[Federal Register: August 12, 2004 (Volume 69, Number 155)]
[Rules and Regulations]
[Page 49784-49800]
From the Federal Register Online via GPO Access [wais.access.gpo.gov]
[DOCID:fr12au04-3]
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COMMODITY FUTURES TRADING COMMISSION
17 CFR Part 1
RIN 3038 -- AB64
Minimum Financial and Related Reporting Requirements for Futures
Commission Merchants and Introducing Brokers
AGENCY: Commodity Futures Trading Commission.
ACTION: Final rule.
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SUMMARY: The Commodity Futures Trading Commission (``Commission'') is
amending several of its regulations relating to the minimum financial
and related reporting requirements for futures commission merchants
(``FCMs'') and introducing brokers (``IBs''). The amended regulations
require an FCM, when calculating its minimum adjusted net capital
requirement, to include a computation based on the risk maintenance
margin levels of positions carried in customer and noncustomer
accounts. The required calculation is identical to capital calculations
that each FCM currently is required to perform pursuant to the rules of
self-regulatory organizations, including one derivatives clearing
organization. The Commission also is adopting conforming margin-based
computations for purposes of the Commission's equity capital,
subordination agreement and ``early warning'' requirements for FCMs.
The margin-based computations required by the final rule replace
computations in the Commission's regulations that had been based on the
amount of funds held by an FCM to margin, guarantee, or secure futures
and option positions carried on behalf of customers. Furthermore, the
Commission is amending its regulations to reduce the time periods for
FCMs and IBs to report events specified in the Commission's early
warning requirements. Finally, the Commission also is adopting
amendments to streamline the financial statement reporting requirements
for FCMs and IBs.
DATES: Effective Date: September 30, 2004.
FOR FURTHER INFORMATION CONTACT: Thomas J. Smith, Associate Deputy
Director and Chief Accountant, at (202) 418-5495, or Thelma Diaz,
Special Counsel, at (202) 418-5137, Division of Clearing and
Intermediary Oversight, Commodity Futures Trading Commission, Three
Lafayette Centre, 1155 21st Street, NW., Washington, DC
[[Page 49785]]
20581. Electronic mail: (tsmith@cftc.gov) or (tdiaz@cftc.gov).
SUPPLEMENTARY INFORMATION:
I. Summary of Rule Amendments as Proposed by the Commission
Section 4f(b) of the Commodity Exchange Act (the ``Act'')
authorizes the Commission, by regulation, to impose minimum financial
and related reporting requirements on FCMs and IBs.\1\ On July 9, 2003,
the Commission issued a release proposing amendments to Commission
Rules 1.10, 1.12, 1.16, 1.17, and 1.18, which set forth certain minimum
financial and related reporting requirements for FCMs and IBs (the
``Proposing Release'').\2\ The key element of the Proposing Release was
a proposal to amend Rule 1.17(a) to require margin-based, also referred
to as ``risk-based,'' capital computations for an FCM's calculation of
its minimum adjusted net capital requirement. The Proposing Release
also included conforming amendments to other paragraphs of Rule 1.17
that set forth capital computations that FCMs must perform for purposes
related to their equity capital and subordination agreements, and to
capital computations in Rule 1.12 that FCMs must make to comply with
the Commission's ``early warning'' requirements. Other rule amendments
in the Proposing Release proposed to shorten the time periods specified
in Commission rules for FCMs and IBs to report certain financial events
to the Commission, and to reduce the time periods before which an FCM
is required to take a capital charge for outstanding margin calls on
its customer and noncustomer accounts. Lastly, the Proposing Release
included proposed revisions of Rules 1.10, 1.16 and 1.18 in order to
amend the requirements for the financial statements that FCMs and IBs
must file with the Commission.
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\1\ The Act is codified at 7 U.S.C. 1 et seq. (2003), and
section 4f(b) of the Act is codified at 7 U.S.C. 6f(b). The
Commission's rules cited in this final rulemaking may be found at 17
CFR Ch. 1 (2003).
\2\ 68 FR 40835 (July 9, 2003). The Proposing Release may be
accessed electronically through the Commission's Web site http://www.cftc.gov/
.
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The Commission received ten letters in response to its request for
comments on the proposed rule amendments in the Proposing Release.\3\
Of these ten comments, five were from individual firms registered as
FCMs,\4\ and two were from industry trade associations, the National
Introducing Brokers Association (``NIBA'') and the Futures Industry
Association (``FIA''). The National Futures Association (``NFA''),\5\
the Joint Audit Committee (``JAC''),\6\ and a former Commission staff
member also submitted comment letters.\7\ These comments are discussed
in more detail later in this supplementary information section.
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\3\ The comment letters are available for inspection and copying
at the Commission's Washington office in its public reading room,
Room 4072, Three Lafayette Centre, 1155 21st Street, NW.,
Washington, DC 20581. The telephone number for the public reading
room is (202) 418-5025. The comment letters also are available on
the Commission's public Web site at http://www.cftc.gov/foia/comment03/foi03_009_1.htm
.
\4\ Comment letters were filed by Cargill Investor Services,
Inc.; Fimat USA, Inc.; Man Financial Inc.; R.J. O'Brien &
Associates, Inc.; and Carr Futures Inc.
\5\ NFA is a registered futures association pursuant to section
17 of the Act.
\6\ The JAC is a committee formed by futures exchanges and other
self-regulatory organizations to coordinate audit and financial
surveillance activities of FCMs.
\7\ Paul H. Bjarnason, Jr. filed a comment letter.
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The Commission, after further consideration, including
consideration of the comments, has determined to adopt the following:
(1) A requirement that an FCM include, as part of the calculation of
its minimum adjusted net capital requirement, a computation based on
the maintenance margin levels of the positions or transactions carried
by the FCM in customer and noncustomer accounts, including futures,
option on futures, and other transactions that the Commission has, by
order or otherwise, approved for carrying in customer segregated
accounts in accordance with section 4d of the Act or that are carried
by the FCM in noncustomer accounts; \8\ (2) a conforming capital
computation for early warning purposes, but which has been modified
from the version proposed in the Proposing Release; and (3) other
capital computations for purposes of an FCM's subordination agreements
and equity capital, which have also been modified, as specified herein,
from the versions that were originally proposed. Further, the
Commission has determined to adopt amendments relating to the financial
reporting requirements of FCMs and IBs as proposed in the Proposing
Release.
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\8\ The Proposing Release explained that the term
``noncustomer'' is defined by Rule 1.17(b)(4) and generally refers
to an entity affiliated with an FCM, including certain employees and
officers of an FCM. 68 FR at 40838.
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Each of the rule amendments that the Commission has determined to
adopt is discussed more fully in Parts II through VI of this
supplementary information section, first by summarizing the background
of the proposed rule amendment, then by summarizing the comments
received in response, and finally by specifying the modifications, if
any, that have been made to the final rule as adopted after
consideration of the comments received.\9\ The Commission also
encourages interested persons to read the detailed analysis in the
Proposing Release for each of the proposed rule amendments. Citations
to the pertinent pages of the Proposing Release have been included as
part of the discussion in this final rulemaking release of the
amendments being adopted by the Commission.
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\9\ Part V summarizes the Commission's determination to not
adopt as part of this final rulemaking the proposed amendments to
reduce the time periods before which an FCM is required, pursuant to
Rule 1.17(c)(5), to take a capital charge for outstanding margin
calls on its customer and noncustomer accounts.
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As discussed in the Proposing Release, Rule 1.10 requires FCMs to
prepare Forms 1-FR-FCM to file financial information with the
Commission and their designated self-regulatory organization. The
Commission advised in the Proposing Release that it would make
conforming amendments to the Form 1-FR-FCM to reflect risk-based
capital and changes to the early warning reporting requirements, if
adopted by the Commission.\10\ The Commission has approved such
conforming amendments to the Form 1-FR-FCM, and the revised form is
available to FCMs upon request from the Commission.\11\
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\10\ 68 FR at 40838, fn. 13. See 60 FR at 40840 -- 40842.
\11\ Requests for the form should be addressed to the
Commission's Office of the Secretariat, Three Lafayette Centre, 1155
21st Street, NW., Washington, DC 20581.
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Rule 1.10(d)(1) provides that each Form 1-FR-FCM, which is not
required to be certified by an independent public accountant, must be
completed in accordance with the instructions to the Form. The
Commission issued a Form 1-FR-FCM Instruction Manual in 1989, and the
Manual has not been revised since it was issued. Accordingly, the
Commission has approved proposed changes to the 1-FR-FCM Instruction
Manual to conform the Manual to rule amendments adopted in this final
rulemaking. The Instruction Manual is available electronically on the
Commission's Web site and hard copies may be obtained by contacting the
Commission.\12\
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\12\ Requests for the Form 1-FR-FCM Instruction Manual should be
addressed to the Commission's Office of the Secretariat, Three
Lafayette Centre, 1155 21st Street, NW., Washington, DC 20581.
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II. Risk-Based Capital Requirements
The Commission's capital requirement for FCMs is set forth in Rule
1.17(a)(1)(i)(A)-(D), which, prior to the amendments adopted by this
rulemaking, required an FCM to maintain minimum adjusted net capital
[[Page 49786]]
equal to, or in excess of, the greatest of the following:
a. $250,000;
b. Four percent of an amount, hereinafter to referred as the
``Segregated Amount,'' that equals the total of the funds required to
be segregated for customers trading on U.S. commodity markets pursuant
to section 4d(a)(2) of the Act, including the funds of customers
trading on registered derivatives transaction execution facilities that
have elected to opt-out of segregation pursuant to Rule 1.68, and the
funds required to be secured for customers trading on foreign commodity
markets pursuant to Rule 30.7, less the market value of options
purchased by customers for which the full premiums have been paid;
c. The amount of adjusted net capital required by a registered
futures association (NFA presently being the only such association) of
which the FCM is a member; or
d. For FCMs that also are registered with the U.S. Securities and
Exchange Commission (``SEC'') as securities brokers or dealers, the
amount of net capital required by SEC Rule 15c3-1(a).\13\
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\13\ The SEC rules cited in this release may be found at 17 CFR
Ch. 2 (2003).
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In the Proposing Release, the Commission noted various limitations
in the current net capital rule that could be addressed by requiring
capital computations based on the margin levels of customer and
noncustomer positions carried by the FCM, in lieu of the capital
computation now required to be based on the Segregated Amount. For
example, a primary limitation of the Segregated Amount is that it does
not include noncustomer positions and therefore does not fully reflect
the extent to which an FCM is financially exposed to commodity
positions that it carries for both customers and noncustomers.\14\ The
Commission accordingly proposed amendments to Rule 1.17(a)(1)(i)(B)
that would delete the computation that is based upon the Segregated
Amount, and would require in its place a computation based on the
aggregate of: (i) Eight percent of the ``risk margin'' requirement on
futures and option on futures positions carried in customer accounts;
and (ii) four percent of the ``risk margin'' requirement on futures and
option on futures positions carried in noncustomer accounts.\15\ As
noted in the Proposing Release, in proposing this requirement the
Commission was intending to frame a margin-based capital computation
that would be identical to the margin-based minimum net capital
computation that several futures self-regulatory organizations,
including one derivatives clearing organization, have adopted for
determining the risk-based capital requirements of their respective
member-FCMs.\16\
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\14\ The Commission discussed in detail other limitations to the
capital rule based upon the Segregated Amount in the Proposing
Release. 68 FR at 40837-40.
\15\ As discussed in the Proposing Release, U.S. commodity
exchanges and numerous foreign commodity exchanges use the Standard
Portfolio Analysis of Risk (``SPAN'') margining system for
calculating margin requirements on a portfolio of futures and option
positions. The SPAN maintenance margin level consists of a ``risk''
component and an ``equity'' component. The risk component covers
potential future losses in the portfolio value. Such losses include
a market move against a futures position or a short (written)
option. The equity component (option premium, marked-to-the market
daily) reflects the asset represented by long option positions or
the liability represented by short (written) option positions in the
portfolio. Id.
\16\ As of January 1, 1998, the Clearing Corporation (formerly
the Board of Trade Clearing Corporation), the Chicago Board of
Trade, and the Chicago Mercantile Exchange have all adopted margin-
based minimum capital requirements for their respective clearing
member firms. The NFA adopted similar risk-based minimum capital
requirements for its member FCMs effective October 31, 2000. All of
these organizations use the same percentages of risk maintenance
margin that the Commission has proposed for its amended net capital
rule. 68 FR at 40837-8.
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For purposes of the proposed risk-based minimum adjusted net
capital requirement, the Commission proposed new or amended definitions
in Rule 1.17(b) for the terms ``customer account,'' ``noncustomer
account,'' and ``risk margin requirement.'' \17\ In general, the term
``customer account'' would be defined by Rule 1.17(b)(7) to include the
account of any customer as defined by Rule 1.17(b)(2), which includes
customers as defined by Rule 1.3(k), option customers as defined by
Rules 1.3(jj) and 32.1(c), and foreign futures and foreign option
customers as defined by Rule 30.1(c), and also would include the
accounts of foreign-domiciled customers trading on foreign boards of
trade. The term ``noncustomer account'' would continue to be defined by
Rule 1.17(b)(4) as an account that is not included in the definition of
either customer (Rule 1.17(b)(2)) or proprietary account (Rule
1.17(b)(3)), and also would include noncustomer accounts for foreign-
domiciled persons trading on foreign boards of trade. The term ``risk
margin'' requirement for an account would be defined by a new Rule
1.17(b)(8), which in the Proposing Release was defined to mean the
level of maintenance margin, or performance bond, that the exchange
\18\ on which a position or portfolio of futures contracts and/or
options on futures contracts is traded requires its members to collect
from the owner of the account, subject to several additional
requirements.
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\17\ 68 FR at 40847-8.
\18\ The applicable exchange rules would include those of
foreign exchanges and those of designated contract markets
(``DCMs'') and derivatives transaction execution facilities
(``DTEFs'') governed by the Act. Also, the proposed definition of
``customer account'' in Rule 1.17(b)(7) would extend to FCM
customers trading on DTEFs. Such customers are included in the
definition of customer in Rule 1.3(k), which is incorporated by
reference in Rule 1.17(b)(2), and all customers included within Rule
1.17(b)(2) are also included in the definition set forth in Rule
1.17(b)(7).
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Upon further review, the Commission has determined that the
definition proposed for Rule 1.17(b)(8) does not adequately encompass
all of the margin or performance bond that FCMs, in accordance with the
requirements of the futures organizations to which they belong,
currently include in their margin-based capital computations. By
limiting the computation to ``futures contracts and options on futures
contracts'', the proposed rule might have been interpreted to exclude
non-futures positions or transactions that the Commission has
authorized to be held in customer accounts pursuant to section 4d of
the Act, or the non-futures positions or transactions that an FCM
elects to hold in noncustomer accounts. For example, options on
securities that are held in commodity customer accounts pursuant to
section 4d of the Act under the terms and conditions of Commission
approved cross-margining programs are included in FCMs' risk-based
margin calculations under the current rules of self-regulatory
organizations. In addition, over-the-counter contracts and options that
FCMs hold in section 4d customer accounts pursuant to Commission orders
also are currently included in the FCMs' risk-based capital
computations. Furthermore, by limiting the computation to margin
required ``by the exchange on which a position or portfolio of futures
contracts and/or options on futures contracts is traded'', the proposed
rule does not reflect the growing diversity in the types of positions
that FCMs may be able to carry for customers and noncustomers,
including positions that are not traded on a DCM or DTEF, but are
cleared by a derivatives clearing organization.\19\
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\19\ In particular, clearing members of the New York Mercantile
Exchange (``NYMEX'') currently maintain accounts for customers
clearing products that are listed, but not traded, on the NYMEX
exchange. The margin requirements for such products are established
by NYMEX as a derivatives clearing organization. See Commission
order dated February 2, 2004, supplementing the Commission's prior
order dated May 30, 2002. A copy of the order is available on the
Commission's Web site at http://www.cftc.gov/files/tm/tmnymexotcorder021004.pdf
.
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[[Page 49787]]
Accordingly, the Commission has determined to modify the definition
it originally proposed to set forth in Rule 1.17(b)(8) for the risk
margin requirement for an account. As modified, an account's risk
margin requirement would mean the level of maintenance margin, or
performance bond, that the FCM is required under the rules of an
exchange (or by a clearing organization if the required margin level is
established not by an exchange but rather by a clearing organization)
to collect from the owner of a customer account or noncustomer account
for all positions, whether futures positions or non-futures positions,
held in such accounts.\20\ This definition would be subject to several
additional requirements, which also were included in the definition
originally described in the Proposing Release. First, the definition of
risk margin would not include the equity component of short or long
option positions maintained in an account. Second, the maintenance
margin or performance bond requirement associated with a long option
position may be excluded from risk margin to the extent that the value
of such long option position does not reduce the total risk maintenance
or performance bond requirement of the account that holds the long
option position.\21\ Third, the risk margin for an account carried by a
futures commission merchant which is not a member of the exchange or
the clearing organization that requires collection of such margin
should be calculated as if the futures commission merchant were such a
member. Finally, if an FCM does not possess sufficient information to
determine what portion of an account's total margin requirement
represents risk margin, the proposed definition would require that the
FCM treat as risk margin all of the margin required by the exchange,
clearing organization, or other FCM or entity for that account. For
example, if customer or noncustomer positions are executed on a foreign
board of trade and the FCM does not possess sufficient information to
determine what portion of the foreign board of trade's required margin
is risk margin as defined under Rule 1.17(b)(8), the FCM is required to
include the entire margin requirement in its risk-based capital
computation.
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\20\ For some limited classes of customer accounts, primarily
those of non-clearing exchange members trading for their own
accounts only, the rules of three DCMs permit member FCMs to refrain
from collecting the exchange-established maintenance margin levels
otherwise required by such rules for positions held in customer
accounts and noncustomer accounts. All of the organizations that
have adopted risk-based capital rules for FCMs (the NFA, a
derivatives clearing organization and two DCMs, as identified in
footnote 16) require their member FCMs to disregard such exceptions
when computing their minimum net capital requirements. The
Commission intends Rule 1.17, as adopted herein, to impose the same
requirement. FCMs must therefore include in their adjusted net
capital requirements the exchange-established maintenance margin
levels for all positions in the accounts held by the FCM for its
customers and noncustomers.
It should also be noted that such rules may permit the exchange
or clearinghouse to increase margin requirements to reflect
circumstances other than changes in SPAN measurements. For example,
an exchange may require an FCM to collect more than the standard
margin from a specific customer due to credit or other concerns. The
definition of risk margin, both as originally proposed and herein
adopted, would include such margin.
\21\ There is generally no risk to the FCM associated with a
long option position, because the maximum potential loss is the full
option premium, which is paid by the customer in full at the
inception of the transaction. However, because long option positions
that hedge other futures and option positions in a portfolio will
reduce the total margin requirement of the portfolio, SPAN includes
a risk maintenance margin component to protect against a decline in
the market value of such long option positions. The Proposing
Release proposed to allow FCMs to deduct from their risk margin
requirements the maintenance margin for long option positions that
are not hedging other futures or option positions. 68 FR at 40838.
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The commenters overwhelmingly endorsed the Commission's proposal to
eliminate the capital computation based upon the Segregated Amount, and
supported the application of minimum adjusted net capital requirements
based upon risk maintenance margin. The commenters also did not object
to any of the definitions proposed by the Commission to implement risk-
based capital requirements. However, FIA and two individual commenters
endorsed conducting further analysis of the margin-based capital
requirements of the NFA and other self-regulatory organizations, with
which the Commission rule, as amended, will now be consistent, for the
purpose of identifying possible enhancements that might be made to the
Commission's rules.\22\ FIA offered to undertake such an analysis, in
coordination with the self-regulatory organizations, and with the
participation of the Commission expressly welcomed.
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\22\ For example, FIA suggested examining such rules to
determine whether they reflected advances in risk management made
since 1998. An FCM also proposed that the Commission's rule should
grant a credit of 25 percent for each dollar of margin that an FCM
carries in excess of that required by the exchange, and Mr.
Bjarnason identified other possible modifications for the Commission
to consider.
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FIA offered a recommendation that it believed might accelerate the
adoption of any changes that received the endorsement of the
participants in the proposed analysis. Under FIA's proposal, Rule
1.17(a) would be amended to delete the current capital computation
based on the Segregated Amount, but no additional amendments would be
made to Rule 1.17(a) to specify a risk-based capital computation. FIA
suggested, and NFA agreed, that any recommendations resulting from the
proposed review of margin-based capital requirements could be put into
effect by NFA's amendment of its rules, because NFA's risk-based
capital requirements apply to all FCMs.
The Commission welcomes and encourages the commitment of industry
resources towards an active and continuous evaluation of the capital
requirements set forth in the Commission's rules. The Commission
believes that the analysis proposed in FIA's letter is neither
precluded by, nor inconsistent with, the Commission's immediate
adoption of the proposed risk-based capital requirements for FCMs. Any
proposals for further amendment to these risk-based capital rules would
be evaluated by the Commission in light of all the Act's financial
safeguards for monitoring the financial integrity of futures
intermediaries, and the Commission can thereafter publish for public
comment in the Federal Register such amendments as it proposes to
adopt.
The Commission has considered the comments received and is adopting
as final the amendments to Rule 1.17(a) and (b) as set forth in the
Proposing Release, with the modification discussed earlier to the
definition of risk margin in Rule 1.17(b)(8). As amended, Rule
1.17(a)(1)(i)(B) will no longer be based upon the Segregated Amount,
but will instead include the following capital computation: Eight
percent of the total risk margin requirement for all positions carried
by the FCM in customer accounts, plus four percent of the total risk
margin requirement for all positions carried by the FCM in noncustomer
accounts. As discussed earlier, the definition of the risk margin
requirement for an account is set forth in a new Rule 1.17(b)(8), and
is determined generally by subtracting from the maintenance margin that
the rules of an exchange or clearinghouse requires an FCM to collect
from the owner of a customer or noncustomer account: (i) The equity
component of each position; and (ii) the maintenance margin for each
long option position that is not held to hedge other positions in the
account. However, as noted in the Proposing Release, the Commission
understands that calculating the maintenance margin on specific long
option positions in a portfolio may require a certain amount of manual
processing under current back office operating procedures, which some
[[Page 49788]]
FCMs may wish to forego because it would not materially reduce their
risk-based minimum capital requirement.\23\ Accordingly, the amended
rule permits, but does not require, an FCM to exclude the risk
maintenance margin for long options that do not hedge other positions
maintained in the account.
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\23\ 68 FR at 40838.
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The amended rule further provides that if the risk margin
associated with cleared positions cannot be determined by the FCM, the
firm will be required to apply the specified percentages for customer
and noncustomer accounts to the total margin required by the exchange,
clearing organization, other futures commission merchant or entity for
the customer and noncustomer positions carried. In addition, as noted
in the Proposing Release, the new margin-based capital computations
will not apply to proprietary (i.e., firm-owned) accounts. Rule
1.17(c)(5)(x) currently includes proprietary positions in the
calculation of adjusted net capital to the extent that uncovered
proprietary positions (i.e., positions that are not hedged by cash
market transactions) result in a charge or ``haircut'' to the firm's
net capital based on clearinghouse or exchange margin requirements.\24\
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\24\ 68 FR at 40837-8.
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III. Early Warning Requirements Under Rule 1.12
Pursuant to Commission Rule 1.12, an FCM or IB must comply with
several requirements upon the occurrence of predefined events that may
raise concerns regarding the firm's ability to meet its obligations to
the market, safeguard customer funds, or otherwise continue normal
business operations. The requirements in Rule 1.12, which include
notices that the FCM or IB must file with the Commission and the firm's
designated self-regulatory organization (``DSRO''),\25\ enhance the
ability of the Commission and the DSRO to respond with a heightened
degree of surveillance, as may be necessary or prudent, in light of the
possibility of deteriorating operating or financial conditions at a
firm. The requirements in Rule 1.12 are therefore generally referred to
as ``early warning'' requirements.
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\25\ The Commission explained in the Proposing Release that a
DSRO is the self-regulatory organization that, pursuant to
Commission Rule 1.52, is primarily responsible for monitoring an
FCM's compliance with minimum financial and related reporting
requirements, receiving and reviewing an FCM's financial reports,
and auditing the FCM's books and records. 68 FR at 40840, fn. 17.
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Paragraph (b) of Rule 1.12 currently provides that if an FCM
maintains adjusted net capital that is equal to or in excess of the
minimum adjusted net capital required by Rule 1.17(a)(1)(i), but below
a specified level that is greater than the FCMs' required minimum (to
be referred to hereafter as the ``early warning capital level''), then
the FCM is required to meet specified notice requirements and to file
with the Commission and the firm's DSRO monthly unaudited financial
statements. The early warning capital level required under Rule 1.12(b)
equals the greatest of the following:
a. $375,000;
b. Six percent of the Segregated Amount;
c. 150 percent of the amount of adjusted net capital required by a
registered futures association (i.e., NFA) of which the FCM is a
member; or
d. For FCMs that also are registered with the SEC as securities
brokers or dealers, the amount of net capital required by SEC Rule 17a-
11(b).
Paragraph (c) of Rule 1.12 currently requires an FCM or IB to
provide same day notice to the Commission and its DSRO of any failure
to make or keep current the books and records that are required by the
Commission's regulations, and the firm also must file within five
business days after giving such notice a written report that describes
what steps have been and are being taken to correct the situation.
Paragraph (d) of Rule 1.12 requires an FCM or IB to provide notice,
within three business days, to the Commission and its DSRO if the firm
discovers or is notified by its independent public accountant of the
existence of any material inadequacy in the internal controls of the
firm. Within five business days after providing the required notice,
the FCM or IB also must file a written report stating what steps have
been and are being taken to correct the material inadequacy in its
internal controls.
A. Early Warning Capital Levels for FCMs
The amendment proposed for Rule 1.12(b) would replace the early
warning capital level computation that is based on six percent of the
Segregated Amount held by an FCM with a computation based upon 150
percent of an FCM's minimum adjusted net capital requirement, as
determined by the margin-based capital requirements in Rule
1.17(a)(1)(i)(B), as amended. The Commission also proposed to amend
Rule 1.12(b) to require that any FCM that did not meet or exceed its
early warning capital level (whether based on the margin-based capital
computation or one of the other computations set forth in Rule
1.17(a)(1)(i)) to submit written notice within 24 hours, instead of the
five business days presently allowed under the Commission's rule.
Moreover, the Commission proposed to delete the requirement in Rule
1.12(b) for monthly unaudited financial statements from an FCM that had
failed to meet its early warning capital level, because this provision
would become moot upon the Commission's adoption of a proposed
amendment to Rule 1.10, discussed below, that would require all FCMs to
file unaudited financial statements on a monthly basis, instead of on a
quarterly basis as is currently required under Rule 1.10.\26\
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\26\ 68 FR at 40842. The Proposing Release also included a
technical amendment to Rule 1.12(b) to correct the reference to SEC
Rule 17a-11(b), which the SEC has redesignated as 17a-11(c). 58 FR
37655 (July 13, 1993.)
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The Proposing Release noted a recommendation from the JAC that the
Commission eliminate from Rule 1.12 not only the monthly filing
requirement, but also the requirement that an FCM failing to meet or
exceed its early warning capital level provide notice to the Commission
and its DSRO. The Commission, however, expressed concern that
eliminating the notice requirement could diminish the Commission's and
the DSRO's ability to react promptly to potential financial crises at
an FCM. To assist the Commission with its analysis of this issue, the
Commission invited comment from interested parties on whether the
proposed 150 percent early warning capital level would be appropriate
under a risk-based capital rule or whether it should be adjusted or
eliminated.
All of the comments received by the Commission recommended against
establishing an early warning capital level for margin-based capital
requirements. According to FIA, the proposed amendment is unnecessary
since risk-based capital requirements encourage FCMs to maintain
capital in excess of their required minimums, reflecting the fact that
margin-based capital requirements are more sensitive to significant
market moves than are capital requirements based on customer segregated
funds.\27\ FIA further suggested that the proposed amendment is
unnecessary because DSROs employ a variety of methods to identify and
to
[[Page 49789]]
monitor their member FCMs that may be experiencing financial stress.
For example, NFA requires each FCM for which it is the DSRO to report a
variety of information on a daily basis, including the FCM's SPAN
margin calculation, the FCM's segregation requirements and the amount
of funds actually held in segregation. FIA stated its belief that
information that the exchanges receive on a daily basis, such as
clearing house variation margin pay and collect information, along with
other reported information that is available to them, provides the
exchanges with sufficient data with which to monitor the capital of a
member FCM on a daily basis, if necessary.
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\27\ When an exchange increases margin requirements to reflect
significant market moves, an FCM's margin-based capital requirements
will increase as well. FIA asserted that FCMs therefore will
maintain some level of excess capital, as a matter of necessity as
well as prudent business practice, to enable them to respond to the
more immediate effect that significant market moves have on their
risk-based capital requirements.
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The JAC stated that the financial surveillance procedures
implemented by the exchanges and the NFA should provide sufficient
advance notice of a firm's inability to meet its minimum capital
requirement. The JAC also noted that Rule 1.12 itself includes other
requirements that serve to provide the Commission and self-regulatory
organizations with notice of events that could impair the financial
viability of an FCM. Such requirements include those set forth in
paragraphs (c) and (d) which, as stated above, relate to notice
requirements to report deficiencies in the FCM's books and records or
internal controls. The JAC further noted that Rule 1.12(g)(1-2)
requires an FCM to provide written notice within two business days if
any event or series of events cause a 20 percent or more reduction in
the FCM's net capital from the amount last reported to the Commission
in a financial report, and a minimum of two days advance notice prior
to any withdrawal of equity capital or any unsecured advance or loan to
any of the designated persons in the rule, if such withdrawal, advance
or loan would cause a 30 percent or more net reduction in the FCM's
excess adjusted net capital.
Finally, FIA also noted that institutional clients generally insist
that their FCMs maintain capital above any applicable early warning
capital level, making the early warning capital level an FCM's
effective minimum adjusted net capital requirement. Accordingly, FIA
and three other commenters stated that many FCMs would be required to
maintain amounts of capital well in excess of 150 percent of the
minimum adjusted net capital requirement if the early warning capital
level were established at 150 percent of margin-based adjusted net
capital requirements.
The Commission appreciates the detailed and insightful comments
received in response to its proposal to establish an early warning
capital level for capital computations that are based on the FCM's
margin requirements. As the Commission has previously explained, the
requirements in Rule 1.12 ``are designed to afford [the Commission] and
industry self-regulatory organizations sufficient advance notice of a
firm's financial or operational problems to take any protective or
remedial action that may be needed to assure the safety of customer
funds and the integrity of the marketplace.'' \28\ After considering
the comments, the Commission continues to believe that the effective
implementation of the financial safeguards of the Act and its
regulations requires provisions that establish a period for prompt
reporting that a firm's adjusted net capital does not meet or exceed a
specified level in excess of the FCM's minimum adjusted net capital
requirement. Such provisions enhance the ability of the Commission and
DSRO to adjust appropriately the level of monitoring of the FCM's
activities when there appears to be circumstances that may detract from
the FCM's ability to safeguard customer funds or otherwise satisfy its
financial obligations. Moreover, the provisions in other paragraphs of
Rule 1.12 cannot alone serve to provide immediate, sufficient notice to
the Commission of a material change in a firm's net capital
requirements. For example, Rule 1.12(g)(1), which requires notice to
the Commission if the amount of the FCM's net capital declines by a
specified percentage, does not result in notice to the Commission if
the FCM experiences a material increase in its minimum capital
requirement, and the FCM does not take appropriate steps to increase
its adjusted net capital. Absent Rule 1.12(b), the Commission would not
receive notice of the change in such firm's capital position until the
increase in the FCM's minimum adjusted net capital requirement had
exceeded the amount of adjusted net capital maintained by the FCM.\29\
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\28\ 63 FR 45711 (August 27, 1998) (final rule adopting
amendments to shorten the time periods for filing
undercapitalization and undersegregation notices required by Rule
1.12).
\29\ The JAC letter included the comment that the Commission
might consider, as an alternative to an early warning capital level,
modifying Rule 1.12(g)(2) to require notification if an FCM's excess
net capital decreases by more than 30 percent due to an increase in
its risk-based capital requirement. Unlike the JAC's other proposal,
it is difficult to gauge the sufficiency of the notice that would be
provided under this proposal, as compared to the requirements of the
Commission's existing rule or proposed amended rule.
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However, further review of data available from FCM financial
reports filed with the Commission does indicate that the Commission's
supervisory concerns can be addressed satisfactorily by an early
warning capital level that is based on a different threshold percentage
of an FCM's margin-based, or risk-based, minimum adjusted net capital
requirement. The JAC comment letter objected that, by its analysis, the
proposed requirement of 150 percent of a firm's risk-based minimum
capital requirement would adversely affect the FCM industry as a whole
by resulting in an onerous increase in FCM capital requirements as
compared to the Commission's current rule. The JAC therefore proposed
that the Commission should consider an alternative that would be lower
than 150 percent of an FCM's margin-based minimum adjusted net capital
requirement, if the Commission believed it necessary to retain an early
warning capital level. The JAC stated that it believed that the
adoption of such an alternative could produce an early warning capital
level that more closely parallels the current early warning capital
level based upon six percent of the Segregated Amount, and would
therefore be far less burdensome upon FCMs and customers.
Commission staff has performed its own analysis of the effects of a
revised early warning capital level equal to 110 percent of an FCM's
minimum adjusted net capital requirement, as determined by the margin-
based requirements adopted by this rule. The analysis indicates that
the revised level would cause FCMs to remain subject to an obligation
to provide notice to the Commission and DSROs in advance of the
undercapitalization of the firm, but that the burden of such an
obligation for the industry as a whole would be no greater than
experienced under the Commission's current regulations. Based on
financial data for all 182 FCMs as of May 31, 2004, the analysis
indicates that 60 of the 182 FCMs would be subject to a risk-based
minimum capital requirement, with the remaining 122 FCMs subject to
either the SEC's minimum capital requirement or the Commission's
$250,000 minimum. Of the 60 FCMs subject to risk-based capital
requirements, the early warning capital level of roughly half would be
lower if determined by an amount equal to 110 percent of risk-based
capital rather than 6 percent of capital based on segregated funds, and
the early warning capital level of the other firms would be higher and,
again, in every case the early warning capital requirements, if
triggered, would, like the minimum capital requirements, be driven by
the particular risk characteristics of the
[[Page 49790]]
positions carried by the individual firm in question. Furthermore, all
of the firms whose early warning capital level would be greater under
the amended rule already hold adjusted net capital in amounts that
exceed the revised requirement of 110 percent of their margin-based
minimum adjusted net capital requirement. Thus, replacing the existing
requirement of 6 percent of the Segregated Amount with the revised
early warning capital level requirement would not require any FCM to
increase its adjusted net capital in order to comply with the amended
rule.
In consideration of the foregoing, the Commission believes that a
revised early warning capital level of 110 percent of the FCM's margin-
based minimum capital requirement would retain an advance notice
requirement that enhances the ability of the Commission and DSROs to
monitor effectively the financial condition of FCMs, while still
remaining consistent with the goal of aligning an FCM's capital
requirements with the risks of its activities. In addition, the
Commission is in the process of enhancing its financial surveillance
capabilities over firms and market participants through the use of
automated systems that will utilize market position data and FCM
financial data to assist Commission staff with identifying situations
that could adversely impact an FCM's ability to safeguard customer
funds and meet its financial obligations to the market. These automated
programs will permit Commission staff to conduct stress testing and
other scenario testing of the positions held by both market
participants and FCMs to gauge the potential impact on such entities
based upon the positions they hold. The Commission is therefore
amending Rule 1.12(b)(2) to delete the early warning capital level
based upon the Segregated Amount, and to set forth in its place an
early warning capital level equal to 110 percent of the FCM's margin-
based capital requirement as determined by amended Rule
1.17(a)(1)(i)(B).
Adopting the amendment to paragraph (b)(2) of Rule 1.12 also will
necessitate a change to paragraph (b)(3) of the rule, which currently
sets forth an early warning capital level equal to ``150 percent of the
amount of adjusted net capital required by a registered futures
association of which [a firm] is a member.'' As noted above, every FCM
must comply with the capital requirements of NFA, a registered futures
association. Furthermore, as detailed above, NFA's risk-based capital
rule includes a risk-based requirement that is identical to the risk-
based capital computation being adopted by the Commission.\30\ The
Commission is therefore amending Rule 1.12(b)(3) to reduce to 110
percent the required percentage of adjusted net capital that is based
on a margin-based capital computation set forth in the rules of a
registered futures association, if the amount of such margin-based
adjusted net capital meets or exceeds the amount computed under the
margin-based computation set forth in Rule 1.17(a)(1)(i)(B). This
amendment will help ensure that the same percentage of adjusted net
capital will be required as early warning capital whenever a margin-
based computation in the rules of a registered futures association is
the same as the margin-based computation in the Commission's rules.
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\30\ The margin-based capital computation included the NFA's
capital requirements for its members is currently set forth in ]
7001 of the NFA Manual, Section 1(a)(vi) (2004).
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The Commission also received comments from the FIA and NFA
objecting to its proposal to reduce the reporting period set forth in
Rule 1.12(b). Currently, Rule 1.12(b) requires that an FCM who ``knows
or should have known'' that its adjusted net capital is below the early
warning level to file a written notice ``within five (5) business days
of such event.'' With the objective of harmonizing the Commission's
rule with the SEC's early warning rule, the Proposing Release included
a proposal to amend the phrase five business days to read 24 hours.\31\
In response, the NFA and FIA expressed concerns that the amended rule
failed to recognize that although FCMs make daily computations of their
capital, whenever such computations are made intra-month they are based
on estimates only. Moreover, FCMs generally do not complete their daily
capital computations until late afternoon, and, given that FCMs conduct
business internationally, FIA stated that it would be ``impossible to
confirm these numbers'' within 24 hours from when such daily capital
computations are made. FIA and NFA therefore argued that FCMs should be
permitted to continue to use established procedures to confirm their
estimates and provide notice, if required, within five business days of
the original estimated daily capital computation. Moreover, FIA stated
that it believed that it would be inappropriate to require early
warning notices based on unconfirmed estimates because such early
warning notices are publicly available.
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\31\ SEC Rule 17a-11(c) requires notice by no later than 24
hours after the broker-dealer's net capital falls below the SEC's
required early warning level.
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The Commission believes that the concerns expressed by these
commenters would be addressed by the ``know or should have known''
standard already set forth in the rule. This same standard applies to
other notices required by the Commission's rules, and, with reference
to the undersegregation notices required under Rule 1.12(h), the
Commission has previously interpreted this standard as follows:
That part of the standard requiring an FCM to report when it
``should know'' of a problem may be defined as the point at which a
party, in the exercise of reasonable diligence, should become aware
of an event.\32\
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\32\ 63 FR 45711, 45713 (August 27, 1988) (adopting rules that
would also apply ``know or should have known'' standard for
undersegregation notices pursuant to Rule 1.12(h)).
With respect to the event at issue, i.e. adjusted net capital that
is less than the required early warning capital level set forth in Rule
1.12(b), but still greater than the minimum required to avoid becoming
undercapitalized under Rule 1.12(a), it appears that reasonable
diligence on the part of the FCM may include expeditious confirmation
of daily, intra-month estimates that have been made in good faith and
are otherwise in compliance with Commission regulations. Hence, if
confirmation of such estimates were both timely and reasonably
necessary, it would be consistent with the amended rule for an FCM to
file its required notice within 24 hours of confirmation of such
estimates, and compliance with the amended rule would not be impossible
under procedures now used by FCMs. The Commission therefore believes it
appropriate to amend Rule 1.12(b) as proposed in the Proposing Release,
and is hereby amending the rule to require an FCM to file written
notice with the Commission and with the FCM's DSRO within 24 hours
after it knows or should have known that its adjusted net capital is
less than the early warning capital level.
B. Early Warning Requirements: Firm's Books and Records and Internal
Controls
Rule 1.12(c) currently requires any FCM or IB that at any time
fails to make or keep current books and records required by Commission
regulations to be maintained to provide notice on the same day that
such event occurs. The notice must specify the books and records that
have not been made or are not current, and within five business days
after providing such notice the FCM or IB must file a written report
[[Page 49791]]
stating what steps have been and are being taken to correct the
situation. Paragraph (d) of Rule 1.12 requires an FCM or IB that
discovers, or is notified by an independent public accountant pursuant
to Rule 1.16(e)(2), of the existence of any material inadequacy as
specified in Rule 1.16(d)(2), to provide notice within three business
days, and within five business days after giving such notice to file a
written report stating what steps have been and are being taken to
correct the material inadequacy.
For paragraphs (c) and (d) of Rule 1.12, the Proposing Release
proposed to reduce the notice and reporting time frames specified
within these paragraphs to be the same as the time frames provided in
corresponding SEC regulations governing registered securities broker-
dealers. Specifically, the proposed revisions would require an FCM or
IB: (i) To transmit within 48 hours the required report stating what
the FCM or IB has done or is doing to correct the situation that has
caused the firm to fail to maintain current books and records; and (ii)
to notify the Commission within 24 hours of discovering a material
inadequacy in its accounting systems, and to transmit the required
report within 48 hours of such discovery.\33\ None of the commenters
objected to the proposed shorter periods in Rules 1.12(c) and (d) for
FCMs and IBs to file the required notices and reports related to their
books and records and internal controls. The Commission is adopting as
final the amendments to paragraphs (c) and (d) as proposed in the
Proposing Release.\34\
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\33\ 68 FR at 40842-3.
\34\ The JAC proposed that the Commission also consider, in
addition to the rule amendments that the Commission had proposed in
the Proposing Release to paragraphs (b), (c) and (d) of Rule 1.12,
an amendment to delete paragraph (f)(5) from Rule 1.12. Rule
1.12(f)(5) currently obligates an FCM to provide notice immediately
whenever its excess adjusted net capital is less than 6 percent of
the maintenance margin required by the FCM on all positions in
accounts of a noncustomer. The JAC stated that it believed that this
regulation would no longer be necessary because the risk-based
capital requirement includes an assessment for an FCM's exposure to
noncustomer positions. Commission staff is reviewing this proposal
for possible future publication as a proposed rule, with request for
public comment.
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IV. Satisfactory Subordination Agreements and Equity Capital
Commission Rule 1.17(c)(4)(i) permits an FCM or IB, in computing
its adjusted net capital, to exclude liabilities that are subordinated
to the claims of the firm's general creditors if such subordinated
liabilities arise under ``satisfactory subordination agreements'' as
defined in Rule 1.17(h). The criteria set forth in Rule 1.17(h) for
such ``satisfactory'' subordination agreements include several
limitations upon the FCM's or IB's ability to repay or prepay the
subordinated obligation. By way of such limitations, the Commission
seeks to enhance the stability and permanence of the firm's capital,
and to prevent the firm's subordinated debt lenders from withdrawing
firm capital to the detriment of the general creditors.
One of the payment limitations specified in Rule 1.17(h) prohibits
any prepayment of the subordinated loan after the first year of the
agreement unless the firm maintains adjusted net capital in excess of
the minimum amount that would otherwise be required under Rule
1.17(a).\35\ Specifically, Rule 1.17(h)(2)(vii)(A) restricts
subordinated debt prepayments if such prepayments would cause the FCM's
or IB's adjusted net capital to be less than the greater of:
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\35\ Prior to the end of the first year, Rule 1.17(h)(2)(vii)
generally prohibits any prepayment of the subordinated loan
irrespective of whether the firm holds sufficient excess capital.
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a. 120 percent of the minimum dollar amount specified for FCMs in
1.17(a)(1)(i)(A) or for IBs in 1.17(a)(1)(iii)(A) (for FCMs, the
required amount would be $300,000, or 120 percent of $250,000; for IB's
the required amount would be $36,000); \36\
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\36\ The Commission redesignated paragraph (a)(1)(ii)(A) of Rule
1.17 as paragraph (a)(1)(iii)(A) in 2001. 66 FR 53510 (October 23,
2001). The Commission therefore proposed technical amendments to
various subparagraphs of Rule 1.17(h), and also to Rule 1.17(e), to
correct all references within those rules to 1.17(a)(1)(ii)(A) to
read 1.17(a)(1)(iii)(A). 68 FR at 40843. The Commission has further
determined that Rules 1.10(j)(8)(ii)(A) and 1.17(a)(2)(ii) require
similar revision, as these rules also include references to
paragraph (a)(1)(ii) of Rule 1.17. The Commission is therefore
adopting amendments to Rules 1.17(h) and (e) as proposed, and also
is adopting similar amendments to Rules 1.10(j)(8) and 1.17(a)(2).
As amended, the existing references within these rules to paragraph
(a)(1)(ii) of Rule 1.17 will be revised to read (a)(1)(iii).
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b. For FCMs, 7 percent of the Segregated Amount;
c. 120 percent of the amount of adjusted net capital required by a
registered futures association of which the FCM is a member; or
d. For FCMs that also are registered with the SEC as securities
brokers or dealers, the amount of net capital required by SEC Rule
15c3-1d(b)(7).
Several other provisions of Rule 1.17(h) also specify percentages
of minimum adjusted net capital to restrict repayments or require
action by firms in connection with their satisfactory subordination
agreements. These provisions specify percentages applicable to each of
the alternative adjusted net capital computations set forth in Rule
1.17(a), including capital computations based upon the Segregated
Amount. For example, Rule 1.17(h)(3)(ii) and (h)(2)(viii)(A) require
FCMs to suspend any repayment of their subordination agreements, and to
provide notice of maturity/accelerated maturity to the Commission, if
the FCM's payment obligations, then due or maturing within a specified
period, would result in adjusted net capital of less than 6 percent of
the Segregated Amount. Furthermore, an FCM whose adjusted net capital
would be less than 7 percent of the Segregated Amount is subject to
restrictions under Rule 1.17(h)(2)(vi)(C) on any reductions of the
unpaid principal balance under a secured demand note subordination
agreement,\37\ and also subject to restrictions under Rule
1.17(h)(3)(v) on the use of temporary subordinations.\38\ Finally, Rule
1.17(h)(2)(vii)(B) restricts ``special prepayments'' by FCMs whose
adjusted net capital would be less than 10 percent of the Segregated
Amount.\39\ In light of the amendments to Rule 1.17(a) adopted by this
rulemaking, the capital computations within Rule 1.17(h) that are based
on the Segregated Amount must also be amended. Furthermore, similar
amendments are also required for Commission Rule 1.17(e), which sets
forth the requirements for a firm's ``debt-equity total'', i.e., the
total of the outstanding principal amount of satisfactory subordination
agreements plus the firm's ``equity capital''.\40\ One of the
provisions of Rule 1.17(e) requires a specified percentage of minimum
adjusted net capital based on the
[[Page 49792]]
Segregated Amount as a condition for permitting an FCM or IB to make
withdrawals of equity capital. Specifically, any withdrawal of equity
capital is prohibited if, among other things, it would result in
adjusted net capital of less than 6 percent of the Segregated Amount.
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\37\ The subordination agreement may provide for the FCM or IB
to receive either (i) cash or (ii) a demand note that is payable to
the FCM or IB and secured by cash or securities that satisfy
requirements set forth in the rule.
\38\ Pursuant to several conditions specified in the rule, an
FCM or IB may qualify for approval of a temporary satisfactory
subordination agreement that has a stated term of no more than 45
days.
\39\ ``Special prepayments'' is the term used in Rule 1.17 for
prepayments made under revolving subordinated agreements. Because
revolving agreements may permit prepayments at any time, such
payments ordinarily would conflict with Rule
1.17(h)(2)(vii)(prohibiting prepayment within one year of the date
upon which the governing subordination agreement became effective.)
In 1982, the Commission determined that special prepayments would be
acceptable if subject to various conditions, including a higher
level of minimum adjusted net capital (10 percent of segregated
funds) than is required for prepayments that are subject to the one-
year restriction (7 percent of segregated funds). 47 FR 22352 (May
24, 1982).
\40\ Rule 1.17(e) requires the firm to hold 30 percent of the
total as equity capital. Rule 1.17(d)(1) defines the term ``equity
capital'' to include retained earnings and other specified forms of
investment. The term also includes funds received under
subordination agreements that are not only satisfactory under Rule
1.17(h), but also meet other, more restrictive criteria specified in
Rule 1.17(d).
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In the Proposing Release, the Commission proposed to conform all of
the computations in paragraphs (e) and (h) of Rule 1.17 that refer to
the Segregated Amount to refer instead to the risk-based capital
computation that was proposed in Rule 1.17(a)(1)(i)(B).\41\ The
Commission stated that the proposed amendments would: (i) Eliminate
calculations based on the Segregated Amount; (ii) adopt calculations
based on the required maintenance margin for customer and noncustomer
futures and option positions carried by an FCM; and (iii) apply
percentage requirements that reflect the same proportional increase
currently required under Rule 1.17(e) and (h).\42\ Thus, for example,
where Rule 1.17(e) included a calculation based upon six percent of the
Segregated Amount, the Commission proposed to eliminate this
calculation and require 150 percent of an FCM's risk-based minimum
adjusted net capital requirement. Using this approach for purposes of
an FCM's equity capital and satisfactory subordination agreements would
result in required percentages of risk-based minimum adjusted net
capital of either 150 percent or 175 percent, except that an FCM would
be required to hold 250 percent of risk-based minimum adjusted net
capital in order to make ``special prepayments'' under a satisfactory
subordination agreement.
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\41\ 68 FR at 40843-4.
\42\ The cited paragraphs also contain references to
1.17(a)(1)(ii)(A), which has been redesignated 1.17(a)(1)(iii)(A).
The Commission therefore also proposed, and is now adopting, a
technical amendment to correct the references in these paragraphs to
read as 1.17(a)(1)(iii)(A).
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Of the ten comment letters received by the Commission, the majority
had no comments on these proposed conforming revisions to Rule 1.17(e)
and (h). One FCM proposed 125 percent as a specific alternative
percentage for the Commission to consider for all of the applicable
provisions of Rule 1.17(e) and (h), while the NFA suggested using 120
percent, which is the same percentage that Rules 1.17(e) and (h)
currently require in the case of minimum adjusted net capital
computations that are based on the capital requirements of a registered
futures association. The JAC suggested that the Commission might
consider reducing the proposed percentages, but did not make any
specific recommendations for the percentages to be included in Rules
1.17(e) and (h).
Upon further consideration, the Commission notes that in all but
one of the relevant paragraphs of Rules 1.17(e) and (h), the required
percentage of minimum adjusted net capital is 120 percent, regardless
of whether the FCM's capital computation is based on a registered
futures association's capital requirements or on the FCM's required
minimum dollar amount ($250,000). This similarity is the product of the
Commission's determination in 1995, when proposing to amend Rules
1.17(e) and (h) to include capital computations that would be based on
the capital requirements of a registered futures association, to apply
the same percentages as then required for capital computations based
upon the minimum dollar amount set forth in Rule 1.17(a)(1)(i)(A).\43\
Accordingly, the Commission has determined to take the same approach
here and reduce to 120 percent all but one of the percentages proposed
in the Proposing Release for Rules 1.17(e) and (h). The exception in
the amended rule will be in paragraph (h)(2)(vii)(B), which restricts
``special prepayments'' made under satisfactory subordination
agreements, and requires a computation of 200 percent of an FCM's
minimum adjusted net capital that is based on a minimum dollar amount,
i.e., 200 percent of $250,000. In light of the comments received on the
enhanced responsiveness of margin-based capital requirements to
significant major market moves, the Commission believes that it is
sufficient for the purposes of the identified paragraph to amend the
rule to require 125 percent of minimum adjusted net capital that is
based on an FCM's margin-based capital requirements. The Commission is
therefore adopting the amendments to Rule 1.17(e) and (h) as set forth
in the Proposing Release, with the following modifications: (1) the
required percentage of risk-based minimum adjusted net capital will be
120 percent for subparagraphs (e)(1)(ii), (h)(2)(vi)(C)(2),
(h)(2)(vii)(A)(2), (h)(2)(viii)(A)(2), (h)(3)(ii)(B), and (h)(3)(v)(B)
of Rule 1.17; and, (2) in subparagraph (h)(2)(vii)(B)(2), the required
percentage will be 125 percent of an FCM's risk-based minimum adjusted
net capital requirement as determined under amended Rule
1.17(a)(1)(i)(B).
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\43\ The Commission's approach is described in the Federal
Register release proposing these amendments in 1995. 60 FR 63995,
63997, fn. 16. (Dec. 13, 1995). The proposed rules were adopted in
1996. 60 FR 19177 (May 1, 1996). These rules were therefore adopted
prior to NFA's amendment of its capital rule, in 2000, to include a
computation based upon maintenance margin.
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The Commission also proposed in the Proposing Release to amend Rule
1.17(h)(3)(vii) to ``grandfather'' in agreements that, prior to the
effective date of the final rules as adopted, had been determined to be
satisfactory subordination agreements pursuant to Rule 1.17(h).\44\ No
commenter objected to this proposal, and the Commission adopts the
amendment as proposed.
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\44\ 68 FR at 40843.
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V. Capital Charge for Undermargined Accounts Under Rule 1.17(c)(5)
Commission Rule 1.17(c)(5)(viii) requires an FCM, in computing its
adjusted net capital, to take a reduction (i.e., capital charge) from
its net capital for any customer account that is undermargined and the
margin call issued to the customer has not been answered by the third
business day following the issuance of the call. Rule 1.17(c)(5)(ix)
requires an FCM to take a capital charge for noncustomer accounts if a
noncustomer fails to answer a margin call by the second business day
following the issuance of the call. The capital charge under Rule
1.17(c)(5)(viii) and (ix) is equal to the amount of funds required in
the undermargined account to meet maintenance margin requirements of
the applicable board of trade that the futures or options contracts
were executed on or the clearing organization that cleared such
transactions. For both customer and noncustomer accounts, the
Commission issued proposed rule amendments that would reduce the
collection period before a capital charge would have to be taken to one
business day following the issuance of a margin call.\45\
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\45\ 68 FR at 40839-40.
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Several commenters expressly acknowledged that payment by
electronic means within one day after the issuance of a margin call
reflects the current practice of the industry in many instances,
especially with respect to institutional customers. FIA, NFA, and all
five of the individual FCMs, however, expressly objected to shortening
the period under Rule 1.17(c)(5)(viii) for outstanding margin calls for
customer accounts. The prevailing theme of these comments is that there
remain instances in which meeting a margin call within one day may not
be possible, and is unrelated to any impaired financial capacity of the
customer to ultimately meet the margin call.
FIA also expressed its view that it is not necessary to reduce the
period
[[Page 49793]]
currently applicable to customer accounts to achieve the Commission's
objectives. FIA pointed out that margin-based capital requirements are
sufficient to address the Commission's concerns articulated in the
Proposing Release, particularly the fact that the futures industry has
recently experienced significant increases in the number of products
offered on futures markets, and the higher volatility associated with
some of these products. Several of FIA's comments also questioned the
Commission's assumption concerning the ease and convenience of meeting
margin calls in one day through the electronic transfer of funds.
First, FIA observed that an international client might receive a margin
call after the closing hours of banks where its accounts are
maintained, or during a holiday schedule applicable in the bank's
location. FIA further stated that it might take more than the
prescribed period to resolve funds that have been mistakenly
misdirected. Finally, FIA pointed out that retail clients generally
continue to meet margin calls by means of a check rather than a wire
transfer.
Two FCMs and the NIBA commented that a number of small to medium
business entities, including small commercial hedgers and agricultural
interests, also meet margin calls through check payments. In many
cases, according to one FCM, the cost of using a wire transfer could be
a significant percentage of the margin call. If the FCM does not
require that its customers incur such wire transfer fees, the FCM will
incur a capital charge for serving this market. Another FCM commented
that the costs of requiring payment by wire transfer, for which most
bank charge substantial fees, would impose a burden on the market
participation of these customers, and the increased cost associated
with servicing this market segment could result in higher commissions
and lower market access for the retail customer.
For those FCMs with a retail client base, therefore, FIA stated
that it is impractical to expect the receipt of margin payment within
less than three business days. FIA further noted that a number of U.S.
futures contracts are denominated in a foreign currency, and it can
take two business days to settle a wire transfer for many of these
currencies. One FCM noted that even with only a moderate retail and
foreign customer base, it anticipated having to double or triple its
daily undermargined capital charge.
Apart from issues related to the use of wire transfers to meet
margin calls, FIA and NFA also expressed concerns that the shorter time
period contemplated by the Commission might be insufficient for
institutional trading managers to meet their margin calls. FIA noted
its understanding that the reconciliation process for trades executed
on behalf of institutional trading managers can extend into the
business day following the trade date, resulting from a number of
factors, including late give-ins. Because these entities actively
manage their cash assets, excess cash must be invested early in the day
in order to enhance available yield, and these trading managers
establish early morning cut-off times for the receipt of margin calls.
Although trading managers generally receive preliminary margin calls
before the early morning cut-off, the size of the call may not be
confirmed until after the established cut-off time, thus possibly
resulting in delays beyond the one-business-day period being proposed
by the Commission.
Upon reviewing the comments received, the Commission has determined
not to adopt the proposed amendments to Rules 1.17(c)(5)(viii) and (ix)
that were set forth in the Proposing Release. The amendments were not
proposed in response to observed specific deficiencies in the FCMs'
processes for the collection of margin, and the Commission is persuaded
that the existing Commission and exchange rules continue to reinforce
the industry's own practices for collecting margin as soon as possible,
while taking into consideration circumstances that may result in margin
not being paid within one day of the issuance of a margin call which
are commercially reasonable and not indicative of any impaired
financial capacity of the recipient to ultimately meet the margin call.
VI. Financial Reporting Requirements
The Proposing Release included amendments to Rule 1.10(b) to
require each FCM to file an unaudited Form 1-FR-FCM, or FOCUS Report
for an FCM also registered with the SEC as a securities broker or
dealer, with the Commission and with the FCM's DSRO as of the end of
each month, including the FCM's fiscal year end. Such financial reports
are required to be filed within 17 business days of the end of each
month.\46\ The preparation of such monthly financial reports also would
satisfy an FCM's requirement to prepare and to maintain a monthly
formal computation of its adjusted net capital under Rule 1.18(b).\47\
The Commission also proposed to facilitate Form 1-FR filings by FCMs
and IBs by expanding the list of persons from whom the Commission would
accept the oath or affirmation that is required by Rule 1.10(d)(4).\48\
FIA, NFA and the JAC expressed support for the proposals to amend Rules
1.10(b), 1.10(d)(4) and 1.18. The Commission has determined to amend
Rules 1.10(b) and 1.18 as proposed, but to revise the text amendments
that were suggested for Rule 1.10(d)(4) in the Proposing Release.
---------------------------------------------------------------------------
\46\ 68 FR at 40840, 40845.
\47\ 68 FR at 40841, 40848.
\48\ 68 FR at 40841, 40846.
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A. Oath and Affirmation Requirements
Rule 1.10(d)(4) seeks to ensure that the required oath or
affirmation is provided by persons that have authority to bind the FCM
or IB, who also have an appropriate level of ongoing financial and/or
managerial responsibility for the financial information provided in the
reports filed with the Commission, and who should be bound by the
personal attestation. Consistent with this purpose, Rule 1.10(d)(4)
currently requires the signature of a chief operating officer, chief
financial officer, general partner, or sole proprietor, if the FCM or
IB is organized as a corporation, partnership or sole proprietorship,
respectively.
As noted in the Proposing Release, the existing list of approved
individuals in Rule 1.10(d)(4) does not address other organizational
structures under which FCMs and IBs may conduct their business,
specifically, limited liability companies (``LLCs''). All fifty states
and the District of Columbia have passed statutes in recent years
allowing formation of LLCs within their jurisdictions.\49\ LLCs are
unincorporated entities that, in accordance with the relevant LLC
statute, may be managed by their members directly or by managers whose
duties are defined by the statute and/or by agreement of the
members.\50\ While some LLCs include the positions of chief executive
officer and chief financial officer, others do not. As of February 29,
2004, at least 40 of the 177 registered FCMs were organized as LLCs.
---------------------------------------------------------------------------
\49\ Susan P. Hamill, The Origins Behind the Limited Liability
Company, 59 Ohio St. L.J. 1459 (1998).
\50\ Larry E. Ribstein and Robert R. Keatinge, Ribstein and
Keatinge on Limited Liability Companies, Sec. Sec. 1.3, 1.6, and
8.2 (2003).
---------------------------------------------------------------------------
In response to the need to modernize Rule 1.10(d)(4), the Proposing
Release suggested revisions to the rule that would be consistent with
amendments then pending to Part 4 of the Commission's rules.\51\ The
proposed amendments focused on the authority of the signer to bind the
FCM or IB, but the Commission believes that it is
[[Page 49794]]
additionally appropriate to ensure that persons who submit financial
information to the Commission hold positions within the firm that
require meaningful familiarity with, and responsibility for, the
ongoing operations and finances of the firm. The Commission has
therefore determined to adopt amendments to Rule 1.10(d)(4) to
designate, for each form of business organization, the officers or
other individuals from whom the oath or affirmation would be required,
as follows: if a sole proprietorship, the proprietor; if a partnership,
any general partner; if a corporation, the chief executive officer or
chief financial officer; and, if a limited liability company or limited
liability partnership, the chief executive officer, the chief financial
officer, the manager, the managing member, or those members vested with
the management authority for the limited liability company or limited
liability partnership.\52\ As amended, Rule 1.10(d)(4) uses some of the
same terms that were adopted by the Commission when modernizing
Commission Regulation 3.1(a) in 2001 to recognize the existence of
limited liability companies.\53\
---------------------------------------------------------------------------
\51\ 68 FR at 40841.
\52\ A limited liability partnership is a general partnership
which, as a result of a filing with the secretary of state (and, in
some cases, the maintenance of a certain level of insurance and the
payment of an annual fee to the state) limits the vicarious
liability of the partners. See Larry E. Ribstein and Robert R.
Keatinge, Ribstein and Keatinge on Limited Liability Companies,
Sec. 16.28 (2003).
\53\ Commission Regulation 3.1(a) specifies those ``principals''
that are required under the Act to register with the Commission.
Rule 3.1(a)(1) includes as principals ``any director, the president,
chief executive officer, chief operating officer, chief financial
officer, the manager, managing member or those members vested with
the management authority'' for a limited liability company or
limited liability partnership.
---------------------------------------------------------------------------
The Proposing Release also proposed to amend Rule 1.10(d)(4) to
permit the oath or affirmation, if the registrant or applicant is
registered with the SEC as a securities broker or dealer, to be
provided by the representative authorized under SEC Rule 17a-5. The
Commission adopts this amendment as proposed in the Proposing Release.
B. Filings With NFA and Other Reporting Requirements
The Commission proposed to amend Rule 1.10(c) to provide that an IB
would file an unaudited Form 1-FR-IB solely with NFA.\54\ The Proposing
Release additionally invited comment on whether, and under what
conditions, the Commission should amend its rules to permit IBs to file
annual certified financial statements solely with NFA. NFA supported
having IBs file solely with NFA both unaudited and audited financial
reports, and no commenters objected to these proposals. Having
considered these proposals, the Commission hereby amends Rule 1.10(c)
to provide that IBs will file the unaudited Form 1-FRs required by Rule
1.10(b)(2)(i), and the annual certified financial statements required
by Rule 1.10(b)(2)(ii), with NFA only.
---------------------------------------------------------------------------
\54\ 68 FR at 40842, 40845.
---------------------------------------------------------------------------
The Proposing Release included amendments that would permit an
FCM's or IB's DSRO, or, as applicable, its designated examining
authority under SEC rules, to approve the FCM's or IB's application for
change in fiscal year under Rule 1.10(e), or an application for an
extension of time to file an audited or unaudited financial statement
under Rules 1.10(f) or 1.16(f), subject to specified conditions.\55\
The Commission is adopting as final the proposed amendments to Rules
1.10(e) and (f) and 1.16(f), with some modifications from the versions
set forth in the Proposing Release. These modifications have been made
to reflect the amendments to Rule 1.10(c) that will require IBs to file
their uncertified and certified financial reports solely with NFA.\56\
---------------------------------------------------------------------------
\55\ 68 FR at 40841-2, 40846-40847.
\56\ Most significantly, the modified versions eliminate the
requirement that IBs file with the Commission copies of their
applications for changes in fiscal year or extended filing
deadlines, or the notices approving or denying such applications.
---------------------------------------------------------------------------
VII. Related Matters
A. Regulatory Flexibility Act
The Regulatory Flexibility Act (``RFA''), 5 U.S.C. 601 et seq.,
requires that agencies, in proposing rules, consider the impact of
those rules on small businesses. The Commission invited the public to
comment on the Chairman's certification that these rules would not have
a significant economic impact on a substantial number of small
entities.\57\ The Commission received no comments on the certification.
---------------------------------------------------------------------------
\57\ 68 FR at 40844.
---------------------------------------------------------------------------
B. Paperwork Reduction Act
This rulemaking includes information collection requirements. As
required by the Paperwork Reduction Act of 1995 (``PRA''),\58\ the
Commission submitted a copy of the proposed rule amendments to the
Office of Management and Budget (``OMB'') for its review. No comments
were received in response to the Commission's invitation in the
proposed rules to comment on any potential paperwork burden associated
with regulation.\59\
---------------------------------------------------------------------------
\58\ 44 U.S.C. 3507(d).
\59\ 68 FR at 40844.
---------------------------------------------------------------------------
C. Cost-Benefit Analysis
Section 15(a) of the Act, as amended by section 119 of the CFMA,
requires the Commission to consider the costs and benefits of its
action before issuing a new regulation under the Act. By its terms,
section 15(a) as amended 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, section 15(a)
simply requires the Commission to ``consider the costs and benefits''
of its action.
Section 15(a) of the Act further specifies that costs and benefits
shall be evaluated 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. Accordingly, the Commission could in its discretion
give greater weight to any one of the five enumerated areas and could
in its discretion determine that, notwithstanding its costs, a
particular rule 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 amended rules adopted by the Commission pertain to the minimum
financial and related reporting requirements for FCMs and IBs.\60\ The
Commission is considering the costs and benefits of these various
proposed rules in light of the specific provisions of section 15(a) of
the Act, as follows:
---------------------------------------------------------------------------
\60\ Section 4f(b) of the Act prohibits persons from becoming
registered as FCMs or IBs if they do not meet the minimum financial
requirements set forth in either the Commission's regulations or in
such Commission-approved requirements as may be established by the
contract markets and derivatives transaction execution facilities of
which the FCM or IB is a member.
---------------------------------------------------------------------------
1. Protection of market participants and the public. The amended
rules for reporting requirements provide the benefit of aiding the
Commission and DSROs to monitor the financial condition of futures
intermediaries and to protect the customers of those firms and the
markets. The Commission anticipates that the costs of compliance with
the amended reporting requirements will be minimized by amended rules
that will streamline filing requirements. In addition, the amended
rules will ``grandfather'' in existing satisfactory subordination
[[Page 49795]]
agreements, meaning that FCMs or IBs would incur no costs to comply
with proposed amendments to Rule 1.17, unless such agreements would be
amended or renewed for other reasons.
2. Efficiency and competition. As stated above, the Commission
anticipates that the amended rules will benefit efficiency by
eliminating duplicate filings and otherwise streamlining reporting
requirements for FCMs and IBs. The amended rules should have no effect,
from the standpoint of imposing costs or creating benefits, on
competition in the futures and options markets.
3. Financial integrity of futures markets and price discovery. The
amended rules contribute to the benefit of ensuring that FCMs and IBs
can meet their financial obligations to customers and other market
participants, thus contributing to the financial integrity of the
futures and options markets as a whole. The amended rules should have
no effect, from the standpoint of imposing costs or creating benefits,
on the price discovery function of such markets.
4. Sound risk management practices. The amended rules for capital
requirements seek to reflect appropriately the level of risk that
different activities and obligations of FCMs and IBs may pose to their
financial condition. The amended rules may therefore contribute to the
sound risk management practices of futures intermediaries.
5. Other public interest considerations. The Commission believes
that the amended rules are beneficial in that they harmonize Commission
and SEC rules with respect to time frames for reporting conditions that
may be potentially adverse to the financial condition of the FCM or IB.
The Commission invited, but did not receive, public comment on its
application of the cost-benefit provision. After considering these
factors, the Commission has determined to issue this final rule.
List of Subjects in 17 CFR Part 1
Brokers, Commodity futures, Reporting and recordkeeping
requirements.
0
For the reasons presented above, the Commission hereby amends 17 CFR
part 1 as follows:
PART 1--GENERAL REGULATIONS UNDER THE COMMODITY EXCHANGE ACT
0
1. The authority citation for part 1 continues to read as follows:
Authority: 7 U.S.C. 1a, 2, 5, 6, 6a, 6b, 6c, 6d, 6e, 6f, 6g, 6h,
6i, 6j, 6k, 6l, 6m, 6n, 6o, 6p, 7, 7a, 7b, 8, 9, 12, 12a, 12c, 13a,
13a-1, 16, 16a, 19, 21, 23, and 24, as amended by the Commodity
Futures Modernization Act of 2000, appendix E of Pub. L. 106-554,
114 Stat. 2763 (2000).
0
2. Section 1.10 is amended by revising paragraphs (b)(1), (b)(2)(i),
(c), (d)(4), (e), and (f) to read as follows:
Sec. 1.10 Financial reports of futures commission merchants and
introducing brokers.
* * * * *
(b) Filing of financial reports. (1)(i) Except as provided in
paragraphs (b)(3) and (h) of this section, each person registered as a
futures commission merchant must file a Form 1-FR-FCM as of the close
of business each month. Each Form 1-FR-FCM must be filed no later than
17 business days after the date for which the report is made.
(ii) In addition to the monthly financial reports required by
paragraph (b)(1)(i) of this section, each person registered as a
futures commission merchant must file a Form 1-FR-FCM as of the close
of its fiscal year, which must be certified by an independent public
accountant in accordance with Sec. 1.16, and must be filed no later
than 90 days after the close of the futures commission merchant's
fiscal year: Provided, however, that a registrant which is registered
with the Securities and Exchange Commission as a securities broker or
dealer must file this report not later than the time permitted for
filing an annual audit report under Sec. 240.17a-5(d)(5) of this
title.
(2)(i) Except as provided in paragraphs (b)(3) and (h) of this
section, and except for an introducing broker operating pursuant to a
guarantee agreement which is not also a securities broker or dealer,
each person registered as an introducing broker must file a Form 1-FR-
IB semiannually as of the middle and the close of each fiscal year
unless the introducing broker elects, pursuant to paragraph (e)(1) of
this section, to file a Form 1-FR-IB semiannually as of the middle and
the close of each calendar year. Each Form 1-FR-IB must be filed no
later than 17 business days after the date for which the report is
made.
* * * * *
(c) Where to file reports. (1) A report filed by an introducing
broker pursuant to paragraph (b)(2)(i) or (b)(2)(ii) of this section
need be filed only with, and will be considered filed when received by,
the National Futures Association. Other reports provided for in this
section will be considered filed when received by the regional office
of the Commission with jurisdiction over the state in which the
registrant's principal place of business is located and by the
designated self-regulatory organization, if any; and reports required
to be filed by this section by an applicant for registration will be
considered filed when received by the National Futures Association and
by the regional office of the Commission with jurisdiction over the
state in which the applicant's principal place of business is located.
(2) Any report filed pursuant to paragraph (b)(1) or (b)(4) of this
section or Sec. 1.12(a) which need not be certified in accordance with
Sec. 1.16 may be submitted to the Commission in electronic form using
a Commission-assigned Personal Identification Number, and otherwise in
accordance with instructions issued by the Commission, if the futures
commission merchant, introducing broker or a designated self-regulatory
organization has provided the Commission with the means necessary to
read and to process the information contained in such report.
(3) Any information required of a registrant by a self-regulatory
organization pursuant to paragraph (b)(4) of this section need be
furnished only to such self-regulatory organization and the Commission,
and any information required of a registrant by the National Futures
Association pursuant to paragraph (b)(4) of this section need be
furnished only to the National Futures Association and the Commission.
(4) Any guarantee agreement entered into between a futures
commission merchant and an introducing broker in accordance with the
provisions of this section need be filed only with, and will be
considered filed when received by, the National Futures Association.
(d) * * *
(4) Attached to each Form 1-FR filed pursuant to this section must
be an oath or affirmation that to the best knowledge and belief of the
individual making such oath or affirmation the information contained in
the Form 1-FR is true and correct. The individual making such oath or
affirmation must be:
(i) If the registrant or applicant is a sole proprietorship, the
proprietor; if a partnership, any general partner; if a corporation,
the chief executive officer or chief financial officer; and, if a
limited liability company or limited liability partnership, the chief
executive officer, the chief financial officer, the manager, the
managing member, or those members vested with the management authority
for the limited liability company or limited liability partnership; or
[[Page 49796]]
(ii) If the registrant or applicant is registered with the
Securities and Exchange Commission as a securities broker or dealer,
the representative authorized under Sec. 240.17a-5 of this title to
file for the securities broker or dealer its Financial and Operational
Combined Uniform Single Report under the Securities Exchange Act of
1934, part II or part IIA. In the case of a Form 1-FR filed via
electronic transmission in accordance with procedures established by
the Commission, such transmission must be accompanied by the
Commission-assigned Personal Identification Number of the authorized
signer and such Personal Identification Number will constitute and
become a substitute for the manual signature of the authorized signer
for the purpose of making the oath or affirmation referred to in this
paragraph.
(e) Election of fiscal year. (1) An applicant wishing to establish
a fiscal year other than the calendar year may do so by notifying the
National Futures Association of its election of such fiscal year, in
writing, concurrently with the filing of the Form 1-FR pursuant to
paragraph (a)(2) of this section, but in no event may such fiscal year
end more than one year from the date of the Form 1-FR filed pursuant to
paragraph (a)(2) of this section. An applicant that does not so notify
the National Futures Association will be deemed to have elected the
calendar year as its fiscal year.
(2) (i) A registrant must continue to use its elected fiscal year,
calendar or otherwise, unless a change in such fiscal year has been
approved pursuant to this paragraph (e)(2).
(ii) Futures commission merchant registrants. (A) A futures
commission merchant may file with its designated self-regulatory
organization an application to change its fiscal year, a copy of which
the registrant must file with the Commission. The application shall be
approved or denied in writing by the designated self-regulatory
organization. The registrant must file immediately with the Commission
a copy of any notice it receives from the designated self-regulatory
organization to approve or deny the registrant's application to change
its fiscal year. A written notice of approval shall become effective
upon the filing by the registrant of a copy with the Commission, and a
written notice of denial shall be effective as of the date of the
notice.
(B) A futures commission merchant that is registered with the
Securities and Exchange Commission as a securities broker or dealer may
file with its designated self-regulatory organization copies of any
notice or application filed with its designated examining authority,
pursuant to Sec. 240.17a-5(d)(1)(i) of this title, for a change in
fiscal year or ``as of'' date for its annual audited financial
statement. The registrant must also file immediately with the
designated self-regulatory organization and the Commission copies of
any notice it receives from its designated examining authority to
approve or deny the registrant's request for change in fiscal year or
``as of'' date. Upon the receipt by the designated self-regulatory
organization and the Commission of copies of any such notice of
approval, the change in fiscal year or ``as of'' date referenced in the
notice shall be deemed approved under this paragraph (e)(2).
(C) Any copy that under this paragraph (e)(2) is required to be
filed with the Commission shall be filed with the regional office of
the Commission with jurisdiction over the state in which the
registrant's principal place of business is located, and any copy or
application to be filed with the designated self-regulatory
organization shall be filed at its principal place of business.
(iii) Introducing broker registrants. (A) An introducing broker may
file with the National Futures Association an application to change its
fiscal year, which shall be approved or denied in writing.
(B) An introducing broker that is registered with the Securities
and Exchange Commission as a securities broker or dealer may file with
the National Futures Association copies of any notice or application
filed with its designated examining authority, pursuant to Sec.
240.17a-5(d)(1)(i) of this title, for a change in fiscal year or ``as
of'' date for its annual audited financial statement. The registrant
must also file immediately with the National Futures Association copies
of any notice it receives from its designated examining authority to
approve or deny the registrant's request for change in fiscal year or
``as of'' date. Upon the receipt by the National Futures Association of
copies of any such notice of approval, the change in fiscal year or
``as of'' date referenced in the notice shall be deemed approved under
this paragraph (e)(2).
(f) Extension of time for filing uncertified reports. (1) In the
event a registrant finds that it cannot file its Form 1-FR, or, in
accordance with paragraph (h) of this section, its Financial and
Operational Combined Uniform Single Report under the Securities
Exchange Act of 1934, part II or part IIA (FOCUS report), for any
period within the time specified in paragraphs (b)(1)(i) or (b)(2)(i)
of this section without substantial undue hardship, it may request
approval for an extension of time, as follows:
(i) Futures commission merchant registrants. (A) A futures
commission merchant may file with its designated self-regulatory
organization an application for extension of time, a copy of which the
registrant must file with the Commission. The application shall be
approved or denied in writing by the designated self-regulatory
organization. The registrant must file immediately with the Commission
a copy of any notice it receives from the designated self-regulatory
organization to approve or deny the registrant's request for extension
of time. A written notice of approval shall become effective upon the
filing by the registrant of a copy with the Commission, and a written
notice of denial shall be effective as of the date of the notice.
(B) A futures commission merchant that is registered with the
Securities and Exchange Commission as a securities broker or dealer may
file with its designated self-regulatory organization a copy of any
application that the registrant has filed with its designated examining
authority, pursuant to Sec. 240.17-a5(l)(5) of this title, for an
extension of time to file its FOCUS report. The registrant must also
file immediately with the designated self-regulatory organization and
the Commission copies of any notice it receives from its designated
examining authority to approve or deny the requested extension of time.
Upon receipt by the designated self-regulatory organization and the
Commission of copies of any such notice of approval, the requested
extension of time referenced in the notice shall be deemed approved
under this paragraph (f)(1).
(C) Any copy that under this subparagraph (f)(1)(i) is required to
be filed with the Commission shall be filed with the regional office of
the Commission with jurisdiction over the state in which the
registrant's principal place of business is located.
(ii) Introducing broker registrants. (A) An introducing broker may
file with the National Futures Association an application for extension
of the time, which shall be approved or denied in writing.
(B) An introducing broker that is registered with the Securities
and Exchange Commission as a securities broker or dealer may file with
the National Futures Association copies of any application that the
registrant has filed with its designated examining authority, pursuant
to Sec. 240.17-a5(l)(5) of this title, for an extension of time to
file its FOCUS report. The registrant
[[Page 49797]]
must also file immediately with the National Futures Association copies
of any notice it receives from its designated examining authority to
approve or deny the requested extension of time. Upon the receipt by
the National Futures Association of a copy of any such notice of
approval, the requested extension of time referenced in the notice
shall be deemed approved under this subparagraph (f)(1(ii).
(2) In the event an applicant finds that it cannot file its report
for any period within the time specified in paragraph (b)(4) of this
section without substantial undue hardship, it may file with the
National Futures Association an application for an extension of time to
a specified date which may not be more than 90 days after the date as
of which the financial statements were to have been filed. The
application must state the reasons for the requested extension and must
contain an agreement to file the report on or before the specified
date. The application must be received by the National Futures
Association before the time specified in paragraph (b)(4) of this
section for filing the report. Notice of such application must be filed
with the regional office of the Commission with jurisdiction over the
state in which the applicant's principal place of business is located
concurrently with the filing of such application with the National
Futures Association. Within ten calendar days after receipt of the
application for an extension of time, the National Futures Association
shall:
(i) Notify the applicant of the grant or denial of the requested
extension; or
(ii) Indicate to the applicant that additional time is required to
analyze the request, in which case the amount of time needed will be
specified.
* * * * *
0
3. Section 1.12 is amended by revising paragraphs (a)(1), (b)(1),
(b)(2), (b)(3), (b)(4), (c), (d), (e), (f), (h) and (i)(1) to read as
follows:
Sec. 1.12 Maintenance of minimum financial requirements by futures
commission merchants and introducing brokers.
(a) * * *
(1) Give telephonic notice, to be confirmed in writing by facsimile
notice, as set forth in paragraph (i) of this section that the
applicant's or registrant's adjusted net capital is less than required
by Sec. 1.17 or by other capital rule, identifying the applicable
capital rule. The notice must be given immediately after the applicant
or registrant knows or should know that its adjusted net capital is
less than required by any of the aforesaid rules to which the applicant
or registrant is subject; and
* * * * *
(b) * * *
(1) 150 percent of the minimum dollar amount required by Sec.
1.17(a)(1)(i)(A);
(2) 110 percent of the amount required by Sec. 1.17(a)(1)(i)(B);
(3) 150 percent of the amount of adjusted net capital required by a
registered futures association of which it is a member, unless such
amount has been determined by a margin-based capital computation set
forth in the rules of the registered futures association, and such
amount meets or exceeds the amount of adjusted net capital required
under the margin-based capital computation set forth in Sec.
1.17(a)(1)(i)(B), in which case the required percentage is 110 percent,
or
(4) For securities brokers or dealers, the amount of net capital
specified in Rule 17a-11(c) of the Securities and Exchange Commission
(17 CFR 240.17a-11(c)), must file written notice to that effect as set
forth in paragraph (i) of this section within twenty-four (24) hours of
such event.
(c) If an applicant or registrant at any time fails to make or keep
current the books and records required by these regulations, such
applicant or registrant must, on the same day such event occurs,
provide facsimile notice of such fact, specifying the books and records
which have not been made or which are not current, and within forty-
eight (48) hours after giving such notice file a written report stating
what steps have been and are being taken to correct the situation.
(d) Whenever any applicant or registrant discovers or is notified
by an independent public accountant, pursuant to Sec. 1.16(e)(2) of
this chapter, of the existence of any material inadequacy, as specified
in Sec. 1.16(d)(2) of this chapter, such applicant or registrant must
give facsimile notice of such material inadequacy within twenty-four
(24) hours, and within forty-eight (48) hours after giving such notice
file a written report stating what steps have been and are being taken
to correct the material inadequacy.
(e) Whenever any self-regulatory organization learns that a member
registrant has failed to file a notice or written report as required by
Sec. 1.12, that self-regulatory organization must immediately report
this failure by telephone, confirmed in writing immediately by
facsimile notice, as provided in paragraph (i) of this section.
(f)(1) Whenever a clearing organization determines that any
position it carries for one of its clearing members which is registered
as a futures commission merchant or as a leverage transaction merchant
must be liquidated immediately, transferred immediately or that the
trading of any account of such futures commission merchant or such
leverage transaction merchant shall be only for the purposes of
liquidation, because that clearing member has failed to meet a call for
margin or to make other required deposits, the clearing organization
must immediately give telephonic notice, confirmed in writing
immediately by facsimile notice, of such a determination to the
principal office of the Commission at Washington, DC.
(2) Whenever a registered futures commission merchant determines
that any position it carries for another registered futures commission
merchant or for a registered leverage transaction merchant must be
liquidated immediately, transferred immediately or that the trading of
any account of such futures commission merchant or leverage transaction
merchant shall be only for purposes of liquidation, because the other
futures commission merchant or the leverage transaction merchant has
failed to meet a call for margin or to make other required deposits,
the carrying futures commission merchant must immediately give
telephonic notice, confirmed in writing immediately by facsimile
notice, of such a determination to the principal office of the
Commission at Washington, DC.
(3) Whenever a registered futures commission merchant determines
that an account which it is carrying is undermargined by an amount
which exceeds the futures commission merchant's adjusted net capital
determined in accordance with Sec. 1.17, the futures commission
merchant must immediately give telephonic notice, confirmed in writing
immediately by facsimile notice, of such a determination to the
designated self-regulatory organization and the principal office of the
Commission at Washington, DC. This paragraph (f)(3) shall apply to any
account carried by the futures commission merchant, whether a customer,
noncustomer, omnibus or proprietary account. For purposes of this
paragraph (f)(3), if any person has an interest of 10 percent or more
in ownership or equity in, or guarantees, more than one account, or has
guaranteed an account in addition to his own account, all such accounts
shall be combined. A designated self-regulatory organization may grant
an exemption from the provisions of this paragraph to a futures
commission merchant with respect to any particular account on a
continuous basis provided
[[Page 49798]]
the designated self-regulatory organization documents the reasons for
granting such an exemption and continues to monitor any such account.
(4) A futures commission merchant shall report immediately by
telephone, confirmed immediately in writing by facsimile notice,
whenever any commodity interest account it carries is subject to a
margin call, or call for other deposits required by the futures
commission merchant, that exceeds the futures commission merchant's
excess adjusted net capital, determined in accordance with Sec. 1.17,
and such call has not been answered by the close of business on the day
following the issuance of the call. This applies to all accounts
carried by the futures commission merchant, whether customer,
noncustomer, or omnibus, that are subject to margining, including
commodity futures and options. In addition to actual margin deposits by
an account owner, a futures commission merchant may also take account
of favorable market moves in determining whether the margin call is
required to be reported under this paragraph.
(5)(i) A futures commission merchant shall report immediately by
telephone, confirmed immediately in writing by facsimile notice,
whenever its excess adjusted net capital is less than six percent of
the maintenance margin required by the futures commission merchant on
all positions held in accounts of a noncustomer other than a
noncustomer who is subject to the minimum financial requirements of:
(A) A futures commission merchant, or
(B) The Securities and Exchange Commission for a securities broker
and dealer.
(ii) For purposes of paragraph (f)(5)(i) of this section,
maintenance margin shall include all deposits which the futures
commission merchant requires the noncustomer to maintain in order to
carry its positions at the futures commission merchant.
* * * * *
(h) Whenever a person registered as a futures commission merchant
knows or should know that the total amount of its funds on deposit in
segregated accounts on behalf of customers, or that the total amount
set aside on behalf of customers trading on non-United States markets,
is less than the total amount of such funds required by the Act and the
Commission's rules to be on deposit in segregated or secured amount
accounts on behalf of such customers, the registrant must report such
deficiency immediately by telephone notice, confirmed immediately in
writing by facsimile notice, to the registrant's designated self-
regulatory organization and the principal office of the Commission in
Washington, DC, to the attention of the Director and the Chief
Accountant of the Division of Clearing and Intermediary Oversight.
(i)(1) Every notice and written report required to be given or
filed by this section (except for notices required by paragraph (f) of
this section) by a futures commission merchant, an applicant for
registration as a futures commission merchant or a self-regulatory
organization must be filed with the regional office of the Commission
with jurisdiction over the state in which the applicant's or
registrant's principal place of business is located, with the
designated self-regulatory organization, if any, with the Securities
and Exchange Commission, if such applicant or registrant is a
securities broker or dealer, and with the National Futures Association,
if the firm is an applicant. In addition, every notice required to be
given by this section must also be filed with the principal office of
the Commission in Washington, DC. Each statement of financial
condition, each statement of the computation of the minimum capital
requirements pursuant to Sec. 1.17 of this part, and each schedule of
segregation requirements and funds on deposit in segregation required
by this section must be filed in accordance with the provisions of
Sec. 1.10(d) of this part unless otherwise indicated.
* * * * *
0
4. Section 1.16 is amended by revising paragraph (f) to read as
follows:
Sec. 11.16 Qualifications and reports of accountants.
* * * * *
(f)(1) Extension of time for filing audited reports. In the event a
registered futures commission merchant or a registered introducing
broker finds that it cannot file, without substantial undue hardship,
its certified financial statements and schedules for any year within
the time specified in Sec. 1.10 (b)(1)(ii) or Sec. 1.10 (b)(2)(ii) of
this part, as applicable, such registrants may request approval for an
extension of time, as follows:
(i) Futures commission merchant registrants. (A) A futures
commission merchant may file with its designated self-regulatory
organization an application for an extension of time, a copy of which
the registrant must file with the Commission. The application shall be
approved or denied in writing by the designated self-regulatory
organization. The registrant must file immediately with the Commission
a copy of any notice it receives from the designated self-regulatory
organization to approve or deny the registrant's request for extension
of time. A written notice of approval shall become effective upon the
filing by the registrant of a copy with the Commission, and a written
notice of denial shall be effective as of the date of the notice.
(B) A futures commission merchant that is registered with the
Securities and Exchange Commission as a securities broker or dealer may
file with its designated self-regulatory organization a copy of any
application that the registrant has filed with its designated examining
authority, pursuant to Sec. 240.17-a5(l)(1)of this title, for an
extension of time to file audited annual financial statements. The
registrant must also file immediately with the designated self-
regulatory organization and the Commission copies of any notice it
receives from its designated examining authority to approve or deny the
requested extension of time. Upon receipt by the designated self-
regulatory organization and the Commission of copies of any such notice
of approval, the requested extension of time referenced in the notice
shall be deemed approved under this paragraph (f)(1)(i).
(C) Any copy that under this paragraph (f)(1)(i) is required to be
filed with the Commission shall be filed with the regional office of
the Commission with jurisdiction over the state in which the
registrant's principal place of business is located.
(ii) Introducing broker registrants. (A) An introducing broker may
file with the National Futures Association an application for extension
of time, which shall be approved or denied in writing.
(B) An introducing broker that is registered with the Securities
and Exchange Commission as a securities broker or dealer may file with
the National Futures Association copies of any application that the
registrant has filed with its designated examining authority, pursuant
to Sec. 240.17-a5(l)(1) of this title, for an extension of time to
file audited annual financial statements. The registrant must also file
immediately with the National Futures Association copies of any notice
it receives from its designated examining authority to approve or deny
the requested extension of time. Upon the receipt by the National
Futures Association of a copy of any such notice of approval, the
requested extension of time referenced in the notice shall be deemed
approved under this paragraph (f)(1)(ii).
(2) Exemption requests. On the written request of any designated
self-regulatory organization or registrant, or
[[Page 49799]]
on its own motion, the Commission may grant an extension of time or an
exemption from any of the certified financial reporting requirements of
this chapter either unconditionally or on specified terms and
conditions.
* * * * *
0
5. Section 1.17 is amended by:
0
a. revising paragraphs (a)(1)(i)(B) and (b)(4),
0
b. adding new paragraphs (b)(7) and (b)(8), and
0
c. revising paragraphs (e)(1)(i), (e)(1)(ii), (h)(2)(vi)(C)(1) and (2),
(h)(2)(vii)(A)(1) and (2), (h)(2)(vii)(B)(1) and (2),
(h)(2)(viii)(A)(1) and (2), (h)(3)(ii)(A) and (B), (h)(3)(v)(A) and (B)
and (h)(3)(vii), to read as follows:
Sec. 1.17 Minimum financial requirements for futures commission
merchants and introducing brokers.
(a)(1)(i) * * *
(B) The futures commission merchant's risk-based capital
requirement computed as follows:
(1) Eight percent of the total risk margin requirement (as defined
in Sec. 1.17(b)(8)) for positions carried by the futures commission
merchant in customer accounts (as defined in Sec. 1.17(b)(7)), plus
(2) Four percent of the total risk margin requirement (as defined
in Sec. 1.17(b)(8)) for positions carried by the futures commission
merchant in noncustomer accounts (as defined in Sec. 1.17(b)(4)).
* * * * *
(b) * * *
(4) ``Noncustomer account'' means a commodity futures or option
account carried on the books of the applicant or registrant which is
either:
(i) An account that is not included in the definition of customer
(as defined in Sec. 1.17(b)(2)) or proprietary account (as defined in
Sec. 1.17(b)(3)), or
(ii) An account for a foreign-domiciled person trading futures or
options on a foreign board of trade, and such account is a proprietary
account as defined in Sec. 1.3(y) of this title, but is not a
proprietary account as defined in Sec. 1.17(b)(3).
* * * * *
(7) ``Customer account'' means a commodity futures or option
account carried on the books of the applicant or registrant which is
either:
(i) An account that is included in the definition of customer (as
defined in Sec. 1.17(b)(2)), or
(ii) An account for a foreign-domiciled person trading on a foreign
board of trade, where such account for the foreign-domiciled person is
not a proprietary account (as defined in Sec. 1.17(b)(3)) or a
noncustomer account (as defined in Sec. 1.17(b)(4)(ii)).
(8) ``Risk margin'' for an account means the level of maintenance
margin or performance bond that the futures commission merchant is
required to collect under the rules of an exchange, or the rules of a
clearing organization if the level of margin to be collected is not
determined by the rules of an exchange, from the owner of a customer
account or noncustomer account, subject to the following:
(i) Risk margin does not include the equity component of short or
long option positions maintained in an account;
(ii) The maintenance margin or performance bond requirement
associated with a long option position may be excluded from risk margin
to the extent that the value of such long option position does not
reduce the total risk maintenance or performance bond requirement of
the account that holds the long option position;
(iii) The risk margin for an account carried by a futures
commission merchant which is not a member of the exchange or the
clearing organization that requires collection of such margin should be
calculated as if the futures commission merchant were such a member;
and
(iv) If a futures commission merchant does not possess sufficient
information to determine what portion of an account's total margin
requirement represents risk margin, all of the margin required by the
exchange or the clearing organization that requires collection of such
margin for that account, shall be treated as risk margin.
* * * * *
(e)(1) * * *
(i) 120 percent of the appropriate minimum dollar amount required
by paragraphs (a)(1)(i)(A) or (a)(1)(iii)(A) of this section;
(ii) For a futures commission merchant or applicant therefor, 120
percent of the amount required by paragraph (a)(1)(i)(B) of this
section;
* * * * *
(h) * * *
(2) * * *
(vi) * * *
(C) * * *
(1) 120 percent of the appropriate minimum dollar amount required
by paragraphs (a)(1)(i)(A) or (a)(1)(iii)(A) of this section;
(2) For a futures commission merchant or applicant therefor, 120
percent of the amount required by paragraph (a)(1)(i)(B) of this
section;
* * * * *
(vii) * * *
(A) * * *
(1) 120 percent of the appropriate minimum dollar amount required
by paragraphs (a)(1)(i)(A) or (a)(1)(iii)(A) of this section;
(2) For a futures commission merchant or applicant therefor, 120
percent of the amount required by paragraph (a)(1)(i)(B) of this
section;
* * * * *
(B) * * *
(1) 200 percent of the appropriate minimum dollar amount required
by paragraphs (a)(1)(i)(A) or (a)(1)(iii)(A) of this section;
(2) For a futures commission merchant or applicant therefor, 125
percent of the amount required by paragraph (a)(1)(i)(B) of this
section;
* * * * *
(viii) * * *
(A) * * *
(1) 120 percent of the appropriate minimum dollar amount required
by paragraphs (a)(1)(i)(A) or (a)(1)(iii)(A) of this section;
(2) For a futures commission merchant or applicant therefor, 120
percent of the amount required by paragraph (a)(1)(i)(B) of this
section;
* * * * *
(h) * * *
(3) * * *
(ii) * * *
(A) 120 percent of the appropriate minimum dollar amount required
by paragraphs (a)(1)(i)(A) or (a)(1)(iii)(A) of this section;
(B) For a futures commission merchant or applicant therefor, 120
percent of the amount required by paragraph (a)(1)(i)(B) of this
section;
* * * * *
(v) * * *
(A) 120 percent of the appropriate minimum dollar amount required
by paragraphs (a)(1)(i)(A) or (a)(1)(iii)(A) of this section;
(B) For a futures commission merchant or applicant therefor, 120
percent of the amount required by paragraph (a)(1)(i)(B) of this
section;
* * * * *
(vii) Subordination agreements that incorporate adjusted net
capital requirements in effect prior to September 30, 2004. Any
subordination agreement that incorporates the adjusted net capital
requirements in paragraphs (h)(2)(vi)(C)(2), (h)(2)(vii)(A)(2) and
(B)(2), (h)(2)(viii)(A)(2), (h)(3)(ii)(B), and (h)(3)(v)(B) of this
section, as in effect prior to September 30, 2004, and which has been
deemed to be satisfactorily subordinated pursuant to this section prior
to September 30, 2004, shall continue to be deemed a satisfactory
subordination agreement until the
[[Page 49800]]
maturity of such agreement. In the event, however, that such agreement
is amended or renewed for any reason, then such agreement shall not be
deemed a satisfactory subordination agreement unless the amended or
renewed agreement meets the requirements of this section.
* * * * *
0
6. Section 1.18 is amended by revising paragraph (b) to read as
follows:
Sec. 1.18 Records for and relating to financial reporting and monthly
computation by futures commission merchants and introducing brokers.
* * * * *
(b)(1) Each applicant or registrant must make and keep as a record
in accordance with Sec. 1.31 formal computations of its adjusted net
capital and of its minimum financial requirements pursuant to Sec.
1.17 or the requirements of the designated self-regulatory organization
to which it is subject as of the close of business each month. Such
computations must be completed and made available for inspection by any
representative of the National Futures Association, in the case of an
applicant, or of the Commission or designated self-regulatory
organization, if any, in the case of a registrant, within 17 business
days after the date for which the computations are made, commencing the
first month end after the date the application for registration is
filed.
(2) An applicant or registrant that has filed a monthly Form 1-FR
or Statement of Financial and Operational Combined Uniform Single
Report under the Securities Exchange Act of 1934, Part II or Part IIA
(FOCUS report) in accordance with the requirements of Sec. 1.10(b)
will be deemed to have satisfied the requirements of paragraph (b)(1)
of this section for such month.
* * * * *
Issued in Washington, DC, on August 5, 2004, by the Commission.
Jean A. Webb,
Secretary of the Commission.
[FR Doc. 04-18349 Filed 8-11-04; 8:45 am]
BILLING CODE 6351-01-P