[Federal Register Volume 66, Number 167 (Tuesday, August 28, 2001)]
[Proposed Rules]
[Pages 45221-45235]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 01-21451]


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COMMODITY FUTURES TRADING COMMISSION

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

RIN 3038-AB56


Rules Relating to Intermediaries of Commodity Interest 
Transactions

AGENCY: Commodity Futures Trading Commission.

ACTION: Proposed rulemaking.

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SUMMARY: Following the enactment of the Commodity Futures Modernization 
Act of 2000 (CFMA) and the resulting revisions to the Commodity 
Exchange Act (CEA or Act), the Commodity Futures Trading Commission 
(CFTC or Commission) is proposing rules relating to intermediation of 
commodity futures and commodity options (commodity interest) 
transactions. These proposed new rules and rule amendments would 
provide greater flexibility in several areas, and address, among other 
things, the definition of the term ``principal,'' certified financial 
reports, ethics training, disclosure, account opening procedures, 
trading standards, reporting requirements, and offsetting positions. 
The Commission would also make 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.
    The proposed rules are consistent with the mandate of the CFMA to 
streamline regulation of entities registered under the Act. Most of the 
proposed new rules and rule amendments were part of the Commission's 
final rules relating to intermediaries that were adopted in December 
2000, and subsequently withdrawn following the CFMA's enactment in 
order to determine their consistency with the CFMA (December Release). 
Upon reviewing the proposed rules in light of the CFMA, as described in 
greater detail below, the Commission has determined that the rules 
proposed herein are consistent with the CFMA. The Commission encourages 
interested persons to read the December Release and the proposals 
published in June 2000 for a discussion of the background and purpose 
of each of the rules and

[[Page 45222]]

rule amendments that is not described in detail in this Federal 
Register release.

DATES: Comments must be received by September 12, 2001.

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

FOR FURTHER INFORMATION CONTACT: Lawrence B. Patent, Associate Chief 
Counsel, or Michael A. Piracci, Attorney-Advisor, Division of Trading 
and Markets, Commodity Futures Trading Commission, Three Lafayette 
Centre, 1155 21st Street, NW, Washington, DC 20581. Telephone: (202) 
418-5450.

SUPPLEMENTARY INFORMATION:

Table of Contents

I. Background
II. Proposed Rules
    A. Registration
    1. Definition of the Term ``Principal''
    2. Application Procedures for IBs and FCMs
    3. Special Procedures Available to Firms Subject to Securities 
or Banking Regulation
    B. Fitness and Supervision
    C. Financial Requirements
    1. Trading by Non-Institutional Customers on DTFs
    2. Segregation of Funds
    3. Investment of Customer Funds
    D. Risk Disclosure and Account Statements
    E. Trading Standards
    F. Recordkeeping
    1. Customer Account Statements
    2. Close-Out of Offsetting Positions
III. Section 4(c) Findings
IV. Cost-Benefit Analysis
V. Related Matters
    A. Regulatory Flexibility Act
    B. Paperwork Reduction Act

I. Background

    Section 2 of the CFMA sets forth the purposes of the CFMA, which 
include streamlining and eliminating unnecessary regulation for the 
commodity futures exchanges and other entities regulated under the Act. 
Section 125 of the CFMA directs the Commission to complete a study of 
its rules, regulations and interpretations governing the conduct of 
persons registered under the Act by December 21, 2001. The proposed 
rules are designed to be an initial step in fulfilling the mandates of 
section 2 and section 125.
    Most of the proposed new rules and rule amendments were part of the 
Commission's final rules relating to intermediaries that were adopted 
in December 2000, and subsequently withdrawn following the CFMA's 
enactment in order to determine their consistency with the CFMA 
(December Release).\1\ Upon reviewing the proposed rules in light of 
the CFMA, as described in greater detail below, the Commission has 
determined that the rules proposed herein are consistent with the CFMA. 
The Commission encourages interested persons to read the December 
Release and the proposals published in June 2000 for a discussion of 
the background and purpose of each of the rules and rule amendments 
that is not described in detail in this Federal Register release.
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    \1\ See Rules Relating to Intermediaries of Commodity Interest 
Transactions, 65 FR 39008 (June 22, 2000) (proposed rules); ``Rules 
Relating to Intermediaries of Commodity Interest Transactions,'' 65 
FR 77993 (Dec. 13, 2000) (final rules); 65 FR 82272 (Dec. 28, 2000) 
(final rules; partial withdrawal).
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    As further discussed below, certain rules have been modified to 
conform to specific provisions of the CFMA. Thus, for example, section 
111 of the CFMA permits a registered derivatives transaction execution 
facility (DTF) to allow by rule certain persons who are regulated by 
other federal financial regulatory agencies to act as intermediaries 
thereon in limited instances without first registering with the 
Commission. Accordingly, the Commission will not repropose the 
``passporting'' registration procedure for certain otherwise regulated 
entities as previously contemplated.\2\ The Commission may revisit this 
issue in the context of the study mandated by section 125 of the CFMA, 
which requires a review of the Act and Commission rules thereunder 
pertaining to registrants.
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    \2\ In addition, Section 252(b)(2) of the CFMA adds a new 
section 4f(a)(2) to the Act to permit ``notice'' registration as a 
futures commission merchant (FCM) or an introducing broker (IB) by 
securities brokers or dealers that will limit their futures-related 
activities to security futures products. See also ``Notice 
Registration as a Futures Commission Merchant or Introducing Broker 
for Certain Securities Brokers or Dealers,'' 66 FR 27476 (May 17, 
2001) (proposed rules); 66 FR 43080 (Aug. 17, 2001) (final rules).
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    The proposals discussed in this release are applicable generally to 
intermediaries transacting business on behalf of customers on 
designated contract markets and registered DTFs. To the extent that an 
existing rule is not addressed in this release, the Commission intends 
that the rule continues to apply to intermediaries transacting business 
on behalf of customers on designated contract markets and registered 
DTFs pending completion of the study mandated by Section 125, 
regardless of whether the contract market or DTF itself, or its 
operators, have been exempted from applicable provisions of the 
rule.\3\ Thus, for example, under Rule 1.35, intermediaries would still 
be required to keep full and complete records, together with pertinent 
data and memoranda, of all transactions relating to their business of 
dealing in commodity interests,\4\ notwithstanding the fact that the 
contract market or DTF on which the intermediaries transacted business 
would be exempt from the provisions of the rule that relate 
specifically to the exchange. When an intermediary transacts business 
on an exempt board of trade,\5\ these transactions are generally 
subject only to the Commission's antifraud and antimanipulation 
authority to the extent applicable. Similarly, where a DTF permits 
trading only on a principal-to-principal basis, CFTC rules related only 
to intermediaries will not generally be applicable to such a market 
structure.\6\
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    \3\ See 66 FR at 14263, 14264 (stating in the proposed 
rulemaking to implement the new statutory framework that contract 
markets and DTFs, respectively, would be exempt from all Commission 
regulations applicable to a trading facility that are not reserved 
in the relevant Part). Unless otherwise noted, Commission rules 
referred to herein are found at 17 CFR Ch. I (2001).
    \4\ These required records include order tickets, a daily 
transaction record, a record of transactions by customer account, a 
financial ledger record and documentation concerning exchanges of 
futures for physicals.
    \5\ While the Act as amended provides that exempt commercial 
markets be restricted to transactions entered on a principal-to-
principal basis (Section 2(h)(3)(A) of the Act), exempt boards of 
trade are not so restricted (Section 5d of the Act).
    \6\ A more complete description of the various new market 
structures can be found in ``A New Regulatory Framework for Trading 
Facilities, Intermediaries and Clearing Organizations,'' 66 FR at 
14264-66 (Mar. 9, 2001) (proposed rules).
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    Certain of the Commission's proposed rule amendments, such as those 
concerning ethics training and the definition of the term 
``principal,'' would affect all registered firms. The other new 
proposed rules and rule amendments would affect mainly FCMs and IBs, 
and are not applicable to commodity pool operators (CPOs) and commodity 
trading advisors (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.
    As examples of its ongoing reform efforts with regard to such 
persons, the Commission has adopted changes that simplify the 
regulatory framework for CPOs and CTAs dealing with certain highly 
accredited pool participants or clients, or ``qualified eligible 
persons,''

[[Page 45223]]

and made this relief under CFTC Rule 4.7 available to more CPOs and 
CTAs by adding more persons to the definition of a ``qualified eligible 
person.'' \7\ The Commission has also adopted Rule 4.14(a)(9) to create 
an additional exemption from registration for CTAs that provide 
standardized advice by means of media such as newsletters, Internet web 
sites, and non-customized computer software.\8\ Further, the Commission 
amended Part 30 of its rules by adding Rule 30.12 to allow CTAs with 
total assets under management exceeding $50 million to place, directly 
with unregistered foreign futures and options brokers, orders for 
foreign futures or foreign options contracts for customers that do not 
otherwise qualify as ``eligible swap participants.''\9\ In adopting 
Rule 30.12, the Commission incorporated industry requests to focus on 
the financial sophistication of the person managing the assets, rather 
than on the sophistication of the individual client advised by the 
CTA.\10\ In addition, the CFTC adopted rule amendments to permit CPOs 
to deliver to prospective participants a summary ``profile'' document 
containing only key information about a pool prior to providing them 
with the pool's complete disclosure document.\11\
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    \7\ See 65 FR 47848 (Aug. 4, 2000).
    \8\ See 65 FR 12938 (Mar. 10, 2000).
    \9\ See 65 FR 47275 (Aug. 2, 2000).
    \10\ Id. at 47277.
    \11\ 65 FR 58648 (Oct. 2, 2000).
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II. The Proposed Rules

A. 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),\12\ all 
officers of a registrant were treated as principals and required to 
register as such.\13\ 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 is proposing 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.\14\ A registrant would, therefore, no longer 
be required to treat every officer as a principal, but only those who 
meet the criteria of the rule as revised.\15\ The proposed amendment to 
the definition of principal thus reduces 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, remain listed as such.
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    \12\ 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.
    \13\ This interpretation was consistent with the language of the 
second proviso to Section 8a(2) of the Act, which states that a 
principal shall mean a general partner of a partnership, any 
officer, director or beneficial owner of at least ten percent of the 
voting shares of a corporation, ``and any other person that the 
Commission by rule, regulation, or order determines has the power, 
directly or indirectly, through agreement or otherwise, to exercise 
a controlling influence over the activities of [firms] which are 
subject to regulation by the Commission.''
    \14\ Thus, the principal definition would include, if the entity 
is organized as a sole proprietorship, the proprietor; if a 
partnership, any general partner (including individuals and 
entities, such as corporations); if a corporation, any director, the 
president, chief executive officer, chief operating officer, chief 
financial officer, and any person in charge of a principal business 
unit, division or function subject to regulation by the Commission; 
and, if a limited liability company or limited liability 
partnership, any director, the president, chief executive officer, 
chief operating officer, chief financial officer, the manager, 
managing member or those members vested with management authority 
for the entity, and any person in charge of a principal business 
unit, division or function subject to regulation by the Commission. 
See proposed Rule 3.1(a)(1).
    The reference in the proposed amendment to the ``principal'' 
definition to ``any person in charge of a principal business unit 
subject to regulation by the Commission'' would not include 
departments such as human resources or administration.
    \15\ As proposed, 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. What constitutes ``a 
controlling influence'' will generally be left for determination on 
a case-by-case basis; however, such influence would be ascribed to, 
among others, those persons who have policymaking or managerial 
authority over the activities of an applicant or registrant that are 
subject to Commission regulation.
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    The principal definition would also include an individual who 
directly or indirectly, through agreement, holding company, nominee, 
trust or otherwise: (1) Is the owner of ten percent or more of any 
class of a firm's securities; (2) is entitled to vote ten percent or 
more of any class of a firm's voting securities; (3) has the power to 
sell or direct the sale of ten percent or more of any class of a firm's 
voting securities; (4) has contributed ten percent or more of a firm's 
capital; or (5) is entitled to receive ten percent or more of a firm's 
profits. Further, the principal definition would include an entity that 
is the direct owner of ten percent or more of any class of a firm's 
securities or that has directly contributed ten percent or more of a 
firm's capital. These proposed amendments would permit the deletion of 
Rule 3.10(a)(2)(ii), which has proved somewhat unwieldy in 
practice.\16\
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    \16\ The proposed amendments would also result in the 
redesignation of Rule 3.10(a)(2)(i) as Rule 3.10(a)(2).
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    The Commission is also proposing 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 would only be required to provide business backgrounds and 
proprietary trading results for those principals who participate in 
making trading or operational decisions, or supervise persons so 
engaged, and not for all officers.
    Finally, in response to industry suggestions, the Commission is 
proposing 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. In its place, a new paragraph (a)(2) 
would be added 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. Proposed 
Rule 3.31(a)(2) was drafted to closely parallel Rule 3.10(a)(2)(i),\17\ 
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 the National Futures 
Association (NFA), a Form 8-R for that principal must accompany the 
Form 3-R amending the registrant's application for registration.\18\
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    \17\ As noted in the preceding footnote, this provision is 
proposed to be redesignated as Rule 3.10(a)(2).
    \18\ An additional conforming amendment is proposed to Rule 
3.21(c) that would reflect the deletion of Rule 3.32, and the 
addition of new paragraph (a)(2) to Rule 3.31.
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2. Application Procedures for IBs and FCMs
    The Commission is proposing that applicants for registration as 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

[[Page 45224]]

than be required to provide certified financial statements with their 
registration application.\19\ A firm taking 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.\20\ This alternative procedure is modeled on similar 
procedures in the securities industry.\21\
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    \19\ See Proposed Rule 1.10(a)(2)(ii)(A)(3). However, those IB 
applicants who do not raise their own capital would continue to be 
required to file a guarantee agreement entered into with an FCM with 
their registration application. 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).
    Filing of financial statements or guarantee agreements would be 
unnecessary for any FCM or IB registered in accordance with Proposed 
Rule 3.10(a)(3), which applies to those securities brokers or 
dealers registering as FCMs or IBs because their only futures-
related activities involve security futures products. See 66 FR 
27476.
    \20\ Although the proposed rule would not require IBs to file a 
certified financial statement with their application for 
registration, this does not preclude any SRO from imposing this 
requirement before accepting an IB for membership.
    \21\ Certain technical amendments are also proposed to be made 
to paragraph (j)(8), which addresses guaranteed IBs' compliance with 
the financial reporting requirements in the event that their 
guarantee agreement has been terminated. Such IBs will be deemed to 
have satisfied the Commission's minimum financial requirements if 
they enter into another guarantee agreement or file a certified 1-
FR-IB statement.
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    With respect to the six-month review that must be conducted should 
an IB choose not to file a certified financial statement with its 
registration application, the Commission believes that the six-month 
time period for the review of 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.\22\ However, the Commission notes that the DSRO 
would be able to conduct the review telephonically where the DSRO does 
not have reason to question the IB's capital. In addition, an applicant 
that does 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.
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    \22\ 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).
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    The Commission notes that the December Release contained a similar 
provision for FCM applicants. NFA commented that ``[t]here is a 
significant difference in the role of FCMs and IBs in terms of safety 
of customer funds. The one-time filing requirement for FCMs is not 
unduly burdensome, especially in light of the potential exposure if the 
initial financial statement is incorrect.'' \23\ Upon further 
consideration in light of the comment filed by NFA opposing the 
elimination of the certified financial report for an FCM applicant, the 
Commission has determined not to repropose the rule change for FCM 
applicants.
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    \23\ NFA Comment Letter at 4 (Aug. 7, 2000), which can be found 
on the Commission's website at http://www.cftc.gov/files/foia/comment00/foicf0022c024.pdf.
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3. Special Procedures Available to Firms Subject to Securities or 
Banking Regulation
    The December Release contained a ``passporting'' registration 
process for certain otherwise federally regulated FCMs or IBs who 
conduct business on futures exchanges solely for institutional 
customers.\24\ The CFMA includes a passporting provision that is 
broader than the CFTC's proposal in certain respects and narrower in 
others. The CFMA provision allows entities subject to regulation by an 
appropriate financial regulator to act as intermediaries on a DTF 
subject to the DTF's election, provided that the entity meets certain 
conditions. Specifically, section 111(e) of the CFMA authorizes a DTF 
to allow by rule a broker-dealer, depository institution, or 
institution of the Farm Credit System to act as an intermediary in 
transactions executed on the facility for any customer of the broker-
dealer, depository institution or Farm Credit institution, provided 
that the firm is in good standing with its appropriate regulator. These 
passporting intermediaries would not be required to register with the 
Commission as an FCM or IB (or even to file a notice registration) or 
to become a member of a registered futures association, unless they 
carry or hold customer accounts or funds for transactions on the DTF 
for more than one business day.\25\ In light of the CFMA provisions, 
the Commission will not be separately reproposing its earlier 
passporting proposal, or the related amendments to Rules 1.17(a)(2) or 
1.52(m).\26\ As noted above, however, the Commission recently adopted 
rules that would permit securities brokers or dealers who limit their 
futures-related activities to security futures products to register as 
FCMs or IBs upon the submission of notice to the Commission.\27\
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    \24\ The term ``institutional customer'' is defined in proposed 
Rule 1.3(g) as an ``eligible contract participant'' within the 
meaning of section 1a(12) of the Act as amended, and generally 
refers to a non-retail customer.
    \25\ These firms and their salespersons would remain subject to 
antifraud provisions of the Act and rules thereunder, however.
    \26\ In the December Release, the Commission would have extended 
its passporting provision to allow broker-dealers and firms 
regulated by appropriate banking regulators to conduct transactions 
for institutional customers on designated contract markets and 
recognized futures exchanges in addition to DTFs. In light of the 
provisions contained in the CFMA, however, a broker-dealer, 
depository institution or Farm Credit institution seeking to act as 
an intermediary on a designated contract market will be required to 
register as an FCM or IB and become a member of a registered futures 
association, even if the firm carries or holds accounts or funds for 
less than one business day.
    Section 5a of the Act as amended further directs the Commission, 
in coordination with the SEC, the Secretary of the Treasury, and 
Federal banking regulatory agencies, to adopt rules and take any 
other appropriate action to facilitate the implementation of the 
passporting procedure by these otherwise federally regulated 
entities.
    \27\ See note 2 supra; see also ``Exemption for Certain Brokers 
or Dealers from Provisions of the Commodity Exchange Act and CFTC 
Regulations,'' 66 FR __ (Aug. 17, 2001) (adopting new rule to govern 
the granting of orders exempting notice-registered broker-dealers 
from provisions of the Act and Commission regulations where the 
Commission determines that the exemption is necessary or appropriate 
in the public interest and consistent with the protection of 
investors).
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    The Commission is separately considering updating and making more 
flexible its minimum net capital requirements for FCMs by adopting 
risk-based net capital requirements.

B. Fitness and Supervision

    An essential component of maintaining fitness is continuing 
education concerning obligations under the Act and rules thereunder. In 
order to provide flexibility and ease compliance for all registrants, 
the Commission is proposing to delete Rule 3.34 and instead to 
implement Congressional intent regarding ethics training through a 
Statement of Acceptable Practices. Rule 3.34 currently specifies 
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 believes that greater flexibility regarding ethics training 
and proficiency testing could be afforded to registrants than is now 
permitted under Rule 3.34. For registrants seeking guidance as to the 
maintenance of proper ethics training procedures, the Statement of 
Acceptable

[[Page 45225]]

Practices would serve as a ``safe harbor.'' \28\
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    \28\ For instance, under the Statement of Acceptable Practices, 
registrants may engage in ethics training programs sponsored by the 
registrants themselves, their DSROs, trade associations or others. 
The format of such training, whether by personal or recorded 
instruction, or by circulation of written materials such as legal 
cases, interpretative letters or advisories, would also be left to 
the discretion of registrants and DSROs. It would also be 
permissible to require training on whatever periodic basis the 
registrants and DSROs deem appropriate. Thus, the Commission would 
not specify any particular programs or procedures that must be 
followed.
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    Although the Commission notes the possibility 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 would 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 would allow registrants to adopt ethics 
training programs that are better tailored to their individual 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 is also proposing to publish its recent ``guidance 
letters'' issued to NFA concerning the treatment of SRO disciplinary 
actions in assessing the fitness of floor brokers (FBs) and floor 
traders (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. 
These letters would be added to the end of Appendix A to Part 3 as they 
relate to the issue of ``other good cause,'' which is discussed at the 
end of Appendix A.

C. Financial Requirements

1. Trading by Non-Institutional Customers on DTFs
    Although access to DTFs is generally limited to institutional 
customers,\29\ under certain conditions a DTF may permit non-
institutional customers to enter into transactions thereon. To address 
the higher degree of risk associated with the lower regulatory 
protections offered to DTF participants, such non-institutional 
customer business may be transacted through a registered FCM that (1) 
is a clearing member of a derivatives clearing organization, and (2) 
has a minimum net capital of at least $20 million.\30\ Such an FCM is 
considered to be more capable of properly handling these transactions 
and the associated risk. In order to provide guidance to non-
institutional customers trading through a highly-capitalized FCM, NFA 
will issue a Statement of Acceptable Practices regarding additional 
disclosures to be made to such customers trading on DTFs and on related 
issues involving price dissemination.
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    \29\ See new Part 37 of the Commission rules, 66 FR 42256 at 
42271 (Aug. 10, 2001).
    \30\ Section 5a of the Act, 7 U.S.C. 7a, as amended by Pub. L. 
No. 106-554, 114 Stat. 2763.
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    In the December Release, the Commission had determined to add a new 
Rule 4.32 that would also permit non-institutional customers to trade 
on a DTF through certain registered CTAs. The Commission is again 
proposing to adopt this rule to permit registered CTAs to enter trades 
on or subject to the rules of a DTF on behalf of a non-institutional 
customer, provided that the CTA: (1) Directs the client's commodity 
interest account; \31\ (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. 
However, 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. See Rule 
1.17(a)(1)(ii)(B).
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    \31\ 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.''
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    As with a highly-capitalized FCM, a CTA meeting this asset test, in 
its capacity as a professional asset manager, would have the 
appropriate financial sophistication to handle the risk associated with 
trading for non-institutional customers on a DTF.\32\ Additionally, 
focusing on the financial sophistication of the person managing the 
assets, rather than on the sophistication of the individual client 
advised by the CTA, is consistent with the approach taken by the 
Commission in adopting Rule 30.12.\33\
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    \32\ See Section 1a(12)(C) of the Act.
    \33\ See 65 FR at 47277.
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2. Segregation of Funds
    The June 2000 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.\34\
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    \34\ 65 FR at 39014.
---------------------------------------------------------------------------

    With respect to the opt-out issue, 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. Consequently, in the 
Adopting Release the Commission determined to continue to study the 
issue and defer action in this area.\35\ Under Section 5a(f) of the 
Act, as amended by the CFMA, however, the Commission was required to 
adopt rules within 180 days after the date of enactment of the CFMA to 
permit a registered DTF to authorize an FCM to offer its customers that 
are eligible contract participants the right not to have their funds 
that are carried by the FCM for purposes of trading on the registered 
DTF, separately accounted for and segregated. Accordingly, on April 19, 
2001, the Commission adopted new rules that, effective June 19, 2001, 
allow FCMs to offer eligible contract participants to opt out of 
segregation.\36\ The Commission also amended existing rules concerning, 
among other things, the bankruptcy treatment of a customer that opts 
out of segregation.
---------------------------------------------------------------------------

    \35\ See 65 FR at 78001.
    \36\ 66 FR 20740 (April 25, 2001).
---------------------------------------------------------------------------

3. Investment of Customer Funds
    The Commission did not withdraw its final rules and rule amendments 
concerning the investment of customer funds, and those rules and rule 
amendments became effective on December 28, 2000. To facilitate the 
implementation of Rule 1.25 and its related amendments, new paragraph 
(a)(7) to Rule 140.91 is proposed to be added to delegate to the 
Director of the Division of Trading and Markets any functions reserved 
to the Commission in Rule 1.25 regarding permitted investments for 
customer funds. The Commission also wishes to note that it has 
determined not to rescind Division of Trading and Markets Financial and 
Segregation Interpretation No. 9 (Interp.

[[Page 45226]]

9).\37\ The Commission had previously indicated that it would do so in 
light of the fact that amendments to Rule 1.25 would now permit 
investment of customer funds in money market mutual funds (MMMFs).\38\ 
Because Interp. 9 addresses the use of money market deposit accounts 
rather than MMMFs, however, the Commission has decided not to rescind 
Interp. 9.
---------------------------------------------------------------------------

    \37\ Comm. Fut. L. Rep. (CCH) para. 7119 (Nov. 23, 1983).
    \38\ See 65 FR at 78001 n.53.
---------------------------------------------------------------------------

D. Risk Disclosure and Account Statements

    The disclosure of risks by intermediaries is an important customer 
protection. Over the years, however, certain persons have suggested 
that customers would be better protected by receiving risk disclosures 
more attuned to their relative level of sophistication and to the 
particular instruments they trade. Other commenters have suggested that 
disclosure obligations could be simplified and streamlined.
    In keeping with these observations, the Commission proposes that 
non-institutional customers continue to receive the risk disclosures 
regarding futures and options trading that are currently required. 
Thus, intermediaries will continue to be required to obtain prior 
acknowledgement of their customers' receipt of the basic risk 
disclosure statements relating to futures and options in accordance 
with Rules 1.55 and 33.7. For institutional customers, as provided in 
proposed Rule 1.55(f), there would continue to be no general disclosure 
requirements.\39\ The Commission also may consider issuing a Statement 
of Acceptable Practices on disclosure to institutional customers, with 
industry input, at a later date. As noted above, the Commission also 
anticipates that NFA will develop appropriate disclosure for qualifying 
FCMs to provide to retail customers permitted to trade on DTFs.
---------------------------------------------------------------------------

    \39\ In contrast to the December Release, which did not restrict 
the type of governmental entities that would be considered to be 
institutional customers, the Act as amended imposes certain 
limitations on the governmental entities that will be considered to 
be eligible contract participants. Compare 65 FR at 78035 with 
section 1a(12)(A)(vii) of the Act as amended.
---------------------------------------------------------------------------

    The Commission recognizes that there are certain areas of the 
account opening process that may be streamlined. Accordingly, in 
proposed amendments to Rules 1.55(d)(1) and (2), the Commission would 
permit certain required disclosures, such as those concerning consent 
to (1) allow electronic transmission of statements under proposed new 
Rule 1.33(g),\40\ or (2) transfer funds out of segregated accounts to 
another account (such as a money market account), to be included in a 
customer agreement and acknowledged through a ``single signature,'' 
rather than the multiple signatures that are currently required.\41\ 
The single signature could be made electronically as provided for in 
recently-adopted Rules 1.3(tt) and 1.4.\42\
---------------------------------------------------------------------------

    \40\ See infra.
    \41\ Contemporaneously with opening an account, an FCM may 
obtain 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. However, the FCM 
remains 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.
    \42\ 65 FR 12466 (Mar. 9, 2000).
---------------------------------------------------------------------------

E. Trading Standards

    The Commission is proposing 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, with certain conforming changes to reflect the recent 
statutory changes to the Act. These requirements would be extended to 
trading by non-institutional customers on DTFs under proposed Rule 
155.6(a). These rules over the years have helped the Commission deter 
such practices as ``front-running,'' ``trading ahead,'' ``bucketing,'' 
and improper disclosure of customer orders. However, for intermediation 
of trades by institutional customers at DTFs, the Commission is 
proposing a new Rule 155.6(b), which sets forth a general standard of 
practice in this area. The Commission believes that this 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.
    Although proposed new Rule 155.6 is intended to proscribe the same 
trade practice abuses as Rules 155.1, 155.3 and 155.4 the Commission 
encourages specific suggestions regarding how these rules might be 
streamlined.\43\ The Commission also will consider the development of a 
Statement of Acceptable Practices to be issued at a later date, with 
the consultation of DTFs, regarding appropriate procedures that should 
be employed in order to ensure compliance with the general 
standard.\44\
---------------------------------------------------------------------------

    \43\ The Commission recently proposed to prohibit dual trading 
in security futures products on designated contract markets and 
registered DTFs, as required by Section 251(c) of the CFMA, which 
amended Section 4j of the Act. See 66 FR 36218 (July 11, 2001).
    \44\ Because the DTF is a new institution, and it is not known 
how such an institution would choose to operate (e.g., a DTF may 
choose to sponsor trading in a traditional open-outcry pit trading 
system, in a purely automated, electronic trading format, or in a 
combination of the two formats), the Commission is not at this time 
issuing a Statement of Acceptable Practices in this area.
---------------------------------------------------------------------------

F. Recordkeeping

1. Customer Account Statements
    In keeping with changes in technology and commercial practices, the 
Commission is proposing to codify its previous Advisory relating to the 
electronic transmission of account statements in a new Rule 
1.33(g).\45\ 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, including: (1) The electronic 
medium or source through which statements would be delivered, (2) the 
duration, whether indefinite or not, of the period during which consent 
would be effective, (3) any charges for such service, (4) the 
information that would be delivered electronically, and (5) a statement 
that consent to electronic delivery may be revoked at any time. For 
non-institutional customers, the FCM would be required to obtain the 
customer's signed consent acknowledging the disclosures, prior to the 
transmission of any statement by means of electronic media. The 
acknowledgement could be made through a single signature in accordance 
with Rule 1.55 as discussed above. Institutional customers would not 
need to provide written consent, and the Commission recommends that 
FCMs confirm procedures relating to electronic transmission of 
statements to institutional customers as described in the above-
referenced Advisory. Any statement required to be furnished to a person 
other than a customer in accordance with paragraph (d) of Rule

[[Page 45227]]

1.33 would also be permitted to be furnished by electronic media.
---------------------------------------------------------------------------

    \45\ 65 FR at 39017; see also 62 FR 31507 (June 10, 1997).
---------------------------------------------------------------------------

2. Close-Out of Offsetting Positions
    The Commission also proposes to revise Rule 1.46 to allow customers 
or account controllers to instruct the FCM (in writing or orally) if 
they wish to deviate from the current 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.\46\ 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.\47\
---------------------------------------------------------------------------

    \46\ An FCM must take into consideration positions in separate 
accounts of the same customer that it is carrying in applying Rule 
1.46. See 57 FR 55082, 55083 n.2 (Nov. 24, 1992), citing U.S. 
Department of Agriculture, Commodity Exchange Authority 
Administrative Determination No. 134 (May 25, 1948).
    \47\ Generally, responsibility for transmitting instructions 
regarding offset would lie with the registrant directing trading. 
Thus, where a pool's trading is directed by a CTA, it would be the 
CTA who would be responsible for transmitting offset instructions, 
not the CPO.
---------------------------------------------------------------------------

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

III. Section 4(c) Findings

    Certain of the rules and rule amendments discussed herein are being 
proposed 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 any of the provisions of the Act (except certain 
provisions governing a group or index of securities and security 
futures products). As relevant here, when granting an exemption 
pursuant to section 4(c), the Commission must find that the exemption 
would be consistent with the public interest.
    As explained above, the proposed rules and rule amendments would 
provide greater flexibility for intermediaries and their customers in 
several areas. Specifically, the Commission is proposing rule 
amendments concerning the definition of the term ``principal'' that are 
narrower than the language of the second proviso of Section 8a(2) of 
the Act. These amendments 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. The Commission 
believes that, in light of the conditions and safeguards provided for 
under the rules and rule amendments, the exemptive relief will have no 
adverse effect on any of the regulatory or self-regulatory 
responsibilities imposed by the Act. Moreover, the Commission believes 
that the additional flexibility for intermediaries and their customers 
provided for by the rules and rule amendments proposed herein would be 
consistent with the public interest. The Commission invites public 
comment on this finding.

IV. Cost-Benefit Analysis

    Section 15 of the Act, as amended by section 119 of the CFMA, 
requires the Commission to consider the costs and benefits of its 
action before issuing a new regulation under the Act. By its terms, 
section 15 as amended does not require the Commission to quantify the 
costs and benefits of a new regulation or to determine whether the 
benefits of the proposed regulation outweigh its costs. Rather, section 
15 simply requires the Commission to ``consider the costs and 
benefits'' of its action.
    The amended section 15 further specifies that costs and benefits 
shall be evaluated in light of five broad areas of market and public 
concern: protection of market participants and the public; efficiency, 
competitiveness, and financial integrity of futures markets; price 
discovery; sound risk management practices; and other public interest 
considerations. Accordingly, the Commission could in its discretion 
give greater weight to any one of the five enumerated areas and could 
in its discretion determine that, notwithstanding its costs, a 
particular rule was necessary or appropriate to protect the public 
interest or to effectuate any of the provisions or to accomplish any of 
the purposes of the Act.
    The proposed rulemaking constitutes a package of related rule 
provisions affecting market intermediaries. The proposed rules and rule 
amendments are intended to provide greater flexibility for 
intermediaries and their customers in their methods of doing business. 
The Commission is considering the costs and benefits of these rules in 
light of the specific provisions of section 15 of the Act:
    1. Protection of market participants and the public. In general, 
the proposed rules would be expected to cost little in terms of 
diminishing the protection of market participants and the public.
    2. Efficiency and competition. The proposed rules are expected to 
benefit competition and market efficiency broadly by providing 
increased flexibility for intermediaries. For instance, the Commission 
is proposing new 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 personnel that exercise or are in a position to 
exercise a controlling influence over the activities of the registrant 
will remain listed as such. In addition, FCMs will be permitted to 
obtain several consents from consumers with a single signature. The 
rules do not impose a cost on market efficiency or competition.
    3. Financial integrity of futures markets and price discovery. The 
proposed rules should have no effect, from the standpoint of imposing 
costs or creating benefits, on the financial integrity or price 
discovery function of the futures and options markets or on the risk 
management practices of FCMs, CTAs, CPOs or IBs.
    4. Sound risk management practices. The Commission has previously 
adopted amendments to its rules regarding the investment of customer 
funds that were originally part of the December Release. These 
amendments expanded the list of permissible investments in which FCMs 
and clearing organizations are permitted to invest cash segregated for 
the benefit of commodity customers, thereby enhancing the yield 
available to FCMs, clearing organizations and their customers, and 
contained specific risk-limiting features intended to minimize credit 
risk, market risk, and liquidity risk.
    5. Other public interest considerations. The Commission's rules

[[Page 45228]]

implementing the new regulatory structure would open up new markets for 
the benefit of market participants and the public, thus making 
available more customized products for risk management purposes. The 
proposed new rules and rule amendments contained herein would establish 
appropriate safeguards for those customers seeking to trade on the new 
DTF and security futures product markets.
    After considering these factors, the Commission has determined to 
propose the revisions to its rules discussed above. The Commission 
invites public comment on its application of the new cost-benefit 
provision. Commenters also are invited to submit any data that they may 
have quantifying the costs and benefits of the proposed rules with 
their comment letters.

V. 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 
proposed 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.\48\ The Commission has previously determined 
that registered FCMs, CPOs, LTMs and ATOMs are not small entities for 
the purpose of the RFA.\49\ 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 proposed herein would not require any registrant to change 
its current method of doing business. For many registrants, the 
proposed revisions should decrease the number of persons within the 
registrant's organization who would be considered principals under the 
CFTC's rules. Further, the proposed revisions should reduce, rather 
than increase, the regulatory requirements that apply to registrants 
and applicants for registration, regardless of size. Accordingly, 
pursuant to 5 U.S.C. 605(b), the Acting Chairman, on behalf of the 
Commission, certifies that the proposed amendments will not have a 
significant economic impact on a substantial number of small entities. 
The Commission invites the public to comment on this finding.
---------------------------------------------------------------------------

    \48\ 47 FR 18618-21 (Apr. 30, 1982).
    \49\ 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

    This proposed rulemaking contains information collection 
requirements. As required by the Paperwork Reduction Act of 1995, 44 
U.S.C. Sec. 3507(d), the Commission has submitted a copy of these 
proposed amendments to its rules to the Office of Management and Budget 
(OMB) for its review.
Collection of Information
    Rules Relating to the Operations and Activities of Commodity Pool 
Operators and Commodity Trading Advisors and to Monthly Reporting by 
Futures Commission Merchants, OMB Control Number 3038-0005.
    Rules Pertaining to Contract Markets and Their Members, OMB Control 
Number 3038-0022.
    Regulations and Forms Pertaining to the Financial Integrity of the 
Marketplace, OMB Control Number 3038-0024.
    The proposed amendments would not affect the paperwork burdens 
associated with the above collections of information, which have 
previously been approved by OMB in connection with the Commission's 
previous submission of the proposed rules.
    Rules, Regulations and Forms for Domestic and Foreign Futures and 
Options Relating to Registration with the Commission, OMB Control 
Number 3038-0023.
    The proposed rules will reduce the collection of information burden 
previously approved by OMB by 2 hours because of the elimination of 
Rule 3.32:
    Estimated number of respondents (after proposed amendment): 0.
    Annual responses by each respondent: 0.
    Estimated average hours per response: 0.
    Annual reporting burden: 0 hours.
    The annual reporting burden of 7,337 hours represents a reduction 
of 2 hours as a result of the proposed new rules.
    Copies of the information collection submission to OMB are 
available from the CFTC Clearance Officer, 1155 21st Street, NW., 
Washington, DC 20581, (202) 418-5160.
    Persons wishing to comment on the information collection 
requirements that would be required by these proposed rules should 
contact the Office of Information and Regulatory Affairs, Office of 
Management and Budget, Room 10235, New Executive Office Building, 
Washington, DC 20503, Attn: Desk Officer for the Commodity Futures 
Trading Commission.
    The Commission considers comments by the public on this proposed 
collection of information in--
     Evaluating whether the proposed collection of information 
is necessary for the proper performance of the functions of the 
Commission, including whether the information will have a practical 
use;
     Evaluating the accuracy of the Commission's estimate of 
the burden of the proposed collection of information including the 
validity of the methodology and assumptions used;
     Enhancing the quality, utility, and clarity of the 
information to be collected; and
     Minimizing the burden of the collection of the information 
on those who are to respond, including through the use of appropriate 
automated, electronic, mechanical or other technological collection 
techniques or other forms of information technology, e.g., permitting 
electronic submissions of responses.
    OMB is required to make a decision concerning the collection of 
information contained in these proposed regulations between 30 and 60 
days after publication of this document in the Federal Register. 
Therefore, a comment to OMB is best assured of having its full effect 
if OMB receives it within 30 days of publication. This does not affect 
the deadline for the public to comment to the Commission on the 
proposed regulations.
    Copies of the information collection submission to OMB are 
available from the CFTC Clearance Officer, 1155 21st Street, NW., 
Washington, DC 20581 (202) 418-5160.

Lists of Subjects

17 CFR Part 1

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

17 CFR Part 3

    Administrative practice and procedure, Brokers, Commodity futures, 
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.

[[Page 45229]]

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.

    For the reasons discussed in the preamble, the Commission hereby 
proposes to amend Chapter I of Title 17 of the Code of Federal 
Regulations as follows:

PART 1--GENERAL REGULATIONS UNDER THE COMMODITY EXCHANGE ACT

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

    Authority: 7 U.S.C. 1a, 2, 5, 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, as amended by Appendix E of Pub. 
L. No. 106-554, 114 Stat. 2763 (2000).

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


Sec. 1.3  Definitions.

* * * * *
    (g) Institutional customer. This term has the same meaning as 
``eligible contract participant'' as defined in section 1a(12) of the 
Act.
* * * * *
    3. Section 1.10 is amended by revising paragraphs (a)(2) and (j)(8) 
to read as follows:


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

    (a) * * *
    (2)(i)(A) Except as provided in paragraphs (a)(3) and (h) of this 
section, each person who files an application for registration as a 
futures commission merchant and who is not so registered at the time of 
such filing, must, concurrently with the filing of such application 
file either:
    (1) A Form 1-FR-FCM certified by an independent public accountant 
in accordance with Sec. 1.16 as of a date not more than 45 days prior 
to the date on which such report is filed; or
    (2) 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.
    (B) 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)(A) Except as provided in paragraphs (a)(3) and (h) of this 
section, each person who files an application for registration as an 
introducing broker and who is not so registered at the time of such 
filing, must, concurrently with the filing of such application file 
either:
    (1) A Form 1-FR-IB certified by an independent public accountant in 
accordance with Sec. 1.16 as of a date not more than 45 days prior to 
the date on which such report is filed;
    (2) 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 and a Form 1-FR-IB 
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;
    (3) 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
    (4) A guarantee agreement.
    (B) Each person filing in accordance with paragraphs (a)(2)(ii)(A) 
(1), (2) or (3) 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.
* * * * *
    (j) * * *
    (8)(i)(A) An introducing broker which is a party to a guarantee 
agreement which has been terminated in accordance with the provisions 
of paragraph (j)(5) of this section, or which is due to expire in 
accordance with the provisions of paragraph (j)(4)(ii) of this section, 
must cease doing business as an introducing broker on or before the 
effective date of such termination or expiration unless, on or before 
10 days prior to the effective date of such termination or expiration 
or such other period of time as the Commission or the designated self-
regulatory organization may allow for good cause shown, the introducing 
broker files with its designated self-regulatory organization either a 
new guarantee agreement effective as of the day following the date of 
termination of the existing agreement, or, in the case of a guarantee 
agreement which is due to expire in accordance with the provisions of 
paragraph (j)(4)(ii) of this section, a new guarantee agreement 
effective on or before such expiration, or either:
    (1) A Form 1-FR-IB certified by an independent public accountant in 
accordance with Sec. 1.16 as of a date not more than 45 days prior to 
the date on which the report is filed; or
    (2) A Form 1-FR-IB as of a date not more than 17 business days 
prior to the date on which the report is filed and a Form 1-FR-IB 
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 the report is filed.
    (B) Each person filing a Form 1-FR-IB in accordance with this 
section must include with the 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)(A) Notwithstanding the provisions of paragraph (j)(8)(i) of 
this section or of Sec. 1.17(a), an introducing broker that is a party 
to a guarantee agreement that has been terminated in accordance with 
the provisions of paragraph (j)(5)(ii) of this section shall not be 
deemed to be in violation of the minimum adjusted net capital 
requirement of Sec. 1.17(a)(1)(ii) or (a)(2) for 30 days following such 
termination. Such an introducing broker must cease doing business as an 
introducing broker on or after the effective date of such termination, 
and may not resume doing business as an introducing broker unless and 
until it files a new agreement or either:
    (1) A Form 1-FR-IB certified by an independent public accountant in 
accordance with Sec. 1.16 of this part as of a date not more than 45 
days prior to the date on which the report is filed; or
    (2) A Form 1-FR-IB as of a date not more than 17 business days 
prior to the date on which the report is filed and a Form 1-FR-IB 
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 the report is filed.
    (B) Each person filing a Form 1-FR-IB in accordance with this 
section must include with the 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

[[Page 45230]]

(a)(1)(iii) and by adding new paragraph (a)(1)(ii) 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 
or any commodity option on or subject to the rules of a registered 
derivatives transaction execution facility from any customer who does 
not qualify as an ``institutional customer'' as defined in Sec. 1.3(g) 
must:
    (A) Be a clearing member of a derivatives clearing organization and 
maintain 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.
* * * * *
    5. 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.
* * * * *
    6. 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 designated contract market or 
registered derivatives transaction execution 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).
* * * * *
    7. 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 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 
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 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'' as defined in Sec. 1.3(g) 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) and 
190.10(c) of this chapter.
* * * * *

PART 3--REGISTRATION

    8. 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, 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.

    9. 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 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

[[Page 45231]]

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
* * * * *


Sec. 3.10  [Amended]

    10. Section 3.10 is amended by removing paragraph (a)(2)(ii) and by 
redesignating paragraph (a)(2)(i) as paragraph (a)(2).
    11. 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) 
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:
* * * * *
    12. 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]

    13. Section 3.32 is removed.


Sec. 3.34  [Removed]

    14. Section 3.34 is removed.
    15. Appendix A to Part 3 is amended by adding to the end thereto 
the following:

Appendix A to Part 3--Interpretative 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 
60606-3447
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 FR 36050 (July 3, 1997). The Notice and Order 
authorized NFA to grant or to maintain, 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

[[Page 45232]]

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 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 
60606-3447
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

[[Page 45233]]

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 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.

    16. Part 3 is amended by adding Appendix B to read as follows:

[[Page 45234]]

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. 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, 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 
registered derivatives transaction execution 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 and 
registered derivatives transaction execution 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 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 or registered derivatives transaction 
execution 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 or 
registered derivatives transaction execution 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

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

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

    18. 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.
* * * * *
    19. 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) * * *

[[Page 45235]]

    (v) Each principal of the persons referred to in this paragraph 
(f)(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;
* * * * *
    20. Section 4.32 is added to read as follows:


Sec. 4.32  Trading on a Registered Derivatives Transaction Execution 
Facility for Non-Institutional Customers.

    (a) A registered commodity trading advisor may enter trades on or 
subject to the rules of a registered derivatives transaction execution 
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 registered derivatives 
transaction execution 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.
    21. 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

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

    Authority: 7 U.S.C. 2, 12a.

    23. Section 140.91 is amended by adding 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

    24. 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.

    25. Section 155.6 is added to read as follows:


Sec. 155.6  Trading standards for the transaction of business on 
registered derivatives transaction execution 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) on a registered 
derivatives transaction execution 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 registered derivatives transaction 
execution facility.

    Issued in Washington, D.C. on August 20, 2001 by the Commission.
Catherine D. Dixon,
Assistant Secretary of the Commission.
[FR Doc. 01-21451 Filed 8-27-01; 8:45 am]
BILLING CODE 6351-01-P