed at least two business days in 
advance of the transaction or series of transactions.6 This would 
permit Commission or DSRO staff to make further inquiries concerning 
the transaction before the transaction is effected to assure that the 
FCM has adequately considered the effect of the transaction on its 
overall liquidity. Ideally, an explanation would be included to 
facilitate this process. The rule does not provide for Commission 
approval or disapproval of the transaction prior to the FCM effecting 
the transaction, nor does it provide a means for the Commission to 
delay or prevent the FCM from carrying out the transaction.7
---------------------------------------------------------------------------

    \5\ Certain exchanges have a similar requirement. The rule 
amendment whose adoption is announced herein is intended to induce 
all SROs to conform their similar rules to the Commission 
requirement. See CME Rule 972A; CBT Rule 285.03; New York Mercantile 
Exchange Rule 2.14(d) and Clearing Rule 9.22(c)(i) and (ii); 
Commodity Exchange, Inc. Rule 7.08(a); Coffee, Sugar and Cocoa 
Exchange, Inc. Clearing Rule 302(c)(i); Kansas City Board of Trade 
Rule 1311.00; Kansas City Board of Trade Clearing Corporation Rule 
8.01(c); and Minneapolis Grain Exchange Rule 2088.00.
    \6\ The SEC also has a similar rule, Rule 240.15c3-1(e)(1), 17 
CFR 240.15c3-1(e)(1)(1995), which requires a BD to provide notice 
two business days prior to withdrawals of equity capital that on a 
net basis exceed in the aggregate in any 30 calendar day period, 30 
percent of the firm's excess net capital, or two business days after 
such withdrawals during any 30 calendar day period exceed 20 percent 
of the firm's excess net capital.
    \7\ As more fully discussed below, the Commission requested 
comment as to whether Rule 1.12(g) should establish a mechanism by 
which the Commission could delay or prevent an FCM from carrying out 
the transaction. The SEC has authority to restrict capital 
withdrawals for up to twenty business days under certain conditions. 
17 CFR 240.15c3-1(e)(3)(1995).
---------------------------------------------------------------------------

    The filing under Rule 1.12(g) is to be made, in accordance with 
Rule 1.12(h), with the regional office of the Commission with which the 
FCM normally files its financial reports under Rule 1.10, with the 
principal office of the Commission in Washington, D.C., with the FCM's 
DSRO and with the SEC if the FCM is also registered as a BD. Rule 
1.12(g) also provides that, following receipt of a notice from an FCM, 
the Director of the Division, or the Director's designee, may request 
additional information concerning the effect of the reported event on 
the FCM's financial or operational condition. The FCM is required to 
provide such additional information within three business days, or 
sooner if the Division believes prompter filing is needed to address 
the condition causing the filing of the early warning notice and so 
requests.
    As adopted in December 1994, Rule 1.12(g) applies only to those 
FCMs which are required to file reports with the Commission under the 
risk assessment rules. Several commenters on the Commission's March 
1994 risk assessment proposals, including FIA and NFA, suggested that 
the reporting requirement now in paragraph (g) be made applicable to 
all FCMs, not just those required to report under Rule 1.15. The 
Commission agreed that this reporting requirement serves to alert the 
Commission and DSRO to potential problems resulting from transactions 
that affect an FCM directly and therefore should not be limited to 
those FCMs subject to the risk assessment rules. Since FCMs that 
believed they were not subject to the risk assessment rules may not 
have taken the opportunity to comment on the Commission's March 1994 
risk assessment rule proposals, the Commission determined to publish 
these proposed changes to Rule 1.12(g) for comment.
    All of the commenters on the Commission's December 1994 proposals 
addressed the Commission's proposal concerning Rule 1.12(g). Two 
commenters expressed support for the extension of Rule 1.12(g) to all 
FCMs. Three commenters noted that several regulators and SROs had 
similar, but slightly different, requirements in this area. They 
further pointed out that the IFSG was attempting to develop a consensus 
on how to harmonize the various requirements directed at the same types 
of reporting and requested that the Commission not adopt its proposals 
until the IFSG completed its study. One of these commenters, FIA, 
suggested in the alternative that the Commission adopt a ``no-action'' 
position to permit an FCM to follow a related rule of its DSRO or the 
New York Stock Exchange, Inc. (NYSE), as elected by the FCM. The IFSG 
reported on its harmonization efforts in its letters to the Division 
dated February 22 and April 8, 1996 and stated that the Commission and 
SEC should adopt similar rules which would require two business days 
prior notice when excess adjusted net capital is to be reduced 30 
percent or more and notice within two business when net capital has 
been reduced by 20 percent or more.8
---------------------------------------------------------------------------

    \8\ IFSG's first letter dated February 22, 1996, which was 
superseded by its April 8, 1996 letter, recommended that the notices 
be made 48 hours, rather than two business days, prior to or 
following the event, and that such notices be based upon net capital 
declines in either situation, rather than upon a decline in excess 
adjusted net capital with respect to prior notice. The prior notice 
rule adopted herein is the same as that of the SEC adjusted to apply 
to FCMs and the subsequent notice in the same as that required by 
the NYSE so adjusted. FCMs that are BDs will continue to have to 
file any additional notices required by the SEC which in the case of 
post-reduction notices may include some notices triggered by 
haircuts.
---------------------------------------------------------------------------

    As noted above, the Commission requested comment as to whether Rule 
1.12(g) should establish a mechanism by which the Commission could 
delay or prevent an FCM from carrying out planned transactions that 
would reduce adjusted net capital by more than 20 percent. Three 
commenters stated that the Commission should not be able to delay or 
prevent capital reductions. A fourth commenter, SIA, stated that for 
firms dually registered as FCMs and BDs, only the SEC should have such 
authority, but it supported CFTC authority to delay or prevent capital 
reductions for other FCMs (i.e., those not also registered as BDs). 
Although it did not directly address the question posed by the 
Commission, the FCM commenter, Bielfeldt, stated that no notice under 
Rule 1.12(g) should be required with respect to capital reductions 
resulting from planned transactions. Another commenter, Mr. Goldberg, 
expressed his belief that the capital rules as written do not require

[[Page 19180]]

firms to establish systems to monitor capital on a day-to-day basis; in 
his view, it is sufficient if a firm can, at a later date, demonstrate 
that it was in compliance on any date. Therefore, Mr. Goldberg believes 
that the effect of planned transactions on a firm's capital would not 
be readily determinable, rendering a firm incapable of providing early 
warning with respect to such transactions.
    There were two other comments related to the proposed amendment of 
Rule 1.12(g). Two commenters requested clarification that notice under 
the rule would not be required with respect to repayment or prepayment 
of subordinated debt, since separate notice of such events and DSRO 
approval is already required. Another commenter stated that the 
calculation used in Rule 1.12(g) should be based upon net capital, as 
modified by the dollar amount of deficit and undermargined accounts, 
rather than adjusted net capital.
    The Commission has carefully considered these comments and has 
determined to amend Rule 1.12(g) consistent with the suggestions of the 
IFSG.9 The Commission believes that this action will make its rule 
concerning capital reductions consistent with the SEC's rule and the 
rules of futures and securities industry SROs in this area. The IFSG's 
letters were jointly addressed to the Division and to the SEC's 
Division of Market Regulation (DMR) and the Division's staff has been 
in contact with DMR staff to assure similarity of treatment regarding 
early warning notices related to capital reductions. The Commission's 
December 1995 proposals, which are discussed more fully below, as well 
as the Commission's February 1996 proposals,10 were intended to 
conform Commission minimum financial and related reporting requirements 
with those of the SROs and SEC in various areas, as recommended by 
several participants in the Commission's roundtable on capital issues 
held on September 18, 1995. A uniform approach among the Commission, 
SEC and the SROs with respect to notices of major capital reductions 
should simplify the reporting requirements for FCMs that are also BDs 
and/or members of more than one futures or securities SRO, eliminating 
needless inconsistencies among required notices relating to the same 
types of circumstances, and provide consistent and sufficient 
information to financial regulators and SROs to permit them to monitor 
effectively the financial condition of firms under their jurisdiction.
---------------------------------------------------------------------------

    \9\ The IFSG's April 8, 1996 letter made two other suggestions 
in addition to those referred to above which were that: (1) notice 
not be triggered by a futures or securities transaction in the 
ordinary course of business between an FCM and an affiliate where 
the FCM makes payment to or on behalf of such affiliate for such 
transaction and then receives payment from such affiliate for such 
transaction within two business days from the date of the 
transaction; and (2) an FCM's DSRO have discretion to exempt the FCM 
from filing notice under Rule 1.12(g) where withdrawals, advances or 
loans in the aggregate, on a net basis, equal $500,000 or less. The 
Commission is adopting the former suggestion as a proviso to Rule 
1.12(g). As to the second suggestion, Commission staff discussed the 
issue with an IFSG representative, who stated that it was included 
in the letter since the SEC rule provides for such exemptions. The 
IFSG representative further indicated that such a provision was not 
an issue of concern to the futures industry members of IFSG so the 
Commission is not including it in Rule 1.12(g).
    \10\ 61 FR 7080 (Feb. 26, 1996). These proposals concerned the 
financial reporting cycle and the debt-equity ratio requirements for 
FCMs and IBs.
---------------------------------------------------------------------------

    The Commission notes that basing the event requiring notice within 
two business days upon a decline in net capital rather than adjusted 
net capital as currently in the rule will require larger reductions to 
trigger the notice since net capital will normally exceed adjusted net 
capital. Conversely, since the prior notice requirement will be based 
upon a decline in excess adjusted net capital rather than adjusted net 
capital as currently in the rule, smaller reductions could trigger the 
notice since adjusted net capital will necessarily exceed excess 
adjusted net capital, despite the fact that the percentage decline 
required to trigger prior notice has been increased from 20 to 30 
percent. The Commission believes that it has now achieved a balanced 
approach in this area that implements its ongoing resolve to streamline 
its rules and avoid unnecessary duplication or redundant or 
inconsistent requirements to the extent consistent with customer 
protection. It also further harmonizes the Commission's rules with SEC 
rules and takes account of the ongoing harmonization project of the 
IFSG.11
---------------------------------------------------------------------------

    \11\ For an FCM dually registered as a BD and taking advantage 
of the option available under Commission Rule 1.10(h) to file a copy 
of its Financial and Operational Combined Uniform Single (FOCUS) 
Report in lieu of Form 1-FR-FCM (which includes about one-half of 
all FCMs), the calculation for subsequent notice would be based upon 
``tentative net capital'' as set forth in SEC Rule 240.15c3-1, i.e., 
net capital before securities haircuts, and the calculation for 
prior notice would be based upon ``excess net capital.'' The 
Commission's definition of net capital and the SEC's definition of 
tentative net capital, as well as the Commission's definition of 
excess adjusted net capital and the SEC's definition of excess net 
capital, are for practical purposes the same.
---------------------------------------------------------------------------

    The Commission has also determined not to establish a mechanism 
whereby it could delay or prevent an FCM from carrying out planned 
transactions that would reduce excess adjusted net capital by 30 
percent or more. The Commission continues to view the early warning 
requirements under Rule 1.12 as essentially a mechanism for 
notification of situations that have or potentially could have a 
negative impact on a firm's ability to carry on normal business 
operations consistent with the Commission's prudential requirements and 
that pose a potential threat to customer funds or a firm's financial 
integrity. In the case of a planned reduction, the Commission believes 
that an explanation should accompany the notice. Although the 
Commission's staff may wish to discuss reported events with the 
FCM,12 the Commission does not believe that a formal mechanism to 
delay or prevent events giving rise to a notice under Rule 1.12(g) is 
warranted at this time. The Commission currently has the authority to 
require specific reports from custodians upon the transfer of 
segregated funds in certain circumstances and also requires 100 percent 
segregation of customer obligations unlike the SEC that has a more 
limited requirement. These two authorities make it less likely that 
there could be a ``run'' on a futures firm or a misappropriation of 
segregated funds without additional authority to preclude reductions of 
capital. Moreover, the Commission is aware of the need for regulators 
to be sensitive to the liquidity needs of a holding company system as a 
whole consistent with its responsibilities to the regulated entity.
---------------------------------------------------------------------------

    \12\ The Commission notes that Rule 1.12(g)(3) provides that the 
Director of the Division or the Director's designee may require an 
FCM filing a notice under Rule 1.12(g) to furnish additional 
information. The Commission believes that it is important to 
maintain this flexibility and this is another reason why early 
warning notices should be filed with the Commission as well as the 
DSRO and not only with the latter as Bielfeldt suggested.
---------------------------------------------------------------------------

    The Commission also wishes to respond to the comments of Bielfeldt 
and Mr. Goldberg that no notice should be required or can be prepared 
with respect to capital reductions resulting from planned transactions. 
As the Commission stated when it published the proposals:

    The Commission's early warning rules relating to an FCM's level 
of capital contemplate that the FCM will have systems in place to 
monitor its capital levels and its compliance with the Commission's 
net capital rules on a day-to-day basis. The Commission requires 
each FCM to be able to demonstrate its capital compliance at any 
time and not just on a required formal computation or filing 
date.13 Consequently,

[[Page 19181]]

the effect of planned transactions on net capital should be readily 
determinable.

    \13\ See Commission Rules 1.17(a)(3)-(5) and 1.18(b), 17 CFR 
1.17(a)(3)-(5) and 1.18(b) (1995).
---------------------------------------------------------------------------

    The Commission further notes that since it issued these proposals, 
the failure of Barings PLC has occurred. That failure only reinforces 
the need for FCMs to have robust internal controls and capital 
monitoring systems that permit a firm to assess its financial position 
on a day-to-day, if not more frequent, basis.
    In response to the request of two of the commenters noted above, 
the Commission wishes to make clear that Rule 1.12(g) does not require 
separate notice with respect to repayment or prepayment of subordinated 
debt since an FCM must always get approval for prepayment of 
subordinated debt from its DSRO as discussed more fully below.14
---------------------------------------------------------------------------

    \14\ See Commission Rules 1.17(h)(2)(vii) and (viii), 17 CFR 
1.17(h)(2)(vii) and (viii) (1995); CFTC Interpretative Letter No. 
85-17, [1984-1986 Transfer Binder] Comm. Fut. L. Rep. (CCH) 
para.22,738 (Sept. 10, 1985).
---------------------------------------------------------------------------

D. Unanswered Margin Calls

    As part of the March 1994 risk assessment rule proposals, the 
Commission had proposed Rule 1.15(b)(2)(iii), which would have required 
an FCM to notify the Division whenever aggregate cumulative losses in 
all noncustomer accounts exceeded the greater of: (A) in any 30-day 
period, 10 percent of the last reported consolidated stockholders' 
equity of the FCM's parent or $50 million, or (B) in any 12-month 
period, 20 percent of the last reported consolidated stockholders' 
equity of the FCM's parent or $100 million.15 This proposal was 
opposed by several commenters. Some of the commenters suggested that, 
as an alternative, an FCM be required to notify the Commission within 
two business days after a margin call to a noncustomer remains 
outstanding for two business days, if the margin call exceeds 20 
percent of the FCM's adjusted net capital.
---------------------------------------------------------------------------

    \15\ 59 FR 9689, 9706 (March 1, 1994).
---------------------------------------------------------------------------

    In response to these comments, the Commission determined in 
December 1994 to propose Rule 1.12(f)(4) which would require an FCM to 
file an early warning notice when a margin call on a customer, 
noncustomer or omnibus account that exceeds the firm's excess adjusted 
net capital is not answered by the close of business on the day 
following the day the call is made. The Commission's proposal would 
permit FCMs to take into account favorable market moves in determining 
whether the margin call would be required to be reported under this 
rule.16
---------------------------------------------------------------------------

    \16\ 59 FR 66822, 66823-24.
---------------------------------------------------------------------------

    For purposes of proposed Rule 1.12(f)(4), a margin call would mean 
any deposit of funds required by the FCM to margin, guarantee or secure 
a futures or commodity option position. Thus, if, with respect to an 
exchange-traded contract, the FCM requires a deposit in excess of the 
minimum required pursuant to exchange rules, that greater amount would 
be the amount used in determining whether a call has been collected 
from an account holder. Although exchanges may exempt firms from the 
requirements of Commission Rule 1.12(f)(3), which requires notice of 
issuance of a margin call in excess of a firm's entire adjusted net 
capital, the Commission proposed not to permit the granting of such 
waivers from the Rule 1.12(f)(4) notice requirement. The Commission 
also requested additional comment, however, on the originally proposed 
trigger event for which Rule 1.12(f)(4) was proposed as an 
alternative.17
---------------------------------------------------------------------------

    \17\ See proposed Rule 1.15(b)(2)(iii) in the March 1994 risk 
assessment proposals, 59 FR 9689, 9706.
---------------------------------------------------------------------------

    The contract market and trade association commenters addressed 
proposed Rule 1.12(f)(4). CBT supported the proposal. CME, FIA and SIA 
stated that the rule should be based upon the exchange minimum 
maintenance margin level only, since such a rule could otherwise be a 
disincentive for FCMs to establish higher internal margin requirements. 
FIA and SIA also requested that the Commission allow more time to meet 
a margin call before notice is required if foreign customers are 
involved. CBT and CME urged the Commission to repeal Rule 1.12(f)(3), 
which requires an FCM to file a notice when an account is undermargined 
by an amount in excess of the FCM's adjusted net capital, since it is 
little used and similar to the proposal. FIA suggested two 
clarifications: (1) That the Commission state that a margin call is 
usually issued on the day following the day the account becomes 
undermargined; and (2) that the provision be applied to all commodity 
interest accounts subject to margining. FIA and SIA also requested that 
the Commission define ``excess adjusted net capital.''
    The Commission has carefully considered these comments and has 
determined to adopt Rule 1.12(f)(4) as proposed. As to whether the 
minimum margin standard in the rule should be the exchange minimum 
level or any higher amount set by the FCM, the Commission believes that 
FCMs establish margin requirements for accounts based upon an 
assessment of the creditworthiness of the account owner and that a Rule 
1.12(f)(4) notice requirement should have negligible impact in the 
context of margin requirements intended to safeguard a firm's financial 
position. Further, if the Commission adopted the view of certain 
commenters that the exchange minimum maintenance margin level is the 
appropriate level for purposes of Rule 1.12(f)(4) and an FCM set an 
account's maintenance margin level higher than the minimum requirement 
of an exchange, the FCM would be required to monitor the impact of the 
lower exchange minimum requirement for purposes of Rule 1.12(f)(4). The 
Commission believes that such a requirement could be more costly and 
confusing to keep track of than simply requiring an FCM to treat a 
margin call for the account as a margin call under Rule 1.12(f)(4).
    Concerning the comment that more time be allowed to meet a margin 
call if foreign customers are involved, the Commission is not persuaded 
that this would be appropriate. As far back as the October 1987 market 
break, the Division noticed a disproportionate incidence of customer 
defaults and liquidations attributable to foreign traders. FCMs were 
urged to establish procedures to assure that they obtain adequate 
security from foreign customers to protect against the potential for 
price fluctuations to result in aberrant margin calls that could not be 
readily satisfied by such customers and that, for the FCM, could be 
unduly costly or impossible to recover were legal action against the 
customer ultimately required.18 The Commission believes that the 
events that have occurred since 1987, including the growing 
internationalization of the futures markets, and the Commission's 
determination, as discussed below, to require gross collection of 
exchange-set margin for all omnibus accounts, including those 
originated by foreign brokers, lead to the conclusion that margin calls 
attributable to foreign traders should not be given preferential 
treatment in the context of the early warning notice requirement of 
Rule 1.12(f)(4).
---------------------------------------------------------------------------

    \18\ Follow-up Report on Financial Oversight of Stock Index 
Futures Markets During October 1987, CFTC Division of Trading and 
Markets, at 84 (Jan. 6, 1988).
---------------------------------------------------------------------------

    In response to FIA's suggestions, the Commission wishes to make 
clear that a margin call is usually issued on the business day 
following the business day the account becomes undermargined and that 
Rule 1.12(f)(4) as proposed and adopted ``applies to all accounts 
carried by the futures commission merchant

[[Page 19182]]

* * * that are subject to margining * * *.'' As to the term ``excess 
adjusted net capital,'' this means an FCM's adjusted net capital less 
its required minimum adjusted net capital computed in accordance with 
Commission Rule 1.17.19 The Commission further wishes to make 
clear that the notice required by Rule 1.12(f)(4) must include account 
name, date of margin call, amount of margin call and the FCM's excess 
adjusted net capital. The Commission also believes that Rule 1.12(f)(3) 
referred to above, although somewhat similar to Rule 1.12(f)(4), should 
continue as a separate early warning notice requirement.
---------------------------------------------------------------------------

    \19\ See also 17 CFR 1.17(d)(3) (1995); Form 1-FR-FCM, page 8, 
line 24.
---------------------------------------------------------------------------

E. Maintenance Margin Factor

    Some commenters on the Commission's March 1994 risk assessment 
proposals also suggested that, in lieu of adopting the proposal 
referred to above concerning the reporting of losses in noncustomer 
accounts, the Commission amend Rule 1.12 to add an early warning 
reporting requirement to require an FCM to report to the Commission 
whenever its excess adjusted net capital is less than six percent of 
the maintenance margin requirement applicable to positions in 
proprietary and noncustomers' accounts. These commenters noted that the 
CME imposes a capital requirement on an informal basis on its clearing 
members that factors in a percentage of proprietary and noncustomers 
margin requirements. The Commission determined to propose an amendment 
to Rule 1.12 in December 1994 in line with the commenters' suggestions.
    All of the commenters on the December 1994 proposals addressed this 
provision and stated that proprietary positions are subject to haircuts 
and thus should not be included in the calculation for an early warning 
notice requirement.20 The trade association commenters also stated 
that positions held by noncustomers who are subject to capital 
requirements of the Commission, or of another regulator or an SRO, 
either domestic or foreign, should not be included in the calculation 
required by Rule 1.12(f)(5).
---------------------------------------------------------------------------

    \20\ Bielfeldt further commented that haircuts on proprietary 
positions should be eliminated and all accounts should be treated 
similarly for capital purposes. This comment addresses issues 
outside of the scope of this rulemaking proceeding.
---------------------------------------------------------------------------

    The Commission has reconsidered its proposal in light of these 
comments. As noted above, the proposal responded to comments on the 
March 1994 risk assessment proposals which apparently misread the CME's 
requirements, since the CME rule only adds a percentage of noncustomer 
margin. The Commission recognizes that proprietary positions are 
already accounted for in the minimum financial rule through haircuts; 
however, noncustomer positions are not and neither are they factored 
into the minimum financial requirement based upon four percent of 
customer funds. Based upon the comments and its reconsideration of the 
issue, the Commission has determined not to include proprietary 
accounts as a factor in determining whether notice is required under 
Rule 1.12(f)(5).21 However, noncustomer accounts will be included 
in the calculation under Rule 1.12(f)(5), unless the noncustomer is 
itself subject to the Commission's minimum financial requirements for 
an FCM or the SEC's minimum financial requirements for a BD. This is 
intended to reflect the fact that affiliates rarely retain excess funds 
at the clearing firm. The Commission will reassess whether this 
exclusion is appropriate in connection with its further review of the 
capital rule as a whole.
---------------------------------------------------------------------------

    \21\ Because of this determination, the Commission's proposal 
that maintenance margin with respect to an FCM's proprietary account 
shall mean the amount of funds the FCM is required to maintain at 
the clearing organization with its clearing broker, or five percent 
of the value of the contract, whichever is greater, is moot. The 
Commission requested comment on that point and CME and Bielfeldt 
objected to the five percent provision, while CBT thought such a 
provision should be used only in the absence of margin being set by 
the exchange or clearing organization.
---------------------------------------------------------------------------

II. Minimum Financial Requirements for FCMs and IBs

    On December 7, 1995, the Commission voted to propose amendments to 
Rule 1.17 to: (a) Increase the required minimum dollar amount of 
adjusted net capital for FCMs from $50,000 to $250,000; 22 (b) 
increase the required minimum dollar amount of adjusted net capital for 
``independent'' IBs from $20,000 to $30,000; 23 and (c) make the 
amount of adjusted net capital required by a registered futures 
association for its member FCMs and IBs an element of the Commission's 
minimum financial requirements for FCMs and IBs.24
---------------------------------------------------------------------------

    \22\ This proposal would also have the effect of increasing an 
FCM's ``early warning'' level of adjusted net capital from $75,000 
to $375,000 despite the fact that Rule 1.12(b)(1) itself would not 
be amended.
    \23\ More than two-thirds of IBs enter into a guarantee 
agreement with an FCM in accordance with Commission Rules 
1.17(a)(2)(ii) and 1.10(j) in lieu of raising their own capital, and 
thus would be unaffected by the proposed amendment.
    \24\ These proposals and others discussed below were published 
at 60 FR 63995 (Dec. 13, 1995).
---------------------------------------------------------------------------

    These amendments were proposed in order to permit the Commission to 
use its authority under Section 6c of the Commodity Exchange Act (Act) 
25 to enforce compliance with what are effectively, for the 
reasons discussed when the proposals were published,26 the current 
minimum adjusted net capital requirements applicable to FCMs and 
independent IBs with the benefit of all of the remedies available to 
the Commission under the Act for the enforcement of compliance with any 
provision of the Act and any rule promulgated thereunder.27 In 
addition, these amendments would harmonize the Commission's minimum 
financial requirements for FCMs and independent IBs with the prevailing 
standards established by NFA rules.28 The amendments would also 
support the objective of assuring that FCMs have a substantial 
commitment to meeting their regulatory obligations to customers, an 
objective for which an increased requirement appears appropriate given 
the increase in the amount of funds held by FCMs and the change in the 
value of the dollar since 1978, the last time the Commission increased 
the required minimum dollar amount of capital for FCMs.29 The 
Commission also believed that the proposed amendments to Rule 1.17 were 
necessary to clarify its authority to require the transfer of positions 
at such time as a firm is no longer in compliance with the NFA rule, 
and to eliminate any confusion that may have existed as to whether the 
Commission could take action where an FCM's adjusted net capital is 
below $250,000 yet still at least $50,000,30 or

[[Page 19183]]

an independent IB's adjusted net capital is below $30,000 yet still 
$20,000 or more.31
---------------------------------------------------------------------------

    \25\ 7 U.S.C. 13a-1 (1994).
    \26\ See 60 FR 63995, 63996.
    \27\ Section 6c of the Act authorizes the Commission, whenever 
it appears that a person has engaged, is engaging, or is about to 
engage in any act or practice constituting a violation of any 
provision of the Act or any rule or regulation thereunder, to bring 
an action to enjoin such act or practice, or to enforce compliance 
with the Act or any rule or regulation thereunder. However, the 
Commission does not have the authority to discipline an exchange 
member for violation of an exchange rule in the absence of the 
exchange's failure to act, or to enforce compliance with a 
registered futures association's own rule upon a member thereof. See 
Sections 8c(a)(1) and 17(l)(1) of the Act, 7 U.S.C. 12c(a)(1) and 
21(l)(1) (1994).
    \28\ Commission Rule 170.15, 17 CFR 170.15 (1995), mandates that 
each person required to register as an FCM become and remain a 
member of a futures association which provides for the membership 
therein of such FCM unless there is no registered futures 
association. NFA is the only registered futures association.
    \29\ 43 FR 39956, 39972 (Sept. 8, 1978).
    \30\ On November 24, 1992, the SEC adopted rule amendments to 
raise its minimum net capital requirements for BDs holding customer 
funds, which had been $25,000, to $250,000 in stages. The 
requirement increased to $100,000 effective July 1, 1993, $175,000 
effective January 1, 1994 and to the current level of $250,000 
effective July 1, 1994. See 57 FR 56973, 56990 (Dec. 2, 1992); 17 
CFR 240.15c3-1e(a) (1995).
    \31\ The Commission's minimum dollar amount of adjusted net 
capital for independent IBs has remained unchanged at $20,000 since 
1983, when rules governing IBs were first adopted, so the change in 
the dollar's value since that time justifies an increase to $30,000 
for the minimum amount. 48 FR 35248 (Aug. 3, 1983).
---------------------------------------------------------------------------

    Four comment letters were received on the December 1995 proposals, 
submitted by FIA, NFA, CBT and CME. FIA and NFA supported the proposed 
amendments to the Commission's minimum financial requirements for FCMs 
and independent IBs. CBT and CME supported raising the minimum dollar 
amounts of the Commission's financial requirements to those of the NFA 
for FCMs and independent IBs, but objected to incorporating all aspects 
of NFA's minimum financial requirements (i.e., the standards based on 
number of branches and associated persons (APs)) into the Commission's 
rules.32 CBT stated that:

    \32\ NFA minimum financial requirements for FCMs and independent 
IBs based upon the number of branches and APs are discussed in the 
proposing release, 60 FR 63995, 63997.
---------------------------------------------------------------------------

    Many SROs have their own internal rules to determine capital 
that have been developed to address a specific need identified by 
that SRO. It can be anticipated that the NFA may develop further 
capital standards to address the capital needs of the firms for 
which it is primarily responsible and although all FCMs doing 
customer business are subject to these requirements, by virtue of 
being members of the NFA, if such requirements become Commission 
mandates, there would be a greater responsibility placed on the 
other DSROs to monitor compliance with what are in essence another 
organization's internal capital requirements.

    The Commission disagrees with this comment. A registered futures 
association cannot impose a minimum financial requirement for its 
member FCMs and IBs unless such a rule is approved by the Commission. 
When the Commission approves such a rule of the registered futures 
association, the proposed amendment would make that standard an element 
of the Commission's minimum requirements. Therefore, SROs effectively 
will be monitoring compliance with the minimum financial requirements 
for doing Commission-regulated FCM business, not another organization's 
internal capital requirements.33
---------------------------------------------------------------------------

    \33\ All SROs are required to have in effect and enforce rules 
approved by the Commission prescribing minimum financial and related 
reporting requirements for member FCMs and IBs. Such requirements 
must be the same as, or more stringent than, those contained in 
Commission Rules 1.10 and 1.17. See Commission Rule 1.52, 17 CFR 
1.52 (1995).
---------------------------------------------------------------------------

    Based upon a review of the comments and its own consideration of 
these issues, the Commission has determined to adopt the amendments to 
Rule 1.17(a) as proposed. The Commission is also adopting conforming 
amendments to the early warning level of adjusted net capital for FCMs 
(new paragraph (b)(3) of Rule 1.12), the restrictions on withdrawals of 
equity capital (new paragraph (e)(1)(iii) of Rule 1.17), and various 
provisions of Rule 1.17(h) concerning subordinated debt.34 The 
Commission further notes that several provisions of Rule 1.17 contain 
cross-references to Rule 1.17(a)(1)(i)(A) and 1.17(a)(1)(ii)(A), the 
minimum dollar amount of adjusted net capital for FCMs and independent 
IBs, respectively. These other provisions of Rule 1.17 restrict or 
require certain actions if specified levels of adjusted net capital, 
which in all cases exceed 100 percent of the minimum dollar amount, are 
breached. Thus, the amendments to Rule 1.17(a)(1)(i)(A) and 
(a)(1)(ii)(A) will have a corresponding impact on various FCM and 
independent IB activities or obligations referred to elsewhere in Rule 
1.17.35
---------------------------------------------------------------------------

    \34\ See 60 FR 63995, 63997.
    \35\ The other provisions of Rule 1.17 referred to herein are 
discussed at 60 FR 63995, 63996.
---------------------------------------------------------------------------

III. Approval of Prepayment of Subordinated Debt

    The Commission also proposed in December 1995 to codify a Division 
``no-action'' letter 36 by amending Commission Rule 
1.17(h)(2)(vii)(C) generally to require submission by an FCM or 
independent IB of a request for approval of prepayment of subordinated 
debt only to its DSRO.37 However, the Commission also proposed 
that dual approval by the DSRO and the Commission would be required if 
the requested prepayment would result in a reduction of 20 percent or 
more of the firm's adjusted net capital.38
---------------------------------------------------------------------------

    \36\ CFTC Interpretative Letter No. 85-17, [1984-1986 Transfer 
Binder] Comm. Fut. L. Rep. (CCH) para. 22,738 (Sept. 10, 1985).
    \37\ In those rare instances where the registrant is not a 
member of any SRO (which would mean that it could not handle 
customer business), such a request would be submitted to the 
Commission.
    \38\ The Commission made clear when it proposed this amendment 
that if a firm's subordinated debt amounts to 25 percent of its 
adjusted net capital and the firm wishes to prepay all outstanding 
subordinated debt and simultaneously enter into new subordinated 
debt arrangements for the same amount, but with a different maturity 
date or interest rate, dual approval would not be required since 
there would be no net effect on the firm's adjusted net capital. 
Similarly, if a firm wanted to convert subordinated debt to paid-in 
capital, dual approval would not be required so long as such 
conversion did not result in a reduction of 20 percent or more of 
the firm's adjusted net capital. 60 FR 63995, 63997-98.
---------------------------------------------------------------------------

    FIA supported the amendment as proposed, but NFA, CBT and CME each 
raised objections to a requirement for dual approval by the DSRO and 
the Commission where prepayments of subordinated debt would reduce a 
firm's adjusted net capital by at least 20 percent. The commenters 
stated that DSROs have demonstrated the capability to competently 
handle prepayment of subordinated debt during the past ten years of the 
no-action period. CME stated that a firm will be required to provide 
notice of a decrease of 20 percent or more in adjusted net capital 
pursuant to Rule 1.12(g), as discussed above. CBT recommended that the 
Commission make clear that a prepayment of subordinated debt that 
results in a decrease of 20 percent or more in adjusted net capital 
constitutes a reporting event to the Commission.39 NFA recommended 
that approval of such prepayment should only be required by the DSRO, 
which in turn should be required to provide the Commission with notice 
of any such approvals.
---------------------------------------------------------------------------

    \39\ The comment letters referred to the adjusted net capital 
standard in the proposal. As noted above, the amendments to Rule 
1.12(g) as adopted are based upon a reduction in a firm's net 
capital or excess adjusted net capital.
---------------------------------------------------------------------------

    The Commission has considered this issue in light of the comments 
received and the other rule amendments it is announcing herein, 
particularly Rule 1.12(g) discussed above. The Commission believes that 
dual approval by the DSRO and the Commission need not be required for 
prepayment of subordinated debt, even if such prepayment would reduce 
an FCM's or independent IB's net capital by 20 percent or more or its 
excess adjusted net capital by 30 percent or more. In such cases, 
however, the DSRO must immediately provide the Commission with a copy 
of any notice of approval of prepayment of subordinated debt issued to 
an FCM or an independent IB.40
---------------------------------------------------------------------------

    \40\ This requirement is in addition to the current requirement 
that each DSRO report monthly to the regional office of the 
Commission nearest to it all actions taken with respect to 
subordinated loan agreements. Division of Trading and Markets 
Financial and Segregation Interpretation No. 4-1, para. 25, 1 Comm. 
Fut. L. Rep. (CCH) para. 7114A, at 7102 (July 29, 1985).
---------------------------------------------------------------------------

IV. Gross Collection of Exchange-Set Margins

    The Commission also proposed in December 1995 to amend Rule 1.58, 
which governs gross collection of exchange-set margin for omnibus 
accounts, to make it applicable to omnibus accounts carried by FCMs for 
foreign brokers. The Commission made this proposal because, in view of 
the

[[Page 19184]]

increasing internationalization of the financial markets, and in 
particular the increasing use of foreign omnibus accounts, the 
Commission believed that foreign broker omnibus accounts should be 
treated in the same manner as omnibus accounts carried for domestic 
FCMs. The Commission also noted that the proposals would conform Rule 
1.58 to the industry practice since, as a result of staff 
recommendations in rule enforcement reviews and SRO rule changes, all 
active U.S. contract markets other than the New York Cotton Exchange 
and the Philadelphia Board of Trade require that FCMs collect margin 
for omnibus accounts of foreign brokers as well as other domestic FCMs 
on a gross basis.
    FIA, CBT and CME supported the proposed amendment to Rule 1.58 and 
the Commission has determined to adopt this amendment as 
proposed.41 The Commission believes that gross collection of 
exchange-set margin at the clearing firm materially improves financial 
control over the positions carried through omnibus accounts.
---------------------------------------------------------------------------

    \41\ A fuller discussion of this issue is set forth in the 
proposing release. 60 FR 63995, 63998.
---------------------------------------------------------------------------

V. Receivables From Foreign Brokers

    Commission Rule 1.17(c)(5)(xiii) requires that an FCM or 
independent IB, when computing its adjusted net capital, take a charge 
against its net capital based upon:

    Five percent of all unsecured receivables includable under 
paragraph (c)(2)(ii)(D) of this section used by the applicant or 
registrant in computing `net capital' and which are not receivable 
from (A) a registered futures commission merchant, or (B) a broker 
or dealer which is registered as such with the Securities and 
Exchange Commission.42

    \42\ This charge relates to funds deposited by an FCM with a 
foreign broker for clearing transactions on non-U.S. markets, as 
distinct from the exclusion from current assets for debit/deficit 
accounts under Rule 1.17(c)(2)(i), where a customer of the FCM has a 
debt to the FCM.
---------------------------------------------------------------------------

This provision has been unchanged since it was adopted by the 
Commission as part of the major overhaul of the minimum financial and 
related reporting requirements in 1978.43 In 1978, foreign futures 
business was totally unregulated and foreign options were banned.
---------------------------------------------------------------------------

    \43\ 43 FR 39956, 39975 (Sept. 8, 1978).
---------------------------------------------------------------------------

    By letter dated January 12, 1996 to the Division, the Joint Audit 
Committee 44 requested that the Commission exempt from the five 
percent capital charge set forth in Rule 1.17(c)(5)(xiii) those 
unsecured receivables from a foreign broker that has been granted 
``comparability relief'' under Commission Rule 30.10.45
---------------------------------------------------------------------------

    \44\ The Joint Audit Committee (JAC) is composed of 
representatives of all U.S. futures SROs. It was established to 
coordinate audit and financial surveillance, plans, policies and 
procedures, particularly with respect to FCMs that are members of 
more than one SRO. Responsibility for monitoring firms that are 
members of more than one SRO is allocated among the SROs under a 
Joint Audit Plan in which all of the exchanges and NFA participate.
    \45\ 17 CFR 30.10 (1995). Part 30 of the Commission's rules 
governs foreign futures and options transactions (i.e., commodity 
interest transactions entered into by a person located in the U.S. 
on or subject to the rules of a foreign board of trade) and 
generally requires, among other things, that persons engaged in such 
transactions for or on behalf of customers located in the U.S. 
register under the Act. However, the Part 30 rules contain an 
exemptive provision pursuant to which the Commission may exempt a 
firm located outside the U.S. from the application of certain of the 
Commission's rules based upon substituted compliance by the firm 
with corresponding regulatory requirements of the foreign 
jurisdiction in areas such as registration, minimum financial 
requirements, safeguarding of customer funds, record-keeping and 
reporting requirements, and sales practice standards, and subject to 
certain conditions primarily related to the protection of customer 
funds.
    The relief is granted to firms designated by a foreign entity 
such as the United Kingdom Securities and Investments Board or the 
Association of Futures Brokers and Dealers (U.K.). A listing of 
these entities is set forth in Appendix C to the Commission's Part 
30 rules.
---------------------------------------------------------------------------

    When the Commission adopted Rule 1.17(c)(5)(xiii) in 1978, there 
were no Part 30 rules and the Commission had little interaction with 
foreign regulators compared to what it has in that regard today. 
Indeed, many foreign jurisdictions had no developed regulatory 
structure for the futures industry at that time. The Commission was 
therefore concerned that unsecured receivables from foreign brokers 
represented greater risk to a firm's financial condition than those 
from a registered FCM or BD, and should be subject to an additional 
capital charge. The increased cooperation among regulators globally and 
enhancement of capital standards monitoring today as compared to 1978 
justifies a reconsideration of the appropriateness of Commission Rule 
1.17(c)(5)(xiii). The Commission also notes that registered FCMs and 
BDs today may have large exposures in a jurisdiction such as the U.K. 
and an unsecured receivable from such an FCM or BD would not be subject 
to a haircut whereas the same receivable from a U.K. affiliate of a 
U.S. firm would be subject to the five percent charge so the five 
percent charge is a regulatory rather than a location charge.
    Based upon its consideration of this issue, the Commission has 
determined to add a proviso to Rule 1.17(c)(5)(xiii) such that the 
haircut will not apply to an unsecured receivable due from a foreign 
broker if the receivable represents deposits required to maintain 
futures and commodity option positions (i.e., ``excess'' deposits by an 
FCM with a foreign broker are still subject to the five percent 
charge), the foreign broker has been granted comparability relief 
pursuant to Commission Rule 30.10 and the receivable is held in 
compliance with the customer funds protection requirements of the 
relevant Commission order made under Rule 30.10 by the foreign broker 
itself, with another foreign broker that has been granted comparability 
relief under Commission Rule 30.10, or at a depository in the same 
jurisdiction as either foreign broker that would qualify as a 
depository for funds in accordance with Commission Rule 30.7. 
Essentially, the Commission is interpreting the existing rule to treat 
``Rule 30.10 firms'' akin to a registered FCM, provided the conditions 
about the nature and location of the receivable are also met. As this 
relieves a burden on FCMs and independent IBs in computing their 
adjusted net capital, and follows a request for such relief by the JAC 
on behalf of the member firms of the SROs, the Commission finds good 
cause that it is unnecessary to publish this rule amendment for public 
comment.46 However, although the Commission is publishing this 
amendment as a final rule, it would encourage any interested parties to 
submit comments on this amendment.
---------------------------------------------------------------------------

    \46\ See 5 U.S.C. 553(b) (1994). Preliminary review of data 
related to this charge by the Commission's staff indicates that 
these receivables are not a substantial asset for most firms. The 
Commission also notes that its staff will review firms' financial 
statements to determine if unsecured receivables from foreign 
brokers are a substantial portion, such as 25 percent, of a firm's 
assets and, if so, may undertake discussions with the firms 
concerning the circumstances involved.
---------------------------------------------------------------------------

VI. Related Matters

A. Regulatory Flexibility Act

    The Regulatory Flexibility Act (RFA), 5 U.S.C. 601-611 (1994), 
requires that agencies, in proposing rules, consider the impact of 
those rules on small businesses. The rule amendment discussed herein 
would affect FCMs and independent IBs. The Commission has previously 
determined that, based upon the fiduciary nature of FCM/customer 
relationships, as well as the requirement that FCMs meet minimum 
financial requirements, FCMs should be excluded from the definition of 
small entity.47
---------------------------------------------------------------------------

    \47\ See 47 FR 18618, 18619 (Apr. 30, 1982).
---------------------------------------------------------------------------

    With respect to IBs, the Commission stated that it is appropriate 
to evaluate within the context of a particular rule whether some or all 
IBs should be considered to be small entities and, if

[[Page 19185]]

so, to analyze the economic impact on such entities at that 
time.48 The amendments to Rules 1.17(c)(5)(xiii) and (h)(2)(vii) 
eliminate the capital charge for unsecured receivables from certain 
foreign brokers and reduce the burden associated with the procedure to 
obtain approval for prepayment of subordinated debt, respectively. 
Accordingly, these amendments impose no additional requirements on an 
independent IB. In addition, the amendment to the minimum adjusted net 
capital requirement for an IB conforms the Commission's requirement to 
that of the NFA and therefore there should be no impact on an IB's 
financial operations. Therefore, these rule amendments will not have a 
significant economic impact on a substantial number of small entities.
---------------------------------------------------------------------------

    \48\ See 48 FR 35248, 35275-78 (Aug. 3, 1983).
---------------------------------------------------------------------------

B. Paperwork Reduction Act

    The Paperwork Reduction Act of 1980 (PRA), 44 U.S.C. 3501 et seq. 
(1994), 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 submitted the December 1994 proposed rule 
amendments and their associated information collection requirements to 
the Office of Management and Budget. The burden associated with that 
entire collection (3038-0024) including the December 1994 proposed rule 
amendments, is as follows:
    Average Burden Hours Per Response: 18.00.
    Number of Respondents: 1,782.
    Frequency of Response: annually, quarterly and on occasion.
    The burden associated with the December 1994 proposed rule 
amendments was as follows:
    Average Burden Hours Per Response: 1.00.
    Number of Respondents: 12.
    Frequency of Response: on occasion.
    The Office of Management and Budget approved the December 1994 
submission concerning collection 3038-0024 on February 1, 1995.
    When the Commission proposed rule amendments in December 1995, it 
noted that the proposed rule amendments had no burden,49 although 
Rules 1.12, 1.17 and 1.58 are part of groups of rules with the 
following burdens.
---------------------------------------------------------------------------

    \49\ The proposed increase in the dollar amount of minimum 
adjusted net capital for an FCM and IB would necessitate only a 
change in line item 23E of the Statement of the Computation of 
Minimum Capital Requirements on Form 1-FR-FCM and in line item 15 of 
that Statement on Form 1-FR-IB, as well as a calculation of the 
minimum adjusted net capital requirement based upon a firm's branch 
offices and APs.
---------------------------------------------------------------------------

    The burden associated with the collection required by Rules 1.12 
and 1.17 (3038-0024), including the rule amendments proposed in 
December 1995, is as noted above. The burden associated with the 
collection required by Rule 1.58 (3038-0026), including the rule 
amendments proposed in December 1995, is as follows:

A. Reporting
    Average Burden Hours Per Response: 0.04.
    Number of Respondents: 100.00.
    Frequency of Response: daily.
B. Recordkeeping
    Average Burden Hours Per Response: 1.00.
    Number of Respondents: 300.00
    Frequency of Response: annually.

    Persons wishing to comment on the estimated paperwork burden 
associated with these rule amendments should contact Jeff Hill, Office 
of Management and Budget, room 3228, NEOB, Washington, DC 20503 (202) 
395-7340. Copies of the information collection submissions to OMB are 
available from Joe F. Mink, CFTC Clearance Officer, 1155 21st Street, 
NW., Washington, DC 20581, (202) 418-5170.

List of Subjects in 17 CFR Part 1

    Commodity futures, Minimum financial requirements.

    In consideration of the foregoing, and pursuant to the authority 
contained in the Commodity Exchange Act, and in particular Sections 
4f(b), 4f(c), 4g and 8a, 7 U.S.C. 6f(b), 6f(c), 6g, and 12a, the 
Commission hereby amends Part 1 of Chapter I of Title 17 of the Code of 
Federal Regulations as follows:

PART 1--GENERAL REGULATIONS UNDER THE COMMODITY EXCHANGE ACT

    1. The authority citation for Part 1 continues to read as follows:

    Authority: 7 U.S.C. 1a, 2, 2a, 4, 4a, 6, 6a, 6b, 6c, 6d, 6e, 6f, 
6g, 6h, 6i, 6j, 6k, 6l, 6m, 6n, 6o, 6p, 7, 7a, 7b, 8, 9, 12, 12a, 
12c, 13a, 13a-1, 16, 16a, 19, 21, 23 and 24.

    2. Section 1.12 is amended by removing the word ``or'' at the end 
of paragraph (b)(2), by redesignating paragraph (b)(3) as paragraph 
(b)(4), by adding a new paragraph (b)(3), by adding paragraphs (f)(4) 
and (f)(5) and by revising the introductory text of paragraph (g), 
paragraph (g)(1) and paragraph (g)(2) to read as follows:


Sec. 1.12  Maintenance of minimum financial requirements by futures 
commission merchants and introducing brokers.

 * * * * *
    (b) * * *
    (3) 150 percent of the amount of adjusted net capital required by a 
registered futures association of which it is a member; or
* * * * *
    (f) * * *
    (4) A futures commission merchant shall report immediately whenever 
any commodity interest account it carries is subject to a margin call, 
or call for other deposits required by the futures commission merchant, 
that exceeds the futures commission merchant's excess adjusted net 
capital, determined in accordance with Sec. 1.17, and such call has not 
been answered by the close of business on the day following the 
issuance of the call. This applies to all accounts carried by the 
futures commission merchant, whether customer, noncustomer, or omnibus, 
that are subject to margining, including commodity futures and options. 
In addition to actual margin deposits by an account owner, a futures 
commission merchant may also take account of favorable market moves in 
determining whether the margin call is required to be reported under 
this paragraph.
    (f)(5)(i) A futures commission merchant shall report immediately 
whenever its excess adjusted net capital is less than six percent of 
the maintenance margin required by the futures commission merchant on 
all positions held in accounts of a noncustomer other than a 
noncustomer who is subject to the minimum financial requirements of:
    (A) A futures commission merchant, or
    (B) The Securities and Exchange Commission for a securities broker 
and dealer.
    (ii) For purposes of paragraph (f)(5)(i), maintenance margin shall 
include all deposits which the futures commission merchant requires the 
noncustomer to maintain in order to carry its positions at the futures 
commission merchant.
    (g) A futures commission merchant shall provide written notice of a 
substantial reduction in capital as compared to that last reported in a 
financial report filed with the Commission pursuant to Sec. 1.10. This 
notice shall be provided as follows:
    (1) If any event or series of events, including any withdrawal, 
advance, loan or loss cause, on a net basis, a reduction in net capital 
(or, if the futures commission merchant is qualified to use the filing 
option available under Sec. 1.10(h), tentative net capital as defined 
in the rules of the Securities and Exchange Commission) of 20 percent 
or more, notice must be provided within two business days of

[[Page 19186]]

the event or series of events causing the reduction; and
    (2) If equity capital of the futures commission merchant or a 
subsidiary or affiliate of the futures commission merchant consolidated 
pursuant to Sec. 1.10(f) (or 17 CFR 240.15c3-1e) would be withdrawn by 
action of a stockholder or a partner or by redemption or repurchase of 
shares of stock by any of the consolidated entities or through the 
payment of dividends or any similar distribution, or an unsecured 
advance or loan would be made to a stockholder, partner, sole 
proprietor, employee or affiliate, such that the withdrawal, advance or 
loan would cause, on a net basis, a reduction in excess adjusted net 
capital (or, if the futures commission merchant is qualified to use the 
filing option available under Sec. 1.10(h), excess net capital as 
defined in the rules of the Securities and Exchange Commission) of 30 
percent or more, notice must be provided at least two business days 
prior to the withdrawal, advance or loan that would cause the 
reduction: Provided, however, That the provisions of paragraphs (g)(1) 
and (g)(2) of this section do not apply to any futures or securities 
transaction in the ordinary course of business between a futures 
commission merchant and any affiliate where the futures commission 
merchant makes payment to or on behalf of such affiliate for such 
transaction and then receives payment from such affiliate for such 
transaction within two business days from the date of the transaction.
* * * * *
    3. Section 1.17 is amended as follows:
    3.1. By revising paragraph (a)(1);
    3.2. By revising paragraph (c)(5)(xiii);
    3.3. By removing the word ``or'' at the end of paragraph 
(e)(1)(ii), by redesignating paragraph (e)(1)(iii) as (e)(1)(iv), and 
by adding a new paragraph (e)(1)(iii);
    3.4. By removing the word ``or'' at the end of paragraph 
(h)(2)(vi)(C)(2), by redesignating paragraph (h)(2)(vi)(C)(3) as 
paragraph (h)(2)(vi)(C)(4), and by adding a new paragraph 
(h)(2)(vi)(C)(3);
    3.5. By removing the word ``or'' at the end of paragraph 
(h)(2)(vii)(A)(2), by redesignating paragraph (h)(2)(vii)(A)(3) as 
paragraph (h)(2)(vii)(A)(4) and, as redesignated, revising it, and by 
adding a new paragraph (h)(2)(vii)(A)(3);
    3.6. By removing the word ``or'' at the end of paragraph 
(h)(2)(vii)(B)(2), by redesignating paragraph (h)(2)(vii)(B)(3) as 
paragraph (h)(2)(vii)(B)(4) and, as redesignated, revising it, and by 
adding new paragraphs (h)(2)(vii)(B)(3) and (h)(2)(vii)(C);
    3.7. By removing the word ``or'' at the end of paragraph 
(h)(2)(viii)(A)(2), by redesignating paragraph (h)(2)(viii)(A)(3) as 
paragraph (h)(2)(viii)(A)(4), and by adding a new paragraph 
(h)(2)(viii)(A)(3);
    3.8. By removing the word ``or'' at the end of paragraph 
(h)(3)(ii)(B), by redesignating paragraph (h)(3)(ii)(C) as paragraph 
(h)(3)(ii)(D), and by adding a new paragraph (h)(3)(ii)(C); and
    3.9. By redesignating paragraphs (h)(3)(v)(C) and (D) as paragraphs 
(h)(3)(v)(D) and (E) and by adding a new paragraph (h)(3)(v)(C). The 
revised and added paragraphs read as follows:


Sec. 1.17  Minimum financial requirements for futures commission 
merchants and introducing brokers.

    (a)(1)(i) Except as provided in paragraph (a)(2)(i) of this 
section, each person registered as a futures commission merchant must 
maintain adjusted net capital equal to or in excess of the greatest of:
    (A) $250,000;
    (B) Four percent of the following amount: The customer funds 
required to be segregated pursuant to the Act and these regulations and 
the foreign futures or foreign options secured amount, less the market 
value of commodity options purchased by customers on or subject to the 
rules of a contract market or a foreign board of trade: Provided, 
however, That the deduction for each customer shall be limited to the 
amount of customer funds in such customer's account(s) and foreign 
futures and foreign options secured amounts;
    (C) The amount of adjusted net capital required by a registered 
futures association of which it is a member; or
    (D) For securities brokers and dealers, the amount of net capital 
required by Rule 15c3-1(a) of the Securities and Exchange Commission 
(17 CFR 240.15c3-1(a)).
    (ii) Except as provided in paragraph (a)(2) of this section, each 
person registered as an introducing broker must maintain adjusted net 
capital equal to or in excess of the greatest of:
    (A) $30,000;
    (B) The amount of adjusted net capital required by a registered 
futures association of which it is a member; or
    (C) For securities brokers and dealers, the amount of net capital 
required by Rule 15c3-1(a) of the Securities and Exchange Commission 
(17 CFR 240.15c3-1(a)).
* * * * *
    (c) * * *
    (5) * * *
    (xiii) Five percent of all unsecured receivables includable under 
paragraph (c)(2)(ii)(D) of this section used by the applicant or 
registrant in computing ``net capital'' and which are not receivable 
from
    (A) A registered futures commission merchant, or
    (B) A broker or dealer which is registered as such with the 
Securities and Exchange Commission: Provided, however, That if the 
unsecured receivable represents deposits required to maintain futures 
and commodity option positions, is receivable from a broker which has 
been granted comparability relief pursuant to Sec. 30.10 of this 
chapter, and is held by the broker itself, with another foreign broker 
that has been granted comparability relief under Sec. 30.10 of this 
chapter, or at a depository in the same jurisdiction as either foreign 
broker that would qualify as a depository for funds in accordance with 
Sec. 30.7 of this chapter, and, in the case of customer funds, is held 
in accordance with the special requirements of the applicable 
Commission order issued under Sec. 30.10 of this chapter, there will be 
no charge.
* * * * *
    (e) * * *
    (1) * * *
    (iii) 120 percent of the amount of adjusted net capital required by 
a registered futures association of which it is a member; or
* * * * *
    (h) * * *
    (2) * * *
    (vi) * * *
    (C) * * *
    (3) 120 percent of the amount of adjusted net capital required by a 
registered futures association of which it is a member; or
* * * * *
    (vii) * * *
    (A) * * *
    (3) 120 percent of the amount of adjusted net capital required by a 
registered futures association of which it is a member; or
    (4) For an applicant or registrant which is also a securities 
broker or dealer, the amount of net capital specified in Rule 15c3-
1d(b)(7) of the Securities and Exchange Commission (17 CFR 240.15c3-
1d(b)(7)).
    (B) * * *
    (3) 120 percent of the amount of adjusted net capital required by a 
registered futures association of which it is a member; or
    (4) For an applicant or registrant which is also a securities 
broker or dealer, the amount of net capital specified in Rule 15c3-
1d(c)(5)(ii) of the Securities and Exchange Commission (17 CFR 
240.15c3-1d(c)(5)(ii)): Provided, however, That no special prepayment 
shall be made if pre-tax losses during the latest three-month period 
were greater than 15 percent of current excess adjusted net capital.

[[Page 19187]]

    (C) Notwithstanding the provisions of paragraphs (h)(2)(vii)(A) and 
(h)(2)(vii)(B) of this section, in the case of an applicant, no 
prepayment or special prepayment shall occur without the prior written 
approval of the National Futures Association; in the case of a 
registrant, no prepayment or special prepayment shall occur without the 
prior written approval of the designated self-regulatory organization, 
if any, or of the Commission if the registrant is not a member of a 
self-regulatory organization. The designated self-regulatory 
organization shall immediately provide the Commission with a copy of 
any notice of approval issued where the requested prepayment or special 
prepayment will result in the reduction of the registrant's net capital 
by 20 percent or more or the registrant's excess adjusted net capital 
by 30 percent or more.
    (viii) * * *
    (A) * * *
    (3) 120 percent of the amount of adjusted net capital required by a 
registered futures association of which it is a member; or
* * * * *
    (3) * * *
    (ii) * * *
    (C) 120 percent of the amount of adjusted net capital required by a 
registered futures association of which it is a member; or
* * * * *
    (v) * * *
    (C) 120 percent of the amount of adjusted net capital required by a 
registered futures association of which it is a member;
* * * * *
    4. Section 1.58 is revised to read as follows:


Sec. 1.58  Gross collection of exchange-set margins.

    (a) Each futures commission merchant which carries a commodity 
futures or commodity option position for another futures commission 
merchant or for a foreign broker on an omnibus basis must collect, and 
each futures commission merchant and foreign broker for which an 
omnibus account is being carried must deposit, initial and maintenance 
margin on each position reported in accordance with Sec. 17.04 of this 
chapter at a level no less than that established for customer accounts 
by the rules of the applicable contract market.
    (b) If the futures commission merchant which carries a commodity 
futures or commodity option position for another futures commission 
merchant or for a foreign broker on an omnibus basis allows a position 
to be margined as a spread position or as a hedged position in 
accordance with the rules of the applicable contract market, the 
carrying futures commission merchant must obtain and retain a written 
representation from the futures commission merchant or from the foreign 
broker for which the omnibus account is being carried that each such 
position is entitled to be so margined.

    Issued in Washington, D.C. on April 25, 1996, by the Commission.
Jean A. Webb,
Secretary of the Commission.
[FR Doc. 96-10714 Filed 4-30-96; 8:45 am]
BILLING CODE 6351-01-P