[Federal Register Volume 65, Number 165 (Thursday, August 24, 2000)]
[Rules and Regulations]
[Pages 51529-51532]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 00-21498]


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

COMMODITY FUTURES TRADING COMMISSION

17 CFR Part 1

RIN 3038-AB54


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

AGENCY: Commodity Futures Trading Commission.

ACTION: Final rule.

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

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

EFFECTIVE DATE: September 25, 2000.

FOR FURTHER INFORMATION CONTACT: Thomas J. Smith, Special Counsel, 
Division of Trading and Markets, Commodity Futures Trading Commission, 
Three Lafayette Centre, 1155 21st Street, N.W., Washington, D.C. 20581; 
telephone (202) 418-5495;

[[Page 51530]]

electronic mail [email protected]; or Henry J. Matecki, Financial Audit 
and Review Branch, Commodity Futures Trading Commission, 300 S. 
Riverside Plaza, Room 1600-N, Chicago, IL 60606; telephone (312) 886-
3217; electronic mail [email protected].

SUPPLEMENTARY INFORMATION:

I. Proposed Rules

    On June 2, 2000, the Commission published for comment proposed 
amendments to Rule 1.17(h), which governs an FCM's or IBI's net capital 
treatment of subordination agreements.\1\ Commission Regulation 1.17 
requires FCMs and IBIs to maintain minimum levels of adjusted net 
capital.\2\ In computing adjusted net capital, FCMs and IBIs are 
permitted to exclude from liabilities funds received which are 
subordinated to the claims of all general creditors of the FCM or IBI 
pursuant to a ``satisfactory subordination agreement,'' as defined in 
Regulation 1.17(h).\3\
---------------------------------------------------------------------------

    \1\ 65 FR 35304 (June 2, 2000).
    \2\ Commission regulations cited herein may be found at 17 CFR 
Ch. I (2000).
    Adjusted net capital is generally defined as current assets less 
liabilities. See Regulation 1.17(c)(5).
    Regulation 1.17(a)(1)(i) requires FCMs to maintain minimum 
adjusted net capital of the greatest of: (1) $250,000; (2) four 
percent of the customer funds required to be segregated and set 
aside pursuant to the Act and the regulations, less the market value 
of commodity options purchased by customers on or subject to the 
rules of a contract market or a foreign board of trade for which the 
full premiums have been paid provided that the deduction for each 
customer is limited to the amount of customer funds in such 
customer's account(s); (3) the amount of adjusted net capital 
required by a registered futures association of which the FCM is a 
member; or (4) for securities brokers and dealers, the amount of net 
capital required by SEC Rule 15c3-1(a) (17 CFR 240.15c3-1(a)).
    Regulation 1.17(a)(1)(ii) requires IBIs to maintain minimum 
adjusted net capital of the greatest of: (A) $30,000; (B) the amount 
of adjusted net capital required by a registered futures associated 
of which the IBI is a member; or (C) for securities brokers and 
dealers, the amount of net capital required by SEC Rule 15c3-1(a).
    \3\ Regulation 1.17(c)(4)(i).
---------------------------------------------------------------------------

    Subordination agreements may take the form of either subordinated 
loan agreements or secured demand notes. Subordinated loan agreements 
are agreements evidencing a subordinated borrowing of cash by the FCM 
or IBI. Secured demand notes are agreements evidencing or governing the 
contribution of a secured demand note to an FCM or IBI and the pledge 
of securities and/or cash as collateral to secure payment of such note. 
The outstanding principal balances of a subordinated loan and a secured 
demand note are recorded as liabilities of an FCM or IBI.\4\
---------------------------------------------------------------------------

    \4\ See Regulation 1.17(h)(1).
---------------------------------------------------------------------------

    Regulation 1.17(h) sets forth several minimum requirements for the 
subordination agreements and other conditions that must be met in order 
for the agreements to qualify as ``satisfactory'' subordination 
agreements.\5\ One condition, set forth in Regulation 1.17(h)(3)(vi), 
provides that an FCM or IBI may not treat any subordination agreement 
as a ``satisfactory'' subordination agreement for net capital purposes 
until the FCM's or the IBI's designated-self regulatory organization 
(``DSRO''), or the Commission if the FCM or the IBI is not a member of 
a DSRO, has reviewed the agreement and determined that it satisfies the 
minimum requirements set forth in Regulation 1.17(h).
---------------------------------------------------------------------------

    \5\ A contract market may impose, or an FCM or IBI may require, 
conditions or restrictions in addition to those established by the 
Commission provided that such conditions or restrictions do not 
cause the subordination agreement to fail to meet the minimum 
requirements of Regulation 1.17(h).
---------------------------------------------------------------------------

    Commission regulations also impose restrictions on an FCM's or 
IBI's ability to make a payment on a subordinated loan prior to the 
scheduled maturity date of such loan or to effect a full or partial 
reduction in the outstanding principal balance of a secured demand 
note. In this regard, Regulation 1.17(h)(2)(vii)(C) requires an FCM or 
IBI to obtain the written approval of its DSRO, or the Commission if 
the FCM or IBI is not a member of a SRO, prior to making a prepayment 
on a subordinated loan or prior to effecting a full or partial 
reduction in the outstanding principal balance of a secured demand 
note.
    The Commission's regulations governing subordination agreements, 
including the provisions cited above, are consistent with requirements 
imposed by the SEC on registered securities brokers or dealers. In this 
regard, SEC Rule 15c3-1d(c)(6)(i) (17 CFR 240.15c3-1d(c)(6)(i)) is 
consistent with CFTC Regulation 1.17(h)(3)(vi) in that it requires a 
registered securities broker or dealer to file copies of any proposed 
subordination agreement with its DEA prior to the effective date of the 
agreement.\6\ The rule further provides that no subordination agreement 
shall be deemed a ``satisfactory'' subordination agreement for capital 
purposes until the DEA has determined that the agreement satisfies the 
minimum requirements for a satisfactory subordination agreement as set 
forth in the SEC's rules.\7\
---------------------------------------------------------------------------

    \6\ Rule 15c3-1(c)(12) of the SEC, 17 CFR 240.15c3-1(c)(12), 
defines DEA as the national securities exchange or the national 
securities association of which the broker or dealer is a member, or 
if the broker or dealer is member of more than one such exchange or 
association, the exchange or association designated by the SEC as 
the examining authority of the broker or dealer.
    \7\ The SEC's minimum requirements for a satisfactory 
subordination agreement are set forth in Rule 15c3-1d(2) (17 CFR 
240.15c3-1d(2)) and are comparable to the minimum requirements 
established by the Commission in Regulation 1.17(h)(2).
---------------------------------------------------------------------------

    In addition, SEC Rule 15c3-1d(b)(7) (17 CFR 240.15c3-1d(b)(7)) is 
consistent with CFTC Regulation 1.17(h)(2)(vii)(C) in that it requires 
a broker or dealer to obtain the written approval of its DEA prior to 
making a prepayment of a subordinated loan before the scheduled 
maturity date of the payment and prior to effecting a reduction in the 
outstanding principal balance of a secured demand note. Therefore, 
registered FCMs and IBIs that are also registered as securities brokers 
or dealers with the SEC (hereinafter referred to as ``dually-
registered'' FCMs or IBIs) are required to obtain the approvals of a 
futures market SRO and a securities market DEA prior to excluding 
subordination agreements from liabilities in computing net capital or 
prior to making a prepayment on a subordinated loan or effecting a 
reduction in the outstanding principal balance of a secured demand 
note.

II. Final Rules

    The National Futures Association submitted a letter to the 
Commission in support of the proposed amendments. This was the only 
comment received.
    After considering the issues, the Commission is amending 
Regulations 1.17(h)(2)(vii)(C) and 1.17(h)(3)(vi) as proposed. The 
amendments provide that a DSRO may rely on a DEA's review of a proposed 
subordination agreement or a request to make a prepayment on a 
subordinated loan or to reduce the outstanding principal balance of a 
secured demand note, provided that the dually-registered FCM or IBI 
files signed copies of the proposals with its applicable DEA, in the 
manner and form provided by the DEA, prior to the proposed effective 
dates. The rule also directs the FCM or IBI to file copies of the 
proposals with its DSRO prior to the respective effective dates and to 
file copies of the DEA's approval of the transactions with the DSRO 
immediately upon receipt of such approval.
    The requirement that the FCM or IBI file copies of the proposals 
with its DSRO provides the DSRO with an opportunity to review the 
transactions to ensure compliance with Commission regulations prior to 
the effective dates. The amendments further provide that the DEA's 
review and approval of the proposals is deemed, absent objection

[[Page 51531]]

by the DSRO, a finding by the DSRO that the proposals meet the minimum 
requirements and conditions set forth in Commission Regulation 1.17(h). 
The final responsibility for ensuring that the proposals satisfy the 
minimum Commission requirements, however, remains with the DSROs.

III. Related Matters

A. Regulatory Flexibility Act

    The Regulatory Flexibility Act (``RFA''), 5 U.S.C. 601-611, 
requires that agencies, in adopting rules, consider the impact of those 
rules on small businesses. The rule amendments discussed herein would 
affect FCMs and IBIs. The Commission has previously determined that, 
based upon the fiduciary nature of FCM/customer relationships, as well 
as the requirement that FCMs meet minimum financial requirements, FCMs 
should be excluded from the definition of small entity.\8\
---------------------------------------------------------------------------

    \8\ 47 FR 18618, 18619-18620 (April 30, 1982).
---------------------------------------------------------------------------

    With respect to IBIs, the Commission stated that it is appropriate 
to evaluate within the context of a particular rule whether some or all 
introducing brokers should be considered to be small entities and, if 
so, to analyze the economic impact on such entities at that time.\9\ 
The amendments to Regulations 1.17(h)(2)(vii)(C) and 1.17(h)(3)(vi) do 
not impose additional requirements on an IBI. Thus, on behalf of the 
Commission, the Chairman certifies that the proposed rule amendments 
will not have a significant economic impact on a substantial number of 
small entities.
---------------------------------------------------------------------------

    \9\ 48 FR 35248, 35275-78 (August 3, 1983).
---------------------------------------------------------------------------

B. Paperwork Reduction Act

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

List of Subjects in 17 CFR Part 1

    Brokers, Commodity futures.

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

PART 1--GENERAL REGULATIONS UNDER THE COMMODITY EXCHANGE ACT

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

    Authority: 7 U.S.C. 1a, 2, 2a, 4, 4a, 6, 6a, 6b, 6c, 6d, 6e, 6f, 
6g, 6h, 6i, 6j, 6k, 6l, 6m, 6n, 6o, 6p, 7, 7a, 7b, 8, 9, 12, 12a, 
12c, 13a, 13a-1, 16, 16a, 19, 21, 23, and 24.
    2. Section 1.17 is amended by revising paragraphs (h)(2)(vii)(C) 
and (h)(3)(vi) to read as follows:


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

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

[[Page 51532]]

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

    Issued in Washington D.C. on August 17, 2000 by the Commission.
Jean A. Webb,
Secretary of the Commission.
[FR Doc. 00-21498 Filed 8-23-00; 8:45 am]
BILLING CODE 6351-01-P