[Code of Federal Regulations]
[Title 17, Volume 1]
[Revised as of April 1, 2003]
From the U.S. Government Printing Office via GPO Access
[CITE: 17CFR1.17]

[Page 40-60]
 
              TITLE 17--COMMODITY AND SECURITIES EXCHANGES
 
             CHAPTER I--COMMODITY FUTURES TRADING COMMISSION
 
PART 1--GENERAL REGULATIONS UNDER THE COMMODITY EXCHANGE ACT--Table of Contents
 
Sec. 1.17  Minimum financial requirements for futures commission merchants and introducing brokers.

    (a)(1)(i) Except as provided in paragraph (a)(2)(i) of this section, 
each person registered as a futures commission merchant must maintain 
adjusted net capital equal to or in excess of the greatest of:
    (A) $250,000;
    (B) Four percent of the following amount: The customer funds 
required to be segregated pursuant to the Act and the regulations in 
this part, plus the funds of opt-out customers that, but for the 
election to opt out pursuant to Sec. 1.68, would be required to be 
segregated, plus the foreign futures or foreign options secured amount, 
less the market value of commodity options purchased by customers on or 
subject to the rules of a contract market or a foreign board of trade 
for which the full premiums have been paid: Provided, however, that the 
deduction for each customer shall be limited to the amount of segregated 
customer funds in such customer's account(s) and foreign futures and 
foreign options secured accounts;
    (C) The amount of adjusted net capital required by a registered 
futures association of which it is a member; or
    (D) For securities brokers and dealers, the amount of net capital 
required by Rule 15c3-1(a) of the Securities and Exchange Commission (17 
CFR 240.15c3-1(a)).
    (ii) Each person registered as a futures commission merchant engaged 
in soliciting or accepting orders and customer funds related thereto for 
the purchase or sale of any commodity for future delivery or any 
commodity option on or subject to the rules of a registered derivatives 
transaction execution facility from any customer who does not qualify as 
an ``institutional customer'' as defined in Sec. 1.3(g) must:
    (A) Be a clearing member of a derivatives clearing organization and 
maintain net capital in the amount of the greater of $20,000,000 or the 
amounts otherwise specified in paragraph (a)(1)(i) of this section; or
    (B) Receive orders on behalf of the customer from a commodity 
trading advisor acting in accordance with Sec. 4.32 of this chapter.
    (iii) Except as provided in paragraph (a)(2) of this section, each 
person registered as an introducing broker must maintain adjusted net 
capital equal to or in excess of the greatest of:
    (A) $30,000;
    (B) The amount of adjusted net capital required by a registered 
futures association of which it is a member; or
    (C) For securities brokers and dealers, the amount of net capital 
required by Rule 15c3-1(a) of the Securities and Exchange Commission (17 
CFR 240.15c3-1(a)).
    (2)(i) The requirements of paragraph (a)(1) of this section shall 
not be applicable if the registrant is a member of a designated self-
regulatory organization and conforms to minimum financial standards and 
related reporting requirements set by such designated self-regulatory 
organization in its bylaws, rules, regulations or resolutions approved 
by the Commission pursuant to section 4f(b) of the Act and Sec. 1.52.
    (ii) The minimum requirements of paragraph (a)(1)(ii) of this 
section shall not be applicable to an introducing broker which elects to 
meet the alternative adjusted net capital requirement for introducing 
brokers by operating pursuant to a guarantee agreement which meets the 
requirements set forth in Sec. 1.10(j). Such an introducing broker shall 
be deemed to meet the adjusted net capital requirement under this 
section so long as such agreement is binding and in full force and 
effect, and, if the introducing broker is also a securities broker or 
dealer, it maintains the amount of net capital required by Rule 15c3-
1(a) of the Securities and Exchange Commission (17 CFR 240.15c3-1(a)).
    (3) No person applying for registration as a futures commission 
merchant or as an introducing broker shall be so

[[Page 41]]

registered unless such person affirmatively demonstrates to the 
satisfaction of the National Futures Association that it complies with 
the financial requirements of this section. Each registrant must be in 
compliance with this section at all times and must be able to 
demonstrate such compliance to the satisfaction of the Commission or the 
designated self-regulatory organization.
    (4) A futures commission merchant who is not in compliance with this 
section, or is unable to demonstrate such compliance as required by 
paragraph (a)(3) of this section, must transfer all customer accounts 
and immediately cease doing business as a futures commission merchant 
until such time as the firm is able to demonstrate such compliance: 
Provided, however, The registrant may trade for liquidation purposes 
only unless otherwise directed by the Commission and/or the designated 
self-regulatory organization: And, Provided further, That if such 
registrant immediately demonstrates to the satisfaction of the 
Commission or the designated self-regulatory organization the ability to 
achieve compliance, the Commission or the designated self-regulatory 
organization may in its discretion allow such registrant up to a maximum 
of 10 business days in which to achieve compliance without having to 
transfer accounts and cease doing business as required above. Nothing in 
this paragraph (a)(4) shall be construed as preventing the Commission or 
the designated self-regulatory organization from taking action against a 
registrant for non-compliance with any of the provisions of this 
section.
    (5) An introducing broker who is not in compliance with this 
section, or is unable to demonstrate such compliance as required by 
paragraph (a)(3) of this section, must immediately cease doing business 
as an introducing broker until such time as the registrant is able to 
demonstrate such compliance: Provided, however, That if such registrant 
immediately demonstrates to the satisfaction of the Commission or the 
designated self-regulatory organization the ability to achieve 
compliance, the Commission or the designated self-regulatory 
organization may in its discretion allow such registrant up to a maximum 
of 10 business days in which to achieve compliance without having to 
cease doing business as required above. If the introducing broker is 
required to cease doing business in accordance with this paragraph 
(a)(5), the introducing broker must immediately notify each of its 
customers and the futures commission merchants carrying the account of 
each customer that it has ceased doing business. Nothing in this 
paragraph (a)(5) shall be construed as preventing the Commission or the 
designated self-regulatory organization from taking action against a 
registrant for non-compliance with any of the provisions of this 
section.
    (b) For the purposes of this section:
    (1) Where the applicant or registrant has an asset or liability 
which is defined in Securities Exchange Act Rule 15c3-1 (Sec. 240.15c3-1 
of this title) the inclusion or exclusion of all or part of such asset 
or liability for the computation of adjusted net capital shall be in 
accordance with Sec. 240.15c3-1 of this title, unless specifically 
stated otherwise in this section.
    (2) Customer means customer (as defined in Sec. 1.3(k)), option 
customer (as defined in Sec. 1.3(jj) of this part and in Sec. 32.1(c) of 
this chapter) and includes a foreign futures and foreign options 
customer (as defined in Sec. 30.1(c) of this chapter).
    (3) Proprietary account means a commodity futures or options account 
carried on the books of the applicant or registrant for the applicant or 
registrant itself, or for general partners in the applicant or 
registrant.
    (4) Noncustomer account means a commodity futures or option account 
carried on the books of the applicant or registrant which is not 
included in the definition of customer (as defined in paragraph (b)(2)) 
or proprietary account (as defined in paragraph (b)(3) of this section).
    (5) Clearing organization means clearing organization (as defined in 
Sec. 1.3(d)) and includes a clearing organization of any board of trade.
    (6) Business day means any day other than a Sunday, Saturday, or 
holiday.
    (c) Definitions: For the purposes of this section:

[[Page 42]]

    (1) Net capital means the amount by which current assets exceed 
liabilities. In determining ``net capital'':
    (i) Unrealized profits shall be added and unrealized losses shall be 
deducted in the accounts of the applicant or registrant, including 
unrealized profits and losses on fixed price commitments and forward 
contracts;
    (ii) All long and all short positions in commodity options which are 
traded on a contract market and listed security options shall be marked 
to their market value and all long and all short securities and 
commodities positions shall be marked to their market value;
    (iii) The value attributed to any commodity option which is not 
traded on a contract market shall be the difference between the option's 
strike price and the market value for the physical or futures contract 
which is the subject of the option. In the case of a call commodity 
option which is not traded on a contract market, if the market value for 
the physical or futures contract which is the subject of the option is 
less than the strike price of the option, it shall be given no value. In 
the case of a put commodity option which is not traded on a contract 
market, if the market value for the physical or futures contract which 
is the subject of the option is more than the strike price of the 
option, it shall be given no value; and
    (iv) The value attributed to any unlisted security option shall be 
the difference between the option's exercise value or striking value and 
the market value of the underlying security. In the case of an unlisted 
call, if the market value of the underlying security is less than the 
exercise value or striking value of such call, it shall be given no 
value; and, in the case of an unlisted put, if the market value of the 
underlying security is more than the exercise value or striking value of 
the unlisted put, it shall be given no value.
    (2) The term current assets means cash and other assets or resources 
commonly identified as those which are reasonably expected to be 
realized in cash or sold during the next 12 months. ``Current assets'' 
shall:
    (i) Exclude any unsecured commodity futures or option account 
containing a ledger balance and open trades, the combination of which 
liquidates to a deficit or containing a debit ledger balance only: 
Provided, however, Deficits or debit ledger balances in unsecured 
customers', non-customers', and proprietary accounts, which are the 
subject of calls for margin or other required deposits may be included 
in current assets until the close of business on the business day 
following the date on which such deficit or debit ledger balance 
originated providing that the account had timely satisfied, through the 
deposit of new funds, the previous day's debit or deficits, if any, in 
its entirety.
    (ii) Exclude all unsecured receivables, advances and loans except 
for:
    (A) Receivables resulting from the marketing of inventories commonly 
associated with the business activities of the applicant or registrant 
and advances on fixed price purchases commitments: Provided, Such 
receivables or advances are outstanding no longer than 3 calendar months 
from the date that they are accrued;
    (B) Interest receivable, floor brokerage receivable, commissions 
receivable from other brokers or dealers (other than syndicate profits), 
mutual fund concessions receivable and management fees receivable from 
registered investment companies and commodity pools: Provided, Such 
receivables are outstanding no longer than thirty (30) days from the 
date they are due; and dividends receivable outstanding no longer than 
thirty (30) days from the payable date;
    (C) Receivables from clearing organizations and securities clearing 
organizations;
    (D) Receivables from registered futures commission merchants or 
brokers, resulting from commodity futures or option transactions, except 
those specifically excluded under paragraph (c)(2)(i) of this section;
    (E) Insurance claims which arise from a reportable segment of the 
applicant's or registrant's overall business activities, as defined in 
generally accepted accounting principles, other than in the commodity 
futures, commodity option, security and security option segments of the 
applicant's or registrant's business activities which

[[Page 43]]

are not outstanding more than 3 calendar months after the date they are 
recorded as a receivable;
    (F) All other insurance claims not subject to paragraph 
(c)(2)(ii)(E) of this section, which are not older than seven (7) 
business days from the date the loss giving rise to the claim is 
discovered; insurance claims which are not older than twenty (20) 
business days from the date the loss giving rise to the claim is 
discovered and which are covered by an option of outside counsel that 
the claim is valid and is covered by insurance policies presently in 
effect; insurance claims which are older than twenty (20) business days 
from the date the loss giving rise to the claim is discovered and which 
are covered by an opinion of outside counsel that the claim is valid and 
is covered by insurance policies presently in effect and which have been 
acknowledged in writing by the insurance carrier as due and payable: 
Provided, Such claims are not outstanding longer than twenty (20) 
business days from the date they are so acknowledged by the carrier;
    (iii) Exclude all prepaid expenses and deferred charges;
    (iv) Exclude all inventories except for:
    (A) Readily marketable spot commodities; or spot commodities which 
``adequately collateralize'' indebtedness under paragraph (c)(7) of this 
section;
    (B) Securities which are considered ``readily marketable'' (as 
defined in Sec. 240.15c3-1(c)(11) of this title) or which ``adequately 
collateralize'' indebtedness under paragraph (c)(7) of this section;
    (C) Work in process and finished goods which result from the 
processing of commodities at market value;
    (D) Raw materials at market value which will be combined with spot 
commodities to produce a finished proc- essed commodity; and
    (E) Inventories held for resale commonly associated with the 
business activities of the applicant or registrant;
    (v) Include fixed assets and assets which otherwise would be 
considered noncurrent to the extent of any long-term debt adequately 
collateralized by assets acquired for use in the ordinary course of the 
trade or business of an applicant or registrant and any other long-term 
debt adequately collateralized by assets of the applicant or registrant 
if the sole recourse of the creditor for nonpayment of such liability is 
to such asset: Provided, Such liabilities are not excluded from 
liabilities in the computation of net capital under paragraph (c)(4)(vi) 
of this section;
    (vi) Exclude all assets doubtful of collection or realization less 
any reserves established therefor;
    (vii) Include, in the case of future income tax benefits arising as 
a result of unrealized losses, the amount of such benefits not exceeding 
the amount of income tax liabilities accrued on the books and records of 
the applicant or registrant, but only to the extent such benefits could 
have been applied to reduce accrued tax liabilities on the date of the 
capital computation, had the related unrealized losses been realized on 
that date;
    (viii) Include guaranteee deposits with clearing organizations and 
stock in clearing organizations to the extent of its margin value;
    (ix) In the case of an introducing broker or an applicant for 
registration as an introducing broker, include 50 percent of the value 
of a guarantee or security deposit with a futures commission merchant 
which carries or intends to carry accounts for the customers of the 
introducing broker; and
    (x) Exclude exchange memberships.
    (3) A loan or advance or any other form of receivable shall not be 
considered ``secured'' for the purposes of paragraph (c)(2) of this 
section unless the following conditions exist:
    (i) The receivable is secured by readily marketable collateral which 
is otherwise unencumbered and which can be readily converted into cash: 
Provided, however, That the receivable will be considered secured only 
to the extent of the market value of such collateral after application 
of the percentage deductions specified in paragraph (c)(5) of this 
section; and
    (ii)(A) The readily marketable collateral is in the possession or 
control of the applicant or registrant; or
    (B) The applicant or registrant has a legally enforceable, written 
security agreement, signed by the debtor, and

[[Page 44]]

has a perfected security interest in the readily marketable collateral 
within the meaning of the laws of the State in which the readily 
marketable collateral is located.
    (4) The term liabilities means the total money liabilities of an 
applicant or registrant arising in connection with any transaction 
whatsoever, including economic obligations of an applicant or registrant 
that are recognized and measured in conformity with generally accepted 
accounting principles. ``Liabilities'' also include certain deferred 
credits that are not obligations but that are recognized and measured in 
conformity with generally accepted accounting principles. For the 
purposes of computing ``net capital'', the term ``liabilities'':
    (i) Excludes liabilities of an applicant or registrant which are 
subordi- nated to the claims of all general creditors of the applicant 
or registrant pursuant to a satisfactory subordination agreement, as 
defined in paragraph (h) of this section;
    (ii) Excludes, in the case of a futures commission merchant, the 
amount of money, securities and property due to commodity futures or 
option customers which is held in segregated accounts in compliance with 
the requirements of the Act and these regulations: Provided, however, 
That such exclusion may be taken only if such money, securities and 
property held in segregated accounts have been excluded from current 
assets in computing net capital;
    (iii) Includes, in the case of an applicant or registrant who is a 
sole proprietor, the excess of liabilities which have not been incurred 
in the course of business as a futures commission merchant or as an 
introducing broker over assets not used in the business;
    (iv) Excludes the lesser of any deferred income tax liability 
related to the items in paragraphs (c)(4)(i) (A), (B), and (C) below, or 
the sum of paragraphs (c)(4)(i) (A), (B), and (C) below:
    (A) The aggregate amount resulting from applying to the amount of 
the deductions computed in accordance with paragraph (c)(5) of this 
section the appropriate Federal and State tax rate(s) applicable to any 
unrealized gain on the asset on which the deduction was computed;
    (B) Any deferred tax liability related to income accrued which is 
directly related to an asset otherwise deducted pursuant to this 
section;
    (C) Any deferred tax liability related to unrealized appreciation in 
value of any asset(s) which has been otherwise excluded from current 
assets in accordance with the provisions of this section;
    (v) Excludes any current tax liability related to income accrued 
which is directly related to an asset otherwise deducted pursuant to 
this section; and
    (vi) Excludes liabilities which would be classified as long term in 
accordance with generally accepted accounting principles to the extent 
of the net book value of plant, property and equipment which is used in 
the ordinary course of any trade or business of the applicant or 
registrant which is a reportable segment of the applicant's or 
registrant's overall business activities, as defined in generally 
accepted accounting principles, other than in the commodity futures, 
commodity option, security and security option segments of the 
applicant's or registrant's business activities: Provided, That such 
plant, property and equipment is not included in current assets pursuant 
to paragraph (c)(2)(v) of this section.
    (5) The term adjusted net capital means net capital less:
    (i) The amount by which any advances paid by the applicant or 
registrant on cash commodity contracts and used in computing net capital 
exceeds 95 percent of the market value of the commodities covered by 
such contracts;
    (ii) In the case of all inventory, fixed price commitments and 
forward contracts, except for inventory and forward contracts in those 
foreign currencies which are purchased or sold for future delivery on or 
subject to the rules of a contract market and covered by an open futures 
contract for which there will be no charge, the applicable percentage of 
the net position specified below:
    (A) Inventory which is currently registered as deliverable on a 
contract market and covered by an open futures contract or by a 
commodity option on a physical.--No charge.

[[Page 45]]

    (B) Inventory which is covered by an open futures contract or 
commodity option.--5 percent of the market value.
    (C) Inventory which is not covered.--20 percent of the market value.
    (D) Fixed price commitments (open purchases and sales) and forward 
contracts which are covered by an open futures contract or commodity 
option.--10 percent of the market value.
    (E) Fixed price commitments (open purchases and sales) and forward 
contracts which are not covered by an open futures contract or commodity 
option.--20 percent of the market value.
    (iii)-(iv) [Reserved]
    (v) In the case of securities and obligations used by the applicant 
or registrant in computing net capital, and in the case of a futures 
commission merchant with securities in segregation pursuant to section 
4d(2) of the Act and the regulations in this chapter which were not 
deposited by customers, the percentages specified in Rule 240.15c3-
1(c)(2)(vi) of the Securities and Exchange Commission (17 CFR 240.15c3-
1(c)(2)(vi)) (``securities haircuts'') and 100 percent of the value of 
``nonmarketable securities'' as specified in Rule 240.15c3-1(c)(2)(vii) 
of the Securities and Exchange Commission (17 CFR 240.15c3-
1(c)(2)(vii));
    (vi) In the case of securities options and/or other options for 
which a haircut has been specified for the option or for the underlying 
instrument in Sec. 240.15c3-1 appendix A of this title, the treatment 
specified in, or under, Sec. 240.15c3-1 appendix A, after effecting 
certain adjustments to net capital for listed and unlisted options as 
set forth in such appendix;
    (vii) In the case of an applicant or registrant who has open 
contractual commitments, as hereinafter defined, the deductions 
specified in Sec. 240.15c3-1(c)(2)(viii) of this title;
    (viii) In the case of a futures commission merchant, for 
undermargined customer commodity futures accounts and commodity option 
customer accounts the amount of funds required in each such account to 
meet maintenance margin requirements of the applicable board of trade or 
if there are no such maintenance margin requirements, clearing 
organization margin requirements applicable to such positions, after 
application of calls for margin or other required deposits which are 
outstanding three business days or less. If there are no such 
maintenance margin requirements or clearing organization margin 
requirements, then the amount of funds required to provide margin equal 
to the amount necessary after application of calls for margin or other 
required deposits outstanding three business days or less to restore 
original margin when the original margin has been depleted by 50 percent 
or more: Provided, To the extent a deficit is excluded from current 
assets in accordance with paragraph (c)(2)(i) of this section such 
amount shall not also be deducted under this paragraph (c)(5)(viii). In 
the event that an owner of a customer account has deposited an asset 
other than cash to margin, guarantee or secure his account, the value 
attributable to such asset for purposes of this subparagraph shall be 
the lesser of (A) the value attributable to the asset pursuant to the 
margin rules of the applicable board of trade, or (B) the market value 
of the asset after application of the percentage deductions specified in 
this paragraph (c)(5);
    (ix) In the case of a futures commission merchant, for undermargined 
commodity futures and commodity option noncustomer and omnibus accounts 
the amount of funds required in each such account to meet maintenance 
margin requirements of the applicable board of trade or if there are no 
such maintenance margin requirements, clearing organization margin 
requirements applicable to such positions, after application of calls 
for margin or other required deposits which are outstanding two business 
days or less. If there are no such maintenance margin requirements or 
clearing organization margin requirements, then the amount of funds 
required to provide margin equal to the amount necessary after 
application of calls for margin or other required deposits outstanding 
two business days or less to restore original margin when the original 
margin has been depleted by 50 percent or more: Provided, To the extent 
a deficit is excluded from current assets in accordance with paragraph 
(c)(2)(i) of this section such amount shall not also be

[[Page 46]]

deducted under this paragraph (c)(5)(ix). In the event that an owner of 
a noncustomer or omnibus account has deposited an asset other than cash 
to margin, guarantee or secure his account the value attributable to 
such asset for purposes of this subparagraph shall be the lesser of (A) 
the value attributable to such asset pursuant to the margin rules of the 
applicable board of trade, or (B) the market value of such asset after 
application of the percentage deductions specified in this paragraph 
(c)(5);
    (x) In the case of open futures contracts and granted (sold) 
commodity options held in proprietary accounts carried by the applicant 
or registrant which are not covered by a position held by the applicant 
or registrant or which are not the result of a ``changer trade'' made in 
accordance with the rules of a contract market:
    (A) For an applicant or registrant which is a clearing member of a 
clearing organization for the positions cleared by such member, the 
applicable margin requirement of the applicable clearing organization;
    (B) For an applicant or registrant which is a member of a self-
regulatory organization 150 percent of the applicable maintenance margin 
requirement of the applicable board of trade, or clearing organization, 
whichever is greater;
    (C) For all other applicants or registrants, 200 percent of the 
applicable maintenance margin requirements of the applicable board of 
trade or clearing organization, whichever is greater; or
    (D) For open contracts or granted (sold) commodity options for which 
there are no applicable maintenance margin requirements, 200 percent of 
the applicable initial margin requirement: Provided, The equity in any 
such proprietary account shall reduce the deduction required by this 
paragraph (c)(5)(x) if such equity is not otherwise includable in 
adjusted net capital;
    (xi) In the case of an applicant or registrant which is a purchaser 
of a commodity option not traded on a contract market which has value 
and such value is used to increase adjusted net capital, ten percent of 
the market value of the physical or futures contract which is the 
subject of such option but in no event more than the value attributed to 
such option;
    (xii) In the case of an applicant or registrant which is a purchaser 
of a commodity option which is traded on a contract market the same 
safety factor as if the applicant or registrant were the grantor of such 
option in accordance with paragraph (c)(5)(x) of this section, but in no 
event shall the safety factor be greater than the market value 
attributed to such option;
    (xiii) Five percent of all unsecured receivables includable under 
paragraph (c)(2)(ii)(D) of this section used by the applicant or 
registrant in computing ``net capital'' and which are not due from:
    (A) A registered futures commission merchant;
    (B) A broker or dealer that is registered as such with the 
Securities and Exchange Commission; or
    (C) A foreign broker that has been granted comparability relief 
pursuant to Sec. 30.10 of this chapter, Provided, however, that the 
amount of the unsecured receivable not subject to the five percent 
capital charge is no greater than 150 percent of the current amount 
required to maintain futures and option positions in accounts with the 
foreign broker, or 100 percent of such greater amount required to 
maintain futures and option positions in the accounts at any time during 
the previous six-month period, and Provided, that, in the case of 
customer funds, such account is treated in accordance with the special 
requirements of the applicable Commission order issued under Sec. 30.10 
of this chapter.
    (xiv) For securities brokers and dealers, all other deductions 
specified in Sec. 240.15c3-1 of this title.
    (6) [Reserved]
    (7) Liabilities are ``adequately collateralized'' when, pursuant to 
a legally enforceable written instrument, such liabilities are secured 
by identified assets that are otherwise unencumbered and the market 
value of which exceeds the amount of such liabilities.
    (8) The term contractual commitments shall include underwriting, 
when issued, when distributed, and delayed delivery contracts; and the 
writing or

[[Page 47]]

endorsement of security puts and calls and combinations thereof; but 
shall not include uncleared regular way purchases and sales of 
securities. A series of contracts of purchase or sale of the same 
security, conditioned, if at all, only upon issuance, may be treated as 
an individual commitment.
    (d) Each applicant or registrant shall have equity capital 
(inclusive of satisfactory subordination agreements which qualify under 
this paragraph (d) as equity capital) of not less than 30 percent of the 
debt-equity total, provided, an applicant or registrant may be exempted 
from the provisions of this paragraph (d) for a period not to exceed 90 
days or for such longer period which the Commission may, upon 
application of the applicant or registrant, grant in the public interest 
or for the protection of investors. For the purposes of this paragraph 
(d):
    (1) Equity capital means a satisfactory subordination agreement 
entered into by a partner or stockholder which has an initial term of at 
least 3 years and has a remaining term of not less than 12 months if:
    (i) It does not have any of the provisions for accelerated maturity 
provided for by paragraphs (h)(2) (ix)(A), (x)(A), or (x)(B) of this 
section, or the provisions allowing for special prepayment provided for 
by paragraph (h)(2)(vii)(B) of this section, and is maintained as 
capital subject to the provisions restricting the withdrawal thereof 
required by paragraph (e) of this section; or
    (ii) The partnership agreement provides that capital contributed 
pursuant to a satisfactory subordination agreement as defined in 
paragraph (h) of this section shall in all respects be partnership 
capital subject to the provisions restricting the withdrawal thereof 
required by paragraph (e) of this section, and
    (A) In the case of a corporation, the sum of its par or stated value 
of capital stock, paid in capital in excess of par, retained earnings, 
unrealized profit and loss, and other capital accounts.
    (B) In the case of a partnership, the sum of its capital accounts of 
partners (inclusive of such partners' commodities, options and 
securities accounts subject to the provisions of paragraph (e) of this 
section), and unrealized profit and loss.
    (C) In the case of a sole proprietorship, the sum of its capital 
accounts of the sole proprietorship and unrealized profit and loss.
    (2) Debt-equity total means equity capital as defined in paragraph 
(d)(1) of this section plus the outstanding principal amount of 
satisfactory subordination agreements.
    (e) No equity capital of the applicant or registrant or a 
subsidiary's or affiliate's equity capital consolidated pursuant to 
paragraph (f) of this section, whether in the form of capital 
contributions by partners (including amounts in the commodities, options 
and securities trading accounts of partners which are treated as equity 
capital but excluding amounts in such trading accounts which are not 
equity capital and excluding balances in limited partners' capital 
accounts in excess of their stated capital contributions), par or stated 
value of capital stock, paid-in capital in excess of par or stated 
value, retained earnings or other capital accounts, may be withdrawn by 
action of a stockholder or partner or by redemption or repurchase of 
shares of stock by any of the consolidated entities or through the 
payment of dividends or any similar distribution, nor may any unsecured 
advance or loan be made to a stockholder, partner, sole proprietor, or 
employee if, after giving effect thereto and to any other such 
withdrawals, advances, or loans and any payments of payment obligations 
(as defined in paragraph (h) of this section) under satisfactory 
subordination agreements and any payments of liabilities excluded 
pursuant to paragraph (c)(4)(vi) of this section which are scheduled to 
occur within six months following such withdrawal, advance or loan:
    (1) Either adjusted net capital of any of the consolidated entities 
would be less than the greatest of:
    (i) 120 percent of the appropriate minimum dollar amount required by 
paragraphs (a)(1)(i)(A) or (a)(1)(ii)(A) of this section;
    (ii) For a futures commission merchant or applicant therefor, 6 
percent of the following amount: The customer

[[Page 48]]

funds required to be segregated pursuant to the Act and the regulations 
in this part, plus the funds of opt-out customers that, but for the 
election to opt out pursuant to Sec. 1.68, would be required to be 
segregated, plus the foreign futures or foreign options secured amount, 
less the market value of commodity options purchased by customers on or 
subject to the rules of a contract market or a foreign board of trade 
for which the full premiums have been paid: Provided, however, That the 
deduction for each customer shall be limited to the amount of customer 
funds in such customer's account(s) and foreign futures and foreign 
options secured amounts;
    (iii) 120 percent of the amount of adjusted net capital required by 
a registered futures association of which it is a member; or
    (iv) For an applicant or registrant which is also a securities 
broker or dealer, the amount of net capital specified in Rule 15c3-1(e) 
of the Securities and Exchange Commission (17 CFR 240.15c3-1(e)); or
    (2) In the case of any applicant or registrant included within such 
consolidation, if equity capital of the applicant or registrant 
(inclusive of satisfactory subordination agreements which qualify as 
equity under paragraph (d) of this section) would be less than 30 
percent of the required debt-equity total as defined in paragraph (d) of 
this section.

Provided, That this paragraph (e) shall not preclude an applicant or 
registrant from making required tax payments or preclude the payment to 
partners of reasonable compensation. The Commission may, upon 
application of the applicant or registrant, grant relief from this 
paragraph (e) if the Commission deems it to be in the public interest or 
for the protection of nonproprietary accounts.
    (f)(1) Every applicant or registrant, in computing its net capital 
pursuant to this section must, subject to the provisions of paragraphs 
(f)(2) and (f)(4) of this section, consolidate in a single computation, 
assets and liabilities of any subsidiary or affiliate for which it 
guarantees, endorses, or assumes directly or indirectly the obligations 
or liabilities. The assets and liabilities of a subsidiary or affiliate 
whose liabilities and obligations have not been guaranteed, endorsed, or 
assumed directly or indirectly by the applicant or registrant may also 
be so consolidated if an opinion of counsel is obtained as provided for 
in paragraph (f)(2) of this section.
    (2)(i) If the consolidation, provided for in paragraph (f)(1) of 
this section, of any such subsidiary or affiliate results in the 
increase of the applicant's or registrant's adjusted net capital or 
decreases the minimum adjusted net capital requirement, and an opinion 
of counsel called for in paragraph (f)(2)(ii) of this section has not 
been obtained, such benefits shall not be recognized in the applicant's 
or registrant's computation required by this section.
    (ii) Except as provided for in paragraph (f)(2)(i) of this section, 
consolidation shall be permitted with respect to any subsidiaries or 
affiliates which are majority owned and controlled by the applicant or 
registrant, and for which the applicant can demonstrate to the 
satisfaction of the National Futures Association, or for which the 
registrant can demonstrate to the satisfaction of the Commission and the 
designated self-regulatory organization, if any, by an opinion of 
counsel, that the net asset values or the portion thereof related to the 
parent's ownership interest in the subsidiary or affiliate, may be 
caused by the applicant or registrant or an appointed trustee to be 
distributed to the applicant or registrant within 30 calendar days. Such 
opinion must also set forth the actions necessary to cause such a 
distribution to be made, identify the parties having the authority to 
take such actions, identify and describe the rights of other parties or 
classes of parties, including but not limited to customers, general 
creditors, subordinated lenders, minority shareholders, employees, 
litigants, and governmental or regulatory authorities, who may delay or 
prevent such a distribution and such other assurances as the National 
Futures Association, the Commission or the designated self-regulatory 
organization by rule or interpretation may require. Such opinion must be 
current and periodically renewed in connection with the applicant's or 
registrant's annual

[[Page 49]]

audit pursuant to Sec. 1.10 or upon any material change in 
circumstances.
    (3) In preparing a consolidated computation of adjusted net capital 
pursuant to this section, the following minimum and non-exclusive 
requirements shall be observed;
    (i) Consolidated adjusted net capital shall be reduced by the 
estimated amount of any tax reasonably anticipated to be incurred upon 
distribution of the assets of the subsidiary or affiliate.
    (ii) Liabilities of a consolidated subsidiary or affiliate which are 
subordinated to the claims of present and future creditors pursuant to a 
satisfactory subordination agreement shall be deducted from consolidated 
adjusted net capital unless such subordination extends also to the 
claims of present or future creditors of the parent applicant or 
registrant and all consolidated subsidiaries.
    (iii) Subordinated liabilities of a consolidated subsidiary or 
affiliate which are consolidated in accordance with paragraph (f)(3)(ii) 
of this section may not be prepaid, repaid, or accelerated if any of the 
entities included in such consolidation would otherwise be unable to 
comply with the provisions of paragraph (h) of this section.
    (iv) Each applicant or registrant included within the consolidation 
shall at all times be in compliance with the adjusted net capital 
requirement to which it is subject.
    (4) No applicant or registrant shall guarantee, endorse, or assume 
directly or indirectly any obligation or liability of a subsidiary or 
affiliate unless the obligation or liability is reflected in the 
computation of adjusted net capital pursuant to this section except as 
provided in paragraph (f)(2)(i) of this section.
    (g) [Reserved]
    (h) The term satisfactory subordination agreement (``subordination 
agreement'') means an agreement which contains the minimum and 
nonexclusive requirements set forth below.
    (1) Certain definitions for purposes of this section:
    (i) A subordination agreement may be either a subordinated loan 
agreement or a secured demand note agreement.
    (ii) The term subordinated loan agreement means the agreement or 
agreements evidencing or governing a subordinated borrowing of cash.
    (iii) The term ``collateral value'' of any securities pledged to 
secure a secured demand note means the market value of such securities 
after giving effect to the percentage deductions specified in Rule 
240.15c3-1d(a)(2)(iii) of the Securities and Exchange Commission (17 CFR 
240.15c3-1d(a)(2)(iii)).
    (iv) The term payment obligation means the obligation of an 
applicant or registrant in respect to any subordination agreement:
    (A) To repay cash loaned to the applicant or registrant pursuant to 
a subordinated loan agreement; or
    (B) To return a secured demand note contributed to the applicant or 
registrant or to reduce the unpaid principal amount thereof and to 
return cash or securities pledged as collateral to secure the secured 
demand note; and (C) ``payment'' shall mean the performance by an 
applicant or registrant of a payment obligation.
    (v)(A) The term secured demand note agreement means an agreement 
(including the related secured demand note) evidencing or governing the 
contribution of a secured demand note to an applicant or registrant and 
the pledge of securities and/or cash with the applicant or registrant as 
collateral to secure payment of such secured demand note. The secured 
demand note agreement may provide that neither the lender, his heirs, 
executors, administrators, or assigns shall be personally liable on such 
note and that in the event of default the applicant or registrant shall 
look for payment of such note solely to the collateral then pledged to 
secure the same.
    (B) The secured demand note shall be a promissory note executed by 
the lender and shall be payable on the demand of the applicant or 
registrant to which it is contributed: Provided, however, That the 
making of such demand may be conditioned upon the occurrence of any of 
certain events which are acceptable to the designated self-regultory 
organization and the Commission.
    (C) If such note is not paid upon presentment and demand as provided 
for

[[Page 50]]

therein, the applicant or registrant shall have the right to liquidate 
all or any part of the securities then pledged as collateral to secure 
payment of the same and to apply the net proceeds of such liquidation, 
together with any cash then included in the collateral, in payment of 
such note. Subject to the prior rights of the applicant or registrant as 
pledgee, the lender, as defined in paragraph (h)(i)(v)(F) of this 
section may retain ownership of the collateral and have the benefit of 
any increases and bear the risks fo any decreases in the value of the 
collateral and may retain the right to vote securities contained within 
the collateral and any right to income therefrom or distributions 
thereon, except the applicant or registrant shall have the right to 
receive and hold as pledgee all dividends payable in securities and all 
partial and complete liquidating dividends.
    (D) Subject to the prior rights of the applicant or registrant as 
pledgee, the lender may have the right to direct the sale of any 
securities included in the collateral, to direct the purchase of 
securities with any cash included therein, to withdraw excess collateral 
or to substitute cash or other securities as collateral: Provided, That 
the net proceeds of any such sale and the cash so substituted and the 
securities so purchased or substituted are held by the applicant or 
registrant as pledgee, and are included within the collateral to secure 
payment of the secured demand note: And provided further, That no such 
transaction shall be permitted, if, after giving effect therto, the sum 
of the amount of any cash, plus the collateral value of the securities, 
then pledged as collateral to secure the secured demand note would be 
less than the unpaid principal amount of the secured demand note.
    (E) Upon payment by the lender, as distinguished from a reduction by 
the lender which is provided for in paragraph (h)(2)(vi)(C) of this 
section or reduction by the applicant or registrant as provided for in 
paragraph (h)(2)(vii) of this section, of all or any part of the unpaid 
principal amount of the secured demand note, the applicant or registrant 
shall issue to the lender a subordinated loan agreement in the amout of 
such payment (or in the case of an pplicant or registrant that is a 
partnership, credit a capital account of the lender), or issue preferred 
or common stock of the applicant or registrant in the amount of such 
payment, or any combination of the foregoing, as provided for in the 
secured demand note agreement.
    (F) The term lender means the person who lends cash to an applicant 
or registrant pursuant to a subordinated loan agreement and the person 
who contributes a secured demand note to an applicant or registrant 
pursuant to a secured demand note agreement.
    (2) Minimum requirements for subordination agreements:
    (i) Subject to paragraph (h)(1) of this section, a subordination 
agreement shall mean a written agreement between the applicant or 
registrant and the lender, which:
    (A) Has a minimum term of 1 year, except for temporary subordination 
agreements provided for in paragraph (h)(3)(v) of this section, and
    (B) Is a valid and binding obligation enforceable in accordance with 
its terms (subject as to enforcement to applicable bankruptcy, 
insolvency, reorganization, moratorium, and other similar laws) against 
the applicant or registrant and the lender and their respective heirs, 
executors, administrators, successors, and assigns.
    (ii) Specific amount. All subordination agreements shall be for a 
specific dollar amount which shall not be reduced for the duration of 
the agreement except by installments as specifically provided for 
therein and except as otherwise provided in this paragraph (h)(2) of 
this section.
    (iii) Effective subordination. The subordination agreement shall 
effectively subordinate any right of the lender to receive any payment 
with respect thereto, together with accrued interest or compensation, to 
the prior payment or provision for payment in full of all claims of all 
present and future creditors of the applicant or registrant arising out 
of any matter occurring prior to the date on which the related payment 
obligation matures, except for claims which are the subject of 
subordination agreements which rank on the same priority as or junior to 
the claim

[[Page 51]]

of the lender under such subordination agreements.
    (iv) Proceeds of subordinated loan agreements. The subordinated loan 
agreement shall provide that the cash proceeds thereof shall be used and 
dealt with by the applicant or registrant as part of its capital and 
shall be subject to the risks of the business.
    (v) Certain rights of the borrower. The subordination agreement 
shall provide that the applicant or registrant shall have the right to:
    (A) Deposit any cash proceeds of a subordinated loan agreement and 
any cash pledged as collateral to secure a secured demand note in an 
account or accounts in its own name in any bank or trust company;
    (B) Pledge, repledge, hypothecate and rehypothecate, any or all of 
the securities pledged as collateral to secure a secured demand note, 
without notice, separately or in common with other securities or 
property for the purpose of securing any indebtedness of the applicant 
or registrant; and
    (C) Lend to itself or others any or all of the securities and cash 
pledged as collateral to secure a secured demand note.
    (vi) Collateral for secured demand notes. Only cash and securities 
which are fully paid for and which may be publicly offered or sold 
without registration under the Securities Act of 1933, and the offer, 
sale, and transfer of which are not otherwise restricted, may be pledged 
as collateral to secure a secured demand note. The secured demand note 
agreement shall provide that if at any time the sum of the amount of any 
cash, plus the collateral value of any securities, then pledged as 
collateral to secure the secured demand note is less than the unpaid 
principal amount of the secured demand note, the applicant or registrant 
must immediately transmit written notice to that effect to the lender. 
The secured demand note agreement shall also provide that if the 
borrower is an applicant, such notice must also be transmitted 
immediately to the National Futures Association, and if the borrower is 
a registrant, such notice must also be transmitted immediately to the 
designated self-regulatory organization, if any, and the Commission. The 
secured demand note agreement shall also require that following such 
transmittal:
    (A) The lender, prior to noon of the business day next succeeding 
the transmittal of such notice, may pledge as collateral additional cash 
or securities sufficient, after giving effect to such pledge, to bring 
the sum of the amount of any cash plus the collateral value of any 
securities, then pledged as collateral to secure the secured demand 
note, up to an amount not less than the unpaid principal amount of the 
secured demand note; and
    (B) Unless additional cash or securities are pledged by the lender 
as provided in paragraph (h)(2)(vi)(A) above, the applicant or 
registrant at noon on the business day next succeeding the transmittal 
of notice to the lender must commence sale, for the account of the 
lender, of such of the securities then pledged as collateral to secure 
the secured demand note and apply so much of the net proceeds thereof, 
together with such of the cash then pledged as collateral to secure the 
secured demand note as may be necessary to eliminate the unpaid 
principal amount of the secured demand note: Provided, however, That the 
unpaid principal amount of the secured demand note need not be reduced 
below the sum of the amount of any remaining cash, plus the collateral 
value of the remaining securities, then pledged as collateral to secure 
the secured demand note. The applicant or registrant may not purchase 
for its own account any securities subject to such a sale; and
    (C) The secured demand note agreement may also provide that, in lieu 
of the procedures specified in the provisions required by paragraph 
(h)(2)(vi)(B) of this section, the lender, with the prior written 
consent of the applicant and the National Futures Association, or with 
the prior written consent of the registrant and the designated self-
regulatory organization or, if the registrant is not a member of a 
designated self-regulatory organization, the Commission, may reduce the 
unpaid principal amount of the secured demand note: Provided, That after 
giving effect to such reduction the adjusted net capital of the 
applicant or

[[Page 52]]

registrant would not be less than the greatest of:
    (1) 120 percent of the appropriate minimum dollar amount required by 
paragraphs (a)(1)(i)(A) or (a)(1)(ii)(A) of this section;
    (2) For a futures commission merchant or applicant therefor, 7 
percent of the following amount: The customer funds required to be 
segregated pursuant to the Act and the regulations in this part, plus 
the funds of opt-out customers that, but for the election to opt out 
pursuant to Sec. 1.68, would be required to be segregated, plus the 
foreign futures or foreign options secured amount, less the market value 
of commodity options purchased by customers on or subject to the rules 
of a contract market or a foreign board of trade for which the full 
premiums have been paid: Provided, however, That the deduction for each 
customer shall be limited to the amount of customer funds in such 
customer's account(s) and foreign futures and foreign options secured 
amounts;
    (3) 120 percent of the amount of adjusted net capital required by a 
registered futures association of which it is a member; or
    (4) For an applicant or registrant which is also a securities broker 
or dealer, the amount of net capital specified in Rule 15c3-
1d(b)(6)(iii) of the Securities and Exchange Commission (17 CFR 
240.15c3-1d(b)(6)(iii)): Provided, further, That no single secured 
demand note shall be permitted to be reduced by more than 15 percent of 
its original principal amount and after such reduction no excess 
collateral may be withdrawn.
    (vii) Permissive prepayments and special prepayments. (A) An 
applicant or registrant at its option, but not at the option of the 
lender, may, if the subordination agreement so provides, make a payment 
of all or any portion of the payment obligation thereunder prior to the 
scheduled maturity date of such payment obligation (hereinafter referred 
to as a ``prepayment''), but in no event may any prepayment be made 
before the expiration of one year from the date such subordination 
agreement became effective: Provided, however, That the foregoing 
restriction shall not apply to temporary subordination agreements which 
comply with the provisions of paragraph (h)(3)(v) of this section nor 
shall it apply to ``special prepayments'' made in accordance with the 
provisions of paragraph (h)(2)(vii)(B) of this section. No prepayment 
shall be made if, after giving effect thereto (and to all payments of 
payment obligations under any other subordination agreements then 
outstanding, the maturity or accelerated maturities of which are 
scheduled to fall due within six months after the date such prepayment 
is to occur pursuant to this provision, or on or prior to the date on 
which the payment obligation in respect to such prepayment is scheduled 
to mature disregarding this provision, whichever date is earlier) 
without reference to any projected profit or loss of the applicant or 
registrant, the adjusted net capital of the applicant or registrant is 
less than the greatest of:
    (1) 120 percent of the appropriate minimum dollar amount required by 
paragraphs (a)(1)(i)(A) or (a)(1)(ii)(A) of this section;
    (2) For a futures commission merchant or applicant therefor, 7 
percent of the following amount: The customer funds required to be 
segregated pursuant to the Act and the regulations in this part, plus 
the funds of opt-out customers that, but for the election to opt out 
pursuant to Sec. 1.68, would be required to be segregated, plus the 
foreign futures or foreign options secured amount, less the market value 
of commodity options purchased by customers on or subject to the rules 
of a contract market or a foreign board of trade for which the full 
premiums have been paid: Provided, however, That the deduction for each 
customer shall be limited to the amount of customer funds in such 
customer's account(s) and foreign futures and foreign options secured 
amounts;
    (3) 120 percent of the amount of adjusted net capital required by a 
registered futures association of which it is a member; or
    (4) For an applicant or registrant which is also a securities broker 
or dealer, the amount of net capital specified in Rule 15c3-1d(b)(7) of 
the Securities and Exchange Commission (17 CFR 240.15c3-1d(b)(7)).

[[Page 53]]

    (B) An applicant or registrant at its option, but not at the option 
of the lender, may, if the subordination agreement so provides, make a 
payment at any time of all or any portion of the payment obligation 
thereunder prior to the scheduled maturity date of such payment 
obligation (hereinafter referred to as a ``special prepayment''). No 
special prepayment shall be made if, after giving effect thereto (and to 
all payments of payment obligations under any other subordination 
agreements then outstanding, the maturity or accelerated maturities of 
which are scheduled to fall due within six months after the date such 
special prepayment is to occur pursuant to this provision, or on or 
prior to the date on which the payment obligation in respect to such 
special prepayment is scheduled to mature disregarding this provision, 
whichever date is earlier) without reference to any projected profit or 
loss of the applicant or registrant, the adjusted net capital of the 
applicant or registrant is less than the greatest of:
    (1) 200 percent of the appropriate minimum dollar amount required by 
paragraphs (a)(1)(i)(A) or (a)(1)(ii)(A) of this section;
    (2) For a futures commission merchant or applicant therefor, 10 
percent of the following amount: The customer funds required to be 
segregated pursuant to the Act and the regulations in this part, plus 
the funds of opt-out customers that, but for the election to opt out 
pursuant to Sec. 1.68, would be required to be segregated, plus the 
foreign futures or foreign options secured amount, less the market value 
of commodity options purchased by customers on or subject to the rules 
of a contract market or a foreign board of trade for which the full 
premiums have been paid: Provided, however, That the deduction for each 
customer shall be limited to the amount of customer funds in such 
customer's account(s) and foreign futures and foreign options secured 
amounts;
    (3) 120 percent of the amount of adjusted net capital required by a 
registered futures association of which it is a member; or
    (4) For an applicant or registrant which is also a securities broker 
or dealer, the amount of net capital specified in Rule 15c3-1d(c)(5)(ii) 
of the Securities and Exchange Commission (17 CFR 240.15c3-
1d(c)(5)(ii)): Provided, however, That no special prepayment shall be 
made if pre-tax losses during the latest three-month period were greater 
than 15 percent of current excess adjusted net capital.
    (C)(1) Notwithstanding the provisions of paragraphs (h)(2)(vii)(A) 
and (h)(2)(vii)(B) of this section, in the case of an applicant, no 
prepayment or special prepayment shall occur without the prior written 
approval of the National Futures Association; in the case of a 
registrant, no prepayment or special prepayment shall occur without the 
prior written approval of the designated self-regulatory organization, 
if any, or of the Commission if the registrant is not a member of a 
self-regulatory organization.
    (2) A registrant may make a prepayment or special prepayment without 
the prior written approval of the designated self-regulatory 
organization: Provided, That the registrant: Is a securities broker or 
dealer registered with the Securities and Exchange Commission; files a 
request to make a prepayment or special prepayment with its applicable 
securities designated examining authority, as defined in Rule 15c3-
1(c)(12) of the Securities and Exchange Commission (17 CFR 240.15c3-
1(c)(12)), in the form and manner prescribed by the designated examining 
authority; files a copy of the prepayment request or special prepayment 
request with the designated self-regulatory organization at the time it 
files such request with the designated examining authority in the form 
and manner prescribed by the designated self-regulatory organization; 
and files a copy of the designated examining authority's approval of the 
prepayment or special prepayment with the designated self-regulatory 
organization immediately upon receipt of such approval. The approval of 
the prepayment or special prepayment by the designated examining 
authority will be deemed approval by the designated self-regulatory 
organization, unless the designated self-regulatory organization

[[Page 54]]

notifies the registrant that the designated examining authority's 
approval shall not constitute designated self-regulatory organization 
approval.
    (3) The designated self-regulatory organization shall immediately 
provide the Commission with a copy of any notice of approval issued 
where the requested prepayment or special prepayment will result in the 
reduction of the registrant's net capital by 20 percent or more or the 
registrant's excess adjusted net capital by 30 percent or more.
    (viii) Suspended repayment. (A) The payment obligation of the 
applicant or registrant in respect of any subordination agreement shall 
be suspended and shall not mature if, after giving effect to payment of 
such payment obligation (and to all payments of payment obligations of 
the applicant or registrant under any other subordination agreement(s) 
then outstanding which are scheduled to mature on or before such payment 
obligation), the adjusted net capital of the applicant or registrant 
would be less than the greatest of:
    (1) 120 percent of the appropriate minimum dollar amount required by 
paragraphs (a)(1)(i)(A) or (a)(1)(ii)(A) of this section;
    (2) For a futures commission merchant or applicant therefor, 6 
percent of the following amount: The customer funds required to be 
segregated pursuant to the Act and the regulations in this part, plus 
the funds of opt-out customers that, but for the election to opt out 
pursuant to Sec. 1.68, would be required to be segregated, plus the 
foreign futures or foreign options secured amount, less the market value 
of commodity options purchased by customers on or subject to the rules 
of a contract market or a foreign board of trade for which the full 
premiums have been paid: Provided, however, That the deduction for each 
customer shall be limited to the amount of customer funds in such 
customer's account(s) and foreign futures and foreign options secured 
amounts;
    (3) 120 percent of the amount of adjusted net capital required by a 
registered futures association of which it is a member; or
    (4) For an applicant or registrant which is also a securities broker 
or dealer, the amount of net capital specified in Rule 15c3-1d(b)(8)(i) 
of the Securities and Exchange Commission (17 CFR 240.15c3-1d(b)(8)(i)): 
Provided, That the subordination agreement may provide that if the 
payment obligation of the applicant or registrant thereunder does not 
mature and is suspended as a result of the requirement of this paragraph 
(h)(2)(viii) for a period of not less than six months, the applicant or 
registrant shall then commence the rapid and orderly liquidation of its 
business, but the right of the lender to receive payment, together with 
accrued interest or compensation, shall remain subordinate as required 
by the provisions of this section.
    (B) [Reserved]
    (ix) Accelerated maturity. Obligation to repay to remain 
subordinate:
    (A) Subject to the provisions of paragraph (h)(2)(viii) of this 
section, a subordination agreement may provide that the lender may, upon 
prior written notice to the applicant and the National Futures 
Association, or upon prior written notice to the registrant and the 
designated self-regulatory organization or, if the registrant is not a 
member of a designated self-regulatory organization, the Commission, 
given not earlier than six months after the effective date of such 
subordination agreement, accelerate the date on which the payment 
obligation of the borrower, together with accrued interest or 
compensation, is scheduled to mature to a date not earlier than six 
months after giving of such notice, but the right of the lender to 
receive payment, together with accrued interest or compensation, shall 
remain subordinate as required by the provisions of this paragraph 
(h)(2) of this section.
    (B) Notwithstanding the provisions of paragraph (h)(2)(viii) of this 
section, the payment obligation of the applicant or registrant with 
respect to a subordination agreement, together with accrued interest and 
compensation, shall mature in the event of any receivership, insolvency, 
liquidation pursuant to the Securities Investor Protection Act of 1970 
or otherwise, bankruptcy, assignment for the benefit of creditors, 
reorganization whether or not pursuant to the bankruptcy laws, or any 
other marshalling of the assets

[[Page 55]]

and liabilities of the applicant or registrant, but the right of the 
lender to receive payment, together with accrued interest or 
compensation, shall remain subordinate as required by the provisions of 
paragraph (h)(2) of this section.
    (x) Accelerated maturity of subordination agreements on event of 
default and event of acceleration. Obligation to repay to remain 
subordinate:
    (A) A subordination agreement may provide that the lender may, upon 
prior written notice to the applicant and the National Futures 
Association, or upon prior written notice to the registrant and the 
designated self-regulatory organization or, if the registrant is not a 
member of a designated self-regulatory organization, the Commission, of 
the occurrence of any event of acceleration (as hereinafter defined) 
given no sooner than six months after the effective date of such 
subordination agreement, accelerate the date on which the payment 
obligation of the applicant or registrant, together with accrued 
interest or compensation, is scheduled to mature, to the last business 
day of a calendar month which is not less than six months after notice 
of acceleration is received by the applicant and by the National Futures 
Association, or by the registrant and the designated self-regulatory 
organization or, if the registrant is not a member of a designated self-
regulatory organization, the Commission. Any subordination agreement 
containing such events of acceleration may also provide that, if upon 
such accelerated maturity date the payment obligation of the applicant 
or registrant is suspended as required by paragraph (h)(2)(viii) of this 
section and liquidation of the applicant or registrant has not commenced 
on or prior to such accelerated maturity date, notwithstanding paragraph 
(h)(2)(viii) of this section, the payment obligation of the applicant or 
registrant with respect to such subordination agreement shall mature on 
the day immediately following such accelerated maturity date and in any 
such event the payment obligations of the applicant or registrant with 
respect to all other subordination agreements then outstanding shall 
also mature at the same time but the rights of the respective lenders to 
receive payment, together with accrued interest or compensation, shall 
remain subordinate as required by the provisions of paragraph (h)(2) of 
this section. Events of acceleration which may be included in a 
subordination agreement complying with this paragraph (h)(2)(x) of this 
section shall be limited to:
    (1) Failure to pay interest or any installment of principal on a 
subordination agreement as scheduled;
    (2) Failure to pay when due other money obligations of a specified 
material amount;
    (3) Discovery that any material, specified representation or 
warranty of the applicant or registrant which is included in the 
subordination agreement and on which the subordination agreement was 
based or continued was inaccurate in a material respect at the time 
made;
    (4) Any specified and clearly measurable event which is included in 
the subordination agreement and which the lender and the applicant or 
registrant agree, (a) is a significant indication that the financial 
position of the applicant or registrant has changed materially and 
adversely from agreed upon specified norms; or (b) could materially and 
adversely affect the ability of the applicant or registrant to conduct 
its business as conducted on the date the subordination agreement was 
made; or (c) is a significant change in the senior management of the 
applicant or registrant or in the general business conducted by the 
applicant or registrant from that which obtained on the date the 
subordination agreement became effective;
    (5) Any continued failure to perform agreed covenants included in 
the subordination agreement relating to the conduct of the business of 
the applicant or registrant or relating to the maintenance and reporting 
of its financial position; and
    (B) Notwithstanding the provisions of paragraph (h)(2)(viii) of this 
section, a subordination agreement may provide that, if liquidation of 
the business of the applicant or registrant has not already commenced, 
the payment obligation of the applicant or registrant shall mature, 
together with accrued interest or compensation, upon the occurrence

[[Page 56]]

of an event of default (as hereinafter defined). Such agreement may also 
provide that, if liquidation of the business of the applicant or 
registrant has not already commenced, the rapid and orderly liquidation 
of the business of the applicant or registrant shall then commence upon 
the happening of an event of default. Any subordination agreement which 
so provides for maturity of the payment obligation upon the occurrence 
of an event of default shall also provide that the date on which such 
event of default occurs shall, if liquidation of the applicant or 
registrant has not already commenced, be the date on which the payment 
obligation of the applicant or registrant with respect to all other 
subordination agreements then outstanding shall mature but the rights of 
the respective lenders to receive payment, together with accrued 
interest or compensation, shall remain subordinate as required by the 
provisions of paragraph (h)(2) of this section. Events of default which 
may be included in a subordination agreement shall be limited to:
    (1) The making of an application by the Securities Investor 
Protection Corporation for a decree adjudicating that customers of the 
applicant or registrant are in need of protection under the Securities 
Investor Protection Act of 1970 and the failure of the applicant or 
registrant to obtain the dismissal of such application within 30 days;
    (2) Failure to meet the minimum capital requirements of the 
designated self-regulatory organization, or of the Commission, 
throughout a period of 15 consecutive business days, commencing on the 
day the borrower first determines and notifies the designated self-
regulatory organization, if any, of which he is a member and the 
Commission, in the case of a registrant, or the National Futures 
Association, in the case of an applicant, or commencing on the day any 
self-regulatory organization, the Commission or the National Futures 
Association first determines and notifies the applicant or registrant of 
such fact;
    (3) The Commission shall revoke the registration of the applicant or 
registrant;
    (4) The self-regulatory organization shall suspend (and not 
reinstate within 10 days) or revoke the applicant or registrant's status 
as a member thereof;
    (5) Any receivership, insolvency, liquidation pursuant to the 
Securities Investor Protection Act of 1970 or otherwise, bankruptcy, 
assignment for the benefit of creditors, reorganization whether or not 
pursuant to bankruptcy laws, or any other marshalling of the assets and 
liabilities of the applicant or registrant. A subordination agreement 
which contains any of the provisions permitted by this subparagraph 
(2)(x) shall not contain the provision otherwise permitted by paragraph 
(h)(2)(ix)(A) of this section.
    (3) Miscellaneous provisions--(i) Prohibited cancellation. The 
subordination agreement shall not be subject to cancellation by either 
party; no payment shall be made with respect thereto and the agreement 
shall not be terminated, rescinded or modified by mutual consent or 
otherwise if the effect thereof would be inconsistent with the 
requirements of paragraph (h) of this section.
    (ii) Notice of maturity or accelerated maturity. Every applicant or 
registrant shall immediately notify the National Futures Association, 
and the registrant shall immediately notify the designated self-
regulatory organization, if any, and the Commission if, after giving 
effect to all payments of payment obligations under subordination 
agreements then outstanding which are then due or mature within the 
following six months without reference to any projected profit or loss 
of the applicant or registrant, its adjusted net capital would be less 
than:
    (A) 120 percent of the minimum dollar amount required by paragraphs 
(a)(1)(i)(A) or (a)(1)(ii)(A) of this section;
    (B) For a futures commission merchant or applicant therefor, 6 
percent of the following amount: The customer funds required to be 
segregated pursuant to the Act and the regulations in this part, plus 
the funds of opt-out customers that, but for the election to opt out 
pursuant to Sec. 1.68, would be required to be segregated, plus the 
foreign futures or foreign options secured amount, less the market value 
of commodity options purchased by customers on or subject to the rules 
of a contract market or a foreign board of

[[Page 57]]

trade for which the full premiums have been paid: Provided, however, 
That the deduction for each customer shall be limited to the amount of 
customer funds in such customer's account(s) and foreign futures and 
foreign options secured amounts;
    (C) 120 percent of the amount of adjusted net capital required by a 
registered futures association of which it is a member; or
    (D) For an applicant or registrant which is also a securities broker 
or dealer, the amount of net capital specified in Rule 15c3-1d(c)(2) of 
the Securities and Exchange Commission (17 CFR 240.15c3-1d(c)(2)).
    (iii) Certain legends. If all the provisions of a satisfactory 
subordination agreement do not appear in a single instrument, then the 
debenture or other evidence of indebtedness shall bear on its face an 
appropriate legend stating that it is issued subject to the provisions 
of a satisfactory subordination agreement which shall be adequately 
referred to and incorporated by reference.
    (iv) Legal title to securities. All securities pledged as collateral 
to secure a secured demand note must be in bearer form, or registered in 
the name of the applicant or registrant or the name of its nominee or 
custodian.
    (v) Temporary subordinations. To enable an applicant or registrant 
to participate as an underwriter of securities or undertake other 
extraordinary activities and remain in compliance with the adjusted net 
capital requirements of this section, an applicant or registrant shall 
be permitted, on no more than three occasions in any 12-month period, to 
enter into a subordination agreement on a temporary basis which has a 
stated term of no more than 45 days from the date the subordination 
agreement became effective: Provided, That this temporary relief shall 
not apply to any applicant or registrant if the adjusted net capital of 
the applicant or registrant is less than the greatest of:
    (A) 120 percent of the appropriate minimum dollar amount required by 
paragraphs (a)(1)(i)(A) or (a)(1)(ii)(A) of this section;
    (B) For a futures commission merchant or applicant therefor, 7 
percent of the following amount: The customer funds required to be 
segregated pursuant to the Act and the regulations in this part, plus 
the funds of opt-out customers that, but for the election to opt out 
pursuant to Sec. 1.68, would be required to be segregated, plus the 
foreign futures or foreign options secured amount, less the market value 
of commodity options purchased by customers on or subject to the rules 
of a contract market or a foreign board of trade for which the full 
premiums have been paid: Provided, however, That the deduction for each 
customer shall be limited to the amount of customer funds in such 
customer's account(s) and foreign futures and foreign options secured 
amounts;
    (C) 120 percent of the amount of adjusted net capital required by a 
registered futures association of which it is a member;
    (D) For an applicant or registrant which is also a securities broker 
or dealer, the amount of net capital specified in Rule 15c3-1d(c)(5)(i) 
of the Securities and Exchange Commission (17 CFR 240.15c3-1d(c)(5)(i)); 
or
    (E) The amount of equity capital as defined in paragraph (d) of this 
section is less than the limits specified in paragraph (d) of this 
section. Such temporary subordination agreement shall be subject to all 
the other provisions of this section.
    (vi) Filing. An applicant shall file a signed copy of any proposed 
subordination agreement (including nonconforming subordination 
agreements) with the National Futures Association at least ten days 
prior to the proposed effective date of the agreement or at such other 
time as the National Futures Association for good cause shall accept 
such filing. A registrant that is not a member of any designated self-
regulatory organization shall file two signed copies of any proposed 
subordination agreement (including nonconforming subordination 
agreements) with the regional office of the Commission nearest the 
principal place of business of the registrant (except that a registrant 
under the jurisdiction of the Commission's Western Regional Office shall 
file such copies with the Commission's Southwestern Regional Office) at

[[Page 58]]

least ten days prior to the proposed effective date of the agreement or 
at such other time as the Commission for good cause shall accept such 
filing. A registrant that is a member of a designated self-regulatory 
organization shall file signed copies of any proposed subordination 
agreement (including nonconforming subordination agreements) with the 
designated self-regulatory organization in such quantities and at such 
time as the designated self-regulatory organization may require prior to 
the effective date. The applicant or registrant shall also file with 
said parties a statement setting forth the name and address of the 
lender, the business relationship of the lender to the applicant or 
registrant and whether the applicant or registrant carried funds or 
securities for the lender at or about the time the proposed agreement 
was so filed. A proposed agreement filed by an applicant with the 
National Futures Association shall be reviewed by the National Futures 
Association, and no such agreement shall be a satisfactory subordination 
agreement for the purposes of this section unless and until the National 
Futures Association has found the agreement acceptable and such 
agreement has become effective in the form found acceptable. A proposed 
agreement filed by a registrant shall be reviewed by the designated 
self-regulatory organization with whom such an agreement is required to 
be filed prior to its becoming effective or, if the registrant is not a 
member of any designated self-regulatory organization, by the regional 
office of the Commission where the agreement is required to be filed 
prior to its becoming effective. No proposed agreement shall be a 
satisfactory subordination agreement for the purposes of this section 
unless and until the designated self-regulatory organization or, if a 
registrant is not a member of any designated self-regulatory 
organization, the Commission, has found the agreement acceptable and 
such agreement has become effective in the form found acceptable: 
Provided, however, That a proposed agreement shall be a satisfactory 
subordination agreement for purpose of this section if the registrant: 
is a securities broker or dealer registered with the Securities and 
Exchange Commission; files signed copies of the proposed subordination 
agreement with the applicable securities designated examining authority, 
as defined in Rule 15c3-1(c)(12) of the Securities and Exchange 
Commission (17 CFR 240.15c3-1(c)(12)), in the form and manner prescribed 
by the designated examining authority; files signed copies of the 
proposed subordination agreement with the designated self-regulatory 
organization at the time it files such copies with the designated 
examining authority in the form and manner prescribed by the designated 
self-regulatory organization; and files a copy of the designated 
examining authority's approval of the proposed subordination agreement 
with the designated self-regulatory organization immediately upon 
receipt of such approval. The designated examining authority's 
determination that the proposed subordination agreement satisfies the 
requirements for a satisfactory subordination agreement will be deemed a 
like finding by the designated self-regulatory organization, unless the 
designated self-regulatory organization notifies the registrant that the 
designated examining authority's determination shall not constitute a 
like finding by the designated self-regulatory organization.
    (vii) Subordination agreements in effect prior to adoption. Any 
subordination agreement which has been entered into prior to the 
effective date of this section and which has been deemed to be 
satisfactorily subordinated pursuant to this section previously in 
effect or the adjusted net capital rules of a self-regulatory 
organization shall continue to be deemed a satisfactory subordination 
agreement until the maturity of such agreement. Provided, That no 
renewal of an agreement which provides for automatic or optional renewal 
by the applicant or registrant or lender shall be deemed to be a 
satisfactory subordination agreement unless such renewal agreement meets 
the requirements of this section, within 6 months of the effective date 
of this section. Provided further, That all subordination agreements 
must meet the requirements of this rule within 5 years of the effective 
date of this section.

[[Page 59]]

    (4) A designated self-regulatory organization and the Commission may 
allow debt with a maturity date of 1 year or more to be treated as 
meeting the provisions of this paragraph (h): Provided, (i) Such 
exemption shall only be given when the registrant's adjusted net capital 
is less than the minimum required by this section or by the capital rule 
of the designated self-regulatory organization to which such registrant 
is subject;
    (ii) That such debt did not exist prior to its use under this 
paragraph (h)(4);
    (iii) Such exemption shall be for a period of 30 days or such lesser 
period as the designated self-regulatory organization and the Commission 
may determine;
    (iv) Such exemption shall not be allowed more than once in any 12 
month period; and
    (v) At all times during such exemption the registrant shall make a 
good faith effort to comply with the provisions of this section or the 
capital rule of the designated self-regulatory organization to which 
such registrant is subject exclusive of any benefits derived from this 
paragraph (h)(4).
    (i) [Reserved]
    (j) For the purposes of this section cover is defined as follows:
    (1) General definition. Cover shall mean transactions or positions 
in a contract for future delivery on a board of trade or a commodity 
option where such transactions or positions normally represent a 
substitute for transactions to be made or positions to be taken at a 
later time in a physical marketing channel, and where they are 
economically appropriate to the reduction of risks in the conduct and 
management of a commercial enterprise, and where they arise from:
    (i) The potential change in the value of assets which a person owns, 
produces, manufactures, processes, or merchandises or anticipates 
owning, producing, manufacturing, processing, or merchandising.
    (ii) The potential change in the value of liabilities which a person 
owes or anticipates incurring, or
    (iii) The potential change in the value of services which a person 
provides, purchases or anticipates providing or purchasing. 
Notwithstanding the foregoing, no transactions or positions shall be 
classified as cover for the purposes of this section unless their 
purpose is to offset price risks incidental to commercial cash or spot 
operations and such positions are established and liquidated in 
accordance with sound commercial practices and unless the provisions of 
paragraphs (j) (2) and (3) of this section have been satisfied.
    (2) Enumerated cover transactions. The definition of covered 
transactions and positions in paragraph (j)(1) of this section includes, 
but is not limited to, the following specific transactions and 
positions:
    (i) Ownership or fixed-price purchase of any commodity which does 
not exceed in quantity (A) the sales of the same commodity for future 
delivery on a board of trade or (B) the purchase of a put commodity 
option of the same commodity for which the market value for the actual 
commodity or futures contract which is the subject of the option is less 
than the strike price of the option or (C) the ownership of a commodity 
option position established by the sale (grant) of a call commodity 
option of the same commodity for which the market value for the actual 
commodity or futures contract which is the subject of the option is more 
than the strike price of the option: Provided, That for purposes of 
paragraph (c)(5)(x) of this section the market value for the actual 
commodity or futures contract which is the subject of such option need 
not be more than the strike price of that option;
    (ii) Fixed-price sale of any commodity which does not exceed in 
quantity (A) the purchase of the same commodity for future delivery on a 
board of trade or (B) the purchase of a call commodity option of the 
same commodity for which the market value for the actual commodity or 
futures contract which is the subject of such option is more than the 
strike price of the option or (C) ownership of a commodity option 
position established by the sale (grant) of a put commodity option of 
the same commodity for which the market value for the actual commodity 
or futures comtract which is the subject of the option is less than the 
strike price of the option: Provided,

[[Page 60]]

That for purposes of paragraph (c)(5)(x) of this section the market 
value for the actual commodity or futures contract which is the subject 
of such option need not be less than the strike price of that option; 
and
    (iii) Ownership or fixed-price contracts of a commodity described in 
paragraphs (j)(2)(i) and (j)(2)(ii) of this section may also be covered 
other than by the same quantity of the same cash commodity, provided 
that the fluctuations in value of the position for future delivery or 
commodity option are substantially related to the fluctuations in value 
of the actual cash position.
    (3) Nonenumerated cases. Upon specific request, the Commission may 
recognize transactions and positions other than those enumerated in 
paragraph (j)(2) of this section as cover in amounts and under the terms 
and conditions as it may specify. Any applicant or registrant who wishes 
to avail itself of the provisions of this paragraph (j)(3) must apply to 
the Commission in writing at its principal office in Washington, DC 
giving full details of the transaction including detailed information 
which will demonstrate that the transaction is economically appropriate 
to the reduction of risk exposure attendant to the conduct and 
management of a commercial enterprise.

(Approved by the Office of Management and Budget under control number 
3038-0024)

[43 FR 39972, Sept. 8, 1978]

    Editorial Note: For Federal Register citations affecting Sec. 1.17, 
see the List of Sections Affected, which appears in the Finding Aids 
section of the printed volume and on GPO Access.