[Federal Register Volume 66, Number 188 (Thursday, September 27, 2001)]
[Notices]
[Pages 49439-49442]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 01-24184]
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SECURITIES AND EXCHANGE COMMISSION
[Release No. 34-44823; File No. SR-NFA-2001-01]
Self-Regulatory Organization; Notice of Filing and Immediate
Effectiveness of Proposed Rule Change by National Futures Association
Relating to Security Futures Products
September 20, 2001.
Pursuant to Section 19(b)(7) of the Securities Exchange Act of 1934
(``Exchange Act''),\1\ and Rule 19b-7 under the Exchange Act,\2\ notice
is hereby given that on August 21, 2001, the National Futures
Association (``NFA'') filed with the Securities and Exchange Commission
(``SEC'' or ``Commission'') the proposed rule change described in Items
I, II, III below, which Items have been prepared by NFA. The Commission
is publishing this notice to solicit comments on the proposed rule
change from interested persons.
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\1\ 15 U.S.C. 78s(b)(7).
\2\ 17 CFR 240.19b-7.
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On July 20, 2001, the NFA submitted the proposed rule change to the
Commodity Futures Trading Commission (``CFTC'') for approval. The CFTC
approved the proposed rule change on August 20, 2001.\3\
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\3\ On August 29, 2001, the NFA submitted a proposed rule change
to the CFTC to amend the ``Interpretive Notice on Obligation to
Customers and Other Market Participants'' (``Interpretive Notice'')
that is included in the instant proposed rule change. On September
7, 2001, pursuant to Section 17(j) of the Commodity Exchange Act, 7
U.S.C. 21(j), the CFTC deemed the proposed rule change to amend the
aforementioned Interpretive Notice to be effective. Telephone
conversation with Kathryn Camp, Associate General Counsel, NFA, and
Marc McKayle and Andrew Shipe, Special Counsel, Division of Market
Regulation (``Division''), Commission, on September 13, 2001. On
September 18, 2001, the NFA filed a proposed rule change (SR-NFA-
2001-02) with the Commission that incorporates the amendment to the
Interpretive Notice.
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I. Self-Regulatory Organization's Description of the Proposed Rule
Change
The Commodity Futures Modernization Act of 2000 (``CFMA'') amended
Section 15A of the Exchange Act to add new subsection (k),\4\ which
makes NFA a national securities association for the limited purpose of
regulating the activities of NFA Members who are registered as brokers
or dealers in security futures products under Section 15(b)(11) of the
Exchange Act.\5\ The most significant provisions of the proposed rule
change would make the requirements that apply to the security futures
activities of these NFA Members reasonably comparable to those that
apply to NASD members,\6\ as required by Section 15(k)(2) of the
Exchange Act.\7\
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\4\ 15 U.S.C. 78o-3(k).
\5\ 15 U.S.C. 78o(b)(11)
\6\ For purposes of clarity, references to ``NASDR,'' ``NASDR
members'' and ``NASDR Conduct Rules'' in this notice have been
changed to ``NASD,'' ``NASD members'' and ``NASD Rules,''
respectively. Telephone conversation with Kathryn Camp, Associate
General Counsel, NFA, and Nancy Sanow, Assistant Director, and Marc
McKayle, Special Counsel, Division, Commission, on September 19,
2001.
\7\ 15 U.S.C. 78o-3(k)(2).
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II. Self-Regulatory Organization's Statement of the Purpose of, and
Statutory Basis for, the Proposed Rule Change
NFA has prepared statements concerning the purpose of, and basis
for, the proposed rule change, burdens on competition, and comments
received from members, participants, and others. The text of these
statements may be examined at the places specified in Item IV below.
These statements are set forth in Sections A, B, and C below. The text
of the proposed rule change is available at the Office of the
Secretary, NFA, and on the Commission's web site (http://www.sec.gov).
A. Self-Regulatory Organization's Statement of the Purpose of, and
Statutory Basis for, the Proposed Rule Change
1. Purpose
The CFMA lifted the 18-year ban on single stock futures and narrow-
based security indices (security futures products) and regulates these
products as both securities and futures. The CFMA amended Section 15A
of the Exchange Act to add new subsection (k),\8\ which makes NFA a
national securities association for the limited purpose of regulating
the activities of NFA Members who are registered as brokers or dealers
in security futures products under Section 15(b)(11) of the Exchange
Act,\9\ which was also added by the CFMA. Section 15A(k)(2) \10\
requires NFA to have anti-fraud, anti-manipulation, and customer
protection rules reasonably comparable to those of the National
Association of Securities Dealers, Inc. (``NASD'') for the purpose of
governing the security futures activities of these Section 15(b)(11)
\11\ broker-dealers.
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\8\ 15 U.S.C. 78o-3(k).
\9\ 15 U.S.C. 78o(b)(11)
\10\ 15 U.S.C. 78o-3(k)(2).
\11\ 15 U.S.C. 78o(b)(11).
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NFA represents that it already has anti-fraud, anti-manipulation,
and customer protection rules that have proven effective in governing
the futures activities of NFA Members. However, NFA's rules sometimes
take a different approach than NASD's rules and, as a result, they do
not correspond in every instance. Therefore, NFA has adopted the
proposed rule change in order to ensure that NFA meets the standards
imposed by Section 15A(k)(2) of the Exchange Act.\12\
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\12\ 15 U.S.C. 78o-3(k)(2).
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In NFA staff's discussions with SEC staff, SEC staff suggested that
NFA's rules should be comparable to those NASD rules that apply to
options since both are derivative instruments. SEC staff also told NFA
in include those rules that apply to writing options since the risks of
futures transactions are more similar to the risks of writing options
than to the risks of purchasing them. These principles guided NFA in
developing the proposed rule change. A more detailed discussion of the
rule change follows.
a. Bylaw 1101 (Doing Business With Non-Members)
Bylaw 1101 prohibits NFA Members from doing business with non-
Members who are required to be registered with the CFTC as futures
commission merchants (``FCMs''), introducing brokers (``IBs''),
commodity pool operators (``CPOs''), or commodity trading advisors
(``CTAs''). Section 4f(a)(4)(C) of the Commodity Exchange Act (``CEA'')
\13\ provides that registered futures associations may not prohibit
their members from doing security futures business with FCMs and IBs
registered under Section 4f(a)(2) of the CEA.\14\ Bylaw 1101 has been
amended accordingly.
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\13\ 7 U.S.C. 6f(a)(4)(C).
\14\ 7 U.S.C. 6f(a)(2).
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b. Bylaw 1507, Compliance Rule 1-1, and Code of Arbitration Section 1
(Definitions)
The definition of futures has been amended to include security
futures products. The amendments make it clear that NFA has both
compliance and arbitration jurisdiction over security futures
transactions involving its NFA Members.
Compliance Rule 1-1 has also been amended to add a definition of
``Exchange Act,'' since the Exchange Act
[[Page 49440]]
is now referred to in a number of places in the Compliance Rules.
c. Compliance Rule 2-7 (Designated Security Futures Principals)
Proposed Compliance Rule 2-7(b) requires NFA Members who register
as broker-dealers under Section 15(b)(11) of the Exchange Act \15\
(``passported Members'') to designate one or more security futures
principals and requires the principal to take the Series 30 examination
(for futures branch office managers), which will be updated to include
questions regarding supervision of activities involving security
futures products.\16\ This is comparable to NASD Rule 1022(f), which
requires NASD members who engage in options transactions to have at
least one registered options principal.
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\15\ 15 U.S.C. 78o(b)(11).
\16\ Current registrants will not have to take the Series 30
examination if they take an appropriate training course.
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Corresponding changes to Compliance Rules 2-8, 2-29, and 2-30
require a designated security futures principal to review discretionary
trades, approve promotional material, and approve customer accounts for
security futures transactions.
d. Compliance Rules 2-22 and 2-26
Compliance Rule 2-22 has been amended to prohibit NFA Members from
implying that they have been sponsored, recommended, or approved by any
federal or state regulatory body. This makes it comparable to NASD Rule
2210(d)(2)(J).
CFTC Regulations 155.3\17\ and 155.4\18\ dictate the terms under
which an associated person (``AP'') of one Member can open and trade an
account with another Member. Compliance Rule 2-26 has been amended to
incorporate these regulations in order to make it comparable to NASD
Rule 3050.
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\17\ 17 CFR 155.3
\18\ 18 CFR 155.4
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e. Compliance Rule 2-29 (Promotional Material)
NFA's and NASD's promotional material rules are comparable for the
most part. NASD's rules do, however, contain several requirements that
are either not included or not explicitly stated in NFA's rules. The
amendments to Compliance Rule 2-29 are intended to make it more like
NASD's promotional material rules in the way it applies to promotional
material for security futures products.
The amendment to Compliance Rule 2-29(b) adds new subsection (6)
regarding testimonials. This requirement is actually stricter than NASD
Rule 2210(d)(2)(D), which is the comparable NASD requirement, since the
proposed NFA requirement actually prohibits the use of any testimonial
that is not representative of all reasonably comparable accounts.
A new section (j) has been added to be comparable with various
requirements in NASD Rules 2210 and 2220. This section applies only to
the promotional material of passported NFA Members (and their
Associates) that specifically refers to security futures products.
Among other things, Compliance Rules 2-29(j):
Requires promotional material that solicits for a trading
program to be managed by an FCM or IB Member to include the cumulative
performance history of the Member's customers who have used the trading
program or to state that the program is unproven;
Requires NFA Members to provide customers with supporting
documentation, upon request, for any claims, comparisons,
recommendations, statistics, and other technical data made in the
promotional material;
Prohibits promotional material from referring to past
trading recommendations in security futures products, the underlying
securities, or derivatives thereof unless it describes all other
recommendations made for similar products over the last year;
Prohibits promotional material for security futures
products from making specific trading recommendations unless the
material discloses conflicts of interest based on activities in the
underlying security and offers to provide information on all
recommendations made for similar products over the last year;
Provides that promotional material that is not accompanied
or preceded by the disclosure statement for security futures products
can only contain a general description of security futures products,
the name of the NFA Member, and the person to contact for a current
disclosure statement; and
Requires NFA Members to pre-file all mass media
advertising that relates to security futures products (unless it merely
mentions them as one of the services it offers).
f. Compliance Rule 2-30 (Suitability)
Two statutory provisions effectively require NFA to have
suitability rules comparable to those of NASD. First, the suitability
requirements are customer protection rules that are included in the
requirements for qualification under Section 15A(k) of the Exchange
Act.\19\ Second, the listing requirements in Section 2(a)(1)(D)(i)(V)
of the CEA \20\ essentially bar transactions by FCMs, IBs, CTAs, CPOs,
and APs that are not subject to suitability requirements comparable to
those of NASD.
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\19\ 15 U.S.C. 78o-3(k).
\20\ 7 U.S.C. 4(a)(1)(D)(i)(V).
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NFA Compliance Rule 2-30 requires NFA Members (and their
Associates) to obtain information about each customer's experience,
income, net worth and age before opening a futures account. It also
requires NFA Members to give risk disclosure, with the risk disclosures
required by the CFTC as the minimum. Compliance Rule 2-30 requires NFA
Members to provide additional risk disclosure if the customer needs it
to make an informed judgment about whether he or she should be involved
in the futures markets. In fact, if the Member believes that futures
are simply too risky for that customer, the Member must tell the
customer that he has no business trading futures. This is true even if
the Member makes no recommendations whatsoever to the customer. If the
customer still decides to trade futures, however, the Member may open
the account.
Like NASD requirements, Compliance Rule 2-30 is designed to keep
customers from trading futures if they are unsuitable. Unlike NFA
Compliance Rule 2-30, however, NASD Rules 2310, 2860(16), 2860(19), and
IM-2860-2: (1) require members to obtain more extensive information
from natural person customers; (2) require members to specifically
approve of disapprove security options accounts based on an evaluation
of the customer' suitability to trade those products; and (3)
explicitly prohibit members from making unsuitable recommendations.
Therefore. NFA has added a new section (j) to Compliance Rule 2-30 to
include these requirements for security futures and apply them to NFA
Members who are not also NASD members and therefore are not subject to
the NASD's suitability requirements).
NFA and a number of other self-regulatory organizations are
currently drafting a standardized disclosure statement that must be
given to all security futures customers. Compliance Rule 2-30(b) has
been revised to required NFA Members to provide this statement when or
before and account is approved to trade security futures products.
g. Compliance Rule 2-37 (Security Futures Products)
Compliance Rule 2-37 is an entirely new rule that applies only to
the
[[Page 49441]]
security futures activities of passported NFA Members and their
Associates.
Section 15A(k)(2)(A) of the Exchange Act \21\ requires NFA
to enforce relevant provisions of the securities laws. Compliance Rule
2-37(a) requires passported NFA Members and their Associates to comply
with Sections 9(a), 9(b), and 10(b) of the Exchange Act,\22\ and
Compliance Rule 2-37(b) requires passported NFA Members to have
procedures reasonably designed to achieve compliance with applicable
securities laws.
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\21\ 15 U.S.C. 78o-3(k)(2)(A).
\22\ 15 U.S.C. 78i(a), 78i(b), and 78j(b).
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Compliance Rule 2-37(c) requires passported NFA Members
that carry accounts to provide security futures customers with annual
information of NFA's BASIC system, which discloses disciplinary
information regarding NFA Members and their Associates. This
requirement is similar to NASD Rule 2280.
Compliance Rule 2-37(d)-(f) requires Associate of
passported NFA Members to report certain information (e.g., significant
customer complaints) to their sponsors and requires those NFA Members
to report similar information to NFA. NFA Members also be required to
file quarterly reports with NFA containing statistical information
about customer complaints received during the quarter. These
requirements are comparable to NASD Rule 3070.
h. Interpretive Notice Regarding Enhanced Supervisory Requirements
This notice, found at Paragraph 9021 of the National Futures
Association Manual, requires enhanced supervisory procedures for firms
that have a significant number of Associates who were previously
employed at firms closed down for sales practice fraud. Although the
notice is generally stricter than NASD Rule 3010(b)(2), which is the
comparable NASD requirement, it has been amended to provide that firms
must have written supervisory procedures for complying with the
requirements for the notice and all applicable provisions of the
securities laws and must file quarterly reports with NFA concerning
their compliance with the requirements of the notice.
i. Interpretive Notice Regarding Obligations to Customers and Other
Market Participants
Both NFA and NASD have rules prohibiting their respective members
from engaging in conduct inconsistent with just and equitable
principles of trade as well as manipulative or fraudulent practices.
See NFA Compliance Rules 2-2 and 2-4 and NASD Rules 2110 and 2120.
Nonetheless, several NASD interpretive memoranda explicitly prohibit
some specific conduct that has not been explicitly prohibited by NFA
rules or interpretive notices. NFA's new interpretive notice explicitly
prohibits this conduct.
One of the linchpins of the futures industry is the concept that
registrants may not trade ahead of customer orders. Most, if not all,
the futures exchanges have rules prohibiting their members from
engaging in this conduct, and CFTC Regulations 155.3(a) \23\ and
155.4(a) \24\ require FCMs and IBs to have and enforce procedures to
insure that they and their employees do not trade ahead of customer
orders. Although NFA does not have a specific requirement prohibiting
NFA Members and Associates from trading ahead of customer orders, NFA
has always considered it a violation of Compliance Rule 2-4. However,
in order to make NFA rules more comparable to NASD IM-2110-2, NFA has
specifically prohibited that conduct in this new interpretive notice.
As noted previously, CFTC Regulation 155.3 25 and 155.4 \26\
have also been incorporated by reference into NFA Compliance Rule 2-26.
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\23\ 17 CFR 155.3(a).
\24\ 17 CFR 155.4(a).
\25\ 17 CFR 155.3.
\26\ 17 CFR 155.4.
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This interpretive notice also contains several provisions that
apply only to passported NFA Members and their Associates when they
engage in security futures activities. These provisions: (1) prohibit
trading ahead of research reports (comparable to NASD IM-2110-4); (2)
prohibit trading based on knowledge or an imminent block transaction
(generally comparable to NASD IM-2110-3), with an exception for hedging
counterpart risk under approved exchange block rules; and (3) require a
sound basis for evaluating the facts regarding a particular security
futures product (comparable to NASD Rule 2210(d)(1)(A)).
j. Interpretive Notice Regarding Special Supervisory Requirements for
NFA Members Registered as Broker-Dealers Under Section 15(b)(11) of the
Exchange Act
Both the NFA and the NASD have extensive requirements regarding
supervision. In some areas, however, the NASD's requirements are more
detailed than NFA's. Therefore, NFA has adopted a new interpretive
notice to NFA Compliance Rule 2-9 (Supervision) regarding Special
Supervisory Requirements for Security Futures Products. The
interpretive notice, which applies only to security futures activities
by passported NFA Members, is intended to be comparable to various
supervisory requirements in NASD Rules 2210(f), 2860(18), 2860(20), and
3010.
Among other things, this interpretive notice requires that:
A designated security futures principal approves all
policies and procedures relating to security futures products;
Each security futures sales office has a designated
security futures principal;
NFA Members adopt and enforce procedures requiring a
designated security futures principal to review correspondence relating
to security futures products;
A designated security futures principal oversees reviews
of branch offices and guaranteed IBs that engage in security futures
activities, including a yearly on-site audit of each office that
engages in security futures activities; and
NFA Members check securities records as well as futures
records when deciding whether to hire an employee or guarantee an IB.
k. Interpretive Notice on Use of Past or Projected Performance and
Disclosing Conflicts of Interest for Security Futures Products
NFA has also adopted a new interpretive notice to NFA Compliance
Rule 2-29 on Use of Past or Project Performance and Disclosing
Conflicts of Interest for Security Futures Products. The notice mostly
describes positions taken by NFA's Business Conduct Committee and
Hearing Panels regarding past and projected performance and is intended
to be comparable to some of the specific provisions of NASD Rules 2210
and 2220. It also explains the responsibilities of passported NFA
Members under new section (j) of Compliance Rule 2-29.
2. Statutory Basis
The rule change is authorized by, and consistent with, Section
15A(k) of the Exchange Act.\27\ The proposed amendments are designed to
make NFA's rules correspond more closely to NASD's rules, as is
contemplated by Section 15A(k) of the Exchange Act.
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\27\ 15 U.S.C. 78o-3(k).
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B. Self-Regulatory Organization's Statement on Burden on Competition
The rule change will not impose any burden on competition that is
not
[[Page 49442]]
necessary or appropriate in furtherance of the purposes of the Exchange
Act and the CEA, as they were amended by the CFMA. In fact, the CFMA is
designed to promote an even regulatory playing field among securities
and futures registrants--and among NFA members and NASD members--so
that neither group has a competitive advantage over the other. NFA's
rule change achieves that objective.
C. Self-Regulatory Organization's Statement of Comments on the Proposed
Rule Change Received From Members, Participants, or Others
NFA worked with Member committees and industry trade associations
in developing the rule change. NFA did not, however, publish the rule
change for comment by its membership. NFA received one written comment
letter from an industry trade association, which generally supported
the rule change.
III. Date of Effectiveness of the Proposed Rule Change and Timing
for Commission Action
The proposed rule change has become effective on August 20, 2001,
which is the date of approval of the proposed rule change by the CFTC.
Within 60 days of the date of effectiveness of the proposed rule
change, the Commission, after consultation with the CFTC, may summarily
abrogate the proposed rule change and require that the proposed rule
change be refiled in accordance with the provisions of Section 19(b)(1)
of the Exchange Act.\28\
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\28\ 15 U.S.C. 78s(b)(1).
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IV. Solicitation of Comments
Interested persons are invited to submit written data, views and
arguments concerning the foregoing, including whether the proposed rule
change conflicts with the Exchange Act. Persons making written
submissions should file nine copies of the submission with the
Secretary, Securities and Exchange Commission, 450 Fifth Street, NW.,
Washington, DC 20549-0609. Comments also may be submitted
electronically to the following e-mail address: [email protected].
Copies of the submission, all subsequent amendments, all written
statements with respect to the proposed rule change that are filed with
the Commission, and all written communications relating to the proposed
rule change between the Commission and any person, other than those
that may be withheld from the public in accordance with the provisions
of 5 U.S.C. 552, will be available for inspection and copying in the
Commission's Public Reference Room. Copies of these filings also will
be available for inspection and copying at the principal office of NFA.
Electronically submitted comments will be posted on the Commission's
Internet website (http://www.sec.gov.). All submissions should refer to
File No. SR-NFA-2001-01 and should be submitted by October 18, 2001.
For the Commission, by the Division of Market Regulation,
pursuant to delegated authority.\29\
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\29\ 17 CFR 200.30-3(a)(75).
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Margaret H. McFarland,
Deputy Secretary.
[FR Doc. 01-24184 Filed 9-26-01; 8:45 am]
BILLING CODE 8010-01-M