[Federal Register Volume 74, Number 240 (Wednesday, December 16, 2009)]
[Proposed Rules]
[Pages 66598-66601]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: E9-29730]


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COMMODITY FUTURES TRADING COMMISSION

17 CFR Part 190

RIN 3038-AC90


Operation, in the Ordinary Course, of a Commodity Broker in 
Bankruptcy

AGENCY: Commodity Futures Trading Commission.

ACTION: Notice of proposed rulemaking.

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SUMMARY: The Commodity Futures Trading Commission (the ``Commission'') 
proposes amending its regulations (17 CFR Chapter 1, hereinafter, the 
``Regulations'') regarding the operation of a commodity broker in 
bankruptcy, in order to permit the trustee in such bankruptcy to 
operate, with the written permission of the Commission, the business of 
such commodity broker in the ordinary course, including the purchase or 
sale of new commodity contracts on behalf of the customers of such 
commodity broker under appropriate circumstances, as determined by the 
Commission.

DATES: Submit comments on or before January 15, 2010.

ADDRESSES: You may submit comments, identified by RIN number, by any of 
the following methods:
     Federal eRulemaking Portal: http://www.regulations.gov. 
Follow the instructions for submitting comments.
     Agency Web Site: http://www.cftc.gov. Follow the 
instructions for submitting comments on the Web site.
     E-mail: [email protected]. Include the RIN number in the 
subject line of the message.
     Fax: 202-418-5521.
     Mail: David A. Stawick, Secretary of the Commission, 
Commodity Futures Trading Commission, Three Lafayette Centre, 1155 21st 
Street, NW., Washington, DC 20581.
     Hand Delivery/Courier: Same as mail above.

FOR FURTHER INFORMATION CONTACT: Robert B. Wasserman, Associate 
Director, Division of Clearing and Intermediary Oversight, 202-418-
5092, [email protected]; or Nancy Schnabel, Special Counsel, Division 
of Clearing and Intermediary Oversight, 202-418-5344, 
[email protected]; Commodity Futures Trading Commission, Three 
Lafayette Centre, 1155 21st Street, NW., Washington, DC 20581.

SUPPLEMENTARY INFORMATION

I. Authority of the Commission To Promulgate and Amend Regulation 
190.04(d)

    The Commission is empowered by Section 20 of the Commodity Exchange 
Act (the ``Act'') to provide ``[n]otwithstanding title 11 of the United 
States Code * * * with respect to a commodity broker that is a debtor 
under chapter 7 of title 11 of the United States Code, by rule or 
regulation * * * (3) the method by which the business of such commodity 
broker is to be conducted or liquidated after the date of the filing of 
the petition under such chapter, including the payment and allocation 
of margin with respect to commodity contracts not specifically 
identifiable to a particular customer pending their orderly 
liquidation.'' \1\
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    \1\ 7 U.S.C. 24.
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    The Commission exercised such power to promulgate Regulation 
190.04(d), which specifies the procedures that a trustee must follow in 
liquidating open commodity contracts carried by a commodity broker in 
bankruptcy. Similarly, the Commission will exercise such power when 
amending Regulation 190.04(d).
    Currently, Regulation 190.04(d)(2) denies a trustee the authority 
to purchase or sell new commodity contracts on behalf of customers of a 
commodity broker in bankruptcy, except to: (1) Offset an open commodity 
contract; (2) transfer any transferable notice (received by either the 
trustee or the commodity broker) applicable to an open commodity 
contract; and (3) cover, in its discretion and with the approval of the 
Commission, inventory or commodity contracts of the commodity broker 
that cannot be immediately liquidated due to market conditions 
(including price limits).\2\
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    \2\ 17 CFR 190.04(d)(2).

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[[Page 66599]]

II. Proposed Amendment To Allow the Trustee To Operate, in the Ordinary 
Course, a Commodity Broker in Bankruptcy

A. Background

    In the proposing release to the original Regulation Part 190 (the 
``Proposing Release''), the Commission specified the purposes that it 
intended Regulation Part 190 to achieve, which included:

    [T]o limit the period during which the bankruptcy estate is at 
risk from fluctuations in value of the commodity contracts and other 
property contained therein; * * * to maximize recovery in kind; and 
* * * to provide an understandable and workable method for operating 
the estate pending liquidation.\3\
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    \3\ 46 FR 57535, 57536 (November 24, 1981).

    In the typical case, a commodity broker in bankruptcy would be 
insolvent. If a commodity broker is insolvent, then it would not have 
the capital necessary for operating its business, including for 
supporting the credit of its customers, or for otherwise performing on 
its obligations.\4\ Thus, preventing a trustee from purchasing or 
selling new commodity contracts, whether for the commodity broker or 
the customers thereof, would generally (i) minimize the risk of loss to 
customers of the commodity broker, and (ii) therefore, maximize the 
scope of recovery for such customers.
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    \4\ In general, commodity brokers are required to guarantee all 
customer positions that they carry, as well as to use their own 
capital to cover the debit balance of any customer in an omnibus 
segregated account that they maintain, in order to prevent the 
commodity broker from using the property belonging to other 
customers to margin, guarantee, or secure the positions of the 
customer incurring such debit. See Section 4d of the Act (7 U.S.C. 
6d). See also CFTC Letter No. 00-106 (November 22, 2000) (stating 
that a commodity broker that is a futures commission merchant 
(``FCM'') must cover any deficit in the customer segregated account 
with its own funds or property, and not the funds or property of 
other customers).
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    However, certain purchases or sales of new commodity contracts may 
actually reduce the risk of loss to customers of a commodity broker in 
bankruptcy. Therefore, when the Commission promulgated Regulation Part 
190 in 1983, the Commission created certain exceptions to Regulation 
190.04(d)(2), as described above. By creating such exceptions, the 
Commission acknowledged that the trustee must be allowed to purchase or 
sell new commodity contracts, whether for the commodity broker or the 
customers thereof, in order to: (1) Liquidate open commodity contracts; 
or (2) transfer an incipient delivery obligation of an open commodity 
contract. Facilitating such liquidation would limit the period in which 
the estate of the commodity broker is at risk for fluctuations in 
value. Permitting such transfer would tend to maximize recovery of 
customers of the commodity broker, by allowing the trustee to minimize 
or avoid claims for losses resulting from the inability of the estate 
of the commodity broker to fulfill obligations to take or effect 
delivery on open commodity contracts.
    In addition to the exceptions enumerated above, the Commission 
acknowledged that, if the trustee cannot immediately liquidate the 
inventory or open commodity contracts of a commodity broker in 
bankruptcy, because of market conditions (including price limits), then 
the trustee should be allowed to purchase or sell new commodity 
contracts, in order to cover or partially cover such inventory or 
commodity contracts. The Commission intended to permit such cover or 
partial cover in order to prevent, among other things, the ``material 
erosion in value'' of such inventory or commodity contracts, which 
would diminish the recovery of the customers of the commodity 
broker.\5\
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    \5\ In the Proposing Release, the Commission included the 
following version of Regulation 190.04(d)(2) (referenced in the 
Proposing Release as Regulation 190.04(d)(3)): Nothing in this Part 
shall be interpreted to permit the trustee to purchase new commodity 
contracts for customers of the debtor: Provided, however, That to 
prevent material erosion in value, the trustee may, in its 
discretion and with the approval of the Commission, cover uncovered 
inventory or commodity contracts of the debtor which cannot be 
liquidated immediately because of limit moves or other market 
conditions.
    46 FR 57353, 57561 (November 24, 1981). However, in the adopting 
release to Regulation Part 190 (the ``Adopting Release''), the 
Commission removed the reference to ``material erosion in value'' in 
proposed Regulation 190.04(d)(2), in response to a comment that such 
reference would ``have limited the cases in which cover transactions 
could be sought by the trustee.'' Nevertheless, the Commission 
reiterated in the Adopting Release that the primary purpose of 
Regulation 190.04(d)(2) was to prevent a ``material erosion in 
value'' of uncovered inventory or commodity contracts, by stating 
that ``the Commission * * * believes cover transactions would be 
limited to this purpose.'' 48 FR 8716, 8729 (March 1, 1983).
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B. The Proposed Amendment

    The Commission is proposing to amend Regulation 190.04(d) to allow 
the trustee, under appropriate circumstances, to operate the business 
of a commodity broker in bankruptcy in the ordinary course, including 
the purchase or sale of new commodity contracts on behalf of the 
customers of the debtor (the ``Amendment''). The appropriateness of a 
particular set of circumstances would be determined by the Commission 
in its discretion, and such operation would require the written 
permission of the Commission. Pursuant to Regulation 190.10(d), the 
Commission has delegated all the functions of the Commission in 
Regulation Part 190, except one, to the Director of the Division of 
Clearing and Intermediary Oversight, and therefore, under this proposed 
amendment, the Director would also have the power to make such 
determination and to issue such written permission.\6\
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    \6\ Regulation 190.10(d) would apply to the proposed Amendment. 
Regulation 190.10(d) states:
    Until such time as the Commission orders otherwise, the 
Commission hereby delegates to the Director of the Division of 
Clearing and Intermediary Oversight, and to such members of the 
Commission's staff acting under his direction as he may designate, 
all the functions of the Commission set forth in this part except 
the authority to approve or disapprove a withdrawal or settlement of 
a commodity account by a public customer pursuant to Sec.  
190.06(g)(3).
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C. Rationale for the Proposed Amendment

    Recently, events have demonstrated that a commodity broker may 
enter into bankruptcy while not insolvent.\7\ For example, on Friday, 
November 25, 2005, after the closing of the relevant markets, Refco, 
LLC (``Refco'') filed for relief under Subchapter IV of Chapter 7 of 
the Bankruptcy Code, primarily to satisfy a precondition for the sale 
of its FCM business to a third party. Previously, the United States 
Bankruptcy Court for the Southern District of New York (``District 
Court'') had approved the sale of that FCM business. According to the 
agreement governing the sale, the third party would give the parent 
entities of Refco (i) a specified sum and (ii) the opportunity to 
retain the net regulatory capital of Refco.\8\
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    \7\ The Bankruptcy Code permits a solvent entity to legally file 
for relief under Chapter 7 of the Bankruptcy Code. See Collier on 
Bankruptcy ] 109.03[2].
    \8\ See In re: Refco, LLC, No. 05-60134-rdd, Docket No. 5 
(Bankr. S.D.N.Y. Nov. 25, 2005).
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    Shortly after Refco filed for relief under Subchapter IV of Chapter 
7 of the Bankruptcy Code, the sale of its FCM business to a third party 
was consummated. Prior to the re-opening of the relevant markets on 
Sunday, November 27, 2005, all of the customer accounts of Refco, 
comprising one hundred percent of the net equity of each customer, were 
transferred to the third party.
    During the Refco proceedings, it was practicable to transfer 
customer accounts when all relevant markets were closed. However, it 
may not always be so practicable. For example, on Friday, September 19, 
2008, prior to the closing of the relevant markets, Lehman Brothers 
Inc. (``Lehman'') became the subject of a proceeding under the 
Securities Investor Protection

[[Page 66600]]

Act of 1970 (``SIPA''),\9\ primarily to satisfy a precondition for the 
sale of its securities broker-dealer business and its FCM business to a 
third party. On Saturday, September 20, 2008, the District Court 
approved the sale of such securities broker-dealer business and FCM 
business, in exchange for the third party giving the parent of Lehman a 
specified sum.\10\ Shortly after such approval, the sale was 
consummated. Soon after the consummation, the customer accounts of 
Lehman began to be transferred to the third party. However, because the 
Lehman proceedings under SIPA had commenced in District Court prior to 
the closing of the relevant markets, customers of Lehman would have 
been unable to manage their accounts, absent a provision in the Order 
issued by the District Court permitting the trustee to conduct business 
in the ordinary course.\11\
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    \9\ 15 U.S.C. 78aaa-111.
    \10\ See In re: Lehman Brothers Holdings Inc., et al., No. 08-
13555, Docket No. 258 (Bankr. S.D.N.Y. Sept. 20, 2008).
    \11\ See S.I.P.C. v. Lehman Brothers, Inc., No. 08-8119, Docket 
No. 3 (S.D.N.Y. September 19, 2008).
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    The Commission is proposing the Amendment to enable customers to 
manage their accounts, after their commodity broker enters into 
bankruptcy and prior to the transfer of their accounts, in certain 
circumstances. As the Refco and Lehman proceedings illustrate, there 
may be cases where a transfer of customer accounts has been arranged 
pre-bankruptcy, and where a commodity broker in bankruptcy may 
nevertheless possess the capital necessary to continue operating its 
business in the ordinary course (e.g., to continue supporting the 
credit of its customers and performing on its other obligations), 
pending imminent transfer of customer accounts to another commodity 
broker. Therefore, permitting the trustee to operate such business in 
the ordinary course may advance the purpose of Regulation Part 190--
namely, ``to provide an understandable and workable method for 
operating the estate pending liquidation.'' \12\ Thus, the proposed 
Amendment is consistent with the past practice of the Commission in 
creating exemptions to Regulation 190.04(d)(2) when necessary to 
advance the purposes of Regulation Part 190. Additionally, allowing 
customers to manage their accounts, as much as possible, as if the 
commodity broker had not entered into bankruptcy would be in the best 
interests of both the customers and the relevant markets in general.
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    \12\ 46 FR 57535, 57536 (November 24, 1981).
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    Whether a commodity broker in bankruptcy has sufficient capital to 
continue operating its business in the ordinary course is inherently a 
factual question. Therefore, the Commission reserves the power to limit 
the application of the proposed Amendment, in its discretion, by: (1) 
Requiring the trustee to obtain the written permission of the 
Commission; and (2) determining the circumstances under which the 
trustee may purchase or sell new commodity contracts on behalf of 
customers of the commodity broker in bankruptcy.
    In deciding whether to apply the proposed Amendment to a particular 
commodity broker in bankruptcy, the Commission may consider the 
following factors: (1) Whether the commodity broker has entered into an 
agreement providing for the imminent transfer of its customer accounts 
to an entity that is ready, willing and able to accept such transfer 
promptly; (2) whether the commodity broker has sufficient capital, at 
the time it becomes subject to bankruptcy proceedings, to continue 
operating its business in the ordinary course pending the transfer; and 
(3) whether a commodity broker will have sufficient capital, after the 
sale of its assets (including its FCM business), to continue operating 
its business in the ordinary course until all of its customer accounts 
have been transferred. The Commission anticipates that future 
bankruptcies of commodity brokers may present new factors for its 
consideration, and the proposed Amendment is therefore intended to 
provide the Commission with flexibility to consider such new factors in 
its discretion.

III. Related Matters

A. Regulatory Flexibility Act

    The Regulatory Flexibility Act (``RFA'') \13\ requires Federal 
agencies, in promulgating regulations, to consider the impact of those 
regulations on small businesses. As mentioned above, the proposed 
Amendment provides a limited exception to Regulation 190.04(d)(2), by 
permitting a trustee to operate, with the written permission of the 
Commission, the business of a commodity broker in bankruptcy in the 
ordinary course, including the purchase or sale of new commodity 
contracts on behalf of the customers of such commodity broker. The 
proposed Amendment does not impose a regulatory burden on either a 
commodity broker pre-bankruptcy or a trustee post-bankruptcy. Moreover, 
the proposed Amendment will affect only FCMs (including certain foreign 
futures commission merchants).\14\ The Commission has previously 
established certain definitions of ``small entities'' to be used by the 
Commission in evaluating the impact of its regulations on such entities 
in accordance with the RFA.\15\ The Commission has previously 
determined that FCMs are not small entities for the purpose of the 
RFA.\16\ Accordingly, pursuant to 5 U.S.C. 605(b), the Chairman 
certifies, on behalf of the Commission, that the proposed Amendment 
will not have a significant economic impact on a substantial number of 
small entities.
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    \13\ 5 U.S.C. 601 et seq.
    \14\ The proposed Amendment may apply, in the future, to other 
commodity brokers that execute trades and carry accounts for 
clearing on behalf of customers--namely, commodity options dealers 
and leverage transaction merchants. Currently, no such commodity 
brokers exist. Therefore, even if such commodity brokers would 
constitute ``small entities'' for purposes of the RFA, the proposed 
Amendment can have no current impact on such commodity brokers. 
However, it is unlikely that such commodity brokers would constitute 
``small entities'' for purposes of the RFA. In defining ``small 
entities'' for the purpose of the RFA, the Commission excluded FCMs 
based on the fiduciary nature of FCM-customer relationships, as well 
as the minimum financial requirements that apply to FCMs. See 47 FR 
18618, 18619 (Apr. 30, 1982). Certain parts of this rationale would 
also be applicable to commodity options dealers, foreign futures 
commission merchants, and leverage transaction merchants.
    \15\ 47 FR 18618 (Apr. 30, 1982).
    \16\ Id. at 18619.
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B. Paperwork Reduction Act

    The Paperwork Reduction Act (``PRA'') \17\ imposes certain 
requirements on Federal agencies in connection with their conducting or 
sponsoring any collection of information as defined by the PRA. The 
proposed Amendment does not require the new collection of information 
on the part of any entities that would be subject to the proposed 
Amendment. Accordingly, for purposes of the PRA, the Commission 
certifies that the proposed Amendment, if promulgated in final form, 
would not impose any new reporting or recordkeeping requirements.
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    \17\ 44 U.S.C. 3501 et seq.
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C. Cost-Benefit Analysis

    Section 15(a) of the Act \18\ requires that the Commission, before 
promulgating a regulation under the Act or issuing an order, consider 
the costs and benefits of its action. By its terms, Section 15(a) of 
the Act does not require the Commission to quantify the costs and 
benefits of a new regulation or to determine whether the benefits of 
the regulation outweigh its costs. Rather,

[[Page 66601]]

Section 15(a) of the Act simply requires the Commission to ``consider 
the costs and benefits'' of its action.
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    \18\ 7 U.S.C. 19.
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    Section 15(a) of the Act further specifies that costs and benefits 
shall be evaluated in light of the following considerations: (1) 
Protection of market participants and the public; (2) efficiency, 
competitiveness, and financial integrity of futures markets; (3) price 
discovery; (4) sound risk management practices; and (5) other public 
interest considerations. Accordingly, the Commission could, in its 
discretion, give greater weight to any one of the five considerations 
and could, in its discretion, determine that, notwithstanding its 
costs, a particular regulation was necessary or appropriate to protect 
the public interest or to effectuate any of the provisions or to 
accomplish any of the purposes of the Act.
    The Commission has evaluated the costs and benefits of the proposed 
Amendment, in light of the specific considerations identified in 
Section 15(a) of the Act, as follows:
1. Protection of Market Participants and the Public
    In the event of the bankruptcy of a commodity broker, the proposed 
Amendment would benefit the customers of such commodity broker, by 
providing them with the opportunity, under certain circumstances, to 
manage their accounts prior to the transfer of such accounts to a new 
commodity broker.
2. Efficiency and Competition
    The proposed Amendment is not expected to have an effect on 
efficiency or competition.
3. Financial Integrity of Futures Markets and Price Discovery
    As mentioned above, the proposed Amendment will promote financial 
integrity of the futures markets by providing customers of a commodity 
broker in bankruptcy with the opportunity, under certain circumstances, 
to manage their accounts prior to the transfer of such accounts to a 
new commodity broker.
4. Sound Risk Management Practices
    The proposed Amendment is not expected to have a direct effect on 
the risk management practices of commodity brokers.
5. Other Public Considerations
    Recent events, such as the Refco and Lehman proceedings, have 
demonstrated that the proposed Amendment is necessary and prudent.
    Accordingly, after considering the five factors enumerated in the 
Act, the Commission has determined to propose the regulations set forth 
below.

List of Subjects in 17 CFR Part 190

    Bankruptcy, Brokers, Commodity futures.

    For the reasons stated in the preamble, the Commission proposes to 
amend 17 CFR part 190 as follows:

PART 190--BANKRUPTCY

    1. The authority citation for Part 190 continues to read as 
follows:

    Authority: 7 U.S.C. 1a, 2, 4a, 6c, 6d, 6g, 7a, 12, 19, and 24, 
and 11 U.S.C. 362, 546, 548, 556, and 761-766, unless otherwise 
noted.

    2. Add new paragraph (d)(3) to Sec.  190.04 to read as follows:


Sec.  190.04  Operation of the debtor's estate--general.

* * * * *
    (d) * * *
    (3) Exception to liquidation only. Notwithstanding paragraph (d)(2) 
of this section, the trustee may, with the written permission of the 
Commission, operate the business of the debtor in the ordinary course, 
including the purchase or sale of new commodity contracts on behalf of 
the customers of the debtor under appropriate circumstances, as 
determined by the Commission.
* * * * *

    Issued in Washington, DC, on December 9, 2009 by the Commission.
David A. Stawick,
Secretary of the Commission.
[FR Doc. E9-29730 Filed 12-15-09; 8:45 am]
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