[Federal Register Volume 63, Number 4 (Wednesday, January 7, 1998)]
[Proposed Rules]
[Pages 695-707]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 98-240]


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 Proposed Rules
                                                 Federal Register
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 This section of the FEDERAL REGISTER contains notices to the public of 
 the proposed issuance of rules and regulations. The purpose of these 
 notices is to give interested persons an opportunity to participate in 
 the rule making prior to the adoption of the final rules.
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  Federal Register / Vol. 63, No. 4 / Wednesday, January 7, 1998 / 
Proposed Rules  

[[Page 695]]


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COMMODITY FUTURES TRADING COMMISSION

17 CFR Part 1


Account Identification for Eligible Bunched Orders

AGENCY: Commodity Futures Trading Commission.

ACTION: Proposed rules.

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SUMMARY: The Commodity Futures Trading Commission (``Commission'') is 
reproposing to amend Commission Regulation 1.35(a-1) to allow eligible 
customer orders to be placed on a contract market without specific 
customer account identification either at the time of order placement 
or at the time of report of execution.1 Specifically, the 
amendment would exempt from the customer account identification 
requirements of Regulation 1.35(a-1) (1), (2)(i), and (4) bunched 
futures and/or futures option orders placed by an eligible account 
manager on behalf of consenting eligible customer accounts as part of 
its management of a portfolio also containing instruments which are 
either exempt from regulation pursuant to the Commission's regulations 
or excluded from regulation under the Commodity Exchange Act (``Act''). 
The proposed rule would permit orders entered on behalf of these 
accounts to be allocated no later than the end of the day on which the 
order is executed.

    \1\ The Commission published a proposed amendment to Regulation 
1.35(a-1) on May 3, 1993. 58 FR 26270 (May 3, 1993).
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DATES: Comments must be received on or before March 9, 1998.

ADDRESSES: Interested persons should submit their views and comments to 
Jean A. Webb, Secretary, Commodity Futures Trading Commission, Three 
Lafayette Centre, 1155 21st Street, N.W., Washington, D.C. 20581. In 
addition, comments may be sent by facsimile transmission to facsimile 
number (202) 418-5521, or by electronic mail to [email protected]. 
Reference should be made to ``Eligible orders.''

FOR FURTHER INFORMATION CONTACT: Duane C. Andresen, Special Counsel, 
Division of Trading and Markets, Commodity Futures Trading Commission, 
Three Lafayette Centre, 1155 21st Street, N.W., Washington, D.C. 20581. 
Telephone: (202) 418-5490.

SUPPLEMENTARY INFORMATION:

Table of Contents

I. Background
    A. Current Regulatory Requirements
    B. Proposed Amendment to CME Rule 536
    C. Proposed Amendment to Regulation 1.35(a-1)
    1. Predetermined Allocation Formulas
    2. End-of-Day Allocation to Eligible Customers
II. Reproposed Amendment to Commission Regulation 1.35(a-1)
    A. Eligible Orders
    1. Proposed Regulation 1.35(a-1)(6)(i)
    2. Comments Received
    3. Reproposed Regulation 1.35(a-1)(5)(i)
    B. Eligible Account Managers
    1. Proposed Regulation 1.35(a-1)(6)(ii)
    2. Comments Received
    3. Reproposed Regulation 1.35(a-1)(5)(ii)
    C. Eligible Customers
    1. Proposed Regulation 1.35(a-1)(6)(iii)
    (a). 1.35(a-1)(6)(iii)(A)--Types of Customers
    (b). 1.35(a-1)(6)(iii)(B)--Proprietary Interest
    2. Comments Received
    (a). 1.35(a-1)(6)(iii)(A)--Types of Customers
    (b). 1.35(a-1)(6)(iii)(B)--Proprietary Interest
    3. Reproposed Regulation 1.35(a-1)(5)(iii)
    (a). 1.35(a-1)(5)(iii)(A)--Types of Customers
    (b). 1.35(a-1)(5)(iii)(B)--Proprietary Interest
    D. Account Certification
    1. Proposed Regulation 1.35(a-1)(6)(iv)
    2. Comments Received
    3. Reproposed Regulation 1.35(a-1)(5)(iv)
    E. Allocation
    1. Proposed Regulation 1.35(a-1)(6)(v)
    2. Comments Received
    3. Reproposed Regulation 1.35(a-1)(5)(v)
    F. Recordkeeping
    1. Proposed Regulation 1.35(a-1)(6)(vi)
    2. Comments Received
    3. Reproposed Regulation 1.35(a-1)(5)(vi)
    G. Contract Market Rule Enforcement Programs
    1. Proposed Regulation 1.35(a-1)(6)(vii)
    2. Comments Received
    3. Reproposed Regulation 1.35(a-1)(5)(vii)
III. Conclusion
IV. Other Matters
    A. Regulatory Flexibility Act
    B. Paperwork Reduction Act

I. Background

A. Current Regulatory Requirements

    Commission regulations specify that customer orders must be 
recorded promptly and include customer account identification at the 
time of entry and the time of report of execution. These recordkeeping 
requirements, in effect since March 24, 1972, permit a specific 
customer's order to be traced at each stage of the order processing 
system and help to prevent the improper allocation of trades and other 
abuses. Specifically, Commission Regulation 1.35(a-1)(1) requires that 
each futures commission merchant (``FCM'') and each introducing broker 
(``IB'') receiving a customer's order immediately prepare a written 
record of that order, which includes an account identifier for that 
customer. Regulation 1.35(a-1)(2)(i) requires that each member of a 
contract market who receives a customer's order on the floor of a 
contract market that is not in writing immediately prepare a written 
record of that order, including the appropriate customer account 
identification. Regulation 1.35(a-1)(4) requires, among other things, 
that each member of a contract market reporting the time of execution 
of a customer's order from the floor of a contract market include the 
account identification on a written record of that order.

B. Proposed Amendment to CME Rule 536

    By letters dated February 24, 1992, CME submitted both a proposed 
amendment to CME Rule 536 pursuant to Section 5a(12) of the 
Act,2 7 U.S.C. 1 et seq., and a petition for rulemaking to 
amend Commission Regulation 1.35(a-1) pursuant to Commission Regulation 
13.2.3 As discussed below, the Commission published requests 
for comments on both submissions.
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    \2\ Now redesignated as Section 5a(a)(12)(A).
    \3\ The Exchange submitted additional information regarding the 
proposed rule amendment in letters dated May 7, 1992, and August 12, 
1992. By letter dated August 20, 1992, the Division of Trading and 
Markets posed a series of questions to the Exchange. The CME 
responded in a letter dated September 25, 1992.
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    The proposed CME rule amendment would have exempted from the 
customer account designation requirement certain orders entered by 
investment advisers registered with the Securities and Exchange 
Commission (``SEC'') pursuant to the Investment

[[Page 696]]

Advisers Act of 1940, 15 U.S.C. 80b et seq. [1988], and banks, 
insurance companies, trust companies, and savings and loan institutions 
subject to federal or state regulation (``account 
managers'').4 These orders could have been placed only for 
certain specified institutional accounts whose owners had been notified 
in writing that their orders were being placed without customer account 
designations. The orders would have been required to be allocated among 
participating accounts prior to the end of the day. Finally, the 
individual or firm directing the allocation of the orders could not 
have a proprietary interest in any account that received any part of 
the order, and no related-party account could receive any part of the 
order.
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    \4\ The term account manager hereinafter is used to include 
investment advisers and other persons identified in the proposed 
regulation, and their principals, if any, who would place orders and 
direct the allocation thereof in accordance with the procedures set 
forth in the reproposed amendment.
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    On June 8, 1992, the Commission published the proposed amendment to 
CME Rule 536 for public comment. 5 The Commission received 
31 comments in response to the CME's proposal. Twenty-six of the 
comments evidenced support for the proposed rule amendment, four were 
opposed to the amendment,6 and one recommended 
caution.7 Those comments were addressed in the Commission's 
subsequent proposed amendment to Regulation 1.35 and are not addressed 
herein.
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    \5\ 57 FR 24251.
    \6\ Commenters opposed to approval of the proposed rule 
amendment included a Commission Administrative Law Judge; his law 
clerk; the Director, Office of Financial Enforcement, Department of 
the Treasury; and the Chief, White-Collar Crimes Section, Criminal 
Investigative Division, Federal Bureau of Investigation. These 
commenters expressed concern that, by weakening the audit trail, the 
proposal could facilitate misallocation, money laundering and tax 
evasion.
    \7\ The United States Attorney for the Northern District of 
Illinois urged that the Commission ``exercise great care before 
taking any action that could provide any opportunity for fraud, 
self-dealing, or other criminal activity.''
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C. Proposed Amendment to Regulation 1.35(a-1)

    On May 3, 1993, the Commission published proposed amendments to 
Regulation 1.35(a-1) for public comment.8 In addition to 
amending Regulations 1.35(a-1)(1), (2), and (4), the Commission 
proposed to add paragraphs 1.35(a-1)(5) and (6). Paragraph (5) 
addressed the placement and allocation of bunched orders generally and 
the use of predetermined allocation formulas. Paragraph (6) was the 
Commission's followup to CME's proposal to permit the allocation of 
certain bunched orders at the end of the day.
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    \8\ 58 FR 26274 (May 3, 1993).
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1. Predetermined Allocation Formulas
    Proposed Regulation 1.35(a-1)(5) would have permitted the placement 
of a bunched order for multiple customer accounts without individual 
customer account identification at the time of entry and the time of 
report of execution, subject to certain requirements.9 
Proposed Regulation 1.35(a-1)(5) is being withdrawn because it has been 
superseded. On May 9, 1997, the Commission published a Notice of 
Interpretation and Approval Order approving the National Futures 
Association (``NFA'') Interpretative Notice to NFA Compliance Rule 2-10 
Relating to the Allocation of Block Orders for Multiple Accounts and 
providing additional Commission guidance regarding bunched orders and 
allocation procedures.10 The guidance provided therein has 
been published as Appendix C to Part One of the Commission's 
regulations.
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    \9\ Those requirements included providing an allocation formula 
for allocating the fills fairly among the participating accounts. 
Directing profitable fills to favored accounts and unprofitable 
fills to unfavored accounts (preferential allocation) is a violation 
of Section 4b of the Act. In the Matter of GNP Commodities, Inc., et 
al., [1990-1992 Transfer Binder] Comm. Fut. L. Rep. (CCH) para. 
25,360 at 39,214 (CFTC August 11, 1992); In the Matter of 
Lincolnwood Commodities, Inc., of California, et al., [1982-1984 
Transfer Binder] Comm. Fut. L. Rep. (CCH) para. 21,986 at 28,246 
(CFTC January 31, 1984).
    \10\ 62 FR 25470 (May 9, 1997).
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2. End-of-Day Allocation to Eligible Customers
    Under proposed Regulation 1.35(a-1)(6), contract markets could have 
submitted rules for Commission approval that would have exempted 
certain orders from the requirement that a specific customer account be 
identified at the time of entry and the time of report of execution if 
specified requirements were met. These orders could have been allocated 
at the end of the day. The specific requirements of the proposal 
addressed: (a) Eligible orders, (b) eligible account managers, (c) 
eligible customers, (d) account certification, (e) allocation 
requirements, (f) account manager recordkeeping, and (g) contract 
market rule enforcement programs. The Commission stated that the 
proposed regulation would encourage and facilitate institutional 
participation in the futures markets subject to customer protection 
requirements that were consistent with the sophistication of the 
institutional customers.
    The Commission received 34 comments in response to the proposed 
amendments to Regulation 1.35(a-1).11 Commenters included 
eleven FCMs; 12 one investment adviser registered with the 
SEC; 13 seven firms registered with both the Commission and 
the SEC; 14 four commodity trading advisors (``CTA''); 
15 three industry associations; 16 the CME, the 
Chicago Board of Trade (``CBT''), and the NFA.17
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    \11\ Only those comments addressing proposed paragraph 1.35(a-
1)(6) are addressed herein.
    \12\ BA Futures, Inc. (``BA''); Cargill Investor Services 
(``Cargill''); Credit Agricole Futures, Inc. (``Credit Agricole''), 
which is also registered as a CTA; Dean Witter Reynolds, Inc., 
Futures Division (``Dean Witter''); First Boston Corporation 
(``First Boston''); Lind-Waldock & Company (``Lind-Waldock''); 
PaineWebber Incorporated (``PaineWebber''); Refco, Inc. (``Refco''); 
Rodman & Renshaw, Inc. (``Rodman''); Sanwa-BGK Futures, Inc. 
(``Sanwa-BGK''); and Saul Stone and Company (``Saul Stone'').
    \13\ Pacific Investment Management Company (``Pacific'').
    \14\ Bear, Stearns & Co., Inc. (``Bear Stearns''); Flaherty & 
Crumrine Inc. (``Flaherty''); Goldman, Sachs & Co. (``Goldman 
Sachs''); Indosuez Carr Futures, Inc. (``Carr''); Merrill Lynch; 
Morgan Stanley & Co. (``Morgan Stanley''); and TSA Capital 
Management (``TSA'').
    \15\ Campbell Company (``Campbell''); John W. Henry & Co., Inc. 
(``John Henry''); Leland O'Brien Rubinstein Associates Inc. 
(``Leland''); and Sunrise Commodities, Inc. (``Sunrise'').
    \16\ Futures Industry Association (``FIA''), Managed Futures 
Association (``MFA''), and Investment Company Institute (``ICI'').
    \17\ The Commission also received comments from the New York 
City Bar Association (``N.Y. Bar'') and a law firm, Abramson and 
Fox.
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    Most commenters found the proposed rule burdensome and too 
restrictive to be of value. In particular, these commenters objected to 
the proposed requirement for an intermarket trading strategy involving 
securities and to the recordkeeping and certification requirements. Two 
comments from the same commenter opposed the proposal,18 and 
one raised concerns about money laundering.19 The Commission 
has carefully reviewed the comments received and, as a result, has 
modified and clarified the proposed amendments to Regulation 1.35(a-1). 
Comments addressing specific areas and an explanation of the 
Commission's revisions are discussed below.
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    \18\ The commenter, who submitted two comments, was a Commission 
Administrative Law Judge. He opposed the proposal because of the 
potential for fraud, money laundering and tax evasion. He further 
commented that the industry has failed to articulate a compelling 
need and that the real reason to do so, the desire to increase 
account managers' flexibility and conform commodity regulation to 
security regulation, does not justify adoption of a system so open 
to abuse.
    \19\ The Chief, Money Laundering Section, Criminal Division, 
Department of Justice, asked that the Commission consider the 
proposal's impact on future money laundering and other law 
enforcement investigations.

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[[Page 697]]

II. Reproposed Amendment to Commission Regulation 1.35(a-1)

    The Commission is reproposing to amend Regulation 1.35(a-1). Under 
reproposed Regulation 1.35(a-1)(5) (formerly 1.35(a-1)(6)), a specific 
customer's account identifier need not be recorded at the time an 
eligible bunched order (``eligible order'') is placed or upon report of 
execution, and the order may be allocated by the end of the day on 
which it is executed, provided that certain requirements are met. In 
addition, the order must be handled in accordance with contract market 
rules that have been submitted to the Commission and approved or 
permitted into effect pursuant to Section 5a(a)(12)(A) of the Act and 
Regulation 1.41. The Commission intends that this reproposal include 
certain core regulatory protections while providing meaningful 
regulatory relief in a manner which is responsive to the comments 
previously received. In the discussion below, the Commission sets forth 
each of the components of its 1993 proposal, a summary of the comments 
then received, and the manner in which the reproposal addresses the 
same issue.

A. Eligible Orders

1. Proposed Regulation 1.35(6)(a-1)(i)
    Proposed Regulation 1.35(6)(a-1)(i) would have required that orders 
entered and allocated pursuant to the proposed regulation must be 
intermarket orders. The term intermarket order was defined as a futures 
or futures option order entered on behalf of an eligible customer as 
part of a bona fide intermarket trading strategy also involving 
securities. The term ``securities'' was defined to mean equity or debt 
securities within the meaning of Section 2(1) of the Securities Act of 
1933.
    This requirement was based on the stated rationale for allowing 
post-trade allocation, which was to permit account managers to provide 
equivalent treatment to customers' accounts traded pursuant to 
strategies involving activity in both futures markets and securities 
markets. For example, if a securities trade is allocable at the end of 
the day and the account manager follows a strategy of buying securities 
and selling futures, with the futures order to be executed throughout 
the day, the account manager may need to await the results of all 
transactions before allocating to the accounts so as to provide 
equivalent treatment. Similarly, for strategies such as duration 
management, where futures transactions are executed on the basis of a 
change in interest rates that affects the price of the bonds in an 
underlying portfolio, the procedure could be used to maintain positions 
of a specified duration under circumstances when this result could not 
be achieved through the use of a predetermined allocation formula.
2. Comments Received
    With regard to the proposal's description of eligible orders, most 
commenters focussed on two issues: the definition of ``intermarket'' 
and the definition of ``securities.'' Numerous commenters suggested 
that the proposal should not be limited to intermarket strategies based 
on a securities requirement and suggested expanding the definition of 
``intermarket'' to include trading strategies that did not involve 
securities directly.\20\ In addition to concerns about the definition 
of intermarket, several commenters voiced the opinion that the 
definition of ``securities'' was too restrictive.\21\ Several 
commenters indicated that the proposal appeared to require a 
transaction test, i.e., that the securities and futures executions 
would be required to occur simultaneously.\22\
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    \20\ Bear Stearns, Dean Witter, Goldman Sachs, Carr, Morgan 
Stanley, Lind-Waldock, TSA, NFA, ICI, N.Y. Bar, CME and CBT.
    CME stated that many other instruments, such as forex and 
commodity and interest rate swaps, are used as part of investment 
strategies and should not be excluded from the proposed amendments. 
CBT commented that the exemption should cover strategies that 
include foreign products and off-exchange products such as swaps. 
The ICI stated that the ``intermarket'' requirement should be 
deleted and that all orders entered on behalf of investment 
companies that are registered with the SEC under the Investment 
Company Act of 1940 should be presumed to be eligible orders.
    \21\ Bear Stearns, Dean Witter, Lind-Waldock, Merrill Lynch, and 
Pacific.
    \22\ The CME noted that a requirement that the futures and 
securities executions must occur simultaneously would inhibit the 
use of duration adjustments, overlay, and other strategies. Goldman 
Sachs commented that the Commission should make clear that the 
proposed rule did not require that the futures transaction be 
related to specific securities transactions, provided that it is 
related to the management of a securities portfolio. Morgan Stanley 
voiced similar concerns.
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3. Reproposed Regulation 1.35(a-1)(5)(i)
    After consideration of the comments, the Commission believes that 
it would be appropriate to delete the term ``intermarket'' as the 
descriptive term used to identify eligible orders. The Commission also 
agrees with the commenters in recognizing that appropriate multi-market 
investment management strategies can involve futures and/or futures 
options and financial instruments other than securities. Thus, the 
Commission is proposing to eliminate the requirement that the trading 
strategy also involve securities. The Commission also wants to make 
clear that eligible orders would be subject to a portfolio test and not 
a transaction test.
    As previously noted, the overriding rationale for allowing post-
trade allocation is to permit equivalent treatment of customers' 
accounts traded pursuant to strategies involving trading activity or 
changes in valuation in more than one market. The Commission believes 
that the account manager, in his or her role as a fiduciary, should be 
permitted to determine that the portfolio management strategy requires 
the placement of this type of order. Generally, this situation exists 
when accounts are being traded in more than one market and the account 
manager must review the results of trading activity in all markets 
prior to directing order allocation in order to assure fairness. Of 
course, it would not be permissible for a purported portfolio to be 
established solely to obtain the relief being proposed. Rather, the 
other financial instruments included in the portfolio must have a 
legitimate financial relationship to the futures or futures option 
orders for post-trade allocation to be appropriate.
    Where trades are executed only on domestic futures exchanges, the 
account manager should be able to achieve equivalent treatment of 
customers' accounts while complying with either the existing customer 
account identifier requirements of Regulation 1.35(a-1)(1) and (2)(i) 
or the predetermined allocation formula exceptions thereto as described 
in Appendix C to Part One of the Commission's regulations. In 
particular, for futures-only orders executed on one domestic futures 
exchange, average pricing would be available to provide fair treatment 
among customers. Accordingly, the Commission is proposing that to be 
eligible, orders must be placed as part of the management of a 
portfolio also containing instruments which are either exempt from 
regulation pursuant to the Commission's regulations or excluded from 
Commission regulation under the Act.
    The Commission has been advised that there may be instances where a 
CTA placing exchange traded futures-only orders on more than one 
futures exchange may need post-trade allocation in order to achieve 
equivalent treatment of customers' accounts. The Commission requests 
comments with regard to whether that relief is necessary. Any comments 
should provide specific examples illustrating why the use of 
predetermined allocation formulas or average pricing is insufficient to 
provide fair treatment.

[[Page 698]]

B. Eligible Account Managers

1. Proposed Regulation 1.35(a-1)(6)(ii)
    Proposed Regulation 1.35(a-1)(6)(ii) would have required that the 
person placing and/or directing the allocation of an eligible order and 
its principal, if any, (``account manager'') must be one of the 
following which had been granted investment discretion with regard to 
the eligible customer accounts:
    (i) an investment adviser registered with the SEC pursuant to the 
Investment Advisers Act of 1940, or
    (ii) a bank, insurance company, trust company, or savings and loan 
association subject to federal or state regulation.
    As proposed, the class of persons eligible to place intermarket 
orders and direct the end-of-day allocation thereof would have been 
identical to that suggested by CME. The Commission believed that, when 
managing multiple accounts, these entities might be better able to 
achieve similar results for institutional accounts being traded 
pursuant to a program which involved multi-market trading strategies. 
Under the proposed regulation, account managers for these types of 
accounts would have been able to allocate futures and futures option 
trades in the same manner as they allocated trades on securities 
exchanges and over-the-counter markets.\23\ Additionally, these 
entities' fiduciary activities were subject to oversight by various 
state or federal regulatory agencies.
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    \23\ See, e.g., Interpretation 88-3 of New York Stock Exchange 
Rule 410(a)(3): ``Member organizations may accept block orders and 
permit investment advisors to make allocations on such orders to 
customers and remain in compliance with Rule 410(a)(3) provided that 
the organizations receive specific account designations or customer 
names by the end of the business day.'' See also Securities and 
Futures Authority Rule Book. Rule 5-41 allows a firm to aggregate 
customers' orders when it is unlikely to disadvantage the customer 
and the firm has disclosed that orders may be aggregated. Rule 5-
34(13), averaging of prices, allows a firm to execute a series of 
transactions within a 24-hour period to meet orders it has 
aggregated. When a firm has aggregated orders, Rule 5-42 specifies 
that the firm must not give unfair preference and if all the orders 
cannot be satisfied, the firm generally must give priority to 
satisfying customer orders.
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2. Comments Received
    Numerous commenters suggested that the list of eligible account 
managers be expanded to include other entities. The suggested 
additional entities include CTAs,24 foreign investment 
advisers subject to regulation in their home jurisdiction,25 
non-U.S. investment advisers registered with the Commission or 
otherwise exempt from registration pursuant to Regulation 
30.10,26 and investment advisers exempt from SEC 
registration under Section 203(b)(3) of the Investment Advisers Act of 
1940.27 Finally, CBT proposed that the proposal should be 
modified to afford sufficient flexibility to allow exchanges to include 
any account manager that is regulated and subject to fiduciary 
liability.
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    \24\ Campbell, First Boston, John Henry, Merrill Lynch, Morgan 
Stanley, PaineWebber, FIA, and NFA. The N.Y. Bar recommended that 
CTAs be considered after the rule had been evaluated.
    \25\ First Boston, Goldman Sachs, Merrill Lynch, and Morgan 
Stanley.
    \26\ Carr and N.Y. Bar.
    \27\ First Boston and N.Y. Bar.
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3. Reproposed Regulation 1.35(a-1)(5)(ii)
    After consideration of the comments, the Commission believes that 
it is appropriate to expand the list of eligible account managers to 
include CTAs registered with the Commission pursuant to the 
Act.28 Because CTAs also attempt to achieve equivalent 
treatment of customers' accounts traded pursuant to strategies 
involving trading activity in more than one market, the Commission 
believes that the relief afforded by this provision should be extended 
to these account managers. In addition, CTAs are subject to Commission 
and NFA regulatory requirements and oversight, including periodic 
audits by the NFA.
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    \28\ Where applicable, the employing firm of an account manager 
should have appropriate internal controls in place to address the 
added discretion that the account manager will be able to exercise 
pursuant to this proposal.
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    The Commission is not including as eligible account managers non-
U.S. investment advisers registered with the Commission or otherwise 
exempt from registration pursuant to Regulation 30.10 and foreign 
investment advisers subject to regulation in their home jurisdiction. 
The Commission is concerned about potential difficulty in auditing 
these entities and in obtaining documentation required to be made 
available pursuant to the recordkeeping requirements discussed below. 
The Commission specifically requests comments concerning this 
determination. The Commission also requests comments with regard to its 
determination not to include, at present, investment advisers exempt 
from SEC registration under Section 203(b)(3) of the Investment 
Advisers Act of 1940.

C. Eligible Customers

1. Proposed Regulation 1.35(a-1)(6)(iii)
(a). 1.35(a-1)(6)(iii)(A)--Types of Customers
    Proposed Regulation 1.35(a-1)(6)(iii)(A) provided that intermarket 
orders could be allocated to accounts maintained by any of the 
following institutional customers:
    (i) An Investment Company registered as such under the Investment 
Company Act of 1940, 15 U.S.C. 80a et seq. [1988].
    (ii) A bank, trust company, insurance company or savings and loan 
association subject to federal or state regulation.
     (iii) An account for which a bank, trust company, insurance 
company or savings and loan association subject to federal or state 
regulation is a fiduciary vested with investment discretion.
    (iv) A corporate qualified pension, profit sharing, or stock bonus 
plan subject to Title 1 of the Employee Retirement Income Security Act 
of 1974 (``ERISA''), or any plan defined as a governmental plan in 
Section 3(32) of Title 1 of such Act, but not including a self-directed 
plan.
    (v) An educational endowment, foundation, charitable institution or 
trust which is organized or qualifies under Section 501(c)(3) of the 
Internal Revenue Code with net assets of more than $100 million.
    This group of proposed eligible customers was substantially the 
same as that included in the proposed amendment to CME Rule 536. The 
CME and certain institutional customers represented that professional 
managers of multi-market portfolios needed the flexibility afforded by 
CME's proposed rule amendment to treat similarly managed accounts 
fairly. Further, the Commission believed that those customers were 
institutional investors whose accounts were subject to other regulatory 
regimes or a portfolio size requirement and who participated in multi-
market investment strategies. Therefore, these customers could benefit 
from use of the proposed regulation. The Commission further believed 
the proposed eligible customer accounts were owned by entities with the 
capacity to review and evaluate the accounts' trading activity and 
results.
(b). 1.35(a-1)(6)(iii)(B)--Proprietary Interest
    Proposed Regulation 1.35(a-1)(6)(iii)(B) provided that the 
following persons may have no interest in any account that receives any 
part of such order or in any related securities account:
    (i) The account manager;
    (ii) The futures commission merchant allocating the order;
    (iii) Any general partner, officer, director, or owner of ten 
percent or more of the equity interest in the account manager or the 
futures commission merchant allocating the order;

[[Page 699]]

    (iv) Any employee or associated person or limited partner of the 
account manager or the futures commission merchant allocating the order 
who affects or supervises the handling of the order;
    (v) Any business affiliate that, directly or indirectly, controls, 
is controlled by, or is under common control with, the account manager 
or the futures commission merchant allocating the order;
    (vi) An employee benefit plan of the account manager, the futures 
commission merchant allocating the order, or an affiliate, as defined 
in subparagraph (v) above; or
    (vii) Any spouse, parent, sibling, or child of the foregoing 
persons.
    The Commission believed, based on its experience with misallocation 
of trades, that the ability to allocate fills between customer and 
proprietary accounts subsequent to execution would have created an 
unacceptably high potential for favoring the proprietary 
accounts.29 The Commission further believed that the ability 
to allocate fills subsequent to execution while maintaining a 
proprietary interest in a related securities account also would have 
created an unacceptably high potential for abuse.30 The 
Commission, therefore, believed that prohibiting the account manager, 
the allocating FCM, and their related or affiliated persons, from 
having any interest in either the futures or a related securities 
account was a preventive approach that effectively eliminated the 
possibility of preferential allocation for personal gain.
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    \29\ See, e.g., In the Matter of GNP Commodities, Inc., et al., 
[1990-1992 Transfer Binder] Comm. Fut. L. Rep. (CCH) para.25,360 
(CFTC August 11, 1992); In the Matter of Lincolnwood Commodities, 
Inc., of California, et al., [1982-1984 Transfer Binder] Comm. Fut. 
L. Rep. (CCH) para.21,986 (CFTC January 31, 1984); Parciasepe v. 
Shearson Hayden Stone, Inc., et al., [1980-1982 Transfer Binder] 
Comm. Fut. L. Rep. (CCH) para.21,461 (CFTC August 18, 1982); Wilke, 
et al., v. Winchester-Hardin Oppenheimer Trading Co., et al., [1977-
1980 Transfer Binder] Comm. Fut. L. Rep. (CCH) para.20,605 (CFTC 
December 29, 1977).
    \30\ The CME's proposed rule amendment would have prohibited the 
individual or firm directing the allocation of the order from having 
a proprietary interest in any account that received any part of such 
order. Commission Regulation 1.3(y) defines a proprietary account to 
include the ownership of ten percent or more of a futures or option 
trading account. Therefore, the proposed CME amendment would have 
permitted the person or firm directing the allocation to have an 
interest of less than ten percent of one or more of the accounts 
receiving part of the allocated order.
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2. Comments Received
(a). 1.35(a-1)(6)(iii)(A)--Types of Customers
    Numerous commenters suggested that the list of eligible customers 
be expanded to include other entities. Several commenters suggested 
that the list be expanded to include ``appropriate persons'' as 
described in Section 4(c)(3) of the Act 31 or eligible swap 
participants.32 One commenter suggested expanding the list 
to include either ``appropriate persons'' or ``accredited investor'' as 
set forth in Rule 501 (Regulation D) of the Securities Act of 
1993.33 Four commenters stated that domestic and foreign 
corporations should be eligible customers.34 Commenters also 
suggested including large, sophisticated corporate investors 
35 and individuals or entities with assets in excess of $100 
million.36 One commenter suggested including a CTA acting 
for its proprietary account.37 Finally, one exchange 
recommended expanding the list to include ``appropriate persons'' and 
all those who qualify for exemptive relief under Commission Regulation 
4.7.38
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    \31\ Carr, Pacific, FIA, and CME. CME also proposed expanding 
the list to include foreign corporations.
    \32\ Dean Witter, First Boston, Lind-Waldock, and Morgan 
Stanley. Goldman Sachs suggested that the eligible customer 
restriction be eliminated because it would require account managers 
to treat their customers in a disparate manner and to disadvantage 
those customers who were not permitted to be included in a bunched 
order. In the alternative, Goldman Sachs recommended that the list 
be expanded to include eligible swap participants.
    \33\ Bear Stearns.
    \34\ Bear Stearns, Dean Witter, Lind-Waldock, and TSA.
    \35\  Flaherty.
    \36\ N.Y. Bar.
    \37\ First Boston. The N.Y. Bar suggested including FCMs, IBs, 
CTAs, and CPOs trading for their own accounts as eligible customers.
    \38\ CBT.
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(b). 1.35(a-1)(6)(iii)(B)--Proprietary Interest
    Many commenters believed the provision limiting proprietary 
interests was overly restrictive. Commenters stated that it would 
inhibit access to U.S. markets 39 and would result in unfair 
customer treatment.40 Two commenters pointed out that the 
provision would exclude certain publicly owned organizations from 
becoming eligible customers.41 Most commenters stated that 
the limit on proprietary interest should be less than 10 percent, which 
is consistent with the definition of proprietary interest contained in 
Commission Regulation 1.3(y).42 One commenter, however, 
stated that a de minimis provision exempting interests of less than one 
percent in participating accounts would be adequate.43
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    \39\ Credit Agricole and Refco.
    \40\ Bear Stearns asserted that it would be unfair to exclude 
otherwise eligible types of funds because the account manager was 
required to have a small interest in a partnership or contributed 
seed money at the start up of a mutual fund or was paid a management 
fee by the fund.
    \41\ Flaherty stated that a registered investment company would 
not be an eligible customer, for instance, if the investment adviser 
made a seed money investment in the initial shares issued by the 
fund or if officers of the account manager served on the Board of 
Directors of the fund and, held shares of the fund. In addition, it 
would be impossible for the account manager or the FCM allocating 
the order to know with certainty that no relative of any of the 
listed persons held any shares in a publicly owned corporation for 
whose account the transaction was executed.
    The ICI commented that the practical effect of the provision 
would be to disqualify most, if not all, investment advisers to 
investment companies from relying on the proposal. Additionally, it 
would be almost impossible for such investment advisers to assure 
compliance on an ongoing basis and it would impede the investment 
adviser's ability to act in the best interests of investment 
companies that were clients.
    \42\ Dean Witter, First Boston, Lind-Waldock, Pacific, FIA, N.Y. 
Bar, CBT, and CME. CME also suggested removing from the list of 
entities subject to the no interest provision ``[a]ny business 
affiliate that, directly or indirectly, controls, is controlled by, 
or is under common control with, the account manager or the futures 
commission merchant allocating the order.'' The CME posited that 
removing this provision would prevent managed accounts from being 
unnecessarily excluded from eligibility.
    \43\ Flaherty stated that while an FCM who is also an 
underwriter and a market maker for securities might want a higher 
percentage interest, permitting an owner of up to 10 percent of the 
interest in the account manager to hold an unlimited interest in a 
participating account would seem to invite possible abuse.
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3. Reproposed Regulation 1.35(a-1)(5)(iii)

(a). 1.35(a-1)(5)(iii)(A)--Types of Customers
    After consideration of the comments, the Commission believes that 
it is appropriate to expand the list of eligible customers. As 
reproposed, the group of eligible customers would be substantially 
similar to those entities defined as ``eligible participants'' for 
purposes of Part 36--Exemption of Section 4(c) Contract Market 
Transactions, of the Commission's regulations, except that sole 
proprietorships, floor brokers, floor traders, and natural persons, as 
well as self-directed employee benefit plans, would not be included as 
eligible customers.
    As the Commission stated in promulgating the final rules for Part 
36, the list of ``eligible participants'' was modeled on the list of 
``appropriate persons'' set forth in Section 4(c)(3)(A) through (J) of 
the Act and on the definition of ``eligible swap participant'' under 
Part 35 of the Commission's regulations.44 Having previously 
considered this group of entities and

[[Page 700]]

determined that they are eligible to participate both in exempt 
transactions and in swaps, the Commission believes that they are 
sufficiently sophisticated to monitor the results of post-trade 
allocations in their accounts. The Commission is incorporating into 
this paragraph the requirement that these entities, in order to be 
considered eligible customers, must have consented in writing that 
eligible orders may be placed, executed, and allocated for their 
accounts. The issue of consent is discussed below.
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    \44\ 60 FR 51328 (October 2, 1995).
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    The Commission does not believe, however, that accounts owned by 
sole proprietorships, floor brokers, floor traders, natural persons, or 
self-directed employee benefit plans should be included as eligible 
customers. The Commission believes that the eligible customers should 
be institutional or other comparatively large entities whose accounts 
are subject to other regulatory or management regimes and who may 
participate in multi-market investment strategies. Although the 
Commission recognizes that natural persons meeting certain asset or net 
worth standards may be sufficiently sophisticated to participate, the 
Commission believes that preferential allocations would be more likely 
to occur if accounts owned by individuals were included in eligible 
orders.45 The Commission requests comments regarding the 
proposed exclusion of natural persons as eligible customers.
---------------------------------------------------------------------------

    \45\ A review of preferential allocation cases reveals that 
misallocations, when they occur, often are made to personal or 
proprietary accounts or to accounts owned by family members.
---------------------------------------------------------------------------

(b). 1.35(a-1)(5)(iii)(B)--Proprietary Interest
    After consideration of the comments, the Commission has determined 
to modify the proposed provisions regarding ownership interest in any 
account that receives any part of an eligible order or in any related 
securities account. The Commission is deleting from the reproposal the 
interest requirement as it applies to any related securities account. 
As reproposed, the regulation requires that there be a portfolio 
containing instruments which are either exempt from regulation pursuant 
to the Commission's regulations or excluded from regulation under the 
Act rather than a related securities account.
    The Commission also is proposing to increase the acceptable level 
of ownership interest in any account that receives any part of an 
eligible order from no interest to an interest of less than ten 
percent, which is similar to the Commission's definition of proprietary 
interest as set forth in Regulation 1.3(y). The Commission is aware 
that the account manager may have ``seed'' money invested in the 
eligible account or, in fact, may invest in the account in order to 
attract other investors. In any event, the Commission believes that 
application of the less than ten percent restriction to the listed 
participants is an appropriate provision that would neither unduly 
restrict the placement of eligible orders nor increase the incentive to 
misallocate.
    Finally, the Commission is proposing to delete the following as one 
of the entities subject to the interest restriction: an employee 
benefit plan of the account manager, the futures commission merchant 
allocating the order, or an affiliate. These plans are subject to 
strict ERISA regulations.

D. Account Certification

1. Proposed Regulation 1.35(a-1)(6)(iv)
    Proposed Regulation 1.35(a-1)(6)(iv)(A) required that the account 
manager, before placing the initial order pursuant to this paragraph, 
certify the following, in writing, to the FCM allocating the order:
    (i) The account manager had no interest in any account to which any 
part of the order may be allocated or in any related securities 
account.
    (ii) The account was owned by an eligible customer.
    (iii) The customer had consented in writing that orders may be 
executed and allocated in accordance with this regulation.
    (iv) Orders for such account would be intermarket orders for which 
it would be impracticable to pre-file a predetermined allocation 
formula.
    (v) Records required by paragraph (a-1)(6)(vi)(A) of the regulation 
would be made available to the Commission or Department of Justice upon 
request of any representative thereof.
    In addition, proposed Regulation 1.35(a-1)(6)(iv)(B) required that 
the account manager, before placing the initial order pursuant to this 
paragraph, must provide the FCM allocating the order with a list of 
eligible accounts and their related securities accounts.
    The Commission believed that these safeguards addressed several 
purposes of the proposed regulation and were intended to reduce the 
likelihood of misallocation. In order to encourage compliance with the 
proposal's requirements, the account manager placing intermarket orders 
would have been required to certify to the FCM allocating the order 
that he or she had no interest in any account to which any part of an 
intermarket order may have been allocated or in any related securities 
account. The account manager also would have been required to certify 
that the accounts to which intermarket orders would be allocated were 
owned by eligible customers. These one-time certification requirements 
would have helped to assure that personal or proprietary accounts were 
not included among the accounts to which intermarket order allocations 
were made.
    With regard to customer consent, the Commission believed that 
notification was insufficient and that these institutional accounts 
should have the opportunity to consent affirmatively to participate in 
the intermarket allocation procedure.\46\ The Commission believed that 
customer consent was an important tool in assuring adequate customer 
oversight of trading activity. Drawing upon comments that the account 
controller had the relevant relationship with the customer for purposes 
of obtaining consent, the Commission believed that the account manager 
would be the appropriate party to obtain that consent and so certify to 
the FCM so that the FCM could assure that intermarket allocations were 
made only to the eligible accounts. The consent could have been 
contained in account opening documents or obtained separately.
---------------------------------------------------------------------------

    \46\ The CME's proposed amendment to Rule 536 would have 
required that the FCM notify the identified eligible account owners 
that orders for those accounts could be bunched and entered without 
individual customer account identification and allocated at the end 
of the day.
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    The proposed amendment was designed for the benefit of 
institutional accounts that were being traded pursuant to a strategy 
that involved related positions in both the futures and securities 
markets. The Commission believed that, whenever possible, the account 
manager should place and allocate the order by use of a predetermined 
allocation formula. The intermarket order allocation procedure was 
available where use of the predetermined allocation formula would not 
permit the account manager to attain equitable results. Thus, the 
Commission believed that a one-time certification that orders placed 
would be intermarket orders for which it would be impracticable to pre-
file a predetermined allocation formula was appropriate.
    The use of the post-trade order allocation procedure would have 
been limited to eligible accounts participating in regulated multi-
market trading and both the futures and the related securities accounts 
would have to have

[[Page 701]]

been identified to the FCM allocating the order.\47\ Additionally, the 
proposed regulation contained a requirement that the account manager 
agree that the records discussed in paragraph (vi)(A) of the proposed 
regulation would be made available to specified government agencies 
upon request.\48\
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    \47\ The identification of both the futures and securities 
accounts was believed to be necessary to assure that (1) use of the 
allocation procedure was restricted to eligible accounts 
participating in multi-market trading and (2) the related securities 
account was known in the event it became necessary to review the 
trading in both markets for possible violative activity.
    \48\ The Commission, although not the primary regulator of the 
account manager, recognized that it might require records of 
transactions in other markets which would not otherwise have been 
readily available in order to review allegations of preferential 
allocation.
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2. Comments Received
    Two commenters stated that all five certifications were unnecessary 
and duplicative.\49\ Numerous commenters opposed the requirement that 
the account manager certify that the customer had consented in writing 
that intermarket orders may be executed and allocated, stating that 
notification would be sufficient.\50\ Commenters also stated that the 
requirement to obtain consent would deter account managers from 
utilizing the markets in this manner \51\ and that it is inconsistent 
with practices in other markets \52\ and with the ability of account 
managers to monitor client activity and to perform in the client's best 
interest.\53\ One commenter agreed that customer consent should be in 
writing.\54\ Several commenters opposed the requirement that the 
account manager certify that the orders would be intermarket orders 
\55\ for which it would be impracticable to pre-file a predetermined 
allocation formula.\56\
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    \49\ CBT and CME. In addition, Morgan Stanley commented that, 
since it was the account manager's obligation to obtain the written 
consent, it seemed redundant to require that the FCM obtain such a 
certification.
    \50\ Dean Witter, Lind-Waldock, Pacific, PaineWebber, TSA, and 
FIA. Bear Stearns stated that the proposal should be clarified so 
that customer consent could be given when the customer signs the 
investment manager contract with the account manager and further 
stated that, for those customers with existing contracts, 
notification with the right of the customer to affirmatively opt out 
should be sufficient.
    \51\ Credit Agricole and PaineWebber.
    \52\ Credit Agricole, Pacific, and CME.
    \53\ Leland. Carr asserted that requiring the expert (account 
manager) to get written permission from the account owner to manage 
the assets in the best possible manner seemed a bit pointless.
    \54\ Flaherty.
    \55\ Leland, Lind-Waldock, TSA, and ICI. Carr commented that the 
requirement to identify the orders as part of an intermarket 
strategy undermined the proprietary nature and confidentiality of a 
trader's strategy. Morgan Stanley stated that the FCM would not be 
in a position to determine whether orders were in fact intermarket 
orders.
    \56\ ICI expressed concern regarding the standards by which 
impracticability would be judged. It recommended elimination of this 
component of the certification requirement.
---------------------------------------------------------------------------

    Numerous commenters stated that the requirement that the account 
manager must provide the FCM with a list of eligible accounts and their 
related securities accounts should be eliminated. Commenters felt that 
this requirement would result in the disclosure of proprietary 
information,57 would serve no useful purpose,58 
and would be overly burdensome because of the potentially large number 
of accounts at issue.59
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    \57\ Dean Witter, Lind-Waldock, TSA, FIA, ICI, CBT, and CME. 
Bear Sterns also stated that providing such information to the FCM 
might be a breach of the account manager's fiduciary duty. Pacific 
stated that it would breach customer confidence to share such 
information with FCMs. Goldman Sachs stated that, for reasons of 
confidentiality, account managers may not be willing to provide FCMs 
with the identification of securities accounts under their 
management. NFA commented that the burden imposed and the privacy 
concerns which may be raised outweighed the minimal benefit to be 
derived from requiring the account manager to provide the FCM with a 
list of related securities accounts.
    \58\ Credit Agricole, Dean Witter, Refco, and FIA. Goldman Sachs 
also stated that, even with the information, the FCM would be unable 
to make any meaningful assessment regarding the nature of the order. 
In addition, in some instances, such as overlay programs, the 
account manager might not have the ability to provide information 
because he or she may not control the accounts.
    \59\ Bear Sterns, Merrill Lynch, Pacific, PaineWebber, FIA, CBT, 
and CME.
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3. Reproposed Regulation 1.35(a-1)(5)(iv)
    After consideration of the comments received, the Commission has 
determined to reduce the required account manager certifications to 
one: any account manager placing eligible orders must certify, in 
writing, to each FCM executing and/or allocating any part of an 
eligible order, that he or she is aware of the provisions of this 
paragraph and is, and will remain, in compliance with the requirements 
therein. The Commission intends that this certification would encourage 
compliance by account managers and need be made only once to each 
applicable FCM, not on an order-by-order basis.60
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    \60\ Where the account manager places orders directly with a 
floor broker rather than an executing FCM, the certification need 
only be filed with each FCM allocating any part of an eligible order 
and not with the floor broker.
---------------------------------------------------------------------------

    The Commission believes that the responsibility for compliance with 
the eligible order provisions should generally fall on the account 
manager and his or her principal, if applicable.61 The 
Commission has become convinced that little regulatory benefit or 
additional customer protection would accrue from requiring the FCM to 
obtain other account manager certifications. The extent of the account 
manager's compliance with these requirements would be determined during 
audits and on a for-cause basis.
---------------------------------------------------------------------------

    \61\ Pursuant to Regulation 166.3, an account manager's 
employer, if registered with the Commission, has a duty diligently 
to supervise his or her activities. Regardless of registration 
status, a principal could be held liable for an account manager's 
wrongdoing under Section 2(a)(1)(A) of the Act.
---------------------------------------------------------------------------

    On the topic of customer consent, the Commission continues to 
believe that notification alone is insufficient and that these eligible 
accounts should have to consent affirmatively prior to participating in 
the post-trade allocation of eligible orders. This is particularly true 
in the context of the reproposal, which has streamlined and deleted 
many previously proposed requirements. As the Commission stated in the 
proposed rule, the account manager is the appropriate party to obtain 
that consent, either in account opening documents or 
separately.62
---------------------------------------------------------------------------

    \62\ Where applicable, the account manager's employing firm 
should be aware that an account manager has the client's consent to 
place eligible orders.
---------------------------------------------------------------------------

    The Commission has eliminated the requirement that the account 
manager must provide the FCM allocating the order with a list of 
related securities accounts. However, the reproposal continues to 
require that the account manager must provide a list of eligible 
futures accounts to the FCM allocating the order. This requirement 
should enable the FCM to assure that allocations are made only to 
eligible accounts.

E. Allocation

1. Proposed Regulation 1.35(a-1)(6)(v)
    Proposed Regulation 1.35(a-1)(6)(v) required the following:
    (1) Intermarket orders allocated pursuant to the regulation must be 
designated as such on the order at the time of entry.
    (2) Intermarket orders must be identified on contract market trade 
registers and other computerized trade practice surveillance records.
    (3) The account manager and the FCM allocating the order must 
allocate fills from intermarket orders to eligible participating 
customer accounts prior to the deadline for final submission of trade 
data to clearing on the day the intermarket order is executed.
    (4) The FCM allocating the order must assure that all intermarket 
orders are allocated to eligible customer accounts.

[[Page 702]]

    The Commission believed that these allocation requirements, in 
combination with the requirement that the account manager, the FCM, and 
their affiliates and related parties not have any interest in any 
participating account or related securities account, would limit the 
potential for self-dealing by the account manager and the FCM. It would 
also provide an audit trail reflecting the ultimate disposition of the 
order. Further, these requirements would be consistent with good 
business practice.
    When the order was placed, it would have to be identified as an 
intermarket order. The exchange would have to assure that the order was 
specially identified on the trade register and other computerized trade 
practice surveillance records. The account manager would have to 
provide allocation instructions for the entire order to the FCM prior 
to the deadline for final submission of trade data to clearing on the 
day the intermarket order was executed. Finally, the FCM would have to 
assure that the entire order was allocated to eligible customer 
accounts previously identified by the account manager.
2. Comments Received
    The CME and CBT stated that the proposed requirement that 
intermarket orders must be so designated at the time of entry was 
inappropriate because it could reveal proprietary information and would 
impose a costly regulatory burden.63 One commenter opposed 
the proposed requirement that these orders be identified on contract 
market trade registers and other records.64 Three 
commenters, while agreeing that allocations should occur by the end of 
the day, stated that the exchange, and not the Commission, should 
decide the trade submission deadlines.65 Finally, several 
commenters expressed concern about holding the FCM responsible for 
assuring that orders are allocated to eligible customer 
accounts.66
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    \63\ CBT also stated that no such requirement existed for 
securities transactions and that the requirement ignored the fact 
that the account manager was already under an existing regulatory 
scheme that imposed fiduciary duties. As previously noted, Carr 
commented that requiring that such orders be designated as part of 
an intermarket strategy undermines the proprietary nature and 
confidentiality of a trader's strategy.
    \64\ CBT stated that the requirement would lead to a costly 
regulatory burden and should be eliminated.
    \65\ FIA, CBT, and CME.
    \66\ Merrill Lynch. First Boston stated that imposing this 
requirement on the FCM failed to recognize that the FCM acts for the 
account manager and that it should be the account manager's 
responsibility to document and to use a fair and equitable 
allocation system. CBT stated that the FCM's allocation 
responsibilities should be limited to making allocations in 
accordance with the account manager's instructions and in a timely 
manner. Commenting on the proposed regulation generally, FIA stated 
that its focus should be to enable account managers the maximum 
latitude in placing trades subject to a fair, equitable and 
demonstrable allocation scheme, while recognizing that FCMs have no 
practical ability to supervise independent account controllers.
---------------------------------------------------------------------------

3. Reproposed Regulation 1.35(a-1)(5)(v)
    After consideration of the comments received, the Commission has 
determined to modify certain of the allocation requirements and to add 
one requirement. In addition, the Commission has reorganized this 
paragraph to include some of the originally proposed allocation 
requirements as recordkeeping requirements.
    The requirement that eligible orders must be so identified on the 
order at time of entry has been redesignated as a recordkeeping 
requirement. The Commission currently is proposing that each eligible 
order, as well as the account manager placing that order, be identified 
on the office order ticket, if applicable, and on the floor order 
ticket at the time of order placement. The Commission believes that the 
maintenance of a complete audit trail requires that eligible orders be 
properly identified from order placement through order allocation. The 
office and/or floor order ticket is the first step in this process.
    Identification of this kind would not appear to reveal any 
proprietary or trading strategy information. The executing and/or 
allocating FCM would not need to know the specifics of the other 
instruments in the portfolio. Moreover, the only accounts identified to 
an FCM would be those to which that FCM would be allocating fills 
either directly or through give-ups. Rather than identifying a trading 
strategy, the designator would only identify an eligible order that 
would be allocated pursuant to these procedures. The requirement that 
each transaction resulting from the execution of an eligible order be 
identified on contract market trade registers and other computerized 
trade practice surveillance records remains substantially unchanged. It 
is simply redesignated as a recordkeeping requirement.
    The reproposal would require that allocation of an eligible order 
must take place prior to the end of the day the order is executed, as 
specified by exchange rules for this purpose. Because this paragraph 
would also require that the account manager and the FCM allocating the 
order allocate fills to eligible participating customer accounts, the 
Commission is deleting as redundant the proposed separate paragraph 
that required that the FCM do so.67
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    \67\ When a trade is allocated to a specific eligible account, 
it belongs to that account and cannot be reallocated to any other 
eligible account. In re Collins, CFTC Docket No. 94-13, Slip op. at 
11-15 (CFTC Dec. 10, 1997).
---------------------------------------------------------------------------

    The Commission agrees that the account manager has the 
responsibility for employing a system that results in fair, equitable, 
and non-preferential allocations. As noted below, the account manager 
must, upon request, provide to the Commission or the Department of 
Justice records that, among other things, identify the trading strategy 
and demonstrate the fairness of the allocations. The FCM's allocation 
responsibilities generally should be limited to complying with 
instructions from the account manager. However, as previously noted, 
the account manager is required to provide the FCM allocating the order 
with a list of eligible accounts. If the FCM were directed to allocate 
eligible orders to accounts not included on the list, or if the FCM 
should become aware of what appear to be preferential allocations, the 
FCM is required to make a reasonable inquiry and, if appropriate, to 
refer the matter to a regulatory authority (i.e., the Commission, the 
NFA, or its designated self regulatory organization). In addition, the 
FCM must act consistently with its obligations under Regulation 166.3 
diligently to supervise the handling of its customer accounts.
    Finally, the Commission is proposing to add a new paragraph to the 
allocation requirements. Specifically, the Commission is proposing a 
requirement that allocations made pursuant to these procedures must be 
fair and non-preferential, taking into account the effect on each 
relevant portfolio in the bunched order.

F. Recordkeeping

1. Proposed Regulation 1.35(a-1)(6)(vi)
    Proposed Regulation 1.35(a-1)(6)(vi) required the following:
    (1) Each account manager must make available, upon request of the 
Commission or the United States Department of Justice, the records 
referred to in paragraph (iv) of the regulation and other records, 
including records of securities transactions, reflecting order 
placement and allocation to the participating customer accounts. These 
records must demonstrate the relationship between the futures and the 
other transactions, the allocations made, the basis for allocation, and 
the nature of the

[[Page 703]]

intermarket strategy. They should also permit reviewers to compare 
results obtained for different customers.
    (2) Each account manager shall make available for review, upon 
request of an eligible customer, documentation sufficient for the 
customer to compare its results with those of other customers. The 
other accounts for which intermarket orders are entered may be 
designated by symbols so that the identity of account holders is not 
disclosed.
    (3) Upon request, each FCM allocating intermarket orders at the 
direction of an account manager will exercise its best efforts to 
obtain from the account manager and to provide to the Commission or the 
Department of Justice records reflecting the related transactions in 
the securities accounts.
    In order that any allegation of misallocation or unfavorable 
treatment could be properly investigated, the Commission believed that 
the account manager should have been required to retain and to make 
available for review, upon request of the Commission or the Department 
of Justice, the investment management rationale for intermarket orders 
and allocations. In order to enhance customer protection and to 
simplify customer account review, the Commission believed that the 
account manager should have been required to make available for review, 
upon request of a customer, documentation sufficient for that customer 
to compare its results with those of other customers. The identity of 
other account holders for which intermarket orders were entered need 
not, however, have been disclosed to another customer.
    Finally, the Commission believed that the FCM allocating 
intermarket orders at the direction of an account manager should have 
been required, upon request of certain government agencies, to exercise 
its best efforts to obtain records reflecting the related transactions 
in the securities accounts. The determination that preferential 
allocation occurred could be accomplished only when all related 
transactions were examined and allocations in all markets were 
compared.\68\
---------------------------------------------------------------------------

    \68\ Based upon discussions with participants in the industry, 
the Commission believed that the documents, worksheets and computer 
programs that determined the allocation formula already were created 
and retained by account managers responsible for allocation 
decisions.
---------------------------------------------------------------------------

2. Comments Received
    Numerous commenters described the proposed recordkeeping 
requirements as burdensome,\69\ unnecessary,\70\ or unreasonable.\71\ 
Commenters addressing the proposed requirement to make documentation 
available to the customer to allow that customer to compare its results 
with those of other customers focussed both on the possible disclosure 
of proprietary or confidential information \72\ and on the limited 
value of such information to the customer.\73\ All commenters who 
addressed the issue opposed the proposed requirement that the FCM 
exercise its best efforts to obtain records reflecting securities 
transactions from the account manager.\74\
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    \69\ Credit Agricole, Goldman Sachs, Pacific, Refco, Saul Stone, 
and NFA.
    \70\ Goldman Sachs, Morgan Stanley, TSA, MFA, and NFA. CBT 
commented that the value of the recordkeeping requirements appeared 
to be minimal.
    \71\ Dean Witter and Lind-Waldock. CME commented that it was 
overreaching for the Commission to impose recordkeeping requirements 
on investment advisers that are otherwise regulated.
    \72\ Flaherty, First Boston, Carr, N.Y. Bar, and CBT. Carr 
commented that it doubted customers would authorize their account 
manager to release details of their trading activity in order for 
another managed account to verify the fairness of its allocations. 
The N.Y. Bar stated that it believed that many customers would 
object to such disclosure, even in the absence of the customer's 
identity. According to the N.Y. Bar, activity in a particular 
account could provide information which would serve to identify a 
particular customer, and even if the identity were shielded, 
customers and advisers may object to the release of information 
which would reveal market strategies.
    \73\ Pacific, CBT, and CME. Flaherty commented that the proposed 
requirement should be modified to data, rather than documentation, 
sufficient for the customer to compare its overall results with 
those of other customers. Flaherty also suggested that eligible 
customers be required to acknowledge in writing that they have been 
informed of their right to request information on comparative 
results.
    \74\ First Boston, Goldman Sachs, Carr, Merrill Lynch, Morgan 
Stanley, Pacific, FIA, NFA, N.Y. Bar, CBT, and CME. According to 
Flaherty, such a requirement would give FCMs substantial leverage 
for obtaining proprietary data of the account manager and its 
clients, would result in account managers switching to FCMs without 
securities operations, and would be unnecessary because the same 
data could be obtained directly from the account manager by the 
Commission or the Department of Justice.
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3. Reproposed Regulation 1.35 (a-1)(5)(vi)
    After consideration of the comments, the Commission has determined 
to modify the recordkeeping requirements originally proposed. As noted 
above, two items formerly identified as allocation requirements have 
been redesignated as recordkeeping requirements. Additionally, the 
Commission is proposing to add the requirement that the FCM carrying an 
eligible account to which an eligible order has been allocated must 
identify each trade resulting from the execution of an eligible order 
on confirmation statements provided to the affected account owner and/
or trustee. The Commission believes that the account owner should be 
informed of all aspects of transactions executed for his or her account 
in order to make informed decisions about the continued use of the 
eligible order procedures. The Commission is deleting the requirement 
that, upon request, the FCM allocating eligible orders exercise its 
best efforts to obtain documentation from the account manager. This 
requirement is unnecessary since the account manager already is 
required to provide such documentation directly to the Commission or 
the Department of Justice if requested.
    The Commission proposes to streamline the documentation that would 
be required to be made available to the Commission or the Department of 
Justice by the account manager. In addition to documentation reflecting 
customer consent to the placement and allocation of eligible orders, 
the account manager would be required to make available records 
reflecting (i) futures and option transactions,\75\ (ii) other 
transactions executed pursuant to the portfolio management strategy, 
and (iii) any other records that identify the strategy and relate to, 
or reflect upon, the fairness of the allocations. Thus, the reproposal 
does not identify with the same specificity the records required to be 
provided. Nonetheless, the account manager would have the 
responsibility to demonstrate, when records are requested or during 
regulatory authority audits, that allocations were made fairly.
---------------------------------------------------------------------------

    \75\ The account manager must create and retain a record 
reflecting the participation of all accounts in each eligible order, 
including the allocation of all fills.
---------------------------------------------------------------------------

    The Commission continues to believe that eligible customers should 
be able to compare results to other customers with similar accounts and 
investment strategies. Thus, the reproposal would require that the 
account manager make available, upon request of an eligible customer, 
data sufficient for that customer to compare its results with those of 
other relevant customers. In addition, the account manager must 
indicate in which of the other relevant customers it or the FCM has an 
interest. The Commission believes that describing the requirement in 
these terms permits the use of established methods used by 
sophisticated institutional investors in securities to measure and to 
compare performance. Data enabling the customer to perform such a 
comparison may be prepared so

[[Page 704]]

as not to disclose the identity of individual account holders.

G. Contract Market Rule Enforcement Programs

1. Proposed Regulation 1.35(a-1)(6)(vii)
    Proposed Regulation 1.35(a-1)(6)(vii) required that, as part of its 
rule enforcement program, each contract market that adopted rules 
allowing the placement of intermarket orders would have to assure that 
all fills resulting from these orders were identified on contract 
market trade registers and other computerized trade practice 
surveillance records. Each contract market, or the designated self-
regulatory organization (``DSRO'') of a member firm, would have to 
adopt an audit procedure to determine compliance with the following 
components of the regulation: recordkeeping requirements in paragraph 
(iv), account certification in paragraph (v), and allocation 
requirements in paragraph (vi).
    The Commission believed that this surveillance was necessary to 
deter possible unlawful activity and to ensure that an adequate audit 
trail existed for intermarket transactions. As part of its routine 
oversight of member firms, the exchange would have been required to 
assure that intermarket orders were correctly identified on exchange 
trade registers. The exchange or the DSRO would have been required to 
audit member firms to assure that (i) the order was allocated prior to 
the deadline for final submission of trade data to clearing on the day 
the intermarket order was executed; (ii) the order was allocated only 
to eligible participating institutional customer accounts whose owners 
had consented to the allocation; and (iii) the FCM received and 
retained required documents from the account managers.
2. Comments Received
    CME and CBT commented adversely on the audit procedures proposed to 
be imposed on exchanges. Both exchanges asserted that costs would be 
high and the benefit to market users would be minimal.
3. Reproposed Regulation 1.35(a-1)(5)(vii)
    The requirement that the contract market assure that all fills 
resulting from eligible orders are identified on trade registers and 
other computerized trade practice surveillance records is being 
retained as a proposed recordkeeping requirement. Therefore, it is 
being deleted from this paragraph as redundant. The remainder of this 
paragraph is substantially consistent with the paragraph originally 
proposed. The contract market must adopt audit procedures to determine 
compliance with the identified provisions of the reproposed regulation. 
Specifically, these provisions would include (i) the certification 
requirements; (ii) the requirement that orders must be allocated to 
eligible accounts by the end of the day; and (iii) the requirement that 
eligible orders must be so identified on trade registers, other 
surveillance records, order tickets, and customer confirmation 
statements. The Commission continues to believe that these requirements 
are necessary to deter possible unlawful activity and to ensure that an 
adequate audit trail is created for eligible transactions.

III. Conclusion

    The Commission is proposing, subject to certain core regulatory 
protections, to permit a limited number of regulated account managers 
to place orders for a defined group of eligible customers without 
providing specific customer account identifiers at the time of order 
placement.\76\ The Commission previously has identified all of these 
customers as eligible to enter swap agreements or execute Section 4(c) 
contract market transactions. The account managers would be required to 
allocate the order at the end of the day.\77\ As discussed below, in 
addition to the customer safeguards being reproposed, significant 
existing audit trail and recordkeeping requirements would remain 
applicable.
---------------------------------------------------------------------------

    \76\ The Commission believes that these core regulatory 
protections adequately address the issues raised by those who 
submitted comments opposed to either the proposed amendment to CME 
Rule 536 or the Commission's proposed amendment to Regulation 1.35.
    The Commission appreciates the views of the law enforcement 
authorities which commented on the previous proposed regulation and 
shares their desire that Commission-regulated futures and option 
markets not be used as a vehicle to commit serious financial crimes. 
It is with those concerns in mind that the Commission has crafted 
the protections incorporated into the reproposed regulation. These 
protections include specific eligibility requirements for account 
managers and customers and recordkeeping provisions intended to 
document fair and non-preferential treatment of customers. Coupled 
with the strong antifraud provisions of the Act and the Commission's 
rigorous supervision rule, these protections should insure that the 
proposed allocation procedure will not unduly threaten customer 
protection or market integrity. Rather, the rule should enable 
portfolio managers acting in a fiduciary capacity to handle customer 
interests across markets, without undermining any legitimate 
customer or law enforcement interests.
    \77\ End-of-day or post-trade allocation of bunched or block 
orders is permissible on foreign futures exchanges and in the cash 
and securities markets. The New York Stock Exchange (``NYSE''), for 
example, has permitted end-of-day allocation of securities block 
orders since October 1983. Interpretation 88-3 of NYSE Rule 
410(a)(3).
---------------------------------------------------------------------------

    Under the reproposal, the customer must consent in advance, in 
writing, that orders may be placed, executed, and allocated as eligible 
orders. Allocations of eligible orders must be fair and non-
preferential, taking into account the effect on the relevant portfolio 
of each customer in the bunched order. The account managers would be 
required to maintain records that would, among other things, reflect 
the portfolio management strategy and demonstrate the fairness of the 
allocations. These records would be available, upon request, to the 
Commission or the Department of Justice. The account manager would be 
required to provide the customer, upon request, with data sufficient to 
compare results with those of other relevant customers.
    The reproposal prohibits an account manager and his or her 
partners, officers, employees, and related parties and affiliates from 
having an interest of ten percent or more in any account to which he or 
she is allocating orders. This prohibition should diminish the 
incentive to make preferential allocations for personal gain. Because, 
in some instances, the FCM may be able to influence the fairness of the 
allocations, the same restriction would apply to the FCM allocating the 
order and its partners, officers, employees, and related parties and 
affiliates. In addition, the reproposed recordkeeping requirements 
would deter and facilitate detection of misallocations which may 
indirectly benefit the account manager.\78\ The reproposal would also 
require that an exchange that permits the placement, execution, and 
allocation of eligible orders must adopt, as part of its rule 
enforcement program, audit procedures to determine compliance with 
relevant provisions.
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    \78\ As a matter of state law and federal securities, 
commodities, or banking law, eligible account managers would have 
fiduciary responsibility for their investment management activities. 
Additionally, account managers would be subject to Section 4b, the 
general antifraud provision of the Act. Account managers who are 
also acting as commodity trading advisors or commodity pool 
operators, irrespective of registration status, would also be 
subject to Section 4o. The securities anti-fraud rules may also 
apply.
---------------------------------------------------------------------------

    Under the reproposal, an eligible order must be identified at time 
of placement on the floor order ticket and, if appropriate, on the 
office order ticket. The identity of the account manager must also be 
included on the order tickets. All trades resulting from the execution 
of an eligible order must be identified on exchange trade registers and 
computerized trade practice

[[Page 705]]

surveillance records. Finally, these trades must also be identified on 
confirmation statements provided to the customer accounts.
    Those requirements, in conjunction with existing audit trail 
requirements, should enable the Commission and self-regulatory 
organizations to track any eligible order from time of placement to 
allocation of fills. At time of placement, the order would be 
identified on order tickets. These order tickets would be timestamped 
upon receipt of the order. The order executions would be identified on 
exchange trade registers by, among other things, both time and price. 
The order tickets would be timestamped again to identify time of report 
of execution. The trading cards and/or order tickets would reflect the 
terms of the order executions. The subsequent allocation of the fills 
would be maintained on FCM and exchange records. Where it is the 
exchange's practice to do so, the allocation of the fills to specific 
customer accounts would be reflected on the exchange's final trade 
register. The order would be identified on confirmation statements sent 
to the owner of the account. Thus, an auditor could determine, among 
other things, the size and time of initial order placement, the times 
and prices of executions, the identities of accounts to which the fills 
were allocated, and the prices and quantities of the fills allocated 
thereto.
    The Commission encourages commenters to address the appropriateness 
of the balance being struck by this reproposal between protection of 
sophisticated market participants and regulatory reform. Additionally, 
the Commission encourages commenters to address the proposition that 
the relief being proposed herein, through an amendment to the 
Commission's recordkeeping requirements, might be achievable to some 
extent through enhanced customer disclosure and reliance on the account 
managers' fiduciary responsibility.

IV. Other Matters

A. Regulatory Flexibility Act

    The Regulatory Flexibility Act (``RFA''), 5 U.S.C. 601 et. seq., 
requires that agencies, in proposing rules, consider the impact of 
those rules on small businesses. The Commission has previously 
determined that contract markets,\79\ futures commission merchants,\80\ 
registered commodity pool operators,\81\ and large traders \82\ are not 
``small entities'' for purposes of the Regulatory Flexibility Act. The 
Commission has previously determined to evaluate within the context of 
a particular rule proposal whether all or some commodity trading 
advisors should be considered ``small entities'' for purposes of the 
Regulatory Flexibility Act and, if so, to analyze the economic impact 
on commodity trading advisors of any such rule at that time.\83\ 
Commodity trading advisors who would place eligible orders pursuant to 
these procedures would do so for multiple clients and would be 
participating as investment managers in more than one financial market. 
Accordingly, the Commission does not believe that commodity trading 
advisers should be considered ``small entities'' for purposes of this 
regulation.
---------------------------------------------------------------------------

    \79\ 47 FR 18618, 18619 (April 30, 1982).
    \80\ Id.
    \81\ Id. at 18620.
    \82\ Id.
    \83\ Id.
---------------------------------------------------------------------------

    Therefore, the Chairperson, on behalf of the Commission, hereby 
certifies, pursuant to 5 U.S.C. 605(b), that the action proposed to be 
taken herein will not have a significant economic impact on a 
substantial number of small entities.
    Proposed Regulation 1.35(a-1)(5) generally would apply to large 
users of the market. It would provide relief from individual account 
identification requirements, thereby providing those small entities who 
elect to use the relief with a less burdensome method for satisfying 
Commission Regulation 1.35 requirements.

B. Paperwork Reduction Act

    When publishing proposed rules, the Paperwork Reduction Act of 1995 
(Pub. L. 104-13 (May 13, 1995)) imposes certain requirements on federal 
agencies (including the Commission) in connection with their conducting 
or sponsoring any collection of information as defined by the Paperwork 
Reduction Act. In compliance with the Act, the Commission, through this 
rule proposal, solicits comments to:
    (1) evaluate whether the proposed collection of information is 
necessary for the proper performance of the functions of the agency, 
including the validity of the methodology and assumptions used; (2) 
evaluate the accuracy of the agency's estimate of the burden of the 
proposed collection of information, including the validity of the 
methodology and assumptions used; (3) enhance the quality, utility, and 
clarity of the information to be collected; and (4) minimize the burden 
of the collection of information on those who are to respond, including 
through the use of appropriate automated, electronic, mechanical, or 
other technological collection techniques or other forms of information 
technology, e.g., permitting electronic submission of responses.
    The Commission has submitted this proposed rule and its associated 
information collection requirements to the Office of Management and 
Budget. The burden associated with this entire collection (3038-0022), 
including this proposed rule, is as follows:
    Average burden hours per response: 3547.01.
    Number of Respondents: 11,011.00.
    Frequency of Response: On Occasion.
    The burden associated with this specific proposed rule is as 
follows:
    Average burden hours per response: 0.75.
    Number of Respondents: 400.00.
    Frequency of Response: On Occasion.
    Persons wishing to comment on the information which would be 
required by this proposed rule should contact the Desk Officer, CFTC, 
Office of Management and Budget, Room 10202, NEOB, Washington, DC 
20503, (202) 395-7340. Copies of the information collection submission 
to OMB are available from the CFTC Clearance Officer, 1155 21st Street, 
NW, Washington, DC 20581, (202) 418-5160.

List of Subjects in 17 CFR Part 1

    Brokers, Commodity futures, Commodity options, Consumer protection, 
Contract markets, Customers, Members of contract markets, 
Noncompetitive trading, Reporting and recordkeeping requirements, Rule 
enforcement programs.
    In consideration of the foregoing, and pursuant to the authority 
contained in the Commodity Exchange Act and, in particular, Sections 5, 
5a, 5b, 6(a), 6b, 8a(7), 8a(9) and 8c, 7 U.S.C. 7, 7a, 7b, 8(a), 8b, 
12a(7), 12a(9), and 12c, the Commission hereby proposes to amend 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 1.35 is proposed to be amended by revising paragraphs 
(a-1)(1), (2)(i), and (4) and by adding paragraph (a-1)(5) to read as 
follows:

[[Page 706]]

Sec. 1.35  Records of Cash Commodity, Futures, and Option Transactions

* * * * *
    (a-1) * * *
    (1) Each futures commission merchant and each introducing broker 
receiving a customer's or option customer's order shall immediately 
upon receipt thereof prepare a written record of the order including 
the account identification, except as provided in paragraph (a-1)(5) of 
this section, and order number, and shall record thereon, by timestamp 
or other timing device, the date and time, to the nearest minute, the 
order is received, and in addition, for option customers' orders, the 
time, to the nearest minute, the order is transmitted for execution.
    (2)(i) Each member of a contract market who on the floor of such 
contract market receives a customer's or option customer's order which 
is not in the form of a written record including the account 
identification, order number, and the date and time, to the nearest 
minute, the order was transmitted or received on the floor of such 
contract market, shall immediately upon receipt thereof prepare a 
written record of the order in nonerasable ink, including the account 
identification, except as provided in paragraph (a-1)(5) of this 
section or appendix C to this part, and order number and shall record 
thereon, by timestamp or other timing device, the date and time, to the 
nearest minute, the order is received.
* * * * *
    (4) Each member of a contract market reporting the execution from 
the floor of the contract market of a customer's or option customer's 
order or the order of another member of the contract market received in 
accordance with paragraphs (a-1)(2)(i) or (a-1)(2)(ii)(A) of this 
section, shall record on a written record of the order, including the 
account identification, except as provided in paragraph (a-1)(5) of 
this section, and order number, by timestamp or other timing device, 
the date and time to the nearest minute such report of execution is 
made. Each member of a contract market shall submit the written records 
of customer orders or orders from other contract market members to 
contract market personnel or to the clearing member responsible for the 
collection of orders prepared pursuant to this paragraph as required by 
contract market rules adopted in accordance with paragraph (j)(1) of 
this section. The execution price and other information reported on 
such order tickets must be written in nonerasable ink.
    (5) Bunched orders for eligible accounts. A specific customer's 
account identifier need not be recorded at the time a bunched order is 
placed on a contract market or upon report of execution, provided that 
the following requirements are met and that the order is handled in 
accordance with contract market rules that have been submitted to the 
Commission and approved or permitted into effect pursuant to Section 
5a(a)(12)(A) of the Act and Sec. 1.41. The bunched order must be 
allocated to the eligible accounts prior to the end of the day on which 
the order is executed.
    (i) Eligible orders. Bunched orders placed, executed, and allocated 
pursuant to this paragraph (a-1)(5) must be placed by an eligible 
account manager on behalf of consenting eligible customers as part of 
its management of a portfolio also containing instruments which are 
either exempt from regulation pursuant to the Commission's regulations 
or excluded from Commission regulation under the Act.
    (ii) Eligible account managers. The person placing and/or directing 
the allocation of an eligible order and its principal, if any, 
(``account manager'') must be one of the following which has been 
granted investment discretion with regard to eligible customer 
accounts:
    (A) A commodity trading advisor registered with the Commission 
pursuant to the Act;
    (B) An investment adviser registered with the Securities and 
Exchange Commission pursuant to the Investment Advisers Act of 1940; or
    (C) A bank, insurance company, trust company, or savings and loan 
association subject to federal or state regulation.
    (iii)Eligible customers.
    (A) Eligible orders may be allocated to accounts owned by the 
following entities which have consented in advance, in writing, to the 
account manager that orders may be placed, executed, and allocated in 
accordance with this paragraph:
    (1) A bank or trust company;
    (2) A savings association or credit union;
    (3) An insurance company;
    (4) An investment company subject to regulation 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 to 
foreign regulation, provided that the investment company or foreign 
person is not formed solely for the purpose of constituting an eligible 
customer and has total assets exceeding $5,000,000;
    (5) A commodity pool formed and operated by a person subject to 
regulation under the Act or a foreign person performing a similar role 
or function subject to foreign regulation, provided that the commodity 
pool or foreign person is not formed solely for the purpose of 
constituting an eligible customer and has total assets exceeding 
$5,000,000;
    (6) A corporation, partnership, proprietorship (but not a sole 
proprietorship), organization, trust, or other entity comprised of more 
than one person, provided that the entity was not formed solely for the 
purpose of constituting an eligible customer and has either a net worth 
exceeding $1,000,000 or total assets exceeding $10,000,000;
    (7) A corporate qualified pension, profit sharing, or stock bonus 
plan subject to Title 1 of the Employee Retirement Income Security Act 
of 1974 (``ERISA''), or a foreign person performing a similar role or 
function subject to foreign regulation, with total assets exceeding 
$5,000,000 or 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, or 
any plan defined as a governmental plan in Section 3(32) of Title 1 of 
ERISA, but not including a self-directed plan;
    (8) 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;
    (9) 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 to foreign regulation, 
acting on its own behalf; provided, however, that the broker-dealer may 
not be a natural person or sole proprietorship; or
    (10) A futures commission merchant subject to regulation under the 
Act or a foreign person performing a similar role or function subject 
to foreign regulation, acting on its own behalf; provided, however, 
that the futures commission merchant may not be a natural person or 
sole proprietorship.
    (B) The following persons, or any combination thereof, may not have 
an interest of ten percent or greater in any account that receives any 
part of an eligible order:
    (1) The account manager;
    (2) The futures commission merchant allocating the order;
    (3) Any general partner, officer, director, or owner of ten percent 
or more of the equity interest in the

[[Page 707]]

account manager or the futures commission merchant allocating the 
order;
    (4) Any employee, associated person, or limited partner of the 
account manager or the futures commission merchant allocating the order 
who affects or supervises the handling of the order;
    (5) Any business affiliate that, directly or indirectly, controls, 
is controlled by, or is under common control with, the account manager 
or the futures commission merchant allocating the order; or
    (6) Any spouse, parent, sibling, or child of the foregoing persons.
    (iv) Account certification.
    (A) Before placing the initial eligible order, the account manager 
must certify, in writing, to each futures commission merchant executing 
and/or allocating any part of the order that the account manager is 
aware of the provisions of this paragraph and is, and will remain, in 
compliance with the requirements of this paragraph.
    (B) Before placing the initial eligible order, the account manager 
must provide each futures commission merchant allocating the order with 
a list of eligible futures accounts.
    (v) Allocation.
    (A) The account manager and the futures commission merchant 
allocating the order must allocate fills from each eligible order to 
eligible participating customer accounts prior to the end of the day 
the order is executed, as specified by exchange rules for this purpose.
    (B) Allocations of eligible orders must be fair and non-
preferential, taking into account the effect on each relevant portfolio 
in the bunched order.
    (vi) Recordkeeping.
    (A) Each eligible order must be identified on the office and floor 
order tickets at the time of placement. These order tickets also must 
identify the account manager placing the order.
    (B) Each transaction resulting from an eligible order must be 
identified on contract market trade registers and other computerized 
trade practice surveillance records.
    (C) The futures commission merchant carrying the account must 
identify each trade resulting from the execution of an eligible order 
on confirmation statements provided to eligible customer accounts.
    (D) Each account manager must make available, upon request of any 
representative of the Commission or the United States Department of 
Justice, the following:
    (1) The customer consent documents required pursuant to paragraph 
(a-1)(5)(iii)(A) of this section; and
    (2) Records reflecting futures and option transactions, other 
transactions executed pursuant to the portfolio management strategy, 
and any other records that would identify the management strategy and 
relate to, or reflect upon, the fairness of the allocations.
    (E) Each account manager must make available for review, upon 
request of an eligible customer, data sufficient for that customer to 
compare its results with those of other relevant customers. These data 
may be prepared so as not to disclose the identity of individual 
account holders.
    (vii) Contract market rule enforcement programs. As part of its 
rule enforcement program, each contract market that adopts rules that 
allow the placement, execution, and allocation of eligible orders must 
adopt audit procedures to determine compliance with the certification, 
allocation, and recordkeeping requirements identified in paragraphs (a-
1)(5)(iv), (v)(A), and (vi)(A) through (C) of this section.
* * * * *
    Issued in Washington, DC on December 31, 1997 by the Commission.
Catherine D. Dixon,
Assistant Secretary of the Commission.
[FR Doc. 98-240 Filed 1-6-98; 8:45 am]
BILLING CODE 6351-01-P