[Federal Register Volume 65, Number 240 (Wednesday, December 13, 2000)]
[Rules and Regulations]
[Pages 77993-78020]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 00-30268]


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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:  Final rules.

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SUMMARY: As part of a comprehensive regulatory reform process, the 
Commodity Futures Trading Commission (CFTC or Commission) has revised 
its rules relating to intermediation of commodity futures and commodity 
options (commodity interest) transactions. These new rules and rule 
amendments will provide greater flexibility in several areas. For 
example, to ease barriers to entry for persons seeking registration as 
futures commission merchants (FCMs) or introducing brokers (IBs), the 
Commission has established a simplified registration procedure for 
those persons who are regulated by other federal financial regulatory 
agencies and who limit their customer base to institutional customers 
only, regardless of the type of market involved.
    With respect to trading on recognized derivatives transaction 
facilities (DTFs), the Commission has determined to permit non-
institutional customers to enter into transactions thereon, provided 
that such non-institutional customer business is transacted either 
through a registered FCM that is a clearing member of at least one 
designated contract market or recognized futures exchange (RFE), and 
that has adjusted net capital of at least $20 million or by a 
registered commodity trading advisor (CTA) who has discretionary 
authority over the non-institutional customer's account, and who has 
assets under management of not less than $25 million. The latter 
circumstance is an expansion of the proposal.
    As proposed, the Commission is expanding the range of instruments 
in which FCMs may invest customer funds. In response to various 
comments concerning the expansion of permissible investments, the 
Commission is making certain adjustments to the proposals relating to, 
among other things, concentration limits as applied to securities held 
in connection with repurchase transactions, permissible investments in 
FCMs and their affiliates by money market mutual funds meeting the 
requirements of Rule 2a-7 under the Investment Company Act of 1940 
(Investment Company Act), and investment in foreign sovereign debt. 
Separately, the Commission also is considering proposing risk-based 
capital rules for FCMs. Further, the Commission recently adopted a 
revised interpretation concerning the treatment of customer funds on 
deposit with

[[Page 77994]]

FCMs for the purpose of trading on foreign markets under Rule 30.7.\1\
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    \1\ 65 FR 60558 (Oct. 11, 2000). Unless otherwise noted, 
Commission rules referred to herein are found at 17 CFR Ch. I 
(2000).
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    In addition, the Commission is announcing herein the adoption of 
other new rules and rule amendments, concerning the definition of the 
term ``principal,'' certified financial reports, ethics training, 
disclosure, account opening procedures, trading standards, reporting 
requirements, and offsetting positions, as proposed. The Commission has 
made additional changes to allow a registrant to notify the Commission 
when a new natural person is added as a principal ``promptly'' after 
the change occurs. With respect to pre-dispute arbitration agreements 
between an institutional customer and a Commission registrant, the 
Commission has determined to allow such parties to negotiate any or all 
terms of the agreement, provided that the signing of such agreement by 
the institutional customer cannot be made a condition of doing business 
with the registrant. The Commission has also determined to allow any 
counterclaim to be heard as part of an arbitration proceeding between a 
non-institutional customer and a registrant where the parties have 
agreed in advance that all such claims must be included in the 
proceeding, provided that the aggregate value of the counterclaim is 
capable of calculation and that the counterclaim arises out of a 
transaction subject to Commission jurisdiction.

EFFECTIVE DATE: February 12, 2001.

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 
Ky Tran-Trong, 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
    A. Background
    B. The Comments Received
II. Responses to the Comments Received
    A. General
    B. 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
    C. Core Principles Two and Six: Fitness and Supervision
    D. Core Principle Three: Financial Requirements
    1. Trading by Non-Institutional Customers on DTFs
    2. Segregation of Funds
    3. Investment of Customer Funds
    E. Core Principle Four: Risk Disclosure and Account Statements
    F. Core Principle Five: Trading Standards
    G. Core Principle Seven: Reporting Requirements
    H. Core Principle Eight: Recordkeeping
    1. General
    2. Customer Account Statements; Close-Out of Offsetting 
Positions
III. Section 4(c) Findings
IV. Related Matters
    A. Regulatory Flexibility Act
    B. Paperwork Reduction Act

I. Introduction

A. Background

    In accordance with the recommendations made in a staff task force 
report submitted to the Commission's Congressional oversight committees 
on February 22, 2000, the Commission on June 22, 2000 published a 
proposed new regulatory structure intended to adapt to the changing 
needs of the modern marketplace (New Regulatory Framework).\2\ In 
reviewing its regulatory structure for intermediaries, the Commission 
in its proposal (Proposing Release) identified eight Core Principles 
that it believes are fundamental to assuring proper conduct by 
intermediaries of commodity interest transactions.\3\ Although the 
Commission did not propose these Core Principles as rules, they guided 
the Commission in its regulatory reform efforts, as the Commission 
reviewed all of its rules related to intermediaries in light of the 
Core Principles. The Commission proposed 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.
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    \2\ See A New Regulatory Framework for Multilateral Transaction 
Execution Facilities, Intermediaries and Clearing Organizations, 65 
FR 38986; Rules Relating to Intermediaries of Commodity Interest 
Transactions, 65 FR 39008; A New Regulatory Framework for Clearing 
Organizations, 65 FR 39027; Exemption for Bilateral Transactions, 65 
FR 39033.
    \3\ 65 FR 39008.
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    To the extent that an existing rule was not addressed in the 
Proposing Release, and no amendment thereto has been adopted, the rule 
will apply to intermediaries transacting business on behalf of 
customers on contract markets, RFEs and DTFs. When an intermediary 
transacts business on an exempt multilateral transaction execution 
facility (exempt MTEF), these transactions are subject only to the 
Commission's antifraud and antimanipulation authority to the extent 
applicable.\4\ Similarly, where a DTF permits trading only on a 
principal-to-principal basis, CFTC rules related only to intermediaries 
will not be applicable to such a market structure.\5\
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    \4\ See id. at 39009 nn.1-3.
    \5\ See id. A more complete description of the various new 
market structures can be found in ``A New Regulatory Framework for 
Multilateral Transaction Execution Facilities, Intermediaries and 
Clearing Organizations,'' published elsewhere in today's edition of 
the Federal Register..
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    The Core Principles that guided the Commission in its review of 
rules 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, commodity 
pool operator (CPO), associated person (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 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 or transaction 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,

[[Page 77995]]

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, maintain, and enforce 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 are required on a routine and non-routine basis, 
as is the case for transactions on contract markets. Reports of 
transactions on an institutional-participant DTF are required only on a 
non-routine basis.\6\
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    \6\ As discussed in a companion release in today's edition of 
the Federal Register, large trader reports will not be required from 
participants trading on a DTF restricted to commercial participants, 
except where the Commission specifically orders otherwise.
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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 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.
    Certain of the Commission's rule amendments, such as those 
concerning ethics training and the definition of the term 
``principal,'' will affect all registered firms. The other new rules 
and rule amendments will affect mainly FCMs and IBs, and are not 
applicable to CPOs and CTAs. The Commission intends to consider further 
rulemaking proposals at a subsequent date that will focus more directly 
upon Part 4 of the Commission's rules, which governs the operations and 
activities of CPOs and CTAs.\7\
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    \7\ The Commission 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. See Financial and Segregation Interpretation No. 
4-2, CFTC Staff Letter 99-32, [1998-1999 Transfer Binder] Comm. Fut. 
L. Rep. (CCH) para. 27,745 (Aug. 20, 1999). Similarly, the 
Commission is considering amendments to the minimum capital 
requirements for FCMs. Those proposed amendments would contain an 
approach, generally referred to as ``risk-based'' capital 
requirements, that is based more upon position risk than is the case 
under the current rules.
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B. The Comments Received

    The Commission received 81 comment letters on the New Regulatory 
Framework, 51 of which were posted to the comment file on 
intermediaries on the Commission's web site. Of those 51 comment 
letters, 31 letters addressed specific provisions of the Proposing 
Release: five from U.S. commodity exchanges; two from the National 
Futures Association (NFA); one from the Futures Industry Association 
(FIA); six from other futures industry professional associations; one 
from the Federal Reserve Bank of Chicago (FRBC); one from the 
Department of the Treasury (Treasury); one from a provider of ethics 
training programs for the futures industry; five from firms registered 
as FCMs; one from a margin settlement bank for various U.S. exchanges 
and clearing corporations; three from trade associations representing 
the grain industry; one from a group of trade associations representing 
various producer groups; two from public policy centers; one from a 
single firm registered as an FCM, CPO and CTA; and one from a certified 
public accounting firm. These commenters, as well as those that 
addressed the concept of regulatory reform in a more general fashion, 
expressed strong support for the Proposing Release, but some suggested 
that the relief did not go far enough towards replacing the 
Commission's regulatory framework concerning intermediaries with core 
principles.\8\
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    \8\ Commenters are generally identified by name below when their 
comments are discussed. Citations to comment letters are denoted as 
``CL 22-x.'' The number 22 represents the comment file for the 
Proposing Release and ``x'' is the number assigned to a particular 
comment letter as set forth on the Commission's website, 
www.cftc.gov.
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    The Commission has carefully reviewed all of the comments received. 
Based upon this review, the Commission generally has determined to 
adopt the new rules and amendments as proposed in the Proposing 
Release. In response to the comments, the Commission has also decided, 
however, to modify the proposal in several respects. First, the 
Commission has determined to expand the ``passport'' provisions with 
respect to those FCMs and IBs that are already registered with the 
Securities and Exchange Commission (SEC) in a similar registration 
capacity, or that are authorized to perform these functions by a 
federal banking authority. As adopted, these rules will allow those 
FCMs and IBs to follow a simplified registration procedure in order to 
conduct business solely for institutional customers on designated 
contract markets and RFEs, in addition to DTFs. Second, the Commission 
has determined to permit certain CTAs to place trades on a DTF on 
behalf of non-institutional customers, provided that the non-
institutional customer's investment decisions are directed by the CTA 
and that total assets over which the CTA has discretionary authority 
are not less than $25 million. The proposal would have required non-
institutional customers wishing to trade on DTFs to transact their 
business only through an FCM with at least $20 million in adjusted net 
capital that is also a clearing member of at least one designated 
contract market or RFE.\9\ Third, the Commission has made adjustments 
to its rules governing permissible investments for customer funds in 
response to the comments received. Fourth, the Commission has adopted 
additional changes to allow a registrant to notify the Commission 
``promptly'' after a new principal is added, rather than prior to the 
change as was the case previously. Fifth, with respect to pre-dispute 
arbitration agreements between an institutional customer and a 
Commission registrant, the Commission has determined to allow such 
parties to negotiate any or all terms of such agreements, provided that 
the signing of the agreement may not be made a condition of doing 
business with the registrant. Sixth, the Commission has decided to 
permit any counterclaim arising out of a transaction subject to the 
Commodity Exchange Act (Act) or regulations thereunder to be heard as 
part of an arbitration proceeding between a non-institutional customer 
and a registrant where the parties have agreed in advance that all such 
claims must be included in the proceeding.
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    \9\ As explained in the separate release on ``A New Regulatory 
Framework for Multilateral Transaction Execution Facilities, 
Intermediaries and Clearing Organizations'' in today's edition of 
the Federal Register, however, the Commission is amending its 
proposal to permit a non-institutional customer to enter an order 
directly to a DTF's electronic trading platform where the customer's 
account is carried by a registered FCM with at least $20 million in 
adjusted net capital that is also a clearing member of at least one 
designated contract market or RFE, provided that such FCM's credit 
filter is maintained as part of the DTF's electronic trading 
platform. See Sec. 37.2(a)(2)(ii)(A).
    In addition, FTs and FBs will be permitted to trade for their 
own account on a DTF, even if they would not otherwise come within 
the definition of an institutional customer, provided that their 
obligations in connection with their trading on the DTF are 
guaranteed by an FCM. See Sec. 37.1(b)(1), (2). Generally, an FT or 
an FB must have total assets exceeding $10,000,000 to be considered 
an institutional customer. See Secs. 1.3(g), 35.2(b)(10), (11).
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    In the Proposing Release, the Commission gave a detailed 
explanation for each revision that it proposed to

[[Page 77996]]

make to the rules relating to intermediation of commodity interest 
transactions. The scope of this Federal Register release generally is 
restricted to the comments received on the Proposing Release and 
changes to the proposed new rules and rule amendments that the 
Commission has made in response thereto. Accordingly, the Commission 
encourages interested persons to read the Proposing Release for a 
discussion of the background and purpose of each of the rule amendments 
that is not described in detail in this Federal Register release.
    The Proposing Release also presented several sets of questions 
intended to elicit public comments on various issues. For instance, the 
Commission requested comment concerning the need to update and to make 
more flexible its minimum net capital requirements for FCMs by 
permitting the application of risk-based net capital requirements.\10\ 
In response to the comments received, the Commission plans to 
separately propose various rules and amendments addressing risk-based 
capital requirements. The Commission also posed certain questions 
related to the treatment of customer funds.\11\ Reactions were mixed 
regarding these additional issues. Consequently, the Commission will 
continue to study these issues.
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    \10\ 65 FR at 39012.
    \11\ Id. at 39014-15.
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II. Responses to the Comments Received

A. General

    As noted above, several commenters urged the Commission to revoke 
many of the rules that govern the relationship between futures and 
options customers and intermediaries, and to adopt in their place a set 
of core principles and statements of acceptable practices that reflect 
the ``largely institutional nature of derivatives market 
participants.'' (CL 22-31 at 2-3; see also CL 22-22 at 9; CL 22-24 at 
1; CL 22-39 at 8; CL 22-35 at 11) In particular, FIA commented that:

[We have] identified the following core principles that we believe 
should govern intermediaries in the conduct of their business, 
without regard to the market on which a transaction is executed: (1) 
Registration of intermediaries and their associated persons; (2) 
minimum financial requirements; (3) protection of customer funds 
appropriate to the type of customer; (4) prohibition against fraud 
and manipulation; (5) large trader reporting requirements; and (6) 
recordkeeping. These core principles, combined with an effective 
self-regulatory organization audit program to assure that 
intermediaries have developed and are enforcing adequate internal 
controls[,] should achieve the Commission's regulatory purpose. (CL 
22-31 at 3 (footnotes omitted))

    In general, the Commission believes that it is more expeditious at 
this time to adopt the specific regulatory reforms contemplated in the 
original release. Replacing the current rules with core principles 
might have delayed these changes, and in some instances, resulted in no 
practical benefit to the regulated community. To use Rule 1.55 as an 
example, the development of a core principle approach in this area 
would have required the Commission to propose the repeal of Rule 1.55 
and the adoption of a core principle for disclosure together with a 
Statement of Acceptable Practices. The Statement of Acceptable 
Practices would likely provide, as the rule does now, no standard 
disclosure requirement for institutional customers and the basic 
single-page statement now applicable to non-institutional customers. At 
the end of this process, there would be no discernible change in FCM or 
IB operations. Firms might theoretically be freer to develop their own 
statements, but to clear them through counsel and self-regulatory 
organization (SRO) staff would likely be costly and time-consuming. 
Accordingly, the Commission did not believe that it would be an 
effective use of the Commission's or the industry's resources at this 
time to replace Rule 1.55 solely for the purpose of establishing a core 
principle concerning disclosure. The Commission reaches similar 
conclusions with respect to the repeal of other rules.
    Second, the Commission believes that certain issues, such as the 
computation of capital for a financial intermediary, do not lend 
themselves easily to a core principle approach. As one commenter 
observed: ``Capital and segregation requirements * * *`` must be 
spelled out in detail to ensure the integrity of customer funds.'' (CL 
22-24 at 1)
    Third, as the New York Mercantile Exchange (NYMEX) noted, a re-
examination of the Commission's rules applicable to intermediaries with 
a goal towards replacing them with a set of Core Principles and 
statements of acceptable practices ``would require an intensive review 
of the applicable rules in this area,'' and accordingly, ``undertaking 
such an examination as part of the current Reform Proposal could so 
greatly lengthen the process as to undermine the entire reform 
effort.'' (CL 22-32 at 16-17)
    Nevertheless, the Commission's decision at this time not to use a 
core principles approach with respect to intermediaries will not affect 
its commitment to the continued review of the rules affecting 
intermediaries to determine where core principles are appropriate.\12\ 
In this regard, the Commission notes the request it made in the 
Proposing Release for specific comments concerning existing rules and 
suggested modifications thereto.\13\ The Commission further notes that 
under Rule 140.99, there remains a procedure in place whereby the 
Commission's staff may consider specific individual circumstances and, 
where warranted, the Commission's staff may grant interpretative, 
exemptive, or no-action relief from requirements under the Act or 
Commission rules to individuals or entities requesting such relief.
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    \12\ Should the Commission in the future adopt core principles 
in the place of some of its existing regulations as they pertain to 
intermediaries, NFA urged the Commission to look to NFA and the 
industry to develop the acceptable practices for satisfying many of 
these core principles, subject to Commission approval. (CL 22-24 at 
2) The Commission notes that it has already taken such an approach 
in certain areas, e.g., disclosure to non-institutional customers 
trading on DTFs, and looks forward to continuing to work with NFA 
and the industry in developing acceptable practices in additional 
areas.
    \13\ 65 FR at 39009.
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    Certain commenters specifically addressed the need for further 
regulatory relief with respect to CPOs and CTAs. (CL 22-22 at 9; CL 22-
43 at 5-6; CL 22-47 at 2) The Commission recognizes that CPOs and CTAs 
represent ``important sectors of the futures industry.'' (CL 22-22 at 
2) As stated above, the regulatory reform process is an ongoing one. 
The Commission continues to explore additional areas in which relief 
for CPOs and CTAs may be warranted, e.g., Part 4 of the Commission's 
rules, and will be making further rulemaking proposals.
    With specific regard to recordkeeping, the Commission in 1999 
adopted amendments to the recordkeeping requirements of Rule 1.31 in 
order to allow recordkeepers to store most records on either 
micrographic or electronic storage media for the full five-year period, 
thereby harmonizing procedures for those firms regulated by both the 
Commission and the SEC.\14\ In order to avoid undue hardship, the 
Commission later extended the effective date of the requirement that 
recordkeepers using only electronic storage media enter into 
arrangements with third-party technical consultants.\15\ The 
Commission's staff is continuing to work with industry representatives 
to implement this procedure.
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    \14\ 64 FR 28735 (May 27, 1999).
    \15\ 64 FR 36568 (July 7, 1999).

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[[Page 77997]]

B. Core Principle One: Registration

1. Definition of the Term ``Principal''
    Under Commission staff's prior interpretation of the definition of 
the term ``principal'' in Rules 3.1(a)(1) and 4.10(e)(1),\16\ all 
officers of a registrant were treated as principals and required to 
register as such. In response to changes in management structures over 
the last 20 years and 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, the Commission 
proposed to amend Rules 3.1(a)(1) and 4.10(e)(1) by defining as 
principals persons within a given organizational structure who hold 
specific offices.\17\ A registrant would, therefore, no longer be 
required to treat every officer as a principal, but only those who met 
the criteria of the rule as revised.
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    \16\ 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 CPOs and CTAs.
    \17\ 65 FR at 39010.
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    Commenters were strongly in support of the proposal to amend the 
definition of ``principal'' to reduce the number of persons required to 
be registered, and the Commission is adopting the amendments as 
proposed.\18\ (CL 22-22 at 11; CL 22-24 at 3; CL 22-25 at 2; CL 22-31 
at 13; CL 22-32 at 16) The Managed Funds Association (MFA) asked the 
Commission to confirm that the reference in the proposed amendment to 
the ``principal'' definition to ``any person in charge of a business 
unit subject to regulation by the Commission'' applied solely to ``the 
aggregate business unit acting in a registered capacity and not 
subsidiary divisions or units such as marketing, human resources, 
audit, and other departments within an operating entity.'' (CL 22-22 at 
11) The Commission agrees with this interpretation, and reiterates that 
the intent of the amended ``principal'' definition is to reduce the 
number of officers that will be considered principals, while ensuring 
that appropriate personnel, e.g., those that exercise, or are in a 
position to exercise, ``a controlling influence over the registrant or 
any of its activities subject to Commission regulation,'' \19\ remain 
listed as such.
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    \18\ As amended, the ``principal'' definition will continue to 
include all directors of a corporate registrant. In addition, the 
definition will include the general provision that defines as a 
principal any person occupying a similar status as or performing 
similar functions to those persons specifically listed, having the 
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. As noted in the Proposing 
Release, what constitutes ``a controlling influence'' will be left 
for determination on ``a case-by-case basis.'' Id. at 39011 n.11.
    \19\ Id. at 39010.
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    The Commission also has determined to adopt, as proposed, 
conforming changes to 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, as incorporated by reference in 
amended Rule 4.10(e)(1). Accordingly, CPOs and CTAs will 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.\20\
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    \20\ Id. at 39011.
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    In response to suggestions by FIA, the Commission has determined to 
delete Rule 3.32, which specifies certain events or changes within a 
firm's management structure that require the firm to file a new 
registration form. (CL 22-31 at 13-14) The Commission is adding a new 
paragraph (a)(2) to Rule 3.31 to require the registrant to file a Form 
8-R on behalf of each new natural person principal who was not listed 
on the registrant's Form 7-R ``promptly'' after the change occurs. Rule 
3.31(a)(2) was drafted to closely parallel Rule 3.10(a)(2)(i), and 
provides that, if the change that renders the application for 
registration deficient or inaccurate results from the addition of a new 
principal without a current Form 8-R on file with NFA, a Form 8-R for 
that principal must accompany the Form 3-R amending the registrant's 
application for registration.\21\
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    \21\ An additional conforming change was made to Sec. 3.21(c) to 
reflect the deletion of Sec. 3.32, and the addition of new paragraph 
(a)(2) to Sec. 3.31.
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2. Special Procedures Available to Firms Subject to Securities or 
Banking Regulation
    The Commission proposed to amend Rule 3.10 to simplify the 
registration process for FCMs or IBs who conduct business solely for 
institutional customers on a DTF, and who are already registered with 
the SEC in a similar registration category or who are authorized to 
perform these functions by a federal banking authority.\22\ The 
Commission stated in the Proposing Release that such applicants would 
be registered as an FCM or IB upon filing notice with 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. In addition, individuals acting in the 
capacity of APs for such FCMs or IBs need not be registered or listed, 
and would not be subject to proficiency testing or ethics training 
requirements. These firms and their salespersons would remain subject 
to antifraud provisions, however.\23\
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    \22\ 65 FR at 39011-12.
    \23\ Id. at 39012.
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    The Chicago Mercantile Exchange (CME), along with other commenters, 
stated that the ``passporting'' provisions did not go far enough and 
urged the Commission to extend the provisions to allow those persons 
who are regulated by the SEC or a federal banking agency, and who opt 
to register as an FCM or IB under the simplified registration 
procedure, to conduct business for institutional customers on all 
trading platforms, rather than limit their access to DTFs.\24\ (CL 22-
35 at 12; see also CL 22-24 at 3-4; CL 22-25 at 2-3) In support of this 
recommendation, the Chicago Board of Trade (CBT) stated, ``[i]f the 
nature of the entity or individual intermediating the transaction and 
the nature of the customer determines the need for any particular 
requirement, whether the transaction facility is a DTF or an RFE is 
irrelevant.'' (CL 22-25 at 3; see also CL 22-35 at 15)
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    \24\ In this regard, the CME stated that given the restrictions 
of the DTF market structure:
    The proposed rulemaking provides no relief whatsoever to a 
securities broker-dealer (not also registered as a FCM) that wishes 
to execute transactions in both stock index futures and the 
underlying stocks in order to implement an asset allocation strategy 
for its institutional customers. So long as the customers are 
sophisticated institutions, we can see no regulatory reason not to 
allow them to use the federally-regulated intermediary of their 
choice in effecting transactions in a futures market, regardless of 
whether the market is regulated as a designated contract market, an 
RFE, a DTF or an exempt MTEF. (CL 22-35 at 12)
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    In contrast, however, the National Introducing Brokers Association 
(NIBA) urged that any person or organization conducting any commodity 
interest business should be subject to full registration requirements 
(CL 22-17 at 4), while MFA stated that firms making use of the 
``passport'' procedure should be subject to a limitation upon their 
commodity interest business, such as a requirement that their commodity 
interest activities be incidental to their primary business as a 
broker-dealer or bank. (CL 22-22 at 11-12)
    Upon consideration of the comments received, the Commission agrees 
that given the nature of the customers (i.e., solely institutional 
customers) for whom a securities broker-dealer or bank would

[[Page 77998]]

be acting as an FCM or IB, the securities broker-dealer or bank should 
be eligible for the simplified FCM or IB registration procedures, 
irrespective of the type of exchange on which the customer seeks to 
conduct its transactions. Accordingly, the Commission has adopted Rule 
3.10(a)(1)(i)(B) to permit an individual or entity who is registered 
with the SEC as a broker-dealer, or has been authorized by the 
appropriate banking authority, to register as an FCM or IB simply by 
filing notice with NFA, together with a certification of registration 
with the appropriate financial regulator.\25\ Such FCMs and IBs who are 
otherwise regulated by another federal financial regulator will be 
permitted to conduct business solely for institutional customers on any 
designated contract market, RFE or DTF.\26\ The Commission notes, 
however, in accordance with FIA's comments, that the simplified 
registration procedure is limited to banks themselves, and not to their 
affiliates, and further, that once registered, securities broker-
dealers and banks would be subject to the same rules that govern all 
FCMs and IBs. (CL 22-34 at 13)
---------------------------------------------------------------------------

    \25\ As noted in the Proposing Release, a firm acting in the 
capacity of an FCM would be required to become a member of a 
registered futures association. See Sec. 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.
    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.
    \26\ Because an intermediary that conducts business on an exempt 
MTEF will not be subject to Commission regulation for activity on 
the exempt MTEF, except for the antifraud and antimanipulation 
provisions of the Act to the extent applicable, it is unnecessary to 
extend the ``passporting'' procedure to firms trading on these 
markets.
---------------------------------------------------------------------------

    Although ``passported'' firms will be eligible for the simplified 
FCM or IB registration procedures without regard to the type of 
exchange on which their institutional customers seek to conduct 
business, the Commission has determined to adopt Rules 1.17(a)(2)(iii) 
and 1.52(m), as proposed, without making further changes. Under Rule 
1.17(a)(2)(iii), the Commission would not require an FCM or IB 
registered under the ``passporting'' procedures in Rule 
3.10(a)(1)(i)(B) to meet the Commission's minimum financial 
requirements if (i) it meets the appropriate net capital requirements 
of its primary regulator, (ii) its activities are limited to serving 
institutional customers trading on DTFs that do not require compliance 
with CFTC minimum financial requirements for such ``passported'' firms, 
and (iii) it conforms to minimum financial standards and related 
reporting requirements set by such DTF in its bylaws, rules, 
regulations or resolutions.\27\
---------------------------------------------------------------------------

    \27\ 65 FR at 39012.
---------------------------------------------------------------------------

    If, however, the ``passported'' FCM or IB chooses to conduct 
transactions on behalf of its institutional customers on a contract 
market or RFE in addition to its DTF activities, the firm would then be 
required to satisfy the Commission's minimum financial requirements. 
The Commission believes that this requirement is important to protect 
the financial integrity of these markets because a customer default may 
have ancillary impacts not just on other customers of the affected 
firm, but also on other firms and their customers transacting business 
on such markets. Moreover, because the Commission anticipates that 
``passported'' firms will conduct most of their business in the 
securities or banking fields, with only a minor portion of their 
activities involving commodity interests, the requirement that such 
firms meet the Commission's minimum financial requirements if they 
conduct business for their institutional customers on a contract market 
or RFE should not impose a significant burden. Rules 1.17(a)(1)(i) and 
(ii) already require the dually registered FCM or IB to meet the 
greater of either the Commission's or SEC's minimum financial 
requirements, and in most cases, those entities that conduct most of 
their business in the securities or banking fields will have satisfied 
the Commission's minimum financial requirements by meeting the SEC 
capital requirements. Similarly, the Commission allows a dually 
registered FCM or IB to satisfy the basic financial reporting 
requirements of Rule 1.10 by filing a copy of its FOCUS report in lieu 
of a Form 1-FR. In addition, Rule 1.52(m) is adopted as proposed to 
relieve a DTF from the requirement that it adopt for ``passported'' 
firms, the Commission's minimum adjusted net capital standards.\28\
---------------------------------------------------------------------------

    \28\ Id.
---------------------------------------------------------------------------

    The Commission continues to encourage 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.
    The Commission also noted in the Proposing Release that it was 
considering updating and making more flexible its minimum net capital 
requirements with respect to FCMs, specifically with respect to 
adopting risk-based net capital requirements.\29\ Commenters were 
overwhelmingly in favor of this proposal, and the CBT further noted 
that it had, along with the Board of Trade Clearing Corporation (BOTCC) 
and the CME, already adopted risk-based capital requirements at the 
clearing organization level. (CL 22-25 at 3) The Commission is 
separately considering proposing rules related to risk-based net 
capital requirements.\30\
---------------------------------------------------------------------------

    \29\ Id.
    \30\ Although the Proposing Release did not generally address 
registration procedures for firms that are dually registered with 
the National Association of Securities Dealers (NASD) and NFA, the 
Association of Registration Management (ARM) made several 
suggestions in that area. Among its comments, ARM recommended that: 
(1) Firms that are dually registered with NASD and NFA should be 
permitted to maintain internal records about branch office location 
and supervision of those locations; (2) NFA should be permitted to 
rely on the fingerprint information available through the NASD's 
Internet-based Central Registration Depository (Web CRD) database 
for dual registrants; and (3) NFA also should be permitted to rely 
on disciplinary and disclosure information filed through amendments 
to Web CRD. (CL 22-23 at 2-3) ARM also recommended that the 
Commission eliminate its Form 7-R annual update requirement by 
allowing NFA to rely upon, and to record changes in a registrant's 
application through use of, the amendments filed via Form 3-R 
throughout the year. (CL 22-23 at 1-2)
    The Commission's Registration Working Group (RWG) will consider 
ARM's suggestions in the near future. In this regard, Commission 
staff indicated in a letter dated July 13, 2000 to NFA that: (1) NFA 
could rely upon reporting by the futures industry SROs and the 
Commission with respect to SRO disciplinary actions and Commission 
enforcement actions; (2) certain requirements related to the 
collection of employment, residential and educational data could be 
reduced; and (3) as part of the annual update process, firms would 
only be required to report any new criminal or civil matters that 
had arisen since the previous update.
---------------------------------------------------------------------------

3. Standard Application Procedures for FCMs and IBs
    The Commission proposed that applicants for registration as FCMs or 
IBs who raise their own capital to satisfy minimum financial 
requirements would be permitted to file an unaudited financial report 
indicating satisfaction of the minimum requirements, rather than be 
required to provide certified financial statements with their 
registration application.\31\ A firm taking

[[Page 77999]]

advantage of the 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. An applicant that did not wish to be 
subject to the six-month review could continue to follow the existing 
rules and file a certified financial statement with its 
application.\32\
---------------------------------------------------------------------------

    \31\ Id. However, as stated in the Proposing Release, those IB 
applicants who do not raise their own capital continue to be 
required to file a guarantee agreement entered into with an FCM with 
their registration application. IBs and FCMs should refer to 
Commission Rules 1.10(j) and 1.57(a)(1) concerning the procedures 
applicable to guarantee agreements. See also First American Discount 
Corp. v. CFTC, 222 F.3d 1008 (D.C. Cir. Aug. 18, 2000).
    \32\ 65 FR at 39013.
---------------------------------------------------------------------------

    In general, commenters supported the proposed elimination of the 
certified financial statement requirement for IB applicants. (CL 22-17 
at 3; CL 22-24 at 4; CL 22-25 at 4) Both NFA and the CBT, however, 
expressed reservations about eliminating the requirement for FCM 
applicants. (CL 22-24 at 4; CL 22-25 at 4) In addition, NFA recommended 
that the Commission consider allowing the DSRO to conduct the six-month 
review of independent IBs telephonically where the DSRO has no reason 
to be concerned about the IB's capital. (CL 22-24 at 4) The CBT 
expressed the view that the six-month time period for the on-site 
review of the FCM by the DSRO should be calculated from the date the 
FCM begins customer business, rather than six months from the date of 
registration. (CL 22-25 at 4).
    The Commission has determined to eliminate the requirement to file 
certified financial statements with FCM or IB registration applications 
by adopting Rules 1.10 (a)(2)(i)(C) and (a)(2)(ii)(C), generally as 
proposed.\33\ This alternative procedure is modeled on similar 
procedures in the securities industry. Although the Commission is not 
requiring FCMs to file a certified financial statement with their 
application for registration, this does not preclude any SRO from 
imposing this requirement before accepting an FCM for membership. With 
respect to the six-month review that must be conducted should an FCM or 
IB choose not to file a certified financial statement with its 
registration application, the Commission does not object, in the case 
of an IB, to allowing the DSRO to conduct the review telephonically 
where the DSRO does not have reason to question the IB's capital. 
However, the Commission believes that the six-month time period for the 
review of both FCMs and IBs should begin from the date the applicant is 
registered. The Commission has held consistently that once a registrant 
becomes registered in a certain capacity, the registrant is immediately 
assumed to be engaging in the activities permitted by such 
registration.\34\
---------------------------------------------------------------------------

    \33\ Rules 1.10(a)(2)(i)(C) and (a)(2)(ii)(C) have been further 
revised to make clear that the Form 1-FR-FCM or Form 1-FR-IB that 
must be submitted by new applicants for registration as FCMs and IBs 
with their application must be dated not more than 17 business days 
prior to the date on which such report is filed. This is consistent 
with Rules 1.10(a)(2)(i)(B) and (a)(2)(ii)(B).
    \34\ See, e.g., In re Premex, [1982-1984 Transfer Binder] Comm. 
Fut. L. Rep. (CCH) para. 21,992 (Feb. 1, 1984), aff'd in relevant 
part, rev'd in part, 785 F.2d 1403 (9th Cir. 1986).
---------------------------------------------------------------------------

C. Core Principles Two and Six: Fitness and Supervision

    The Commission proposed to delete Rule 3.34 and instead to 
implement Congressional intent regarding ethics training through a 
Statement of Acceptable Practices.\35\ Rule 3.34 specified frequency 
and duration of ethics training, the suggested curriculum, 
qualifications of instructors, and the necessary proof of attendance at 
such classes. In proposing to replace the rule with a Statement of 
Acceptable Practices that would leave the format, frequency, and 
providers of ethics training up to the registrants themselves, the 
Commission expressed its belief that greater flexibility regarding 
ethics training and proficiency testing could be afforded to 
registrants than was permitted under Rule 3.34. For registrants seeking 
guidance as to the maintenance of proper ethics training procedures 
consistent with the purposes of the Core Principle that intermediaries 
must be and remain fit, the Commission stated that the Statement of 
Acceptable Practices could function as a ``safe harbor.'' \36\
---------------------------------------------------------------------------

    \35\ 65 FR at 39013.
    \36\ Id.
---------------------------------------------------------------------------

    In general, commenters expressed strong support for the 
Commission's proposal, stating, for example, that Rule 3.34 had become 
``far too detailed and administratively cumbersome,'' (CL 22-24 at 5) 
and that ``each registrant should be responsible for implementing an 
ethics training program that addresses the registrant's business 
activities.'' (CL 22-31 at 14) Other commenters, however, expressed 
their beliefs that Rule 3.34 already provided sufficient flexibility to 
registrants, and that by eliminating the rule, the Commission risks 
sending the wrong message to the industry regarding the importance the 
Commission assigns to the ethics requirement. (CL 22-7 at 3; CL 22-43 
at 6).
    Upon consideration of the comments received, the Commission is 
deleting Rule 3.34 and issuing the Statement of Acceptable Practices as 
a new Appendix B to Part 3 of its Rules as proposed. Although the 
Commission notes the concern that eliminating Rule 3.34 may lead firms 
to place an inadequate priority on ethics training, the Commission does 
not believe that the replacement of the rule with a Statement of 
Acceptable Practices will diminish a registrant's obligations to remain 
fit and to adequately supervise the handling of customer accounts. 
Instead, the Commission hopes that the Statement of Acceptable 
Practices, which allows registrants to adopt ethics training programs 
that are better tailored to their needs, will help to imbue firms with 
a ``culture of ethics'' that is ongoing rather than episodic. The 
Commission believes that the essence of the ethics training or 
continuing education requirement is to remain current as to the legal 
requirements applicable to a person's role in the futures industry, 
which a registrant ignores at his or her peril.
    The Commission also proposed to publish its recent ``guidance 
letters'' issued to NFA concerning the treatment of SRO disciplinary 
actions in assessing the fitness of FBs and FTs. The guidance letters 
were issued to provide greater clarity in interpreting the ``other good 
cause'' ground for statutory disqualification from registration under 
Section 8a(3)(M) of the Act. Support was expressed for this proposal 
and, accordingly, the Commission is hereby publishing both letters as 
an addition to Appendix A to Part 3 of its Rules.\37\ (CL 22-25 at 4-5)
---------------------------------------------------------------------------

    \37\ In the Proposing Release, the Commission indicated that 
these letters would be published as an accompanying statement to 
this Federal Register release. The Commission has determined to add 
these letters to Appendix A to Part 3 because they relate to the 
issue of ``other good cause,'' which is discussed at the end of 
Appendix A, and to provide an easier way to access the texts of 
these letters.
---------------------------------------------------------------------------

    The Commission also requested comment regarding additional changes 
that should be considered in this area. In response, NFA urged the 
Commission to consider prohibiting exchange ``subscribers'' from 
accessing electronic exchanges where they have been barred by another 
exchange. (CL 22-22 at 5) As explained by NFA, the term ``subscriber'' 
describes the type of person that is equivalent to an FT. The 
Commission previously stated, when it adopted rules to govern FT 
registration, that it would defer consideration of the application of 
such requirements to persons using electronic trading systems to a 
later date.\38\ To date, the Commission has not revisited the issue, 
and accordingly does not believe that it is appropriate to adopt NFA's 
request at this time. Nevertheless, the exchanges remain free to ban 
such ``subscribers''

[[Page 78000]]

from access pursuant to their own rules and policies. As with the case 
of certified financial statements for FCM applicants discussed above, 
SROs may determine to impose requirements that are stricter than the 
minimum standards set forth in Commission rules.
---------------------------------------------------------------------------

    \38\ 58 FR 19575, 19576 (Apr. 15, 1993).
---------------------------------------------------------------------------

D. Core Principal Three: Financial Requirements

1. Trading by Non-Institutional Customers on DTFs
    Under the New Regulatory Framework, trading on DTFs would be 
limited to futures and options on specified commodities or those 
commodities deemed eligible under a case-by-case Commission 
determination.\39\ In addition, DTFs could permit trading in any 
commodities if trading is limited to qualifying commercial 
participants.\40\ The Commission proposed, however, that under certain 
conditions a DTF might permit non-institutional customers to enter into 
transactions thereon.\41\ To address the higher degree of risk 
associated with the lower regulatory protections offered to DTF 
participants, such non-institutional customer business could be 
transacted only 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.\42\ Such an FCM 
is considered to be more capable of properly handling these 
transactions and the associated risk. The Commission further noted 
that, in order to provide guidance to such customers and their FCMs, 
NFA would issue a Statement of Acceptable Practices regarding 
additional disclosures to be made to non-institutional customers 
trading on DTFs and related issues involving price dissemination.\43\
---------------------------------------------------------------------------

    \39\ 65 FR at 38990.
    \40\ Id.
    \41\ 65 FR at 39013.
    \42\ Id.
    \43\ Id.
---------------------------------------------------------------------------

    Several commenters objected to the $20 million adjusted net capital 
requirement for FCMs set forth in Rule 1.17(a)(1)(ii) as proposed, 
stating that the amount was arbitrary, and urging that it be eliminated 
or reduced. (CL 22-35 at 8; CL 22-46 at 3-4; CL 22-48 at 3) The CBT 
observed that the $20 million minimum adjusted net capital requirement 
would prevent more than half of all registered FCMs from intermediating 
on DTFs for retail customers. (CL 22-25 at 5) Instead, the CBT 
suggested that the Commission focus on the FCM's record of customer 
protection, and permit any registered FCM to transact retail customer 
business on a DTF if the firm: (1) Has been registered as an FCM for at 
least three years; and (2) has not been found by a governmental or SRO 
authority to have committed any sales practice violations against 
retail customers during the past three years. (CL 22-25 at 5) 
Goldenberg, Hehmeyer & Co. (GHC) recommended that the Commission apply 
risk-based capital requirements in lieu of the $20 million minimum net 
capital requirement to assess the FCM's financial soundness. (CL 22-19 
at 1-2) In a somewhat related vein, Treasury commented that a more 
appropriate measure of an intermediary's soundness is the amount of 
adjusted net capital in excess of the minimum required by regulation. 
(CL 22-34 at 3-4) Treasury further observed, however, that because the 
Commission's adjusted net capital requirements are based on the amount 
of segregated funds, whether excess adjusted net capital is an 
appropriate measure of an FCM's soundness in addition to total adjusted 
net capital depended on what the Commission ultimately decided on the 
segregation of funds issue. Accordingly, Treasury recommended that the 
Commission consider the segregation of funds issue in conjunction with 
its review of net capital rules. (CL 22-34 at 3-4)
    Although MFA supported the Commission's proposal to allow non-
institutional customers access to DTFs through qualifying FCMs (i.e., 
those that are clearing members of at least one designated contract 
market or RFE and that have at least $20 million in adjusted net 
capital), it urged that customers who opted to trade through certain 
registered CTAs should also have such access. (CL 22-22 at 5) 
Specifically, MFA recommended that CTAs with at least $25 million in 
assets under management be permitted to access both exempt MTEFs and 
DTFs and engage in transactions on behalf of their customers in those 
markets. In support, MFA pointed out that in adopting Rule 30.12, which 
included in the definition of ``authorized customer'' any person whose 
investment decisions with respect to foreign futures and foreign option 
transactions are made by a CTA with total assets under management 
exceeding $50 million,\44\ the Commission recognized that where a 
professional asset manager such as a CTA acts for a customer, it is 
appropriate to rely on the financial sophistication of the person 
managing the assets rather than on the sophistication of the individual 
CTA client. (CL 22-22 at 5) MFA further stated that because customers 
select their CTAs precisely on the basis of their determination that 
those CTAs are best qualified to make trading decisions on their 
behalf, precluding a CTA from being able to access DTF markets ``would 
* * * deprive customers of their ability to elect and receive the full 
benefits of the professional management for which the customer has 
retained the CTA.'' (CL 22-22 at 6) MFA estimated that less than 10 
percent of all registered CTAs would qualify under a $25 million assets 
under management threshold, and expressed the view that this ``small 
but sophisticated'' class of CTAs would be an appropriate group for the 
Commission to permit access to all types of futures markets. (CL 22-22 
at 8)
---------------------------------------------------------------------------

    \44\ 65 FR at 47277.
---------------------------------------------------------------------------

    The Commission has reviewed these comments carefully. The 
Commission has determined to adopt, as proposed, the $20 million 
minimum adjusted net capital requirement for FCMs wishing to transact 
business on behalf of non-institutional customers on a DTF. The Core 
Principle addressing financial standards encourages intermediaries to 
maintain adequate capital to ensure they are able to meet their 
obligations to customers, and the Commission believes that the $20 
million adjusted net capital requirement is a sufficient proxy for 
ensuring that FCMs will be financially capable of properly maintaining 
and servicing customer accounts. The Commission will monitor the 
effects of this requirement and make adjustments if appropriate.
    The Commission has determined to add a new Rule 4.32 to permit 
registered CTAs to enter trades on or subject to the rules of a DTF on 
behalf of a non-institutional client, provided that the CTA: (1) 
Directs the client's commodity interest account; \45\ (2) directs 
accounts containing total assets of not less than $25 million at the 
time the trade is entered; and (3) discloses to the client that it may 
enter trades on a DTF on the client's behalf. Paragraph (b) of Rule 
4.32 further requires that the client's commodity interest account be 
carried by a registered FCM. An FCM who receives orders on behalf of a 
non-institutional customer from a CTA acting in accordance with Rule 
4.32 need not maintain $20 million in minimum adjusted net capital, 
however. See Rule 1.17(a)(1)(ii)(B). In addition, a CTA placing trades 
on a DTF on behalf of a non-institutional client will be required to 
make any necessary

[[Page 78001]]

disclosures pursuant to Rule 4.34(h), which requires a CTA to disclose 
to the client if, pursuant to Rule 1.46, the CTA has instructed the FCM 
carrying the client account either not to close out all offsetting 
positions or to close out offsetting positions on other than a first-
in, first-out basis. This issue is discussed in greater detail below.
---------------------------------------------------------------------------

    \45\ The term ``direct,'' as defined in Rule 4.10(f), refers to, 
in the context of trading commodity interest accounts, ``agreements 
whereby a person is authorized to cause transactions to be effected 
for a client's commodity interest account without the client's 
specific authorization.''
---------------------------------------------------------------------------

2. Segregation of Funds
    The Proposing Release raised two sets of questions seeking comments 
about whether, and under what circumstances, the Commission should 
permit (1) customers to opt out of segregation and (2) 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.\46\ Differing 
views were presented on both issues, and the Commission has determined 
to defer action in these areas. With respect to customer opt-out of 
segregation, most parties commenting on the issue urged the Commission 
to consider thoroughly the potential implications with respect to the 
bankruptcy rules, e.g., priority of distribution, before proceeding on 
the issue. (CL 22-18 at 1; CL 22-22 at 6; CL 22-25 at 7; CL 22-31 at 7-
8; CL 22-32 at 14-15; CL 22-34 at 3) NFA further expressed the view 
that there was no current need for, or interest in, allowing 
institutional customers to opt out of segregation, as the FCM community 
is more interested in being able to provide customers with a unified 
account statement reflecting their holdings across all products, not 
just futures contracts. (CL 22-24 at 5)
---------------------------------------------------------------------------

    \46\ 65 FR at 39014.
---------------------------------------------------------------------------

    In response to the Commission's query on whether the types of 
permissible instruments held in the same customer account should be 
expanded, FIA expressed the view that Section 4d(2) of the Act permits 
the Commission to authorize any FCM that wishes to carry a customer's 
cash, OTC derivatives, securities and futures positions in a single 
account to maintain that account as a customer segregated account. The 
CBT cautioned the Commission to give further consideration to 
bankruptcy implications before proceeding in this area. The Commission 
agrees that action on this issue should be deferred to allow for 
additional study and consultation with other regulators, including 
members of the President's Working Group (PWG), and in addition, that 
any ultimate determination must be made in conjunction with deciding 
the customer opt-out of segregation issue.\47\
---------------------------------------------------------------------------

    \47\ The Commission notes, however, that cross-margining 
arrangements are already in place with respect to trading of stock 
index options and stock index futures.
---------------------------------------------------------------------------

3. Investment of Customer Funds
    The Commission proposed to amend Rule 1.25, which sets forth the 
types of instruments in which FCMs and clearing organizations are 
permitted to invest customer funds pursuant to Section 4d(2) of the Act 
(permitted investments), by expanding the list of permitted 
investments.\48\ Previously, an FCM or clearing organization was 
permitted to invest segregated funds only in obligations of the U.S., 
in general obligations of any State or of any political subdivision 
thereof, or in obligations fully guaranteed as to principal and 
interest by the U.S.
---------------------------------------------------------------------------

    \48\ 65 FR at 39014.
---------------------------------------------------------------------------

    The Commission proposed, subject to specific risk-limiting 
features, to permit FCMs to invest customer segregated funds in the 
following additional instruments: (1) Obligations issued by any agency 
sponsored by the U.S.; (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 (MMMFs). In addition, an FCM 
or a clearing organization would also be permitted to both buy and sell 
the permitted investments pursuant to agreements for resale or 
repurchase of the instruments (repurchase transactions).\49\
---------------------------------------------------------------------------

    \49\ Id.
---------------------------------------------------------------------------

    The Proposing Release contained several provisions intended to 
minimize credit risk, market risk, and liquidity risk, including: (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 MMMFs that are not required to be 
rated; (ii) a requirement that the dollar-weighted average of the time 
remaining to maturity of the debt securities held in the segregated 
portfolio not exceed 24 months, excluding investment in MMMFs because 
MMMFs have no maturity date; (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 included in the 
records of the FCM or clearing organization.\50\
---------------------------------------------------------------------------

    \50\ Id. at 39014-15.
---------------------------------------------------------------------------

    In connection with the proposed revisions to Rule 1.25, the 
Commission also proposed 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 the 
rules and orders promulgated thereunder.\51\ The elimination of the 
written acknowledgment requirement would be 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 the Act and the Commission's rules and orders, of all funds held 
on behalf of customers and all instruments purchased with customer 
funds.\52\
---------------------------------------------------------------------------

    \51\ Id. at 39015.
    \52\ Id. This codifies a staff no-action letter issued three 
years ago. See CFTC Staff Letter No. 97-45, [1996-1998 Transfer 
Binder] Comm. Fut. L. Rep. (CCH) para.27,085 (May 5, 1997).
---------------------------------------------------------------------------

    In general, commenters responded favorably to the Commission's 
proposals to expand the permissible investments, and the Commission has 
determined to adopt the amendments generally as proposed.\53\ 
Notwithstanding their overall support, however, commenters addressed 
several areas in which they sought additional adjustments or 
clarifications concerning the rule amendments. Commenters also 
responded to specific questions raised by the Commission in the 
Proposing Release.
---------------------------------------------------------------------------

    \53\ Because the Commission has determined to include MMMFs in 
the list of permissible investments for customer funds, subject to 
the limitations adopted in Rule 1.25, it is hereby rescinding 
Division of Trading and Markets Financial and Segregation 
Interpretation No. 9, which previously prohibited such investment. 
See Financial and Segregation Interpretation No. 9, 1 Comm. Fut. L. 
Rep. (CCH) para.7,119 (Nov. 23, 1983).
---------------------------------------------------------------------------

    The CBT suggested that the Commission set guidelines with regard to 
the marketability of the permitted investments. The CBT recommended 
that the guidelines limit permitted investments to those instruments 
for which there are available quotes or valuations and, further, that 
the guidelines provide that there be a likelihood that any permitted 
investments can be liquidated within a

[[Page 78002]]

reasonable time period. (CL 22-25 at 7) The final rule has been 
modified so that paragraph (b)(1) of Rule 1.25 requires that the 
permitted securities held in segregation be ``readily marketable'' 
consistent with SEC Rule 15c3-1 under the Securities Exchange Act of 
1934.\54\
---------------------------------------------------------------------------

    \54\ 17 CFR 240.15c3-1. As a result of the addition of new Rule 
1.25(b)(1), proposed paragraph (b)(6) of Rule 1.25 concerning 
recordkeeping is being adopted unchanged as paragraph (b)(7).
---------------------------------------------------------------------------

    The CBT also recommended that the Commission use a simpler approach 
for the valuation of downgraded investments than the proposed 20 
percent per day reduction. The CBT suggested instead that a set number 
of days be permitted for disposal of the investment and that, during 
that permitted time period, the firm be allowed to use the full market 
value of the instrument towards meeting its segregated liability. The 
CBT also indicated that it thought the 20 percent per day reduction in 
value for a downgraded instrument could lead to errors in calculation. 
(CL 22-25 at 7-8) The Commission has determined not to change this 
provision because it believes that the 20 percent per day write-down 
will provide an appropriate valuation under the circumstances and that 
it will serve as an incentive for the firm to take action to dispose of 
a downgraded investment sooner. See Rule 1.25(b)(2)(ii).
    Rosenthal Collins Group, LLC (RCG) stated that the proposed credit 
rating requirements were too restrictive. (CL 22-18 at 2) The 
Commission notes that these requirements are intended to result in the 
holding of ``investment grade'' securities only. After the new rule 
takes effect, the Commission plans to monitor the effectiveness of the 
rule on an ongoing basis. If experience shows that the required ratings 
are too stringent, adjustments to the rule will be considered.
    RCG also stated that the Commission should not impose rating 
requirements on investments in municipal securities because some of 
these securities are not rated due to the costs associated with 
obtaining a rating. RCG stated further that if the rule were adopted as 
proposed, investments that comply with the present rules but that do 
not comply with the new requirements should be ``grandfathered'' as 
part of an existing portfolio. (CL 22-18 at 2) In response to this 
comment, the Commission will not require the disposal of investments 
held as of December 13, 2000, i.e., such investments may be held until 
they mature or are liquidated in the ordinary course of business, 
although no new acquisitions of non-compliant investments will be 
permitted.
    Brown Brothers Harriman (BBH) stated that the prohibition against 
an FCM investing in an MMMF that has investments in securities issued 
by a parent or affiliate of the FCM should be dropped. (CL 22-20 at 5) 
This recommendation was made because MMMFs are often operated 
independently of the sponsoring affiliated entity and, in any event, 
are subject to a five percent concentration limit in the securities of 
any single issuer. BBH also noted that many FCMs are affiliated with 
world-class financial enterprises and that a prohibition against MMMFs 
investing in securities of the FCMs' affiliates would eliminate a large 
and important group of instruments. The Commission finds merit in this 
suggestion and has modified Rule 1.25(b)(6)(ii) accordingly. The 
Commission also notes that Section 17 of the Investment Company Act 
\55\ restricts investments made by MMMFs in securities issued by any 
entity affiliated with the MMMF or its sponsors, and that the 
concentration limit set forth in SEC Rule 2a-7 under the Investment 
Company Act \56\ is similar to the concentration provision of CFTC Rule 
1.25.
---------------------------------------------------------------------------

    \55\ 15 U.S.C. 80a-17.
    \56\ 17 CFR 270.2a-7.
---------------------------------------------------------------------------

    BBH also requested that the requirement that a fund be ``SEC 
registered'' be defined to mean registration under the Investment 
Company Act only and not require registration under the Securities Act 
of 1933. (CL 22-20 at 6) This clarification has been made to paragraph 
(c)(1) of Rule 1.25.
    Sentinel Management Group, Inc. (Sentinel) requested clarification 
as to whether the concentration limits provided for in the proposed 
rule would apply to securities held in connection with repurchase 
agreements. (CL 22-41 at 1) Sentinel stated that the concentration 
limits should not apply because of: (1) The burden that would be 
imposed upon the FCMs; (2) the fact that complete information on such 
securities is sometimes not known until the day following entry into 
the repurchase transaction; (3) the fact that the duration of 
repurchase transactions is only one day; and (4) the fact that the 
obligation created pursuant to a repurchase transaction is that of the 
counterparty and not the issuer of the securities. Therefore, it 
argued, the creditworthiness of the counterparty augments the value of 
the securities held pursuant to the repurchase agreement. (CL 22-41 at 
1-2) This same point was raised by BBH in follow-up conversations.
    Taking into consideration these comments, as well as the 
requirement contained in the Proposing Release that counterparties for 
repurchase transactions must be regulated financial institutions 
(generally large banks or brokerage firms), the Commission has 
concluded that the focus of concentration should be primarily upon the 
counterparties and secondarily upon the securities held in connection 
with the repurchase agreement. Therefore, the final rule contains 
several clarifying or enhancing changes.
    First, paragraph (b)(4)(ii) provides that securities that are held 
by a counterparty, i.e., securities that have been ``repoed out,'' are 
subject to the concentration limitations along with currently-owned 
direct investment securities. This clarification was made because a 
security that has been sold subject to repurchase at a later date 
presents the FCM or clearing organization with the same price risk as a 
security that is currently held in the portfolio. Second, paragraph 
(b)(4)(iii) provides concentration limit percentages for securities 
that are held by the FCM or clearing organization pursuant to a reverse 
repurchase agreement that are double those required for direct 
investments, provided that the counterparty has a credit rating of 
single A or higher from two or more NRSROs. In addition, the rule was 
changed to provide that the concentration percentages for such 
securities shall be computed using only the securities contained in the 
portfolio of securities supplied by each counterparty of the FCM or 
clearing organization. This change was made because the counterparty 
has the direct control over what specific securities will be supplied 
in a repurchase transaction. Thus, the Commission expects that an FCM 
or clearing organization will inform its counterparties as to the per-
issuer concentration limits that must be observed, as set forth in the 
rule. Finally, paragraph (b)(4)(v) makes explicit that the 
concentration limits do not apply to securities owned by customers that 
have been posted by customers as collateral with the FCM. This 
clarification was made primarily because changes in the value of 
customer-owned securities accrue to the customers who posted the 
securities and, therefore, in a properly margined account such 
securities pose no direct price risk to the FCM. The Commission 
believes that these changes and clarifications will provide additional 
flexibility to FCMs and clearing

[[Page 78003]]

organizations without unduly increasing associated risk.
    The Investment Company Institute (ICI) suggested that MMMFs 
sponsored by investment advisers registered under the Investment 
Advisers Act of 1940 be included in the list of permitted investments. 
(CL 22-27 at 6) The Commission has made this suggested change. See Rule 
1.25(c)(2).
    ICI noted that the proposed rule appeared to require valuation of 
the investment portfolio by 9 a.m. each day and suggested, instead, 
that valuation not be required until after the close of the markets 
each day, i.e., not until after 4 p.m. (CL 22-27 at 7) The Commission's 
intention was to require valuation by 9 a.m. the business day following 
the investment, so that the valuation would be available in time for 
the segregation calculation, which is required to be completed on a 
daily basis by noon the following business day. The final rule 
(paragraph (c)(4) of Rule 1.25) has been changed to correctly state the 
Commission's intention more precisely.
    ICI also suggested that the proposed rule should be changed to 
permit MMMFs that are not rated by an NRSRO to invest in unrated 
securities. The proposed rule provided that only MMMFs that are rated 
may invest in unrated securities. ICI cited the comprehensive approach 
to risk control and preservation of capital contained in SEC Rule 2a-7 
and noted that that rule permits an MMMF to invest in unrated 
securities if the MMMF determines that the securities are of comparable 
quality to otherwise eligible securities. (CL 22-27 at 4) The 
Commission has changed the final rule (Rule 1.25(b)(2)(i)(D)) to permit 
unrated MMMFs to invest in unrated securities because of the risk-
limiting features of SEC Rule 2a-7.
    ICI also recommended two revisions to paragraph (c)(3) of Rule 1.25 
concerning MMMFs. First, because fund shares are usually 
uncertificated, ICI recommended that the first sentence be revised to 
provide that the ownership of fund shares must be noted (by book-entry 
or otherwise) in a custody account of the FCM or clearing organization. 
Second, to ensure that confirmations for transactions in fund shares 
are retained, ICI recommended that the confirmation relating to the 
purchase be retained in the FCM's or clearing organization's records. 
(CL 22-27 at 6) The Commission has made these suggested changes.
    ICI further recommended that the one-day liquidity requirement 
applicable to MMMFs be extended to seven days, to be consistent with 
SEC requirements and the longer settlement time-frames associated with 
direct investments. (CL 22-27 at 7)
    The Commission believes the one-day liquidity requirement for 
investments in MMMFs is necessary to ensure that the funding 
requirements of FCMs will not be impeded by a long liquidity time 
frame. Since a material portion of an FCM's customer funds could well 
be invested in a single MMMF, this is an important provision of the 
rule. The Commission notes that, although sales of directly-owned 
securities settle in longer than one-day time-frames, an FCM or 
clearing organization could obtain liquidity by entering into a 
repurchase transaction. Therefore, the Commission has retained the one-
day liquidity requirement imposed on investments in MMMFs and, in view 
of the importance of this provision, has clarified that demonstration 
that this requirement has been met may include either an appropriate 
provision in the offering memorandum of the fund or a separate side 
agreement between the fund and an FCM or clearing organization. See 
Rule 1.25(c)(5).
    The FRBC commented that permitted investments should have either a 
CUSIP or ISIN number, and that permitted investments should be required 
to have a reasonably transparent secondary market enabling accurate and 
efficient valuation of the investments. (CL 22-30 at 6) The Commission 
has changed the final rule to include securities with ISIN numbers as 
permitted investments.
    The FRBC also recommended that permitted investments have a 
reasonably transparent secondary market. As noted above, the Commission 
strengthened the rule in this respect by adding a requirement that all 
permitted securities, except for MMMFs, meet the SEC's ``readily 
marketable'' standard. The Commission intends to monitor closely for 
any problems concerning valuation of permitted investments, and will 
consider proposing further rule amendments if appropriate.
    The FRBC also recommended that permitted investments should settle 
on a same-day or next-day basis, to ensure adequate liquidity. It 
pointed out that, currently in the U.S., virtually all corporate and 
municipal debt securities settle on a T+3 basis, which is not 
sufficient for futures clearing organization demands, and that this 
delay could deprive the FCM or clearing organization of the liquidity 
that is so important in times of market stress or emergency. (CL 22-30 
at 5) The Commission has elected to permit investment of customer funds 
in investment grade corporate notes and municipal securities because 
FCMs have methods of obtaining liquidity other than by selling the 
securities, such as by entering into repurchase transactions and by 
establishing backup bank lines of credit using the securities as 
collateral.
    The FRBC further recommended that CFTC rules should permit the 
investment of customer funds held in a foreign currency in identically-
denominated sovereign debt securities. (CL 22-30 at 4-5; see also CL 
22-31 at 9; CL 22-42 at 2) The Commission notes that, under the rule as 
proposed, an FCM that decided to invest deposits of foreign currencies 
was required to convert the foreign currencies received to a U.S. 
dollar-denominated asset. This would increase its exposure to foreign 
currency fluctuation risk, unless it incurred the additional expense of 
hedging. Therefore, the Commission has determined that the FRBC's 
suggestion should be adopted. The Commission has changed the proposed 
rule to permit investment in the general obligations of any country 
whose sovereign debt is rated in the highest category by at least one 
NRSRO, but limited as follows: an FCM may invest in the sovereign debt 
of a country to the extent it has balances owed to its customers 
denominated in that currency; a clearing organization may invest in the 
sovereign debt of a country to the extent it has balances owed to its 
clearing member FCMs denominated in that currency.\57\ The Commission 
notes that foreign sovereign debt that is denominated in the Euro will 
qualify as a permitted investment under this rule, provided the country 
that issued the debt qualifies as a permitted country under the rule, 
the obligation is a general obligation of the country, and the balances 
owed to the customers or the FCMs are Euro-denominated. As with other 
aspects of Rule 1.25, the Commission will monitor the effect of this 
provision and stands ready to make additional adjustments as experience 
dictates.
---------------------------------------------------------------------------

    \57\ As is the case for U.S. government securities and those 
MMMFs that are not required to be rated, permitted foreign sovereign 
debt will not be subject to a credit rating requirement. See 
Sec. 1.25(b)(2)(i)(A).
---------------------------------------------------------------------------

    In addition, the FRBC suggested that the CFTC expressly approve the 
use of certain ``sweep'' accounts in connection with the investment of 
customer funds in MMMFs or other permissible forms of investment. (CL 
22-30 at 6) The Commission notes that Rule 1.25 will not preclude the 
use of sweep accounts and encourages this practice to enhance the 
efficiency of liquidity management.
    The FRBC also suggested that, with respect to the concentration 
provision, the rule should be clarified that it applies only to the 
portfolio of securities

[[Page 78004]]

purchased with customer funds, i.e., the provision does not apply to 
customer-owned securities posted as margin. (CL 22-30 at 6) As noted 
previously, the Commission has made this clarification in paragraph 
(b)(4)(v) of Rule 1.25.
    FIA suggested that the Commission clarify what is meant by the 
required ratings in the rule, where the ``two highest ratings of an 
NRSRO'' are specified, i.e., AAA and AA. In particular, it recommended 
that the Commission clarify whether ``AA'' includes all variations 
included within the AA rating. (CL 22-31 at 8) The Commission confirms 
that this interpretation is correct.
    FIA also suggested that the Commission clarify whether a security 
would be a permitted investment if one NRSRO gave it an acceptable 
rating, even though another NRSRO gave it an unacceptable rating. (CL 
22-31 at 9) The Commission hereby confirms that if one NRSRO gave an 
acceptable rating and another did not, investment in the security would 
be permitted. The Commission believes that it would be rare for such 
differences to occur at the investment grade ratings level and, 
further, that any differences would probably be temporary.
    FIA also suggested providing a grace period for FCMs or clearing 
organizations that find themselves in violation of the concentration 
limits. (CL 22-31 at 9) The Commission has decided against adopting 
this suggestion because the Commission would not expect FCMs to violate 
the concentration limits, except perhaps under unusual circumstances. 
Further, the Commission is concerned that were a formal grace period 
provided in the rule, it might be subject to abuse.
    In addition, FIA suggested that the Commission plan to review the 
list of permitted investments every six months to determine whether 
revisions should be made. (CL 22-31 at 9) The Commission plans to 
review all aspects of the new rule on an ongoing basis and further 
changes will be proposed, if appropriate.
    Two exchanges, the NYMEX and the CME, pointed out that each 
clearing organization would need to make its own determination as to 
the types of assets that would be accepted by that clearing 
organization. (CL 22-32 at 16; CL 22-35 at 13) The Commission 
recognizes that an SRO may adopt more restrictive requirements than 
those set forth in Rule 1.25 for its member FCMs.

E. Core Principle Four: Risk Disclosure and Account Statements

    Although the Commission stated in the Proposing Release that non-
institutional customers should continue to receive the risk disclosures 
regarding futures and options trading that are currently required,\58\ 
it proposed to streamline the account opening process by amending Rules 
1.55(d)(1) and (2) to expand the list of disclosures and consents that 
could be provided in a single document and acknowledged with a single 
signature.\59\ This list includes: (1) The disclosures required by new 
Rule 1.33(g) (relating to electronic transmission of statements); \60\ 
(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. The single 
signature could be made electronically as provided for in recently-
adopted Commission Rules 1.3(tt) and 1.4. \61\ Disclosure concerning 
arbitration of disputes, however, would continue to require a separate 
signed acknowledgement by non-institutional customers, pursuant to 
proposed Rule 166.5 (which was modeled on, and would replace, prior 
Rule 180.3).\62\
---------------------------------------------------------------------------

    \58\ 65 FR at 39015. There would continue to be no specific 
disclosure requirements for institutional customers. Id. at 39016.
    \59\ Id. at 39015-16.
    \60\ See infra.
    \61\ 65 FR 12466 (Mar. 9, 2000).
    \62\ 65 FR at 39016. This is discussed further below.
---------------------------------------------------------------------------

    All of the commenters who addressed the proposed amendments to Rule 
1.55(d) responded favorably to the expansion of disclosures and 
consents that could be acknowledged and made by a single signature, and 
the Commission is adopting the amendments as proposed. (CL 22-17 at 3; 
CL 22-24 at 6; CL 22-25 at 8; CL 22-31 at 14; CL 22-32 at 16; CL 22-35 
at 11; CL 22-44 at 2) FIA requested that the Commission confirm that an 
FCM may obtain an acknowledgement of receipt and understanding of the 
risk disclosure statement contemporaneously with opening an account. 
The Commission agrees that the FCM may open the customer account 
simultaneously with receiving the acknowledgment of receipt and 
understanding of the risk disclosure statement, along with margin funds 
and any other required account opening documents, from the customer. 
The FCM will remain responsible for ensuring that the risk disclosure 
document is furnished to the customer in such a way that the customer 
can review and understand the document before committing funds to the 
FCM.
    NFA commented generally that the Commission should not dictate the 
specifics of how disclosures and consents are delivered and 
acknowledged, and that it would be willing to develop best practice 
guidance in this area. (CL 22-24 at 6) The Commission believes that its 
rules requiring risk disclosure and customer acknowledgments do not 
impose a significant burden in light of their important customer 
protections. The Commission is providing additional flexibility to the 
industry in this area. As the Commission noted in the Proposing 
Release, there would continue to be no specific disclosure requirements 
for institutional customers and, in addition, as provided in Rule 
35.1(b), governmental entities would be included in the definition of 
``institutional customer,'' and consequently would not be required to 
receive and to acknowledge a disclosure statement.\63\ Further, the 
single signature acknowledgment could be made electronically as 
provided for in Rules 1.3(tt) and 1.4. The Commission looks forward to 
working with NFA and the industry both in developing a Statement of 
Acceptable Practices for disclosure to non-institutional customers 
trading on DTFs, and in developing more streamlined disclosure 
requirements for domestic exchange-traded options under Rule 33.7.
---------------------------------------------------------------------------

    \63\ Id.
---------------------------------------------------------------------------

    As noted above, the Commission proposed to continue to require a 
separate signed acknowledgement by non-institutional customers with 
respect to disclosure concerning arbitration of disputes. Nevertheless, 
the Commission also solicited comment on whether to maintain this 
requirement.\64\ FIA opposed continuing to require a separate signature 
from non-institutional customers if their account agreement contains a 
pre-dispute arbitration provision. (CL 22-31 at 14) In general, FIA 
expressed the opinion that the Commission should eliminate all of its 
rules pertaining to the use of pre-dispute arbitration agreements, as 
well as the Commission's reparations program. For example, FIA 
commented that the Commission's rule that an FCM may not require a 
customer to sign a pre-dispute arbitration agreement as a condition to 
opening an account with the FCM inhibits the ability of FCMs that are 
also securities broker-dealers to enter into a single agreement with 
their customers, because the SEC does not prohibit the use of such 
mandatory agreements. (CL 22-31 at 10) At the very least, FIA stated 
that the Commission

[[Page 78005]]

should permit institutional customers contractually to waive their 
right to file a complaint under the Commission's reparations program. 
(CL 22-31 at 10) In this regard, NFA maintained that intermediaries and 
institutional customers should be allowed to negotiate all terms in 
pre-dispute arbitration agreements. (CL 22-24 at 8).
---------------------------------------------------------------------------

    \64\ Id.
---------------------------------------------------------------------------

    The Commission is adopting Rule 166.5 as it pertains to non-
institutional customers as proposed. Further, the Commission believes 
that no customer, regardless of their level of sophistication, should 
be required to sign a pre-dispute arbitration agreement as a condition 
for doing business in the futures industry. The Commission has 
determined, however, to allow institutional customers and 
intermediaries to negotiate any terms of a pre-dispute arbitration 
agreement as they deem appropriate, including a waiver of the 
customer's right to file a complaint under the Commission's reparations 
program. Accordingly, the definition of the term ``customer'' in Rule 
166.5(a)(2) has been changed to exclude institutional customers from 
general application of the rule. In addition, new paragraph (g) has 
been added to make clear that an institutional customer and a 
registrant may negotiate any terms of a pre-dispute arbitration 
agreement, except that the institutional customer may not be required 
to sign a pre-dispute arbitration agreement as a condition of opening 
an account with the registrant.\65\
---------------------------------------------------------------------------

    \65\ As a result of these changes, proposed paragraphs (c)(2) 
(ii) and (iii) of Rule 166.5 are adopted as paragraphs (c)(2) (i) 
and (ii), respectively. In addition, to reflect the recent 
amendments to Rule 4.7, paragraph (c)(2)(ii) of Rule 166.5 (formerly 
paragraph (c)(2)(iii)) has been modified to apply to a person who is 
a ``qualified eligible person'' as defined by Rule 4.7. See 65 FR 
47848 (Aug. 4, 2000).
---------------------------------------------------------------------------

    NFA specifically requested that the Commission clarify the reach of 
pre-dispute arbitration agreements and confirm that such agreements are 
binding on both the intermediary as well as the customer, unless the 
agreement states specifically that the registrant is not required to 
arbitrate its claims.\66\ (CL 22-24 at 9) Former Part 180, which is to 
be replaced by Rule 166.5, was mainly intended to provide for fair and 
equitable SRO arbitration forums and to prevent firms from requiring 
customers to agree to arbitration in order to do business. Part 180 did 
not require registrants to submit their claims against customers to 
arbitration, and the Commission did not propose to require that 
registrants do so in the Proposing Release. Thus, provided that a 
registrant pursues a dispute in accordance with the terms of the 
customer agreement, and the procedures followed do not violate Rule 
166.5, Commission rules would not prohibit the registrant's actions.
---------------------------------------------------------------------------

    \66\ NFA referred to several recent lower court cases where 
registrants who brought debit balance claims against their customers 
in state court successfully argued, in response to the customers' 
attempts to force the claims to arbitration, that a pre-dispute 
arbitration agreement did not apply to their claims against 
customers. NFA questioned the logic of these decisions, stating that 
there is no consideration for a customer to sign a pre-dispute 
arbitration agreement if it does not apply to the intermediary's 
claims as well. (CL 22-24 at 9)
---------------------------------------------------------------------------

    NFA also objected to proposed Rule 166.5(f), which would permit 
counterclaims that do not arise out of the same transaction or 
occurrence that is the subject of the original claim only if (1) The 
customer agreed to the counterclaim being heard after it has arisen, 
and (2) the aggregate monetary value of the counterclaim is capable of 
calculation. NFA believes that, for both retail and institutional 
customers, the parties should be allowed to agree in advance that any 
counterclaim would be required to be included in the arbitration 
proceeding. (CL 22-24 at 9) The Commission has determined to adopt 
NFA's suggestion, and has revised Rule 166.5(f) to permit any 
counterclaim arising out of a transaction subject to the Act and 
Commission regulations promulgated thereunder for which a non-
institutional customer has utilized the services of a registrant, to be 
made part of an arbitration proceeding between the non-institutional 
customer and the registrant where the parties have agreed in advance to 
require that any such claim be included in the arbitration proceeding, 
provided that the aggregate monetary value of the counterclaim is 
capable of calculation. As noted above, under Rule 166.5(g), 
institutional customers remain free to negotiate any terms of their 
pre-dispute arbitration agreement, including the type of counterclaims 
that may be included in an arbitration proceeding.

F. Core Principle Five: Trading Standards

    The Commission proposed that Rules 155.1, 155.3 and 155.4, which 
collectively require FCMs and IBs to establish and to maintain 
supervisory procedures to assure that neither they nor any affiliated 
persons use their knowledge of customer orders to the customer's 
disadvantage, would continue to apply to intermediation of trades on 
contract markets. These requirements would be extended to trading on 
RFEs, and to trading by non-institutional customers on DTFs under new 
Rule 155.6(a).\67\ These rules over the years have helped the 
Commission deter such practices as ``front-running,'' ``trading 
ahead,'' ``bucketing,'' taking the opposite side of customer orders, 
and improper disclosure of customer orders. However, for intermediation 
of trades by institutional customers at DTFs, the Commission proposed a 
new Rule 155.6(b), which set forth a general standard of practice in 
this area that parallels the language of the core principle concerning 
trading standards. The Commission stated that ``it is nevertheless 
intended to proscribe the same trade practice abuses as Rules 155.1-
155.5.'' \68\
---------------------------------------------------------------------------

    \67\ 65 FR at 39016.
    \68\ Id.
---------------------------------------------------------------------------

    The commenters who addressed this section were critical of the 
Commission's approach. The CBT expressed its belief that all 
prescriptive rules regarding trading practices should be replaced with 
core principles, not just the rules governing trades for institutional 
customers on DTFs. (CL 22-25 at 8) MFA stated that it was inconsistent 
to add a general prohibition against ``misuse'' of knowledge as 
contained in Proposed Rule 155.6(b) if the rule was intended to 
proscribe the same trade practice abuses referred to in Rules 155.1-
155.5. (CL 22-22 at 13-14) NFA commented that RFEs and DTFs should not 
be treated differently with respect to trading standards rules, because 
otherwise operators of DTFs would have a competitive advantage over 
operators of RFEs. (CL 22-24 at 6)
    The Commission has determined to leave unchanged Rules 155.1-155.5 
at this time, and to adopt Rule 155.6 as proposed. The Commission 
believes that the existing rules should continue to apply in connection 
with non-institutional customer trades no matter where they occur 
because of such customers' greater susceptibility to trading abuses by 
intermediaries, as compared to institutional customers. The Commission 
recognizes that, with respect to institutional customers trading on a 
DTF, a general standard of practice is more appropriate. However, the 
Commission remains open to specific suggestions regarding how 
individual provisions in Rules 155.3 and 155.4 might be streamlined.
    The Commission notes that because the core principle concerning 
trading standards states that intermediaries must not misuse their 
knowledge of their customers' orders without making any distinctions 
regarding the nature of the customer, the same trade practice abuses 
that are proscribed by Rules 155.1-155.5 should also be considered

[[Page 78006]]

as being in violation of Rule 155.6(b). The Commission believes that 
its overall approach with respect to trading standards strikes a 
reasonable balance in preserving rules that have worked successfully 
over the years in curbing abusive trading practices, while relaxing 
certain of the specific provisions of the existing rules in connection 
with the trading on DTFs by more sophisticated customers.

G. Core Principle Seven: Reporting Requirements

    The Commission proposed to apply its existing large trader 
reporting requirements to intermediaries on RFEs, but would reduce 
reporting requirements with respect to intermediaries transacting 
business on DTFs, because of the nature of the instruments traded or 
the limited access granted to non-institutional traders. Intermediaries 
trading on DTFs would be subject to large trader reporting requirements 
only by special call.
    The Commission received varying comments in response to its large 
trader reporting proposal. NFA agreed with both aspects of the 
Commission's proposal, asserting that large trader reporting 
requirements should remain in place for intermediaries on RFEs, while a 
more flexible approach would be appropriate for gathering information 
from intermediaries trading on DTFs. (CL 22-24 at 7) FC Stone suggested 
that reduced large trader reporting should be available to all FCMs 
with institutional customers only, not just to those trading on DTFs. 
(CL 22-44 at 4) The CBT stated that the Commission should permit 
individual markets to require large trader reporting, as they deem 
necessary, and that any large trader reporting to the Commission should 
be done pursuant to special call, without drawing a distinction between 
DTFs and RFEs. (CL 22-25 at 8-9) NIBA also commented that the 
Commission should not make a distinction between DTFs and RFEs; NIBA 
stated, however, that regular large trader reports should be required 
on both types of exchanges, and that otherwise customers who trade on 
RFEs would lose the benefit of price transparency. (CL 22-17 at 4) 
Treasury expressed concern about the mechanics of large trader 
reporting on a DTF, stating that because eligible participants would 
not be required to use FCMs to execute trades on a DTF, it was unclear 
how large trader positions could be reported. In addition, Treasury 
noted that large trader reporting requirements have worked well in the 
market for Treasury bond futures, both for the information they reveal 
to regulators and their deterrent effect, and consequently, urged the 
Commission to establish a mechanism for large trader reporting for 
government securities futures trading on DTFs. (CL 22-34 at 4) The 
Economic Strategy Institute agreed with Treasury that the elimination 
of large trader reports would reduce the Commission's ability to 
effectively detect and deter manipulation. (CL 22-45 at 2) Finally, the 
American Farm Bureau Federation, the American Soybean Association, the 
National Association of Wheat Growers, the National Cattlemen's Beef 
Association, the National Corn Growers Association, the National 
Farmers Union, the National Grain Sorghum Producers and the National 
Pork Producers Council collectively commented that if the Commission 
determined to permit agricultural products to be traded on a DTF, large 
trader reports relating thereto should be filed with the Commission. 
(CL 22-51 at 1)
    The Commission has determined to adopt the large trader reporting 
requirements for RFEs and DTFs as proposed, except that large trader 
reports will not be required from participants trading on a commercial-
participant DTF. The reporting system is critical to the Commission's 
ability to oversee markets and provides a valuable bulwark against 
illegitimate trade practices. RFEs in particular permit unconditioned 
access to any type of trader, including both institutional and non-
institutional customers or participants, and may list contracts on any 
type of commodity, including those based on commodities that have 
finite deliverable supplies or cash markets with limited liquidity. 
Such markets potentially have a greater susceptibility to price 
manipulation and raise greater customer protection concerns than do 
DTFs. Consequently, regular large trader reports are necessary to 
enable the Commission to carry out its oversight responsibilities for 
RFE markets.
    With respect to intermediaries transacting business on DTFs, 
however, because of the nature of the instruments traded and the 
limited access granted to non-institutional traders, large trader 
reporting on a less routine basis, i.e., upon special call by the 
Commission, is more appropriate. Where trading access on a DTF is 
restricted to eligible commercial participants only, however, large 
trader reports generally will not be required from such 
participants.\69\ The Commission will rely instead on its investigative 
authority, which also applies to a person's cash market activities.\70\
---------------------------------------------------------------------------

    \69\ As explained in a companion release in today's edition of 
the Federal Register, large trader reports may be required upon 
special call depending upon the nature of the commodity interest 
traded on a commercial-participant DTF.
    \70\ Large trader reports may be required upon special call on 
the DTF itself, however. See Sec. 37.6(a).
---------------------------------------------------------------------------

H. Core Principle Eight: Recordkeeping

1. General
    The Core Principles state that all registrants must keep full books 
and records of their activities related to their business. Thus, the 
Commission did not propose to amend any of its recordkeeping 
requirements in the Proposing Release.\71\ NFA asked the Commission to 
consider replacing Rule 1.31 with a core principle and acceptable 
practice guidance that follows NFA's December 1997 proposal. NFA's 
proposal recommended that Rule 1.31 be rewritten to require only that 
registrant recordkeeping systems meet general reliability and 
accessibility standards. (CL 22-24 at 7) The Commission revised Rule 
1.31 in 1999 to provide additional flexibility to recordkeepers, 
allowing them to store most required records on either micrographic or 
electronic storage media for the full five-year required retention 
period.\72\ The Commission intends to revisit NFA's proposal in the 
future and, where appropriate, will undertake to work with the SEC to 
make additional changes in this area.
---------------------------------------------------------------------------

    \71\ 65 FR at 39017.
    \72\ 64 FR 28735.
---------------------------------------------------------------------------

2. Customer Account Statements; Close-Out of Offsetting Positions
    The Commission proposed to codify its June 1997 advisory relating 
to the electronic transmission of account statements in a new Rule 
1.33(g).\73\ 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. 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. Before transmitting any statement electronically to a 
customer, however, the FCM would be required to make certain 
disclosures regarding the practice, and in the case of non-
institutional customers, the FCM would be required to obtain the 
customer's signed consent acknowledging the disclosures. The 
acknowledgement could be made through a single signature in accordance 
with Rule 1.55 as discussed above. NIBA and FC Stone responded 
favorably to the

[[Page 78007]]

Commission's proposal (CL 22-17 at 3; CL 22-44 at 2), while NFA 
commented that the 1997 Advisory should be treated as acceptable 
practices guidance rather than codified in a new rule. (CL 22-24 at 7) 
The Commission has determined to adopt the rule as proposed, believing 
that, as noted previously, a certain level of uniformity and 
standardization is essential in an area such as reporting to customers 
to facilitate the processing of massive quantities of data, which is 
often accomplished by third-party, ``back office'' firms.
---------------------------------------------------------------------------

    \73\ 65 FR at 39017; see also 62 FR 31507 (June 10, 1997).
---------------------------------------------------------------------------

    The Commission also proposed to revise Rule 1.46 to allow customers 
or account controllers to instruct the FCM if they wished to deviate 
from the default rule that the FCM close out offsetting positions on a 
first-in, first-out basis, looking across all accounts it carries for 
the same customer.\74\ CPOs and CTAs would be required to disclose, 
under proposed amendments to Rules 4.24(h)(2) and 4.34(h), 
respectively, if they instruct an FCM to deviate from the default rule 
for closing out offsetting positions.\75\
---------------------------------------------------------------------------

    \74\ 65 FR at 39017.
    \75\ Id.
---------------------------------------------------------------------------

    After considering the comments received, the Commission is adopting 
the revisions as proposed. Nevertheless, the Commission agrees with NFA 
that FCMs should closely monitor the activity in those customer 
accounts that depart from the default close-out method set forth in 
Rule 1.46 to ensure that their customers are not offsetting their 
positions other than by a first-in, first-out method solely to avoid 
taxes, to launder money, or to improve their delivery position. (CL 22-
24 at 7)
    In addition, the Commission believes that customers may transmit 
their offset instructions to their FCMs orally, as requested by FIA. 
(CL 22-31 at 8) In the case of CPOs and CTAs, the Commission agrees 
with MFA that responsibility for transmitting instructions regarding 
offset should normally lie with the registrant directing trading. 
Generally, where a pool's trading is directed by a CTA, this should be 
the CTA, not the CPO. (CL 22-22 at 14) The Commission does not agree, 
however, that it is unnecessary to require CPOs and CTAs to disclose 
whether they instructed their FCM to offset positions in a manner other 
than by a first-in, first-out method. The Commission does not believe 
that this requirement would impose a significant burden on CPOs and 
CTAs, particularly in light of the fact that these entities would no 
longer be prevented from offsetting their positions in a manner other 
than on a first-in, first-out basis, as was previously the case. The 
Commission believes that it is appropriate in this area to provide 
greater choice balanced with disclosure as to the method of operation.

III. Section 4(c) Findings

    Certain of these final rules and rule amendments are being 
promulgated under Section 4(c) of the Act, which grants the Commission 
broad exemptive authority. Section 4(c) of the Act provides that, in 
order to promote responsible economic or financial innovation and fair 
competition, the Commission may, by rule, regulation or order, exempt 
any class of agreements, contracts or transactions, including any 
person or class of persons offering, entering into, rendering advice or 
rendering other services with respect to, the agreement, contract, or 
transaction, from the contract market designation requirement of 
Section 4(a) of the Act, or any other provision of the Act other than 
Section 2(a)(1)(B), if the Commission determines that the exemption 
would be consistent with the public interest. Furthermore, Section 
4(c)(2) of the Act provides that the Commission may not grant an 
exemption from the contract market designation requirement of Section 
4(a) of the Act unless the Commission also finds that: (i) The contract 
market designation requirement should not be applied to the agreement, 
contract, or transaction for which the exemption is requested and the 
exemption would be consistent with the public interest and the purposes 
of the Act; (ii) the exempted transaction will be entered into solely 
between ``appropriate persons''; and (iii) the agreement, contract or 
transaction in question will not have a material adverse effect on the 
ability of the Commission or any contract market to discharge its 
regulatory or self-regulatory duties under the Act. For the reasons 
stated below, the Commission believes that issuing the exemptive relief 
as set forth in these final rules and rule amendments is consistent 
with those determinations.
    As explained above, certain of the final rules and rule amendments 
would provide greater flexibility for intermediaries and their 
customers in several areas. Specifically, the Commission is adopting 
final rule amendments concerning the definition of the term 
``principal'' that recognize the evolution of management structures by 
reducing the number of officers that will be considered principals, 
while ensuring that appropriate personnel that perform significant 
roles within the firm remain listed as such. In addition, the 
Commission is expanding the range of instruments in which FCMs may 
invest customer funds beyond those listed in Section 4d(2) of the Act 
to enhance the yield available to FCMs, clearing organizations and 
their customers, without compromising the safety of customer funds. 
These final rule amendments acknowledge the development of new 
financial instruments over the last 60 years, and should both enable 
FCMs to remain competitive globally and domestically and maintain 
safeguards against systemic risk. In light of the foregoing, the 
Commission has determined that the adoption of the final rules and rule 
amendments relating to the definition of the term ``principal'' and the 
expansion of permitted instruments for the investment of customer funds 
will be consistent with the public interest.
    Further, the final rules and rule amendments adopted herein, as 
well as the existing rules as they also relate to the transaction of 
business by intermediaries, will be applied, or extended, to 
agreements, contracts and transactions carried out on new markets, 
i.e., RFEs and DTFs. As more fully discussed in a companion release 
published in this edition of the Federal Register, the rules pertaining 
to the new markets establish a new regulatory framework that is 
intended to promote innovation and competition in the trading of 
derivatives and to permit the markets the flexibility to respond to 
technological and structural changes in the markets. The new framework 
establishes three regulatory tiers with regulations tailored to the 
nature of the commodities traded and the nature of the market 
participant, and access to each of the tiers is dependent upon the 
appropriateness of the participant. In this respect, the Commission 
believes that the actions taken herein are consistent with the ``public 
interest'' as that term is used in Section 4(c) of the Act. When that 
provision was enacted, the Conference Report accompanying the Futures 
Trading Practices Act of 1992 \76\ stated that the ``public interest'' 
in this context would ``include the national public interests noted in 
the Act, the prevention of fraud and the preservation of the financial 
integrity of the markets, as well as the promotion of responsible 
economic or financial innovation and fair competition.'' \77\
---------------------------------------------------------------------------

    \76\ Pub. L. No. 102-546 (1992), 106 Stat. 3590.
    \77\ H.R. Rep. No. 978, 102d Cong., 2d Sess. 78 (1992). The 
Conference Report also states that the reference in Section 4(c) to 
the ``purposes of the Act'' is intended to ``underscore [the 
Conferees'] expectation that the Commission will assess the impact 
of a proposed exemption on the maintenance of the integrity and 
soundness of markets and market participants.'' Id.

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

[[Page 78008]]

    The Commission has retained or adopted safeguards to ensure that 
transactions will be carried out between appropriate persons. 
Appropriate persons can include, beyond those specified in Section 
4(c)(3)(A)-(J) of the Act, ``[s]uch other persons that the Commission 
determines to be appropriate in light of their financial or other 
qualifications, or the applicability of appropriate regulatory 
protections.'' \78\ The Commission has determined that it is 
appropriate to permit any person to trade on an RFE because the rules 
pertaining to RFEs will be closest to those currently pertaining to 
contract markets and the bulk of the existing regulatory framework 
pertaining to intermediaries will apply in connection with their 
intermediation of transactions on RFEs. On the other hand, customers on 
DTFs, which will be subject to looser regulation than RFEs, are 
generally restricted to the types of persons specified in Section 
4(c)(3)(A)-(J) of the Act. The Commission has determined, however, that 
it is appropriate to allow access to retail, or non-institutional, 
customers on DTFs, subject to stated limits and conditions. For 
example, if a non-institutional customer seeks to enter into 
transactions on a DTF permitting such access, such customer may only do 
so through either: a) a registered FCM that is a clearing member of at 
least one designated contract market or RFE, and that has adjusted net 
capital of at least $20 million; or b) a registered CTA who has 
discretionary authority over the non-institutional customer's account, 
and who has assets under management of not less than $25 million. The 
Commission further believes that, in light of these conditions and 
safeguards, the exemptive relief would have no adverse effect on any of 
the regulatory or self-regulatory responsibilities imposed by the Act.
---------------------------------------------------------------------------

    \78\ See Section 4(c)(3)(K) of the Act, 7 U.S.C. 6(c)(3)(K).
---------------------------------------------------------------------------

IV. 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 rules 
adopted 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.\79\ The Commission has previously determined 
that registered FCMs, CPOs, LTMs and ATOMs are not small entities for 
the purpose of the RFA.\80\ 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. In this regard, the 
rules being adopted herein would not require any registrant to change 
its current method of doing business. For many registrants, the 
revisions should decrease the number of persons within the registrant's 
organization who would be considered principals under the CFTC rules. 
Further, the 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 the 
action taken herein will not have a significant economic impact on a 
substantial number of small entities. In this regard, the Commission 
notes that it did not receive any comments concerning the RFA 
implications of the rules and rule amendments discussed herein.
---------------------------------------------------------------------------

    \79\ 47 FR 18618-21 (Apr. 30, 1982).
    \80\ Id. at 18619-20 (discussing FCMs and CPOs); 54 FR 19556, 
19557 (May 8, 1989) (discussing LTMs); and 63 FR 18821, 18830 (Apr. 
16, 1998) (discussing ATOMs).
---------------------------------------------------------------------------

B. Paperwork Reduction Act

    As required by the Paperwork Reduction Act of 1995 [44 U.S.C. 
3507(d)], the Commission submitted a copy of the proposed amendments to 
its rules to the Office of Management and Budget for its review. The 
Commission did not receive any comments on any potential paperwork 
burden associated with the Proposing Release.

List 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, 
Principals, Registration, Reporting and recordkeeping requirements.

17 CFR Part 4

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

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, 
4(c), 4b, 4d, 4f, 4m, 4n, 8a, and 19 thereof, 7 U.S.C. 2, 6(c), 6b, 6d, 
6f, 6m, 6n, 12a and 23, the Commission hereby amends 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 amended by adding new paragraphs (g), (m) and (v) 
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.
* * * * *
    (m) Derivatives transaction facility. This term has the same 
meaning as a ``derivatives transaction facility'' under part 37 of this 
chapter.
* * * * *
    (v) Recognized futures exchange. This term has the same meaning as 
a ``recognized futures exchange'' under part 38 of this chapter.
* * * * *

    3. Section 1.10 is amended as follows:
    a. Revising paragraph (a)(2)(i)(B);
    b. Adding paragraph (a)(2)(i)(C);
    c. Designating the undesignated paragraph following paragraph

[[Page 78009]]

(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 as of a date not more than 17 business days 
prior to the date on which such report is filed, 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 as of a date not more than 17 business days 
prior to the date on which such report is filed, 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 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 customer who does not qualify as an ``institutional customer'' as 
defined in Sec. 1.3(g):
    (A) 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; or
    (B) Receive orders on behalf of the customer from a commodity 
trading advisor acting in accordance with Sec. 4.32 of this chapter.
* * * * *
    (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 rules.
* * * * *

    5. Section 1.20 is 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 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,

[[Page 78010]]

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 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) General 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 that carries deposits 
insured by the Federal Deposit Insurance Corporation;
    (v) Commercial paper;
    (vi) Corporate notes;
    (vii) General obligations of any country whose sovereign debt is 
rated in the highest category by at least one nationally recognized 
statistical rating organization (NRSRO), as that term is defined in 
Sec. 270.2a-7 of this title (permitted foreign sovereign debt), subject 
to the following limits: a futures commission merchant may invest in 
the sovereign debt of a country to the extent it has balances in 
segregated accounts owed to its customers denominated in that country's 
currency; a clearing organization may invest in the sovereign debt of a 
country to the extent it has balances in segregated accounts owed to 
its clearing member futures commission merchants denominated in that 
country's currency; and
    (viii) 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 (viii) 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) Marketability. Except for interests in money market mutual 
funds, investments must be ``readily marketable'' as defined in 
Sec. 240.15c3-1 of this title.
    (2) Ratings. (i) Initial requirement. Instruments that are required 
to be rated by this section must be rated by an NRSRO. For an 
investment to qualify as a permitted investment, ratings are required 
as follows:
    (A) U.S. government securities and the permitted sovereign debt of 
the countries listed in paragraph (a)(1)(vii) of this section, 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.
    (ii) Effect of downgrade. If an NRSRO lowers the rating of an 
instrument that was previously a permitted investment on the basis of 
that rating 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.
    (3) 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)(3)(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 
according to its written terms.
    (4) Concentration. (i) Direct investments. (A) U.S. government 
securities, money market mutual funds, and permitted foreign sovereign 
debt securities shall not be subject to a concentration limit.
    (B) Securities of any single issuer of government sponsored agency 
securities held by a futures commission merchant or clearing 
organization may not exceed 25 percent of total assets held in 
segregation by the futures commission merchant or clearing 
organization.
    (C) Securities of any single issuer of municipal securities, 
certificates of deposit, commercial paper, or corporate notes held by a 
futures commission merchant or clearing organization may not exceed 5 
percent of total assets held in segregation by the futures commission 
merchant or clearing organization.
    (ii) Repurchase agreements. For purposes of determining compliance 
with the concentration limits set forth in this section, securities 
sold by a futures commission merchant or clearing organization subject 
to agreements to repurchase shall be combined with securities held by 
the futures commission merchant or clearing organization as direct 
investments.
    (iii) Reverse repurchase agreements. The concentration limit 
applicable to securities of each issuer that are held by a futures 
commission merchant or clearing organization subject to agreements to 
resell to a particular counterparty shall be as follows:
    (A) For a portfolio of securities held that are subject to resale 
to a counterparty that has been rated single A or higher by two or more 
NRSROs, or whose obligation under an agreement is guaranteed by a 
parent or affiliate company that has been rated single A or higher by 
two or more NRSROs:
    (1) Government sponsored agency debt, issued by the same issuer and 
supplied by the counterparty, may not exceed 50 percent of the total 
amount of securities supplied by such counterparty; and
    (2) Municipal securities, certificates of deposit, commercial 
paper, and corporate notes, issued by the same issuer and supplied by 
the counterparty,

[[Page 78011]]

may not exceed 10 percent of the total amount of securities supplied by 
such counterparty; and
    (B) For a portfolio of securities held that are subject to resale 
to a counterparty that does not have a rating or guarantee as specified 
in paragraph (b)(4)(iii)(A) of this section:
    (1) Government sponsored agency debt, issued by the same issuer and 
supplied by the counterparty, may not exceed 25 percent of the total 
amount of securities supplied by such counterparty; and
    (2) Municipal securities, certificates of deposit, commercial 
paper, and corporate notes, issued by the same issuer and supplied by 
the counterparty, may not exceed 5 percent of the total amount of 
securities supplied by such counterparty.
    (iv) Treatment of securities issued by affiliates. For purposes of 
determining compliance with the concentration limits set forth in this 
section, securities issued by entities that are affiliated, as defined 
in paragraph (b)(6) of this section, shall be aggregated and deemed the 
securities of a single issuer. An interest in a permitted money market 
mutual fund is not deemed to be a security issued by its sponsoring 
entity.
    (v) Treatment of customer-owned securities. For purposes of 
determining compliance with the concentration limits set forth in this 
section, securities owned by the customers of a futures commission 
merchant and posted as margin collateral are not included in total 
assets held in segregation by the futures commission merchant, and 
securities posted by a futures commission merchant with a clearing 
organization are not included in total assets held in segregation by 
the clearing organization.
    (5) 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.
    (6) Investments in instruments issued by affiliates. (i) 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.
    (7) 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 an investment company that is 
registered under the Investment Company Act of 1940 with the Securities 
and Exchange Commission and that holds itself out to investors as a 
money market fund, in accordance with Sec. 270.2a-7 of this title. 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, an investment adviser registered under the 
Investment Advisers Act of 1940, 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 
maintain the confirmation relating to the purchase in its records in 
accordance with Sec. 1.31 and note the ownership of fund shares (by 
book-entry or otherwise) in a custody account of the FCM or clearing 
organization 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 by 9 a.m. of 
the business day following each business day and made available to the 
futures commission merchant or clearing organization by that time.
    (5) A fund must be able to redeem an interest by the business day 
following a redemption request by the futures commission merchant or 
clearing organization. Demonstration that this requirement has been met 
may include either an appropriate provision in the offering memorandum 
of the fund or a separate side agreement between the fund and a 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 listed in paragraphs (a)(1)(i) through (viii) of 
this section pursuant to agreements for resale or repurchase of the 
securities (agreements to repurchase or resell), provided the 
agreements to repurchase or resell conform to the following 
requirements:
    (1) The securities are specifically identified by coupon rate, par 
amount, market value, maturity date, and CUSIP or ISIN 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 executed in compliance with the 
concentration limit requirements applicable to the securities held in 
connection with the agreements to repurchase referred to in paragraphs 
(b)(4)(ii) and (iii) of this section.
    (4) 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)(12) of this 
section and which states that the

[[Page 78012]]

parties thereto intend the transaction to be treated as a purchase and 
sale of securities.
    (5) The term of the agreement is no more than one business day, or 
reversal of the transaction is possible on demand.
    (6) 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 Company 
in an account that complies with the requirements of Sec. 1.26.
    (7) 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 
or ISIN 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.
    (8) 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.
    (9) 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.
    (10) 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.
    (11) 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.''
    (12) 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) Deposit of firm-owned securities into segregation. 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 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

[[Page 78013]]

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.


Sec. 1.27  [Amended]

    8. Section 1.27 is amended by:
    a. Revising the word ``obligations'' to read ``instruments'' each 
time it appears; and
    b. Adding the phrase ``or ISIN'' following the word ``CUSIP'' each 
time it appears.


Secs. 1.28 and 1.29  [Amended]

    9. Sections 1.28 and 1.29 are amended by revising the word 
``obligations'' to read ``instruments'' each time it appears.

    10. Section 1.33 is 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 any 
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 customer who does not qualify as an 
``institutional customer'' as defined in Sec. 1.3(g), a futures 
commission merchant must obtain the 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.
* * * * *

    11. Section 1.46 is 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, recognized futures 
exchange or derivatives transaction facility:
* * * * *
    (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).
* * * * *

    12. Section 1.52 is 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).
* * * * *

    13. Section 1.55 is 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

    14. 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.


    15. Section 3.1 is 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

[[Page 78014]]

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
* * * * *

    16. Section 3.10 is 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 on or subject to 
the rules of a contract market, recognized futures exchange or 
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 on or subject to the 
rules of a contract market, recognized futures exchange, or 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.
* * * * *

    17. Section 3.21 is amended by revising paragraph (c) introductory 
text to read as follows:


Sec. 3.21  Exemption from fingerprinting requirement in certain cases.

* * * * *
    (c) Outside directors. Any futures commission merchant, introducing 
broker, commodity trading advisor, commodity pool operator or leverage 
transaction merchant that has a principal who is a director but is not 
also an officer or employee of the firm may, in lieu of submitting a 
fingerprint card in accordance with the provisions of 
Secs. 3.10(a)(2)(i) and 3.31(a)(2), file a ``Notice Pursuant to Rule 
3.21(c)'' with the National Futures Association. Such notice shall 
state, if true, that such outside director:
* * * * *

    18. Section 3.31 is amended by redesignating paragraph (a) as 
paragraph (a)(1), and by adding new paragraph (a)(2) to read as 
follows:


Sec. 3.31  Deficiencies, inaccuracies, and changes, to be reported.

    (a) * * *
    (1) * * *
    (2) Where the deficiency or inaccuracy is created by the addition 
of a new principal not listed on the registrant's application for 
registration (or amendment of such application prior to the granting of 
registration), each Form 3-R filed in accordance with the requirements 
of paragraph (a)(1) of this section must be accompanied by a Form 8-R, 
completed in accordance with the instructions thereto and executed by 
each natural person who is a principal of the registrant and who was 
not listed on the registrant's initial application for registration or 
any amendment thereto. The Form 8-R for each such principal must be 
accompanied by the fingerprints of that principal on a fingerprint card 
provided by the National Futures Association for that purpose, unless 
such principal is a director who qualifies for the exemption from the 
fingerprint requirement pursuant to Sec. 3.21(c). The provisions of 
this paragraph do not apply to any principal who has a current Form 8-R 
on file with the Commission or the National Futures Association.
* * * * *


Sec. 3.32  [Removed]

    19. Section 3.32 is removed.


Sec. 3.34  [Removed]

    20. Section 3.34 is removed.

    21. Appendix A to Part 3 is amended by adding to the end thereto 
the following:

Appendix A to Part 3--Interpretive Statement with Respect to 
Section 8A(2)(C) and (E) and Section 8A(3)(J) and (M) of the 
Commodity Exchange Act

* * * * *
    The Commission has further addressed ``other good cause'' under 
Section 8a(3)(M) of the Act in issuing guidance letters on assessing 
the fitness of floor brokers, floor traders or applicants in either 
category:

[First guidance letter]

December 4, 1997.
Robert K. Wilmouth,

President, National Futures Association, 200 West Madison Street, 
Chicago, IL.
    Re:  Adverse Registration Actions with Respect to Floor Brokers, 
Floor Traders and Applicants for Registration in Either Category

Dear Mr. Wilmouth:
    As you know, the Commission on June 26, 1997, approved for 
publication in the Federal Register a Notice and Order concerning 
adverse registration actions by the National Futures Association 
(``NFA'') with respect to registered floor brokers (``FBs''), 
registered floor traders (``FTs'') and applicants for registration 
in either category. 62 Fed. Reg. 36050 (July 3, 1997). The Notice 
and Order authorized NFA to grant or to maintain,

[[Page 78015]]

either with or without conditions or restrictions, FB or FT 
registration where NFA previously would have forwarded the case to 
the Commission for review of disciplinary history. The Commission 
has worked with its staff to determine which of the pending matters 
could efficiently be returned to NFA for handling, and such matters 
have been forwarded to NFA. The Commission will continue to accept 
or to act upon requests for exemption, and the Commission staff will 
consider requests for ``no-action'' opinions with respect to 
applicable registration requirements.
    By this correspondence, the Commission is issuing guidance that 
provides NFA further direction on how it expects NFA to exercise its 
delegated power, based upon the experience of the Commission and the 
staff with the registration review process during the past three 
years. This guidance will help ensure that NFA exercises its 
delegated power in a manner consistent with Commission precedent.
    In exercising its delegated authority, NFA, of course, needs to 
apply all of the provisions of Sections 8a(2) and (3) of the 
Commodity Exchange Act (``Act'').\1\ In that regard, NFA should 
consider the matters in which the Commission has taken action in the 
past and endeavor to seek similar registration restrictions, 
conditions, suspensions, denials, or revocations under similar 
circumstances.
---------------------------------------------------------------------------

    \1\ 7 U.S.C. 12a(2) and (3) (1994). The letter is intended to 
supplement, not to supersede, other guidance provided in the past to 
NFA. In this regard, the NFA should continue to follow other 
guidance provided by the Commission or its staff.
---------------------------------------------------------------------------

    One of the areas in which NFA appears to have had the most 
uncertainty is with regard to previous self-regulatory organization 
(``SRO'') disciplinary actions. Commission Rule 1.63\2\ provides 
clear guidelines for determining whether a person's history of 
``disciplinary offenses'' should preclude service on SRO governing 
boards or committees.\3\ In determining whether to grant or to 
maintain, either with or without conditions or restrictions, FB or 
FT registration, NFA should, as an initial matter, apply the Rule 
1.63(a)(6) criteria to those registered FBs, registered FTs and 
applicants for registration in either category. However, NFA should 
be acting based upon any such offenses that occurred within the 
previous five years, rather than the three years provided for in 
Rule 1.63(c). NFA should consider disciplinary actions taken by an 
SRO as that term is defined in Section 3(a)(26) of the Securities 
Exchange Act of 1934 no differently from disciplinary actions taken 
by an SRO in the futures industry as defined in Rule 1.3(ee).\4\ 
Application of the Rule 1.63 criteria, as modified, to these matters 
will aid NFA in making registration determinations that are 
reasonably consonant with Commission views.\5\ NFA should focus on 
the nature of the underlying conduct rather than the sanction 
imposed by an SRO. Thus, if a disciplinary action would not come 
within the coverage of Rule 1.63 but for the imposition of a short 
suspension of trading privileges (such as for a matter involving 
fighting, use of profane language or minor recordkeeping 
violations), NFA could exercise discretion, as has the Commission, 
not to institute a statutory disqualification case. On the other 
hand, conduct that falls clearly within the terms of Rule 1.63, such 
as violations of rules involving potential harm to customers of the 
exchange, should not be exempt from review simply because the 
exchange imposed a relatively minor sanction.
---------------------------------------------------------------------------

    \2\ Commission rules referred to herein are found at 17 CFR Ch. 
I.
    \3\ Rule 1.63(c) provides that a person is ineligible from 
serving on an SRO's disciplinary committees, arbitration panels, 
oversight panels or governing board if, as provided in Rule 1.63(b), 
the person, inter alia: (1) within the past three years has been 
found by a final decision of an SRO, an administrative law judge, a 
court of competent jurisdiction or the Commission to have committed 
a disciplinary offense; or (2) within the past three years has 
entered into a settlement agreement in which any of the findings or, 
in the absence of such findings, any of the acts charged included a 
disciplinary offense.
    Rule 1.63(a)(6) provides that a ``disciplinary offense'' 
includes: (i) any violation of the rules of an SRO except those 
rules related to (A) decorum or attire, (B) financial requirements, 
or (C) reporting or record-keeping unless resulting in fines 
aggregating more than $5,000 within any calendar year; (ii) any rule 
violation described in subparagraphs (A) through (C) above that 
involves fraud, deceit or conversion or results in a suspension or 
expulsion; (iii) any violation of the Act or the regulations 
promulgated thereunder; or (iv) any failure to exercise supervisory 
responsibility with respect to an act described in paragraphs (i) 
through (iii) above when such failure is itself a violation of 
either the rules of an SRO, the Act or the regulations promulgated 
thereunder.
    \4\ Thus, for example, a disciplinary action taken by the 
Chicago Board Options Exchange or the National Association of 
Securities Dealers, Inc. should be considered in a manner similar to 
a disciplinary action of the Chicago Board of Trade or NFA.
    \5\ In reviewing these matters, the NFA should bear in mind 
recent Commission precedent which allows for reliance on settled 
disciplinary proceedings in some circumstances. See In the Matter of 
Michael J. Clark, [1996-1998 Transfer Binder] Comm. Fut. L. Rep. 
(CCH) para. 27,032 (Apr. 22, 1997) (``other good cause'' under 
Section 8a(3)(M) of the Act exists based upon a pattern of exchange 
disciplinary actions resulting in significant sanctions for serious 
rule violations--whether settlements or adjudications), aff'd sub 
nom., Clark v. Commodity Futures Trading Commission, No. 97-4228 (2d 
Cir. June 4, 1999) (unpublished).
---------------------------------------------------------------------------

    The Commission has treated the registration process and the SRO 
disciplinary process as separate matters involving separate 
considerations. The fact that the Commission has not pursued its own 
enforcement case in a particular situation does not necessarily mean 
that the Commission considers the situation to be a minor matter for 
which no registration sanctions are appropriate. Further, the 
Commission believes that it and NFA, entities with industry-wide 
perspective and responsibilities, are the appropriate bodies, rather 
than any individual exchange, to decide issues relating to 
registration status, which can affect a person's ability to function 
in the industry well beyond the jurisdiction of a particular 
exchange. Thus, NFA's role is in no way related to review of 
exchange sanctions for particular conduct, but rather it is the 
entirely separate task of determining whether an FB's or FT's 
conduct should impact his or her registration.
    NFA also should look to Commission precedent in selecting 
conditions or restrictions to be imposed, such as a dual trading ban 
where a person has been involved in disciplinary offenses involving 
customer abuse. Where conditions or restrictions are imposed, or 
agreed upon, NFA also should follow Commission precedent, under 
which such conditions or restrictions generally have been imposed 
for a two-year period.
    The Commission has required sponsorship for conditioned FBs and 
FTs when their disciplinary offenses have involved noncompetitive 
trading and fraud irrespective of the level of sanctions imposed by 
an SRO. Indeed, but for a sponsorship requirement there would be no 
one routinely watching and responsible for the activities of these 
registrants. Absent sponsorship, such FBs and FTs would only be 
subject to routine Commission and exchange surveillance. The 
Commission's rules are premised upon the judgment that requiring FTs 
and FBs to have sponsors to ensure their compliance with conditions 
is both appropriate and useful. See Rule 3.60(b)(2)(i).
    A question has arisen whether, if NFA is required to prove up 
the underlying facts of an SRO disciplinary action, the exchanges 
can provide information on exchange disciplinary proceedings 
directly to NFA. Although Section 8c(a)(2) of the Act states that an 
exchange shall not disclose the evidence for a disciplinary action 
except to the person disciplined and to the Commission, Section 
8a(10) of the Act allows the Commission to authorize any person to 
perform any portion of the registration functions under the Act, 
notwithstanding any other provision of law. The effective discharge 
of the delegated registration function requires NFA to have access 
to the exchange evidence. Thus, the Commission believes that Section 
8a(10) may reasonably be interpreted to allow the disclosure of 
information from exchange disciplinary proceedings directly to NFA 
despite the provisions of Section 8c(a)(2).
    Nothing in the Notice and Order affects the Commission's 
authority to review the granting of a registration application by 
NFA in the performance of Commission registration functions, 
including review of the sufficiency of conditions or restrictions 
imposed by NFA, to review the determination by NFA not to take 
action to affect an existing registration, or to take its own action 
to address a statutory disqualification. Moreover, the Commission 
Order contemplates that to allow for appropriate Commission 
oversight of NFA's exercise of this delegated authority, NFA will 
provide for the Commission's review quarterly schedules of all 
applicants cleared for registration and all registrants whose 
registrations are maintained without adverse action by NFA's 
Registration, Compliance, Legal Committee despite potential 
statutory disqualifications.
    The Commission will continue to monitor NFA activities through 
periodic rule enforcement reviews, and NFA remains subject to the 
present requirement that it

[[Page 78016]]

monitor compliance with the conditions and restrictions imposed on 
conditioned and restricted registrants.
    Sincerely,
Jean A. Webb,
Secretary of the Commission.

[Second guidance letter]

April 13, 2000.
Robert K. Wilmouth,
President, National Futures Association, 200 West Madison Street, 
Chicago, IL.
    Re: Use of Exchange Disciplinary Actions as ``Other Good Cause'' 
to Affect Floor Broker/Floor Trader Registration

    Dear Mr. Wilmouth:

I. Introduction and Background
    In July 1997, the Commission issued a Notice and Order 
authorizing the National Futures Association (``NFA'') to grant or 
to maintain, either with or without conditions or restrictions, 
floor broker (``FB'') or floor trader (``FT'') registration where 
NFA previously would have forwarded the case to the Commission for 
review of disciplinary history.\1\ By letter dated December 4, 1997 
(``Guidance Letter''), the Commission provided further direction on 
how the Commission expected NFA to exercise its delegated power and 
to ensure that NFA exercised its delegated power in a manner 
consistent with Commission precedent.
---------------------------------------------------------------------------

    \1\ Registration Actions by National Futures Association With 
Respect to Floor Brokers, Floor Traders and Applicants for 
Registration in Either Category, 62 FR 36050 (July 3, 1997).
---------------------------------------------------------------------------

    The Commission has determined to revise the Guidance Letter. 
Specifically, the Commission is revising the portion of the Guidance 
Letter that addresses the use of exchange disciplinary actions as 
``other good cause'' to affect FB and FT registrations. The 
Commission has made this determination following its own 
reconsideration of the issue and at the urging of industry 
members.\2\
---------------------------------------------------------------------------

    \2\ See letters submitted by James Bowe, former president of the 
New York Board of Trade (``NYBOT''), dated October 13, 1999, 
Christopher Bowen, general counsel of the New York Mercantile 
Exchange (``NYMEX''), dated October 18, 1999, and the Joint 
Compliance Committee (``JCC''), dated February 2, 2000. The JCC 
consists of senior compliance officials from all domestic futures 
exchanges and the NFA (i.e., the domestic self-regulatory 
organizations (``SROs'')). In addition, staff from the Contract 
Markets Section of the Commission's Division of Trading and Markets 
attend the JCC meetings as observers. The JCC was established to aid 
in the development of improved compliance systems through joint 
efforts and information-sharing among the SROs. Commission staff 
have also discussed this issue with SRO staff.
---------------------------------------------------------------------------

    The Guidance Letter pointed out that, in exercising its 
delegated authority, NFA must apply all of the provisions of 
Sections 8a(2) and (3) of the Commodity Exchange Act (``Act'').\3\ 
In particular, Section 8a(3)(M) of the Act authorizes the Commission 
to refuse to register or to register conditionally any person if it 
is found, after opportunity for hearing, that there is other good 
cause for statutory disqualification from registration beyond the 
specifically listed grounds in Sections 8a(2) and 8a(3) of the Act. 
The Commission held in In the Matter of Clark that statutory 
disqualification under the ``other good cause'' provision of Section 
8a(3)(M) may arise on the basis of, among other things, a pattern of 
exchange disciplinary actions alleging serious rule violations that 
result in significant sanctions, and that it is immaterial whether 
the sanctions imposed resulted from a fully-adjudicated disciplinary 
action or an action that was taken following a settlement.\4\
---------------------------------------------------------------------------

    \3\ 7 U.S.C. 12a(2) and (3) (1994).
    \4\ In the Matter of Clark, [1996-1998 Transfer Binder] Comm. 
Fut. L. Rep. (CCH) para. 27,032 (Apr. 22, 1997), aff'd sub nom., 
Clark v. Commodity Futures Trading Commission, No. 97-4228 (2d Cir. 
June 4, 1999) (unpublished).
---------------------------------------------------------------------------

    The Guidance Letter recommended the application of the 
provisions of Commission Rule 1.63 \5\ as criteria to aid in 
assessing the impact of an FB or FT applicant's or registrant's 
previous disciplinary history on the person's fitness to be 
registered, with the exception that NFA should be acting based on 
disciplinary history from the previous five years, rather than the 
three years provided for in Rule 1.63.\6\ The Guidance Letter also 
noted that NFA should consider disciplinary actions taken not only 
by futures industry SROs but also those taken by SROs as defined in 
Section 3(a)(26) of the Securities Exchange Act of 1934 (``1934 
Act''), including settled disciplinary actions.
---------------------------------------------------------------------------

    \5\ Commission rules referred to in this letter are found at 17 
CFR Ch. 1.
    \6\ Rule 1.63 provides, among other things, that a person is 
ineligible from serving on SRO disciplinary committees, arbitration 
panels, oversight panels or governing boards if that person, inter 
alia, entered into a settlement agreement within the past three 
years in which any of the findings or, in the absence of such 
findings, any of the acts charged included a disciplinary offense.
    Rule 1.63(a)(6) defines a ``disciplinary offense'' to include:
    (i) any violation of the rules of an SRO except those rules 
related to (A) decorum or attire, (B) financial requirements, or (C) 
reporting or record-keeping unless resulting in fines aggregating 
more than $5,000 within any calendar year; (ii) any rule violation 
described in subparagraphs (A) through (C) above that involves 
fraud, deceit or conversion or results in a suspension or expulsion; 
(iii) any violation of the Act or the regulations promulgated 
thereunder; or (iv) any failure to exercise supervisory 
responsibility with respect to an act described in paragraphs (i) 
through (iii) above when such failure is itself a violation of 
either the rules of an SRO, the Act or the regulations promulgated 
thereunder.

---------------------------------------------------------------------------
II. Revised Guidance

    As stated above, the Commission has determined to revise the 
Guidance Letter. From this point forward, NFA should cease using 
Rule 1.63 as the basis to evaluate the impact of an FB or FT 
applicant's or registrant's disciplinary history on his or her 
fitness to be registered. Instead, as Clark stated, when reviewing 
disciplinary history to assess the fitness to be registered of an 
FB, FT, or applicant in either category, a pattern of exchange 
disciplinary actions alleging serious rule violations that result in 
significant sanctions will trigger the ``other good cause'' 
provision of Section 8a(3)(M). The ``pattern'' should consist of at 
least two final exchange disciplinary actions, whether settled or 
adjudicated.
    NFA also should consider initiating proceedings to affect the 
registration of the FB or FT, even if there is only a single 
exchange action against the FB or FT, if the exchange action was 
based on allegations of particularly egregious misconduct or 
involved numerous instances of misconduct occurring over a long 
period of time. If, however, a proceeding is initiated based on a 
single exchange action that was disposed of by settlement, NFA may 
have to prove up the underlying misconduct. Furthermore, traditional 
principles of collateral estoppel apply to adjudicated actions, 
whether they are being considered individually or as part of a 
pattern.\7\
---------------------------------------------------------------------------

    \7\ Clark at 44,929.
---------------------------------------------------------------------------

    As provided by the Guidance Letter, ``exchange disciplinary 
actions'' would continue to include disciplinary actions taken by 
both futures industry SROs and SROs as defined in Section 3(a)(26) 
of the 1934 Exchange Act. Furthermore, NFA should review an 
applicant's or registrant's disciplinary history for the past five 
years.\8\ At least one of the actions forming the pattern, however, 
must have become final after Clark was decided by the Commission on 
April 22, 1997. Finally, ``serious rule violations'' consist of, or 
are substantially related to, charges of fraud, customer abuse, 
other illicit trading practices, or the obstruction of an exchange 
investigation.
---------------------------------------------------------------------------

    \8\ The Commission generally looked at a five-year period of 
disciplinary history. On occasion, however, the Commission examined 
a longer period of an applicant's or registrant's disciplinary 
history. For example, the Commission revoked the registration of one 
FB on the basis of exchange disciplinary cases that extended back 
six years, see Clark, 2 Comm. Fut. L. Rep. (CCH) para. 27,032, and 
denied an application for registration as an FT on the basis of 
exchange disciplinary cases that extended back seven years, see In 
the Matter of Castellano, [1987-1990 Transfer Binder] Comm. Fut. L. 
Rep. (CCH) para. 24,360 (Nov. 23, 1988), summarily aff'd (May 29, 
1990), reh. denied [1990-1992 Transfer Binder] Comm. Fut. L. Rep. 
para. 24,870 (June 26, 1990), aff'd sub nom. Castellano v. CFTC, 
Docket No. 90-2298 (7th Cir. Nov. 20, 1991).
---------------------------------------------------------------------------

    Congress, the courts and the Commission have indicated the 
importance of considering an applicant's history of exchange 
disciplinary actions in assessing that person's fitness to 
register.\9\ Furthermore, NFA's review of exchange disciplinary 
actions within the context of the registration process should not 
simply mirror the disciplinary actions undertaken by the exchanges. 
The two processes are separate matters that involve separate 
considerations. As part of their ongoing self-regulatory 
obligations, exchanges must take disciplinary action \10\ and such 
disciplinary matters necessarily focus on the specific misconduct 
that forms the allegation. In a statutory disqualification action, 
however, NFA must determine whether the disciplinary history of an 
FB, FT or applicant over the preceding five years should impact his 
or her registration. Additionally, NFA possesses industry-wide 
perspective and responsibilities. As such, NFA, rather than an 
individual exchange, should decide registration status issues, since 
those issues affect an individual's status

[[Page 78017]]

within the industry as a whole, well beyond the jurisdiction of a 
particular exchange.
---------------------------------------------------------------------------

    \9\ Letter dated July 14, 1995, from Mary L. Schapiro to R. 
Patrick Thompson, President, New York Mercantile Exchange 
(unpublished). See also Castellano, supra note 8.
    \10\ See Rule 1.51(a)(7).
---------------------------------------------------------------------------

    The Commission also wants to clarify to the fullest extent 
possible that its power to delegate the authority to deny or 
condition the registration of an FB, FT, or an applicant for 
registration in either category permits exchanges to disclose to NFA 
all evidence underlying exchange disciplinary actions, 
notwithstanding the language of Section 8c(a)(2) of the Act.\11\ The 
Commission's power to delegate stems from Section 8a(10) of the Act, 
which permits delegation of registration functions, including 
statutory disqualification actions, to any person in accordance with 
rules adopted by such person and submitted to the Commission for 
approval or for review under Section 17(j) of the Act, 
``notwithstanding any other provision of law.'' Certainly, Section 
8c(a)(2) qualifies as ``any other provision of law.'' Furthermore, 
the effective discharge of the delegated function requires NFA to 
have access to the exchange evidence. Thus, the exercise of the 
delegated authority pursuant to Section 8a(10) permits the exchanges 
to disclose all evidence underlying disciplinary actions to NFA.\12\
---------------------------------------------------------------------------

    \11\ Section 8c(a)(2) states, in relevant part, that ``[A]n 
exchange * * * shall not disclose the evidence therefor, except to 
the person who is suspended, expelled, disciplined, or denied 
access, and to the Commission.''
    \12\ Of course, the Commission could request records from the 
exchange and forward them to NFA. The Commission believes that this 
is an unnecessary administrative process and that NFA should obtain 
the records it needs to carry out the delegated function of 
conducting disciplinary history reviews directly from the exchanges. 
In this context and pursuant to Commission orders authorizing NFA to 
institute adverse registration actions, NFA should be viewed as 
standing in the shoes of the Commission.
---------------------------------------------------------------------------

    This letter supersedes the Guidance Letter to the extent 
discussed above. In all other aspects, the Guidance Letter and other 
guidance provided by the Commission or its staff remain in effect. 
Therefore, NFA should continue to follow Commission precedent when 
selecting conditions or restrictions to be imposed. For example, NFA 
should impose a dual trading ban where customer abuse is involved 
and any conditions or restrictions imposed should be for a two-year 
period. Furthermore, NFA should require sponsorship for conditioned 
FBs or FTs when their disciplinary offenses involve noncompetitive 
trading and fraud.
    Nothing in the Notice and Order or this letter affects the 
Commission's authority to review the granting of a registration 
application by NFA in the performance of Commission registration 
functions, including review of the sufficiency of conditions or 
restrictions imposed by NFA, to review the determination by NFA not 
to take action to affect an existing registration, or to take its 
own action to address a statutory disqualification. Moreover, the 
Commission Order contemplates that to allow for appropriate 
Commission oversight of NFA's exercise of this delegated authority, 
NFA will provide for the Commission's review quarterly schedules of 
all applicants cleared for registration and all registrants whose 
registrations are maintained without adverse action by NFA's 
Registration, Compliance, Legal Committee despite potential 
statutory disqualifications.
    The Commission will continue to monitor NFA activities through 
periodic rule enforcement reviews, and NFA remains subject to the 
present requirement that it monitor compliance with the conditions 
and restrictions imposed on conditioned and restricted registrants.
    Sincerely,

Jean A. Webb,
Secretary of the Commission.

    22. Part 3 is 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;
    (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

[[Page 78018]]

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

    23. 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.


    24. Section 4.10 is 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.
* * * * *

    25. Section 4.24 is 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 persons referred to in this paragraph 
(b)(1) 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;
* * * * *

    26. Section 4.32 is added to read as follows:


Sec. 4.32  Trading on a derivatives transaction facility for non-
institutional customers.

    (a) A registered commodity trading advisor may enter trades on or 
subject to the rules of a derivatives transaction facility on behalf of 
a client who does not qualify as an ``institutional customer'' as 
defined in Sec. 1.3(g) of this chapter, provided that the trading 
advisor:
    (1) Directs the client's commodity interest account;
    (2) Directs accounts containing total assets of not less than 
$25,000,000 at the time the trade is entered; and
    (3) Discloses to the client that the trading advisor may enter 
trades on or subject to the rules of a derivatives transaction facility 
on the client's behalf.
    (b) The commodity interest account of a client described in 
paragraph (a) of this section must be carried by a registered futures 
commission merchant.
    27. Section 4.34 is 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

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

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


    29. Section 140.91 is 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.
* * * * *

PART 155--TRADING STANDARDS

    30. 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.

[[Page 78019]]

Secs. 155.2, 155.3, 155.4 and 155.5  [Amended]

    31. Sections 155.2, 155.3, 155.4 and 155.5 are amended by adding 
the words ``or recognized futures exchange'' after the words ``contract 
market'' each time they appear.

    32. Section 155.6 is 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 customer who does not qualify as an 
``institutional customer'' as defined in Sec. 1.3(g) of this chapter 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

    33. The authority citation for Part 166 is 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.


    34. Section 166.5 is 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. 
Provided, however, a person who is an ``institutional customer'' as 
defined in Sec. 1.3(g) of this chapter shall not be deemed to be a 
customer within the meaning of this section.
    (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) 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
    (ii) A person who is a ``qualified eligible person'' 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 facility (mixed panel): Provided,

[[Page 78020]]

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 exchange, 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 exchange, 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 exchange, or 
derivatives transaction facility does not have jurisdiction. Other 
counterclaims arising out of a transaction subject to the Act and rules 
promulgated thereunder for which the customer utilizes the services of 
the registrant may be permissible where the customer and the registrant 
have agreed in advance to require that all such submissions be included 
in the proceeding, and if the aggregate monetary value of the 
counterclaim is capable of calculation.
    (g) Institutional customers. (1) A person who is an ``institutional 
customer'' as defined in Sec. 1.3(g) of this chapter may negotiate any 
term of an agreement or understanding with a Commission registrant in 
which the institutional customer agrees, prior to the time a claim or 
grievance arises, to submit such claim or grievance to any settlement 
procedure, except that signing the agreement must not be made a 
condition for the institutional customer to use the services offered by 
the registrant.
    (2) If the agreement is contained as a clause or clauses of a 
broader agreement, the institutional customer must separately endorse 
the clause or clauses containing the agreement; Provided, however, a 
futures commission merchant or introducing broker may obtain such 
endorsement as provided in Sec. 1.55(d) of this chapter.

    Issued in Washington, D.C. on November 21, 2000 by the 
Commission.
Jean A. Webb,
Secretary of the Commission.
[FR Doc. 00-30268 Filed 12-12-00; 8:45 am]
BILLING CODE 6351-01-P