[Federal Register Volume 75, Number 221 (Wednesday, November 17, 2010)]
[Proposed Rules]
[Pages 70152-70159]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 2010-29003]
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COMMODITY FUTURES TRADING COMMISSION
17 CFR Part 1
RIN 3038-AC96
Implementation of Conflicts of Interest Policies and Procedures
by Futures Commission Merchants and Introducing Brokers
AGENCY: Commodity Futures Trading Commission.
ACTION: Notice of proposed rulemaking.
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SUMMARY: The Commodity Futures Trading Commission (Commission or CFTC)
is proposing rules to implement new statutory provisions enacted by
Title VII of the Dodd-Frank Wall Street
[[Page 70153]]
Reform and Consumer Protection Act (Dodd-Frank Act). The proposed
regulations establish conflicts of interest requirements for futures
commission merchants (FCMs) and introducing brokers (IBs) for the
purpose of ensuring that such persons implement adequate policies and
procedures in compliance with the Commodity Exchange Act (CEA), as
amended by the Dodd-Frank Act.
DATES: Comments must be received on or before January 18, 2011.
ADDRESSES: You may submit comments, identified by RIN number 3038-AC96
and FCM-IB Conflicts of Interest, by any of the following methods:
Agency Web site, via its Comments Online process: http://comments.cftc.gov. Follow the instructions for submitting comments
through the Web site.
Mail: David A. Stawick, Secretary of the Commission,
Commodity Futures Trading Commission, Three Lafayette Centre, 1155 21st
Street, NW., Washington, DC 20581.
Hand Delivery/Courier: Same as mail above.
Federal eRulemaking Portal: http://www.regulations.gov.
Follow the instructions for submitting comments.
Please submit your comments using only one method.
All comments must be submitted in English, or if not, accompanied
by an English translation. Comments will be posted as received to
http://www.cftc.gov. You should submit only information that you wish
to make available publicly. If you wish the Commission to consider
information that you believe is exempt from disclosure under the
Freedom of Information Act, a petition for confidential treatment of
the exempt information may be submitted according to the procedures
established in CFTC Regulation 145.9, 17 CFR 145.9.
The Commission reserves the right, but shall have no obligation, to
review, pre-screen, filter, redact, refuse or remove any or all of your
submission from http://www.cftc.gov that it may deem to be
inappropriate for publication, such as obscene language. All
submissions that have been redacted or removed that contain comments on
the merits of the rulemaking will be retained in the public comment
file and will be considered as required under the Administrative
Procedure Act and other applicable laws, and may be accessible under
the Freedom of Information Act.
FOR FURTHER INFORMATION CONTACT: Sarah E. Josephson, Associate
Director, Division of Clearing and Intermediary Oversight, (202) 418-
5684, [email protected], or Ward P. Griffin, Counsel, Office of
General Counsel, (202) 418-5425, [email protected], Commodity Futures
Trading Commission, Three Lafayette Centre, 1155 21st Street, NW.,
Washington, DC 20581.
SUPPLEMENTARY INFORMATION:
I. Background
On July 21, 2010, President Obama signed the Dodd-Frank Act.\1\
Title VII of the Dodd-Frank Act \2\ amended the CEA \3\ to establish a
comprehensive regulatory framework to reduce risk, increase
transparency, and promote market integrity within the financial system
by, among other things: (1) Providing for the registration and
comprehensive regulation of swap dealers and major swap participants;
(2) imposing clearing and trade execution requirements on standardized
derivative products; (3) creating rigorous recordkeeping and real-time
reporting regimes; and (4) enhancing the rulemaking and enforcement
authorities of the Commission with respect to all registered entities
and intermediaries subject to the Commission's oversight.
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\1\ See Dodd-Frank Wall Street Reform and Consumer Protection
Act, Public Law 111-203, 124 Stat. 1376 (2010). The text of the
Dodd-Frank Act may be accessed at http://www.cftc.gov.
\2\ Pursuant to section 701 of the Dodd-Frank Act, Title VII may
be cited as the ``Wall Street Transparency and Accountability Act of
2010.''
\3\ 7 U.S.C. 1 et seq.
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This proposed rulemaking relates to the conflicts of interest
provisions set forth in section 732 of the Dodd-Frank Act. In relevant
part, section 732 of the Dodd-Frank Act amends section 4d of the CEA to
direct each FCM and IB to implement conflicts of interest systems and
procedures that establish safeguards within the firm to ensure that any
persons researching or analyzing the price or market for any commodity
are separated by ``appropriate informational partitions'' within the
firm from review, pressure, or oversight of persons whose involvement
in trading or clearing activities might potentially bias the judgment
or supervision of the persons. Section 732 also requires that such
conflicts of interest systems and procedures ``address such other
issues as the Commission determines to be appropriate.''
Section 754 of the Dodd-Frank Act establishes that ``[u]nless
otherwise provided in this title, the provisions of this subtitle shall
take effect on the later of 360 days after the date of the enactment of
this subtitle or, to the extent a provision of this subtitle requires a
rulemaking, not less than 60 days after publication of the final rule
or regulation implementing such provision of this subtitle.''
Consequently, the Commission will seek to promulgate rules--by July 15,
2011--implementing the conflicts of interest provisions of section 732
of the Dodd-Frank Act.
Accordingly, pursuant to authority granted under sections 4d(c) and
8a(5) of the CEA, as amended by the Dodd-Frank Act, the Commission is
proposing to adopt Regulation 1.71 to address potential conflicts of
interest in the preparation and release of research reports by FCMs and
IBs, and the establishment of ``appropriate informational partitions''
within such firms, as required by the Dodd-Frank Act. The proposed rule
also will address other issues, such as enhanced disclosure
requirements, in order to minimize the potential that conflicts of
interest will arise within FCMs and IBs.
The proposed rules reflect consultation with staff of the following
agencies: (i) The Securities and Exchange Commission; (ii) the Board of
Governors of the Federal Reserve System; (iii) the Office of the
Comptroller of the Currency; and (iv) the Federal Deposit Insurance
Corporation. Staff from each of these agencies has had the opportunity
to provide oral and/or written comments to the proposal, and the
proposed rules incorporate elements of the comments provided.
The Commission requests comment on all aspects of the proposed
rules, as well as comment on the specific provisions and issues
highlighted in the discussion below.
II. Proposed Regulations
A. Conflicts of Interest in Research or Analysis
Section 732 of the Dodd-Frank Act requires, in relevant part, that
FCMs and IBs implement conflicts of interest systems and procedures
that ``establish structural and institutional safeguards to ensure that
the activities of any person within the firm relating to research or
analysis of the price or market for any commodity are separated by
appropriate informational partitions within the firm from the review,
pressure, or oversight of persons whose involvement in trading or
clearing activities might potentially bias the judgment or supervision
of the persons.''
The language in section 732 of the Dodd-Frank Act is similar to
certain language contained in section 501(a) of the Sarbanes-Oxley Act
of 2002,\4\ which
[[Page 70154]]
amended the Securities Exchange Act of 1934 by creating a new section
15D. In relevant part, section 15D(a) mandates that the Securities and
Exchange Commission, or a registered securities association or national
securities exchange, adopt ``rules reasonably designed to address
conflicts of interest that can arise when securities analysts recommend
equity securities in research reports and public appearances, in order
to improve the objectivity of research and provide investors with more
useful and reliable information, including rules designed * * * to
establish structural and institutional safeguards within registered
brokers or dealers to assure that securities analysts are separated by
appropriate informational partitions within the firm from the review,
pressure, or oversight of those whose involvement in investment banking
activities might potentially bias their judgment or supervision * *
*.''
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\4\ Public Law 107-204, 116 Stat. 745 (2002) (codified at 15
U.S.C. 78o-6).
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Unlike section 15D of the Securities Exchange Act of 1934, section
732 of the Dodd-Frank Act does not expressly limit the requirement for
informational partitions to only those persons who are responsible for
the preparation of the substance of research reports; rather, section
732 could be read to require informational partitions between persons
involved in trading or clearing activities and any person within a FCM
or IB who engages in ``research or analysis of the price or market for
any commodity,'' whether or not such research or analysis is to be made
part of a research report that may be publicly disseminated.
However, the Commission believes that an untenable outcome could
result from implementing informational partitions between persons
involved in trading or clearing activities and all persons who may be
engaged in ``research or analysis of the price or market for any
commodity,'' given that persons involved in trading or clearing
activities are routinely--or even primarily--engaged in ``research or
analysis of the price or market for'' commodities. Sound trading and/or
clearing activities necessarily require some form of pre-decisional
research or analysis of the facts supporting such trading or clearing
determinations.
Therefore, given the untenable alternative, the proposed rules
reflect the Commission's belief that the Congressional intent
underlying section 732 with respect to ``research and analysis of the
price or market of any commodity'' is primarily intended to prevent
undue influence by persons involved in trading or clearing activities
over the substance of research reports that may be publicly
disseminated, and to prevent pre-public dissemination of any material
information in the possession of a person engaged in research and
analysis, or of the research reports, to traders.
Many elements of the proposed rule, particularly those provisions
relating to potential conflicts of interest surrounding research and
analysis, have been adapted from National Association of Securities
Dealers (NASD) Rule 2711. To construct the ``structural and
institutional safeguards'' mandated by Congress under section 732 of
the Dodd-Frank Act, the proposed rule establishes specific restrictions
on the interaction and communications between persons within a FCM or
IB involved in research or analysis of the price or market for any
derivative \5\ and persons involved in trading or clearing activities.
The proposed rules also impose duties and constraints on persons
involved in the research or analysis of the price or market for any
derivative. For instance, such persons will be required to disclose
conspicuously during public appearances any relevant personal financial
interests relating to any derivative of a type that the person follows.
FCMs and IBs similarly will be obligated to make certain disclosures
clearly and prominently in research reports, including third-party
research reports that are distributed or made available by the FCM or
IB. Further, FCMs and IBs, as well as employees involved in trading or
clearing activities, will be prohibited from retaliating against any
person involved in the research or analysis of the price or market for
any derivative who produces, in good faith, a research report that
adversely impacts the current or prospective trading or clearing
activities of the FCM or IB.
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\5\ Use of the term ``derivative'' is based upon the products
listed in the definitions of futures commission merchant and
introducing broker in sections 1a(28) and 1a(29) of the CEA.
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Although section 732 of the Dodd-Frank Act requires that
appropriate informational partitions be constructed within FCMs and
IBs, the Commission recognizes that the appropriateness of such
partitions may be affected by the size of the FCM or IB and the scope
of its operations. The Commission invites comment on how these rules
should apply to FCMs and IBs, considering the varying size and scope of
the operations of such firms. For instance, NASD Rule 2711(k) provides
an exception from certain requirements for ``small firms,'' defined to
include those firms that over the past three years have participated in
ten or fewer ``investment banking services transactions'' and
``generated $5 million or less in gross investment banking services
revenues from those transactions.'' The Commission solicits comment on
whether a similar approach should be adopted for small FCMs and IBs.
Moreover, the exceptions to the definition of ``research report'' are
designed to address issues typically found in smaller firms where
individuals in the trading unit perform their own research to advise
their clients or potential clients. These exceptions do not in any way
impact or lessen the restrictions placed on firms that prepare research
reports and release them for public consumption. Any attempt by such
firms to move research personnel into a trading unit to attempt to
avail themselves of the exception will result in insufficient
``structural and institutional safeguards'' and will be a violation of
Section 732 of the Dodd-Frank Act and these Regulations.
To address the possibility that the proposed rules could be evaded
by employing research analysts in an affiliate of a FCM or IB, the
proposed rules also will restrict communications with research analysts
employed by an affiliate. An affiliate will be defined as an entity
controlling, controlled by, or under common control with, a FCM or IB.
B. Other Issues
In addition to mandating the establishment of ``appropriate
informational partitions'' within FCMs and IBs that focus on the
activities of persons involved in the ``research or analysis of the
price or market for any commodity,'' section 732 of the Dodd-Frank Act
also requires FCMs and IBs to ``implement conflict-of-interest systems
and procedures that * * * address such other issues as the Commission
determines to be appropriate.'' Having considered the potential
conflicts of interest that may arise in a FCM or IB, the Commission is
proposing rules that will address two general topics: (1) Clearing
activities; and (2) the potential for undue influence on customers. The
intended cumulative effect of the proposed rules is to fulfill
Congress's objective that FCMs and IBs construct ``structural and
institutional safeguards'' to minimize the potential conflicts of
interest that could arise within such firms.
With respect to the proposed language relating to clearing
activities, although the Commission is exercising its statutory
authority under section 4d(c)(2) of the CEA, as amended by the Dodd-
Frank Act, the impetus underlying the proposed language originates in
the Dodd-Frank Act: Section 731. Section 731 creates a new
[[Page 70155]]
section 4s of the CEA, which provides for the registration and
regulation of swap dealers (SDs) and major swap participants (MSPs).
New section 4s contains a conflicts of interest provision that is
similar--though not identical--to the conflicts of interest provision
in section 732 of the Dodd-Frank Act. New section 4s(j)(5) requires the
establishment of ``structural and institutional safeguards''
surrounding the activities of any person ``providing clearing
activities or making determinations as to accepting clearing
customers''--specifically that the activities of such persons be
separated from the review, pressure, or oversight of persons involved
in pricing, trading, or clearing. Although the quoted language is not
contained in section 4d(c) of the CEA, as amended by section 732 of the
Dodd-Frank Act, the Commission believes that to effectuate fully the
intent of section 4s(j)(5) of the CEA, these issues should be addressed
with regard to FCMs.
The Dodd-Frank Act stipulates that only a person registered as a
FCM may accept money, securities or property to clear a swap through a
derivatives clearing organization on behalf of another person, though
the restriction does not prohibit a SD or MSP from clearing its own
swap transaction.\6\ New section 4s(j)(5) of the CEA requires that
certain determinations be made relating to the provision of clearing
activities or the acceptance of clearing customers, such as (1) whether
to enter into a cleared or uncleared trade, (2) whether to refer a
counterparty to a particular FCM for clearing, or (3) whether to send a
cleared trade to a particular derivatives clearing organization.
Although the ultimate determination as to whether to accept a customer
for clearing would be made at a FCM, an affiliated SD or MSP could have
incentives to try to influence that decision improperly. Such influence
may be motivated by conflicts of interest that could have a direct
impact on the clearing treatment of transactions. Moreover, in any
situation where a person is dually registered as a FCM and as a SD or
MSP, the restrictions on clearing activities set forth in the proposed
regulations are intended to apply to the relationship between the
clearing unit of the FCM and the business trading unit of the SD or
MSP, even though the business trading unit and clearing unit reside
within the same entity. The proposed rules, set forth at subsection
(d), have been adapted from NASD Rule 2711(b).
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\6\ See section 4d(f)(1) of the CEA, as amended by section
724(a) of the Dodd-Frank Act.
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The Commission specifically requests comment regarding whether
there are alternative approaches that could be taken to address the
potential conflicts of interest that may arise between a FCM providing
clearing services to customers and the business trading unit personnel
of an affiliated swap dealer or major swap participant. For example,
what approach would address an attempt by a swap dealer's trading desk
personnel to interfere with an affiliated FCM's decision to offer
clearing services to a particular customer because of a perceived
competitive threat?
As an additional safeguard, the Commission is proposing to require
that each affected FCM and IB implement policies and procedures
mandating the disclosure to its customers of any material conflicts of
interest that relate to a customer's decision on the execution or
clearing of a transaction.
III. Related Matters
A. Regulatory Flexibility Act
The Regulatory Flexibility Act (RFA) \7\ requires that agencies, in
proposing rules, consider whether the rules they propose will have a
significant economic impact on a substantial number of small entities
and, if so, provide a regulatory flexibility analysis addressing the
impact. The proposed rules would impact FCMs and IBs, each of which is
addressed separately in the following paragraphs.
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\7\ 5 U.S.C. 601 et seq.
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The Commission previously has established certain definitions of
``small entities'' to be used in evaluating the impact of the
Commission's rules on such small entities in accordance with the RFA.
In the Commission's ``Policy Statement and Establishment of Definitions
of `Small Entities' for Purposes of the Regulatory Flexibility Act,''
\8\ the Commission concluded that registered FCMs should not be
considered to be small entities for purposes of the RFA. The
Commission's determination in this regard was based, in part, upon the
obligation of registered FCMs to meet the capital requirements
established by the Commission. Likewise, the Commission determined
``that, for the basic purpose of protection of the financial integrity
of futures trading, Commission regulations can make no size distinction
among registered FCMs.'' \9\ Thus, with respect to registered FCMs, the
Commission believes that the proposed regulations will not have a
significant economic impact on a substantial number of small entities.
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\8\ 47 FR 18618, Apr. 30, 1982.
\9\ Id. at 18619.
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The Commission previously has determined that, for purposes of the
RFA, the Commission should ``evaluate within the context of a
particular rule proposal whether all or some [IBs] should be considered
to be small entities and, if so, to analyze the economic impact on
[IBs] of any such rule at that time. Specifically, the Commission
recognizes that the [IB] definition, even as narrowed to exclude
certain persons, undoubtedly encompasses many business enterprises of
variable size.'' \10\ At present, IBs are subject to various existing
rules that govern and impose minimum requirements on their internal
compliance operations, based on the nature of their business. The
proposed amendments would merely augment the existing compliance
requirements of such persons to address potential conflicts of interest
within such firms. To the extent that certain IBs may be considered to
be small entities, the Commission believes that the proposed
regulations will not have a significant economic impact.
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\10\ 48 FR 35248, 35276, Aug. 3, 1983.
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Accordingly, pursuant to Section 605(b) of the RFA, 5 U.S.C.
605(b), the Chairman, on behalf of the Commission, certifies that these
proposed rule amendments will not have a significant economic impact on
a substantial number of small entities. However, the Commission invites
the public to comment on this finding.
B. Paperwork Reduction Act
The Paperwork Reduction Act (PRA),\11\ imposes certain requirements
on Federal agencies in connection with their conducting or sponsoring
any collection of information as defined by the PRA. Certain provisions
of this proposed rulemaking would result in new collection of
information within the meaning of the PRA. The Commission therefore is
submitting this proposal to the Office of Management and Budget (OMB)
for review in accordance with 44 U.S.C. 3597(d) and 5 CFR 1320.11. The
title for this collection is ``Conflicts of Interest Policies and
Procedures by Futures Commission Merchants and Introducing Brokers.''
An agency may not conduct or sponsor, and a person is not required to
respond to, a collection of information unless it displays a currently
valid control number. OMB has not yet assigned a control number to the
new collection.
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\11\ 44 U.S.C. 3501 et seq.
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[[Page 70156]]
The collection of information under these proposed rules is
necessary to implement certain provisions of the CEA, as amended by the
Dodd-Frank Act. Specifically, it is essential to ensuring that FCMs and
IBs develop and maintain the required conflicts of interest systems and
procedures. The Commission's staff would use the information collected
when conducting examination and oversight to evaluate the completeness
and effectiveness of the conflicts of interest procedures and
disclosures of FCMs and IBs.
If the proposed regulations are adopted, responses to this new
collection of information would be mandatory. The Commission will
protect proprietary information according to the Freedom of Information
Act and 17 CFR part 145, ``Commission Records and Information.'' In
addition, section 8(a)(1) of the CEA strictly prohibits the Commission,
unless specifically authorized by the CEA, from making public ``data
and information that would separately disclose the business
transactions or market positions of any person and trade secrets or
names of customers.'' The Commission also is required to protect
certain information contained in a government system of records
according to the Privacy Act of 1974.\12\
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\12\ 5 U.S.C. 552a.
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1. Information Provided by Reporting Entities/Persons
The proposed rules will require FCMs and IBs to adopt conflicts of
interest policies and procedures that may impose PRA burdens,
particularly through the implementation of certain recordkeeping
requirements. For purposes of the PRA, the term ``burden'' means the
``time, effort, or financial resources expended by persons to generate,
maintain, or provide information to or for a Federal agency.'' \13\
This burden will result from the recordkeeping obligations related to
an FCM and IB's obligations to adopt and implement written policies and
procedures reasonably designed to ensure compliance with the proposed
regulation, document certain communications between non-research
personnel and research department personnel, and provide certain
disclosures. The burden relates solely to recordkeeping requirements;
the proposed regulation does not contain any reporting requirements.
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\13\ 44 U.S.C. 3502(2).
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The burden for compliance per respondent is expected to be 44.5
hours, at a cost annually of $4,450 for each respondent. This estimate
includes the time needed to review applicable laws and regulations;
develop and update conflicts of interest policies and procedures and to
maintain records of certain communications and disclosures periodically
required by the proposed regulation. The Commission does not expect
respondents to incur any start-up costs in connection with this
proposed regulation as it anticipates that respondents already maintain
personnel and systems for regulatory recordkeeping.
There are currently 159 registered FCMs and 1,645 registered IBs
that will be required to comply with the proposed conflicts of interest
provisions (or a total of 1,804 registrants). It is expected that the
compliance officers of those firms will be the employees charged with
fulfilling the regulatory obligations imposed by the proposed
regulations. According to recent Bureau of Labor Statistics, the mean
hourly wage of an employee under occupation code 13-1041, ``Compliance
Officers, Except Agriculture, Construction, Health and Safety, and
Transportation,'' that is employed by the ``Securities and Commodity
Contracts Intermediation and Brokerage'' industry is $38.77.\14\
Because FCMs and IBs include financial institutions whose compliance
employees' salaries may exceed the mean wage, the Commission has taken
a conservative approach and estimated the cost burden of these proposed
regulations based upon an average salary of $100 per hour. Accordingly,
the estimated burden was calculated as follows:
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\14\ http://www.bls.gov/oes/current/oes131041.htm.
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Recordkeeping Related to Maintenance of Conflicts of Interest
Policies and Procedures
Number of registrants: 1,804.
Average number of annual responses by each registrant: 1.
Estimated average hours per response: 2.
Frequency of collection: Annually.
Aggregate annual burden: 1,804 registrants x 1 response x 2 hours =
3,608 burden hours.
Recordkeeping Related to Communications Between Certain Personnel
Number of registrants: 1,804.
Average number of annual responses by each registrant: 20.
Estimated average hours per response: 0.5.
Frequency of collection: As needed.
Aggregate annual burden: 1,804 registrants x 20 responses x 0.5
hours = 18,040 burden hours.
Recordkeeping Related to Disclosure Requirements
Number of registrants: 1,804.
Average number of annual responses by each registrant: 65.
Estimated average hours per response: 0.5.
Frequency of collection: As needed.
Aggregate annual burden: 1,804 registrants x 65 responses x 0.5
hours = 58,630 burden hours.
Based upon the above, the aggregate cost for all registrants is
80,278 burden hours and $8,027,800 [80,278 burden hours x $100 per
hour].
2. Information Collection Comments
The Commission invites the public and other federal agencies to
comment on any aspect of the recordkeeping burdens discussed above.
Pursuant to 44 U.S.C. 3506(c)(2)(B), the Commission solicits comments
in order to: (i) Evaluate whether the proposed collection of
information is necessary for the proper performance of the functions of
the Commission, including whether the information will have practical
utility; (ii) evaluate the accuracy of the Commission's estimate of the
burden of the proposed collection of information; (iii) determine
whether there are ways to enhance the quality, utility, and clarity of
the information to be collected; and (iv) minimize the burden of the
collection of information on those who are to respond, including
through the use of automated collection techniques or other forms of
information technology.
Comments may be submitted directly to the Office of Information and
Regulatory Affairs, by fax at (202) 395-6566 or by e-mail at
[email protected]. Please provide the Commission with a copy
of submitted comments so that they can be summarized and addressed in
the final rule. Refer to the Addresses section of this notice of
proposed rulemaking for comment submission instructions to the
Commission. A copy of the supporting statements for the collections of
information discussed above may be obtained by visiting http://www.RegInfo.gov. OMB is required to make a decision concerning the
collection of information between 30 and 60 days after publication of
this release. Consequently, a comment to OMB is most assured of being
fully effective if received by OMB (and the Commission) within 30 days
after publication of this notice of proposed rulemaking.
C. Cost-Benefit Analysis
Section 15(a) of the CEA \15\ requires the Commission to consider
the costs
[[Page 70157]]
and benefits of its actions before issuing a rulemaking under the Act.
By its terms, section 15(a) does not require the Commission to quantify
the costs and benefits of the rule or to determine whether the benefits
of the rulemaking outweigh its costs; rather, it requires that the
Commission ``consider'' the costs and benefits of its actions.
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\15\ 7 U.S.C. 19(a).
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Section 15(a) further specifies that the costs and benefits of a
proposed rulemaking shall be evaluated in light of five broad areas of
market and public concern: (1) Protection of market participants and
the public; (2) efficiency, competitiveness and financial integrity of
futures markets; (3) price discovery; (4) sound risk management
practices; and (5) other public interest considerations. The Commission
may, 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 is necessary or
appropriate to protect the public interest or to effectuate any of the
provisions or accomplish any of the purposes of the Act.
1. Summary of Proposed Requirements
The proposed regulations would implement section 732 of the Act,
which amends section 4d of the CEA \16\ to direct each FCM and IB to
implement conflicts of interest systems and procedures to ensure that
any persons researching or analyzing the price or market for any
commodity are separated by ``appropriate informational partitions''
within the firm from review, pressure, or oversight of persons whose
involvement in trading or clearing activities might potentially bias
the judgment or supervision of the persons. Such conflicts of interest
systems and procedures also must address any other issues that the
Commission determines to be appropriate.
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\16\ 7 U.S.C. 6d.
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2. Costs
With respect to costs, the Commission has determined that costs to
FCMs and IBs would be minimal because the anticipated implementation of
the proposed rules would require little additional resources beyond
internal organizational changes to prevent compliance violations.
3. Benefits
With respect to benefits, the Commission has determined that formal
conflicts of interest rules will enhance transparency, bolster
confidence in markets, reduce risk and allow regulators to better
monitor and manage risks to our financial system.
4. Public Comment
The Commission invites public comment on its cost-benefit
considerations. Commenters also are invited to submit any data or other
information that they may have quantifying or qualifying the costs and
benefits of the proposed regulations with their comment letters.
List of Subjects in 17 CFR Part 1
Brokers, Commodity futures, Conflicts of interest, Reporting and
recordkeeping requirements.
For the reasons stated in this release, the Commission proposes to
amend 17 CFR part 1 as follows:
PART 1--GENERAL REGULATIONS UNDER THE COMMODITY EXCHANGE ACT
1. The authority citation for part 1 is revised to read as follows:
Authority: 7 U.S.C. 1a, 2, 6, 6a, 6b, 6b-1, 6c, 6d, 6e, 6f, 6g,
6h, 6i, 6j, 6k, 6l, 6m, 6n, 6o, 6p, 7, 7a, 7b, 8, 9, 9a, 12, 12a,
16, 18, 19, 21, 23.
2. Section 1.71 is added to read as follows:
Sec. 1.71 Implementation of conflicts of interest policies and
procedures by futures commission merchants and introducing brokers.
(a) Definitions. For purposes of this section, the following terms
shall be defined as provided.
(1) Affiliate. This term means, with respect to any person, a
person controlling, controlled by, or under common control with, such
person.
(2) Business trading unit. This term means any department,
division, group, or personnel of a futures commission merchant or
introducing broker or any of its affiliates, whether or not identified
as such, that performs or is involved in any pricing, trading, sales,
marketing, advertising, solicitation, structuring, or brokerage
activities on behalf of a futures commission merchant or introducing
broker.
(3) Clearing unit. This term means any department, division, group,
or personnel of a futures commission merchant or any of its affiliates,
whether or not identified as such, that performs or is involved in any
proprietary or customer clearing activities on behalf of a futures
commission merchant.
(4) Derivative. This term means (i) a contract for the purchase or
sale of a commodity for future delivery; (ii) a security futures
product; (iii) a swap; (iv) any agreement, contract, or transaction
described in section 2(c)(2)(C)(i) or section 2(c)(2)(D)(i) of the Act;
(v) any commodity option authorized under section 4c of the Act; and
(vi) any leverage transaction authorized under section 19 of the Act.
(5) Non-research personnel. This term means any employee of the
business trading unit or clearing unit, or any other employee of the
futures commission merchant or introducing broker who is not directly
responsible for, or otherwise involved with, research concerning a
derivative, other than legal or compliance personnel.
(6) Public appearance. This term means any participation in a
conference call, seminar, forum (including an interactive electronic
forum) or other public speaking activity before 15 or more persons, or
interview or appearance before one or more representatives of the
media, radio, television or print media, or the writing of a print
media article, in which a research analyst makes a recommendation or
offers an opinion concerning a derivatives transaction. This term does
not include a password-protected Webcast, conference call or similar
event with 15 or more existing customers, provided that all of the
event participants previously received the most current research report
or other documentation that contains the required applicable
disclosures, and that the research analyst appearing at the event
corrects and updates during the public appearance any disclosures in
the research report that are inaccurate, misleading, or no longer
applicable.
(7) Research analyst. This term means the employee of a futures
commission merchant or introducing broker who is primarily responsible
for, and any employee who reports directly or indirectly to such
research analyst in connection with, preparation of the substance of a
research report relating to any derivative, whether or not any such
person has the job title of ``research analyst.''
(8) Research department. This term means any department or division
that is principally responsible for preparing the substance of a
research report relating to any derivative on behalf of a futures
commission merchant or introducing broker, including a department or
division contained in an affiliate of a futures commission merchant or
introducing broker.
(9) Research report. This term means any written communication
(including electronic) that includes an analysis of the price or market
for any derivative, and that provides information reasonably sufficient
upon which to base a decision to enter into a
[[Page 70158]]
derivatives transaction. This term does not include:
(i) Communications distributed to fewer than 15 persons;
(ii) periodic reports or other communications prepared for
investment company shareholders or commodity pool participants that
discuss individual derivatives positions in the context of a fund's
past performance or the basis for previously-made discretionary
decisions;
(iii) any communication generated by an employee of the business
trading unit that is conveyed as a solicitation for entering into a
derivatives transaction, and is conspicuously identified as such; and
(iv) internal communications that are not given to current or
prospective customers.
(b) Policies and Procedures. Each futures commission merchant and
introducing broker subject to this rule must adopt and implement
written policies and procedures reasonably designed to ensure that the
futures commission merchant or introducing broker and its employees
comply with the provisions of this rule.
(c) Research Analysts and Research Reports.
(1) Restrictions on Relationship with Research Department.
(i) Non-research personnel shall not influence the content of a
research report of the futures commission merchant or the introducing
broker.
(ii) No research analyst may be subject to the supervision or
control of any employee of the futures commission merchant's or
introducing broker's business trading unit or clearing unit, and no
personnel engaged in trading or clearing activities may have any
influence or control over the evaluation or compensation of a research
analyst.
(iii) Except as provided in paragraph (c)(1)(iv) of this section,
non-research personnel, other than the board of directors and any
committee thereof, shall not review or approve a research report of the
futures commission merchant or introducing broker before its
publication.
(iv) Non-research personnel may review a research report before its
publication as necessary only to verify the factual accuracy of
information in the research report, to provide for non-substantive
editing, to format the layout or style of the research report, or to
identify any potential conflicts of interest, provided that:
(A) Any written communication between non-research personnel and
research department personnel concerning the content of a research
report must be made either through authorized legal or compliance
personnel of the futures commission merchant or introducing broker or
in a transmission copied to such personnel; and
(B) Any oral communication between non-research personnel and
research department personnel concerning the content of a research
report must be documented and made either through authorized legal or
compliance personnel acting as an intermediary or in a conversation
conducted in the presence of such personnel.
(2) Restrictions on Communications. Any written or oral
communication by a research analyst to a current or prospective
customer, or to any employee of the futures commission merchant or
introducing broker, relating to any derivative must not omit any
material fact or qualification that would cause the communication to be
misleading to a reasonable person.
(3) Restrictions on Research Analyst Compensation. A futures
commission merchant or introducing broker may not consider as a factor
in reviewing or approving a research analyst's compensation his or her
contributions to the futures commission merchant's or introducing
broker's trading or clearing business. No employee of the business
trading unit or clearing unit of the futures commission merchant or
introducing broker may influence the review or approval of a research
analyst's compensation.
(4) Prohibition of Promise of Favorable Research. No futures
commission merchant or introducing broker may directly or indirectly
offer favorable research, or threaten to change research, to an
existing or prospective customer as consideration or inducement for the
receipt of business or compensation.
(5) Disclosure Requirements.
(i) Ownership and Material Conflicts of Interest. A futures
commission merchant or introducing broker must disclose in research
reports and a research analyst must disclose in public appearances
whether the research analyst maintains, from time to time, a financial
interest in any derivative of a type that the research analyst follows,
and the general nature of the financial interest.
(ii) Prominence of Disclosure. Disclosures and references to
disclosures must be clear, comprehensive, and prominent. With respect
to public appearances by research analysts, the disclosures required by
paragraph (c)(5) of this section must be conspicuous.
(iii) Records of Public Appearances. Each futures commission
merchant and introducing broker must maintain records of public
appearances by research analysts sufficient to demonstrate compliance
by those research analysts with the applicable disclosure requirements
under paragraph (c)(5) of this section.
(iv) Third-Party Research Reports.
(A) For the purposes of paragraph (c)(5)(iv) of this section,
``independent third-party research report'' shall mean a research
report, in respect of which the person or entity producing the report:
(1) Has no affiliation or business or contractual relationship with
the distributing futures commission merchant or introducing broker, or
that futures commission merchant's or introducing broker's affiliates,
that is reasonably likely to inform the content of its research
reports; and
(2) makes content determinations without any input from the
distributing futures commission merchant or introducing broker or from
the futures commission merchant's or introducing broker's affiliates.
(B) Subject to paragraph (c)(5)(iv)(C) of this section, if a
futures commission merchant or introducing broker distributes or makes
available any independent third-party research report, the futures
commission merchant or introducing broker must accompany the research
report with, or provide a web address that directs the recipient to,
the current applicable disclosures, as they pertain to the futures
commission merchant or introducing broker, required by this section.
Each futures commission merchant and introducing broker must establish
written policies and procedures reasonably designed to ensure the
completeness and accuracy of all applicable disclosures.
(C) The requirements of paragraph (c)(5)(iv)(B) of this section
shall not apply to independent third-party research reports made
available by a futures commission merchant or introducing broker to its
customers:
(1) Upon request; or
(2) through a website maintained by the futures commission merchant
or introducing broker.
(6) Prohibition of Retaliation Against Research Analysts. No
futures commission merchant or introducing broker, and no employee of a
futures commission merchant or introducing broker who is involved with
the futures commission merchant's or introducing broker's trading or
clearing activities, may, directly or indirectly, retaliate against or
threaten to retaliate against any research analyst employed by the
futures commission merchant or introducing broker or its affiliates as
a
[[Page 70159]]
result of an adverse, negative, or otherwise unfavorable research
report or public appearance written or made, in good faith, by the
research analyst that may adversely affect the futures commission
merchant's or introducing broker's present or prospective trading or
clearing activities.
(d) Clearing activities.
(1) No futures commission merchant shall permit any affiliated swap
dealer or major swap participant to directly or indirectly interfere
with, or attempt to influence, the decision of the clearing unit
personnel of the futures commission merchant with regard to the
provision of clearing services and activities, including but not
limited to:
(i) Whether to offer clearing services and activities to customers;
(ii) Whether to accept a particular customer for the purposes of
clearing derivatives;
(iii) Whether to submit a transaction to a particular derivatives
clearing organization;
(iv) Setting risk tolerance levels for particular customers;
(v) Determining acceptable forms of collateral from particular
customers; or
(vi) Setting fees for clearing services.
(2) Each futures commission merchant shall create and maintain an
appropriate informational partition between business trading units of
an affiliated swap dealer or major swap participant and clearing unit
personnel of the futures commission merchant. At a minimum, such
informational partitions shall require that:
(i) No employee of a business trading unit of an affiliated swap
dealer or major swap participant may review or approve the provision of
clearing services and activities by clearing unit personnel of the
futures commission merchant, make any determination regarding whether
the futures commission merchant accepts clearing customers, or
participate in any way with the provision of clearing services and
activities by the futures commission merchant;
(ii) No employee of a business trading unit of an affiliated swap
dealer or major swap participant shall supervise, control, or influence
any employee of a clearing unit of the futures commission merchant; and
(iii) No employee of the business trading unit of an affiliated
swap dealer or major swap participant shall influence or control
compensation or evaluation of any employee of the clearing unit of the
futures commission merchant.
(e) Undue Influence on Customers. Each futures commission merchant
and introducing broker must adopt and implement written policies and
procedures that mandate the disclosure to its customers of any material
incentives and any material conflicts of interest regarding the
decision of a customer as to the trade execution and/or clearing of the
derivatives transaction.
(f) All records that a futures commission merchant or introducing
broker is required to maintain pursuant to this regulation shall be
maintained in accordance with Commission Regulation Sec. 1.31 and
shall be made available promptly upon request to representatives of the
Commission.
Issued in Washington, DC, on November 10, 2010, by the
Commission.
David A. Stawick,
Secretary of the Commission.
Statement of Chairman Gary Gensler
Implementation of Conflicts of Interest Policies and Procedures by
Futures Commission Merchants and Introducing Brokers
I support the proposed rulemakings that establish firewalls to
ensure a separation between the research arm, the trading arm and the
clearing activities of swap dealers, major swap participants, futures
commission merchants and introducing brokers. This rule proposal
relates to the conflicts-of-interest provisions of the Dodd-Frank Act
that direct swap dealers and major swap participants to have
appropriate informational partitions. The proposal builds upon similar
protections in the securities markets as mandated in the Sarbanes-Oxley
Act. The proposed rules will protect market participants and the public
while also promoting the financial integrity of the marketplace.
[FR Doc. 2010-29003 Filed 11-16-10; 8:45 am]
BILLING CODE 6351-01-P