[Federal Register Volume 67, Number 49 (Wednesday, March 13, 2002)]
[Rules and Regulations]
[Pages 11223-11229]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 02-5778]


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COMMODITY FUTURES TRADING COMMISSION

17 CFR Parts 37, 38, 41, and 155

RIN 3038-AB83


Regulation To Restrict Dual Trading in Security Futures Products

AGENCY: Commodity Futures Trading Commission.

ACTION: Final rulemaking.

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SUMMARY: The Commodity Futures Trading Commission (``Commission'') 
hereby adopts regulation 41.27 that restricts dual trading by floor 
brokers in security futures products. Under the regulation, the dual 
trading restriction affects floor brokers that trade security futures 
products through open outcry on the trading floor of a designated 
contract market (``DCM'') or registered derivatives transaction 
execution facility (``DTF''). The regulation provides for certain 
exceptions to the restriction, including provisions for the correction 
of errors, customer consent, spread transactions, market emergencies, 
and unique or special characteristics of an agreement, contract, or 
transaction, or of the DCM or DTF.

EFFECTIVE DATE: April 12, 2002.

ADDRESSES: Commodity Futures Trading Commission, Three Lafayette 
Centre, 1155 21st Street, NW., Washington, DC 20581, Attention: Office 
of the Secretariat. Comments may be sent by facsimile transmission to 
(202) 418-5521 or by e-mail to [email protected]. Reference should be 
made to ``Restriction of Dual Trading in Security Futures Products by 
Floor Brokers.''

FOR FURTHER INFORMATION CONTACT: Stephen Braverman, Associate Director, 
or Rachel Berdansky, Special Counsel, Division of Trading and Markets, 
Commodity Futures Trading Commission, Three Lafayette Centre, 1155 21st 
Street, NW., Washington, DC 20581, (202) 418-5490, Electronic mail: 
[email protected] or [email protected].

SUPPLEMENTARY INFORMATION:

I. Introduction

    On December 15, 2000, Congress passed the Commodity Futures 
Modernization Act of 2000 (``CFMA''), which was signed by the President 
and became effective on December 21, 2000. Among other things, the 
CFMA, which substantially amended the Commodity Exchange Act (``Act''), 
establishes two categories of markets subject to Commission regulatory 
oversight, DCMs and DTFs.\1\ In addition, Title II of the CFMA repeals 
the longstanding ban on single stock futures and directs the Commission 
and the Securities and Exchange Commission (``SEC'') to implement a 
joint regulatory framework for security futures products.
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    \1\ Appendix E of Pub. L. 106-554, 114 Stat. 2763 (2000). Prior 
to its recent amendment, the Act referred to ``designated contract 
markets'' as Commission-approved products traded on a board of 
trade. The Act, as amended, however, uses the term ``designated 
contract market'' to refer to the approved or licensed market on 
which futures contracts and commodity options are traded. Regulation 
41.27 refers to DCMs in this sense.
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    On July 11, 2001, the Commission published proposed regulation 
41.27 (``proposing release''), which generally restricts floor brokers 
from dual trading security futures products through open outcry during 
the same trading session, in accordance with the statutory mandate of 
section 4j(a) of the Act, as amended by section 251(c) of the CFMA.\2\ 
Section 4j(a), as amended, also requires that the Commission permit 
exceptions to the dual trading restriction in order to ensure fairness 
and orderly trading in security futures product markets.\3\ Moreover, 
section 2(a)(D)(i) of the Act sets forth listing standards for security 
futures products traded on a DCM or DTF. In particular, section 
2(a)(D)(i)(VI) requires that security futures products be subject to 
the dual trading restriction of section 4j of the Act and the 
regulations thereunder or section 11(a) of the Securities Exchange Act 
of 1934 (`` '34 Act'') and the regulations thereunder.\4\
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    \2\ See Proposed Regulation to Restrict Dual Trading in Security 
Futures Products, 66 FR 36218.
    \3\ Section 4j of the Act, as amended, is different in scope 
than its predecessor and the Commission regulation promulgated 
thereunder. Commission regulation 155.5 restricted dual trading in 
any contract market that exceeded certain volume thresholds unless 
an exchange requested, and the Commission granted, a dual trading 
exemption. As part of this rulemaking, the Commission is removing 
regulation 155.5.
    \4\ With certain enumerated exceptions, section 11(a)(1) of the 
'34 Act and SEC rule 11a-1 make it unlawful for any member of a 
national securities exchange to effect any transaction for his or 
her own account, the account of an associated person, or an account 
with respect to which it or an associated person has discretion.
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    Section 5f of the Act provides that any board of trade that is 
registered with the SEC as a national securities exchange or as a 
national securities association, or as an alternative trading system, 
shall be considered a DCM in security futures products, provided that 
certain enumerated requirements are satisfied upon filing a notice with 
the Commission. Section 5f(b)(1)(B), however, specifically exempts such 
notice-registered entities from section 4j of the Act. Similarly, 
section 6(g) of the '34 Act, as amended by section 202(a) of

[[Page 11224]]

the CFMA, provides that any board of trade that has been designated as 
a contract market by the Commission or has registered with the 
Commission as a DTF may register with the SEC as a national securities 
exchange by filing notice with the SEC solely for the purposes of 
trading security futures products, provided that certain enumerated 
requirements are satisfied. DCMs and DTFs that notice register with the 
SEC for the purpose of trading security futures products are exempt 
from section 11(a)(1) of the '34 Act.
    The Commission received four comment letters on a variety of issues 
regarding the proposing release.\5\ CME fully supported proposed 
regulation 41.27, and stated that, ``the Commission's proposed dual 
trading regulation for security futures products appropriately balances 
customer protection with regulatory oversight.'' CBOT, AMEX, and NYBOT 
raised several issues regarding the proposing release's definition of 
``customer'' and ``dual trading,'' application of the dual trading 
restriction under certain circumstances to electronic trading systems, 
and the possible addition of a low volume exception. Those comments are 
discussed, as appropriate, below.
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    \5\ Letters were received from: (1) Chicago Mercantile Exchange 
(``CME''), (2) Board of Trade of the City of Chicago (``CBOT''), (3) 
The American Stock Exchange (``AMEX''), and (4) Board of Trade of 
the City of New York (``NYBOT'').
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II. Final Rule

A. Definitions

1. Customer
    Proposed regulation 41.27(a)(4) defined ``customer'' to mean an 
account owner for which a trade is executed other than (i) an account 
in which a floor broker's ownership interest or share of trading 
profits is ten percent or more; (ii) an account for which a floor 
broker has discretion; (iii) an account controlled by a person with 
whom a floor broker has a relationship through membership in a broker 
association; (iv) a house account for a floor broker's clearing member; 
or (v) an account for another member present on the floor of a DCM or 
DTF or an account controlled by such other member. To make the 
regulation more consistent with section 11(a) of the '34 Act, the 
Commission has modified the language of section 41.27(a)(4)(i) by 
deleting the reference to ``ten percent or more.'' \6\ Thus, 
Sec. 41.27(a)(4)(i), as adopted, provides, ``(c)ustomer means an 
account owner for which a trade is executed other than (i) an account 
in which such floor broker has any interest.'' \7\
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    \6\ See infra note 4.
    \7\ AMEX commented that the final regulation should delete the 
``ten percent or more'' ownership provision because it limited the 
definition of dual trading and was not included in section of 4j of 
the Act, as amended.
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    CBOT and NYBOT commented regarding the proposed definition of 
``customer'' in Sec. 41.27(a)(4). NYBOT commented that proposed 
Sec. 41.27(a)(4)(iv) and (v) included two categories of non-customer 
accounts, a house account for a floor broker's clearing member, and an 
account for another member present on the floor of a DCM or DTF or an 
account controlled by such other member, that were not considered non-
customer accounts under regulation 155.5.\8\ Specifically, NYBOT 
believes that regulation 155.5 permitted a floor broker to trade 
security futures products for a customer and for the house account of a 
floor broker's clearing member or for another member present on the 
floor during the same trading session.\9\
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    \8\ Similarly, CBOT commented that the inclusion of an account 
for another member present on the floor of a DCM or DTF or an 
account controlled by such other member as a non-customer account 
differs from the treatment of such accounts under Regulation 155.5.
    \9\ NYBOT would like the Commission to remove an account for a 
floor broker's clearing member, or an account for another member 
present on the floor of a DCM or DTF or an account controlled by 
such other member, from the list of non-customer accounts. CBOT 
would include the house account for a floor broker's clearing member 
as a non-customer account, but would like the Commission to create 
an exception to the dual trading restriction for the accounts of all 
other clearing members, members present on the floor, and members 
not present on the floor.
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    After carefully reviewing regulation 155.5, the Commission believes 
that although it intended that a house account for a floor broker's 
clearing member and an account for another member present on the floor 
or an account controlled by such other member be considered non-
customer accounts, the language in regulation 155.5 was ambiguous. 
Accordingly, regulation 41.27 clearly expresses the Commission's intent 
that floor brokers be prohibited from trading the same security futures 
product for a customer and for a house account for a floor broker's 
clearing member or for an account for another member present on the 
floor or an account controlled by such member during the same trading 
session. In this regard, the Commission believes that to allow 
otherwise could disadvantage customers because a floor broker may be 
motivated to obtain a better fill for its clearing member or for 
another member present on the floor. Regulation 41.27, however, would 
permit a floor broker to trade the same security futures product for 
his or her own account and non-customer accounts enumerated under 
regulation 41.27(a)(4)(i)-(v) during the same trading session.
    Additionally, the Commission requested comment as to whether 
accounts for clearing members other than the house account of a floor 
broker's clearing member and members not present on the floor should be 
considered non-customer accounts for the purpose of regulation 
41.27(a)(4). By defining these accounts as non-customer accounts, a 
floor broker would be permitted to trade for these accounts and the 
floor broker's personal account during the same trading session. NYBOT 
and CBOT commented that accounts for clearing members other than the 
house account of a floor broker's clearing member and members not 
present on the floor, should not be included as non-customer accounts 
in Sec. 41.27(a)(4).\10\ The Commission therefore has determined that 
the accounts of clearing members other than the floor broker's clearing 
member, and the accounts of members not present on the floor of a DCM 
or DTEF, should be included as customer accounts for purposes of this 
rule.
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    \10\ Both NYBOT and CBOT contend that if clearing members other 
than the house account of a floor broker's clearing member and 
members not present on the floor are included as non-customer 
accounts in Sec. 41.27(a)(4), floor brokers would be limited to 
trading security futures products during the same trading session 
for such accounts and other non-customer accounts listed in 
Sec. 41.27(a)(4)(i)-(v). In particular, CBOT believes that ``these 
are not the types of brokers to whom other clearing firms or members 
would be likely to direct their orders.''
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2. Dual Trading
    Section 41.27(a)(6) of the proposing release, which is renumbered 
as Sec. 41.27(a)(5) in the final rule, defined ``dual trading'' as the 
``execution of customer orders by a floor broker through open outcry 
during the same trading session in which the floor broker executes, 
directly or indirectly, either through open outcry or through a trading 
system that electronically matches bids and offers, a transaction for 
the same security futures product on the same designated contract 
market or registered derivatives transaction execution facility for an 
account'' of a non-customer.
    This definition referred to a floor broker executing ``directly or 
indirectly'' a transaction for a non-customer account, but did not 
explain what was meant by ``indirectly.'' Rather, in discussing the 
various sections of the proposed rule, the proposing release noted that 
the word ``indirectly'' was

[[Page 11225]]

intended to prevent a floor broker from executing a customer order and 
during the same trading session initiating and passing an order for a 
non-customer account identified by regulations 41.27(a)(4)(i)-(v) to 
another broker for execution. CBOT commented that to avoid ambiguity, 
the Commission should explicitly state what it means by ``indirect 
execution'' in the final regulation, similar to the dual trading 
definition in regulation 155.5(a)(4).\11\ The Commission agrees and has 
made the appropriate change in the final regulation.
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    \11\ Regulation 155.5(a)(4) defined dual trading as ``the 
execution of customer orders by a floor broker during the same 
trading session in which the floor broker executes directly or 
initiates and passes to another member for execution in the same 
contract market. * * *'' (emphasis added).
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    Additionally, the Commission is amending the language of the dual 
trading definition that describes an electronic trading system not 
subject to the dual trading prohibition to make it more precise and 
consistent with current practices. Specifically, the words ``a trading 
system that electronically matches bids and offers'' has been amended 
in Sec. 41.27(a)(5) of the regulation to read ``a trading system that 
electronically matches bids and offers pursuant to a predetermined 
algorithm.'' \12\
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    \12\ The ``dual trading'' definition set forth in 
Sec. 41.27(a)(5) will now read:
    Dual trading means the execution of customer orders by a floor 
broker through open outcry during the same trading session in which 
the floor broker executes directly or by initiating and passing to 
another member, either through open outcry or through a trading 
system that electronically matches bids and offers pursuant to a 
predetermined algorithm, a transaction for the same security futures 
product on the same designated contract market or registered 
derivatives transaction execution facility for an account described 
in paragraphs (a)(4)(i)-(v) of this section.
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3. Other Definitions
    The proposing release also defined the terms ``trading session,'' 
``member,'' ``broker association,'' and ``security futures product.'' 
\13\ The term ``security futures product'' will be deleted from 
Sec. 41.27(a) in the final regulation because of a final Commission 
rulemaking subsequent to the proposing release that defined the 
term.\14\ No comments were received regarding Sec. 41.27(a)(1)-(3) of 
the proposing release and the Commission has determined to adopt those 
sections as proposed.
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    \13\ See sections 41.27(a)(1), (2), (3), and (5) of the 
proposing release, respectively.
    \14\ Regulation 41.1(i) provides that ``(s)ecurity futures 
product shall have the meaning set forth in section 1a(32) of the 
Act.'' 66 FR 44960, 44965 (August 27, 2001).
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B. Application of the Dual Trading Prohibition to Electronic Trading 
Systems

    In the proposing release, the Commission stated that under the 
plain language of section 4j of the Act, as amended, the dual trading 
restriction would not apply to a DCM or DTF that trades security 
futures products solely through an electronic trading system. This 
interpretation takes into account the plain language of the statute, 
which refers to ``floor brokers'' who ``execute'' orders.\15\ In 
addition, this interpretation recognizes that a floor broker who 
executes a customer order through open outcry has more control over 
that order than a customer order entered into an electronic trading 
system that matches bids and offers pursuant to a predetermined 
algorithm where members do not have a time and place advantage. In the 
latter instance, the floor broker does not have the ability to 
influence or guide the order once it enters the system because the 
order is matched pursuant to a predetermined algorithm.
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    \15\ Section 4j(b) defines dual trading as the ``execution of 
customer orders by a floor broker during the same trading session in 
which the floor broker executes any trade in the same contract [on a 
designated contract market] or registered derivatives transaction 
execution facility.''
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    The Commission also acknowledged in the proposing release that a 
DCM or DTF may permit the simultaneous trading of security futures 
products through open outcry on a trading floor and on an electronic 
trading system for the same product, also known as ``side-by-side 
trading.'' The Commission would permit a floor broker, during the same 
trading session, to enter a bid or offer for a security futures product 
for a customer account on an electronic trading system and to trade the 
same product for non-customer accounts listed in Secs. 41.27(a)(4)(i)-
(v) through open outcry. However, recognizing the extent of control 
that a floor broker exercises with respect to an open outcry customer 
order, the Commission noted that a floor broker would be prohibited 
during the same trading session from executing a customer order for a 
particular security futures product through open outcry and entering a 
bid or offer on an electronic trading system for the same product for 
non-customer accounts.
    NYBOT and AMEX contend that the Act does not limit the dual trading 
restriction to open outcry trading and commented that a dual trading 
restriction also should be applicable to the trading of security 
futures products on electronic trading systems. CBOT disagrees with 
NYBOT and AMEX, and commented that it believes the Commission correctly 
determined that under the Act a dual trading restriction is not 
applicable to a DCM or DTF that trades security futures products solely 
through an electronic trading system, because there is no floor broker 
involved in the trade.\16\ CBOT, however, disagrees with the 
Commission's application of the dual trading restriction with respect 
to side-by-side trading. Specifically, CBOT does not believe that a 
dual trading restriction should be applicable to side-by-side trading, 
regardless of whether the customer order is executed though open outcry 
or entered on an electronic trading system.
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    \16\ As stated earlier, the Commission noted in the proposing 
release that the dual trading definition found in section 4j(b) of 
the Act refers to ``floor brokers'' who ``execute'' customer orders. 
Floor brokers execute customer orders on the trading floor, whereas 
various registrants as well as unregistered individuals enter orders 
into electronic trading systems that then match orders pursuant to a 
predetermined algorithm where members do not have a time and place 
advantage and relinquish the ability to influence or guide the order 
once it enters the system. In this connection, the definition of 
``floor broker'' found in section 1a(16) of the Act contemplates a 
person ``in or surrounding * * * any pit, ring, or post * * * '' on 
the floor of an exchange and not through a system that 
electronically matches bids and offers.
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    The Commission is not persuaded by the comments that its 
interpretation and application of the dual trading restriction is 
inconsistent with the Act. In this connection, NYBOT commented that 
``the definition of ``floor broker'' must be read in the light of the 
evolution of the markets to electronic trading, and the dual trading 
restrictions applied to all orders that are intermediated, regardless 
of the ultimate mode of execution.'' In adopting the CFMA, however, 
Congress did not substantively amend the definition of ``floor 
broker,'' nor does the Act, as amended, include language demonstrating 
that Congress intended to apply a dual trading restriction to security 
futures products traded on an electronic trading system.
    Nonetheless, the Commission has separately determined, given the 
possibility of further developments in electronic markets and 
electronic trading systems, to adopt Sec. 41.27(b)(2).\17\ Section 
41.27(b)(2) would require a DCM or DTF that operates an electronic 
market or electronic trading system that

[[Page 11226]]

provides market participants with a time or place advantage, or the 
ability to override a predetermined algorithm, to submit an appropriate 
rule proposal to the Commission pursuant to the procedures enumerated 
in regulation 40.5. Specifically, the proposed rule must prohibit 
electronic market participants with a time or place advantage or with 
the ability to override a predetermined algorithm from trading a 
security futures product for accounts in which these same participants 
have any interest during the same trading session that they also trade 
the same security futures product for other accounts.\18\ The 
Commission notes, however, that Sec. 41.27(b)(2) would not apply to 
execution priorities or quantity guarantees granted to market makers 
who perform that function, or to market participants who receive 
execution priorities based on price improvement activity, in accordance 
with rules governing the DCM or DTF.
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    \17\ Section 41.27(b) of the proposing release is renumbered as 
Sec. 41.27(b)(1) in the final rule. In addition, a reference to 
Sec. 41.27(e) has been added to this paragraph. Section 41.27(b)(1) 
will now read:
    No floor broker shall engage in dual trading in a security 
futures product on a designated contract market or registered 
derivatives transaction execution facility, except as otherwise 
provided under paragraphs (d), (e), and (f) of this section.
    \18\ An example of a time advantage would be providing certain 
market participants with faster access to an electronic trading 
system. An example of a place advantage would be granting certain 
market participants with better access to the market or market 
information. To date, however, no entity with electronic trading 
system characteristics identified in section 41.27(b)(2) has sought 
designation as a contract market or registration as a derivatives 
transaction execution facility.
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C. Rules Implementing the Dual Trading Prohibition

    As the Commission indicated in the proposing release, prior to 
listing a security futures product for trading on a trading floor where 
bids and offers are executed through open outcry, a DCM or DTF must 
adopt a rule prohibiting dual trading. Under regulation 41.27(c)(1), a 
DCM must submit such a rule to the Commission in accordance with 
regulation 40.6, along with a written certification that the rule 
complies with the Act and the regulations promulgated there-under, or 
must obtain Commission approval of such a rule pursuant to regulation 
40.5. Under regulation 41.27(c)(2), a DTF must notify the Commission in 
accordance with regulation 37.7(b) that it has adopted a rule 
prohibiting dual trading or obtain Commission approval of such a rule 
pursuant to regulation 37.7(c). No comments were received regarding 
Sec. 41.27(c). Accordingly, the Commission is adopting Sec. 41.27(c) as 
proposed.

D. Specific Permitted Exceptions to the Dual Trading Prohibition and 
Unique or Special Characteristics of an Agreement, Contract, or 
Transaction, or of the DCM or DTF

    Proposed regulation 41.27(d) would implement the directive of 
sections 4j(a)(2)(A) and (B) of the Act to permit certain exceptions to 
the dual trading restriction. Regulation 41.27(d)(1)-(4) provides 
exceptions to the dual trading restriction to permit the correction of 
errors resulting from the execution of a customer order, to permit a 
customer to designate in writing a floor broker to dual trade while 
executing orders for the customer's account, to permit a broker who 
unsuccessfully attempts to leg into a spread transaction to take the 
executed leg into his or her personal account and to offset such 
position, and to address market conditions that result in a temporary 
emergency. As the Commission indicated in the proposing release, a DCM 
or DTF, prior to permitting such exceptions to a dual trading 
prohibition, would have to adopt a rule permitting the specific 
exceptions and submit the rule to the Commission or obtain Commission 
approval pursuant to the rule submission procedures of regulations 
41.27(e)(1) or (2).\19\
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    \19\ These procedures are identical to the procedures under 
regulation 41.27(c)(1) and (2) for a DCM or DTF to submit a rule 
prohibiting dual trading.
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    One comment was received regarding Sec. 41.27(d). CBOT encouraged 
the Commission to add a low volume exception to regulation 41.27. The 
CBOT believes that adding a low volume exception may assist fledgling 
security futures products to become established before a trading 
prohibition would become applicable, and would improve liquidity. CBOT 
noted that section 11(c) of the '34 Act permits the SEC, upon 
application of an exchange, to grant a low volume exemption from 
section 11(a).
    At this time, the Commission does not have data on the trading 
volume of security futures products upon which to base a threshold 
amount to create a low volume exception. However, similar to section 
11(c) of the '34 Act with respect to the SEC, section 4j(a)(2)(C) of 
the Act affords the Commission broad authority to permit exceptions to 
``further the public interest consistent with the promotion of market 
efficiency, innovation, and expansion of investment opportunities.'' 
Specifically, Sec. 41.27(f) would allow DCMs and DTFs to permit, 
pursuant to a rule, an exception to the dual trading prohibition to 
address an agreement, contract, or transaction that presents a unique 
or special characteristic, or to address a unique or special 
characteristic of the specific DCM or DTF. Accordingly, an exchange 
seeking a low volume exception to the dual trading restriction could 
seek to implement such an exception by making a submission pursuant to 
the procedures set forth in Sec. 41.27(f).
    The Commission did not receive any other comments regarding 
Sec. 41.27(d) or (f) and is adopting those sections as proposed.

III. Amendments to Regulations 37.2, 38.2 and 41.34

    In order to facilitate the promulgation of proposed regulation 
41.27, the Commission also is promulgating procedural amendments to 
regulations 37.2 and 38.2. Regulations 37.2 and 38.2 generally exempt 
DCMs and DTFs from certain Commission regulations and list those 
regulations that are applicable under the Act. Regulation 41.27 is 
hereby added to the list of regulations that remain applicable to DCMs 
and DTFs pursuant to regulations 37.2 and 38.2.\20\
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    \20\ Amended Sec. 37.2 would provide:
    Contracts, agreements, or transactions traded on a derivatives 
transaction execution facility registered as such with the 
Commission under section 5a of the Act, the facility and the 
facility's operator are exempt from all Commission regulations for 
such activity, except for the requirements of this part 37 and 
Secs. 1.3, 1.31, 1.59(d), 1.63(c), 15.05, 33.10, 41.27, part 40, and 
part 190 of this chapter, and as applicable to the market, parts 15 
through 21 of this chapter, which are applicable to a registered 
derivatives transaction execution facility as though they were set 
forth in this section and included specific reference to derivatives 
transaction execution facilities. (emphasis added).
    Amended Sec. 38.2 would provide:
    Agreements, contracts, or transactions traded on a designated 
contract market under section 6 of the Act, the contract market and 
the contract market's operator are exempt from all Commission 
regulations for such activity, except for the requirements of this 
part 38 and Secs. 1.3, 1.12(e), 1.31, 1.38, 1.52, 1.59(d), 1.63(c), 
1.67, 33.10, 41.27, parts 15 through 21, part 40, and part 190 of 
this chapter. (emphasis added).
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    Additionally, the Commission is amending regulation 41.34(b) to 
exempt notice designated contract markets in security futures products 
(``SFPCMs'') from regulation 41.27.\21\ As discussed

[[Page 11227]]

earlier, section 5f(b)(1)(B) of the Act specifically exempts boards of 
trade that register with the SEC as a national securities exchange, a 
national securities association, or as an alternative trading system 
from section 4j of the Act, upon filing notice with the Commission.\22\ 
Regulation 41.34(b) generally exempts SFPCMs from certain Commission 
regulations. Therefore, because regulation 41.27 is being promulgated 
pursuant to section 4j of the Act, the Commission is adding regulation 
41.27 to the list of 41.34(b) exemptions.
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    \21\ Amended Sec. 41.34 provides:
    Any board of trade notice-designated as a contract market in 
security futures products pursuant to Sec. 41.31 of this chapter 
also shall be exempt from:
    (a) The following provisions of the Act, pursuant to section 
5f(b)(1) of the Act:
    (1) Section 4(c)(c);
    (2) Section 4(c)(e);
    (3) Section 4(c)(g);
    (4) Section 4j;
    (5) Section 5;
    (6) Section 5c;
    (7) Section 6a;
    (8) Section 8(d);
    (9) Section 9(f);
    (10) Section 16 and;
    (b) The following provisions, pursuant to section 5f(b)(4) of 
the Act:
    (1) Section 6(a);
    (2) Part 38 of this chapter;
    (3) Part 40 of this chapter; and
    (4) Section 41.27 of this chapter. (emphasis added).
    \22\ See section I. of the preamble for a more detailed 
discussion.
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IV. Cost-Benefit Analysis

    Section 15(a) of the Act, as amended by the CFMA, requires the 
Commission to consider the costs and benefits of its action before 
issuing a new regulation under the Act. Section 15(a) 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(a) simply requires the 
Commission to consider the costs and benefits of its action 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.
    The Commission's proposing release contained an analysis of the 
consideration of the costs and benefits and solicited public comment 
thereon.\23\ The Commission specifically invited commenters to submit 
any data that they had quantifying the costs and benefits of the 
proposed rules with their comment letters.\24\ The Commission did not 
receive any comments on this issue.
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    \23\ 66 FR at 36221.
    \24\ Id.
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    Compliance with regulation 41.27 would impose costs on DCMs and 
DTFs with respect to enacting and enforcing rules restricting dual 
trading of security futures products traded through open outcry on a 
trading floor. The costs of enacting and enforcing rules associated 
with regulation 41.27 are either balanced or outweighed by the 
increased protection of market participants and the public. The 
Commission's exercise of its discretion in implementing the 
Congressional directive to restrict dual trading, as set forth in 
section 4j of the Act, would not unreasonably increase costs related to 
efficiency, competitiveness, and financial integrity of financial 
markets; price discovery; or sound risk management practices. After 
considering these factors, the Commission has determined to adopt 
regulation 41.27.

V. Related Matters

A. Regulatory Flexibility Act

    The Regulatory Flexibility Act (``RFA''), 5 U.S.C. 601 et seq., 
requires federal agencies, in promulgating regulations, to consider the 
impact of those regulations on small entities. The regulation adopted 
herein would affect DCMs, DTFs, and floor brokers. The Commission 
previously has established certain definitions of ``small entities'' to 
be used by the Commission in evaluating the impact of its regulations 
on small entities in accordance with the RFA.\25\ In its previous 
determinations, the Commission has concluded that contract markets are 
not small entities for the purpose of the RFA.\26\ The Commission has 
recently determined that DTFs, for reasons similar to those applicable 
to contract markets, are not small entities for purposes of the 
RFA.\27\
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    \25\ See 47 FR 18618-21 (Apr. 30, 1982).
    \26\ See 47 FR 18618 at 18619 (discussing contract markets).
    \27\ See A New Regulatory Framework for Trading Facilities, 
Intermediaries and Clearing Organizations 66 FR 42256, 42268 (August 
10, 2001).
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    As the Commission stated in its proposing release, certain floor 
brokers would be affected by proposed regulation 41.27. The Commission, 
however, believes that regulation 41.27 as adopted will not have a 
significant economic impact on a substantial number of small entities. 
The Commission requested comment on this issue, but received no 
comments. Therefore, the Chairman, on behalf of the Commission, hereby 
certifies, pursuant to 5 U.S.C. 605(b), that the rule amendments will 
not have a significant impact on a substantial number of small 
entities.

B. Paperwork Reduction Act of 1995

    This rule contains information collection requirements. As required 
by the Paperwork Reduction Act of 1995, (44 U.S.C. 3507(d)) the 
Commission has submitted a copy of this rule to the Office of 
Management and Budget for its review. No comments were received in 
response to the Commission's invitation in the proposing release to 
comment on any potential paperwork burden associated with this 
regulation.

List of Subjects in 17 CFR Parts 37, 38, 41, and 155

    Commodity futures, Contract markets, Reporting and recordkeeping 
requirements, Security futures products.

PART 37--DERIVATIVES TRANSACTION EXECUTION FACILITIES

    1. The authority citation for Part 37 continues to read as follows:

    Authority: 7 U.S.C. 2, 5, 6, 6c, 7a and 12a.


    2. Section 37.2 is revised to read as follows:


Sec. 37.2  Exemption.

    Contracts, agreements, or transactions traded on a derivatives 
transaction execution facility registered as such with the Commission 
under section 5a of the Act, the facility and the facility's operator 
are exempt from all Commission regulations for such activity, except 
for the requirements of this part 37 and Secs. 1.3, 1.31, 1.59(d), 
1.63(c), 15.05, 33.10, 41.27, part 40, and part 190 of this chapter, 
and as applicable to the market, parts 15 through 21 of this chapter, 
which are applicable to a registered derivatives transaction execution 
facility as though they were set forth in this section and included 
specific reference to derivatives transaction execution facilities.

PART 38--DESIGNATED CONTRACT MARKETS

    3. The authority citation for Part 38 continues to read as follows:

    Authority: 7 U.S.C. 2, 5, 6, 6c, 7a and 12a.


    4. Section 38.2 is revised to read as follows:


Sec. 38.2  Exemption.

    Agreements, contracts, or transactions traded on a designated 
contract market under section 6 of the Act, the contract market and the 
contract market's operator are exempt from all Commission regulations 
for such activity, except for the requirements of this part 38 and 
Secs. 1.3, 1.12(e), 1.31, 1.38, 1.52, 1.59(d), 1.63(c), 1.67, 33.10, 
41.27, parts 15 through 21, part 40 and part 190 of this chapter.

PART 41--SECURITY FUTURES

    5. The authority citation for Part 41 is revised to read as 
follows:

    Authority: 7 U.S.C. 1a, 2, 4, 6f, 6j, 7a-2, 7b, 12a.


    6. Section 41.27 is added as follows:

[[Page 11228]]

Sec. 41.27  Prohibition of Dual Trading In Security Futures Products By 
Floor Brokers.

    (a) Definitions. For purposes of this section:
    (1) Trading session means hours during which a designated contract 
market or registered derivatives transaction execution facility is 
scheduled to trade continuously during a trading day, as set forth in 
its rules, including any related post settlement trading session. A 
designated contract market or registered derivatives transaction 
execution facility may have more than one trading session during a 
trading day.
    (2) Member shall have the meaning set forth in section 1a(24) of 
the Act.
    (3) Broker association includes two or more designated contract 
market or registered derivatives transaction execution facility members 
with floor trading privileges of whom at least one is acting as a floor 
broker who:
    (i) Engage in floor brokerage activity on behalf of the same 
employer;
    (ii) Have an employer and employee relationship which relates to 
floor brokerage activity;
    (iii) Share profits and losses associated with their brokerage or 
trading activity; or
    (iv) Regularly share a deck of orders.
    (4) Customer means an account owner for which a trade is executed 
other than:
    (i) An account in which such floor broker has any interest;
    (ii) An account for which a floor broker has discretion;
    (iii) An account controlled by a person with whom a floor broker 
has a relationship through membership in a broker association;
    (iv) A house account of the floor broker's clearing member; or
    (v) An account for another member present on the floor of a 
designated contract market or registered derivatives transaction 
execution facility or an account controlled by such other member.
    (5) Dual trading means the execution of customer orders by a floor 
broker through open outcry during the same trading session in which the 
floor broker executes directly or by initiating and passing to another 
member, either through open outcry or through a trading system that 
electronically matches bids and offers pursuant to a predetermined 
algorithm, a transaction for the same security futures product on the 
same designated contract market or registered derivatives transaction 
execution facility for an account described in paragraphs (a)(4)(i)-(v) 
of this section.
    (b) Dual Trading Prohibition. (1) No floor broker shall engage in 
dual trading in a security futures product on a designated contract 
market or registered derivatives transaction execution facility, except 
as otherwise provided under paragraphs (d), (e), and (f) of this 
section.
    (2) A designated contract market or a registered derivatives 
transaction execution facility operating an electronic market or 
electronic trading system that provides market participants with a time 
or place advantage or the ability to override a predetermined algorithm 
must submit an appropriate rule proposal to the Commission consistent 
with the procedures set forth in Sec. 40.5. The proposed rule must 
prohibit electronic market participants with a time or place advantage 
or the ability to override a predetermined algorithm from trading a 
security futures product for accounts in which these same participants 
have any interest during the same trading session that they also trade 
the same security futures product for other accounts. This paragraph, 
however, is not applicable with respect to execution priorities or 
quantity guarantees granted to market makers who perform that function, 
or to market participants who receive execution priorities based on 
price improvement activity, in accordance with the rules governing the 
designated contract market or registered derivatives transaction 
execution facility.
    (c) Rules Prohibiting Dual Trading. (1) Designated contract 
markets. Prior to listing a security futures product for trading on a 
trading floor where bids and offers are executed through open outcry, a 
designated contract market:
    (i) Must submit to the Commission in accordance with Sec. 40.6, a 
rule prohibiting dual trading, together with a written certification 
that the rule complies with the Act and the regulations thereunder, 
including this section; or
    (ii) Must obtain Commission approval of such rule pursuant to 
Sec. 40.5.
    (2) Registered derivatives transaction execution facilities. Prior 
to listing a security futures product for trading on a trading floor 
where bids and offers are executed through open outcry, a registered 
derivatives transaction execution facility:
    (i) Must notify the Commission in accordance with Sec. 37.7(b) that 
it has adopted a rule prohibiting dual trading; or
    (ii) Must obtain Commission approval of such rule pursuant to 
Sec. 37.7(c).
    (d) Specific Permitted Exceptions. Notwithstanding the 
applicability of a dual trading prohibition under paragraph (b) of this 
section, dual trading may be permitted on a designated contract market 
or a registered derivatives transaction execution facility pursuant to 
one or more of the following specific exceptions:
    (1) Correction of errors. To offset trading errors resulting from 
the execution of customer orders, provided, that the floor broker must 
liquidate the position in his or her personal error account resulting 
from that error through open outcry or through a trading system that 
electronically matches bids and offers as soon as practicable, but, 
except as provided herein, not later than the close of business on the 
business day following the discovery of error. In the event that a 
floor broker is unable to offset the error trade because the daily 
price fluctuation limit is reached, a trading halt is imposed by the 
designated contract market or registered derivatives transaction 
execution facility, or an emergency is declared pursuant to the rules 
of the designated contract market or registered derivatives transaction 
execution facility, the floor broker must liquidate the position in his 
or her personal error account resulting from that error as soon as 
practicable thereafter.
    (2) Customer consent. To permit a customer to designate in writing 
not less than once annually a specifically identified floor broker to 
dual trade while executing orders for such customer's account. An 
account controller acting pursuant to a power of attorney may designate 
a dual trading broker on behalf of its customer, provided, that the 
customer explicitly grants in writing to the individual account 
controller the authority to select a dual trading broker.
    (3) Spread transactions. To permit a broker who unsuccessfully 
attempts to leg into a spread transaction for a customer to take the 
executed leg into his or her personal account and to offset such 
position, provided, that a record is prepared and maintained to 
demonstrate that the customer order was for a spread.
    (4) Market emergencies. To address emergency market conditions 
resulting in a temporary emergency action as determined by a designated 
contract market or registered derivatives transaction execution 
facility.
    (e) Rules Permitting Specific Exceptions. (1) Designated contract 
markets. Prior to permitting dual trading under any of the exceptions 
provided in paragraphs (d)(1)-(4) of this section, a designated 
contract market:
    (i) Must submit to the Commission in accordance with Sec. 40.6, a 
rule permitting the exception(s), together

[[Page 11229]]

with a written certification that the rule complies with the Act and 
the regulations thereunder, including this section; or
    (ii) Must obtain Commission approval of such rule pursuant to 
Sec. 40.5.
    (2) Registered derivatives transaction execution facilities. Prior 
to permitting dual trading under any of the exceptions provided in 
paragraphs (d)(1)-(4) of this section, a registered derivatives 
transaction execution facility:
    (i) Must notify the Commission in accordance with Sec. 37.7(b) that 
it has adopted a rule permitting the exception(s); or
    (ii) Must obtain Commission approval of such rule pursuant to 
Sec. 37.7(c).
    (f) Unique or Special Characteristics of Agreements, Contracts, or 
Transactions, or of Designated Contract Markets or Registered 
Derivatives Transaction Execution Facilities.
    Notwithstanding the applicability of a dual trading prohibition 
under paragraph (b) of this section, dual trading may be permitted on a 
designated contract market or registered derivatives transaction 
execution facility to address unique or special characteristics of 
agreements, contracts, or transactions, or of the designated contract 
market or registered derivatives transaction execution facility as 
provided herein. Any rule of a designated contract market or registered 
derivatives transaction execution facility that would permit dual 
trading when it would otherwise be prohibited, based on a unique or 
special characteristic of agreements, contracts, or transactions, or of 
the designated contract market or registered derivatives transaction 
execution facility must be submitted to the Commission for prior 
approval under the procedures set forth in Sec. 40.5. The rule 
submission must include a detailed demonstration of why an exception is 
warranted.

    7. Section 41.34 is revised to read as follows:


Sec. 41.34  Exempt Provisions.

    Any board of trade notice-designated as a contract market in 
security futures products pursuant to Sec. 41.31 also shall be exempt 
from:
    (a) The following provisions of the Act, pursuant to section 
5f(b)(1) of the Act:
    (1) Section 4(c)(c);
    (2) Section 4(c)(e);
    (3) Section 4(c)(g);
    (4) Section 4j;
    (5) Section 5;
    (6) Section 5c;
    (7) Section 6a;
    (8) Section 8(d);
    (9) Section 9(f);
    (10) Section 16 and;
    (b) The following provisions, pursuant to section 5f(b)(4) of the 
Act:
    (1) Section 6(a);
    (2) Part 38 of this chapter;
    (3) Part 40 of this chapter; and
    (4) Section 41.27.

PART 155--TRADING STANDARDS

    8. 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.


Sec. 155.5  [Removed and Reserved]

    9. Section 155.5 is removed and reserved.

    Issued in Washington, DC on March 1, 2002 by the Commission.
Catherine D. Dixon,
Assistant Secretary of the Commission.
[FR Doc. 02-5778 Filed 3-12-02; 8:45 am]
BILLING CODE 6351-01-P