[Federal Register Volume 63, Number 73 (Thursday, April 16, 1998)]
[Rules and Regulations]
[Pages 18821-18835]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 98-9879]


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COMMODITY FUTURES TRADING COMMISSION

17 CFR Parts 3, 32 and 33


Trade Options on the Enumerated Agricultural Commodities

AGENCY: Commodity Futures Trading Commission.

ACTION: Interim final rules.

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SUMMARY: Generally, the offer or sale of commodity options is 
prohibited except on designated contract markets. 17 CFR 32.11. One of 
several specified exceptions to the general prohibition on off-exchange 
options is for ``trade options.'' Trade options are off-exchange 
options ``offered by a person having a reasonable basis to believe that 
the option is offered to'' a person or entity within the categories of 
commercial users specified in the rule, where such commercial user ``is 
offered or enters into the transaction solely for purposes related to 
its business as such.'' 17 CFR 32.4(a). Trade options, however, are not 
permitted on the agricultural commodities which are enumerated in the 
Commodity Exchange Act (Act). 7 U.S.C. 1a(3).
    The Commodity Futures Trading Commission (Commission or CFTC) is 
removing the prohibition on off-exchange trade options on the 
enumerated agricultural commodities pursuant to a three-year pilot 
program. Because it intends to reexamine these rules during and at the 
conclusion of the pilot program, these rules are being promulgated as 
interim final rule (interim rules). The interim rules, like the 
proposed rules, permit only agricultural trade options which, if 
exercised, will result in delivery of the commodity. Such options may 
not be resold, repurchased, or otherwise cancelled other than through 
the exercise or natural expiration of the contract.
    Also, the interim rules permit only those entities which handle the 
commodity in normal cash market channels to solicit, to offer to buy or 
sell, or to buy or sell such options. Vendors of such options would be 
required to become registered as agricultural trade option merchants, 
to report to the Commission on their transactions, to provide their 
customers with disclosure statements, and to safeguard their customers' 
premiums. The interim rules substantially streamline requirements 
contained in the proposed rules, particularly the proposed 
registration, reporting rules, particularly the proposed registration, 
reporting and customer fund segregation requirements. The Commission is 
exempting from the prohibition and these interim rules individuals or 
entities which meet a substantial financial requirement, as it 
proposed. Finally, the Commission is removing the prohibition on the 
offer or sale of exchange-traded options on physicals on these 
commodities.
    CFTC will publish at a late time a document in the Federal Register 
requesting comments on these interim rules.

EFFECTIVE DATE: June 15, 1998.

FOR FURTHER INFORMATION CONTACT: Paul M. Architzel, Chief Counsel, 
Division of Economic Analysis, Commodity Futures Trading Commission, 
Three Lafayette Centre, 1155 21st Street, N.W., Washington, D.C. 20581, 
(202) 418-5260, or electronically at [PA[email protected]].

SUPPLEMENTARY INFORMATION: 

I. Background

A. The Prohibition of Agricultural Trade Options

    In 1936, responding to a history of large price movements and 
disruptions in the futures markets attributed to speculative trading in 
options, Congress completely prohibited the offer or sale of option 
contracts both on and off exchange in the specific list of agricultural 
commodities then under regulation.\1\ Any commodity not so enumerated 
was unaffected by the prohibition.
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    \1\ The specific agricultural commodities originally regulated 
under the 1936 Act included, among others, grains, cotton, butter, 
eggs, and potatoes. Later, fats and oils, soybeans and livestock, as 
well as others, were added to the list of enumerated agricultural 
commodities. Commodity Exchange Act of 1936, Public Law No. 74-675, 
49 Stat. 1491 (1936). See, H. Rep. No. 421, 74th Cong., 1st Sess. 1, 
2 (1934); H. Rep. No. 1551, 72d Cong., 1st Sess. 3 (1932). A more 
complete statement of the statutory and regulatory history of the 
ban is provided in the Notice of Proposed Rulemaking, 62 FR 59624 
(November 4, 1997).
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    A history of abusive practices and fraud in the offer and sale of 
off-exchange options in the non-enumerated commodities was one of the 
catalysts leading to enactment of the Commodity Futures Trading 
Commission Act of 1974 (1974 Act). The 1974 Act created the Commission, 
substantially strengthen the Commodity Exchange Act and broadened its 
scope by bringing all commodities under regulation for the first time. 
The newly-created CFTC, vested with plenary authority to regulate the 
offer and sale of commodity options,\2\ promulgated a comprehensive 
regulatory framework applicable to off-exchange commodity option 
transactions in the non-enumerated commodities.\3\ This comprehensive 
framework exempted ``trade options'' from most of its provisions except 
for a rule prohibiting fraud (rule 32.9).\4\ In contrast, the 
prohibition on the offer and sale of all options on the enumerated 
agricultural commodities remained as a consequence of both statutory 
provision and Commission rule. See, 17 CFR 32.2.
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    \2\ Section 4c(b) of the Act provides that no person ``shall 
offer to enter into, or confirm the execution of, any transaction 
involving any commodity regulated under this Act'' which is in the 
nature of an option ``contrary to any rule, regulation, or other of 
the Commission prohibiting any such transaction or allowing any such 
transaction under such terms and conditions as the Commission shall 
prescribe.'' 7 U.S.C. 6c(b).
    \3\ 17 CFR part 32. See 41 FR 51808 (Nov. 24, 1976) (Adoption of 
Rules Concerning Regulation and Fraud in Connection with Commodity 
Option Transactions). See also, 41 FR 7774 (February 20, 1976) 
(Notice of Proposed Rules on Regulation of Commodity Option 
Transactions); 41 FR 44560 (October 8, 1976) (Notice of Proposed 
Regulation of Commodity Options).
    \4\ As noted above, trade options are defined as off-exchange 
options ``offered by a person having a reasonable basis to believe 
that the option is offered to the categories of commercial users 
specified in the rule, where such commercial user is offered or 
enters into the transaction solely for purposes related to its 
business as such.'' 41 FR at 51815; rule 32.4(a) (1976). This 
exemption was promulgated based upon an understanding that 
commercial users of the underlying commodity has sufficient 
information concerning commodity markets insofar as transactions 
related to their business as such, so that application of the full 
range of regulatory requirements was unnecessary for business-
related transactions in options on the non-enumerated commodities. 
See 41 FR 44563, ``Report of the Advisory Committee on Definition 
and Regulation of Market Instruments,'' appendix A-4, p. 7 (January 
22, 1976).
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    However, the attempt to create a regulatory framework to govern the 
offer and sale of off-exchange commodity options was unsuccessful and 
was suspended.\5\ In 1982, based on the separate, successful pilot 
program to introduce exchange-traded options on the non-enumerated 
commodities, Congress eliminated the statutory prohibition on options 
on the enumerated agricultural commodities.\6\ As a consequence, the 
Commission

[[Page 18822]]

initiated a pilot program to permit the reintroduction of exchange-
traded options on those agricultural commodities. The Commission 
declined at that time to permit the trading of the specified 
agricultural options off-exchange.\7\
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    \5\ Because of continuing, persistent, and widespread abuse and 
fraud in their offer and sale, the Commission in 1978 suspended all 
trading in commodity options, except for trade (and subsequently, 
dealer) options. 43 FR 16153 (April 17, 1976). Congress later 
codified the Commission's options ban, establishing a general 
prohibition against commodity option transactions other than trade 
and dealer options. Public Law No. 95-405, 92 Stat. 865 (1978).
    \6\ Public Law No. 97-444, 96 Stat. 2294, 2301 (1983).
    \7\ 48 FR 46797 (October 14, 1983). Although the Commission 
noted that ``there may be possible benefits to commercials and to 
producers from the trading of these `trade' options in domestic 
agricultural commodities,'' it determined that ``in light of the 
lack of recent experience with agricultural options and because the 
trading of exchange-traded options is subject to more comprehensive 
oversight,'' ``proceeding in a gradual fashion by initially 
permitting only exchange-traded agricultural options'' was the 
prudent course. Id. at 46800.
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B. The Advance Notice of Proposed Rulemaking

    On June 9, 1997, the Commission published an advance notice of 
proposed rulemaking (advance notice) in the Federal Register seeking 
comment on whether it should propose rules to lift the prohibition on 
trade options on the enumerated agricultural options subject to 
conditions and, if so, what conditions would be appropriate (62 FR 
31375).\8\ In order to focus comment on the relevant issues, the 
advance notice invited commenters to respond to 30 specific questions.
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    \8\ The Commission based the advance notice on a study by the 
Commission's Division of Economic Analysis (Division). The complete 
text of that study, entitled ``Policy Alternatives Relating to 
Agricultural Trade Options and Other Agricultural Risk-Shifting 
Contracts,'' was forwarded to the Commission by the Division on May 
14, 1997. It is available through the Commission's Internet site at 
http://www.cftc.gov/ag8.htm.
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    The Commission received a total of 76 comment letters from 82 
commenters in response, almost evenly divided between those in favor 
and those opposed to lifting the ban. In addition to the written 
comments, the Commission received oral and written statements during 
two public field meetings at which members of the public had an 
opportunity to address the Commission and to answer its questions 
regarding these issues. One of the meetings was held in Bloomington, 
Illinois, and the other was held in Memphis, Tennessee. A third 
informational briefing was held in conjunction with a general 
membership meeting of the National Cattlemen's Beef Association. 
Generally, speakers at these events reflected the range of views 
expressed in the written comments and were likewise equally divided in 
their support or opposition to lifting the prohibition on agricultural 
trade options.\9\
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    \9\ Transcripts of the proceedings at all three events were 
included in the Commission's comment file and are available through 
the Commission's internet web site.
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    Many of the comments responding to the advance notice expressed the 
view that the potential risk of permitting trade options clearly 
outweighed any benefit which they might provide. These commenters 
typically assumed that agricultural trade options would be offered 
under the same level of regulation currently applicable to other trade 
options.\10\ An approximately equal number of commenters expressed the 
view that the prohibition on trade options should be lifted, 
particularly in response to the new challenges agriculture faces as a 
result of changes in government programs. The vast majority of 
commenters, both those favoring and opposing lifting the prohibition on 
agricultural trade options, urged caution.
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    \10\ Currently, trade options and those offering them are 
subject only to regulations regarding fraud. See, 17 CFR 32.4.
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C. The Proposed Rules

    The Commission, based upon the analysis in the Division's study, 
the comments responding to the advance notice and the commentary 
presented during its field meetings, proposed rules establishing a 
pilot program to permit the offer and sale of trade options subject to 
a number of strict regulatory conditions. 62 FR 59624. The Commission's 
proposed rules were based on its evaluation of the likely risks 
associated with lifting the prohibition on agricultural trade options, 
the likely immediate uses for agricultural trade options and the level 
of regulation appropriate to both. The Commission proposed initially to 
include within the pilot program options between commercial parties in 
the normal merchandising chain for the underlying commodity, the 
exercise of which would require delivery from one party to the other 
either by immediate transfer of title or by transfer of a forward 
contract commitment. 62 FR 59628.
    The Commission further proposed to require vendors of agricultural 
trade options to register as agricultural trade options merchants and 
their sales forces to register as associated persons. The Commission 
proposed a minimum net worth requirement of $50,000 for registration as 
an agricultural trade option merchant and passing a proficiency test 
for individuals to be registered as an associated person. As proposed, 
agricultural trade option merchants also would have been required to 
keep records, to report to the Commission and to disclose risks to 
customers. The Commission also proposed several restrictions on 
agricultural trade option contracts' permissible structure and use.
    Four hundred forty-eight commenters responded to the notice of 
proposed rulemaking, submitting a total of 441 comment letters to the 
Commission. Commenters remain divided on whether the Commission should 
lift the prohibition on agricultural trade options. Twelve commenters, 
including among them an agricultural marketing cooperative, two 
exchanges and a risk-management firm opposed lifting the prohibition in 
any form. In their view, existing exchange-traded products are adequate 
to manage agricultural risk, and trade options would merely replicate 
existing exchange products, but in a less safe environment. The 
remaining commenters supported lifting the prohibition, but differed in 
their assessment of the conditions proposed by the Commission.
    Of those supporting lifting the prohibition, three agreed fully 
with the Commission's proposed rules. They included an association of 
introducing brokers and two producer associations. The remaining 
commenters opposed to varying degrees the conditions proposed by the 
Commission. Twenty-four comment letters submitted by producer 
associations, other agricultural associations and agribusinesses 
opposed as unduly restrictive or burdensome most, if not all, of the 
proposed rules.\11\ Others took exception, or offered suggestions 
relating, to specific rule provisions. Two United States Senators 
suggested that the pilot program be modified to permit cash settlement 
of option contracts and not to limit potential vendors to those able to 
take delivery of the commodity.
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    \11\ The Commission also received 395 identical letters from 
individual producers opposing the proposed rules on the grounds that 
they result ``in the most extensive, far reaching regulatory 
requirements ever imposed on cash grain marketing contracts. * * * 
mak[ing] it virtually impossible for my local grain company to make 
these contracts available. * * *''
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II. The Interim Rules

A. Over-all Structure

1. Pilot Program
    Based upon thorough and careful consideration of the comments to 
the notice of proposed rulemaking, the responses to the advance notice 
of proposed rulemaking, the written and oral statements provided at the 
field hearings and the Division's study, the Commission is promulgating 
interim rules establishing a three-year pilot program to permit the 
trading of agricultural trade options subject to the conditions 
discussed below. A number

[[Page 18823]]

of commenters expressed concern that a three-year pilot program might 
discourage the Commission from evaluating the interim rules and 
considering their amendment until the conclusion of the full three-year 
pilot period. To the contrary, however, the Commission views the pilot 
program as an opportunity to monitor and to assess the efficacy of 
these rules on an ongoing basis and ``to amend them as experience 
warrants.'' \12\ 62 FR 59627. (Similarly, the Commission's 
implementation of the 1982 pilot program to reintroduce exchange-traded 
commodity options included a number of rule amendments during the 
program and before its termination.)
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    \12\ The Commission noted in the notice of proposed rulemaking 
that ``it will evaluate the efficacy of the interim final rules at 
the conclusion of the pilot program.'' 62 FR 59627, n.19. That does 
not suggest, however, that the Commission will not consider altering 
the interim rules during this period, but only that it is the 
Commission's intention not to make the interim rules final until a 
full review of the pilot program experience.
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    Several commenters expressed concern that the Commission, in 
connection with its final consideration of permanent rules, is unlikely 
to revisit or to reconsider the fundamental policy decisions relating 
to its present determination of the pilot program's overall structure. 
They suggested that the Commission delay promulgating interim rules and 
repropose an entirely different set of regulatory conditions which 
would apply to the trading of agricultural trade options, including 
permitting them to be cash-settled.
    The Commission disagrees with this suggested approach. The 
Commission views the pilot program as an experiment, has not foreclosed 
the reconsideration of any specific issue and, by determining that 
particular rules are appropriate at the initiation of the pilot 
program, has made no judgment regarding the permanent rules that it 
ultimately will promulgate. The Commission believes that proposing a 
new set of rules without any market-based experience would foster delay 
and provide little additional substantive information to inform its 
decision on how to proceed. For this reason, the Commission believes 
that the public interest will best be served by making agricultural 
trade options available to the market now under the regulatory 
structure as proposed and by consideration of possible amendment of the 
interim rules based upon actual market experience.
2. Physical Delivery
    The overall structure of the interim rules adheres closely to the 
proposal. The interim rules, like the proposed rules, permit only the 
trading of off-exchange agricultural options that if exercised, would 
require physical delivery from one commercial party to another in the 
normal merchandising chain. In proposing this provision, the Commission 
reasoned that such options would explicitly include a merchandising 
function which exchange-traded contracts did not, that such options 
would be between those having pre-existing cash market relationships 
and that the mechanics of these options were likely to be well-
understood. See, 63 FR at 59627.
    A number of comments, including one from two United States Senators 
and a joint comment of seven farm and commodity representative 
organizations (joint comment), suggested that the Commission also 
include within the pilot program cash-settled options. However, not all 
commenters agreed with this view. For example, one state-level farm 
organization strongly supported the proposed provision requiring 
physical delivery, noting that it was:

in complete agreement * * * that the off-exchange agricultural trade 
option be settled by either delivery of the physical commodity or by 
the writing of a forward contract which will guarantee delivery. To 
allow a cash-settled instrument would potentially foster cash 
speculation between vendors and buyers.

    Many of those advocating inclusion of cash-settled options 
suggested that the proposed physical delivery requirement would 
preclude any flexibility in the type of options that could be offered, 
making it impossible, for example, to offer options combining 
production and price protection--so called ``revenue'' contracts. 
Revenue option contracts would enable producers to lock in a minimum 
revenue for production on their farms. An association representing 
grain elevators reasoned that:

[t]he rules, as written, provide no apparent authority to write 
revenue contracts combining both yield and price risk management 
into one contract. * * * [R]evenue contracts that could utilize the 
yield contracts offered by the Chicago Board of Trade to shift a 
substantial part of this risk are, in our view, very important to 
the farmer. They are also important to the cash grain industry in 
having the opportunity to work along side the insurance industry in 
offering a more ``complete'' line of futures-based revenue 
contracts. We strongly urge the CFTC to include revenue contracts 
(and other legitimate agricultural trade option contracts where 
physical delivery is not possible) under the pilot program. 
(Emphasis omitted.)

    The physical delivery requirement does not preclude development of 
revenue-type option contracts. Nothing in the rules requires that the 
trade option specify the underlying commodity by referencing an 
absolute number of bushels or other delivery unit. The amount of the 
commodity underlying the option could be expressed by referencing the 
yield on a designated number of acres, based either on the producer's 
actual yield or a reported average yield, thereby providing a minimum 
return to a producer per acre without running afoul of the rules' 
requirements. If the total price for the amount of commodity required 
to be delivered were above the guaranteed price, the producer would let 
the option expire and deliver outside of its terms. If the total price 
were below the option's strike price, the producer would exercise the 
option, delivering his or her production to the option writer.\13\ The 
Commission anticipates that a wide variety of option structures could 
be designed to offer additional forms of revenue protection under the 
pilot program's rules and invites those interested in developing such 
instruments to seek its guidance if questions arise regarding their 
permissibility.
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    \13\ It is common practice for certain commodities to provide a 
cash adjustment where the commodity delivered departs from quality 
or other contract specifications, including tolerances for the 
actual amount or weight delivered compared to the contract amount. 
Similarly, if a state-wide average yield were used as a reference 
and the producer's actual production fell somewhat short, the total 
price could be adjusted to account for the relative shortfall 
without abrogating its fundamental nature as a delivery contract.
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    A number of commenters similarly objected that the proposed rule 
requiring that agricultural trade options be settled only by physical 
delivery further unduly restricted their potential flexibility and 
utility by forbidding their early termination through offset. This 
requirement was proposed as a means to ensure that agricultural trade 
options maintain a close relationship to the cash market activities of 
participants and to dissuade speculative use of the contracts. Several 
commenters, however, argued that a producer's ability to capture any 
remaining value left on the option by selling the option back to the 
issuer under the terms of the original contract when the optional price 
protection was no longer wanted was not inconsistent with these 
objectives.
    However, permitting the offset of an option prior to its expiration 
would render meaningless the provision requiring physical delivery of 
the option, if exercised. The right to offset would eviscerate the 
physical delivery requirement by enabling the option

[[Page 18824]]

holder at any time to avoid delivery, essentially cash-settling the 
option.\14\ This would undermine the Commission's efforts to develop a 
pilot program to reintroduce agricultural trade options under 
controlled conditions.
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    \14\ See, CFTC Interpretive Letter No. 96-41, Division of 
Economic Analysis Statement of Policy in Connection with the 
Unwinding of Certain Existing Contracts for the Delivery of Grain, 
[1994-1996 Transfer Binder] Comm. Fut. L. Rep. (CCH) para. 26,691 
(Division of Economic Analysis) for a discussion of impermissible 
offset provisions.
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    Although the interim rules have not been modified to permit the 
offset of agricultural trade options, the rules as proposed permitted a 
degree of flexibility to capture an option's remaining value prior to 
its expiration. The proposed rules recognized that agricultural trade 
option contracts could be amended to ``reflect changes * * * [in] 
activity or commitments in the underlying cash market or to reflect the 
carrying of inventory.'' 62 FR at 59638.\15\ Such amendments could 
include deferral of an option contract's delivery date with alteration 
of the contract's price to reflect, among other adjustments, any 
remaining value on the original option.\16\
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    \15\ Proposed rule 32.13(a)(7)(i) (paragraph of required 
disclosure statement entitled ``Business Use of Trade Options'').
    \16\ Accordingly, proposed rule 32.13(a)(7)(ii)(D) required 
disclosure of the worst possible financial outcome where ``through 
amendments to the option contract it is possible to lose more than 
the amount of the initial purchase price.'' 62 FR 59638.
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    The proposed rules also contemplated that delivery on an option 
contract, if exercised, could be by the ``immediate transfer of title 
to the commodity or by transfer of a forward contract commitment.'' 62 
FR 59627. Proposed rule 32.13(a)(3)'s requirement that the ``option can 
only be settled through physical delivery of the underlying commodity'' 
should be read as permitting termination of the option contract prior 
to its expiration through entry into a forward contract commitment as 
well as permitting use of a forward contract upon exercise. Once the 
forward contract has been substituted for the trade option, the forward 
contract is a firm commitment to deliver, and the optional ``walk-
away'' nature of the option cannot be reestablished. The substitution 
of a forward contract for the physical delivery option prior to the 
option's expiration is consistent with the overall purpose of the rule 
of maintaining a close relationship between the option transaction and 
the participant's cash market activities and of dissuading use of 
agricultural trade options as speculative vehicles. The Commission is 
modifying the interim rule to clarify that settlement of the option by 
physical delivery does not preclude the option contract's amendment, or 
its termination by entry into a forward contract, prior to expiration 
with an appropriate adjustment to the contract price.\17\
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    \17\ A price adjustment to reflect the remaining value of the 
trade option contract upon substitution of a fixed-price forward 
contract for the option is consistent with the treatment accorded 
minimum price guaranteed forward contracts by Commission staff. The 
Division of Economic Analysis in CFTC Interpretative Letter 96-23, 
(Re: Sections 1a(11) and 2(a)(1) of the Commodity Exchange Act--
Request for Guidance Regarding Producer Option Contract), [1994-1996 
Transfer Binder], Comm. Fut. L. Rep. (CCH) para.26,646, expressed 
the view that, within a forward delivery contract offering a 
guaranteed minimum price, the holder of the contract could elect to 
eliminate the upside pricing potential (the option-like pricing 
component) in the contract in return for establishing a fixed price 
forward contract, the price of which was adjusted to reflect the 
liquidated remaining value of the option component. The option-like 
pricing component could not, however, be reestablished in the 
contract.
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3. Eligible Vendors
    A number of commenters also advocated expansion of those eligible 
to be agricultural trade option merchants to additional classes of 
vendors. Specifically, for example, the joint comment suggested that 
all ``financial institutions with a direct interest in production 
agriculture'' be permitted to become agricultural trade option vendors. 
Other commenters supported the Commission's proposed limitation, 
suggesting that trade options appropriately should be limited to 
``producers and buyers of the enumerated commodities.''
    Several commenters opposed the conditions for registration as an 
agricultural trade option merchant on the assumption that eligibility 
would be restricted to ``first handlers'' of the commodity. Although 
first handlers typically would be eligible to become agricultural trade 
option merchants, other categories of commercial users would also be 
eligible to apply for registration. For example, as one commenter 
noted, ``[w]e assume the CFTC would also permit cash grain 
merchandisers, which have no facilities, but do take title to 
commodities, to also write options.'' As discussed above, the 
requirement that the option contracts, if exercised, be physically 
delivered does not require that the agricultural trade option merchant 
accept delivery only in an over-the-scales operation. To the contrary, 
delivery of the commodity can occur through any bona fide means of 
conveying legal ownership of the commodity, including the transfer of 
warehouse receipts. Accordingly, grain merchants, investment bankers 
with active commodity trading operations and various types of 
agricultural processors or commercial users of the commodity might be 
eligible to register to operate as an agricultural trade option 
merchant. In light of the potential diversity of eligible registrants, 
the Commission believes that the interim rules will not result in lack 
of competition among vendors.\18\
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    \18\ One comment letter questioned whether agricultural 
cooperatives would be able to meet the net worth requirement for 
registration as an agricultural trade option merchant by combining 
the individual net worth of each member. Generally the rules do not 
distinguish cooperatives from any other type of enterprise. 
Accordingly, the cooperative must itself have a net worth of $50,000 
to meet the applicable requirement. To the extent that cooperatives 
act on behalf of members as a commodity merchandiser, they may 
purchase agricultural trade options in connection with their 
merchandising function. Of course, in doing so they would have to 
have the contractual right to deliver the commodity to settle those 
options which they choose to exercise.
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    The Commission is convinced that the overall structure of the 
interim rules is both a necessary and appropriate means to introduce 
this new class of instrument. Recent experience with various types of 
agricultural marketing schemes and contracts indicates that a degree of 
caution is required. Introducing these instruments as a pilot program, 
limited initially to option contracts which upon exercise result in 
physical delivery, traded between commercials in the underlying 
commodity, should provide a degree of protection to the parties and a 
solid foundation upon which to lift the current prohibition on such 
instruments.
    As discussed above, the proposed rules provided greater flexibility 
than credited by many of the commenters. Moreover, in the interim rules 
the Commission has modified or clarified the rules as proposed, 
providing further avenues for flexibility. The Commission is convinced 
that the interim rules will provide the market with room to innovate 
and to create useful risk-management tools within its overall 
structure.
    Moreover, the interim rules have been modified from the proposed 
rules in a number of important respects apart from issues relating to 
the pilot program's overall structure. In response to specific 
suggestions by commenters, the interim rules clarify and streamline 
several specific regulatory requirements. In several instances, the 
interim rules significantly lessen the burden that the proposed rules 
would have imposed on those who register as agricultural trade option 
merchants and their sales forces, as well as the requirements relating 
to

[[Page 18825]]

the merchant's on-going business operations. These modifications are 
intended to achieve the same regulatory goals, and provide a similar 
degree of protection, as the rules as proposed, but in a less costly or 
burdensome manner. The specific changes are discussed in greater detail 
below.

B. Regulation of Agricultural Trade Option Merchants

1. Registration
    Registration of commodity professionals is an important means by 
which the Commission polices the futures and option industry and is the 
primary mechanism for reassuring the public of the honesty and 
proficiency of futures professionals. As the Commission noted in its 
notice of proposed rulemaking, ``registration * * * will be critically 
important in the decentralized market permitted under the pilot 
program.'' The notice further noted, however, that the need for 
extensive registration requirements is offset by the fact that the 
offer and sale of trade options would be a complement to the first-
handler's existing cash market businesses. Accordingly, the Commission 
proposed a streamlined form of registration, consisting of a single 
application form covering both the agricultural trade option merchant 
as an entity and its authorized sales force.
    The Commission also proposed to delegate administration of the 
registration function to the National Futures Association (NFA). 
Although some commenters opposed this on the grounds that it would 
``permit another user-fee based regulator * * * to initiate far-
reaching regulatory activities among cash market businesses,'' the 
delegation to the NFA is narrow, confined to administration of the 
registration function,\19\ and necessary to conserve Commission 
resources.
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    \19\ Fees will be limited to the cost of this one function and 
are expected to be modest.
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    Based upon its administrative experience, NFA suggested a number of 
modifications to the proposed registration rules. In its view, a single 
application for registration of the agricultural trade option merchant 
and its sales force ``rather than providing a streamlined registration 
process, * * * will unduly complicate and actually hinder the 
registration of ATMs.'' Because the Commission's ultimate goal is for 
the overall registration process to be streamlined, the Commission has 
incorporated the NFA's suggestions into the interim rules. Accordingly, 
agricultural trade option merchants and their associated persons will 
be required to file separate registration applications, each focussed 
specifically on the requirements for that category of registrant. 
Separate forms in support of the agricultural trade option merchant's 
application for registration are also required of the natural persons 
who are its principals. Individual application forms for each category 
should result in greater simplicity for each and not in an increase in 
the total length of the applications or in the amount of information 
provided.
    NFA also suggested a number of rule clarifications, including the 
addition of definitions of the registration categories and 
incorporation by explicit reference of the procedures for denial, 
suspension and revocation of applications for registration which are 
applicable to all classes of registrant under the Commission's rules. 
The interim rules have been modified to reflect these technical 
changes.\20\
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    \20\ The Commission's explicit application of various of its 
procedural rules to agricultural trade option merchants and their 
associated persons in no way limits the applicability of any other 
statutory or regulatory provision which is applicable to Commission 
registrants. In this regard, the Act and many of the Commission's 
rules impose requirements or prohibitions on Commission registrants 
using the phrase ``any person or registrant who is registered under 
this Act'' or similar words. For example, Section 14 of the Act 
provides aggrieved customers with the opportunity to bring before 
the Commission for adjudication disputes involving violations of the 
Act or rules by ``any person registered under this Act.'' See also, 
17 CFR 3.34, 3.56, 3.60. Although ``agricultural trade option 
merchant'' and ``associated person of an agricultural trade option 
merchant'' are not registration categories defined by the Act, they 
are nevertheless registration categories ``under the Act'' by virtue 
of the Commission's promulgation of rules creating these 
registration categories under section 4c(b) of the Act (its plenary 
authority over the regulation of options) and under section 8a(5) of 
the Act (its general rulemaking authority). The Commission's 
reparations program under section 14 of the Act will therefore be 
available to customers of agricultural trade option merchants and 
their associated persons as it is for all other categories of 
Commission registrant. Customers will be apprised of this right in 
the required summary disclosure document.
---------------------------------------------------------------------------

    Many commenters offered the view that the proposed registration 
requirements for agricultural trade option vendors should be relaxed. 
This view was shared by both potential customers and vendors alike. The 
joint comment noted the agricultural associations' ``concern () that 
the high level of specific regulation * * * will impose excessive costs 
* * * that are not reflective of, or proportionate to, the risks 
associated with removing the ban * * * for a narrowly defined range of 
products.'' Specifically, the joint comment suggested that the 
fingerprint requirement was unnecessary and that the proficiency and 
ethics training requirements be relaxed. A company active in the cash 
grain business noted that ``[r]egistration for those organizations 
offering ATOs in the pilot program period seems reasonable, but the 
imposition of testing requirements, ethics training, and fingerprinting 
push the regulatory oversight of these products beyond a reasonable 
limit.''
    The Commission has reconsidered these proposals in light of similar 
comments received from a broad range of commenters. The reason that 
fingerprints typically are required of registrants is to perform a 
background check verifying the information submitted on the 
registration application. This requirement may be less necessary in the 
context of agricultural trade options where a likely characteristic of 
the market is a pre-existing commercial relationship between the vendor 
and customer. The likelihood of such a relationship is reinforced by 
the requirement that options, if exercised, must be physically 
delivered. That requirement generally will tend to keep the markets 
local, where there is a greater likelihood that customers will have 
personal knowledge of the background of the agricultural trade option 
merchant and its sales force.\21\ Accordingly, the Commission has 
removed this requirement from the interim rules, and because the 
primary delay in processing registration applications has been 
associated with fingerprint checks, the Commission has also removed 
from the interim rules provisions relating to temporary licensing of 
registrants.
---------------------------------------------------------------------------

    \21\ The local nature of cash marketing channels is typical for 
many, but certainly not all, commodities. The interim rule's 
requirements must generally be understood within the normal cash 
marketing channels for each commodity. For some commodities, normal 
cash marketing channels include delivery obligations being 
undertaken as to processors or users at a considerable distance from 
producers.
---------------------------------------------------------------------------

    The interim rules modify the requirement that persons applying for 
registration pass a competency test and fulfill an ethics training 
requirement. Many commenters representing both potential customers and 
vendors suggested that the testing requirement would dissuade 
individuals from registering, particularly because this would be a 
sideline to their core cash-businesses. Several commenters specifically 
objected that the Series 3 examination, which was included in the 
proposed regulations as a permissible alternative to a more focussed 
test not yet developed, would not be relevant to these products.
    As noted in the advance notice, a competency test is only one means 
for ensuring the market vendors have the

[[Page 18826]]

requisite professional and market knowledge. Development of a testing 
program specifically focussed on this market may be premature in light 
of the unknown number or composition of potential vendors and the 
existing tests' admitted lack of direct relevance to these products. 
However, almost all those commenting agreed that education was needed. 
Many organizations representing both likely customers and potential 
vendors suggested that this education be voluntary and stated an 
intention to offer educational training opportunities to their members.
    As the Commission noted in its notice of proposed rulemaking, 
``customers have the right to expect that such merchants and their 
sales forces will have successfully demonstrated mastery of the issues 
relevant to the offer or sale of these instruments.'' 62 FR 59630, n. 
35. In order to provide customers with some assurance that this 
expectation will be met, the interim rules substitute for the proposed 
competency test a requirement that those seeking registration as 
associated persons of an agricultural trade option merchant complete 
six hours of instruction in the requirements of the Act and rules 
promulgated thereunder, the economic functioning and risks of 
agricultural trade options, and the registrant's responsibility to 
observe just and equitable principles of trade relating to such 
options. This course of instruction includes among others, the subjects 
which would have been specified by the proposed ethics training 
requirement. Accordingly, that proposal has been deleted. Instruction 
can be by videotape or electronic media and need not be through 
classroom attendance.
    The applicant for registration as an associated person must include 
in the application evidence provided by an eligible instructional 
provider that the applicant completed this instructional requirement. 
This evidence of completion must include a certification that the 
instructor has three years of relevant experience, is not subject to a 
statutory or other disqualification and a disclaimer that the 
Commission or the NFA has not approved the course of study's 
content.\22\ Instructors must notify the NFA of their intent and 
eligibility to offer such training prior to doing so, and must maintain 
appropriate documentation of applicants' completion of the requirement.
---------------------------------------------------------------------------

    \22\ At least one commenter, a large grain merchant, commented 
that it provided in-house ethics and business training for its 
employees. In-house training by an agricultural trade option 
merchant for its associated persons is not precluded by these rules, 
nor is the use of employees as instructors. Employee-instructors 
meeting the requisite requirements will be qualified to certify 
fulfillment of the training requirement for other employees. Such 
employee-instructors, however, cannot be the direct supervisor of 
the associated person applying for registration.
---------------------------------------------------------------------------

    There is no educational requirement for customers. However, as the 
Commission previously stated:

it strongly urges private sector organizations to provide a variety 
of means of fulfilling this need. The success of the pilot program 
will depend, in part, on the success of various organizations in 
educating potential trade option customers.

Id.
2. Financial Requirements
    The Commission, in proposing various financial protection 
requirements, noted that agricultural trade options, like all commodity 
futures or option instruments, involve risk arising from the need for 
performance at a future date by the contract's counterparties. Off-
exchange transactions such as these, however, do not have the safety of 
an exchange clearinghouse to reduce credit risk. Because many 
agricultural trade option customers will not have the resources to 
conduct formal credit worthiness evaluations of their counterparties, 
the Commission proposed that agricultural trade option merchants be 
required to maintain a minimum level of net worth and to segregate from 
their own funds premiums paid by customers at initiation of an option 
contract. It did not propose requiring agricultural trade option 
merchants to cover their market exposure. 62 FR 59628-59630.
    The Commission proposed the minimum net worth requirement ``to 
establish a base level for entry or access to a market * * * to assure 
that companies or entities conducting business offer some assurance of 
having the financial wherewithal to perform on their obligations.'' 62 
FR 59628. Commenters on the advance notice were not unanimous in 
support of such a minimum financial requirement. Some were opposed in 
order not to exclude smaller entities, and others argued that various 
state financial requirements would be sufficient. Believing that a 
common federal minimum standard should prevail, the Commission proposed 
to apply to agricultural trade option merchants the $50,000 minimum net 
worth requirement established by the United States Department of 
Agriculture (USDA) (and many states) as a condition of obtaining a 
federal grain warehouse license.
    A number of commenters took issue with the $50,000 minimum net 
worth requirement, suggesting that it was too low. The joint comment 
suggested that agricultural trade option merchants be required to 
``maintain a bond equal to * * * premiums of all customer options less 
the current cash value of the contracted commodities in addition to 
existing state or federal bonding requirements.'' One potential vendor 
recommended a minimum net worth of $1 million with adjustments ``to 
require that the risk exposure of a seller of options has an 
appropriate relationship to the seller's net worth,'' reasoning that 
``one of the greatest risks to the development of an efficient 
agricultural trade option market is that undercapitalized sellers of 
the options will default.'' Other commenters supported the proposed net 
worth requirement as an appropriate minimum level.
    The Commission agrees that the $50,000 net worth requirement will 
offer only limited protection from counterparty default risk. However, 
the price risk to the agricultural trade option merchant of an option 
position will be similar to that of a forward contract position. 
Greater financial protection would indeed be achieved, as suggested by 
several commenters, by requiring vendors to post bond or to maintain 
increasing levels of net worth as the degree of exposure rises. 
Nevertheless, constructing a meaningful regulatory scheme to achieve 
that goal, however appealing the concept, would result in rules which 
are far more complex than any of those proposed, including rules on 
uniformly valuing various risks. In this regard, the rules governing 
computation of regulatory capital which must be maintained by futures 
commission merchants are among the most complex of all of the 
Commission's rules. In addition, such a dynamic valuation requirement 
would require a degree of regulatory supervision that would be 
difficult if not impossible to achieve in this decentralized, over-the-
counter market.\23\ In these circumstances, the suggested bonding 
requirement might lull market participants into a false sense of 
security. Accordingly, the Commission is adopting the minimum net worth 
requirement as proposed.
---------------------------------------------------------------------------

    \23\ The regulated futures markets provide a high level of 
financial protection through their clearinghouses. Each exchange has 
a compliance and audit staff, and clearing members and futures 
commission merchants devote significant resources to auditing for 
compliance with the various financial requirements. The Commission 
cannot offer comparable protection for transactions outside of the 
regulated exchange environment. Customers must accept the fact that 
trading off-exchange entails greater counterparty risk.
---------------------------------------------------------------------------

    The interim rules, as proposed, provide that the net worth 
requirement is ongoing in nature, requiring

[[Page 18827]]

agricultural trade option merchants to maintain the specified level of 
net worth in order to enter into new trade option contracts and 
requiring them to notify the Commission at any time if they have fallen 
below prescribed levels. In addition, the agricultural trade option 
merchant must perform a reconciliation of its financial position at 
least monthly to determine compliance with this requirement. It need 
not change accounting procedures to conform to specific Commission 
accounting requirements, provided it uses ``fair value'' accounting 
under Generally-Accepted Accounting Principles, the accounting method 
generally used by cash market businesses.\24\
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    \24\ The Commission believes that the guidance provided in the 
American Institute of Certified Public Accountant's Audit and 
Accounting Guide entitled ``Brokers and Dealers in Securities'' 
provides the relevant guidance which should be followed in 
connection with assigning a fair value to agricultural trade 
options. It states, ``Under generally accepted accounting 
principles, fair value is measured in a variety of ways depending on 
the nature of the instrument and the manner in which it is traded. 
Many financial instruments are publicly traded, and end-of-day 
market quotations are readily available. Quoted market prices, if 
available, are the best evidence of the fair value of a financial 
instrument. If quoted market prices are not available, management's 
best estimate of fair value should be based on the consistent 
application of a variety of factors available to management.'' A 
complete discussion of the factors is provided in the audit guide.
---------------------------------------------------------------------------

    However, the interim rule has been modified from the proposed rule 
which required agricultural trade option merchants to hold in 
segregation all premiums paid by customers at the initiation of the 
option contract. Several commenters suggested that the requirement as 
proposed would discourage vendors from responsibly covering the risk of 
the transaction and suggested that the Commission permit vendors to use 
customer premiums to hedge that risk. The Commission proposed the 
segregation requirement both as a means of discouraging a business in 
financial difficulty from writing options to generate immediate cash 
and as a means of better safeguarding customer funds. 62 FR 59629. 
Permitting the vendor to hedge the option's risk using the customer's 
funds, particularly if the covering transaction is exchange-traded, 
also achieves these objectives. Accordingly, although the Commission is 
not mandating that agricultural trade option merchants cover their 
risk, the interim rules permit the merchant to use up-front customer 
premiums to hedge those risks using exchange-traded instruments. 
Customer funds not used for this purpose, as proposed, must be treated 
as the funds of the customer and be kept in a segregated account.\25\
---------------------------------------------------------------------------

    \25\ An agribusiness company commented that the rules ``should 
indicate (like Sec. 1.25) that the seller of the options can invest 
funds in government obligations to earn interest.'' The proposed 
(and interim) rules so provide. See, paragraph (e) of Sec. 32.6, 
incorporated by reference in proposed rule 32.13(a)(4).
---------------------------------------------------------------------------

3. Recordkeeping and Reporting Requirements
    In proposing recordkeeping requirements, the Commission reasoned 
that ``the maintenance of full, complete, and systematic books and 
records by agricultural trade option merchants is crucial to the 
Commission's ability to respond to complaints of customer abuse arising 
from such transactions and is necessary to the agricultural trade 
option merchant's establishment of appropriate internal controls of 
their financial operations.'' 62 FR 59633. Most commenters agreed and 
supported the requirements as proposed. At least one commenter, 
however, questioned the requirement that a record of unfilled or 
canceled contract orders be kept. It reasoned that ``[r]ecording all 
orders and cancellations will likely provide little insight to the CFTC 
when compared to the arduous task of tracking these records for those 
offering these products.'' This recordkeeping requirement, however, 
serves a different purpose than informational reporting to the 
Commission. The keeping of complete books and records is necessary to 
resolve particular customer disputes, if they arise, and is a sound 
business practice. The Commission therefore is adopting the 
recordkeeping rule as proposed.\26\ However, the Commission has 
modified the interim rule by deleting the NFA's proposed authority to 
inspect books and records at the request of the NFA and as suggested by 
other commenters.
---------------------------------------------------------------------------

    \26\ As proposed, the final rules require that records relating 
to agricultural trade options including covering transactions must 
be kept and maintained for a period of five years and must be 
readily accessible during the first two years of that five-year 
period. See, 17 CFR 1.31.
---------------------------------------------------------------------------

    In addition to the keeping of books and records, the Commission 
proposed two distinct reporting requirements--routine and special call 
reporting. Routine reports are required for general market surveillance 
purposes, to permit the Commission to construct a picture of the market 
and to evaluate the impact of activity in the trade option market on 
the cash and exchange-traded markets.\27\ One commenter suggested that 
information on the total premiums collected and the total value of all 
fees, commissions, or other charges during the reporting period was not 
necessary to this surveillance function. The Commission agrees, and the 
interim rules do not require the routine reporting of premiums, fees, 
commissions, or other charges. However, this information may be helpful 
to a complete understanding of the market's operation, particularly 
during the pilot phase of the rules. Accordingly, the Commission is 
retaining the authority to request such information on a special call 
basis.
---------------------------------------------------------------------------

    \27\ Initially, the Commission anticipates that such reports 
will be filed manually, including by facsimile. However, it also 
anticipates that as the pilot program proceeds, reports will be 
filed electronically, by dial-up transmission or via the Internet. 
The NFA, which has been delegated authority to collect these 
reports, is encouraged to work cooperatively with the industry in 
advancing appropriate procedures, conventions and standards for 
electronic transmission.
---------------------------------------------------------------------------

    Special calls are a reporting device used by the Commission for 
obtaining information only when needed. A special call may be used to 
elicit information from a particular trader or registrant for market or 
financial surveillance purposes or to gather data for market-wide 
studies. As the Commission explained in the notice of proposed 
rulemaking, it anticipates the need to issue special calls for 
information during the pilot program to gather data with which to 
assess its success. 62 FR 59633. At least one commenter suggested that 
the proposed rule be clarified that the agricultural trade option 
merchant ``be required to report * * * only the `options' portion of 
the * * * position.'' As proposed, rule 32.13(e) in the introductory 
paragraph stated that special calls were for ``information relating to 
agricultural trade options.'' However, to clarify further the 
provision, the Commission is modifying the rule as adopted to provide 
that the information which can be requested by special call concerning 
futures or cash transactions must be related to the agricultural trade 
option position. In this regard, potential agricultural trade option 
merchants should be assured that the Commission exercises its existing 
special call authority in other markets with restraint and with an 
understanding of the costs involved in any such request. As noted in 
the notice of proposed rulemaking, the Commission encourages 
agricultural trade option merchants to maintain a current listing of 
customers names and other identifying information for ease of 
compliance.\28\
---------------------------------------------------------------------------

    \28\ Generally, a special call for study purposes requests 
specified information on all positions open on the call date. The 
Commission expects that any special calls would request information 
related to a customer's positions in agricultural trade options 
along with the customer's name and other identifying information. In 
the past, some firms have maintained some, but not all identifying 
information at a central location, and branch locations have kept 
the remaining information in differing formats, creating difficulty 
in providing the information requested. Accordingly, in setting up 
their information systems, firms should keep in mind the likelihood 
of a request for this information during the pilot program.

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

[[Page 18828]]

C. Customer Protections--Risk Disclosure, Required Contract Terms and 
Required Account Information

1. Risk Disclosure Statement
    Almost all commenters agreed that required risk disclosure was a 
valuable and necessary means of protecting customers. In promulgating 
the interim rule, the Commission has clarified the requirement that 
both an initial summary risk disclosure statement and transaction-
specific disclosure statements be provided.
    Many of the commenters opined that the proposed summary risk 
disclosure was too lengthy and feared that many customers would forego 
reading it. The Commission after reviewing the proposed summary 
disclosure statement has shortened it by deleting some redundant 
information, by further summarizing other information and by 
simplifying its language.\29\
---------------------------------------------------------------------------

    \29\ One commenter opined that the reparations language of the 
summary disclosure document was unclear as to its impact on the 
availability of other venues for dispute resolution, such as 
arbitration offered under the auspices of a trade association. The 
language of the summary disclosure document has been modified to 
make clear that all customers have the right to use the Commission's 
reparations program to resolve disputes. Thus, the customer may not 
be compelled to waive this right by any other provision in the 
customer agreement or elsewhere. Customers may, however, voluntarily 
agree to an alternative method of dispute resolution specified in 
the customer agreement, the contract or elsewhere. Compare, 
Commission Regulation 180.3(b)(3).
---------------------------------------------------------------------------

    Some customers opposed the transaction-specific disclosure, 
objecting that this requirement would prove to be burdensome for the 
limited sales forces many agricultural trade option merchants may 
employ. Other commenters strongly supported it, noting that the 
transaction-specific disclosures are necessary to a customer's 
understanding of the nature of the option transaction being entered. 
The Commission concurs. The transaction specific disclosures need not 
be voluminous, are not required to be in a separate document and can be 
included as an addendum to the contract form itself. Although some 
commenters objected to the requirement that the worst possible 
financial outcome be disclosed, that requirement is only triggered when 
the option premium is not collected up front or when the contract is 
amended. The worst possible outcome need not take into account lost 
opportunity cost--therefore, it often will only be the potential loss 
of the premium and other related charges. Where a contract is being 
amended, such as by rolling the delivery date, the worst possible 
outcome will include the cost of the additional premium, fees and 
adjustment to the price resulting from any gain or loss on the contract 
at the time of the amendment or contract roll. In light of the 
imperfect understanding many hedge-to-arrive customers had of the 
effect of rolling on their final contract price, such a disclosure is 
plainly needed. Accordingly, the Commission is adopting this rule as 
proposed.
    As the Commission explained in the notice of proposed rulemaking, 
``the provision of the mandatory risk disclosure statement will not 
relieve the agricultural trade option merchant of the responsibility to 
avoid material misstatements or omissions or any other form of 
fraudulent misconduct.'' 62 FR 59632. Thus, providing a mandatory risk 
disclosure statement will not necessarily cure what is otherwise fraud. 
See, e.g., Clayton Brokerage Co. v. Commodity Futures Trading 
Commission, 794 F.2d 573, 580-581 (11th cir. 1986). Accordingly, 
agricultural trade option merchants may need to make such additional 
disclosures as necessary in light of all the particular circumstances, 
including the nature of the instrument and the customer.\30\
---------------------------------------------------------------------------

    \30\ One commenter suggested that the Commission clarify that 
the disclosure statement could be electronic. The Commission agrees 
and has clarified that electronic disclosure is permitted.
---------------------------------------------------------------------------

2. Written Contract Terms
    Generally, commenters supported the proposed rules requiring that 
specific contract terms be in writing. However, several commenters 
objected to the proposed requirement that the written contract terms 
include the quality or grade of commodity to be delivered if the 
contract is exercised and any adjustment or price for deviation from 
stated quality or grade. One commenter, a cash grain merchant, stated 
that the proposed requirement was not consistent with cash market 
practice. That commenter stated that:

transactions are established in most instances, for a specific 
quality of grain. * * * To the degree that the actual grain 
delivered under these agreements fails to meet the standard grade 
specified in the contract, the buyer and seller must determine the 
impact on the value of the commodity delivered, and negotiate 
discounts/premiums accordingly.

    Others active in the cash markets agreed, nothing that common cash 
market practice is for a forward contract to specify price for a 
standard commodity grade and for adjustments to be made for variance 
from this specification by reference to posted schedules of discounts 
or premiums. Reportedly, these schedules vary frequently, often daily. 
In light of these comments, the Commission is modifying the interim 
rule to make clear that an exact schedule of discounts/premiums need 
not be specified and that such adjustments can be stated as a range and 
method for determining adjustments, such as ``posted market scale of 
discounts at delivery.''
3. Customer Account Information
    Many commenters supported the proposed requirement that 
agricultural trade option merchants provide customers with information 
regarding their positions and accounts. However, several noted that the 
monthly account statement would impose a costly informational burden 
for a questionable benefit. They explained that few entities likely to 
become agricultural trade option merchants have available the 
information infrastructure to produce monthly account statements 
valuing the transactions and that such information would be of only 
marginal utility to customers in light of the requirement that option 
contracts must be settled by delivery. The Commission finds this 
persuasive and is modifying the monthly account statement requirement 
to provide that the agricultural trade option merchant notify customers 
of the expiration date of each option which will expire within the next 
month. This should greatly reduce the informational burden on 
agricultural trade option merchants but nevertheless provide customers 
with notice sufficient to reduce the occasions on which customers 
permit in-the-money options to expire due to inattention.\31\
---------------------------------------------------------------------------

    \31\ At least one commenter representing producers suggested 
that, although the monthly account statement requirement might be 
unduly burdensome, agricultural trade option merchants as a matter 
of best practices should periodically update their customers on 
market conditions, particularly during times of high volatility. The 
Commission agrees that this is desirable and will consider further 
the issue of periodic customer statements based on experience under 
the pilot rules.
---------------------------------------------------------------------------

    In addition to the monthly account statements, the Commission 
proposed that agricultural trade option merchants provide customers in 
writing, within twenty-four hours of a request, current commodity price 
quotes or other information relevant to the customer's position and 
account. A number of

[[Page 18829]]

commenters supported this requirement, but others suggested that it 
could prove to be an undue burden, particularly because it required a 
written response within so short a time. In light of the modification 
of the monthly account statement requirement discussed above, the 
requirement to provide customers with account-related information upon 
request is of even greater importance. However, the Commission is 
modifying the interim rule to lessen the burden which it imposes by 
requiring that all responses be in writing. This may be particularly 
useful where the requested information relates mainly to market 
conditions or quotes and the agricultural trade option merchant 
provides an immediate response by telephone. The customer may ask, 
however, that the information be supplied in writing, and under the 
rule as modified the agricultural trade option merchant must do so 
within 48 hours of the request. These modifications should strike the 
appropriate balance between providing customers with timely account-
related information and the burden on the agricultural trade option 
merchant of doing so.

D. Exemption for Sophisticated Entities

    The Commission proposed to exempt individuals or entities who are 
commercials and have a net worth of at least $10 million from 
compliance with the conditions for trading agricultural trade options. 
Several commenters suggested that the Commission clarify whether a high 
net worth entity acting as a vendor would be exempt from the rules' 
requirements. The exemption applies only to high net worth entities 
trading among themselves. If an option customer does not meet the net 
worth requirement, the agricultural trade option merchant must comply 
with all of the rules applicable to such option transactions.
    In addition, a number of commenters suggested that the Commission 
clarify that the exemption also applies to the associated registration 
requirement and to the trade option prohibition itself. The Commission 
has done so. However, it should be equally clear that the exemption 
from the conditions under which the prohibition is being lifted is not 
independent of the pilot program, but rather part of it. Thus, the 
exemption for high net worth individuals and entities will be the 
subject of Commission oversight and may be reconsidered, as with any 
other of the interim rules, based upon market experience during the 
pilot period.
    Several commenters questioned the reason for, and the effect of, 
the higher dollar level for this exemption than the exemptions 
applicable to high net worth persons under parts 35 and part 36 of the 
Commission's rules.\32\ The Commission remains convinced that the 
dollar level of this exemption is appropriate and is adopting it as 
proposed. The exemptions under parts 35 and 36 were promulgated a 
number of years ago, and the Commission has announced that it will 
publish a concept release seeking comment on them. Issues relating to 
the dollar level of those exemptions are more appropriately considered 
in that context.
---------------------------------------------------------------------------

    \32\ The Commission explained in the notice of proposed 
rulemaking that, ``[u]nder parts 35 and 36, corporations or 
partnerships having total assets exceeding $10 million or net worth 
of $1 million in cases where the transaction was entered into in 
connection with the conduct of its business or to manage the risk of 
an asset or liability, are considered eligible for the exemption. 
Some have observed, however, that these qualifying amounts when 
applied to entities in agriculture are too low given the relatively 
large investment in land and equipment needed to operate a farm. The 
concern is that a relatively large number of individuals engaged in 
agriculture might meet these financial criteria based not so much on 
their investment sophistication and ability to gather and manage a 
sizable asset portfolio, but rather simply reflecting the need to 
acquire a threshold level of land and machinery to operate 
successfully a farm or agricultural enterprise. Accordingly, the 
Commission is proposing that, to qualify for this exemption, 
individuals or entities should have a net worth of at least $10 
million.'' 62 FR 59634.
---------------------------------------------------------------------------

    One commenter representing swaps dealers requested that the 
Commission clarify that the part 35 exemption applies to off-exchange 
agricultural options rather than this exemption. The Commission 
disagrees. Any off-exchange option on an enumerated agricultural 
commodity must comply with Commission rule 32.13(g) for exemption from 
the Act and Commission rules, and no other exemptive provision is 
available.\33\
---------------------------------------------------------------------------

    \33\ In supporting its view, the commenter suggested that the 
Commission ``clarify that the restrictions on the use of 
agricultural trade options do not limit the scope of the Swap 
Exemption,'' citing the study of the Commission's Division of 
Economic Analysis. The commenter further stated that in that way, 
``the CFTC will eliminate uncertainty.'' Promulgation of this 
exemption which explicitly is applicable to options on agricultural 
commodities eliminates any such uncertainty.
---------------------------------------------------------------------------

    Another commenter suggested that the Commission modify the proposed 
rule to exempt transactions ``between parties whose obligations under 
the option contract are guaranteed by a high net worth affiliate.'' The 
Commission recognizes that certain sophisticated, high net worth 
entities may choose to conduct business through less well capitalized 
affiliates or subsidiaries for a variety of reasons. Accordingly, it is 
modifying the interim rule to permit a party to qualify for the 
exemption on the strength of a guarantee by its affiliate which does 
meet the net-worth requirement.

E. Relief for Exchange-Traded Instruments

    Representatives of several futures and option exchanges expressed 
the concern that lifting the ban on agricultural trade options would 
put the exchanges at a competitive disadvantage. In commenting on the 
advance notice, an exchange official noted that futures exchanges 
currently are prohibited from offering options on physicals for these 
same commodities,\34\ thereby restricting their ability to offer 
certain flexible exchange-traded instruments and to compete with 
agricultural trade options.\35\
---------------------------------------------------------------------------

    \34\ Commission rule 33.4 provides in part that ``[t]he 
Commission may designate any board of trade located in the United 
States as a contract market for the trading of * * * options on 
physicals in any commodity regulated under the Act other than those 
commodities which are specifically enumerated in section 1a(3) of 
the Act * * *''
    \35\ Flex options on futures on the enumerated agriculture 
commodities have recently been proposed by exchanges and approved by 
the Commission under current rules. These options are flexible in 
terms of strike prices, last trading days, the underlying futures 
months, and the style of exercise--American or European. Additional 
types of flexible terms involving physical delivery would be 
permitted if the Commission's rule is amended.
---------------------------------------------------------------------------

    The Commission agreed with the exchange commenter and proposed to 
remove the restriction on exchange trading of options on physicals on 
these commodities. A different exchange responded to this proposal, 
labeling it a ``remarkably empty gesture.'' \36\ Whether or not the 
exchanges choose to compete with physically-settled trade options by 
offering flexible physically-settled option contracts, the Commission 
believes that there is no longer a reason to preclude them from doing 
so by regulation. Accordingly, it is removing the restriction for 
exchange-traded

[[Page 18830]]

physically-settled agricultural contracts, as proposed.
---------------------------------------------------------------------------

    \36\ The exchange further complained that it ``is uncertain if 
there is sufficient demand for exchange-trade[d] options on 
physicals. In contrast, the present demand for our futures options 
contracts is measurable, and the [exchange] is justifiably fearful 
that the Commission's proposed pilot-program will adversely affect 
such demand.'' Finally, the exchange notes that the Commission 
unfairly holds the exchanges to higher regulatory standards than 
proposed here and failed to include agricultural options within the 
Part 36 pilot program.
    Part 36 was promulgated by the Commission to initiate a pilot 
program for less regulated exchange markets for professionals. No 
futures exchange has listed a contract to trade pursuant to those 
rules. Although the Commission did not include the agricultural 
commodities in the pilot program initially, had the Part 36 pilot 
program been successful, the Commission might have reconsidered its 
scope as it did with the initial 1982 pilot program to introduce 
exchange-traded options.
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IV. Other Matters

A. Paperwork Reduction Act (PRA)

    When publishing final rules, the PRA 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 PRA. In compliance with the 
Act, these interim final rules inform the public of:

    (1) the reasons the information is planned to be and/or has been 
collected; (2) the way such information is planned to be and/or has 
been used to further the proper performance of the functions of the 
agency; (3) an estimate, to the extent practicable, of the average 
burden of the collection (together with a request that the public 
direct to the agency any comments concerning the accuracy of this 
burden estimate and any suggestions for reducing this burden); (4) 
whether responses to the collection of information are voluntary, 
required to obtain or retain a benefit or mandatory; (5) the nature 
and extent of confidentiality to be provided, if any; and (6) the 
fact that an agency may not conduct or sponsor, and a person is not 
required to respond to, a collection of information unless it 
displays a currently valid OMB control number.''

    The Commission previously submitted these rules in proposed form 
and its associated information collection requirements to the Office of 
Management and Budget (OMB). OMB approved the collection of information 
associated with these rules on January 15, 1998 and assigned OMB 
control number 3038-0048 to these rules. The burden associated with 
this entire collection is as follows:
    Average burden hours per response: 74.35.
    Number of respondents: 3610.
    Frequency of response: Daily.
    Persons wishing to comment on the information required by these 
interim final rules 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.

B. Regulatory Flexibility Act (RFA)

    The RFA, 5 U.S.C. 601 et seq., requires that agencies consider the 
impact of those rules on small businesses. The Commission has not 
previously determined whether all or some agricultural trade option 
merchants should be considered ``small entities'' for purposes of the 
RFA and, if so, the economic impact on such entities. However, the 
Commission is requiring as one of the conditions for registration as an 
agricultural trade option merchant that the entity maintain a minimum 
net worth of $50,000. The Commission previously found that other 
entities which were required to maintain minimum levels of net capital 
were not small entities for purposes of the RFA. See, 47 FR 18618, 
18619 (April 30, 1982). The Commission has also found, however, that 
one category of Commission registrant required to maintain a minimum 
level of net capital--introducing brokers (IBs)--may include small 
entities for purposes of the RFA.\37\ In addition to the $50,000 
minimum net worth required for registration as an agricultural trade 
option merchant, such registrants must be in business in the underlying 
cash commodity so that they are able to take physical delivery on those 
option contracts. This will require that they have additional resources 
in order to qualify as an agricultural trade option merchant, in 
contrast to an IB whose additional investment beyond the minimum net 
capital may be relatively small. For this reason, the Commission 
believes that agricultural trade option merchants are more 
appropriately treated as not small entities under the RFA. Therefore, 
the Chairperson, on behalf of the Commission, hereby certifies, 
pursuant to 5 U.S.C. 605(b), that the action taken herein will not have 
a significant economic impact on a substantial number of small 
entities. This certification is based on the fact that the interim 
final rules will remove a complete ban on the offer or sale of trade 
options on the agricultural commodities enumerated under the Act. The 
interim final rules permitting such transactions subject to the 
specified conditions, therefore, remove a burden for all entities, 
regardless of size.
---------------------------------------------------------------------------

    \37\ An IB is required to maintain adjusted net capital in the 
amount of $30,000, unless it enters into a guarantee agreement with 
an FCM. Most IBs operate pursuant to such an agreement. See, 61 FR 
19177 (May 1, 1996).
---------------------------------------------------------------------------

List of Subjects

17 CFR Part 3

    Administrative practice and procedure, Brokers, Commodity futures.

17 CFR Part 32

    Commodity futures, Commodity options, Prohibited transactions, and 
Trade options.

17 CFR Part 33

    Commodity futures, Consumer protection, Fraud.

    In consideration of the foregoing, and pursuant to the authority 
contained in the Act, and in particular sections 2(a)(1)(A), 4c, and 
8a, 7 U.S.C. 2, 6c, and 12a, as amended, the Commission hereby amends 
parts 3, 32, and 33 of chapter I of title 17 of the Code of Federal 
Regulations as follows:

PART 3--REGISTRATION

    1. The authority citation for part 3 continues to read as follows:

    Authority: 7 U.S.C. 1a, 2, 4, 4a, 6, 6b, 6c, 6e, 6f, 6g, 6h, 6i, 
6k, 6m, 6n, 6o, 6p, 8, 9, 9a, 12, 12a, 13b, 13c, 16a, 18, 19, 21, 
23; 5 U.S.C. 552, 552b.

    2. Part 3 is amended by adding new Secs. 3.13 and 3.14 to read as 
follows:


Sec. 3.13  Registration of agricultural trade option merchants and 
their associated persons.

    (a) Definitions. (1) Agricultural trade option merchant. 
``Agricultural trade option merchant'' means any person that is in the 
business of soliciting, offering to enter into, entering into, 
confirming the execution of, or maintaining a position in, transactions 
or agreements in interstate commerce which are not conducted or 
executed on or subject to the rules of a contract market, and which are 
or are held out to be of the character of, or are commonly known to the 
trade as, an ``option,'' ``privilege,'' ``indemnity,'' ``bid,'' 
``offer,'' ``put,'' ``call,'' ``advance guarantee,'' or ``decline 
guarantee,'' involving wheat, cotton, rice, corn, oats, barley, rye, 
flaxseed, grain sorghums, mill feeds, butter, eggs, solanum tuberosum 
(Irish potatoes), wool, wool tops, fats and oils (including lard, 
tallow, cottonseed oil, peanut oil, soybean oil and all other fats and 
oils), cottonseed meal, cottonseed, peanuts, soybeans, soybean meal, 
livestock, livestock products, and frozen concentrated orange juice. 
Provided, however, that any person entering into such transactions 
solely for the purpose of managing the risk arising from the conduct of 
his or her own commercial enterprise is not considered to be in the 
business described in this paragraph.
    (2) Associated person of an agricultural trade option merchant. 
``Associated person of an agricultural trade option merchant'' means a 
partner, employee, or agent (or any person occupying a similar status 
or performing similar functions) that:
    (i) Solicits or accepts customers' orders (other than in a clerical 
capacity) or

[[Page 18831]]

    (ii) Supervises any person or persons so engaged.
    (b) Registration required. It shall be unlawful for any person in 
the business of soliciting, offering or selling the instruments listed 
in Sec. 32.2 of this chapter to solicit, to offer to enter into, or to 
enter into, to confirm the execution of, or to maintain transactions in 
such instruments or to supervise persons so engaged except if 
registered as an agricultural trade option merchant or as an associated 
person of such a registered agricultural trade option merchant under 
this section.
    (c) Duration of registration. (1) A person registered in accordance 
with the provisions of this section shall continue to be registered 
until the revocation or withdrawal of registration.
    (2) Agricultural trade option merchants must notify the National 
Futures Association within twenty days when an associated person has 
ceased to be so associated.
    (3) An associated person who ceases to be associated with a 
registered agricultural trade option merchant is prohibited from 
engaging in activities requiring registration under Sec. 32.13 of this 
chapter or representing himself or herself to be a registrant until:
    (i) A registered agricultural trade option merchant notifies the 
National Futures Association of the person's association; and
    (ii) The associated person certifies to the National Futures 
Association that he or she is not disqualified from registration for 
the reasons listed in section 8a(2) and (3) of the Act; Provided 
however, no such certification is required when the associated person 
becomes associated with the new agricultural trade option merchant 
within ninety days from when the associated person ceased the previous 
association.
    (d) Conditions for registration. (1) Applicants for registration as 
an agricultural trade option merchant must meet the following 
conditions:
    (i) The agricultural trade option merchant must have and maintain 
at all times net worth of at least $50,000 computed in accordance with 
generally accepted accounting principles;
    (ii) The agricultural trade option merchant must identify each of 
the natural persons who are the agricultural trade option merchant's 
principals, as defined in Sec. 3.1(a), and for any principal which is a 
non-natural person, each natural person who is the holder or beneficial 
owner of ten percent or more of the outstanding shares of any class of 
stock or has contributed ten percent or more of the capital of the 
entity that is principal;
    (iii) Each of the natural persons identified in paragraph (d)(1) of 
this section must certify that he or she is not disqualified from 
registration for the reasons listed in section 8a(2) and (3) of the 
Act;
    (iv) The agricultural trade option merchant must certify that to 
the best of its knowledge, information and belief each of its 
associated persons or persons it intends to employ as an associated 
person within thirty days of that person's registration meets the 
requirements for registration as such; and
    (v) The agricultural trade option merchant must provide access to 
any representative of the Commission or the U.S. Department of Justice 
for the purpose of inspecting books and records.
    (2) Applicants for registration as an associated person of an 
agricultural trade option merchant must meet the following conditions. 
Such persons must:
    (i) Identify the agricultural trade option merchant with whom the 
person is associated or to be associated within thirty days of the 
person's registration;
    (ii) Certify that he or she is not disqualified from registration 
for the reasons listed in section 8a(2) and (3) of the Act; and
    (iii) Complete six hours of instruction in the requirements of the 
Act and rules promulgated thereunder, the economic functioning and 
risks of the transactions permitted in Sec. 32.13 of this chapter, and 
the registrant's responsibility to observe just and equitable 
principles of trade relating to such transactions. Such instruction can 
be by classroom, videotape or electronic presentation.
    (e) Applications for registration. (1) The agricultural trade 
option merchant including its principals and associated persons of an 
agricultural trade option merchant must apply for registration on the 
appropriate forms specified by the National Futures Association and 
approved by the Commission, in accordance with the instructions 
thereto, including the separate certifications from each natural person 
that he or she is not disqualified for any of the reasons listed in 
section 8a(2) and (3) of the Act and such other identifying background 
information as may be specified.
    (2) The agricultural trade option merchant's application must also 
include its most recent annual financial statements certified by an 
independent certified public accountant in accordance with generally 
accepted auditing standards prepared within the prior 12 months.
    (3) An associated person's application must also include written 
evidence from the person providing the instruction that the applicant 
completed the six hours of instruction required by paragraph 
(d)(2)(iii) of this section.
    (4) These applications must be supplemented to include any changes 
in the information required to be provided thereon on a form specified 
by the National Futures Association and approved by the Commission.
    (f) Withdrawal of application for registration; denial, suspension 
and revocation of registration. The provisions of Secs. 3.51, 3.55, 
3.56 and 3.60 shall apply to applicants for registration and 
registrants as agricultural trade options merchants and their 
associated persons under this part 3 as though they were an applicant 
or registrant in any capacity under the Act.
    (g) Withdrawal from registration. An agricultural trade option 
merchant that has ceased or has not commenced engaging in activities 
requiring registration may withdraw from registration 30 days after 
notifying the National Futures Association on the specified form of its 
intent to do so, unless otherwise notified by the National Futures 
Association or by the Commission. Such a withdrawal notification must 
include information identifying the location of, and the custodian 
authorized to release, the agricultural trade option merchant's 
records, a statement of the disposition of customer positions, cash 
balances, securities or other property and a statement that no 
obligations to customers arising from agricultural trade options remain 
outstanding.
    (h) Dual registration of associated persons. An associated person 
of an agricultural trade option merchant may be associated with other 
registrants subject to the provisions of Sec. 3.12(f).


Sec. 3.14  Requirements for trainers of associated persons of 
agricultural trade option merchants.

    (a) A person offering instruction or preparing an instructional 
videotape or electronic presentation under this section must meet the 
following conditions:
    (1) Has a minimum of three years of relevant experience; and
    (2) Is not subject to:
    (i) Statutory disqualification from registration under section 
8a(2) and (3) of the Act;
    (ii) A bar from service on self-regulatory organization governing 
boards or committees based on disciplinary history pursuant to 
Sec. 1.63

[[Page 18832]]

of this chapter or any self-regulatory organization rule adopted 
thereunder; or
    (iii) A pending adjudicatory proceeding under sections 6(c), 6(d), 
6c, 6d or 9 of the Act or similar proceeding under section 8a of the 
Act or Secs. 3.55, 3.56 or 3.60.
    (b) Persons offering instruction or preparing an instructional 
videotape or electronic presentation under this section must provide 
written evidence of completion of the six hours of instruction required 
under Sec. 3.13 to those completing this instruction. The written 
evidence of completion must include:
    (1) A certification that the person offering the instruction meets 
the conditions of paragraph (a) of this section; and
    (2) A disclaimer which reads: ``The content, quality or accuracy of 
this training program has not been passed upon or endorsed by the 
Commodity Futures Trading Commission or the National Futures 
Association.''
    (c) Before offering such training, a person must notify the 
National Futures Association of the intention to do so, provide a 
certification to the National Futures Association that the person 
offering such training meets the requirements of each condition of 
paragraph (a) of this section, and notify the National Futures 
Association of any subsequent changes in circumstances which would make 
the certification inaccurate.
    (d) Persons offering instruction or preparing an instructional 
videotape or electronic presentation under this section must maintain 
in accordance with Sec. 1.31 of this chapter documentation reasonably 
designed to verify the completion of this training by persons taking 
instruction.
    (e) Persons offering instruction or preparing an instructional 
videotape or electronic presentation under this section may not 
represent or imply in any manner whatsoever that the person has been 
sponsored, recommended or approved, or that such person's abilities or 
qualification, or the content, quality or accuracy of the person's 
instructional program have in any respect been passed upon or endorsed, 
by the Commission or the National Futures Association.

PART 32--REGULATION OF COMMODITY OPTION TRANSACTIONS.

    3. The authority citation for part 32 continues to read as follows:

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

    4. Section 32.2 is revised to read as follows:


Sec. 32.2  Prohibited transactions.

    Notwithstanding the provisions of Sec. 32.11, no person may offer 
to enter into, confirm the execution of, or maintain a position in, any 
transaction in interstate commerce involving wheat, cotton, rice, corn, 
oats, barley, rye, flaxseed, grain sorghums, mill feeds, butter, eggs, 
solanum tuberosum (Irish potatoes), wool, wool tops, fats and oils 
(including lard, tallow, cottonseed oil, peanut oil, soybean oil and 
all other fats and oils), cottonseed meal, cottonseed, peanuts, 
soybeans, soybean meal, livestock, livestock products, and frozen 
concentrated orange juice if the transaction is or is held out to be of 
the character of, or is commonly known to the trade as an ``option,'' 
``privilege,'' ``indemnity,'' ``bid,'' ``offer,'' ``put,'' ``call,'' 
``advance guarantee,'' or ``decline guarantee,'' except as provided 
under Sec. 32.13 of this part.
    5. New Sec. 32.13 is added to part 32 to read as follows:


Sec. 32.13  Exemption from prohibition of commodity option transactions 
for trade options on certain agricultural commodities.

    (a) The provisions of Sec. 32.11 shall not apply to the 
solicitation or acceptance of orders for, or the acceptance of money, 
securities or property in connection with, the purchase or sale of any 
commodity option on a physical commodity listed in Sec. 32.2 by a 
person who is a producer, processor, or commercial user of, or a 
merchant handling, the commodity which is the subject of the commodity 
option transaction, or the products or byproducts thereof, if all of 
the following conditions are met at the time of the solicitation or 
acceptance:
    (1) That person is registered with the Commission as an 
agricultural trade option merchant and that person's associated persons 
and their supervisors are registered as associated persons of an 
agricultural trade option merchant under Sec. 3.13 of this chapter.
    (2) The option offered by the agricultural trade option merchant is 
offered to a producer, processor, or commercial user of, or a merchant 
handling, the commodity which is the subject of the commodity option 
transaction, or the products or byproducts thereof, and such producer, 
processor, commercial user, or merchant is offered or enters into the 
commodity option transaction solely for purposes related to its 
business as such.
    (3) The option cannot be off-set and, if exercised, must result in 
physical delivery of the underlying commodity; Provided, however, that 
nothing in this paragraph precludes amendment of the option contract's 
delivery date or the substitution of a forward contract agreement for 
the option contract prior to the option's expiration or exercise.
    (4) To the extent that payment by the customer of the purchase 
price is made to the agricultural trade option merchant prior to option 
expiration or exercise, that amount:
    (i) May only be used by the agricultural trade option merchant to 
purchase a covering position on a contract market designated under 
section 6 of the Act or part 33 of this chapter; and
    (ii) Any amount not so used, shall be treated as belonging to the 
customer until option expiration or exercise as provided under 
Sec. 32.6, provided, however, that notwithstanding the last proviso of 
Sec. 32.6(a), the full amount of such payment shall be treated as 
belonging to the option customer.
    (5) Producers may not:
    (i) Grant or sell a put option; or
    (ii) Grant or sell a call option, except to the extent that such a 
call option is purchased or combined with a purchased or long put 
option position, and only to the extent that the customer's call option 
position does not exceed the customer's put option position in the 
amount to be delivered. Provided, however, that the options must be 
entered into simultaneously and expire simultaneously or at any time 
that one or the other option is exercised.
    (6) All option contracts, including all terms and conditions, 
offered or sold pursuant to this section shall be in writing, an 
executed copy of which shall be provided to the customer, and shall 
contain terms relating to the following:
    (i) The procedure for exercise of the option contract, including 
the expiration date and latest time on that date for exercise;
    (ii) The strike price(s) of the option contract;
    (iii) The total quantity of commodity underlying the option 
contract;
    (iv) The quality or grade of commodity to be delivered if the 
contract is exercised and any adjustments to price for deviations from 
stated quality or grade, or the range of, and a statement of the method 
for calculating, such adjustments;
    (v) The delivery location if the contract is exercised;
    (vi) The separate elements comprising the purchase price to be 
charged, including the premium, mark-ups on the premium, costs, fees 
and other charges; and
    (vii) The additional costs, if any, in addition to the purchase 
price which

[[Page 18833]]

may be incurred by an option customer if the commodity option is 
exercised, including, but not limited to, the amount of storage fees, 
interest, commissions (whether denominated as sales commissions or 
otherwise) and all similar fees and charges which may be incurred.
    (7) Prior to the entry by a customer into the first option 
transaction with an agricultural trade option merchant, the 
agricultural trade option merchant shall furnish, through written or 
electronic media, a summary disclosure statement to the option 
customer. The summary disclosure statement shall include:
    (i) The following statements in boldface type on the first page(s) 
of the summary disclosure statement:

    This brief statement does not disclose all of the risks and 
other significant aspects of trading in commodity trade options. You 
are encouraged to seek out as much information as possible from 
sources other than the person selling you this option about the use 
and risks of option contracts before entering into this contract. 
The issuer of your option should be willing and able to answer 
clearly any of your questions.

Appropriateness of Option Contracts

    Option contracts may result in the total loss of any funds you 
pay to the issuer of your option. You should carefully consider 
whether trading in such instruments is appropriate for you in light 
of your experience, objectives, financial resources and other 
relevant circumstances. The issuer of your option contract should be 
willing and able to explain the financial outcome of your option 
contract under all market conditions. You should also be aware that 
you may be able to obtain a similar contract or execute a similar 
risk management strategy using an instrument traded on a futures 
exchange which offers greater regulatory and financial protections.

Costs and Fees Associated With an Option Contract

    Before entering into an option contract, you should understand 
all of the costs and obligations associated with your option 
contract. These include the option premium, commissions, fees, costs 
associated with delivery if the option is exercised and any other 
charges which may be incurred. All of these costs and fees must be 
specified in the terms of your option contract and must be explained 
in the transaction disclosure statement.

Business Use of Trade Options

    In order to comply with the law, you must be buying this option 
for business-related purposes. The terms and structure of the 
contracts must therefore relate to your activity or commitments in 
the underlying cash market. If a trade option is exercised, delivery 
of the commodity must occur. Any amendments allowed to the option 
contract must reflect changes in your activity, in your commitments 
in the underlying cash market or in the carrying of inventory. 
Produces are not permitted to enter into short call options unless 
the producer is also entering into a long put option contract for 
the same amount or more of the commodity, at the same time and with 
the same expiration date. Producers are not permitted to sell put 
options, whether alone or in combination with a call option.

Dispute Resolution

    If a dispute should arise under the terms of this trade option 
contract, you have the right to choose to use the reparations 
program run by the Commodity Futures Trading Commission or any other 
dispute resolution forum provided to you under the terms of your 
customer agreement or by law. For more information on the 
Commission's Reparations Program contact: Office of Proceedings, 
Commodity Futures Trading Commission, Three Lafayette Centre, 1155 
21st Street, NW., Washington, DC 20581, (202) 418-5250.

Acknowledgement of Receipt

    The Commodity Futures Trading Commission requires that all 
customers receive and acknowledge receipt of this disclosure 
statement. The Commodity Futures Trading Commission does not intend 
this statement as a recommendation or endorsement of agricultural 
trade options. These commodity options have not been approved or 
disapproved by the Commodity Futures Trading Commission, nor has the 
Commission passed upon the accuracy or adequacy of this disclosure 
statement. Any representation to the contrary is a violation of the 
Commodity Exchange Act and Federal regulations.

    (ii) The following acknowledgment section:

I hereby acknowledge that I have received and understood this 
summary risk disclosure statement.
----------------------------------------------------------------------
Date

----------------------------------------------------------------------
Signature of Customer

    (8) Prior to entry by a customer into each option transaction with 
an agricultural trade option merchant, the agricultural trade option 
merchant shall furnish, through written or electronic media, a 
transaction disclosure statement to the option customer. The 
transaction disclosure statement shall include the following 
information:
    (i) The procedure for exercise of the option contract, including 
the expiration date and latest time on that date for exercise;
    (ii) A description of the elements comprising the purchase price to 
be charged, including the premium, mark-ups on the premium, costs, fees 
and other charges, and the services to be provided for the separate 
elements comprising the purchase price;
    (iii) A description of any and all costs in addition to the 
purchase price which may be incurred by an option customer if the 
commodity option is exercised, including, but not limited to, the 
amount of storage fees, interest, commissions (whether denominated as 
sales commissions or otherwise) and all similar fees and charges which 
may be incurred;
    (iv) Where the full option premium or purchase price of the option 
is not collected up front or where through amendments to the option 
contract it is possible to lose more than the amount of the initial 
purchase price of the option, a description of the worst possible 
financial outcome on the contract that could be suffered by the 
customer; and
    (v) The following acknowledgment section:

I hereby acknowledge that I have received and understood this 
transaction risk disclosure statement.
----------------------------------------------------------------------
Date

----------------------------------------------------------------------
Signature of Customer

    (b) Report of account information. Registered agricultural trade 
option merchants must provide customers with open positions the 
following information:
    (1) Within 24 hours of execution of an agricultural trade option, 
written confirmation of the transaction, including an executed copy of 
the written contract and all information required in paragraph (a)(6) 
of this section;
    (2) Within 24 hours of a request by the customer, or 48 hours of a 
request for a response in writing, current commodity price quotes, all 
other information relevant to the customer's position or account, and 
the amount of any funds owed by, or to, the customer;
    (3) Written notice of the expiration date of each option which will 
expire within the subsequent calendar month.
    (c) Recordkeeping. Registered agricultural trade option merchants 
shall keep full, complete and systematic books and records together 
with all pertinent data and memoranda of or relating to such 
transactions, including customer solicitations and covering 
transactions, maintain such books and records as specified in Sec. 1.31 
of this chapter, and make such reports to the Commission as provided 
for in paragraphs (c) and (d) of this section and as the Commission may 
otherwise require by rule, regulation, or order. Such books and records 
shall be open at all times to inspection by any representative of the 
Commission and the United States Department of Justice.
    (d) Reports. Registered agricultural trade option merchants must 
file reports quarterly with the National Futures Association, in the 
form and manner

[[Page 18834]]

specified by the National Futures Association and approved by the 
Commission, which shall contain the following information:
    (1) By commodity and put, call or combined option:
    (i) Total number of new contracts entered into during the reporting 
period;
    (ii) Total quantity of commodity underlying new contracts entered 
into during the reporting period;
    (iii) Total number of contracts outstanding at the end of the 
reporting period;
    (iv) Total quantity of underlying commodity outstanding under 
option contracts at the end of the reporting period;
    (v) Total number of options exercised during the reporting period; 
and
    (vi) Total quantity of commodity underlying the exercise of options 
during the reporting period.
    (2) Total number of customers by commodity with open option 
contracts at the end of the reporting period.
    (e) Special calls. Upon special call by the Commission for 
information relating to agricultural trade options offered or sold on 
the dates specified in the call, each agricultural trade option 
merchant shall furnish to the Commission within the time specified the 
following information as specified in the call:
    (1) All positions and transactions in agricultural trade options 
including information on the identity of agricultural trade option 
customers and on the value of premiums, fees, commissions, or charges 
other than option premiums, collected on such transactions.
    (2) All related positions and transactions for future delivery or 
options on contracts for future delivery or on physicals on all 
contract markets.
    (3) All related positions and transactions in cash commodities, 
their products, and by-products.
    (f) Internal controls. (1) Each agricultural trade option merchant 
registered with the Commission shall prepare, maintain and preserve 
information relating to its written policies, procedures, or systems 
concerning the agricultural trade option merchant's internal controls 
with respect to market risk, credit risk, and other risks created by 
the agricultural trade option merchant's activities, including systems 
and policies for supervising, monitoring, reporting and reviewing 
trading activities in agricultural trade options; policies for hedging 
or managing risk created by trading activities in agricultural trade 
options, including a description of the types of reviews conducted to 
monitor positions; and policies relating to restrictions or limitations 
on trading activities.
    (2) The financial statements of the agricultural trade option 
merchant must on an annual basis be audited by a certified public 
accountant in accordance with generally accepted auditing standards.
    (3) The agricultural trade option merchant must file with the 
Commission a copy of its certified financial statements within 90 days 
after the close of the agricultural trade option merchant's fiscal 
year.
    (4) The agricultural trade option merchant must perform a 
reconciliation of its books at least monthly.
    (5) The agricultural trade option merchant:
    (i) Must report immediately if its net worth falls below the level 
prescribed in Sec. 3.13(d)(i) of this chapter and must report within 
three days discovery of a material inadequacy in its financial 
statements by an independent public accountant or any state or federal 
agency performing an audit of its financial statements to the 
Commission and National Futures Association by facsimile, telegraphic 
or other similar electronic notice; and
    (ii) Within five business days after giving such notice, the 
agricultural trade option merchant must file a written report with the 
Commission stating what steps have been taken or are being taken to 
correct the material inadequacy.
    (6) If the agricultural trade option merchant's net worth falls 
below the level prescribed in Sec. 3.13(d)(i) of this chapter, it must 
immediately cease offering or entering into new option transactions and 
must notify customers having premiums which the agricultural trade 
option merchant is holding under paragraph (a)(4) of this section that 
such customers can obtain an immediate refund of that premium amount, 
thereby closing the option position.
    (g) Exemption. (1) The provisions of Secs. 3.13, 32.2, 32.11 and 
this section shall not apply to a commodity option offered by a person 
which has a reasonable basis to believe that:
    (i) The option is offered to a producer, processor, or commercial 
user of, or a merchant handling, the commodity which is the subject of 
the commodity option transaction, or the products or byproducts 
thereof;
    (ii) Such producer, processor, commercial user or merchant is 
offered or enters into the commodity option transaction solely for 
purposes related to its business as such; and
    (iii) Each party to the option contract has a net worth of not less 
than $10 million or the party's obligations on the option are 
guaranteed by a person which has a net worth of $10 million and has a 
majority ownership interest in, is owned by, or under common ownership 
with, the party to the option.
    (2) Provided, however, that Sec. 32.9 continues to apply to such 
option transactions.

PART 33--REGULATION OF DOMESTIC EXCHANGE-TRADED COMMODITY OPTION 
TRANSACTIONS

    6. The authority citation for part 33 continues to read as follows:

    Authority: 7 U.S.C. 1a, 2, 4, 6, 6a, 6d, 6e, 6f, 6g, 6h, 6i, 6j, 
6k, 6l, 6m, 6n, 6o, 7, 7a, 7b, 8, 9, 11, 12a, 13a, 13a-1, 13b, 19, 
and 21.

    7. The first sentence of the introductory text of Sec. 33.4 is 
revised to read as follows:


Sec. 33.4  Designation as a contract market for the trading of 
commodity options.

    The Commission may designate any board of trade located in the 
United States as a contract market for the trading of options on 
contracts of sale for future delivery or for options on physicals in 
any commodity regulated under the Act, when the applicant complies with 
and carries out the requirements of the Act (as provided in Sec. 33.2), 
the regulations in this part, and the following conditions and 
requirements with respect to the commodity option for which the 
designation is sought:
* * * * *
    Issued this 8th day of April, 1998, in Washington, D.C., by the 
Commodity Futures Trading Commission.
Jean A. Webb,
Secretary of the Commission.

Concurring Remarks of Commissioner David D. Spears on Trade Options on 
the Enumerated Agricultural Commodities

    I respectfully concur with my colleagues on the promulgation of 
interim final rules that permit the offer and sale of agricultural 
trade options off-exchange between commercial users, subject to 
certain regulatory conditions. I am pleased to say that the interim 
rules reflect a significant improvement from the proposed rules of 
November 4, 1997. I think that the industry will agree that the 
rules are more streamlined and impose less regulatory conditions 
than the rules as proposed in November.
    Nevertheless, in seeking to strike the balance between 
reasonable regulation and undue regulatory burdens, I am of the view 
that the interim rules remain somewhat restrictive in certain 
respects. Therefore, I would encourage the Commission to review, at 
least on an annual basis, the progress of the agricultural trade 
option pilot program and to pay careful attention to the program's 
regulatory provisions to assess their usefulness and necessity.

[[Page 18835]]

    In making its reviews of the pilot program, the Commission 
should focus specific attention on the restrictions imposed on 
option contract design and strategies. The success of risk 
management tools is partly dependent upon the ability of users to 
tailor contracts to meet specific business concerns. The Commission 
has made some changes from its proposed rules to provide additional 
flexibility in contract design. However, the pilot program should 
afford participants even greater flexibility to negotiate specific 
contract terms and strategies, subject only to general guidelines.
    In addition, the $10 million net worth requirement necessary to 
trigger an exemption from the regulations should be scrutinized more 
closely. My view is that there may be a more appropriate net worth 
level at which to set exemption eligibility. I therefore would 
recommend a reconsideration of the net worth amount within one year 
following the effective date of the interim rules, if not sooner.
    Finally, I believe we have made significant progress towards 
transforming the November proposal into a less complex, shorter and 
more workable program. The fact that the program is, by its terms, a 
pilot program, provides the Commission and the industry with an 
opportunity to address individual situations that arise in the 
marketplace. To this end, I am hopeful that the agricultural 
community, the futures exchanges and others involved in the futures 
industry will remain in close contact with the Commission during the 
interim period. It is important that we maintain open lines of 
communication and that the Commission is apprised of the needs of 
the private sector. In this manner, adjustments to the pilot program 
may be made, as appropriate.

    Dated: April 7, 1998.
David D. Spears.
Commissioner.

Concurring Remarks of Commissioner Barbara Pedersen Holum, Interim 
Final Rules, Trade Options on the Enumerated Agricultural Commodities

    I agree with and join in the action the Commission is taking to 
permit exchange trading of options on physicals on the enumerated 
agricultural commodities. In particular, I believe this important 
initiative recognizes the potential of exchanges in offering more 
flexible option contracts. Exchanges in the past have demonstrated 
an exceptional ability to meet the demands of the market. I am 
therefore confident, now that the prohibition is to be lifted, the 
exchanges will work with the end-users to develop option contracts 
with the necessary flexibility to meet their individualized needs.
    While I also join in the Commission's lifting of the prohibition 
on the offer and sale of off-exchange trade options on the 
enumerated agricultural commodities, I have serious concerns about 
the extensive regulatory provisions included in the interim rules. 
Specifically, these interim rules create a regulatory infrastructure 
essentially duplicating that which already exists on the exchanges. 
While the Commission has acted to exempt other off-exchange 
transactions from much of the centralized regulatory structure, 
these interim rules impose new, extensive, and costly regulatory 
mandates. In my opinion, the imposition of this far-reaching 
regulatory structure, and its additional costs, will limit 
participation and deny producers and processors the very risk 
management tools that lifting the ban envisions.

    Dated: April 8, 1998.
Barbara Pedersen Holum,
Commissioner.
[FR Doc. 98-9879 Filed 4-15-98; 8:45 am]
BILLING CODE 6351-01-M