[Federal Register Volume 65, Number 107 (Friday, June 2, 2000)]
[Proposed Rules]
[Pages 35304-35307]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 00-13606]


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COMMODITY FUTURES TRADING COMMISSION

17 CFR Part 1

RIN 3038-AB54


Minimum Financial Requirements for Futures Commission Merchants 
and Introducing Brokers; Amendments to the Provisions Governing 
Subordination Agreements Included in the Net Capital of a Futures 
Commission Merchant or Independent Introducing Broker

AGENCY: Commodity Futures Trading Commission.

ACTION: Proposed rules.

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SUMMARY: The Commodity Futures Trading Commission (``Commission'' or 
``CFTC'') is proposing to amend certain provisions of Regulation 
1.17(h) which governs the net capital treatment of subordination 
agreements. Currently, futures commission merchants (``FCMs'') and 
independent introducing brokers (``IBIs'') that are members of a self-
regulatory organization (``SRO''--i.e., a contract market or the 
National Futures Association) and that are securities brokers or 
dealers registered with the Securities and Exchange Commission 
(''SEC'') are required to obtain the approval of both a futures SRO and 
a securities designated examining authority (``DEA'') for any proposed 
subordination agreement, proposed prepayment of a subordinated loan, or 
proposed reduction in the outstanding principal balance of a secured 
demand note. The proposed amendments would ease the regulatory burden 
imposed upon SROs, FCMs, and IBIs by allowing SROs, subject to the 
conditions set forth below, to rely on a DEA's review and approval of a 
proposed subordination agreement, a proposed prepayment of a 
subordinated loan, or a proposed reduction in the outstanding principal 
balance of a secured demand note submitted to the DEA by an FCM or IBI.

DATES: Comments must be received on or before July 3, 2000.

ADDRESSES: Comments should be mailed to Jean A. Webb, Secretary, 
Commodity Futures Trading Commission, Three Lafayette Centre, 1155 21st 
Street, NW, Washington, DC 20581. In addition, comments may be sent by 
facsimile to (202) 418-5521, or by electronic mail to 
[email protected]. Reference should be made to ``Minimum Financial 
Requirements for Futures Commission Merchants and Introducing Brokers--
Subordination Agreements.''

FOR FURTHER INFORMATION CONTACT: Thomas J. Smith, Special Counsel, 
Division of Trading and Markets, Commodity Futures Trading Commission, 
Three Lafayette Centre, 1155 21st Street, NW, Washington, DC 20581; 
telephone (202) 418-5495; electronic mail [email protected]; or Henry J. 
Matecki, Financial Audit and Review Branch, Commodity Futures Trading 
Commission, 300 S. Riverside Plaza, Room 1600-N, Chicago, IL 60606; 
telephone (312) 886-3217; electronic mail [email protected].

SUPPLEMENTARY INFORMATION:   

I. Subordination Agreements Included in the Net Capital of a 
Futures Commission Merchant or Independent Introducing Broker

A. Background

    Commission Regulation 1.17 \1\ requires FCMs and IBIs to maintain 
minimum levels of adjusted net capital. \2\ In computing adjusted net 
capital, FCMs and IBIs are permitted to

[[Page 35305]]

exclude from liabilities funds received which are subordinated to the 
claims of all general creditors of the FCM or IBI pursuant to a 
``satisfactory subordination agreement,'' as defined in Regulation 
1.17(h).\3\
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    \1\ Commission regulations cited herein may be found at 17 CFR 
Ch. I (1999).
    \2\ Adjusted net capital is generally defined as current assets 
less liabilities. See Regulation 1.17(c)(5).
    Regulation 1.17(a)(1)(i) requires FCMs to maintain minimum 
adjusted net capital of the greatest of: (1) $250,000; (2) four 
percent of the customer funds required to be segregated and set 
aside pursuant to the Act and the regulations, less the market value 
of commodity options purchased by customers on or subject to the 
rules of a contract market or a foreign board of trade for which the 
full premiums have been paid provided that the deduction for each 
customer is limited to the amount of customer funds in such 
customer's account(s); (3) the amount of adjusted net capital 
required by a registered futures association of which the FCM is a 
member; or (4) for securities brokers and dealers, the amount of net 
capital required by SEC Rule 15c3-1(a) (17 CFR 240.15c3-1(a)).
    Regulation 1.17(a)(1)(ii) requires IBIs to maintain minimum 
adjusted net capital of the greatest of: (A) $30,000; (B) the amount 
of adjusted net capital required by a registered futures association 
of which the IBI is a member; or (C) for securities brokers and 
dealers, the amount of net capital required by SEC Rule 15c3-1(a).
    \3\ Regulation 1.17(c)(4)(i).
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    Subordination agreements may take the form of either subordinated 
loan agreements or secured demand notes. Subordinated loan agreements 
are agreements evidencing a subordinated borrowing of cash by the FCM 
or IBI. Secured demand notes are agreements evidencing or governing the 
contribution of a secured demand note to an FCM or IBI and the pledge 
of securities and/or cash as collateral to secure payment of such note. 
The outstanding principal balances of a subordinated loan and a secured 
demand note are recorded as liabilities of an FCM or IBI.\4\
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    \4\ See Regulation 1.17(h)(1).
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    Regulation 1.17(h) sets forth several minimum requirements for the 
subordination agreements and other conditions that must be met in order 
for the agreements to qualify as ``satisfactory'' subordination 
agreements.\5\ One condition, set forth in Regulation 1.17(h)(3)(vi), 
provides that an FCM or IBI may not treat any subordination agreement 
as a ``satisfactory'' subordination agreement for net capital purposes 
until the FCM's or the IBI's designated-self regulatory organization 
(``DSRO''), or the Commission if the FCM or the IBI is not a member of 
a DSRO, has reviewed the agreement and determined that it satisfies the 
minimum requirements set forth in Regulation 1.17(h).
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    \5\ A contract market may impose, or an FCM or IBI may require, 
conditions or restrictions in addition to those established by the 
Commission provided that such conditions or restrictions do not 
cause the subordination agreement to fail to meet the minimum 
requirements of Regulation 1.17(h).
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    Commission regulations also impose restrictions on an FCM's or 
IBI's ability to make a payment on a subordinated loan prior to the 
scheduled maturity date of such loan or to effect a full or partial 
reduction in the outstanding principal balance of a secured demand 
note. In this regard, Regulation 1.17(h)(2)(vii)(C) requires an FCM or 
IBI to obtain the written approval of its DSRO, or the Commission if 
the FCM or IBI is not a member of a SRO, prior to making a prepayment 
on a subordinated loan or prior to effecting a full or partial 
reduction in the outstanding principal balance of a secured demand 
note.
    The Joint Audit Committee (``JAC'') has requested that the 
Commission amend Regulations 1.17(h)(3)(vi) and 1.17(h)(2)(vii)(C).\6\ 
The JAC states that the Commission's regulations governing 
subordination agreements, including the provisions cited above, are 
consistent with requirements imposed by the SEC on registered 
securities brokers or dealers. Therefore, registered FCMs and IBIs that 
are also registered as securities brokers or dealers with the SEC 
(hereinafter referred to as ``dually-registered'' FCMs or IBIs) are 
required to obtain the approvals of a futures market SRO and a 
securities market DEA prior to excluding subordination agreements from 
liabilities in computing net capital or prior to making a prepayment on 
a subordinated loan or effecting a reduction in the outstanding 
principal balance of a secured demand note.\7\
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    \6\ The JAC is comprised of representatives of the audit and 
compliance departments of the self-regulatory organizations 
(''SROs'') and National Futures Association. The JAC coordinates the 
industry's audit and ongoing surveillance activities to promote a 
uniform framework of self-regulation.
    \7\ Rule 15c3-1(c)(12) of the SEC, 17 CFR 240.15c3-1(c)(12), 
defines DEA as the national securities exchange or the national 
securities association of which the broker or dealer is a member, or 
if the broker or dealer is member of more than one such exchange or 
association, the exchange or association designated by the SEC as 
the examining authority of the broker or dealer.
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    The JAC requests that the Commission amend Regulations 
1.17(h)(3)(vi) and 1.17(h)(2)(vii)(C) to allow DSROs to adopt 
procedures that would permit a DSRO to rely on a DEA's review and 
approval of a proposed subordination agreement, a proposed prepayment 
of a subordinated loan, or a proposed reduction in the outstanding 
principal balance of a secured demand note submitted by a dually-
registered FCM or IBI. In support of its position, the JAC states that 
since the Commission's and SEC's regulations are consistent with 
respect to subordination agreements, permitting the DSRO to rely on the 
review performed by a DEA will reduce the regulatory burden imposed 
upon dually-registered FCMs and IBIs without increasing the risk of 
noncompliance with Commission regulations. The JAC also states that the 
amendments would allow a DSRO to more efficiently use its financial 
surveillance resources.

B. Proposed Rule Amendments

    The Commission is proposing to amend Regulations 1.17(h)(2)(vii)(C) 
and 1.17(h)(3)(vi) to allow a DSRO to rely on a review performed by a 
DEA with respect to a proposed subordination agreement, a proposed 
prepayment of a subordinated loan, or a proposed reduction of the 
outstanding principal balance of a secured demand note submitted by a 
dually-registered FCM or IBI. As noted above, the Commission's 
regulations regarding subordination agreements are consistent in all 
material respects with the rules of the SEC for brokers or dealers. In 
this regard, SEC Rule 15c3-1d(c)(6)(i) (17 CFR 240.15c3-1d(c)(6)(i)) is 
consistent with CFTC Regulation 1.17(h)(3)(vi) in that it requires a 
registered securities broker or dealer to file copies of any proposed 
subordination agreement with its DEA prior to the effective date of the 
agreement. The rule further provides that no subordination agreement 
shall be deemed a ``satisfactory'' subordination agreement for capital 
purposes until the DEA has determined that the agreement satisfies the 
minimum requirements for a satisfactory subordination agreement as set 
forth in the SEC's rules.\8\
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    \8\ The SEC's minimum requirements for a satisfactory 
subordination agreement are set forth in Rule 15c3-1d(2) (17 CFR 
240.15c3-1d(2)) and are comparable to the minimum requirements 
established by the Commission in Regulation 1.17(h)(2).
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    Furthermore, SEC Rule 15c3-1d(b)(7) (17 CFR 240.15c3-1d(b)(7)) is 
consistent with CFTC Regulation 1.17(h)(2)(vii)(C) in that it requires 
a broker or dealer to obtain the written approval of its DEA prior to 
making a prepayment of a subordinated loan before the scheduled 
maturity date of the payment and prior to effecting a reduction in the 
outstanding principal balance of a secured demand note. Therefore, as 
noted above, subordination agreements of dually-registered FCMs and 
IBIs are currently subject to review and approval by two separate 
regulatory authorities applying consistent standards.
    The proposed amendments would provide that a DSRO may rely on a 
DEA's review of a proposed subordination agreement or a request to make 
a prepayment on a subordinated loan or to reduce the outstanding 
principal balance of a secured demand note, provided that the dually-
registered FCM or IBI files signed copies of the proposals with its 
applicable DEA, in the manner and form provided by the DEA, prior to 
the proposed effective dates. The proposal would also direct the FCM or 
IBI to file copies of the proposals with its DSRO prior to the 
respective effective dates and to file copies of the DEA's approval of 
the transactions with the DSRO immediately upon receipt of such 
approval.
    The requirement that the FCM or IBI file copies of the proposals 
with its DSRO provides the DSRO with an opportunity to review the 
transactions to ensure compliance with Commission regulations prior to 
the effective dates. The proposed amendments would

[[Page 35306]]

further provide that the DEA's review and approval of the proposals 
would be deemed, absent objection by the DSRO, a finding by the DSRO 
that the proposals meet the minimum requirements and conditions set 
forth in Commission Regulation 1.17(h). The final responsibility for 
ensuring that the proposals satisfy the minimum Commission 
requirements, however, would remain with the DSROs.

II. Related Matters

A. Regulatory Flexibility Act

    The Regulatory Flexibility Act (``RFA''), 5 U.S.C. 601-611, 
requires that agencies, in proposing rules, consider the impact of 
those rules on small businesses. The proposed rule amendments discussed 
herein would affect FCMs and IBIs. The Commission has previously 
determined that, based upon the fiduciary nature of FCM/customer 
relationships, as well as the requirement that FCMs meet minimum 
financial requirements, FCMs should be excluded from the definition of 
small entity.\9\
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    \9\ 47 FR 18618, 18619-18620 (April 30, 1982).
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    With respect to IBIs, the Commission stated that it is appropriate 
to evaluate within the context of a particular rule whether some or all 
introducing brokers should be considered to be small entities and, if 
so, to analyze the economic impact on such entities at that time.\10\ 
The proposed amendments to Regulations 1.17(h)(2)(vii)(C) and 
1.17(h)(3)(vi) do not impose additional requirements on an IBI. Thus, 
on behalf of the Commission, the Chairman certifies that the proposed 
rule amendments will not have a significant economic impact on a 
substantial number of small entities.
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    \10\ 48 FR 35248, 35275-78 (August 3, 1983).
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B. Paperwork Reduction Act

    The Paperwork Reduction Act of 1995, 44 U.S.C. 3501 et seq. (Supp. 
I 1995), imposes certain requirements on federal agencies (including 
the Commission) to review rules and rule amendments to evaluate the 
information collection burden that they impose on the public. The 
Commission believes that the proposed amendments to Regulation 1.17(h) 
do not impose an information collection burden on the public.

List of Subjects in 17 CFR Part 1

    Brokers, Commodity futures.

    In consideration of the foregoing and pursuant to the authority 
contained in the Commodity Exchange Act and, in particular, sections 
4f, 4g and 8a(5) thereof, 7 U.S.C. 6d, 6g and 12a(5), the Commission 
hereby proposes to amend chapter I of Title 17 of the Code of Federal 
Regulations as follows:

PART 1--GENERAL REGULATIONS UNDER THE COMMODITY EXCHANGE ACT

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

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

    2. Section 1.17 is proposed to be amended by revising paragraphs 
(h)(2)(vii)(C) and (h)(3)(vi) to read as follows:


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

* * * * *
    (h) * * *
    (2) * * *
    (vii) * * *
    (C)(1) Notwithstanding the provisions of paragraphs (h)(2)(vii)(A) 
and (h)(2)(vii)(B) of this section, in the case of an applicant, no 
prepayment or special prepayment shall occur without the prior written 
approval of the National Futures Association; in the case of a 
registrant, no prepayment or special prepayment shall occur without the 
prior written approval of the designated self-regulatory organization, 
if any, or of the Commission if the registrant is not a member of a 
self-regulatory organization.
    (2) A registrant may make a prepayment or special prepayment 
without the prior written approval of the designated self-regulatory 
organization: Provided, That the registrant: is a securities broker or 
dealer registered with the Securities and Exchange Commission; files a 
request to make a prepayment or special prepayment with its applicable 
securities designated examining authority, as defined in Rule 15c3-
1(c)(12) of the Securities and Exchange Commission (17 CFR 240.15c3-
1(c)(12)), in the form and manner prescribed by the designated 
examining authority; files a copy of the prepayment request or special 
prepayment request with the designated self-regulatory organization at 
the time it files such request with the designated examining authority 
in the form and manner prescribed by the designated self-regulatory 
organization; and files a copy of the designated examining authority's 
approval of the prepayment or special prepayment with the designated 
self-regulatory organization immediately upon receipt of such approval. 
The approval of the prepayment or special prepayment by the designated 
examining authority will be deemed approval by the designated self-
regulatory organization, unless the designated self-regulatory 
organization notifies the registrant that the designated examining 
authority's approval shall not constitute designated self-regulatory 
organization approval.
    (3) The designated self-regulatory organization shall immediately 
provide the Commission with a copy of any notice of approval issued 
where the requested prepayment or special prepayment will result in the 
reduction of the registrant's net capital by 20 percent or more or the 
registrant's excess adjusted net capital by 30 percent or more.
    (3) * * *
    (vi) Filing. An applicant shall file a signed copy of any proposed 
subordination agreement (including nonconforming subordination 
agreements) with the National Futures Association at least ten days 
prior to the proposed effective date of the agreement or at such other 
time as the National Futures Association for good cause shall accept 
such filing. A registrant that is not a member of any designated self-
regulatory organization shall file two signed copies of any proposed 
subordination agreement (including nonconforming subordination 
agreements) with the regional office of the Commission nearest the 
principal place of business of the registrant (except that a registrant 
under the jurisdiction of the Commission's Western Regional Office 
shall file such copies with the Commission's Southwestern Regional 
Office) at least ten days prior to the proposed effective date of the 
agreement or at such other time as the Commission for good cause shall 
accept such filing. A registrant that is a member of a designated self-
regulatory organization shall file signed copies of any proposed 
subordination agreement (including nonconforming subordination 
agreements) with the designated self-regulatory organization in such 
quantities and at such time as the designated self-regulatory 
organization may require prior to the effective date. The applicant or 
registrant shall also file with said parties a statement setting forth 
the name and address of the lender, the business relationship of the 
lender to the applicant or registrant and whether the applicant or 
registrant carried funds or securities for the lender at or about the 
time the proposed agreement was so filed. A proposed agreement filed by 
an applicant with the National Futures

[[Page 35307]]

Association shall be reviewed by the National Futures Association, and 
no such agreement shall be a satisfactory subordination agreement for 
the purposes of this section unless and until the National Futures 
Association has found the agreement acceptable and such agreement has 
become effective in the form found acceptable. A proposed agreement 
filed by a registrant shall be reviewed by the designated self-
regulatory organization with whom such an agreement is required to be 
filed prior to its becoming effective or, if the registrant is not a 
member of any designated self-regulatory organization, by the regional 
office of the Commission where the agreement is required to be filed 
prior to its becoming effective. No proposed agreement shall be a 
satisfactory subordination agreement for the purposes of this section 
unless and until the designated self-regulatory organization or, if a 
registrant is not a member of any designated self-regulatory 
organization, the Commission, has found the agreement acceptable and 
such agreement has become effective in the form found acceptable: 
Provided, however, That a proposed agreement shall be a satisfactory 
subordination agreement for purpose of this section if the registrant: 
is a securities broker or dealer registered with the Securities and 
Exchange Commission; files signed copies of the proposed subordination 
agreement with the applicable securities designated examining 
authority, as defined in Rule 15c3-1(c)(12) of the Securities and 
Exchange Commission (17 CFR 240.15c3-1(c)(12)), in the form and manner 
prescribed by the designated examining authority; files signed copies 
of the proposed subordination agreement with the designated self-
regulatory organization at the time it files such copies with the 
designated examining authority in the form and manner prescribed by the 
designated self-regulatory organization; and files a copy of the 
designated examining authority's approval of the proposed subordination 
agreement with the designated self-regulatory organization immediately 
upon receipt of such approval. The designated examining authority's 
determination that the proposed subordination agreement satisfies the 
requirements for a satisfactory subordination agreement will be deemed 
a like finding by the designated self-regulatory organization, unless 
the designated self-regulatory organization notifies the registrant 
that the designated examining authority's determination shall not 
constitute a like finding by the designated self-regulatory 
organization.
* * * * *

    Issued in Washington D.C. on May 25, 2000 by the Commission.
Jean A. Webb,
Secretary of the Commission.
[FR Doc. 00-13606 Filed 6-1-00; 8:45 am]
BILLING CODE 6351-01-U