[Federal Register Volume 65, Number 121 (Thursday, June 22, 2000)]
[Proposed Rules]
[Pages 39008-39027]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 00-14915]


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COMMODITY FUTURES TRADING COMMISSION

17 CFR Parts 1, 3, 4, 140, 155 and 166

RIN 3038-AB56


Rules Relating to Intermediaries of Commodity Interest 
Transactions

AGENCY: Commodity Futures Trading Commission.

ACTION: Proposed rules.

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SUMMARY: On February 22, 2000, a staff task force of the Commodity 
Futures Trading Commission (``CFTC'' or ``Commission'') submitted a 
report to the CFTC's Congressional oversight committees entitled A New 
Regulatory Framework. To further the regulatory reform process, the 
Commission is proposing to revise its rules relating to intermediation 
of commodity futures and commodity options (``commodity interest'') 
transactions.
    The proposed new rules would provide greater flexibility in several 
areas. To ease barriers to entry for persons seeking registration as 
futures commission merchants (``FCMs'') or introducing brokers 
(``IBs''), the Commission would: Provide a simplified registration 
procedure for those persons wishing to operate as FCMs or IBs only on 
recognized derivatives transaction facilities ``DTFs'' for 
institutional customers, and who are regulated by other federal 
financial regulatory agencies; and eliminate the requirement to submit 
a certified financial report as part of the standard registration 
application for FCMs and IBs. For all registrants, the Commission would 
eliminate its rule requiring ethics training, replacing it with a 
Statement of Acceptable Practices. In addition, the Commission would 
respond favorably to a rule change of the National Futures Association 
(``NFA'') that would relieve sales personnel dealing only with 
institutional customers of the requirement to pass a proficiency test. 
The Commission is also proposing to amend the definition of the term 
``principal'' in Rule 3.1(a), mainly to eliminate inclusion of certain 
types of officers of a firm, and to make conforming amendments to other 
rules.
    Account opening procedures would be simplified to allow for all 
required disclosures (with the exception of arbitration agreements) to 
be acknowledged with a single signature, which may be an electronic 
signature. The obligation for FCMs and IBs to provide a specific 
disclosure statement would also be eliminated for a greater number of 
spohisticated customers. Electronic transmission of account statements 
would also be permitted, and the Commission's rules as to close-out of 
offsetting positions would be streamlined to allow for customer choice.
    Further, the Commission proposes to expand the range of instruments 
in which FCMs may invest customer funds. The Commission also requests 
comment concerning whether customers should be allowed to ``opt out'' 
of the rules requiring segregation of customer funds, and whether FCMs 
should be allowed to maintain, in the same customer segregated account, 
funds used for the purpose of securing or margining instruments other 
than those currently permitted. Finally, the Commission is considering 
the issuance of a separate order revising its previous pronouncements 
regarding the treatment of customer funds on deposit with FCMs for the 
purpose of trading on foreign markets.

DATES: Comments must be received on or before August 7, 2000.

ADDRESSES: Comments on the proposed rules should be sent to Jean A. 
Webb, Secretary, Commodity Futures Trading Commission, Three Lafayette 
Centre, 1155 21st Street, NW., Washington, DC 20581. Comments may be 
sent by facsimile transmission to (202) 418-5521, or by e-mail to 
[email protected]. Reference should be made to ``Proposed Rules 
Concerning Intermediaries.''

FOR FURTHER INFORMATION CONTACT: Lawrence B. Patent, Associate Chief 
Counsel, Paul H. Bjarnason, Jr., Special Advisor for Accounting Policy 
(with respect to Rule 1.25 concerning investment of customer funds), or 
Andrew J. Shipe, Attorney-Advisor, Division of Trading and Markets, 
Commodity Futures Trading Commission, Three Lafayette Centre, 1155 21st 
Street, N.W., Washington, D.C. 20581. Telephone: (202) 418-5450.

SUPPLEMENTARY INFORMATION:

Table of Contents

I. Introduction
II. Proposed Rules
    A. Core Principle One: Registration
    1. Definition of the Term ``Principal''
    2. Special Procedures Available to Firms Subject to Securities 
or Banking Regulation
    3. Standard Application Procedures for FCMs and IBs
    B. Core Principles Two and Six: Fitness and Supervision
    1. Proficiency Testing and Ethics Training for Individual 
Registrants
    2. Reforms Relating to Statutory Disqualification From 
Registration
    C. Core Principle Three: Financial Requirements
    1. Trading by Non-Institutional Customers on DTFs

[[Page 39009]]

    2. Segregation of Funds
    3. Investment of Customer Funds
    D. Core Principle Four: Risk Disclosure and Account Statements
    E. Core Principle Five: Trading Standards
    F. Core Principle Seven: Reporting Requirements
    G. Core Principle Eight: Recordkeeping
    1. General
    2. Customer Account Statements; Close-Out of Offsetting 
Positions
III. Related Matters
    A. Regulatory Flexibility Act
    B. Paperwork Reduction Act

I. Introduction

    As announced elsewhere in this edition of the Federal Register, the 
Commission has proposed a new regulatory structure that is intended to 
adapt to the changing needs of the modern marketplace. In reviewing its 
regulatory structure, the Commission has identified eight Core 
Principles that it believes are fundamental to assuring proper conduct 
by intermediaries of commodity interest transactions. While the 
Commission is not proposing to adopt these Core Principles as rules, 
they have guided the Commission in its regulatory reform efforts. The 
Commission has reviewed all of its rules related to intermediaries in 
light of the Core Principles. To the extent that an existing rule is 
not discussed herein, and no amendment thereto is being proposed, the 
rule would apply to intermediaries transacting business on behalf of 
customers on contract markets, recognized futures exchanges (``RFEs'') 
and DTFs.
    In accordance with these Core Principles, the Commission now 
proposes reforms contemplating greater flexibility for intermediaries 
and their customers via a regulatory structure that acknowledges the 
different levels of safeguards appropriate to the types of instruments, 
customers and markets involved.1-3 While the Commission, in 
this release, is announcing certain proposed changes in its regulatory 
structure that would be applicable to all categories of Commission 
registrants (e.g., the principal definition and ethics training 
requirements discussed below), the Commission is aware that certain 
proposals would mainly affect FCMs and IBs, and would not be applicable 
to commodity pool operators (``CPOs'') and commodity trading advisors 
(``CTAs''). Nevertheless, the Commission seeks comment on these 
proposals from all categories of Commission registrant.
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    \1-3\ As noted elsewhere in this edition of the Federal 
Register, the Commission is proposing a new market structure, an 
exempt multilateral transaction execution facility (``MTEF''), 
wholly exempt from Commission regulation, except for the antifraud 
and antimanipulation provisions of the Commodity Exchange Act 
(``Act''). Intermediaries would generally not be subject to 
regulation as to their activities on such an exempt MTEF. 
Accordingly, the proposals discussed in this release are applicable 
generally only to intermediaries on RFEs, DTFs and contract markets. 
It should also be noted that some DTFs may permit trading only on a 
principal-to-principal basis. Since the rule amendments proposed 
herein relate only to intermediaries, they would not be applicable 
to such a market structure.
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    The Commission also wishes to make clear that its regulatory reform 
efforts are an ongoing process. Thus, for example, as a part of the 
regulatory reform process, the Division of Trading and Markets recently 
permitted designated self-regulatory organizations (``DSROs'') to 
conduct ``risk-based'' auditing and thereby take into account a firm's 
business practices in establishing the scope and timing of audits.\4\ 
Similarly, the Commission is considering various changes to the capital 
requirements for FCMs, including a risk-based approach.
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    \4\ See Interpretative No. 4-2, CFTC Staff Letter 99-32, [1998-
1999 Transfer Binder] Comm. Fut. L. Rep. (CCH) para.27,745 (August 
20, 1999).
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    The Commission also intends to consider further rulemaking 
proposals at a subsequent date that may focus more directly upon Part 4 
of the Commission's rules, which govern the activities of CPOs and 
CTAs. As examples of its reform efforts with regard to such persons, 
the Commission has recently proposed to bring more persons within the 
definition of a ``qualified eligible client'' of a CTA or a ``qualified 
eligible participant'' of a commodity pool, see 65 FR 11253 (March 2, 
2000), which would lessen the disclosure, recordkeeping and reporting 
requirements for CTAs and CPOs, and to permit CTAs to compute the rate 
of return for partially funded accounts (also known as ``notionally 
funded accounts'') by dividing net performance by the agreed-upon 
nominal account size, see 64 FR 41843 (Aug. 2, 1999).
    Industry representatives have indicated that they would prefer 
uniform standards for intermediaries dealing with institutional 
customers without regard to the type of facility on which a trade is 
executed. Many of the proposals contained herein would have that 
effect. The Commission requests comment on whether there are other 
specific requirements that should be modified toward that end.
    The Core Principles applicable to intermediaries, which relate to 
registration, fitness of registrants, financial requirements, risk 
disclosure, trading standards, supervision of personnel, large position 
reporting requirements, and recordkeeping, are as follows:
1. Registration Required.
    Any person or entity intermediating a transaction on an RFE, or on 
a DTF that permits intermediation of trading, must be registered in the 
appropriate capacity with the Commission as an FCM, IB, CTA, CPO, AP of 
any of the foregoing, or floor broker (``FB''). In addition, a person 
trading solely for his or her own account on an RFE or DTF with a 
trading floor must register as a floor trader (``FT'').
2. Fitness of Registrants
    Intermediaries and FTs in all MTEF markets recognized by the CFTC 
must be and remain fit.
3. Financial
    FCMs must keep and safeguard customer money and FCMs and IBs must 
have sufficient capital to ensure their capacity to meet their 
obligations to customers.
4. Risk Disclosure
    Intermediaries must provide to customers risk disclosure 
appropriate to the particular instrument and the customer.
5. Trading Standards
    Intermediaries and their affiliated persons are prohibited from 
misusing knowledge of their customers' orders.
6. Supervision
    All intermediaries, including APs having supervisory 
responsibilities, must diligently supervise all commodity interest 
accounts that they carry, operate, advise, introduce, handle or trade, 
as well as all of the other activities that arise in their business as 
intermediaries. All intermediaries must establish and maintain 
supervisory procedures.
7. Reporting of Positions
    All intermediaries must report to the Commission, RFE or DTF 
information that permits the Commission, RFE or DTF to identify 
concentrations of positions and market composition. Reports of 
transactions on RFEs would be required on a routine and nonroutine 
basis as is the case for transactions on contract markets. Reports of 
transactions on DTFs would be required only on a non-routine basis.
8. Recordkeeping
    All intermediaries (and FTs) must keep full books and records of 
all activities related to their business as an FCM, IB, CPO, CTA, FB or 
FT, in a form

[[Page 39010]]

and manner acceptable to the Commission for a period of five years. 
Such information must be readily available during the first two years 
and be produced to the Commission at the expense of the person required 
to keep the books or records. All such books and records shall be open 
to inspection by any representative of the Commission or the U.S. 
Department of Justice.

II. Proposed Rules

A. Core Principle One: Registration

1. Definition of the Term ``Principal''
    The second proviso to Section 8a(2) of the Act states that a 
principal shall mean a general partner of a partnership, any officer, 
director or beneficial owner of at least ten percent of the voting 
shares of a corporation, ``and any other person that the Commission by 
rule, regulation or order determines has the power, directly or 
indirectly, through agreement or otherwise, to exercise a controlling 
influence over the activities of [a firm] which are subject to 
regulation by the Commission.''
    The Commission has implemented this statutory provision by adopting 
a definition of ``principal'' in its registration rules that includes 
certain specified persons, such as corporate officers and directors, as 
well as persons who have the power ``directly or indirectly, through 
agreement or otherwise, to exercise a controlling influence'' over the 
activities of a firm.\5\ The identification of an applicant's or 
registrant's principals is crucial to enabling the Commission or the 
National Futures Association (``NFA''), which performs various 
registration functions for the Commission pursuant to delegations of 
authority, to perform a fitness assessment under the Act. It also 
provides information about individuals and firms who provide commodity 
interest services to market participants. Because of the important role 
principals play in the Commission's regulatory structure, CFTC rules 
impose various listing, disclosure, and recordkeeping requirements on a 
registrant with regard to its principals.\6\
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    \5\ Rule 3.1(a) defines ``principal'' for purposes of the 
Commission's Part 3 rules, which govern registration. Rule 4.10(e) 
defines ``principal'' for purposes of the Commission's Part 4 rules, 
which apply to the activities of commodity pool operators (``CPOs'') 
and commodity trading advisors (``CTAs''). The rules are 
substantially equivalent, although Rule 3.1(a)(1) contains the final 
clause ``to exercise a controlling influence over its activities 
which are subject to regulation by the Commission'' while Rule 
4.10(e)(1)(i) concludes ``to exercise a controlling influence over 
the activities of the entity.'' This distinction has not been 
significant in the Commission's analysis of whether a given person 
is a principal. The Commission nevertheless proposes to conform 
these definitions, as detailed herein, to remove any possible 
ambiguity.
    \6\ See, e.g., CFTC Rule 3.10(a)(2) (principals must complete a 
Form 8-R and submit a fingerprint card); Rules 4.24(e)(1), 
4.24(f)(1)(v) and 4.24(j)(1)(v), applicable to CPOs, and 4.34(e)(1), 
4.34(f)(1)(ii), and 4.34(j)(1)(iv), applicable to CTAs (identity of 
principals, business background of those principals who participate 
in making trading or operational decisions or supervise persons so 
engaged, and information about any conflicts of interest regarding 
principals must be disclosed in the Disclosure Document); Rules 
4.23(b)(2)(ii) and 4.33(b)(2)(ii), applicable to CPOs and CTAs, 
respectively (recordkeeping requirements for transactions of 
principals); Rules 4.25(a)(8)(ii)(A), 4.25(b)(2), 4.25(c)(2)(i)(B), 
4.25(c)(2)(ii), applicable to CPOs, and Rules 4.35(a)(7)(ii)(A) and 
4.35(b), applicable to CTAs (disclosure requirements for performance 
of accounts or pools owned or controlled by principals).
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    The Commission staff's current interpretation of Rules 3.1(a)(1) 
and 4.10(e)(1)(i) is to treat all officers and directors of a 
registrant as principals, pursuant to the language of the second 
proviso to Section 8a(2) of the Act.\7\ The Commission recognizes, 
however, that there have been changes in management structures over the 
last 20 years. The Commission further notes that it has received 
requests from registrants that certain employees, such as some vice 
presidents, not be considered principals because they do not exercise a 
controlling influence over the registrant or any of its activities 
subject to Commission regulation. While the Commission believes that, 
under its rules, certain officers should continue to be listed as 
principals, it also recognizes that listing may be unnecessary for some 
mid-level officers. The Commission therefore believes it appropriate to 
amend its rules so that not all of a registrant's officers will be 
considered to be principals, while ensuring that appropriate personnel 
remain listed as such.
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    \7\ See, e.g., CFTC Staff Letter No. 76-15, [1975-1977 Transfer 
Binder] Comm. Fut. L. Rep. (CCH) para. 20,194 (Office of General 
Counsel, Aug. 2, 1976) (the term ``individual principals'' includes 
officers, directors, principal shareholders and any other person 
who, directly or indirectly, controls the CTA); CFTC Staff Letter 
No. 95-19, [1994-1996 Transfer Binder] Comm. Fut. L. Rep. (CCH) 
para. 26,346 (Division of Trading and Markets, Feb. 24, 1995) (CTA 
required to list corporate secretary as a principal despite 
contention that her duties were clerical); CFTC Staff Letter No. 98-
29, [1996-1998 Transfer Binder] Comm. Fut. L. Rep. (CCH) para. 
27,312 (Division of Trading and Markets, Apr. 1, 1998) (CTA required 
to list sixteen employees who were either vice presidents, senior 
vice presidents or executive vice presidents as principals).
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    The Commission proposes to amend Rule 3.1(a)(1) by defining as 
principals persons within a given organizational structure who hold 
specific offices. Thus, the principal definition would include, if the 
entity is organized as a sole proprietorship, the proprietor; if a 
partnership, any general partner (including individuals and entities, 
such as corporations); if a corporation, any director, the president, 
chief executive officer, chief operating officer, chief financial 
officer.\8\ and any person in charge of a principal business unit, 
division or function subject to regulation by the Commission; and, if a 
limited liability company or limited liability partnership, any 
director, the president, chief executive officer, chief operating 
officer, chief financial officer, the manager, managing member or those 
members vested with management authority for the entity, and any person 
in charge of a principal business unit, division or function subject to 
regulation by the Commission. Thus, a registrant would no longer 
automatically be required to treat every officer as a principal, but 
only those who met the criteria of the rule.
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    \8\ As an indication of the importance of the chief financial 
officer, the Commission notes that for purposes of filing a Notice 
of Claim of Exemption (``Notice'') under Rules 4.7, 4.12 or 4.13, if 
the registrant is organized as a corporation, the rules provide that 
the chief financial officer may sign the Notice. The Commission also 
notes that the attestation to the truth and correctness of 
information contained in a financial report can be made by a chief 
financial officer. Rule 1.10(d)(4) (applicable to FCMs and IBs).
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    The principal definition would also include an individual who 
directly or indirectly, through agreement, holding company, nominee, 
trust or otherwise: (1) Is the owner of ten percent or more of any 
class of a firm's securities; (2) is entitled to vote ten percent or 
more of any class of a firm's voting securities; (3) has the power to 
sell or direct the sale of ten percent or more of any class of a firm's 
voting securities; (4) has contributed ten percent or more of a firm's 
capital (excluding unaffiliated banks and insurance companies); or (5) 
is entitled to receive ten percent or more of a firm's profits. 
Further, the principal definition would include an entity that is the 
direct owner of ten percent or more of any class of a firm's securities 
or that has directly contributed ten percent or more of a firm's 
capital.\9\ These proposed amendments would permit the deletion of Rule 
3.10(a)(2)(ii), which has proved somewhat unwieldy in practice.\10\
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    \9\ The portion of the principal definition concerning 
contribution of capital retains the current provisions of Rule 
3.1(a)(3), which does not appear in this release because it is not 
being amended.
    \10\ The proposed amendments would also result in the 
redesignation of Rule 3.10(a)(2)(i) as Rule 3.10(a)(2) and 
conforming modifications to Rule 3.32(a)(2).
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    Finally, the principal definition would continue to include the 
general provision that defines as a principal any person occupying a 
similar status or performing similar functions, having the

[[Page 39011]]

power, directly or indirectly, through agreement or otherwise, to 
exercise a controlling influence over a firm's activities that are 
subject to regulation by the Commission.\11\
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    \11\ While the Commission recognizes that what constitutes ``a 
controlling influence'' is best left for determination on a case-by-
case basis, such influence would be ascribed to, among others, those 
persons who have policymaking or managerial authority over the 
activities of an applicant or registrant that are subject to 
Commission regulation.
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    The Commission also proposes to amend Rule 3.1(a) to conform it 
with certain provisions of Rule 3.32, which governs re-registration and 
specifies certain events or changes within a firm's management that 
require a new registration. Absent this proposed amendment, the 
interplay of Rule 3.32 and Rule 3.1 could create an anomaly when, for 
example, under Rule 3.1, a firm would not be required to list a person 
as a principal, but under Rule 3.32 would be required, because of that 
person, to obtain a new registration.
    Thus, to conform to Rule 3.1(a)(1), paragraph (a)(1)(v) of Rule 
3.32, addressing corporate registrants, would be amended to include any 
person who becomes ``the president, chief executive officer, chief 
operating officer or chief financial officer of a corporate registrant, 
or becomes in charge of a principal business unit, division or function 
subject to regulation by the Commission, or comes to occupy a position 
of similar status or perform a similar function.'' Similarly, with 
respect to limited liability companies and limited liability 
partnerships, a new paragraph (a)(1)(vi) would be added so that re-
registration would also be required when there is a new person who 
becomes ``a director, president, chief executive officer, chief 
operating officer, chief financial officer, manager, managing member or 
member vested with management authority for the registrant, or * * * in 
charge of a principal business unit, division or function subject to 
regulation by the Commission, or comes to occupy a position of similar 
status or perform a similar function.'' \12\ In line with new paragraph 
(a)(1)(vi) of Rule 3.32, which brings within the ambit of the rule 
changes affecting the management of a limited liability company or 
limited liability partnership, Rule 3.32(a)(1)(i) would be amended to 
delete the word ``corporate'' before ``registrant's voting securities'' 
so as to permit a broader application of that paragraph to registrants 
other than corporate registrants. To conform Rule 3.32(a)(1)(v) and 
(a)(1)(vi) to Rule 3.32(e)(1), the latter would be amended by adding a 
reference to the former.\13\
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    \12\ The existing paragraphs (a)(1)(vi) and (a)(1)(vii) of Rule 
3.32 would be redesignated as paragraphs (a)(1)(vii) and 
(a)(1)(viii), respectively.
    \13\ Re-registration can be avoided by following the procedures 
in paragraph (e)(1) of Rule 3.32, which require a registrant to file 
a Form 3-R to amend its Form 7-R, and to include a Form 8-R and 
fingerprint card for the new officer, manager or member, unless a 
current Form 8-R is already on file for that person. These documents 
must be submitted to the NFA prior to the date of the change in 
personnel, which is not considered effective until the NFA provides 
the registrant with written approval. Therefore, some advance 
planning by registrants should make this a relatively 
straightforward process.
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    In addition, the Commission proposes to amend Rule 4.10(e)(1) to 
incorporate by reference the definition of ``principal'' in amended 
Rule 3.1(a). \14\ Finally, the Commission proposes to amend Rules 
4.24(f)(1)(v), 4.25(a)(8)(ii)(A) and 4.25(c)(2)(i)(B), applicable to 
CPOs and 4.34(f)(1)(ii) and 4.35(a)(7)(ii)(A), applicable to CTAs, to 
conform these rules to proposed Rule 3.1(a)(1), as incorporated by 
reference in amended Rule 4.10(e)(1). Thus, a registrant would only be 
required to provide business backgrounds and proprietary trading 
results for those principals who participate in making trading or 
operational decisions, or supervise persons so engaged, and not all 
officers.
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    \14\ Although Rule 4.10(e) was amended in 1981 to conform more 
closely to the wording of Rule 3.1(a)(1)-(a)(3), the terminology in 
the Rules remained slightly different. When Rule 4.10(e)(1) was 
adopted, the Commission explained that ``[b]ecause the term 
`principal' is employed in both Part 3 and Part 4 to obtain similar 
critical information about certain persons associated with a CPO or 
a CTA, the Commission has determined to use the same term in both 
parts. To serve the objectives of Part 4, however, the term 
`principal' does not need to be defined as broadly as it is in 
Sec. 3.1(a).'' 46 FR 26004, 26005 (May 8, 1981). Because the 
amendments to Rule 3.1(a) proposed herein will restrict the 
definition of principal so that, for example, not all officers of a 
corporate registrant will be included, the Commission believes it is 
no longer appropriate to have different definitions of the term 
``principal'' in Parts 3 and 4.
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    The Commission's intent in proposing these amendments is to provide 
a uniform definition and treatment of principals under its rules. The 
amendments would require the filing of fewer individual registration 
forms (Forms 8-R) and fingerprint cards, and would also require less 
disclosure by CPOs and CTAs. The Commission does not intend to alter 
the application of any other CFTC rule that provides relief from 
registration requirements. For example, the exemption from registration 
as an associated person (``AP'') that is available to the chief 
operating officer, general partner or other person in the supervisory 
chain-of-command of a registrant under Rule 3.12(h)(1)(iii) would 
remain intact.\15\
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    \15\ That rule provides an exemption from AP registration for 
certain principals provided that, among other requirements, the 
sponsoring firm's revenue from commodity interest related activity 
for customers is no more than ten percent of its total revenue on an 
annual basis.
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2. Special Procedures Available to Firms Subject to Securities or 
Banking Regulation
    As reflected in the Core Principles, intermediaries and FTs in all 
CFTC recognized markets, absent an exemption, are and will be required 
to be registered with the CFTC under the Act. Registration 
requirements, however, could be eased in several ways, depending on the 
particular markets on which the intermediary transacts business.
    Under the proposed rules, persons who intermediate transactions on 
or subject to the rules of an RFE must be registered under the Act as 
FCMs, IBs, CPOs, CTAs, APs of any of the foregoing, or FBs, or qualify 
for an existing statutory or regulatory exemption from 
registration.\16\ If such persons are required to register as FCMs, 
they must also become and remain a member of a registered futures 
association.\17\ In addition, persons who trade for their own account 
on the floor of an exchange must register as FTs.
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    \16\ See, e.g., Section 4m(1) of the Act, Commission Rules 
3.10(c), 4.13 and 4.14.
    \17\ Commission Rule 170.15. NFA is currently the only 
registered futures association. NFA Bylaw 1101 essentially provides 
that no NFA member may deal with another person with respect to an 
account, order or transaction where the other person is acting in a 
capacity that requires registration, unless that other person is 
also a member of a registered futures association. The combination 
of Commission Rule 170.15 and NFA Bylaw 1101 therefore requires most 
registrants to become members of NFA.
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    Persons whose business is limited exclusively to transactions 
conducted on or subject to the rules of a DTF also would be required to 
register as FCMs, IBs, CPOs, CTAs, FBs or FTs, if they perform those 
functions. Registration as an FCM or IB, however, would be simplified 
for persons that conduct business solely for institutional customers 
\18\ on a DTF, if they were already registered with the Securities and 
Exchange Commission (``SEC'') in a similar registration category or 
they were authorized to perform these functions by a federal banking 
authority. Under the proposed changes to Rule 3.10, such applicants 
would be

[[Page 39012]]

registered in the corresponding CFTC registration category (FCM or IB) 
upon filing notice with the NFA of their intent to undertake such 
limited activities, together with a certification that they are 
registered or authorized to engage in a similar function by, and are in 
good standing with, the SEC or a federal banking authority.\19\ This 
would avoid the need to file CFTC registration forms and fingerprints. 
A firm acting in the capacity of an FCM would, however, be required to 
become a member of a registered futures association.\20\ Because it 
would be difficult to track individual sales personnel of these firms 
without registration forms, individuals acting in the capacity of APs 
for such FCMs or IBs would not be required to be registered or listed, 
and would not be subject to proficiency testing or ethics training 
requirements. Finally, such firms and their salespersons would, of 
course, remain subject to antifraud provisions.
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    \18\ The Commission proposes a definition of the term 
``institutional customer'' in Rule 1.3(g), which would be the same 
as the definition of ``eligible participant'' in Rule 35.1(b) that 
is set forth in one of the Commission's other Federal Register 
notices published today.
    \19\ The Commission will, naturally, consult with other agencies 
to solicit their views and determine the most appropriate method of 
effecting this proposal.
    \20\ See Rule 170.15. The Commission may consider not requiring 
NFA membership in the future if reciprocal arrangements were made by 
the primary regulators of other financial industry segments to 
recognize CFTC registration without requiring corresponding SRO 
membership.
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    The Commission believes that this proposed structure is appropriate 
because (i) firms and individuals involved would be permitted to deal 
only with institutional customers, (ii) they would be subject to 
oversight by other federal regulatory authorities, and (iii) the 
Commission anticipates that they will conduct most of their business in 
the securities or banking fields, with only a minor portion of their 
activities involving commodity interests. Nevertheless, the Commission 
wishes to stress that its reform efforts are an ongoing process, and 
that it seeks comment on all facets of the proposal.
    In order to implement these changes, the text of Rule 3.10 would be 
revised by redesignating paragraph (a)(1)(i) as (a)(1)(i)(A), and a new 
paragraph (a)(1)(i)(B) would be added. The new paragraph would provide 
that an applicant for registration as an FCM or IB that will conduct 
transactions exclusively on or subject to the rules of a DTF for 
institutional customers, and who is registered with the SEC as a 
securities broker or dealer or is a bank or any other financial 
depository institution subject to regulation by the United States, may 
apply for registration by filing with NFA notice of its intention to 
undertake transactions exclusively on or subject to the rules of a DTF 
for institutional customers, together with a certification of 
registration and good standing with the appropriate authority or of 
authorization to engage in such transactions by said authority.
    Further, paragraph (d) of Rule 3.10 is proposed to be amended by 
replacing the existing cross-reference to ``paragraph (a)'' with a 
conforming cross-reference to ``paragraph (a)(1)(i)(A)'' so that those 
registrants who choose to follow these newly proposed registration 
procedures will not be required to file an annual update of the basic 
registration form for firms, Form 7-R.
    The Commission also proposes not to require such ``passported'' 
registrants to meet the Commission's minimum financial requirements if 
(i) they meet the appropriate net capital requirements of their primary 
regulator, (ii) their activities are limited to serving institutional 
customers trading exclusively on DTFs that do not require compliance 
with CFTC minimum financial requirements, and (iii) they conform to 
minimum financial standards and related reporting requirements set by 
such DTF in its bylaws, rules, regulations or resolutions.\21\ In this 
regard the Commission seeks comment on the propriety of such reforms.
---------------------------------------------------------------------------

    \21\ Intermediaries engaged in transactions on DTFs that are not 
registered or licensed by another regulator would be subject to the 
CFTC's minimum financial requirements, even if all of the 
transactions they are involved in occur on or subject to the rules 
of a DTF. It should also be noted that these rule amendments relate 
only to intermediaries, and are thus inapplicable to persons who 
participate in transactions on DTFs solely on a principal-to-
principal basis in accordance with DTF rules.
---------------------------------------------------------------------------

    The Commission is therefore proposing to add a new paragraph (iii) 
to Rule 1.17(a)(2), which currently contains two exemptions from the 
Rule's adjusted net capital requirements. The new paragraph would 
provide that the basic minimum financial requirements would not apply 
to an FCM registered under the new ``passporting'' procedures in 
proposed Rule 3.10(a)(1)(i)(B) whose business is limited to transacting 
business on behalf of institutional customers on a DTF, and who 
conforms to minimum financial standards and related reporting 
requirements set by such DTF in its bylaws, rules, regulations or 
resolutions. A conforming amendment would be added to Rule 1.52 by 
adding a new paragraph (m) to relieve a DTF from the requirement that 
it adopt minimum adjusted net capital standards that are modeled on 
those of the Commission with respect to these ``passported'' firms.
    The Commission notes that as it proposes to simplify the 
registration process for SEC registrants that may wish to conduct the 
limited activities in futures markets described above, it encourages 
the SEC to consider reciprocal amendments to its rules to accommodate 
FCMs and IBs that are not now dually registered as securities brokers 
or dealers, but that may wish to act as intermediaries in the 
securities markets.
    Finally, the Commission is considering updating and making more 
flexible its standard minimum net capital requirements with respect to 
FCMs by permitting the application of risk-based net capital 
requirements. At this time, the Commission is not proposing changes to 
its requirements in this area. Rather, the Commission wishes to solicit 
input from commenters regarding the most effective approach to 
developing changes to these rules.
3. Standard Application Procedures for FCMs and IBs
    In order to lower a potential barrier to entry for new firms and to 
conform CFTC practice more closely with that of the SEC, the Commission 
proposes to streamline further its current application requirements for 
the registration of FCMs and IBs. Current Commission Rules 
3.10(a)(1)(ii) and 1.10(a)(2) require new applicants for registration 
as FCMs and IBs to file Form 1-FR-FCM or 1-FR-IB, respectively, with 
their applications. Pursuant to Rule 1.10(a)(2), these forms must be 
certified by an independent public accountant.
    The Commission is proposing that applicants for registration as 
FCMs or IBs who raise their own capital to satisfy minimum financial 
requirements would not be required to provide these certified financial 
statements with their registration applications.\22\ Rather, such 
applicants would be permitted to file an unaudited financial report 
indicating satisfaction of the minimum requirements. A firm taking 
advantage of this new procedure would be subject to an on-site review 
within six months of registration by the firm's DSRO or, at the DSRO's 
discretion, a conference between appropriate staff of the firm and the 
DSRO at the DSRO's offices. This alternative procedure is modeled on 
similar procedures in the securities industry. An applicant would 
remain

[[Page 39013]]

free to follow the existing rules concerning the filing of a certified 
financial statement with its application and thereby delay the initial 
DSRO review.\23\ Appropriate rule changes would be made by adding new 
paragraphs (a)(2)(i)(C) and (a)(2)(ii)(D) to Rule 1.10.
---------------------------------------------------------------------------

    \22\ Those IB applicants who do not raise their own capital 
would continue to be required to file a guarantee agreement entered 
into with an FCM with their registration application.
    \23\ Of course, a DSRO retains the authority to inspect its 
member firms at any time.
---------------------------------------------------------------------------

B. Core Principles Two and Six: Fitness and Supervision

1. Proficiency Testing and Ethics Training for Individual Registrants
    The second of the Core Principles for intermediaries identified by 
the Commission is that intermediaries in commodity interest markets 
must be and remain fit. This requirement is reflected by various 
provisions of the Act. Section 4p(a) of the Act permits the Commission 
to require written proficiency examinations for individual applicants 
for registration. Section 17(p) of the Act further requires that any 
futures association registered under the Act must submit to the 
Commission for approval rules to establish training standards and 
proficiency testing for persons involved in solicitations of 
transactions, their supervisors and all persons for whom the 
association has registration responsibilities. The NFA administers this 
testing program through the facilities of the National Association of 
Securities Dealers, Inc. NFA rules that the Commission has approved 
generally require that all applicants for AP registration present 
evidence of passage of a proficiency test, the basic test being the 
National Commodity Futures Examination (commonly known as the ``Series 
3 Test''). In keeping with the recommendations of A New Regulatory 
Framework, the Commission believes that those APs dealing only with 
institutional customers need not pass a specific proficiency 
examination, and it would consider an NFA rule change to this effect. 
The Commission notes that under Sections 4p(a) and 17(p) of the Act and 
Rule 170.10, NFA is currently allowed to adopt such rules as it may 
deem appropriate, subject to Commission approval. Therefore, no changes 
to the Commission's rules are deemed necessary to effect these changes.
    Section 4p(b) of the Act requires the Commission to issue 
regulations requiring new registrants to attend ethics training 
sessions within six months of registration, and requiring all 
registrants to attend such training on a periodic basis. The Commission 
has issued Rule 3.34 to fulfill this statutory mandate. Rule 3.34 
specifies the frequency and duration of such training, the suggested 
curriculum, qualifications of instructors, and the necessary proof of 
attendance at such classes.
    In order to provide flexibility and ease compliance for all 
registrants, the Commission proposes to delete Rule 3.34. In place of 
that rule, the Commission proposes to implement Congressional intent 
through a Statement of Acceptable Practices consistent with its second 
Core Principle, which requires intermediaries to be and remain fit. The 
Commission believes that the maintenance of professional ethical 
standards is a key element of a registrant's fitness. Further, training 
standards in the field of ethics are relevant to adherence to the sixth 
Core Principle, requiring adequate supervision of handling accounts by 
a firm and its personnel. The Commission therefore proposes to issue 
this Statement of Acceptable Practices as an Appendix to Part 3 of its 
Rules. The Commission believes that Section 4p(b) of the Act expresses 
Congressional intent that futures industry professionals remain abreast 
of their responsibilities to the public under the Act and rules 
thereunder. The Commission further believes that there can be greater 
flexibility concerning acceptable practices to achieve this objective 
than is permitted under the existing rule. For registrants seeking 
guidance as to the maintenance of proper ethics training procedures in 
keeping with the purposes of the Core Principles, the Statement of 
Acceptable Practices would function as a ``safe harbor.''
    For instance, under the Statement of Acceptable Practices, 
registrants may engage in ethics training programs sponsored by the 
registrants themselves, their DSROs, trade associations or others. The 
format of such training, whether by personal or recorded instruction, 
or by circulation of written materials such as legal cases, 
interpretative letters or advisories, would also be left to the 
discretion of registrants and DSROs. It would also be permissible to 
require training on whatever periodic basis the registrant and DSROs 
deem appropriate. Thus, the Commission would not specify any particular 
programs or procedures that must be followed.
2. Reforms Relating to Statutory Disqualification From Registration
    The grounds for statutory disqualification from registration, which 
establish fitness standards based upon disciplinary history, are set 
forth in Sections 8a(2) and (3) of the Act. One of those provisions 
states that registration can be denied or conditioned based upon, in 
addition to specific matters such as revocation of a previous 
registration or a felony conviction, ``other good cause'' (see Section 
8a(3)(M) of the Act). In an effort to provide greater clarity in this 
area, the Commission recently revised the ``Guidance Letter'' issued to 
NFA concerning the treatment of self-regulatory organization (``SRO'') 
disciplinary actions in assessing the fitness of FBs, FTs or applicants 
in either category. See CFTC Letter No. 00-56 (April 13, 2000); CFTC 
Guidance to NFA Concerning Floor Broker and Floor Trader Registration 
Actions, [1996-1998 Transfer Binder] Comm. Fut. L. Rep. para. 27,202 
(Dec. 4, 1997). The Commission considers these letters to be part of 
its overall regulatory reform efforts and intends to publish both as an 
accompanying statement when it publishes final rules. The Commission 
requests comment as to any further changes that should be considered in 
this area.

C. Core Principal Three: Financial Requirements

1. Trading by Non-Institutional Customers on DTFs
    As noted above, the Commission's proposed new regulatory framework 
contemplates the recognition of a new form of trading facility that is 
subject to an intermediate degree of regulatory oversight, the DTF. 
Under the proposed rules, trading on DTFs generally would be limited to 
futures and options on specified commodities. In addition, DTFs could 
permit trading on any commodities if trading is limited to qualifying 
commercial participants.
    Thus, although trading on DTFs would generally be limited to 
institutional or commercial customers, under certain conditions a DTF 
might permit non-institutional customers to enter into transactions 
thereon. Because of the lower regulatory protections offered to 
participants in these markets, and the higher degree of risk associated 
therewith, the Commission is proposing that such non-institutional 
customers' business be transacted through FCMs that are more capable of 
properly maintaining such accounts and handling the associated risk. 
This is in accordance with the third Core Principle, which requires 
intermediaries to maintain adequate capital to ensure they are able to 
meet their obligations to customers. Thus, non-institutional customers 
who desire to conduct transactions on or subject to the rules of

[[Page 39014]]

a DTF would be required to do so through a registered FCM that (1) is a 
clearing member of at least one designated contract market or RFE, and 
(2) has a minimum adjusted net capital of at least $20 million (the 
basic minimum requirement for FCMs is $250,000). The Commission notes 
that this would not prevent a DTF from including any similar or greater 
restrictions in its own rules or bylaws. Further, in order to provide 
guidance to such customers and their FCMs, NFA will issue a Statement 
of Acceptable Practices regarding additional disclosures to be made to 
non-institutional customers trading on DTFs and on related issues 
involving price dissemination. The Commission presumes that this would 
be forthcoming as DTFs come into existence. Since DTFs do not yet 
exist, and it is not known how such institutions would choose to 
operate, the Commission believes that it is premature at this time to 
propose a Statement of Acceptable Practices in this area.
    Therefore, the Commission proposes to amend Rule 1.17, to add a new 
paragraph (a)(1)(ii) and to redesignate current paragraph (a)(1)(ii) as 
(a)(1)(iii). The new paragraph (a)(1)(ii) would provide that an FCM 
engaged in soliciting or accepting orders and customer funds related 
thereto from a non-institutional customer for the purchase or sale of 
any commodity for future delivery on or subject to the rules of a DTF 
must be a clearing member of a contract market or an RFE and must 
maintain adjusted net capital at least equal to the greater of $20 
million or the other amounts specified in Rule 1.17.
2. Segregation of Funds
    The futures industry has a long history of keeping customer funds 
safe. The Commission believes that segregation of customer funds has 
worked well and should continue to be required for the funds of all 
customers trading on an RFE and the funds of all non-institutional 
customers trading on a DTF that permits such customers. Nevertheless, 
the Commission is considering whether, and under what circumstances, to 
permit other customers to ``opt out'' of segregation. Before proposing 
any rule changes in this area, however, the Commission seeks comment as 
to how, if at all, this change should be implemented. Commenters may 
wish to address several issues in this area, including:

     Whether opting out of segregation should be permitted;
     If so, whether it should be limited to the accounts of 
institutional customers;
     Where such non-segregated funds should be held;
     How such funds would be accounted for, especially for 
purposes of establishing minimum capital requirements, and computing 
a firm's adjusted net capital;
     How accounts that have opted out of segregation would 
be treated under Part 190 of the Commission's rules, and under the 
Bankruptcy Code;
     What the effects of similar practices have been in 
other jurisdictions; and
     What an FCM's disclosure obligations should be in this 
area.

    The Commission notes that certain industry participants have also 
suggested that the Commission revise its regulations to permit FCMs to 
maintain, in the same customer segregated account, various instruments, 
such as over-the-counter (``OTC'') derivatives, equity securities, and 
other cash market positions, as well as the funds used for the purpose 
of securing or margining such products and positions. The Commission 
notes that, pursuant to its authority under the second proviso of 
Section 4d(2) of the Act,\24\ it has previously permitted futures and 
securities options to be held in the same customer segregated account 
pursuant to cross-margining arrangements.\25\ The Commission believes 
that, under Section 4d(2) of the Act, the segregation requirements 
could be modified to permit such additional instruments and funds to be 
held in a single segregated account at both the FCM and the clearing 
organization level. As with the concept of ``opting out'' of 
segregation, the Commission believes, however, that further 
consideration is necessary in this area before a formal proposal can be 
made. Therefore, the Commission seeks comment as to how such changes 
might be implemented. Commenters may wish to address several issues in 
this area, including:
---------------------------------------------------------------------------

    \24\ 7 U.S.C. 6d(2) (1994).
    \25\ See, e.g., Commission Order, In the Matter of the Chicago 
Mercantile Exchange Proposal to Expand its Cross-Margining Program 
with the Options Clearing Corporation to Include the Cross-Exchange 
Net Margining of the Positions of Market Professionals, (November 
26, 1991), reprinted in 56 FR 61404 (December 3, 1991); Commission 
Order, In the Matter of The Intermarket Clearing Corporation 
Proposal to Expand its Cross-Margining Program with the Options 
Clearing Corporation to Include the Cross-Exchange Net Margining of 
the Positions of Market Professionals (November 26, 1991), reprinted 
in 56 FR 61406 (December 3, 1991). For each of these programs, the 
SEC approved parallel rules of the Options Clearing Corporation.

     What protections would be necessary in order to permit 
FCMs and clearing organizations to maintain, in the same customer 
segregated account, additional instruments and products and the 
funds used for the purpose of securing or margining such instruments 
and products;
     Whether such practices should be limited to the 
accounts of institutional customers;
     Whether, if this is permitted, it would be desirable to 
permit ``opting out'' of segregation;
     How such funds would be accounted for, especially for 
purposes of establishing minimum capital requirements and computing 
a firm's adjusted net capital;
     How such accounts would be treated under Part 190 of 
the Commission's Rules, and under the Bankruptcy Code;
     What the effects of similar practices have been in 
other jurisdictions; and
     What an FCM's disclosure obligations should be in this 
area.
3. Investment of Customer Funds
    The Commission also is proposing to amend Rule 1.25, which sets 
forth the types of instruments in which FCMs and clearing organizations 
are permitted to invest (the permitted investments) cash segregated for 
the benefit of regulated commodity customers pursuant to Section 4d(2) 
of the Act. Currently, Rule 1.25 permits an FCM or clearing 
organization to invest segregated funds only in obligations of the 
U.S., in general obligations of any State or of any political 
subdivison thereof, or in obligations fully guaranteed as to principal 
and interest by the U.S. The Commission believes that an expanded list 
of permitted investments could enhance the yield available to FCMs, 
clearing organizations and their customers, without compromising the 
safety of customer funds.
    Subject to specific risk-limiting features contained in the 
proposal, the following additional investments would be permitted: (1) 
Obligations issued by any agency sponsored by the United States; (2) 
certificates of deposit issued by a bank, as defined in Section 3(a)(6) 
of the Securities Exchange Act of 1934, or a domestic branch of a 
foreign bank insured by the Federal Deposit Insurance Corporation; (3) 
commercial paper; (4) corporate notes; and (5) interests in money 
market mutual funds. In addition, it is proposed than an FCM or a 
clearing organization may both buy and sell the permitted investments 
pursuant to agreements for resale or repurchase of the instruments.
    The proposal includes several provisions intended to minimize 
credit risk, volatility risk and liquidity risk. These features 
include: (i) A requirement that the investments be highly-rated by a 
nationally-recognized statistical rating agency (NRSRO), except for 
U.S. government securities and those money market mutual funds that are 
not required to be rated; (ii) a requirement that the dollar-weighted

[[Page 39015]]

average of the time remaining to maturity of the debt securities held 
in the segregated portfolio not exceed 24 months, excluding investment 
in money market mutual funds; (iii) concentration limits on the 
percentage of the portfolio that may be comprised of the securities of 
individual issuers; (iv) specific prohibitions against leverage, 
embedded derivatives, and options; and (v) a requirement that the daily 
value and gains and losses on each investment be recorded in the 
records of the FCM or clearing organization. The Commission recognizes 
that events beyond the control of an FCM or clearing organization could 
cause a portfolio to exceed the time-to-maturity and concentration 
requirements. Accordingly, the Commission would permit portfolios to be 
adjusted within a reasonable period of time to meet these requirements. 
The Commission plans to modify the segregation computation schedule, 
which is prepared by FCMs every day, to reflect changes in value of the 
investments.
    As noted above, in addition to expanding the list of permitted 
investments, the proposal would allow investments to be bought and sold 
pursuant to agreements for repurchase or resale of the instruments. 
These transactions are usually simply referred to as ``repurchase 
transactions.'' This part of the proposal essentially incorporates 
Division of Trading and Markets Financial and Segregation 
Interpretation No. 2-1 (Interp. 2-1) \26\ with three significant 
modifications. First, in order to increase the liquidity of the 
segregated portfolio, repurchase transactions will be permitted for the 
first time. (Interp. 2-1 currently only permits reverse repurchase 
transactions.) Second, the 180-day cap on the time-to-maturity of 
collateral subject to reverse repurchase agreements, contained in 
footnote No. 13 of Interp. 2-1, has been deleted. The Commission has 
been persuaded by comment received regarding Interp. 2-1 that 
collateral of any maturity would serve adequately, subject to other 
regulatory protections in place such as capital charges. Third, the 
Depository Trust Corporation has been added as a permitted depository 
for securities. If this rule proposal is adopted by the Commission, it 
will take the place of Interp. 2-1, which will be rescinded.
---------------------------------------------------------------------------

    \26\ 1 Comm. Fut. L. Rep. para. 7112A (December 15, 1993).
---------------------------------------------------------------------------

    The Commission notes that the specific safeguards applicable to the 
permitted investments set forth in Rule 1.25 will not be the only 
protections in place. The Commission's proposed Rule 1.25 would take 
its place as part of a broad set of protections built into the system 
intended to guard against financial risk at FCMs. First, FCMs generally 
must meet the Commission's net capital and segregation requirements, as 
well as SRO requirements. An FCM that is a contract market clearing 
member also will likely have capital requirements that are higher than 
those set by the Commission. Second, Commission regulations require 
firms to keep current books and records, prepare a daily segregation 
computation and a formal, monthly capital calculation, among other 
things. Further, an early-warning system requires FCMs to report 
certain events to the Commission and the SROs. These requirements serve 
as elements of the overall system of controls to protect segregated 
funds.
    The Commission recognizes that some adjustments may be desirable 
before the proposal is adopted in final form. Accordingly, the 
Commission seeks industry and public comment on a number of issues:

     Whether the proposed list of investments is appropriate 
for segregated funds investments, considering the primary objective 
of safety of principal;
     Whether the proposed list of investments would create 
any risks that are not properly contained by the risk-limiting 
features of the proposed rule and, if so, what additional features 
should be provided for in the rule;
     The proposed rule contains credit-rating standards and 
a cap on the dollar-weighted average for the time-to-maturity of 
investments held in the portfolio. The Commission notes that certain 
types of structured notes may have significant prepayment and other 
risks, because they offer a large variety of payment obligations 
and, therefore, present substantial market and liquidity risks in 
addition to credit risk. Does the rule sufficiently address this 
type of exposure?;
     Whether the proposed standards for money market funds 
are appropriate;
     Whether there are other categories of funds that could 
be included, and, if so, pursuant to what standards; and
     As is currently the case under Interp. 2-1, the 
proposed rule limits the permitted counterparties in purchases or 
sales of securities subject to a repurchase agreement. The 
Commission requests comment on whether the class of permitted 
counterparties should be expanded and, if so, to what extent.

    The Commission is also proposing to amend Rules 1.20(a) and 1.26(a) 
to eliminate the requirement that an FCM obtain a written 
acknowledgment, from each clearing organization where the FCM has 
deposited customer funds or instruments purchased with customer funds, 
that the clearing organization was informed that the customer funds or 
instruments purchased with customer funds and deposited therein belong 
to customers and are being held in accordance with the provisions of 
the Act and rules thereunder. The proposed elimination of the 
requirement that an FCM obtain a clearing organization acknowledgment 
is conditioned upon the clearing organization's adoption and submission 
to the Commission of rules that provide for the segregation as customer 
funds, in accordance with all relevant provisions of the Act and the 
rules and orders promulgated thereunder, of all funds held on behalf of 
customers and all instruments purchased with customer funds. These 
proposed rule amendments would codify a staff no-action letter issued 
three years ago.\27\ An FCM's obligation to obtain written 
acknowledgments from banks, trust companies and other FCMs, and a 
clearing organization's obligation to obtain written acknowledgments 
from banks and trust companies, concerning the treatment of customer 
funds would be unaffected.
---------------------------------------------------------------------------

    \27\ CFTC Staff Letter No. 97-45, [1996-1998 Transfer Binder] 
Comm. Fut. L. Rep. (CCH) para. 27,085 (May 5, 1997).
---------------------------------------------------------------------------

D. Core Principle Four: Risk Disclosure and Account Statements

    As reflected in the fourth Core Principle, the disclosure of risks 
by intermediaries is an important customer protection. Over the years, 
however, certain persons have suggested that customers would be better 
protected by receiving risk disclosures more attuned to their relative 
level of sophistication and to the particular instruments they trade. 
Other commenters have suggested that disclosure obligations could be 
simplified and streamlined.
    In keeping with these observations, the Commission proposes that 
non-institutional customers continue to receive the risk disclosures 
regarding futures and options trading that are currently required. 
Thus, intermediaries will continue to be required to obtain prior 
acknowledgement by non-institutional customers of their receipt of the 
basic risk disclosure statements relating to futures and options in 
accordance with Rules 1.55 and 33.7.
    The Commission is proposing that the account opening process be 
streamlined, however, in certain areas. The Commission would permit 
certain required disclosures, such as those concerning consent to allow 
cross-trades or to transfer funds out of segregated accounts to another 
account (such as a money market account), to be included in a customer 
agreement and acknowledged through a ``single

[[Page 39016]]

signature'' (which could include an electronic signature as provided 
for in recently-adopted Commission Rules 1.3(tt) and 1.4),\28\ rather 
than the multiple signatures that are currently required.\29\ In order 
to enhance the ``single-signature'' format for account opening 
agreements, the Commission would amend Rules 1.55(d)(1) and (2) by 
expanding the list of disclosures and consents that may be provided in 
a single document and acknowledged with a single signature to include: 
(1) The disclosures required by new Rule 1.33(g) (relating to 
electronic transmission of statements); \30\ (2) the consent referenced 
in Rule 155.3(b)(2) (relating to customer permission for FCMs to take 
the opposite side of an order); and (3) a provision for 
preauthorization of transfers of funds from a customer's segregated 
account to another account of that customer. Disclosure concerning 
arbitration of disputes, however, would continue to require a separate 
signed acknowledgment by non-institutional customers, pursuant to 
proposed new Rule 166.5 (this proposed new rule would replace and is 
modeled on current Rule 180.3).\31\ The Commission specifically 
requests comment on whether to continue to require a separate signed 
acknowledgment by non-institutional customers of a pre-dispute 
arbitration agreement.
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    \28\ 65 FR 12466 (March 9, 2000).
    \29\ This would reverse existing Commission policy. See 58 FR 
17495, 17499 (April 5, 1993).
    \30\ See proposed changes to Rule 1.33, below.
    \31\ Part 180 is proposed to be deleted in its entirety, as 
detailed elsewhere in today's Federal Register. The Commission is 
also proposing to add a new Rule 166.5 to govern the use of pre-
dispute arbitration agreements for customer claims and grievances 
arising out of transactions executed on or subject to the rules of a 
contract market, an RFE or a DTF. Proposed Rule 166.5 restates 
current Rule 180.3, while taking into account the additional trading 
facilities that may be available to customers. Proposed Rule 166.5 
also expands the use of the ``single-signature'' format for account 
opening agreements to include, in addition to entities that are 
excluded from the definition of a commodity pool operator under Rule 
4.5 and ``qualified eligible participants'' as defined in Rule 4.7, 
institutional customers as defined in proposed Rule 1.3(g) and 
``qualified eligible clients'' as defined in Rule 4.7. Since certain 
of the persons currently eligible to use the single signature format 
are included within the proposed definition of institutional 
customer, the provisions of proposed Rule 166.5(c)(2) contain 
modifications of rule 180.3(b)(2) so as to avoid duplication. The 
Commission is also proposing to include within the group of persons 
who need not separately endorse the provisions of a pre-dispute 
arbitration agreement persons other than those who would be defined 
as institutional customers. The Commission is making this proposal 
because the institutional customer definition would not include all 
of those now eligible for the single signature treatment under Rule 
180.3(b)(2) (e.g., a foreign insurance company or a qualified 
eligible participant) and the Commission does not intend to 
restrict, but rather intends to expand, this aspect of the rule. The 
proposed rule further recognizes that a registered futures 
association may be authorized to act as a decision-maker in customer 
dispute resolution proceedings involving floor brokers that are not 
members of the registered futures association and makes additional 
stylistic changes designed to make the rule more readable.
---------------------------------------------------------------------------

    In contrast, for institutional customers, as provided in Rule 
1.55(f), there would continue to be no specific disclosure 
requirements.\32\ Because the definition of institutional customer 
referred to above would include governmental entities, these entities 
would not be required to receive and to acknowledge a disclosure 
statement. This reverses the position that the Commission took when it 
last amended its risk disclosure rules two years ago.\33\
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    \32\ In this regard, the Commission would, with industry input, 
issue a Statement of Acceptable Practices on disclosure to 
institutional customers at a later date.
    \33\ 63 FR 8566, 8568 (February 20, 1998). Particular 
governmental entities and trade associations for such entities are, 
of course, free to establish their own restrictions concerning 
futures trading through statute, regulation or Statements of 
Acceptable Practices.
---------------------------------------------------------------------------

    Finally, the Commission is considering developing more streamlined 
disclosure requirements for domestic exchange-traded options under Rule 
33.7. The Commission therefore seeks comments regarding how such 
disclosure may be more effectively presented to customers while 
reducing the associated burdens on registrants.

E. Core Principle Five: Trading Standards

    Under the Core Principles, intermediaries and their affiliated 
persons are prohibited from misusing knowledge of their customers' 
orders. Currently, FCMs and IBs are required to establish and to 
maintain supervisory procedures to assure that neither they nor any 
affiliated persons (as defined in Rule 155.1) abuse their knowledge of 
customer orders to the customer's disadvantage. These rules have proven 
effective in the Commission's efforts to curb such practices as 
``front-running,'' ``trading ahead,'' ``bucketing,'' taking the 
opposite side of customer orders, or improper disclosure of customer 
orders to third parties. Indeed, the Commission has found that these 
rules have generated few comments from industry professionals. The 
Commission therefore proposes that Rules 155.1, 155.3 and 155.4 will 
continue to apply to intermediation of trades at contract markets, 
RFEs, and for non-institutional customers' trades at DTFs. See proposed 
new Rule 155.6(a).
    For intermediation of trades by institutional customers at DTFs, 
the Commission is proposing a new Rule 155.6(b) setting forth a general 
standard of practice in this area. The rule would simply parallel the 
language of the Core Principle prohibiting the misuse of knowledge of 
customer orders. Although the proposed new Rule 155.6(b) would not 
include as much detail as the current trading standards rules, it is 
nevertheless intended to proscribe the same trade practice abuses as 
Rules 155.1-155.5. Such practices as ``front-running,'' ``trading 
ahead,'' ``bucketing,'' taking the opposite side of customer orders, or 
disclosure of customer orders to third parties, would thus be deemed to 
be misuse of knowledge of customer orders and violations of Rule 155.6. 
The Commission will consider the development of a Statement of 
Acceptable Practices to be issued at a later date, with the 
consultation of DTFs, regarding appropriate procedures that should be 
employed in order to ensure compliance with the general standard.\34\
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    \34\ As noted above, the DTF is at this point a proposed new 
institution, and it is not known how such institutions would choose 
to operate. Such institutions may choose to sponsor trading in a 
traditional open-outcry pit trading system with natural persons 
acting as FBs or FTs. On the other hand, some DTFs may choose a 
purely automated, electronic trading format, or a combination of 
open outcry and electronic trading. Because it cannot be known at 
this time how such entities will choose to organize themselves, and 
what policies they will wish to pursue, the Commission is not at 
this time issuing a Statement of Acceptable Practices in this area.
---------------------------------------------------------------------------

F. Core Principle Seven: Reporting Requirements

    The Commission has found that its reporting system provides a 
valuable bulwark against illegitimate trade practices. Accordingly, the 
Commission would continue, and apply to intermediaries on RFEs, its 
large trader reporting requirements. Thus, FCMs would be required to 
report to the Commission and RFEs information that permits the 
identification of concentrations of positions and market composition on 
a routine and nonroutine basis, and information to detect manipulation, 
price distortion and disruptions of the delivery or cash settlement 
process.
    With respect to intermediaries transacting business on DTFs, 
however, because of the nature of the instruments traded or the limited 
access granted thereto for non-institutional traders, the Commission 
would reduce its reporting requirements. Such intermediaries would only 
be subject to large trader reporting requirements by special call. 
These proposed reforms are detailed elsewhere in today's Federal 
Register.

[[Page 39017]]

G. Core Principal Eight: Recordkeeping

1. General
    The Core Principles maintain that all registrants must keep full 
books and records of their activities related to their business. Thus, 
the Commission would maintain recordkeeping requirements as they relate 
to intermediaries, while considering whether greater use may be made of 
information technology in this regard. The Commission notes that Rule 
1.31 was recently revised to provide for enhanced electronic 
recordkeeping similar to SEC recordkeeping requirements. See 64 FR 
36568 (July 7, 1999); 64 FR 28735 (May 27, 1999). The Commission seeks 
comments regarding Rule 1.31 and on how greater use of information 
technology may be made in the future for recordkeeping purposes.
2. Customer Account Statements; Close-Out of Offsetting Positions
    In keeping with changes in technology and commercial practices, the 
Commission is proposing to codify its previous Advisory relating to the 
electronic transmission of account statements, 62 FR 31507 (June 10, 
1997), in a new Rule 1.33(g). Thus, an FCM would be permitted, with 
customer consent, to deliver required confirmation, purchase-and-sale, 
and monthly account statements electronically in lieu of mailing a 
paper copy. In keeping with the above-referenced Advisory, FCMs would 
need only to retain the daily confirmation statement as of the end of 
the trading session, provided that it reflects all trades made during 
that session, to satisfy recordkeeping obligations.
    Proposed Rule 1.33(g) also provides, as did the above-referenced 
Advisory, that an FCM must, prior to the transmission of any statement 
by means of electronic media, disclose (1) The electronic medium or 
source through which statements will be delivered, (2) the duration, 
whether indefinite or not, of the period during which consent will be 
effective, (3) any charges for such service, (4) the information that 
will be delivered electronically, and (5) that consent to electronic 
delivery may be revoked at any time. In the case of a non-institutional 
customer, an FCM must obtain the non-institutional customer's signed 
consent acknowledging disclosure of this information prior to the 
transmission of any statement by means of electronic media. This 
acknowledgment can be included in a customer account agreement and 
acknowledged through a single signature in accordance with Rule 1.55. 
Institutional customers would not need to provide written consent, and 
the Commission recommends that FCMs confirm procedures relating to 
electronic transmission of statements to institutional customers as 
described in the above-referenced Advisory. The Commission specifically 
requests comment, however, as to whether FCMs may treat non-
institutional customers in the same manner as institutional customers 
are proposed to be treated in this area. Any statement required to be 
furnished to a person other than a customer in accordance with 
paragraph (d) of Rule 1.33 would also be permitted to be furnished by 
electronic media.
    The Commission also proposes to revise Rule 1.46 so that its 
general standard would function as a default rule in the absence of 
instruction by a customer or account controller. The Rule currently 
requires, absent one of several exceptions, that an FCM close out 
offsetting positions on a first-in, first-out basis, looking across all 
accounts it carries for the same customer.\35\ Under the proposed rule, 
any customer or account controller could instruct the FCM otherwise, so 
that offsetting positions could be held open or closed out on other 
than a first-in, first-out basis. CPOs and CTAs would be required to 
disclose if they operate in this fashion, by amending Rules 4.24(h)(2) 
(which applies to CPOs) and 4.34(h) (which applies to CTAs) to include 
reference to the CPO's or CTA's instructions to FCMs concerning 
application of offsetting positions pursuant to Rule 1.46.
---------------------------------------------------------------------------

    \35\ An FCM must take into consideration positions in separate 
accounts of the same customer that it is carrying in applying Rule 
1.46. 57 FR 55082, 55083 n. 2 (November 24, 1992), citing U.S. 
Department of Agriculture, Commodity Exchange Authority 
Administrative Determination No. 134 (May 25, 1948).
---------------------------------------------------------------------------

    In order to implement this revision of Rule 1.46, the Commission 
proposes to amend the rule by inserting, after the words ``omnibus 
accounts'' in paragraph (a), the phrase ``or where the customer or 
account controller has instructed otherwise.'' Rule 1.46 also would be 
amended by revising paragraph (e) to correspond to proposed new Rule 
1.33(g) (the substance of the current paragraph (e) of Rule 1.46 would 
be deleted because it currently relates back to paragraph (d)(6), which 
is being removed and reserved) to read: ``The statements required by 
paragraph (a) of this section may be furnished to the customer or the 
person described in Sec. 1.33(d) by means of electronic transmission, 
in accordance with Sec. 1.33(g).''

III. Related Matters

A. Regulatory Flexibility Act

    The Regulatory Flexibility Act (``RFA''), 5 U.S.C. 601 et seq. 
(1994 & Supp. II 1996), requires federal agencies, in proposing rules, 
to consider the impact of those rules on small businesses. The rule 
amendments discussed herein would affect FCMs, IBs, CPOs, CTAs, FBs, 
FTs, leverage transaction merchants (``LTMs'') and agricultural trade 
option merchants (``ATOMs''), as well as principals thereof. The 
Commission has previously established certain definitions of ``small 
entities'' to be used by the Commission in evaluating the impact of its 
rules on small entities in accordance with the RFA.\36\ The Commission 
has previously determined that registered FCMs, CPOs, LTMs and ATOMs 
are not small entities for the purpose of the RFA.\37\ With respect to 
IBs, CTAs, FBs and FTs, the Commission has stated that it is 
appropriate to evaluate within the context of a particular rule 
proposal whether some or all of the affected entities should be 
considered small entities and, if so, to analyze the economic impact on 
them of any rule.
---------------------------------------------------------------------------

    \36\ 47 FR 18618-18621 (April 30, 1982).
    \37\ 47 FR 18619-18620 (discussing FCMs and CPOs); 54 FR 19556, 
19557 (May 8, 1989) (discussing LTMs); and 63 FR 18821, 18830 (April 
16, 1998) (discussing ATOMs).
---------------------------------------------------------------------------

    The amendments proposed herein would not require any registrant to 
change its current method of doing business. For many registrants, the 
proposed revisions should decrease the number of persons within the 
registrant's organization who would be considered principals under the 
CFTC rules. Further, the proposed revisions should reduce, rather than 
increase, the regulatory requirements that apply to registrants and 
applicants for registration, regardless of size. Accordingly, pursuant 
to 5 U.S.C. 605(b), the Chairman, on behalf of the Commission, 
certifies that these proposed amendments will not have a significant 
economic impact on a substantial number of small entities.

B. Paperwork Reduction Act

    As required by the Paperwork Reduction Act of 1995 [44 U.S.C. 
3507(d)], the Commission has submitted a copy of these proposed 
amendments to its rules to the Office of Management and Budget for its 
review.
Collection of Information
    Rules Relating to the Operations and Activities of Commodity Pool 
Operators and Commodity Trading Advisors and to Monthly Reporting by 
Futures

[[Page 39018]]

Commission Merchants, OMB Control Number 3038-0005.
    The Commission believes that the amendments to Part 4 of its 
regulations impose no burden. While these proposed rule amendments have 
no burden, the group of rules (3038-0005) of which the rules proposed 
to be amended are a part, has the following burden:
    Average burden hours per response: 7.25.
    Number of respondents: 7,362.
    Frequency of response: Monthly, Quarterly, Annually, On Occasion.
    Rules Pertaining to Contract Markets and Their Members, OMB Control 
Number 3038-0022.
    The Commission believes that the amendments to Parts 1 and 155 of 
its regulations impose no burden. While these proposed rule amendments 
have no burden, the group of rules (3038-0022) of which the rules 
proposed to be amended are a part, has the following burden:
    Average burden hours per response: 2.
    Number of respondents: 15,894.
    Frequency of response: On Occasion.
    Rules, Regulations and Forms for Domestic and Foreign Futures and 
Options Relating to Registration with the Commission, OMB Control 
Number 3038-0023.
    The expected effect of the proposed amended rule will be to reduce 
the burden previously approved by OMB for this collection by 5,521.8 
hours.
    Specifically: The burden associated with Commission Rule 3.10(a) as 
applied to FCMs is expected to be decreased by 2 hours:
    Estimated number of respondents (after proposed amendment): 6.
    Annual responses by each respondent: 1.
    Estimated average hours per response: 0.5.
    Annual reporting burden: 3 hours.
    The burden associated with Commission Rule 3.10(a) as applied to 
IBs is expected to be decreased by 54.8 hours:
    Estimated number of respondents (after proposed amendment): 343.
    Annual responses by each respondent: 1.
    Estimated average hours per response: 0.4.
    Annual reporting burden: 137.2 hours.
    The burden associated with Form 8-R is expected to be decreased by 
132 hours:
    Estimated number of respondents (after proposed amendment): 2,400.
    Annual responses by each respondent: 1.
    Estimated average hours per response: 0.33.
    Annual reporting burden: 792 hours.
    The burden associated with Commission Rule 3.32 is expected to be 
decreased by 1 hour:
    Estimated number of respondents (after proposed amendment): 10.
    Annual responses by each respondent: 1.
    Estimated average hours per response: 0.2.
    Annual reporting burden: 2 hours.
    The recordkeeping and reporting burdens associated with Commission 
Rule 3.34 are expected to be decreased by 5,332 hours:
    Estimated number of respondents (after proposed amendment): 0.
    Annual responses by each respondent: 0.
    Estimated average hours per response: 0.
    Annual reporting burden: 0 hours.
    Regulations and Forms Pertaining to the Financial Integrity of the 
Marketplace, OMB Control Number 3038-0024.
    The expected effect of the proposed amended rule will be to reduce 
the burden previously approved by OMB for this collection by 7.5 hours.
    Specifically: The burden associated with Commission Rule 1.10 is 
expected to be decreased by 7.5 hours:
    Estimated number of respondents (after proposed amendment): 15.
    Annual responses by each respondent: 1.
    Estimated average hours per response: 1.
    Annual reporting burden: 15 hours.
    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.
    Persons wishing to comment on the information collection 
requirements that would be required by these proposed rules should 
contact the Office of Information and Regulatory Affairs, Office of 
Management and Budget, Room 10235, New Executive Office Building, 
Washington, DC 20503, Attn: Desk Officer for the Commodity Futures 
Trading Commission.
    The Commission considers comments by the public on this proposed 
collection of information in--
     Evaluating whether the proposed collection of information 
is necessary for the proper performance of the functions of the 
Commission, including whether the information will have a practical 
use;
     Evaluating the accuracy of the Commission's estimate of 
the burden of the proposed collection of information including the 
validity of the methodology and assumptions used;
     Enhancing the quality, utility, and clarity of the 
information to be collected; and
     Minimizing the burden of the collection of the information 
on those who are to respond, including through the use of appropriate 
automated, electronic, mechanical or other technological collection 
techniques or other forms of information technology, e.g. permitting 
electronic submissions of responses.
    OMB is required to make a decision concerning the collection of 
information contained in these proposed regulations between 30 and 60 
days after publication of this document in the Federal Register. 
Therefore, a comment to OMB is best assured of having its full effect 
if OMB receives it within 30 days of publication. This does not affect 
the deadline for the public to comment to the Commission on the 
proposed regulations.
    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.

Lists of Subjects

17 CFR Part 1

    Brokers, Commodity futures, Consumer protection, Reporting and 
recordkeeping requirements.

17 CFR Part 3

    Administrative practice and procedure, Brokers, Commodity futures, 
Reporting and recordkeeping requirements, Registration, Principals.

17 CFR Part 4

    Advertising, Commodity futures, Consumer protection, Reporting and 
recordkeeping requirements, Principals, Commodity pool operators, 
Commodity trading advisors, Disclosure.

17 CFR Part 140

    Authority delegations (Government agencies), Conflict of interests, 
Organization and functions (Government agencies).

17 CFR Part 155

    Brokers, Commodity futures, Reporting and recordkeeping 
requirements.

17 CFR Part 166

    Brokers, Commodity futures, Consumer protection, Reporting and 
recordkeeping requirements.

    In consideration of the foregoing, and pursuant to the authority 
contained in the Commodity Exchange Act, and in particular, Sections 2, 
4b, 4d, 4f, 4m, 4n, 8a, and 19 thereof, 7 U.S.C. 2, 6b, 6d,

[[Page 39019]]

6f, 6m, 6n, 12a and 23, the Commission hereby proposes to amend Parts 
1, 3, 4, 140, 155 and 166 of Chapter I of Title 17 of the Code of 
Federal Regulations as follows:

PART 1--GENERAL REGULATIONS UNDER THE COMMODITY EXCHANGE ACT

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

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

    2. Section 1.3 is proposed to be amended by adding a new paragraph 
(g) to read as follows:


Sec. 1.3  Definitions.

* * * * *
    (g) Institutional customer. This term has the same meaning as 
``eligible participant'' as defined in Sec. 35.1(b) of this chapter.
* * * * *
    3. Section 1.10 is proposed to be amended as follows:
    a. Revising paragraph (a)(2)(i)(B);
    b. Adding paragraph (a)(2)(i)(C);
    c. Designating the undesignated paragraph following paragraph 
(a)(2)(i)(B) as paragraph (a)(2)(i)(D) and revising it;
    d. Designating the undesignated paragraph following paragraph 
(a)(2)(ii)(C) as paragraph (a)(2)(ii)(E) and revising it;
    e. Redesignating paragraph (a)(2)(ii)(C) as (a)(2)(ii)(D) and 
revising it; and
    f. Adding a new paragraph (a)(2)(ii)(C).
    The revisions and additions read as follows:


Sec. 1.10  Financial reports of futures commission merchants and 
introducing brokers.

    (a) * * *
    (2) * * *
    (i) * * *
    (B) A Form 1-FR-FCM as of a date not more than 17 business days 
prior to the date on which such report is filed and a Form 1-FR-FCM 
certified by an independent public accountant in accordance with 
Sec. 1.16 as of a date not more than one year prior to the date on 
which such report is filed; or
    (C) A Form 1-FR-FCM, Provided however, that such applicant shall be 
subject to a review by the applicant's designated self-regulatory 
organization within six months of being granted registration.
    (D) Each such person must include with such financial report a 
statement describing the source of his current assets and representing 
that his capital has been contributed for the purpose of operating his 
business and will continue to be used for such purpose.
    (ii) * * *
    (C) A Form 1-FR-IB, Provided however, that such applicant shall be 
subject to a review by the applicant's designated self-regulatory 
organization within six months of registration; or
    (D) A guarantee agreement.
    (E) Each person filing in accordance with paragraphs (a)(2)(ii) 
(A), (B) or (C) of this section must include with such financial report 
a statement describing the source of his current assets and 
representing that his capital has been contributed for the purpose of 
operating his business and will continue to be used for such purpose.
* * * * *
    4. Section 1.17 is proposed to be amended by redesignating 
paragraph (a)(1)(ii) as (a)(1)(iii) and by adding new paragraphs 
(a)(1)(ii) and (a)(2)(iii) to read as follows:


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

    (a) * * *
    (1) * * *
    (ii) Each person registered as a futures commission merchant 
engaged in soliciting or accepting orders and customer funds related 
thereto for the purchase or sale of any commodity for future delivery 
on or subject to the rules of a derivatives transaction facility from 
any non-institutional customer must be a clearing member of a 
designated contract market or recognized futures exchange, and must 
maintain adjusted net capital in the amount of the greater of 
$20,000,000 or the amounts otherwise specified in paragraph (a)(1)(i) 
of this section.
* * * * *
    (2) * * *
    (iii) The requirements of paragraph (a)(1) of this section shall 
not be applicable if the registrant is a futures commission merchant or 
introducing broker registered in accordance with Sec. 3.10(a)(1)(i)(B) 
of this chapter, whose business is limited to transacting business on 
behalf of institutional customers on a derivatives transaction 
facility, and who conforms to minimum financial standards and related 
reporting requirements set by such derivatives transaction facility in 
its bylaws, rules, regulations or resolutions.
* * * * *
    5. Section 1.20 is proposed to be amended by revising paragraphs 
(a) and (c) to read as follows:


Sec. 1.20  Customer funds to be segregated and separately accounted 
for.

    (a) All customer funds shall be separately accounted for and 
segregated as belonging to commodity or option customers. Such customer 
funds when deposited with any bank, trust company, clearing 
organization or another futures commission merchant shall be deposited 
under an account name which clearly identifies them as such and shows 
that they are segregated as required by the Act and this part. Each 
registrant shall obtain and retain in its files for the period provided 
in Sec. 1.31 a written acknowledgment from such bank, trust company, 
clearing organization, or futures commission merchant, that it was 
informed that the customer funds deposited therein are those of 
commodity or option customers and are being held in accordance with the 
provisions of the Act and this part: Provided, however, that an 
acknowledgment need not be obtained from a clearing organization that 
has adopted and submitted to the Commission rules that provide for the 
segregation as customer funds, in accordance with all relevant 
provisions of the Act and the rules and orders promulgated thereunder, 
of all funds held on behalf of customers. Under no circumstances shall 
any portion of customer funds be obligated to a clearing organization, 
any member of a contract market, a futures commission merchant, or any 
depository except to purchase, margin, guarantee, secure, transfer, 
adjust or settle trades, contracts or commodity option transactions of 
commodity or option customers. No person, including any clearing 
organization or any depository, that has received customer funds for 
deposit in a segregated account, as provided in this section, may hold, 
dispose of, or use any such funds as belonging to any person other than 
the option or commodity customers of the futures commission merchant 
which deposited such funds.
* * * * *
    (c) Each futures commission merchant shall treat and deal with the 
customer funds of a commodity customer or of an option customer as 
belonging to such commodity or option customer. All customer funds 
shall be separately accounted for, and shall not be commingled with the 
money, securities or property of a futures commission merchant or of 
any other person, or be used to secure or guarantee the trades, 
contracts or commodity options, or to secure or extend the credit, of 
any person other than the one for whom the same are held: Provided, 
however, That customer funds treated as belonging to

[[Page 39020]]

the commodity or option customers of a futures commission merchant may 
for convenience be commingled and deposited in the same account or 
accounts with any bank or trust company, with another person registered 
as a futures commission merchant, or with a clearing organization, and 
that such share thereof as in the normal course of business is 
necessary to purchase, margin, guarantee, secure, transfer, adjust, or 
settle the trades, contracts or commodity options of such commodity or 
option customers or resulting market positions, with the clearing 
organization or with any other person registered as a futures 
commission merchant, may be withdrawn and applied to such purposes, 
including the payment of premiums to option grantors, commissions, 
brokerage, interest, taxes, storage and other fees and charges, 
lawfully accruing in connection with such trades, contracts or 
commodity options: Provided, further, That customer funds may be 
invested in instruments described in Sec. 1.25.
    6. Section 1.25 is proposed to be revised to read as follows:


Sec. 1.25  Investment of customer funds.

    (a) Permitted investments. (1) Subject to the terms and conditions 
set forth in this section, a futures commission merchant or a clearing 
organization may invest customer funds in the following instruments 
(permitted investments):
    (i) Obligations of the United States and obligations fully 
guaranteed as to principal and interest by the United States (U.S. 
government securities);
    (ii) General obligations of any State or of any political 
subdivision thereof (municipal securities);
    (iii) Obligations issued by any agency sponsored by the United 
States (government sponsored agency securities);
    (iv) Certificates of deposit issued by a bank (certificates of 
deposit) as defined in section 3(a)(6) of the Securities Exchange Act 
of 1934, or a domestic branch of a foreign bank insured by the Federal 
Deposit Insurance Corporation;
    (v) Commercial paper;
    (vi) Corporate notes; and
    (vii) Interests in money market mutual funds.
    (2) In addition, a futures commission merchant or a clearing 
organization may buy and sell the permitted investments listed in 
paragraphs (a)(1)(i) through (vii) of this section pursuant to 
agreements for resale or repurchase of the instruments, in accordance 
with the provisions of paragraph (d) of this section.
    (b) General terms and conditions. A futures commission merchant or 
a clearing organization is required to manage the permitted investments 
consistent with the objectives of preserving principal and maintaining 
liquidity and according to the following specific requirements.
    (1) Ratings--(i) Initial requirement. Instruments that are required 
to be rated by this section must be rated by a nationally recognized 
statistical rating organization (NRSRO), as that term is defined in 
Sec. 270.2a-7 of this title. Ratings are required for permitted 
investments as follows:
    (A) U.S. government securities need not be rated;
    (B) Municipal securities, government sponsored agency securities, 
certificates of deposit, commercial paper, and corporate notes, except 
notes that are asset-backed, must have the highest short-term rating of 
an NRSRO or one of the two highest long-term ratings of an NRSRO;
    (C) Corporate notes that are asset-backed must have the highest 
rating of an NRSRO; and
    (D) Money market mutual funds that are rated by an NRSRO must be 
rated at the highest rating of the NRSRO or, if the fund is not rated, 
investments made by the fund must comply with the requirements 
applicable to direct investments under this section.
    (ii) Effect of downgrade. If an NRSRO lowers the rating of an 
instrument that was previously a permitted investment to below the 
minimum rating required under this section, the value of the instrument 
recognized for segregation purposes will be the lesser of:
    (A) The current market value of the instrument; or
    (B) The market value of the instrument on the business day 
preceding the downgrade, reduced by 20 percent of that value for each 
business day that has elapsed since the downgrade.
    (2) Restrictions on instrument features. (i) With the exception of 
money market mutual funds, no permitted investment may contain an 
embedded derivative of any kind, including but not limited to a call 
option, put option, or collar, cap or floor on interest paid.
    (ii) No instrument may contain interest-only payment features.
    (iii) No instrument may provide payments linked to a commodity, 
currency, reference instrument, index, or benchmark except as provided 
in paragraph (b)(2)(iv) of this section.
    (iv) Variable-rate securities are permitted, provided the interest 
rates paid correlate closely and on an unleveraged basis to a benchmark 
of either the Federal Funds target or effective rate, the prime rate, 
the three-month Treasury Bill rate, or the one-month or three-month 
LIBOR rate.
    (v) Certificates of deposit, if negotiable, must be able to be 
liquidated within one business day or, if not negotiable, must be 
redeemable at the issuing bank within one business day, with any 
penalty for early withdrawal limited to any accrued interest earned.
    (3) Concentration. (i) The aggregate investment in U.S. government 
securities or in money market mutual funds shall not be subject to a 
concentration limit.
    (ii) The aggregate investment in the securities of any one issuer, 
or related issuers, of government sponsored agency securities shall not 
exceed 25 percent of the total assets held in segregation by the 
futures commission merchant or the clearing organization. Securities 
issued by an entity that directly or indirectly constitute an interest 
in securities issued by a government sponsored agency shall be combined 
and treated as the securities of a single issuer for the purpose of 
determining the concentration limit.
    (iii) The aggregate investment in the obligations of any one 
issuer, or related issuers, of any permitted investments, other than 
U.S. government securities, money market mutual funds, and government 
sponsored agency instruments, may not exceed five percent of the total 
assets held in segregation by the futures commission merchant or the 
clearing organization.
    (4) Time-to-maturity. Except for investments in money market mutual 
funds, the dollar-weighted average of the time-to-maturity of the 
portfolio, as that average is computed pursuant to Sec. 270.2a-7 of 
this title, may not exceed 24 months.
    (5) Investments in instruments issued by affiliates. (i) Except as 
provided in paragraph (b)(5)(ii) of this section, a futures commission 
merchant shall not invest customer funds in obligations of an entity 
affiliated with the futures commission merchant, and a clearing 
organization shall not invest customer funds in obligations of an 
entity affiliated with the clearing organization. An affiliate includes 
parent companies, including all entities through the ultimate holding 
company, subsidiaries to the lowest level, and companies under common 
ownership of such parent company or affiliates.
    (ii) A futures commission merchant or clearing organization may 
invest customer funds in a fund affiliated with that futures commission 
merchant or clearing organization provided that the

[[Page 39021]]

fund itself does not invest in any instrument issued by the futures 
commission merchant, clearing organization or affiliate thereof.
    (6) Recordkeeping. A futures commission merchant and a clearing 
organization shall prepare and maintain a record that will show for 
each business day with respect to each type of investment made pursuant 
to this section, the following information:
    (i) The type of instruments in which customer funds have been 
invested;
    (ii) The original cost of the instruments; and
    (iii) The current market value of the instruments.
    (c) Money market mutual funds. The following provisions will apply 
to the investment of customer funds in money market mutual funds (the 
fund).
    (1) Generally, the fund must be registered with the Securities and 
Exchange Commission as a money market mutual fund, in compliance with 
applicable requirements. A fund sponsor, however, may petition the 
Commission for an exemption from this requirement. The Commission may 
grant such an exemption provided that the fund can demonstrate that it 
will operate in a manner designed to preserve principal and to maintain 
liquidity. The application for exemption must describe how the fund's 
structure, operations and financial reporting are expected to differ 
from the requirements contained in Sec. 270.2a-7 of this title and the 
risk-limiting provisions for direct investments contained in this 
section. The fund must also specify the information that the fund would 
make available to the Commission on an ongoing basis.
    (2) The fund must be sponsored by a federally-regulated financial 
institution, a bank as defined in section 3(a)(6) of the Securities 
Exchange Act of 1934, or a domestic branch of a foreign bank insured by 
the Federal Deposit Insurance Corporation, except for a fund exempted 
in accordance with paragraph (c)(1) of this section.
    (3) A futures commission merchant or clearing organization shall 
hold its shares of the fund in a custody account in accordance with 
Sec. 1.26(a). If the futures commission merchant or the clearing 
organization holds its shares of the fund with the fund's shareholder 
servicing agent, the sponsor of the fund and the fund itself are 
required to provide the acknowledgment letter required by Sec. 1.26.
    (4) The net asset value of the fund must be computed daily by 9 
a.m. of each business day and made available to the futures commission 
merchant or clearing organization by that time.
    (5) An interest in a fund must be able to be liquidated by the 
business day following a request to liquidate by the futures commission 
merchant or clearing organization.
    (6) The agreement pursuant to which the futures commission merchant 
or clearing organization has acquired and is holding its interest in a 
fund must contain no provision that would prevent the pledging or 
transferring of shares.
    (d) Repurchase and reverse repurchase agreements. A futures 
commission merchant or clearing organization may buy and sell the 
permitted investments pursuant to agreements for resale or repurchase 
of the securities (repurchase transactions), provided the agreements 
for resale or repurchase conform to the following requirements:
    (1) The securities are specifically identified by coupon rate, par 
amount, market value, maturity date, and CUSIP number.
    (2) Counterparties are limited to a bank as defined in section 
3(a)(6) of the Securities Exchange Act of 1934, a domestic branch of a 
foreign bank insured by the Federal Deposit Insurance Corporation, a 
securities broker or dealer, or a government securities broker or 
government securities dealer registered with the Securities and 
Exchange Commission or which has filed notice pursuant to section 
15C(a) of the Government Securities Act of 1986.
    (3) The transaction is made pursuant to a written agreement signed 
by the parties to the agreement, which is consistent with the 
conditions set forth in paragraphs (d)(1) through (d)(11) of this 
section and which states that the parties thereto intend the 
transaction to be treated as a purchase and sale of securities.
    (4) The term of the agreement is no more than one business day, or 
reversal of the transaction is possible on demand.
    (5) The securities transferred under the agreement are held in a 
safekeeping account with a bank as referred to in paragraph (d)(2) of 
this section, a clearing organization or the Depository Trust 
Corporation in an account that complies with the requirements of 
Sec. 1.26.
    (6) The futures commission merchant or the clearing organization 
may not use securities received under the agreement in another similar 
transaction and may not otherwise hypothecate or pledge such 
securities, except securities may be pledged on behalf of customers at 
another futures commission merchant or clearing organization. 
Substitution of securities is allowed, provided, however, that:
    (i) The qualifying securities being substituted and original 
securities are specifically identified by date of substitution, market 
values substituted, coupon rates, par amounts, maturity dates and CUSIP 
numbers;
    (ii) Substitution is made on a ``delivery versus delivery'' basis; 
and (iii) The market value of the substituted securities is at least 
equal to that of the original securities.
    (7) The transfer of securities is made on a delivery versus payment 
basis in immediately available funds. The transfer is not recognized as 
accomplished until the funds and/or securities are actually received by 
the custodian of the futures commission merchant's or clearing 
organization's customer funds or securities purchased on behalf of 
customers. The transfer or credit of securities covered by the 
agreement to the futures commission merchant's or clearing 
organization's customer segregated custodial account is made 
simultaneously with the disbursement of funds from the futures 
commission merchant's or clearing organization's customer segregated 
cash account at the custodian bank. On the sale or resale of 
securities, the futures commission merchant's or clearing 
organization's customer segregated cash account at the custodian bank 
must receive same-day funds credited to such segregated account 
simultaneously with the delivery or transfer of securities from the 
customer segregated custodial account.
    (8) A written confirmation to the futures commission merchant or 
clearing organization specifying the terms of the agreement and a 
safekeeping receipt are issued immediately upon entering into the 
transaction and a confirmation to the futures commission merchant or 
clearing organization is issued once the transaction is reversed.
    (9) The transactions effecting the agreement are recorded in the 
record required to be maintained under Sec. 1.27 of investments of 
customer funds, and the securities subject to such transactions are 
specifically identified in such record as described in paragraph (d)(1) 
of this section and further identified in such record as being subject 
to repurchase and reverse repurchase agreements.
    (10) An actual transfer of securities by book entry is made 
consistent with Federal or State commercial law, as applicable. At all 
times, securities received subject to an agreement are reflected as 
``customer property.''

[[Page 39022]]

    (11) The agreement makes clear that, in the event of the bankruptcy 
of the futures commission merchant or clearing organization, any 
securities purchased with customer funds that are subject to an 
agreement may be immediately transferred. The agreement also makes 
clear that, in the event of a futures commission merchant or clearing 
organization bankruptcy, the counterparty has no right to compel 
liquidation of securities subject to an agreement or to make a priority 
claim for the difference between current market value of the securities 
and the price agreed upon for resale of the securities to the 
counterparty, if the former exceeds the latter.
    (e) A futures commission merchant shall not be prohibited from 
directly depositing unencumbered securities of the type specified in 
this section, which it owns for its own account, into a segregated 
safekeeping account or from transferring any such securities from a 
segregated account to its own account, up to the extent of its residual 
financial interest in customers' segregated funds; provided, however, 
that such investments, transfers of securities, and disposition of 
proceeds from the sale or maturity of such securities are recorded in 
the record of investments required to be maintained by Sec. 1.27. All 
such securities may be segregated in safekeeping only with a bank, 
trust company, clearing organization, or other registered futures 
commission merchant. Furthermore, for purposes of Secs. 1.25, 1.26, 
1.27, 1.28 and 1.29, investments permitted by Sec. 1.25 that are owned 
by the futures commission merchant and deposited into such a segregated 
account shall be considered customer funds until such investments are 
withdrawn from segregation.
    7. Section 1.26 is proposed to be revised to read as follows:


Sec. 1.26  Deposit of instruments purchased with customer funds.

    (a) Each futures commission merchant who invests customer funds in 
instruments described in Sec. 1.25 shall separately account for such 
instruments and segregate such instruments as belonging to such 
commodity or option customers. Such instruments, when deposited with a 
bank, trust company, clearing organization or another futures 
commission merchant, shall be deposited under an account name which 
clearly shows that they belong to commodity or option customers and are 
segregated as required by the Act and this part. Each futures 
commission merchant upon opening such an account shall obtain and 
retain in its files an acknowledgment from such bank, trust company, 
clearing organization or other futures commission merchant that it was 
informed that the instruments belong to commodity or option customers 
and are being held in accordance with the provisions of the Act and 
this part. Provided, however, that an acknowledgment need not be 
obtained from a clearing organization that has adopted and submitted to 
the Commission rules that provide for the segregation as customer 
funds, in accordance with all relevant provisions of the Act and the 
rules and orders promulgated thereunder, of all funds held on behalf of 
customers and all instruments purchased with customer funds. Such 
acknowledgment shall be retained in accordance with Sec. 1.31. Such 
bank, trust company, clearing organization or other futures commission 
merchant shall allow inspection of such obligations at any reasonable 
time by representatives of the Commission.
    (b) Each clearing organization which invests money belonging or 
accruing to commodity or option customers of its clearing members in 
instruments described in Sec. 1.25 shall separately account for such 
instruments and segregate such instruments as belonging to such 
commodity or option customers. Such instruments, when deposited with a 
bank or trust company, shall be deposited under an account name which 
will clearly show that they belong to commodity or option customers and 
are segregated as required by the Act and this part. Each clearing 
organization upon opening such an account shall obtain and retain in 
its files a written acknowledgment from such bank or trust company that 
it was informed that the instruments belong to commodity or option 
customers of clearing members and are being held in accordance with the 
provisions of the Act and this part. Such acknowledgment shall be 
retained in accordance with Sec. 1.31. Such bank or trust company shall 
allow inspection of such instruments at any reasonable time by 
representatives of the Commission.


Secs. 1.27, 1.28 and 1.29  [Amended]

    8. Sections 1.27, 1.28 and 1.29 are proposed to be amended by 
revising the word ``obligations'' to read ``instruments'' each time it 
appears.
    9. Section 1.33 is proposed to be amended by adding a new paragraph 
(g) to read as follows:


Sec. 1.33  Monthly and confirmation statements.

* * * * *
    (g) Electronic transmission of statements. (1) The statements 
required by this section, and by Sec. 1.46, may be furnished to anyt 
customer by means of electronic media if the customer so requests, 
Provided, however, that a futures commission merchant must, prior to 
the transmission of any statement by means of electronic media, 
disclose the electronic medium or source through which statements will 
be delivered, the duration, whether indefinite or not, of the period 
during which consent will be effective, any charges for such service, 
the information that will be delivered by such means, and that consent 
to electronic delivery may be revoked at any time.
    (2) In the case of a non-institutional customer, a futures 
commission merchant must obtain the non-institutional customer's signed 
consent acknowledging disclosure of the information set forth in 
paragraph (g)(1) of this section prior to the transmission of any 
statement by means of electronic media.
    (3) Any statement required to be furnished to a person other than a 
customer in accordance with paragraph (d) of this section may be 
furnished by electronic media.
    (4) A futures commission merchant who furnishes statements to any 
customer by means of electronic media must retain a daily confirmation 
statement for such customer as of the end of the trading session, 
reflecting all transactions made during that session for the customer, 
in accordance with Sec. 1.31.
    10. Section 1.46 is proposed to be amended as follows:
    a. By revising paragraph (a), introductory text,
    b. By removing and reserving paragraphs (d)(4) through (d)(7),
    c. By removing paragraph (d)(9) and
    d. By revising paragraph (e) to read as follows:


Sec. 1.46  Application and closing out of offsetting long and short 
positions.

    (a) Application of purchases and sales. Except with respect to 
purchases or sales which are for omnibus accounts, or where the 
customer has instructed otherwise, any futures commission merchant who, 
on or subject to the rules of a contract market:
* * * * *
    (e) The statements required by paragraph (a) of this section may be 
furnished to the customer or the person described in Sec. 1.33(d) by 
means of electronic transmission, in accordance with Sec. 1.33(g).

[[Page 39023]]

    11. Section 1.52 is proposed to be amended by adding a new 
paragraph (m) to read as follows:


Sec. 1.52  Self-regulatory organization adoption and surveillance of 
minimum financial requirements.

* * * * *
    (m) Nothing in this section shall apply to the activities of a 
derivatives transaction facility or the minimum adjusted net capital 
requirements it may require of persons operating thereon pursuant to 
Sec. 1.17(a)(2)(iii).
    12. Section 1.55 is proposed to be amended by revising paragraphs 
(d) and (f) to read as follows:


Sec. 1.55  Distribution of ``Risk Disclosure Statement'' by futures 
commission merchants and introducing brokers.

* * * * *
    (d) Any futures commission merchant, or in the case of an 
introduced account any introducing broker, may open a commodity futures 
account for a customer without obtaining the separate acknowledgments 
of disclosure and elections required by this section and by 
Sec. 1.33(g), and by Secs. 33.7, 155.3(b)(2), and 190.06 of this 
chapter, provided that:
    (1) Prior to the opening of such account, the futures commission 
merchant or introducing broker obtains an acknowledgment from the 
customer, which may consist of a single signature at the end of the 
futures commission merchant's or introducing broker's customer account 
agreement, or on a separate page, of the disclosure statements and 
elections specified in this section and Sec. 1.33(g), and in 
Secs. 33.7, 155.3(b)(2), and 190.06 of this chapter, and which may 
include authorization for the transfer of funds from a segregated 
customer account to another account of such customer, as listed 
directly above the signature line, provided the customer has 
acknowledged by check or other indication next to a description of each 
specified disclosure statement or election that the customer has 
received and understood such disclosure statement or made such 
election;
    (2) The acknowledgment referred to in paragraph (d)(1) of this 
section must be accompanied by and executed contemporaneously with 
delivery of the disclosures and elective provisions required by this 
section and Sec. 1.33(g), and by Secs. 33.7, 155.3(b)(2), and 190.06 of 
this chapter.
* * * * *
    (f) A futures commission merchant or, in the case of an introduced 
account an introducing broker, may open a commodity futures account for 
an institutional customer without furnishing such institutional 
customer the disclosure statements or obtaining the acknowledgements 
required under paragraph (a) of this section, Secs. 1.33(g) and 
1.65(a)(3), and Secs. 30.6(a), 33.7(a), 155.3(b)(2), and 190.10(c) of 
this chapter.
* * * * *

PART 3--REGISTRATION

    13. The authority citation for Part 3 is revised to read as 
follows:

    Authority: 5 U.S.C. 522, 522b; 7 U.S.C. 1a, 2, 4, 4a, 6, 6a, 6b, 
6c, 6d, 6e, 6f, 6g, 6h, 6i, 6k, 6m, 6n, 6o, 6p, 8, 9, 9a, 12, 12a, 
13b, 13c, 16a, 18, 19, 21, 23.

    14. Section 3.1 is proposed to be amended by revising paragraphs 
(a)(1) and (a)(2) to read as follows:


Sec. 3.1  Definitions.

    (a) * * *
    (1) If the entity is organized as a sole proprietorship, the 
proprietor; if a partnership, any general partner; if a corporation, 
any director, the president, chief executive officer, chief operating 
officer, chief financial officer, and any person in charge of a 
principal business unit, division or function subject to regulation by 
the Commission; if a limited liability company or limited liability 
partnership, any director, the president, chief executive officer, 
chief operating officer, chief financial officer, the manager, managing 
member or those members vested with the management authority for the 
entity, and any person in charge of a principal business unit, division 
or function subject to regulation by the Commission; and, in addition, 
any person occupying a similar status or performing similar functions, 
having the power, directly or indirectly, through agreement or 
otherwise, to exercise a controlling influence over the entity's 
activities that are subject to regulation by the Commission;
    (2)(i) Any individual who directly or indirectly, through 
agreement, holding company, nominee, trust or otherwise, is the owner 
of ten percent or more of the outstanding shares of any class of stock, 
is entitled to vote or has the power to sell or direct the sale of ten 
percent or more of any class of voting securities, or is entitled to 
receive ten percent or more of the profits; or
    (ii) Any person other than an individual that is the direct owner 
of ten percent or more of any class of securities; or
* * * * *
    15. Section 3.10 is proposed to be amended by revising paragraph 
(a)(1)(i), by redesignating paragraph (a)(2)(i) as paragraph (a)(2), by 
removing paragraph (a)(2)(ii), and by revising paragraph (d) to read as 
follows:


Sec. 3.10  Registration of futures commission merchants, introducing 
brokers, commodity trading advisors, commodity pool operators and 
leverage transaction merchants.

    (a) Application for Registration. (1)(i)(A) Except as provided in 
paragraph (a)(1)(i)(B) of this section, application for registration as 
a futures commission merchant, introducing broker, commodity trading 
advisor, commodity pool operator or leverage transaction merchant must 
be on Form 7-R, completed and filed with the National Futures 
Association in accordance with the instructions thereto.
    (B) An applicant for registration as a futures commission merchant 
or introducing broker that will conduct transactions exclusively on or 
subject to the rules of a derivatives transaction facility for 
institutional customers, and which is registered with the Securities 
and Exchange Commission as a securities broker or dealer, or is a bank 
or any other financial depository institution subject to regulation by 
the United States, may apply for registration by filing with the 
National Futures Association notice of its intention to undertake 
transactions exclusively on or subject to the rules of a derivatives 
transaction facility for institutional customers, together with a 
certification of registration and good standing with the appropriate 
authority or of authorization to engage in such transactions by said 
authority.
* * * * *
    (d) Annual filing. Any person registered as a futures commission 
merchant, introducing broker, commodity trading advisor, commodity pool 
operator or leverage transaction merchant in accordance with paragraph 
(a)(1)(i)(A) of this section must file with the National Futures 
Association a Form 7-R, completed in accordance with the instructions 
thereto, annually on a date specified by the National Futures 
Association. The failure to file the Form 7-R within thirty days 
following such date shall be deemed to be a request for withdrawal from 
registration. On at least thirty days written notice, and following 
such action, if any, deemed to be necessary by the Commission or the 
National Futures Association, the National Futures Association may 
grant the request for withdrawal from registration.
    16. Section 3.32 is proposed to be amended as follows:
    a. Adding paragraphs
    (a)(1)(i)(A) and (B);

[[Page 39024]]

    b. Revising paragraphs (a)(1)(ii) and (a)(1)(v);
    c. Redesignating paragraphs (a)(1)(vi)and (a)(1)(vii) as paragraphs 
(a)(1)(vii) and (a)(1)(viii), respectively;
    d. Adding a new paragraph (a)(1)(vi);
    e. Revising paragraph (a)(2)(i); and
    f. Revising paragraph (e)(1).
    The revisions and additions read as follows:


Sec. 3.32  Changes requiring new registration; addition of principals.

    (a)(1) * * *
    (i) * * *
    (A) As an individual, directly or indirectly, through agreement, 
holding company, nominee, trust or otherwise, becomes the owner of ten 
percent or more of the outstanding shares of any class of stock or 
acquires the right to vote or the power to sell or to direct the sale 
of ten percent or more of the registrant's voting securities;
    (B) Any person other than an individual that becomes the direct 
owner of ten percent or more of any class of a registrant's securities;
    (ii) As an individual becomes entitled to receive ten percent or 
more of the registrant's profits;
* * * * *
    (v) Becomes the president, chief executive officer, chief operating 
officer or chief financial officer of the corporate registrant, or 
becomes in charge of a principal business unit, division or function 
subject to regulation by the Commission, or comes to occupy a position 
of similar status or perform a similar function;
    (vi) Becomes a director, president, chief executive officer, chief 
operating officer, chief financial officer, manager, managing member or 
a member vested with the management authority for the registrant or 
becomes in charge of a principal business unit, division or function 
subject to regulation by the Commission, or comes to occupy a position 
of similar status or perform a similar function in the case of a 
limited liability company or limited liability partnership;
* * * * *
    (2)(i) If a person becomes a principal of the registrant because of 
an event described in paragraph (a)(1)(i)(B) of this section, the 
registrant's registration shall not be deemed to terminate and a new 
Form 7-R need not be filed: Provided, however, that within twenty days 
of the occurrence of the event described in paragraph (a)(1)(i)(B) of 
this section, the registrant must notify the National Futures 
Association of the name of such added principal on Form 3-R and must 
file written certifications with the National Futures Association 
stating:
    (A) The ultimate day-to-day control of the registrant remains the 
same,
    (B) The addition of the new principal will not affect the conduct 
or the day-to-day operations of the registrant, and
    (C) The insertion of the new principal into the chain of ownership 
is not being done for the purpose, and will not have the effect, of 
limiting any liability of the registrant.
* * * * *
    (e)(1) Except where a registrant chooses to file an application 
pursuant to paragraph (d) of this section, if applicable, in the event 
of a change as described in paragraph (a)(1)(v) or (a)(1)(vi) of this 
section, a new registration will not be required if the registrant 
submits a written notice on Form 3-R to the National Futures 
Association prior to the date of such change in control (and such 
change does not occur until the registrant receives written approval 
from the National Futures Association) and includes with such notice a 
Form 8-R, completed in accordance with the instructions thereto and 
executed by the person referred to in paragraph (a)(1)(v) or (a)(1)(vi) 
of this section. The Form 8-R for such individual must be accompanied 
by the fingerprints of that individual on a fingerprint card provided 
for that purpose by the National Futures Association: Provided, 
however, That a fingerprint card need not be provided under this 
paragraph for any individual who has a current Form 8-R on file with 
the National Futures Association or the Commission.
* * * * *


Sec. 3.34  [Removed]

    17. Section 3.34 is proposed to be removed.
    18. Part 3 is proposed to be amended by adding Appendix B to read 
as follows:

Appendix B to Part 3--Statement of Acceptable Practices With 
Respect to Ethics Training

    (a) The provisions of Section 4p(b) of the Act (7 U.S.C. 6p(b) 
(1994)) set forth requirements regarding training of registrants as 
to their responsibilities to the public. This section requires the 
Commission to issue regulations requiring new registrants to attend 
ethics training sessions within six months of registration, and all 
registrants to attend such training on a periodic basis. Consistent 
with the will of Congress, the Commission believes that a Core 
Principle for all persons intermediating transactions in recognized 
multilateral trade execution facilities is fitness. The awareness 
and maintenance of professional ethical standards are essential 
elements of a registrant's fitness. Further, the use of ethics 
training programs is relevant to a registrant's maintenance of 
adequate supervision, itself a Core Principle, and a requirement 
under Rule 166.3.
    (b)(1) The Commission recognizes that technology has provided 
new, faster means of sharing and distributing information. In view 
of the foregoing, the Commission has chosen to allow registrants to 
develop their own ethics training programs. Nevertheless, futures 
industry professionals may want guidance as to the role of ethics 
training. Registrants may wish to consider what ethics training 
should be retained, its format, and how it might best be 
implemented. Therefore, the Commission finds it appropriate to issue 
this Statement of Acceptable Practices regarding appropriate 
training for registrants, as interpretative guidance for 
intermediaries on fitness and supervision. Commission registrants 
may look to this Statement of Acceptable Practices as a ``safe 
harbor'' concerning acceptable procedures in this area.
    (2) The Commission believes that section 4p(b) of the Act 
reflects an intent by Congress that industry professionals be aware, 
and remain abreast, of their continuing obligations to the public 
under the Act and the regulations thereunder. The text of the Act 
provides guidance as to the nature of these responsibilities. As 
expressed in section 4p(b) of the Act, personnel in the industry 
have an obligation to the public to observe the Act, the rules of 
the Commission, the rules of any appropriate self-regulatory 
organizations or contract markets (which would also include 
recognized futures exchanges and recognized derivatives transactions 
facilities), or other applicable federal or state laws or 
regulations. Further, section 4p(b) acknowledges that registrants 
have an obligation to the public to observe ``just and equitable 
principles of trade.''
    (3) Additionally, section 4p(b) reflects Congress' intent that 
registrants and their personnel retain an up-to-date knowledge of 
these requirements. The Act requires that registrants receive 
training on a periodic basis. Thus, it is the intent of Congress 
that Commission registrants remain current with regard to the 
ethical ramifications of new technology, commercial practices, 
regulations, or other changes.
    (c) The Commission believes that training should be focused to 
some extent on a person's registration category, although there will 
obviously be certain principles and issues common to all registrants 
and certain general subjects that should be taught. Topics to be 
addressed include:
    (1) An explanation of the applicable laws and regulations, and 
the rules of self-regulatory organizations or contract markets, 
recognized futures exchanges and derivatives transaction facilities;
    (2) The registrant's obligation to the public to observe just 
and equitable principles of trade;
    (3) How to act honestly and fairly and with due skill, care and 
diligence in the best interests of customers and the integrity of 
the market;
    (4) How to establish effective supervisory systems and internal 
controls;

[[Page 39025]]

    (5) Obtaining and assessing the financial situation and 
investment experience of customers;
    (6) Disclosure of material information to customers; and
    (7) Avoidance, proper disclosure and handling of conflicts of 
interest.
    (d) An acceptable ethics training program would apply to all of 
a firm's associated persons and its principals to the extent they 
are required to register as associated persons. Additionally, 
personnel of firms that rely on their registration with other 
regulators, such as the Securities and Exchange Commission, should 
be provided with ethics training to the extent the Act and the 
Commission's regulations apply to their business.
    (e) As to the providers of such training, the Commission 
believes that classes sponsored by independent persons, firms, or 
industry associations would be acceptable. It would also be 
permissible to conduct in-house training programs. Further, 
registrants should ascertain the credentials of any ethics training 
providers they retain. Thus, persons who provide ethics training 
should be required to provide proof of satisfactory completion of 
the proficiency testing requirements applicable to the registrant 
and evidence of three years of relevant industry or pedagogical 
experience in the field. This industry experience might include the 
practice of law in the fields of futures or securities, or 
employment as a trader or risk manager at a brokerage or end-user 
firm. Likewise, the Commission believes that registrants should 
employ as ethics training providers only those persons they 
reasonably believe in good faith are not subject to any 
investigations or to bars to registration or to service on a self-
regulatory organization governing board or disciplinary panel.
    (f)(1) With regard to the frequency and duration of ethics 
training, it is permissible for a firm to require training on 
whatever periodic basis and duration the registrant (and relevant 
self-regulatory organizations) deems appropriate. It may even be 
appropriate not to require any such specific requirements as, for 
example, where ethics training could be termed ongoing. For 
instance, a small entity, sole proprietorship, or even a small 
section in an otherwise large firm, might satisfy its obligation to 
remain current with regard to ethics obligations by distribution of 
periodicals, legal cases, or advisories. Use of the latest 
information technology, such as Internet websites, can be useful in 
this regard. In such a context, there would be no structured 
classes, but the goal should be a continuous awareness of changing 
industry standards. A corporate culture to maintain high ethical 
standards should be established on a continuing basis.
    (2) On the other hand, larger firms which transact business with 
a larger segment of the public may wish to implement a training 
program that requires periodic classwork. In such a situation, the 
Commission believes it appropriate for registrants to maintain such 
records as evidence of attendance and of the materials used for 
training. In the case of a floor broker or floor trader, the 
applicable contract market, recognized futures exchange or 
derivatives transaction facility should maintain such evidence on 
behalf of its member. This evidence of ethics training could be 
offered to demonstrate fitness and overall compliance during audits 
by self-regulatory organizations, and during reviews of contract 
market, recognized futures exchange or derivatives transaction 
facility operations.
    (g) The methodology of such training may also be flexible. 
Recent innovations in information technology have made possible new, 
fast, and cost-efficient ways for registrants to maintain their 
awareness of events and changes in the commodity interest markets. 
In this regard, the Commission recognizes that the needs of a firm 
will vary according to its size, personnel, and activities. No 
format of classes will be required. Rather, such training could be 
in the form of formal class lectures, video presentation, Internet 
transmission, or by simple distribution of written materials. These 
options should provide sufficiently flexible means for adherence to 
Congressional intent in this area.
    (h) Finally, it should be noted that self-regulatory 
organizations and industry associations will have a significant role 
in this area. Such organizations may have separate ethics and 
proficiency standards, including ethics training and testing 
programs, for their own members.

PART 4--COMMODITY POOL OPERATORS AND COMMODITY TRADING ADVISORS

    19. The authority citation for Part 4 continues to read as follows:

    Authority: 7 U.S.C. 1a, 2, 4, 6b, 6c, 6l, 6m, 6n, 6o, 12a, and 
23.

    20. Section 4.10 is proposed to be amended by revising paragraph 
(e)(1) to read as follows:


Sec. 4.10  Definitions.

* * * * *
    (e)(1) Principal, when referring to a person that is a principal of 
a particular entity, shall have the same meaning as the term principal 
under Sec. 3.1(a) of this chapter.
* * * * *
    21. Section 4.24 is proposed to be amended by revising paragraphs 
(f)(1)(v) and (h)(2) to read as follows:


Sec. 4.24  General Disclosures required.

* * * * *
    (f) * * *
    (1) * * *
    (v) Each principal of the foregoing persons who participates in 
making trading or operational decisions for the pool or who supervises 
persons so engaged.
* * * * *
    (h) * * *
    (2) A description of the trading and investment programs and 
policies that will be followed by the offered pool, including the 
method chosen by the pool operator concerning how futures commission 
merchants carrying the pool's accounts shall treat offsetting positions 
pursuant to Sec. 1.46 of this chapter, if the method is other than to 
close out all offsetting positions or to close out offsetting positions 
on other than a first-in, first-out basis, and any material 
restrictions or limitations on trading required by the pool's 
organizational documents or otherwise. This description must include, 
if applicable, an explanation of the systems used to select commodity 
trading advisors, investee pools and types of investment activity to 
which pool assets will be committed;
* * * * *
    22. Section 4.34 is proposed to be amended by revising paragraphs 
(f)(1)(ii) and (h) to read as follows:


Sec. 4.34  General Disclosures required.

* * * * *
    (f) * * *
    (1) * * *
    (ii) Each principal of the trading advisor who participates in 
making trading or operational decisions for the trading advisor or 
supervises persons so engaged.
* * * * *
    (h) Trading program. A description of the trading program, which 
must include the method chosen by the commodity trading advisor 
concerning how futures commission merchants carrying accounts it 
manages shall treat offsetting positions pursuant to Sec. 1.46 of this 
chapter, if the method is other than to close out all offsetting 
positions or to close out offsetting positions on other than a first-
in, first-out basis, and the types of commodity interests and other 
interests the commodity trading advisor intends to trade, with a 
description of any restrictions or limitations on such trading 
established by the trading advisor or otherwise.
* * * * *

PART 140--ORGANIZATION, FUNCTIONS AND PROCEDURES OF THE COMMISSION

    23. The authority citation for Part 140 continues to read as 
follows:

    Authority: 7 U.S.C. 4a, 12a.

    24. Section 140.91 is proposed to be amended by adding a new 
paragraph (a)(7) to read as follows:


Sec. 140.91  Delegation of authority to the Director of the Division of 
Trading and Markets.

    (a) * * *
    (7) All functions reserved to the Commission in Sec. 1.25 of this 
chapter.
* * * * *

[[Page 39026]]

PART 155--TRADING STANDARDS

    25. The authority citation for Part 155 continues to read as 
follows:

    Authority: 7 U.S.C. 6b, 6c, 6g, 6j and 12a unless otherwise 
noted.

    26. Sections 155.2, 155.3, 155.4 and 155.5 are proposed to be 
amended by adding the words ``or recognized futures exchange'' after 
the words ``contract market'' each time they appear.
    27. Section 155.6 is proposed to be added to read as follows:


Sec. 155.6.  Trading Standards for the Transaction of Business on 
Derivatives Transaction Facilities.

    (a) A futures commission merchant, or affiliated person thereof, 
transacting business on behalf of a non-institutional customer on a 
derivatives transaction facility shall comply with the provisions of 
Sec. 155.3.
    (b) No futures commission merchant, introducing broker or 
affiliated person thereof shall misuse knowledge of any institutional 
customer's order for execution on a derivatives transaction facility.

PART 166--CUSTOMER PROTECTION RULES

    28. The authority citation for Part 166 is proposed to be amended 
to read as follows:

    Authority: 7 U.S.C. 1a, 2, 4, 6b, 6c, 6d, 6g, 6h, 6k, 6l, 6o, 
7a, 12a, 21 and 23, unless otherwise noted.

    29. Section 166.5 is proposed to be added to read as follows:


Sec. 166.5  Dispute settlement procedures.

    (a) Definitions.
    (1) The term claim or grievance as used in this section shall mean 
any dispute that
    (i) Arises out of any transaction executed on or subject to the 
rules of a contract market, a recognized futures exchange or a 
derivatives transaction facility,
    (ii) Is executed or effected through a member of such facility, a 
participant transacting on or through such facility or an employee of 
such facility, and
     (iii) Does not require for adjudication the presence of essential 
witnesses or third parties over whom the facility does not have 
jurisdiction and who are not otherwise available.
     (iv) The term claim or grievance does not include disputes arising 
from cash market transactions that are not a part of or directly 
connected with any transaction for the purchase or sale of any 
commodity for future delivery or commodity option.
    (2) The term customer as used in this section includes an option 
customer (as defined in Sec. 1.3(jj) of this chapter) and any person 
for or on behalf of whom a member of a contract market, a recognized 
futures exchange or a derivatives transaction facility or a participant 
transacting on or through such market, exchange or facility effects a 
transaction on or through such market, exchange or facility, except 
another member of or participant in such market, exchange or facility.
    (3) The term Commission registrant as used in this section means a 
person registered under the Act as a futures commission merchant, 
introducing broker, floor broker, commodity pool operator, commodity 
trading advisor, or associated person.
    (b) Voluntariness. The use by customers of dispute settlement 
procedures shall be voluntary as provided in paragraph (c) of this 
section.
    (c) Pre-Dispute Arbitration Agreements. No Commission registrant 
shall enter into any agreement or understanding with a customer in 
which the customer agrees, prior to the time a claim or grievance 
arises, to submit such claim or grievance to any settlement procedure 
except as follows:
    (1) Signing the agreement must not be made a condition for the 
customer to utilize the services offered by the Commission registrant.
    (2) If the agreement is contained as a clause or clauses of a 
broader agreement, the customer must separately endorse the clause or 
clauses containing the cautionary language and provisions specified in 
this section. A futures commission merchant or introducing broker may 
obtain such endorsement as provided in Sec. 1.55(d) of this chapter for 
the following classes of customers only:
    (i) An institutional customer as defined in Sec. 1.3(g) of this 
chapter;
    (ii) A plan defined as a government plan or church plan in section 
3(32) or section 3(33) of title I of the Employee Retirement Income 
Security Act of 1974, or a foreign person performing a similar role or 
function subject as such to comparable foreign regulation; and
    (iii) A person who is a ``qualified eligible participant'' or a 
``qualified eligible client'' as defined in Sec. 4.7 of this chapter.
    (3) The agreement may not require the customer to waive the right 
to seek reparations under section 14 of the Act and part 12 of this 
chapter. Accordingly, the customer must be advised in writing that he 
or she may seek reparations under section 14 of the Act by an election 
made within 45 days after the Commission registrant notifies the 
customer that arbitration will be demanded under the agreement. This 
notice must be given at the time when the Commission registrant 
notifies the customer of an intention to arbitrate. The customer must 
also be advised that if he or she seeks reparations under section 14 of 
the Act and the Commission declines to institute reparation 
proceedings, the claim or grievance will be subject to the pre-existing 
arbitration agreement and must also be advised that aspects of the 
claim or grievance that are not subject to the reparations procedure 
(i.e., do not constitute a violation of the Act or rules thereunder) 
may be required to be submitted to the arbitration or other dispute 
settlement procedure set forth in the pre-existing arbitration 
agreement.
    (4) The agreement must advise the customer that, at such time as he 
or she may notify the Commission registrant that he or she intends to 
submit a claim to arbitration, or at such time as such person notifies 
the customer of its intent to submit a claim to arbitration, the 
customer will have the opportunity to elect a qualified forum for 
conducting the proceeding.
    (5) Election of forum. (i) Within ten business days after receipt 
of notice from the customer that he or she intends to submit a claim to 
arbitration, or at the time a Commission registrant notifies the 
customer of its intent to submit a claim to arbitration, the Commission 
registrant must provide the customer with a list of organizations whose 
procedures meet Acceptable Practices established by the Commission for 
customer dispute resolution, together with a copy of the rules of each 
forum listed. The list must include:
    (A) The contract market, recognized futures exchange or derivatives 
transaction facility, if available, upon which the transaction giving 
rise to the dispute was executed or could have been executed;
    (B) A registered futures association; and
    (C) At least one other organization that will provide the customer 
with the opportunity to select the location of the arbitration 
proceeding from among several major cities in diverse geographic 
regions and that will provide the customer with the choice of a panel 
or other decision-maker composed of at least one or more persons, of 
which at least a majority are not members or associated with a member 
of the contract market, recognized futures exchange or derivatives 
transaction facility or employee thereof, and that are not otherwise 
associated with the contract market, recognized futures exchange or 
derivatives transaction

[[Page 39027]]

facility (mixed panel): Provided, however, that the list of qualified 
organizations provided by a Commission registrant that is a floor 
broker need not include a registered futures association unless a 
registered futures association has been authorized to act as a 
decision-maker in such matters.
    (ii) The customer shall, within forty-five days after receipt of 
such list, notify the opposing party of the organization selected. A 
customer's failure to provide such notice shall give the opposing party 
the right to select an organization from the list.
    (6) Fees. The agreement must acknowledge that the Commission 
registrant will pay any incremental fees that may be assessed by a 
qualified forum for provision of a mixed panel, unless the arbitrators 
in a particular proceeding determine that the customer has acted in bad 
faith in initiating or conducting that proceeding.
    (7) Cautionary Language. The agreement must include the following 
language printed in large boldface type:
    THREE FORUMS EXIST FOR THE RESOLUTION OF COMMODITY DISPUTES: CIVIL 
COURT LITIGATION, REPARATIONS AT THE COMMODITY FUTURES TRADING 
COMMISSION (CFTC) AND ARBITRATION CONDUCTED BY A SELF-REGULATORY OR 
OTHER PRIVATE ORGANIZATION.
    THE CFTC RECOGNIZES THAT THE OPPORTUNITY TO SETTLE DISPUTES BY 
ARBITRATION MAY IN SOME CASES PROVIDE MANY BENEFITS TO CUSTOMERS, 
INCLUDING THE ABILITY TO OBTAIN AN EXPEDITIOUS AND FINAL RESOLUTION OF 
DISPUTES WITHOUT INCURRING SUBSTANTIAL COSTS. THE CFTC REQUIRES, 
HOWEVER, THAT EACH CUSTOMER INDIVIDUALLY EXAMINE THE RELATIVE MERITS OF 
ARBITRATION AND THAT YOUR CONSENT TO THIS ARBITRATION AGREEMENT BE 
VOLUNTARY.
    BY SIGNING THIS AGREEMENT, YOU: (1) MAY BE WAIVING YOUR RIGHT TO 
SUE IN A COURT OF LAW; AND (2) ARE AGREEING TO BE BOUND BY ARBITRATION 
OF ANY CLAIMS OR COUNTERCLAIMS WHICH YOU OR [NAME] MAY SUBMIT TO 
ARBITRATION UNDER THIS AGREEMENT. YOU ARE NOT, HOWEVER, WAIVING YOUR 
RIGHT TO ELECT INSTEAD TO PETITION THE CFTC TO INSTITUTE REPARATIONS 
PROCEEDINGS UNDER SECTION 14 OF THE COMMODITY EXCHANGE ACT WITH RESPECT 
TO ANY DISPUTE THAT MAY BE ARBITRATED PURSUANT TO THIS AGREEMENT. IN 
THE EVENT A DISPUTE ARISES, YOU WILL BE NOTIFIED IF [NAME] INTENDS TO 
SUBMIT THE DISPUTE TO ARBITRATION. IF YOU BELIEVE A VIOLATION OF THE 
COMMODITY EXCHANGE ACT IS INVOLVED AND IF YOU PREFER TO REQUEST A 
SECTION 14 ``REPARATIONS'' PROCEEDING BEFORE THE CFTC, YOU WILL HAVE 45 
DAYS FROM THE DATE OF SUCH NOTICE IN WHICH TO MAKE THAT ELECTION.
    YOU NEED NOT SIGN THIS AGREEMENT TO OPEN OR MAINTAIN AN ACCOUNT 
WITH [NAME]. SEE 17 CFR 166.5.
    (d) Enforceability. A dispute settlement procedure may require 
parties utilizing such procedure to agree, under applicable state law, 
submission agreement or otherwise, to be bound by an award rendered in 
the procedure, provided that the agreement to submit the claim or 
grievance to the procedure was made in accordance with paragraph (c) of 
this section or that the agreement to submit the claim or grievance was 
made after the claim or grievance arose. Any award so rendered shall be 
enforceable in accordance with applicable law.
    (e) Time limits for submission of claims. The dispute settlement 
procedure established by a contract market, recognized futures exchange 
or derivatives transaction facility shall not include any unreasonably 
short limitation period foreclosing submission of customers' claims or 
grievances or counterclaims.
    (f) Counterclaims. A procedure established by a contract market, 
recognized futures exchanges or derivatives transaction facility under 
the Act for the settlement of customers' claims or grievances against a 
member or employee thereof may permit the submission of a counterclaim 
in the procedure by a person against whom a claim or grievance is 
brought. The contract market, recognized futures exchanges or 
derivatives transaction facility may permit such a counterclaim where 
the counterclaim arises out of the transaction or occurrence that is 
the subject of the customer's claim or grievance and does not require 
for adjudication the presence of essential witnesses, parties or third 
persons over whom the contract market, recognized futures exchanges or 
derivatives transaction facility does not have jurisdiction. Other 
counterclaims are permissible only if the customer agrees to the 
submission after the counterclaim has arisen, and if the aggregate 
monetary value of the counterclaim is capable of calculation.

    Issued in Washington, DC on June 8, 2000, by the Commission.
Jean A. Webb,
Secretary of the Commission.
[FR Doc. 00-14915 Filed 6-21-00; 8:45 am]
BILLING CODE 6351-01-U