[Federal Register Volume 69, Number 70 (Monday, April 12, 2004)]
[Notices]
[Pages 19166-19168]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 04-8235]


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COMMODITY FUTURES TRADING COMMISSION


Futures Market Self-Regulation

AGENCY: Commodity Futures Trading Commission.

ACTION: Request for comment.

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SUMMARY: The Commodity Exchange Act (the ``Act''),\1\ through Core 
Principles added by the Commodity Futures Modernization Act of 2000 
(``CFMA'') \2\ and otherwise, imposes upon trading facilities 
(designated contract markets or ''DCMs'' and derivatives transaction 
execution facilities or ``DTEFs''), upon registered futures 
associations (``RFAs''),\3\ and upon clearinghouses (derivatives 
clearing organizations or ``DCOs'') certain self-regulatory obligations 
with respect to futures commission merchants (``FCMs'') that are 
members of such DCMs, DTEFs, RFAs, and DCOs (together, ``self-
regulatory organizations'' or ``SROs''). In order to avoid duplicative 
supervisory burdens upon FCMs that are members of more than one SRO, 
the Commodity Futures Trading Commission (the ``Commission'' or 
``CFTC'') permits SROs to enter into voluntary, cooperative agreements 
to both allocate certain supervisory responsibilities among themselves 
so that each FCM has a single designated self-regulatory organization 
(``DSRO'') and to share relevant financial and risk information among 
themselves. Under such an agreement, each DSRO is primarily responsible 
for conducting periodic examinations of firms assigned to it, and the 
other SROs rely upon the findings of such examinations, yet under the 
Act and Commission regulations each SRO retains ultimate responsibility 
for ensuring proper performance of its self-regulatory duties.\4\
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    \1\ 7 U.S.C. 1 et seq. (2000).
    \2\ See Pub. L. 106-554, 114 Stat. 2763 (Dec. 21, 2000).
    \3\ CFTC Regulation 170.15 requires each FCM to be a member of 
at least one RFA that is registered with the Commission pursuant to 
section 17 of the Act. Commission regulations referred to herein may 
be found at 17 CFR Ch. I (2003).
    \4\ DSROs also monitor compliance in the areas of sales 
practice, recordkeeping, and anti-money laundering protections.
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    Any two or more SROs may propose to enter into an agreement to 
effectuate a DSRO plan but such a plan may not be implemented unless 
and until the Commission, following appropriate notice and opportunity 
for public comment, approves the plan (in whole or in part and as 
submitted or as modified according to the Commission's direction). \5\ 
The Commission also may, after appropriate notice and opportunity for 
hearing, withdraw its approval of a plan (in whole or in part) that it 
has previously approved if, in the Commission's determination, the plan 
(or part) no longer adequately effectuates the purposes of the Act or 
Commission regulations.\6\
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    \5\ Regulation 1.52(g) states:
    After appropriate notice and opportunity for comment, the 
Commission may, by written notice, approve such a plan, or any part 
of the plan, if it finds that the plan, or any part of it: (1) Is 
necessary or appropriate to serve the public interest; (2) Is for 
the protection and in the interest of customers; (3) Reduces 
multiple monitoring and auditing for compliance with the minimum 
financial rules of the [SROs] submitting the plan for any [FCM or IB 
that] is a member of more than one [SRO]; (4) Reduces multiple 
reporting of the financial information necessitated by such minimum 
financial and related reporting requirements by any [FCM or IB that] 
is a member of more than one [SRO]; (5) Fosters cooperation and 
coordination among the contract markets; and (6) Does not hinder the 
development of [an RFA] under [S]ection 17 of the Act.
    \6\ See Regulation 1.52(i).
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    In 1984, a number of SROs entered into a Joint Audit Agreement 
(``1984 Agreement'') to effectuate a DSRO plan.\7\ Proposed amendments 
to the 1984 Agreement were recently submitted for approval (``Proposed 
Agreement''). In accordance with Sec.  1.52(g) of its regulations and 
in conjunction with its ongoing review of the self-regulatory system 
for futures markets, the Commission is publishing this notice to

[[Page 19167]]

request public comment on the Proposed Agreement.
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    \7\ See 49 FR 28906 (Jul. 17, 1984) (approved in large part on 
Oct. 10, 1984 (``1984 Commission Letter'')).

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DATES: Comments must be received on or before May 27, 2004.

ADDRESSES: Interested persons should submit their views and comments to 
Jean A. Webb, Secretary, Commodity Futures Trading Commission, Three 
Lafayette Centre, 1155 21st Street, NW., Washington, DC 20581. In 
addition, comments may be sent by facsimile transmission to (202) 418-
5521, or by electronic mail to [email protected]. Reference should be 
made to ``Futures Market Self-Regulation''. This document also will be 
available for comment at http://www.regulations.gov.

FOR FURTHER INFORMATION CONTACT: Thomas J. Smith, Associate Deputy 
Director and Chief Accountant, or Natalie A. Markman, Senior Special 
Counsel, Division of Clearing and Intermediary Oversight, Commodity 
Futures Trading Commission, Three Lafayette Centre, 1155 21st Street, 
NW., Washington, DC 20581. Telephone (202) 418-5450.

SUPPLEMENTARY INFORMATION:

I. Background

A. The DSRO System

    The Commission promulgated Regulation 1.52 in 1978 to permit 
cooperative self-regulatory arrangements such as the DSRO system that 
operates today.\8\ Under CFTC regulations, the term ``designated self-
regulatory organization'' means an SRO of which an FCM is a member or, 
if the FCM is a member of more than one SRO, the SRO to whom certain 
self-regulatory responsibilities are delegated pursuant to a DSRO 
agreement.\9\ Notwithstanding the DSRO system, moreover, each SRO must 
establish and maintain appropriate procedures for monitoring the 
financial integrity of its member firms.\10\ This fundamental 
obligation is reflected in the Act.\11\
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    \8\ 43 FR 39956, 39981-82 (Sep. 8, 1978). Although the 
regulation has been amended over the years, its fundamental 
requirements have remained substantially the same.
    \9\ Originally, Regulation 1.3(ff) defined a DSRO to be an SRO:
    \10\ Commission staff has provided detailed guidance on 
conducting an effective surveillance program. See Division of 
Trading and Markets Financial and Segregation Interpretation No. 4-
1--Advisory Interpretation for Self-Regulatory Organization 
Surveillance over Members' Compliance with Minimum Financial, 
Segregation, Reporting, and Related Recordkeeping Requirements, 1 
Comm. Fut. L. Rep. (CCH) ] 7114A at ] 43 (Jul. 29, 1985).
    \11\ Both trading facilities and clearing organizations have 
important self-regulatory obligations under the Act. Core Principle 
2 requires each DCM to monitor and enforce compliance with its 
rules. Core Principle 11 further requires each DCM to establish and 
enforce rules to ensure the financial integrity of FCMs and IBs and 
the protection of customer funds. 7 U.S.C. 7(d)(2) and (11). Core 
Principle H requires each DCO to monitor and enforce its rules, and 
the rules of a clearing organization focus extensively on issues of 
financial integrity. Moreover, Core Principle C requires each DCO to 
establish appropriate continuing eligibility standards (including 
appropriate minimum financial requirements) for its members and 
participants, and Core Principle M directs each DCO to enter into 
all appropriate and applicable information-sharing agreements and to 
use relevant information obtained thereby in carrying out its risk 
management program. 7 U.S.C. 7a-1(c)(2)(C), (H), and (M); see also, 
DTEF Registration Criterion 4, 7 U.S.C. 7a(c)(4); DTEF Core 
Principle 2, 7 U.S.C. 7a(d)(2); and Section 17(b)(4) of the Act 
(financial responsibility standards for RFA members), 7 U.S.C. 
21(b)(4).

Of which [an FCM] is a member or, if the [FCM] is a member of more than 
one [SRO] and such [FCM] is the subject of an approved plan under Sec.  
1.52, then [an SRO] delegated the responsibility by such a plan for 
monitoring and auditing such [FCM] for compliance with the minimum 
financial and related reporting requirements of the [SROs] of which the 
[FCM] is a member, and for receiving the financial reports necessitated 
by such minimum financial and related reporting requirements from such 
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[FCM].

43 FR at 39967. Regulation 1.3(ff) subsequently has been amended to 
include introducing brokers (``IBs'') and leverage transaction 
merchants.
    The 1984 Agreement created a Joint Audit Committee (``JAC'' or 
``Committee'') made up of one representative appointed by each of the 
parties to the agreement.\12\ Currently, if an FCM is a member of a 
single DCM among a group of certain DCMs that are long-time JAC 
members, then that DCM serves as DSRO for such firm. If an FCM is a 
member of more than one DCM within that group, then the Committee 
designates one of those DCMs to act as the firm's DSRO. If an FCM is 
not a member of one of the DCMs within that group, then NFA acts as the 
DSRO for such FCM.
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    \12\ The parties to the 1984 Agreement were: the Board of Trade 
of the City of Chicago (''CBOT''); Board of Trade of Kansas City 
(``KCBOT''); Chicago Mercantile Exchange (``CME''); Chicago Rice and 
Cotton Exchange; Coffee, Sugar & Cocoa Exchange, Inc. (``CSCE''); 
Commodity Exchange, Inc. (``COMEX''); MidAmerica Commodity Exchange; 
Minneapolis Grain Exchange (``MGE''); New York Cotton Exchange 
(``NYCE''); New York Futures Exchange, Inc.; New York Mercantile 
Exchange (``NYMEX''); and NFA.
    Current JAC members are: the AMEX Commodities Corp.; BrokerTec 
Futures Exchange, LLC; CBOE Futures Exchange, LLC; CBOT; CME; CSCE; 
COMEX; Island Futures Exchange, LLC; KCBOT; Merchants' Exchange, 
LLC; MGE; NQLX, LLC; NFA; NYCE; NYMEX; OneChicago, LLC; Philadelphia 
Board of Trade; and U.S. Futures Exchange, LLC. Not all members, 
however, have been assigned DSRO responsibilities.
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    In addition to allocating DSRO responsibilities among certain SROs, 
the Committee also oversees the design and implementation of the 
examination program utilized by those DSROs that maintain in-house 
examination staffs in their examinations of assigned firms. (The NFA 
has a comparable examination program that it utilizes in examining 
firms for which it has been assigned as DSRO and firms that it examines 
under contractual arrangements with other SROs.) The Committee also 
determines the minimum examination practices and procedures to be 
followed in the conduct of examinations. Committee members may share 
information with each other about the financial condition and risk 
exposures of FCMs but are under confidentiality restrictions with 
respect to sharing such information with other persons.\13\
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    \13\ For example, Paragraph 8(b) of the 1984 Agreement does not 
permit a DSRO to share such information with any clearinghouse 
except the clearinghouse that clears transactions executed on the 
DSRO's trading facility. The proposed amendments, however, would 
permit a DSRO to share information about an FCM with any DCO of 
which the FCM is a member.
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B. Commission Review of the DSRO System

    CFTC Chairman James Newsome announced in May 2003 that the 
Commission would review ``the roles, responsibilities, and capabilities 
of SROs in the context of market changes,'' such as demutualization and 
increasing competition.\14\ Chairman Newsome recognized that self-
regulation ``has been integral to the success of the futures markets'' 
and stated that it is appropriate for the Commission ``to ensure that 
the principles of objectivity, confidentiality, and consistency 
continue to be adhered to as well as they have always been in this 
business.'' \15\
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    \14\ Address by Chairman James E. Newsome at the Futures 
Industry Association Law and Compliance Luncheon (May 28, 2003), 
available at <http://www.cftc.gov/opa/speeches03/opanewsm-40.htm.
    \15\ In congressional testimony, Chairman Newsome explained that 
he initiated a review of the SRO system ``not because there are any 
particular issues that have arisen; but given the number of changes 
that have taken place in the industry over the last 2 or 3 years of 
both the exchanges and the firms, we think it is prudent and 
responsible for the CFTC to take a look at SROs and to make sure 
that the same principles that applied when SROs were put into place[ 
] apply now.'' Commodity Futures Modernization Act: Hearings Before 
the Subcomm. on General Farm Commodities and Risk Management of the 
House Comm. on Agriculture, 108th Cong., 1st Sess. 6 (2003) 
(statement of James E. Newsome, Chairman, CFTC).
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    In February 2004, the Commission issued a press release announcing 
several initiatives in connection with its

[[Page 19168]]

ongoing review of self-regulation.\16\ One such initiative is the 
examination of the DSRO system, including its cooperative agreements 
and programs.\17\ The CFTC's Division of Clearing and Intermediary 
Oversight has been assessing the impact of changes in the futures 
industry, such as new entrants being designated as DCMs \18\ and the 
CFMA's creation of a new registration category for DCOs,\19\ upon the 
DSRO system and its examination programs. A timely review of the DSRO 
system will ensure that DSROs continue to meet the needs of the markets 
and their participants. Accordingly, staff is conducting a formal 
review of the DSRO system as administered by the JAC through its 
examination program, including assessment of: (1) The governance and 
operation of the JAC; and (2) the effectiveness of the JAC and NFA 
examination programs, and related programs (``Programs'').
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    \16\ CFTC Press Release 4890-04 (Feb. 6, 2004), available at 
http://www.cftc.gov/opa/press04/opa4890-04.htm.
    \17\ In a related initiative, the Commission encouraged each SRO 
to reexamine its policies and procedures, training efforts, and day-
to-day practices to confirm that there are adequate safeguards to 
prevent the inappropriate use of confidential information obtained 
by SROs during audits, investigations, or other self-regulatory 
activities. The Commission also encouraged SROs to publicize any 
safeguards so market participants would continue to have faith in 
the integrity of the self-regulatory process and to participate 
enthusiastically in it.
    \18\ The Commission has designated seven new DCMs since passage 
of the CFMA.
    \19\ The CFMA changed the manner in which clearing organizations 
are recognized and regulated under the Act, and granted the 
Commission explicit authority to regulate DCOs. See 7 U.S.C. 7a-1. 
Each DCO must comply with certain core principles to maintain its 
registration. In particular, Section 5b(c)(2)(H)--Core Principle H 
on rule enforcement--requires a DCO to ``maintain adequate 
arrangements and resources for the effective monitoring and 
enforcement of compliance'' with its rules and for resolving 
disputes and to ``have the authority and ability to discipline, 
limit, suspend, or terminate a member's or participant's activities 
for violations'' of its rules.
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    The Commission invites comment on the Proposed Agreement, 
particularly with respect to the ability of the DSRO system to serve 
the public interest, reduce duplicative reporting and examination 
burdens on FCMs, strengthen customer protections, and foster 
cooperation and coordination among the markets. Some, but certainly not 
all, of the issues that the Commission may consider in its assessment 
of the Proposed Agreement include:
    1. Membership criteria;
    2. Decision-making processes and the limitation of voting 
eligibility on the bases of longevity and self-performance of 
examination services;
    3. The process by which an FCM is assigned to a particular DSRO;
    4. Delegation versus outsourcing of examination services;
    5. Distinctions between RFAs and non-RFAs with respect to 
delegation and outsourcing issues;
    6. Distinctions between DSRO responsibilities and SRO 
responsibilities;
    7. The extent to which the Commission should review the JAC's 
governance and operation on a more routine, periodic basis; and
    8. The general transparency of the DSRO system and its 
operation.\20\
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    \20\ Commission staff receives and reviews the Programs on an 
annual basis, but has not in the past reviewed the Joint Audit 
Agreement except in response to the submission of a new agreement.

In addition to the issues mentioned above, the Commission welcomes 
comment on any aspect of the DSRO system.
    The 1984 Agreement, 1984 Commission Letter, and the Proposed 
Agreement are available on the Commission's Web site at http://www.cftc.gov upon the issuance of this notice by the Commission. Copies 
also may be obtained from the Office of the Secretariat, Commodity 
Futures Trading Commission, 1155 21st Street, NW., Washington, DC 
20581.

    Issued in Washington, DC, on April 7, 2004, by the Commission.
Jean A. Webb,
Secretary of the Commission.
[FR Doc. 04-8235 Filed 4-9-04; 8:45 am]
BILLING CODE 6351-01-P