[Federal Register Volume 67, Number 83 (Tuesday, April 30, 2002)]
[Notices]
[Pages 21313-21315]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 02-10579]


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SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-45812; File No. SR-NFA-2002-01]


Self-Regulatory Organization; Notice of Filing of a Proposed Rule 
Change by the National Futures Association Relating to Interpretive 
Notice Regarding NFA Compliance Rule 2-9, Supervision of the Use of 
Automated Order-Routing Systems

April 24, 2002.
    Pursuant to section 19(b)(7) of the Securities Exchange Act of 1934 
(``Act'') \1\ and Rule 19b-7 under the Act,\2\ notice is hereby given 
that on March 5, 2002, the National Futures Association (``NFA'') filed 
with the Securities and Exchange Commission (``SEC'' or ``Commission'') 
the proposed

[[Page 21314]]

rule change described in Items I, II, and III below, which Items have 
been prepared by the NFA. The Commission is publishing this notice to 
solicit comments on the proposed rule change from interested persons. 
The NFA has also filed the proposed rule change with the Commodity 
Futures Trading Commission (``CFTC'').
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    \1\ 15 U.S.C. 78s(b)(7).
    \2\ 17 C.F.R. 240.19b-7.
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    The NFA, on March 1, 2002, submitted the proposed rule change to 
the CFTC for approval. On March 21, 2002, the CFTC issued a notice and 
request for comment regarding the proposed rule change.\3\ Under 
Section 19(b)(7)(B) of the Act, the proposed rule change may take 
effect upon approval by the CFTC.
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    \3\ 67 FR 14701 (March 27, 2002).
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I. Self-Regulatory Organization's Description of the Proposed Rule 
Change

    Section 15A(k) of the Act \4\ makes the 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 Act.\5\ The proposed 
Interpretive Notice to NFA Compliance Rule 2-9 Regarding the 
Supervision of the Use of Automated Order-Routing Systems (``AORSs'') 
applies to all NFA members who accept orders for futures accounts, 
regardless of the underlying product and, therefore, will apply to NFA 
members registered as broker-dealers under Section 15(b)(11) of the Act 
with regard to their security futures activities.
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    \4\ 15 U.S.C. 78o-3(k).
    \5\ 15 U.S.C. 78o(b)(11).
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    In November 2000, NFA's Board of Directors--responding to a letter 
from then CFTC Chairman Rainer--asked its Special Committee to Review 
Technology (``Special Committee'') to develop standards relating to 
security, capacity, and controls for AORSs that route orders through a 
futures commission merchant (``FCM''). The Board also directed the 
Special Committee to find a middle ground between one-size-fits-all 
requirements that mandate specific technology and guidelines that are 
so general as to be meaningless. The proposed Interpretive Notice 
addresses AORS issues by providing interpretive guidance to NFA members 
on their supervisory responsibilities over orders entered through those 
systems.

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.

A. Self-Regulatory Organization's Statement of the Purpose of, and 
Statutory Basis for, the Proposed Rule Change

1. Purpose
    The proposed interpretive notice recognizes that NFA members have a 
supervisory responsibility to process orders in a reliable and timely 
manner and to impose credit and risk-management controls on trading 
done by any particular customer. The notice also recognizes that 
supervisory standards do not change with the medium used but that how 
those standards are applied may be affected by technology. Therefore, 
as the Board directed, the notice tries to achieve a middle ground 
between one-size-fits-all requirements that mandate specific technology 
and guidelines that are so general as to be meaningless.
    Regarding security, the notice states that NFA members who accept 
orders must adopt and enforce written procedures reasonably designed to 
protect the reliability and confidentiality of orders and account 
information at all points during the order-routing process. To that 
end, the notice states that NFA members should have procedures 
regarding authentication of users, encryption of information, 
firewalls, authorization of users, periodic testing of the AORS's 
security systems, and who will administer system security.
    On the subject of capacity, the notice provides that NFA members 
who accept orders must adopt and enforce written procedures reasonably 
designed to maintain adequate personnel and facilities for the timely 
and efficient delivery of customer orders and reporting of executions. 
In this regard, the procedures should cover capacity reviews, disaster 
recovery and redundancies, and advance disclosure to customers of both 
potential systems problems and alternative procedures for customers to 
use if problems occur.
    In connection with credit and risk-management controls, the notice 
states that NFA members who accept orders must adopt and enforce 
written procedures reasonably designed to prevent customers from 
entering into trades that create undue financial risks for the NFA 
member or the NFA member's other customers. In particular, the 
procedures should address pre-execution and post-execution controls and 
how to determine which controls apply to a particular customer, special 
considerations for authorizing use of direct access systems, and on 
going review of the controls imposed.
2. Statutory Basis
    The rule change is authorized by, and consistent with, Section 
15A(k) of the Act.\6\
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    \6\ 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 Act 
and the Commodity Exchange Act (``CEA''). The Special Committee 
considered the economic burdens the rule change could impose on smaller 
entities and attempted to minimize those burdens. In any event, any 
burdens imposed are necessary and appropriate in order to ensure that 
customer orders are handled properly.

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

    NFA sent a notice to all NFA members requesting comments on the 
proposed interpretive notice. NFA received nine comment letters. NFA's 
FCM, introducing broker (``IB''), commodity pool operators' (``CPO'') 
and commodity trading advisors' (``CTA'') Advisory Committees also 
provided comments. In general:
     All of the commenters except the FCM Advisory Committee 
supported NFA's efforts to provide guidance to NFA members on their 
supervisory responsibilities for orders entered through an AORS;
     Several of the commenters questioned the specific approach 
taken by the proposed interpretive notice, which they interpreted as 
being overly prescriptive rather than simply providing guidance; and
     Some commenters believed that NFA should not mandate that 
the supervisory procedures be in writing. Some commenters also felt 
that it is unnecessary to have procedures covering protections that are 
already written into an automated system.

[[Page 21315]]

     In contrast to the other commenters, NFA's FCM Advisory 
Committee felt that NFA should not issue interpretive guidance on the 
use of AORSs. The FCM Advisory Committee believes that decisions 
regarding AORSs should be a matter of business judgment, not 
regulation.
Special Committee's Response to Comments
    The Special Committee considered all of the comments that it 
received. Although it recognizes the FCM Advisory Committee's concerns, 
the Special Committee continues to believe that its mandate from the 
Board requires it to propose interpretive guidance. The Special 
Committee also believes, however, that the industry needs guidance and 
that it is appropriate for NFA to issue it. The Special Committee 
believes that the interpretive notice provides that guidance by 
clarifying existing requirements.
    As noted above, some of the commenters felt the interpretive notice 
was too prescriptive. As a general matter, the Special Committee 
believes that the standards must be clear enough to provide meaningful 
guidance and ensure that firms can be audited for compliance. The 
Special Committee did, however, agree with a number of the specific 
comments that were made and revised the interpretive notice 
accordingly.
    Finally, despite some comments, the Special Committee believes that 
the supervisory procedures should be in writing. It did, however, add a 
footnote to clarify that the procedures do not have to contain 
technical specifications or duplicate procedures that are documented 
elsewhere.
    The Board agreed with the Special Committee's conclusions and 
adopted the Interpretive Notice as recommended.

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 Act.\7\
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    \7\ 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 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-2002-01 and should be submitted by May 21, 2002.

    For the Commission, by the Division of Market Regulation, 
pursuant to delegated authority.\8\
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    \8\ 17 C.F.R. 200.30-3(a)(75).
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Margaret H. McFarland,
Deputy Secretary.
[FR Doc. 02-10579 Filed 4-29-02; 8:45 am]
BILLING CODE 8010-01-U