[Federal Register Volume 67, Number 73 (Tuesday, April 16, 2002)]
[Notices]
[Pages 18664-18666]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 02-9192]


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SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-45720; File No. SR-NFA-2002-02]


Self-Regulatory Organizations; Notice of Filing of Proposed Rule 
Change by National Futures Association Regarding Broker-Dealer 
Registration, Fair Commissions, and Best Execution Obligations with 
Respect to Security Futures Products

April 10, 2002.
    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 March 20, 2002, National Futures Association 
(``NFA'') filed with the Securities and Exchange Commission (``SEC'' or 
``Commission'') the proposed rule changes described in Items I, II, and 
III below, which Items have been prepared by NFA. The Commission is 
publishing this notice to solicit comments on the proposed rule changes 
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 March 19, 2002, NFA submitted the proposed rule change to the 
Commodity Futures Trading Commission (``CFTC'') for approval. Under 
section 19(b)(7)(B) of the Act,\3\ the proposed rule change may take 
effect upon approval by the CFTC.
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    \3\ 15 U.S.C. 78s(b)(7)(B).
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I. Self-Regulatory Organization's Description of the Proposed Rule 
Change

    Section 15A(k) of the Exchange Act \4\ makes NFA a national 
securities association for the limited purpose of regulating the 
activities of members who are registered as brokers or dealers in 
security futures products under section 15(b)(11) of the Exchange 
Act.\5\ The proposed ``Interpretive Notice to NFA Compliance Rule 2-4 
Regarding the Registration Requirements for Trading Security Futures 
Products' clarifies that it is a violation of NFA rules for an NFA 
member to act as a broker-dealer for security futures products unless 
the member is properly registered as a broker-dealer. Proposed NFA 
Compliance Rule 2-37(g) and the proposed interpretive notices regarding 
fair commissions and best execution are in keeping with the SEC's 
August 21, 2001 Order, which requires NFA to adopt customer protection 
rules comparable to the rules of the National Association of Securities 
Dealers, Inc. (``NASD'').\6\ Proposed NFA Compliance Rule 2-37(g) and 
its ``Interpretive Notice Regarding Fair Commissions'' specifically 
require notice-registered broker-dealers to charge fair commissions. 
The proposed ``Interpretive Notice to NFA Compliance Rule 2-4 Regarding 
Best Execution'' sets forth a notice-registered broker-dealer's best 
execution obligation for security futures orders.
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    \4\ 15 U.S.C. 78o-3(k).
    \5\ 15 U.S.C. 78o(b)(11).
    \6\ See Securities Exchange Act Release No. 44729.
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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 for inspection at the Office 
of the Secretary, the NFA, the Commission's Public Reference Room, 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

Proposed Interpretive Notice to NFA Compliance Rule 2-4 Regarding the 
Registration Requirements for Trading Security Futures Products

    The CFMA provides that security futures products are securities as 
well as futures and therefore are subject to

[[Page 18665]]

regulation in both the futures and securities industries. As a result, 
NFA members that solicit or accept orders or carry accounts for 
security futures products are also required to be registered as broker-
dealers under the Exchange Act. Any NFA member that is not currently 
registered as a full broker-dealer under the Exchange Act may notice-
register as a broker-dealer by filing form BD-N with NFA. The proposed 
interpretive notice clarifies that it is a violation of NFA rules for 
an NFA member to solicit or accept orders, carry accounts or otherwise 
act as a broker-dealer for security futures products unless the Member 
is properly registered as a broker-dealer under the Exchange Act.

Proposed NFA Compliance Rule 2-37(g) and Its Proposed Interpretive 
Notice Relating to Fair Commissions for Security Futures Products

    NFA believes that NFA Compliance Rule 2-37(g) is almost identical 
to the provisions of NASD Rule 2440 relating to agency transactions. 
Its proposed interpretive notice discusses these provisions in more 
detail and reassures NFA members that most members' current commission 
practices already comply with these requirements. For example, the 
interpretive notice explicitly notes that the following practices are 
acceptable under Compliance Rule 2-37(g): charging commissions based on 
costs plus a reasonable profit, taking the services provided by the 
member into consideration when setting commissions, and negotiating 
commissions with institutional customers based on volume or similar 
measures. NFA represents that the interpretive notice is also 
consistent with NFA's traditional approach, which requires full 
disclosure of fees and commissions.
    As with most of the other security futures rules, NFA states that 
proposed Compliance Rule 2-37(g) and its interpretive notice would 
apply only to FCMs and IBs who notice-register as broker-dealers under 
section 15(b)(11) of the Exchange Act. \7\ According to NFA, dual 
registrants would presumably be subject to the NASD's requirements 
(i.e., NASD Rule 2440 and NASD IM-2440).
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    \7\ 15 U.S.C. 78o(b)(11).
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Proposed Interpretive Notice to NFA Compliance Rule 2-4 Regarding the 
Best Execution Obligation of NFA Members Registered as Broker-Dealers 
Under section 15(b)(11) of the Securities Exchange Act of 1934

    The SEC's August 21, 2001 Order also requires NFA to adopt a best 
execution rule. Given the complexity of the issues relating to best 
execution, NFA staff formed a working group with representatives from 
the futures exchanges, FCMs, end users, a securities options exchange, 
and an alternative trading system to help formulate a best execution 
interpretive notice. In formulating NFA's approach to best execution, 
NFA states that the working group analyzed NASD Rule 2320's terms, how 
best execution works in the equity options markets, and the SEC's rules 
relating to order execution and routing. From the outset, the working 
group felt that NFA's approach to best execution should be an 
interpretation of NFA Compliance Rule 2-4, which imposes an obligation 
upon members to put their customers' interests before their own when 
soliciting and executing futures transactions.
    The proposed interpretive notice is designed to set forth a 
member's best execution obligation yet provide members with flexibility 
in meeting this obligation. The interpretive notice reiterates NFA 
Compliance Rule 2-4's obligation of all members and associates to put 
their customers' interests before their own when soliciting and 
executing futures transactions. In those cases where a customer's order 
may be executed on two or more markets trading security futures 
contracts that are not materially different, members and associates 
have an obligation to use reasonable diligence to ascertain the market 
in which the customer's security futures order will receive the most 
favorable terms and, in particular, the best price available under 
prevailing market conditions. The interpretive notice provides guidance 
on how to fulfill that obligation.
    First, the interpretive notice makes clear that if a customer or 
customer's designee requests that a security futures order be directed 
to a particular market, then the member or associate is required to 
follow the customer's or designee's instructions. However, in the 
absence of customer instructions, a member or associate must consider 
the relevant facts and circumstances including, at a minimum, the 
following factors in discharging its obligation to use reasonable 
diligence in ascertaining where a customer's security futures order 
would receive the most favorable execution available:
     The character of the market including, but not limited to, 
price, volatility, liquidity, depth, speed of execution, and pressure 
on available communications;
     The size and type of transaction, including the type of 
order; and
     The location, reliability and accessibility to the 
customer's intermediary of primary markets and quotation sources.
    Members and associates must also consider differences in the fees 
and costs to customers (e.g., transaction fees, clearing costs and 
expenses) associated with executing transactions in each market. Unless 
specifically instructed by a customer or customer's designee or 
necessary to obtain the execution of an order, a member shall not 
channel an order through a third party unless the member can show that 
by doing so the total cost or proceeds of the transaction were better 
than if the member decided not to channel the order through the third 
party.
    The interpretive notice also recognizes that it may be 
impracticable for members and associates to make order routing 
decisions for retail orders on an order-by-order basis. Members and 
associates that do not make order routing decisions for retail orders 
on an order-by-order basis should, at a minimum, consider the above 
factors and the materiality of any differences among contracts traded 
on different markets when establishing their retail order-routing 
practices and perform a regular and rigorous review of those practices 
to ensure that their best execution obligation is fulfilled.
    As with most of the other security futures rules, NFA represents 
that the proposed interpretive notice would apply only to FCMs and IBs 
who notice-register as broker-dealers under section 15(b)(11) of the 
Exchange Act.\8\ Dual registrants would presumably be subject to the 
NASD's requirements (i.e., NASD Rule 2320).
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    \8\ 15 U.S.C. 78o(b)(11).
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2. Statutory Basis
    The rule change is authorized by, and consistent with, section 
15A(k) of the Exchange Act.\9\
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    \9\ 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 necessary or appropriate in furtherance of the purposes of the 
Exchange Act and the CEA. Any burdens imposed are

[[Page 18666]]

necessary and appropriate in order to protect customers.

C. Self-Regulatory Organization's Statement of Comments on the Proposed 
Rule Change Received From Members, Participants, or Others

    NFA worked with industry representatives in developing the rule 
changes. NFA did not, however, publish the rule changes to the 
membership for comment. NFA did not receive comment letters concerning 
the rule changes.

III. Date of Effectiveness of the Proposed Rule Change and Timing 
for Commission Action

    The proposed rule change will become effective upon approval 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. \10\
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    \10\ 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 
Web site (http://www.sec.gov). All submissions should refer to File No. 
SR-NFA-2002-02 and should be submitted by May 7, 2002.

    For the Commission, by the Division of Market Regulation, 
pursuant to delegated authority.\11\
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    \11\ 17 CFR 200.30-3(a)(75).
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Margaret H. McFarland,
Deputy Secretary.
[FR Doc. 02-9192 Filed 4-15-02; 8:45 am]
BILLING CODE 8010-01-P