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2012-26435

  • Federal Register, Volume 77 Issue 220 (Wednesday, November 14, 2012)[Federal Register Volume 77, Number 220 (Wednesday, November 14, 2012)]

    [Proposed Rules]

    [Pages 67865-67971]

    From the Federal Register Online via the Government Printing Office [www.gpo.gov]

    [FR Doc No: 2012-26435]

    [[Page 67865]]

    Vol. 77

    Wednesday,

    No. 220

    November 14, 2012

    Part II

    Commodity Futures Trading Commission

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    17 CFR Parts 1, 3, 22 et al.

    Enhancing Protections Afforded Customers and Customer Funds Held by

    Futures Commission Merchants and Derivatives Clearing Organizations;

    Proposed Rule

    Federal Register / Vol. 77 , No. 220 / Wednesday, November 14, 2012 /

    Proposed Rules

    [[Page 67866]]

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    COMMODITY FUTURES TRADING COMMISSION

    17 CFR Parts 1, 3, 22, 30, and 140

    RIN 3038-AD88

    Enhancing Protections Afforded Customers and Customer Funds Held

    by Futures Commission Merchants and Derivatives Clearing Organizations

    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 to adopt new regulations and amend existing

    regulations to require enhanced customer protections, risk management

    programs, internal monitoring and controls, capital and liquidity

    standards, customer disclosures, and auditing and examination programs

    for futures commission merchants (``FCMs''). The proposal also

    addresses certain related issues concerning derivatives clearing

    organizations (``DCOs'') and chief compliance officers (``CCOs''). The

    proposed rules will afford greater assurances to market participants

    that: customer segregated funds and secured amounts are protected;

    customers are provided with appropriate notice of the risks of futures

    trading and of the FCMs with which they may choose to do business; FCMs

    are monitoring and managing risks in a robust manner; the capital and

    liquidity of FCMs are strengthened to safeguard their continued

    operations; and the auditing and examination programs of the Commission

    and the self-regulatory organizations (``SROs'') are monitoring the

    activities of FCMs in a prudent and thorough manner.

    DATES: Comments must be received on or before January 14, 2013.

    ADDRESSES: You may submit comments, identified by RIN 3038-AD88, 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: Send to David A. Stawick, Secretary, Commodity

    Futures Trading Commission, 1155 21st Street NW., Washington, DC 20581.

    Hand delivery/Courier: Same as Mail above.

    Federal eRulemaking Portal: http://www.regulations.gov/search/index.jsp.

    Follow the instructions for submitting comments.

    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 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 set forth in

    Sec. 145.9 of the Commission's regulations.\1\

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    \1\ Commission regulations referred to herein are found at 17

    CFR Ch. 1 (2012). Commission regulations are accessible on the

    Commission's Web site, www.cftc.gov.

    _____________________________________-

    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 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:

    Division of Swap Dealer and Intermediary Oversight: Gary Barnett,

    Director, 202-418-5977, gbarnett@cftc.gov; Thomas Smith, Deputy

    Director, 202-418-5495, tsmith@cftc.gov; Frank Fisanich, Chief Counsel,

    202-418-5949, ffisanich@cftc.gov; or Ward P. Griffin, Associate Chief

    Counsel, 202-418-5425, wgriffin@cftc.gov, Three Lafayette Centre, 1155

    21st Street NW., Washington, DC 20581, or Kevin Piccoli, Deputy

    Director, 646-746-9834, kpiccoli@cftc.gov, 140 Broadway, 19th Floor,

    New York, NY 10005.

    Division of Clearing and Risk: Robert B. Wasserman, Chief Counsel, 202-

    418-5092, rwasserman@cftc.gov, Three Lafayette Centre, 1155 21st Street

    NW., Washington, DC 20581.

    Office of the Chief Economist: Camden Nunery, Economist,

    cnunery@cftc.gov, 202-418-5723, Three Lafayette Centre, 1155 21st

    Street NW., Washington, DC 20581.

    SUPPLEMENTARY INFORMATION:

    I. Background

    A. General Statutory and Current Regulatory Structure

    The protection of customers--and the safeguarding of money,

    securities or other property deposited by customers with an FCM--is a

    fundamental component of the Commission's disclosure and financial

    responsibility framework. Section 4d(a)(2) \2\ of the Commodity

    Exchange Act (``Act'') \3\ requires each FCM to segregate from its own

    assets all money, securities and other property deposited by futures

    customers to margin, secure, or guarantee futures contracts and options

    on futures contracts traded on designated contract markets.\4\ Section

    4d(a)(2) further requires an FCM to treat and deal with futures

    customer funds as belonging to the futures customer, and prohibits an

    FCM from using the funds deposited by a futures customer to margin or

    extend credit to any person other than the futures customer that

    deposited the funds. Section 4d(f) of the Act, which was added by

    section 724(a) of the Dodd-Frank Wall Street Reform and Consumer

    Protection Act,\5\ requires each FCM to segregate from its own assets

    all money, securities and other property deposited by Cleared Swaps

    Customers to margin transactions in Cleared Swaps.\6\

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    \2\ 7 U.S.C. 6d(a)(2).

    \3\ 7 U.S.C. 1 et seq.

    \4\ The term '' futures customer'' is defined in Sec. 1.3(iiii)

    to include any person who uses a futures commission merchant as an

    agent in connection with trading in any contract for the purchase or

    sale of a commodity for future delivery or an option on such

    contract (excluding any proprietary accounts under Sec. 1.3(y)).

    The Commission adopted the definition of the term ``futures

    customer'' on October 16, 2012 as part of the final rulemaking that

    amended existing Commission regulations to incorporate swaps. The

    Federal Register release adopting the final rules can be accessed at

    http://www.cftc.gov/ucm/groups/public/@newsroom/documents/file/federalregister101612.pdf.

    \5\ See Dodd-Frank Act, Public Law 111-203, 124 Stat. 1376

    (2010). The text of the Dodd-Frank Act may be accessed at http://www.cftc.gov/LawRegulation/OTCDERIVATIVES/index.htm.

    \6\ The term ``Cleared Swaps Customer'' is defined in Sec. 22.1

    as any person entering into a Cleared Swap, but excludes: (1) Any

    owner or holder of a Cleared Swaps Proprietary Account with respect

    to the Cleared Swaps in such account; and (2) A clearing member of a

    DCO with respect to Cleared Swaps cleared on that DCO.

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    The Commission has adopted Sec. Sec. 1.20 through 1.30, and Sec.

    1.32, to implement section 4d(a)(2) of the Act, and adopted Part 22 to

    implement section 4d(f) of the Act. The purpose of these regulations is

    to safeguard funds deposited by futures customers and Cleared Swaps

    Customers, respectively.

    Regulation 1.20 requires each FCM and DCO to separately account for

    and to segregate from its own proprietary funds all money, securities,

    or other property deposited by futures customers for trading on

    designated contract markets. Regulation 1.20 also provides that an FCM

    or DCO may deposit futures customer funds only with a bank, trust

    company, and for FCMs only, a DCO or another FCM. The funds must be

    deposited under an account

    [[Page 67867]]

    name that clearly identifies the funds as belonging to the futures

    customers of the FCM or DCO and further shows that the funds are

    segregated as required by section 4d(a)(2) of the Act and Commission

    regulations. FCMs and DCOs also are required to obtain a written

    acknowledgment from a depository stating that the depository was

    informed that funds deposited are customer funds being held in

    accordance with the Act.

    FCMs and DCOs also are restricted in their use of futures customer

    funds. Regulations 1.20 and 1.22 provide that the funds deposited by

    one futures customer may not be used to margin or to secure the

    contracts or option positions, or extend credit to any person, other

    than the futures customer that deposited the funds. An FCM or DCO,

    however, may for convenience commingle and hold funds deposited as

    margin by multiple futures customers in the same account or accounts

    with one of the recognized depositories. An FCM or DCO also may invest

    futures customer funds in certain permitted investments under Sec.

    1.25.

    Part 22 of the Commission's regulations, which governs Cleared

    Swaps transactions, implements section 4d(f) of the Act and parallels

    many of the provisions in Part1 addressing the manner in which, and the

    responsibilities imposed upon, an FCM holding funds for futures

    customers trading on designated contract markets.\7\ Regulation 22.2

    requires an FCM to treat and to deal with funds deposited by Cleared

    Swaps Customers as belonging to such Cleared Swaps Customers and to

    hold such funds separately from the FCM's own funds. Regulation 22.4

    provides that an FCM may deposit Cleared Swaps Customer Collateral with

    a bank, trust company, DCO, or another registered FCM. Regulation 22.6

    requires that the account holding the Cleared Swaps Customers

    Collateral must clearly identify the account as an account for Cleared

    Swaps Customers of the FCM engaging in cleared swap transactions and

    that the funds maintained in the account are subject to the segregation

    provisions of section 4d(f) of the Act and Commission regulations.

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    \7\ The Commission approved the part 22 regulations on January

    11, 2012, with an effective date of April 9, 2012. Compliance with

    the part 22 regulations is required by November 8, 2012. See,

    Protection of Cleared Swaps Customer Contracts and Collateral;

    Conforming Amendments to the Commodity Broker Bankruptcy Provisions,

    77 FR 6336 (Feb. 7, 2012).

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    Regulation 22.2(d) also prohibits an FCM from using the funds

    deposited by one Cleared Swaps Customer to purchase, margin, or settle

    cleared swap transactions of any person other the Cleared Swaps

    Customer that deposited the funds. Further, Sec. 22.2(c) permits an

    FCM to commingle the Cleared Swaps Customer Collateral of multiple

    Cleared Swaps Customers into one or more accounts, and Sec. 22.2(e)(1)

    permits an FCM to invest Cleared Swaps Customer Collateral in permitted

    investments under Sec. 1.25.

    In addition to holding funds for futures customers transacting on

    designated contract markets and for Cleared Swaps Customers engaging in

    cleared swap transactions, FCMs also hold funds for persons trading

    futures contracts listed on foreign boards of trade. Section 4(b) of

    the Act provides that the Commission may adopt rules and regulations

    proscribing fraud and requiring minimum financial standards, the

    disclosure of risk, the filing of reports, the keeping of books and

    records, the safeguarding of the funds deposited by persons for trading

    on foreign markets, and registration with the Commission by any person

    located in the United States who engages in the offer or sale of any

    contract of sale of a commodity for future delivery that is made

    subject to the rules of a board of trade located outside of the United

    States. Pursuant to the statutory authority of section 4(b), the

    Commission adopted Part 30 of its regulations to address foreign

    futures and foreign option transactions.

    The segregation provisions for funds deposited by foreign futures

    or foreign options customers to margin foreign futures or foreign

    options transactions under Part 30, however, are significantly

    different from the requirements set forth in Sec. 1.20 for futures

    customers trading on designated contract markets and Part 22 for

    Cleared Swaps Customers engaging in cleared swap transactions.

    Regulation 30.7 provides that an FCM may deposit the funds belonging to

    foreign futures or foreign options customers in an account or accounts

    maintained at a bank or trust company located in the United States; a

    bank or trust company located outside of the United States that has in

    excess of $1 billion of regulatory capital; an FCM registered with the

    Commission; a DCO; a member of a foreign board of trade; a foreign

    clearing organization; or a depository selected by the member of a

    foreign board of trade or foreign clearing organization. The account

    with the depository must be titled to clearly specify that the account

    holds funds belonging to the foreign futures or foreign options

    customers of the FCM that are trading on foreign futures markets. An

    FCM also is permitted to invest the funds deposited by foreign futures

    or foreign option customers in accordance with Sec. 1.25.

    However, unlike Sec. 1.20 and Part 22, which require an FCM to

    hold a sufficient amount of funds in segregation to meet the total

    account equities of all of the FCM's futures customers and Cleared

    Swaps Customers at all times (i.e., the Net Liquidating Equity Method),

    Sec. 30.7 requires an FCM to maintain in separate accounts an amount

    of funds only sufficient to cover the margin required on open foreign

    futures contracts, plus or minus any unrealized gains or losses on such

    open positions, plus any funds representing premiums payable or

    received on foreign options (including any additional funds necessary

    to secure such options, plus or minus any unrealized gains or losses on

    such options) (i.e., the ``Alternative Method''). Thus, under the Part

    30 Alternative Method an FCM is not required to maintain a sufficient

    amount of funds in such separate accounts to pay the full account

    balances of all of its foreign futures or foreign options customers at

    all times.

    In addition to the segregation requirements of sections 4d(a)(2)

    and 4d(f) of the Act, and the secured amount requirements in Part 30 of

    the Commission's regulations, FCMs also are subject to minimum net

    capital and financial reporting requirements that are intended to

    ensure that such firms meet their financial obligations in a regulated

    marketplace, including their financial obligations to customers and

    DCOs. Each FCM is required to maintain a minimum level of ``adjusted

    net capital,'' which is generally defined under Sec. 1.17 as the

    firm's net equity as computed under generally accepted accounting

    principles, less all of the firm's liabilities and further excluding

    all assets that are not liquid or readily marketable. Regulation

    1.17(c)(5) further requires an FCM to impose capital charges (i.e.,

    deductions) on certain of its liquid assets to protect against possible

    market risks in such assets.

    FCMs also are subject to financial recordkeeping and reporting

    requirements. FCMs that carry customer accounts are required under

    Sec. 1.32 to prepare a schedule each business day demonstrating their

    compliance with the segregation and secured amount requirements.

    Regulation 1.32 requires the calculation to be performed by noon each

    business day, reflecting the account balances and open positions as of

    the close of business on the previous business day.

    Each FCM also is required by Sec. 1.10 to file with the Commission

    and with its

    [[Page 67868]]

    designated self-regulatory organization (``DSRO'') monthly unaudited

    financial statements and an annual audited financial report, as well as

    notices of certain predefined events.\8\ Regulation 1.12 requires an

    FCM to file a notice with the Commission and with the firm's DSRO

    whenever, among other things, the firm: (1) Fails to maintain

    compliance with the Commission's capital requirements; (2) fails to

    hold sufficient funds in segregated or secured amount accounts to meet

    its regulatory requirements; (3) fails to maintain current books and

    records; or (4) experiences a significant reduction in capital from the

    previous month-end. The purpose of the regulatory notices is to alert

    the Commission and the firm's DSRO as early as possible to potential

    financial issues at the firm that may adversely impact the ability of

    the FCM to comply with its obligations to safeguard customer funds, or

    to meet its financial obligations to other FCMs or DCOs.

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    \8\ The term ``self-regulatory organization'' is defined by

    Sec. 1.3 to mean a contract market, a swap execution facility, or a

    registered futures association. A DSRO is the SRO that is appointed

    to be primarily responsible for conducting ongoing financial

    surveillance of an FCM under a joint audit agreement submitted to

    and approved by the Commission under Sec. 1.52.

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    The statutory mandate to segregate customer funds--to treat them as

    belonging to the customer and not use the funds inappropriately--takes

    on greater meaning in light of the devastating events experienced over

    the past year. Those events, which are discussed in greater detail

    below, demonstrate that the risks of misfeasance and malfeasance, and

    the risks of failing to maintain sufficient excess funds in

    segregation: (i) Put customer funds at risk; and (ii) are exacerbated

    by stresses on the business of the FCM. Many of those risks can be

    mitigated significantly by better risk management systems and controls,

    along with an increase in risk-oriented oversight and examination of

    the FCMs.

    Determining what is a ``sufficient'' amount of excess funds in

    segregation for any particular FCM requires a full understanding of the

    business of that FCM, including a proper analysis of the factors that

    affect the actual amount of segregated funds held by the FCM relative

    to the minimum amount of segregated funds it is required to hold.

    Further, appropriate care must be taken to avoid withdrawing such

    excess funds at times of great stress to cover needs unrelated to the

    purposes for which excess segregated and secured funds are maintained.

    In times of stress, excess funds may look like an easy liquidity source

    to help cover other risks of the business; yet withdrawing it makes it

    unavailable when it may be most needed. The recent market events

    illustrate both the need to: (i) Require that care be taken about

    monitoring excess segregated and secured funds, and the conditions

    under and the extent to which such funds may be withdrawn; and (ii)

    place appropriate risk management controls around the other risks of

    the business to help relieve (A) the likelihood of an exigent event or,

    (B) if such an event occurs, the likelihood of a failure to prepare for

    such an event, which in either case could create pressures that result

    in an inappropriate withdrawal of customer funds.

    Although the Commission's existing regulations provide an essential

    foundation to fostering a well-functioning marketplace, wherein

    customers are protected and institutional risks are minimized, recent

    events have demonstrated that additional measures are necessary to

    effectuate the fundamental purposes of the statutory provisions

    discussed above. Further, concurrently with the enhanced

    responsibilities for FCMs that are proposed herein, the oversight and

    examination systems must be enhanced to mitigate risks and effectuate

    the statutory purposes.

    B. Self-Regulatory Structure

    The Commission's oversight structure provides that SROs are the

    frontline regulators of FCMs, introducing brokers (``IBs''), commodity

    pool operators, and commodity trading advisors. In 2000, Congress

    affirmed the Commission's reliance on SROs by amending section 3 of the

    Commodity Exchange Act to state: ``It is the purpose of this Act to

    serve the public interests through a system of effective self-

    regulation of trading facilities, clearing systems, market participants

    and market professionals under the oversight of the Commission.''

    As part of its oversight responsibility, an SRO is required to

    conduct periodic examinations of member FCMs' compliance with

    Commission and SRO financial and related reporting requirements,

    including the FCMs' holding of customer funds in segregated and secured

    accounts. The Commission oversees the SROs by examining them for the

    performance of their duties. More recently, the Commission has moved to

    conducting quarterly reviews of the SROs' FCM examination program in

    which the Commission selects a small sample of the SRO's FCM work

    papers to review. In addition, the Commission also conducts limited-

    scope reviews of FCMs in a ``for cause'' situation that are sometimes

    referred to as ``audits,'' but they are not full-scale audits as

    accountants commonly use that term.

    In addition, because there are multiple SROs who share the same

    member FCMs, to avoid subjecting FCMs to duplicative examinations from

    SROs, the Commission has a permissive system that allows the SROs to

    agree how to allocate FCMs amongst them. An SRO who is allocated

    certain FCMs for such examination is referred to as the DSRO of those

    FCMs.

    Under Commission regulations, FCMs must have their annual financial

    statements audited by an independent certified public accountant

    following U.S. Generally Accepted Auditing Standards (``U.S. GAAS'').

    As part of this certified annual report, the independent accountant

    also must conduct appropriate reviews and tests to identify any

    material inadequacies in systems and controls that could violate the

    Commission's segregation or secured amount requirements. Any such

    inadequacies are required to be reported to the FCM's DSRO and to the

    Commission.

    C. Futures Commission Merchant Insolvencies and Failures of Risk

    Management

    Recent events demonstrate the need for revisions to the

    Commission's customer protection regime. Since October 2011, two FCMs

    have entered into insolvency proceedings. On October 31, 2011, MF

    Global, Inc. (``MFGI''), which was dually-registered as an FCM with the

    Commission and as a securities broker-dealer (``BD'') with the U.S.

    Securities and Exchange Commission (``SEC''), was placed into a

    liquidation proceeding under the Securities Investor Protection Act by

    the Securities Investor Protection Corporation (``SIPC''). The trustee

    appointed to oversee the liquidation of MFGI has reported a potential

    $900 million shortfall of funds necessary to repay the account balances

    due to customers trading futures on designated contract markets, and an

    approximately $700 million shortfall in funds immediately available to

    repay the account balances of customers trading on foreign futures

    markets.\9\ The shortfall in customer segregated accounts is

    attributable by the MFGI Trustee to significant transfers of funds out

    of the customer accounts that were used by MFGI for various purposes

    other than to meet obligations to or on

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    behalf of customers. The trustee also is attempting to recover

    approximately $640 million of customer funds that was deposited by MFGI

    with its London, U.K. affiliate, MFGUK, as margin funds for trading on

    foreign markets. The MFGI trustee and the Special Administrators

    handling the liquidation of MFGUK are disputing the legal status of the

    funds and whether they are customer funds under English law. The

    outcome of this dispute will have a significant impact on the amount of

    funds that are returned to MFGI.

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    \9\ See Report of the Trustee's Investigation and

    Recommendations, In re MF Global Inc., No. 11-2790 (MG) SIPA (Bankr.

    S.D.N.Y. Jun. 4, 2012).

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    In addition, the Commission filed a civil injunctive complaint in

    federal district court on July 10, 2012, against Peregrine Financial

    Group, Inc. (``PFG''), a registered FCM and its Chief Executive Officer

    (``CEO'') and sole owner, Russell R. Wasendorf, Sr., alleging that PFG

    and Wasendorf, Sr. committed fraud by misappropriating customer funds,

    violated customer fund segregation laws, and made false statements

    regarding the amount of funds in customer segregated accounts in

    financial statements filed with the Commission. The complaint states

    that in July 2012 during an NFA examination PFG falsely represented

    that it held in excess of $220 million of customer funds when in fact

    it held approximately $5.1 million.\10\

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    \10\ Complaint, U.S. Commodity Futures Trading Commission v.

    Peregrine Financial Group, Inc., and Russell R. Wasendorf, Sr., No.

    12-cv-5383 (N.D. Ill. July 10, 2012). A copy of the Commission's

    complaint has been posted to the Commission's Web site.

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    Recent incidents also have demonstrated the value of establishing

    robust risk management systems within FCMs and enhanced early warning

    systems to detect and address capital issues. In particular, problems

    that arise through an FCM's non-futures-related business can have a

    direct and significant impact on the FCM's regulatory capital, raising

    questions as to whether the FCM will be able to maintain the minimum

    financial requirements mandated by the Act and Commission

    regulations.\11\

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    \11\ See, e.g., Edward Krudy, Jed Horowitz and John McCrank,

    ``Knight's Future in Balance After Trading Disaster,'' Reuters (Aug.

    3, 2012), available at http://in.reuters.com/article/2012/08/03/knightcapital-loss-idINL2E8J27QE20120803 (noting that a software

    issue caused the firm to incur a $440 million trading loss, which

    represented much of the firm's capital); Chris Dieterich and

    Nathalie Tadena, ``Penson Worldwide's US Securities Accounts To Be

    Acquired By Apex Clearing,'' available at http://online.wsj.com/article/BT-CO-20120531-717791.html (discussing circumstances that

    led Penson to sell its futures business).

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    These recent incidents have highlighted weaknesses in the customer

    protection regime prescribed in the Commission's regulations and

    through the self-regulatory system. In particular, questions have

    arisen on the requirements surrounding the holding and investment of

    customer funds, including the ability of FCMs to withdraw funds from

    customer segregated accounts and Part 30 secured accounts.

    Additionally, the incidents have underscored the need for additional

    safeguards--such as robust risk management systems, strengthened early-

    warning systems surrounding margin and capital requirements, and

    enhanced public disclosures--to promote the protection of customer

    funds and to minimize the systemic risk posed by certain actions of

    market participants. Further questions have arisen on the system of

    audits and examinations of FCMs, and whether the system functions

    adequately to monitor FCMs' activities, verify segregated fund and

    secured amount balances, and detect fraud. Consequently, the Commission

    has taken steps to study and address the issues raised by the

    incidents, and industry participants likewise have taken steps to

    address the issues. Such steps are described in greater detail in the

    next section.

    D. Recent Commission Rulemakings and Other Initiatives Relating to

    Customer Protection

    Since late 2011, the Commission has promulgated rules directly

    impacting the protection of customer funds. The Commission also has

    studied the current regulatory framework surrounding customer

    protection, particularly in light of the recent incidents outlined

    above, in order to identify potential enhancements to the systems and

    Commission regulations protecting customer funds. The Commission's

    efforts have been informed, in part, by efforts undertaken by industry

    participants. The proposed rule amendments set forth in this release

    have been informed by the efforts detailed below.

    In December 2011, the Commission adopted final rule amendments

    revising the types of investments that an FCM or DCO can make with

    customer funds under Sec. 1.25, for the purpose of affording greater

    protection for such funds.\12\ Among other changes to Sec. Sec. 1.25

    and 30.7, the final rule amendments removed from the list of permitted

    investments: (1) corporate debt obligations not guaranteed by the

    United States; (2) foreign sovereign debt; and (3) in-house and

    affiliate transactions.

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    \12\ See, Investment of Customer Funds and Funds Held in an

    Account for Foreign Futures and Foreign Options Transactions, 76 FR

    78776 (Dec. 19, 2011).

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    In adopted the amendments to Sec. 1.25, the Commission was mindful

    that customer segregated funds must be invested by FCMs and DCOs in a

    manner that minimizes their exposure to credit, liquidity, and market

    risks both to preserve their availability to customers and DCOs, and to

    enable investments to be quickly converted to cash at a predictable

    value in order to avoid systemic risk. The amendments are consistent

    with the general prudential standard contained in Sec. 1.25, which

    provides that all permitted investments must be ``consistent with the

    objectives of preserving principal and maintaining liquidity.''

    The Commission also approved final regulations that require DCOs to

    collect initial customer margin from FCMs on a gross basis.\13\ Under

    the final regulations, FCMs are no longer permitted to offset one

    customer's margin requirement against another customer's margin

    requirements and deposit only the net margin collateral with the DCO.

    As a result of the rule change, a greater portion of customer initial

    margin will be posted by FCMs to the DCOs.

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    \13\ See Commission Regulation 39.12(g)(8)(i) and Derivatives

    Clearing Organization General Provisions and Core Principles, 76 FR

    69334 (Nov. 8, 2011).

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    The Commission also approved a new margining regime for cleared

    swaps positions.\14\ Under the traditional futures margining model,

    DCOs hold an FCM's customer funds on a collective basis and are

    permitted to use the collective margin funds held for the FCM's

    customers to satisfy a margin deficiency caused by a single customer.

    The Commission approved an alternative margin rule for cleared swap

    transactions. Under the ``LSOC rule'' (legal segregation with

    operational comingling), the DCOs that clear swaps transactions have

    greater information regarding the margin collateral of individual Swaps

    Customers, and each Swaps Customer's collateral is protected

    individually all the way to the clearinghouse.

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    \14\ See 77 FR 6336 (Feb. 7, 2012).

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    The Commission also included customer protection enhancements in

    the final rule for designated contract markets. These provisions codify

    into rules staff guidance on minimum requirements for SROs regarding

    their financial surveillance of FCMs.\15\ The rules require that a DCM

    have arrangements and resources for effective

    [[Page 67870]]

    rule enforcement and trade and financial surveillance programs,

    including the authority to collect information and examine books and

    records of members and market participants. The rules also establish

    minimum financial standards for both member FCMs and IBs and non-

    intermediated market participants. The Commission expressly noted in

    the preamble of the Adopting Release that ``a DCM's duty to set

    financial standards for its FCM members involves setting capital

    requirements, conducting surveillance of the potential future exposure

    of each FCM as compared to its capital, and taking appropriate action

    in light of the results of such surveillance.'' \16\ Further, the rules

    mandate that DCMs adopt rules for the protection of customer funds,

    including the segregation of customer and proprietary funds, the

    custody of customer funds, the investment standards for customer funds,

    intermediary default procedures and related recordkeeping.

    ---------------------------------------------------------------------------

    \15\ See Core Principles and Other Requirements for Designated

    Contract Markets, 77 FR 36612 (June 19, 2012).

    \16\ Id. at 36646.

    ---------------------------------------------------------------------------

    In addition to the rulemaking efforts outlined above, the

    Commission has sought additional information through a series of

    roundtables and other meetings. On February 29 and March 1, 2012, the

    Commission solicited comments and held a public roundtable to solicit

    input on customer protection issues from a broad cross-section of the

    futures industry, including market participants, FCMs, DCOs, SROs,

    securities regulators, foreign clearing organizations, and

    academics.\17\ The roundtable focused on issues relating to the

    advisability and practicality of modifying the segregation models for

    customer funds; alternative models for the custody of customer

    collateral; enhancing FCM controls over the disbursement of customer

    funds; increasing transparency surrounding an FCM's holding and

    investment of customer funds; and lessons learned from recent commodity

    brokerage bankruptcy proceedings.

    ---------------------------------------------------------------------------

    \17\ Further information on the public roundtable, including

    video recordings and transcripts of the discussions, have been

    posted to the Commission's Web site. See http://www.cftc.gov/PressRoom/Events/opaevent_cftcstaff022912 (relating to Feb. 29,

    2012); http://www.cftc.gov/PressRoom/Events/opaevent_cftcstaff030112 (relating to Mar. 1, 2012).

    ---------------------------------------------------------------------------

    The Commission also hosted a public meeting of the Technology

    Advisory Committee (``TAC'') on July 26, 2012.\18\ Panelists and TAC

    members discussed potential technological solutions directed at

    enhancing the protection of customers funds by identifying and

    exploring technological issues and possible solutions relating to the

    ability of the Commission, SROs and customers to verify the location

    and status of funds held in customer segregated accounts.

    ---------------------------------------------------------------------------

    \18\ Additional information, including documents submitted by

    meeting participants, has been posted to the Commission's Web site.

    See http://www.cftc.gov/PressRoom/Events/opaevent_tac072612.

    ---------------------------------------------------------------------------

    Commission staff hosted an additional roundtable on August 9, 2012,

    to discuss SRO requirements for examinations of FCMs and Commission

    oversight of SRO examination programs. The roundtable also focused on

    the role of the independent public accountant in the FCM examination

    process, and proposals addressing various alternatives to the current

    system for segregating customer funds.

    In developing the proposals set forth in this release, the

    Commission also has been informed by efforts undertaken by industry

    participants. On February 29, 2012, the Futures Industry Association

    (``FIA'') initiated steps to educate customers on the extent of the

    protections provided under the current regulatory structure. FIA issued

    a list of Frequently Asked Questions (``FAQ'') prepared by members of

    the FIA Law and Compliance Division addressing the basics of

    segregation, collateral management and investments, capital

    requirements and other issues for FCMs and joint FCM/BDs, and

    clearinghouse guaranty funds.\19\ The FAQ is intended to provide

    existing and potential customers with a better understanding of the

    risks of engaging in futures trading and a clear explanation of the

    extent of the protections provided to customers and their funds under

    the Act and Commission regulations.

    ---------------------------------------------------------------------------

    \19\ The FIA's release addressing FAQs on the protection of

    customer funds is accessible on the FIA's Web site at http://www.futuresindustry.org/downloads/PCF-FAQs.PDF.

    ---------------------------------------------------------------------------

    FIA also issued a series of initial recommendations for the

    protection of customer funds.\20\ The recommendations were prepared by

    the Financial Management Committee, whose members include

    representatives of FIA member firms, DCOs and depository institutions.

    The initial recommendations address enhanced disclosure on the

    protection of customer funds, reporting on segregated funds balances by

    FCMs, FCM internal controls surrounding the holding and disbursement of

    customer funds, and revisions to Part 30 regulations to make the

    protections comparable to those provided for customers trading on

    designated contract markets.

    ---------------------------------------------------------------------------

    \20\ The FIA's initial recommendations are accessible on the

    FIA's Web site at http://www.futuresindustry.org/downloads/Initial_Recommendations_for_Customer_Funds_Protection.pdf.

    ---------------------------------------------------------------------------

    On July 13, 2012, the Commission approved new FCM financial

    requirements proposed by the National Futures Association

    (``NFA'').\21\ The NFA Financial Requirements Section 16 and its

    related Interpretive Notice entitled NFA Financial Requirements Section

    16: FCM Financial Practices and Excess Segregated Funds/Secured Amount

    Disbursements (collectively referred to as ``the Segregated Funds

    Provisions'') were developed in consultation with Commission staff.

    ---------------------------------------------------------------------------

    \21\ For more information relating to the new FCM financial

    requirements, see http://www.nfa.futures.org/news/newsNotice.asp?ArticleID=4072.

    ---------------------------------------------------------------------------

    NFA's Segregated Funds Provisions require each FCM to: (1) Maintain

    written policies and procedures governing the deposit of the FCM's

    proprietary funds (i.e., excess or residual funds) in customer

    segregated accounts and Part 30 secured accounts; (2) maintain a

    targeted amount of excess funds in segregate accounts and Part 30

    secured accounts; (3) file on a daily basis the FCM's segregation and

    Part 30 secured amount computations with NFA; (4) obtain the approval

    of senior management prior to a withdrawal that is not for the benefit

    of customers, whenever the withdrawal equals 25 percent or more of the

    excess segregated or Part 30 secured amount funds; (5) file a notice

    with NFA of any withdrawal that is not for the benefit of customers,

    whenever the withdrawal equals 25 percent or more of the excess

    segregated or Part 30 secured amount funds; (6) file detailed

    information regarding the depositories holding customer funds and the

    investments made with customer funds as of the 15th day (or the next

    business day if the 15th is not a business day) and the last business

    day of each month; and (7) file additional monthly net capital and

    leverage information with NFA.

    Significantly, NFA's Segregated Funds Provisions also require FCMs

    to compute their Part 30 secured amount requirement and compute their

    targeted excess Part 30 secured funds using the same Net Liquidating

    Equity Method that is required by the Act and Commission regulations

    for computing the segregation requirements for customers trading on

    U.S. contract markets under section 4d of the Act. FCMs are not

    permitted under the NFA rules to use the Alternative Method to compute

    the Part 30 secured amount requirement. The failure of an FCM to

    maintain its targeted amount of excess Part 30 funds computed using the

    Net

    [[Page 67871]]

    Liquidating Equity Method may result in NFA initiating a Membership

    Responsibility Action (``MRA'') against the firm.

    In addition, in setting the target amount of excess funds, the

    FCM's management must perform a due diligence inquiry and consider

    various factors relating, as applicable, to the nature of the FCM's

    business, including the type and general creditworthiness of the FCM's

    customers, the trading activity of the customers, the types and

    volatility of the markets and products traded by the FCM's customers,

    and the FCM's own liquidity and capital needs. The FCM's Board of

    Directors (or similar governing body), CEO or Chief Financial Officer

    (``CFO'') must approve in writing the FCM's targeted residual amount,

    any changes thereto, and any material changes in the FCM's written

    policies and procedures.

    The NFA Board of Directors also approved on August 16, 2012,

    amendments to NFA financial requirements for FCMs that will require

    each FCM to provide its DSRO with view-only access via the Internet to

    account information for each of the FCM's customer segregated funds

    account(s) maintained and held at a bank or trust company. The same

    requirement would apply to the FCM's customer secured account(s) held

    for customers trading on foreign futures exchanges.

    In addition, the NFA rule amendments provide that if a bank or

    trust company is unable to allow the FCM to provide its DSRO with view-

    only full access via the Internet, the bank or trust company will not

    be deemed an acceptable depository to hold customer segregated and

    secured accounts. NFA intends to expand its oversight of FCMs under the

    amended rules, once the amendments are implemented, to receive daily

    reports from all depositories for customer segregated and secured

    accounts, including FCMs that are clearing members of DCOs. NFA plans

    to develop a program to compare the balances reported by the

    depositories with the balances reported by the FCMs in their daily

    segregation reports. An immediate alert would be generated for any

    material discrepancies.

    E. Commission's Proposal

    The incidents outlined above, coupled with the information

    generated through the recent efforts undertaken by the Commission and

    industry participants, demonstrate the need for new rules and

    amendments to existing rules. In particular, an examination of FCM

    business operations--including the non-futures business of FCMs--and

    the currently regulatory framework evince a need for enhanced customer

    protections, risk management programs, disclosure requirements, and

    auditing and examination programs. The amendments proposed herein

    address these issues in several ways.

    First, recognizing problems surrounding the treatment of customer

    segregated funds and foreign futures or foreign options secured

    amounts, the Commission is proposing to amend several components of

    Parts 1, 22, and 30 of the Commission's regulations. The Commission

    believes that the proposed amendments will provide greater certainty to

    market participants that the customer funds entrusted to FCMs will be

    protected. Second, to address shortcomings in the risk management of

    FCMs, the Commission is proposing a new Sec. 1.11 that will establish

    robust risk management programs. Third, the Commission determined that

    the current regulatory framework should be re-oriented to implement a

    more risk-based, forward-looking perspective, affording the Commission

    and SROs with read-only access to accounts holding customer funds and

    additional information on depositories and the customer assets held in

    such depositories. The proposed amendments to Sec. Sec. 1.10, 1.12,

    1.20, 1.26, and 1.32 address those and other issues. Fourth, given the

    difficulties that can arise in an FCM's business, and the direct and

    significant impact on the FCM's regulatory capital that can result from

    such difficulties, the Commission is proposing to amend Sec.

    1.17(a)(4) to ensure that an FCM's capital and liquidity are sufficient

    to safeguard the continuation of operations at the FCM. Fifth, to

    effect the change in orientation needed in FCM examinations programs,

    as well as to assure quality control over program contents,

    administration and oversight, the Commission is proposing to amend

    Sec. 1.52, which, among other things, addresses the formation of Joint

    Audit Committees and the implementation of Joint Audit Programs. And

    sixth, recognizing the need to increase the information provided to

    customers concerning the risks of futures trading and the FCMs with

    which they may choose to conduct business, the Commission is proposing

    amendments to Sec. 1.55 that will enhance the disclosures provided by

    FCMs. These amendments are discussed in greater detail in the next

    Section.

    II. Section by Section Analysis of Proposed Commission Regulations and

    Proposed Amendments to Existing Commission Regulations

    A. Proposed Amendments to Sec. 1.10: Financial Reports of Futures

    Commission Merchants and Introducing Brokers

    Regulation 1.10 requires each FCM to file with the Commission and

    with the firm's DSRO an unaudited financial report each month. The

    financial report must be prepared using Form 1-FR-FCM. An FCM, however,

    that is dually-registered as a BD, may file a Financial and Operational

    Combined Uniform Single Report under the Securities Exchange Act of

    1934 (``FOCUS Report'') in lieu of the Form 1-FR-FCM. Each FCM also is

    required to file an annual report certified by an independent public

    accountant with the Commission and with its DSRO.

    The unaudited monthly and certified annual financial reports are

    required to contain basic financial statements including a statement of

    financial condition, a statement of income (loss), and a statement of

    changes in ownership equity. The financial statements also are required

    to include additional schedules designed to address specific regulatory

    objectives to demonstrate that the FCM is in compliance with minimum

    capital and customer funds segregation requirements. These additional

    schedules include a statement of changes in liabilities subordinated to

    claims of general creditors, a statement of the computation of the

    minimum capital requirements (``Capital Computation Schedule''), a

    statement of segregation requirements and funds in segregation for

    customers trading on U.S. commodity exchanges (``Segregation

    Schedule'') and a statement of secured amounts and funds held in

    separate accounts for foreign futures and foreign options customers

    (``Secured Amount Schedule''). In addition, the certified annual report

    must contain a reconciliation of material differences between the

    Capital Computation Schedule, the Segregation Schedule, and the Secured

    Amount Schedule contained in the certified annual report and the

    unaudited monthly report for the FCM's year-end month.

    The Forms 1-FR-FCM and the FOCUS Reports are necessary financial

    reporting for Commission and DSRO staff to assess the ongoing financial

    condition of an FCM and provide significant information regarding the

    operations of the firm that may impact the FCM's ability to maintain

    [[Page 67872]]

    compliance with Commission requirements and the protection of customer

    funds. The Form 1-FR-FCM and FOCUS Reports are filed electronically

    with the Commission and are subject to automated edits by the

    Commission's financial statement surveillance software. Alerts and edit

    checks, which may indicate a need for further analysis and follow-up by

    staff, are generated by the financial surveillance software and major

    issues are immediately and automatically forwarded to Commission staff

    for review.

    The Segregation Schedule and the Secured Amount Schedule generally

    indicate, respectively, the total amount of funds held by the FCM in

    segregated or secured accounts, the total amount of funds that the FCM

    must hold in segregated or secured accounts to meet its regulatory

    obligations to futures customers and foreign futures or foreign options

    customers, and whether the firm holds excess segregated or secured

    funds in the segregated or secured accounts as of the reporting date.

    The Commission is proposing to amend Sec. 1.10 to require each FCM to

    also disclose in the Segregation Schedule and in the Secured Amount

    Schedule \22\ a target amount of ``residual interest'' (denoting the

    FCM's proprietary funds) that the FCM is required to maintain in

    customer segregated accounts and secured accounts based upon its

    written policies and procedures for computing a targeted amount

    required under the new risk management provisions in Sec. 1.11

    discussed in Section II.B below.\23\ In addition to the target amount

    of residual interest, the FCM also will be required to report on the

    Segregation Schedule and the Secured Amount Schedule the sum of

    outstanding margin deficits of the relevant customers for each

    computation, to ensure that the residual interest is at all times in

    excess of such sum, demonstrating compliance with the newly proposed

    procedures in Sec. Sec. 1.22 and 1.23, which shall require residual

    interest to exceed the sum of such margin deficits.

    ---------------------------------------------------------------------------

    \22\ The Commission also proposes to revise the title of the

    ``Secured Amount Schedule'' by adding the term ``30.7 Customer'' to

    specify that the secured amount will include both U.S.-domiciled and

    foreign-domiciled customers consistent with the proposed amendments

    to Part 30 of the Commission Regulations discussed in Section II.R

    below.

    \23\ The NFA recently adopted a similar amendment to its rules,

    mandating that its member FCMs maintain written policies and

    procedures identifying a target amount that the FCM will seek to

    maintain as its residual interest in customer segregated and secured

    accounts. See NFA Notice I-12-14 (July 18, 2012), available at

    http://www.nfa.futures.org/news/newsNotice.asp?ArticleID=4072.

    ---------------------------------------------------------------------------

    As more fully discussed in Section II.B below, proposed Sec. 1.11

    will require each FCM that carries customer funds to determine a

    necessary level of excess segregated and secured funds that the firm

    should hold in segregated or secured accounts to ensure against

    becoming undersegregated or undersecured as a result of the withdrawal

    of proprietary funds from segregated or secured accounts. Each FCM is

    required under proposed Sec. 1.11 to compute or determine the

    necessary target of residual interest based upon appropriate due

    diligence and consideration of various factors relating to the nature

    of the FCM's business,\24\ including the type and general

    creditworthiness of the customer base, the amount of the undermargined

    customer accounts on any given day, and the volatility and liquidity of

    the markets and products traded by customers.

    ---------------------------------------------------------------------------

    \24\ The term ``Cleared Swaps Customer Collateral'' is defined

    in Sec. 22.1 to mean all money, securities, or other property

    received by a futures commission merchant or by a derivatives

    clearing organization from, for, or on behalf of a Cleared Swaps

    Customer to margin a Cleared Swap or the settlement value of a

    Cleared Swap, and includes any accruals on such Cleared Swap

    transactions.

    ---------------------------------------------------------------------------

    The disclosure of the targeted amount of the FCM's residual

    interest in segregated or secured accounts will allow the Commission

    and DSRO to assess the size of the target relative to both the total

    funds held in segregation or secured accounts and to compare the target

    to other FCMs. Such information will assist the Commission and DSROs in

    assessing the potential risk that a firm may become undersegregated or

    undersecured, and will enhance the Commission's and DSRO's ability to

    protect customer funds.

    The Commission also is proposing to revise Form 1-FR-FCM to adopt a

    new ``Statement of Cleared Swap Customer Segregation Requirements and

    Funds in Cleared Swap Customer Accounts Under Section 4d(f) of the

    Act'' (``Cleared Swaps Segregation Schedule''). The Commission is

    proposing the Cleared Swaps Segregation Schedule to implement

    provisions in section 724(a) of the Dodd-Frank Act.\25\ Section 724(a)

    amended section 4d of the Act, and requires an FCM to segregate from

    its own assets any money, securities and other property deposited by a

    Cleared Swaps Customer to margin its cleared swaps positions. As part

    of the implementation of section 724(a) of the Dodd-Frank Act, the

    Commission adopted Sec. 22.2(g) which requires an FCM to compute, as

    of the close of business each business day, a segregation computation

    demonstrating compliance with its obligation to hold sufficient funds

    in segregated accounts in an amount sufficient to cover the total Net

    Liquidating Equity of each of the FCM's Cleared Swaps Customers.\26\

    The proposed Cleared Swaps Segregation Schedule will be comparable to

    the current Segregation Schedule and will allow the Commission and the

    FCM's DSRO to obtain information on the FCM's holding of Cleared Swaps

    Customer Collateral to ensure that such funds are held in accordance

    with the provisions of Part 22 of the Commission's regulations and that

    the FCM is reporting that it has sufficient funds in segregated

    accounts to meet its obligations to all of its Cleared Swaps Customers

    computed under the Net Liquidating Equity Method.

    ---------------------------------------------------------------------------

    \25\ 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/LawRegulation/OTCDERIVATIVES/index.htm.

    \26\ See 77 FR 6336 (February 7, 2012).

    ---------------------------------------------------------------------------

    The Commission previously proposed a Cleared Swaps Segregation

    Schedule as part of its proposed regulations to adopt capital

    requirements for swap dealers and major swap participants.\27\ In light

    of the Commission's decision to revise the Cleared Swaps Segregation

    Schedule from the version that was published for comment as part of the

    Commission's proposed capital rules for swap dealers and major swap

    participants by requiring the FCM to separately disclose its targeted

    residual interest in Cleared Swaps Customer Accounts and the sum of

    margin deficits for such accounts, the Commission is republishing the

    Cleared Swaps Segregation Schedule as part of this proposal to provide

    the public with an opportunity to comment on the proposal.\28\

    ---------------------------------------------------------------------------

    \27\ See Capital Requirements of Swap Dealers and Major Swap

    Participants, 76 FR 27802 (May 12, 2011).

    \28\ Regulation 1.10(h) provides that a dually-registered FCM/BD

    may file a FOCUS Report in lieu of the Form 1-FR-FCM provided that

    all information that is required to be included in the Form 1-FR-FCM

    is included in the FOCUS Report. Currently, dual-registrant FCM/BDs

    include a Segregation Schedule and a Secured Amount Schedule in the

    FOCUS Report filings as supplemental schedules. If the Commission

    were to adopt a Cleared Swaps Segregation Schedule, dual-registrant

    FCM/BDs would have to include such schedule in their Focus Report

    filings.

    ---------------------------------------------------------------------------

    The Commission also is proposing to amend Sec. 1.10(g)(2) to

    provide that the Cleared Swaps Segregation Schedule is a public

    document. Regulation 1.10 currently provides that the Commission will

    treat the monthly Form 1-FR-FCM

    [[Page 67873]]

    reports and monthly FOCUS Reports as exempt from mandatory public

    disclosure for purposes of the Freedom of Information Act and the

    Government in the Sunshine Act, except for certain capommission Rulemakings and Other Initiatives Relating to

    Customer Protection

    Since late 2011, the Commission has promulgated rules directly

    impacting the protection of customer funds. The Commission also has

    studied the current regulatory framework surrounding customer

    protection, particularly in light of the recent incidents outlined

    above, in order to identify potential enhancements to the systems and

    Commission regulations protecting customer funds. The Commission's

    efforts have been informed, in part, by efforts undertaken by industry

    participants. The proposed rule amendments set forth in this release

    have been informed by the efforts detailed below.

    In December 2011, the Commission adopted final rule amendments

    revising the types of investments that an FCM or DCO can make with

    customer funds under Sec. 1.25, for the purpose of affording greater

    protection for such funds.\12\ Among other changes to Sec. Sec. 1.25

    and 30.7, the final rule amendments removed from the list of permitted

    investments: (1) corporate debt obligations not guaranteed by the

    United States; (2) foreign sovereign debt; and (3) in-house and

    affiliate transactions.

    ---------------------------------------------------------------------------

    \12\ See, Investment of Customer Funds and Funds Held in an

    Account for Foreign Futures and Foreign Options Transactions, 76 FR

    78776 (Dec. 19, 2011).

    ---------------------------------------------------------------------------

    In adopted the amendments to Sec. 1.25, the Commission was mindful

    that customer segregated funds must be invested by FCMs and DCOs in a

    manner that minimizes their exposure to credit, liquidity, and market

    risks both to preserve their availability to customers and DCOs, and to

    enable investments to be quickly converted to cash at a predictable

    value in order to avoid systemic risk. The amendments are consistent

    with the general prudential standard contained in Sec. 1.25, which

    provides that all permitted investments must be ``consistent with the

    objectives of preserving principal and maintaining liquidity.''

    The Commission also approved final regulations that require DCOs to

    collect initial customer margin from FCMs on a gross basis.\13\ Under

    the final regulations, FCMs are no longer permitted to offset one

    customer's margin requirement against another customer's margin

    requirements and deposit only the net margin collateral with the DCO.

    As a result of the rule change, a greater portion of customer initial

    margin will be posted by FCMs to the DCOs.

    ---------------------------------------------------------------------------

    \13\ See Commission Regulation 39.12(g)(8)(i) and Derivatives

    Clearing Organization General Provisions and Core Principles, 76 FR

    69334 (Nov. 8, 2011).

    ---------------------------------------------------------------------------

    The Commission also approved a new margining regime for cleared

    swaps positions.\14\ Under the traditional futures margining model,

    DCOs hold an FCM's customer funds on a collective basis and are

    permitted to use the collective margin funds held for the FCM's

    customers to satisfy a margin deficiency caused by a single customer.

    The Commission approved an alternative margin rule for cleared swap

    transactions. Under the ``LSOC rule'' (legal segregation with

    operational comingling), the DCOs that clear swaps transactions have

    greater information regarding the margin collateral of individual Swaps

    Customers, and each Swaps Customer's collateral is protected

    individually all the way to the clearinghouse.

    ---------------------------------------------------------------------------

    \14\ See 77 FR 6336 (Feb. 7, 2012).

    ---------------------------------------------------------------------------

    The Commission also included customer protection enhancements in

    the final rule for designated contract markets. These provisions codify

    into rules staff guidance on minimum requirements for SROs regarding

    their financial surveillance of FCMs.\15\ The rules require that a DCM

    have arrangements and resources for effective

    [[Page 67870]]

    rule enforcement and trade and financial surveillance programs,

    including the authority to collect information and examine books and

    records of members and market participants. The rules also establish

    minimum financial standards for both member FCMs and IBs and non-

    intermediated market participants. The Commission expressly noted in

    the preamble of the Adopting Release that ``a DCM's duty to set

    financial standards for its FCM members involves setting capital

    requirements, conducting surveillance of the potential future exposure

    of each FCM as compared to its capital, and taking appropriate action

    in light of the results of such surveillance.'' \16\ Further, the rules

    mandate that DCMs adopt rules for the protection of customer funds,

    including the segregation of customer and proprietary funds, the

    custody of customer funds, the investment standards for customer funds,

    intermediary default procedures and related recordkeeping.

    ---------------------------------------------------------------------------

    \15\ See Core Principles and Other Requirements for Designated

    Contract Markets, 77 FR 36612 (June 19, 2012).

    \16\ Id. at 36646.

    ---------------------------------------------------------------------------

    In addition to the rulemaking efforts outlined above, the

    Commission has sought additional information through a series of

    roundtables and other meetings. On February 29 and March 1, 2012, the

    Commission solicited comments and held a public roundtable to solicit

    input on customer protection issues from a broad cross-section of the

    futures industry, including market participants, FCMs, DCOs, SROs,

    securities regulators, foreign clearing organizations, and

    academics.\17\ The roundtable focused on issues relating to the

    advisability and practicality of modifying the segregation models for

    customer funds; alternative models for the custody of customer

    collateral; enhancing FCM controls over the disbursement of customer

    funds; increasing transparency surrounding an FCM's holding and

    investment of customer funds; and lessons learned from recent commodity

    brokerage bankruptcy proceedings.

    ---------------------------------------------------------------------------

    \17\ Further information on the public roundtable, including

    video recordings and transcripts of the discussions, have been

    posted to the Commission's Web site. See http://www.cftc.gov/PressRoom/Events/opaevent_cftcstaff022912 (relating to Feb. 29,

    2012); http://www.cftc.gov/PressRoom/Events/opaevent_cftcstaff030112 (relating to Mar. 1, 2012).

    ---------------------------------------------------------------------------

    The Commission also hosted a public meeting of the Technology

    Advisory Committee (``TAC'') on July 26, 2012.\18\ Panelists and TAC

    members discussed potential technological solutions directed at

    enhancing the protection of customers funds by identifying and

    exploring technological issues and possible solutions relating to the

    ability of the Commission, SROs and customers to verify the location

    and status of funds held in customer segregated accounts.

    ---------------------------------------------------------------------------

    \18\ Additional information, including documents submitted by

    meeting participants, has been posted to the Commission's Web site.

    See http://www.cftc.gov/PressRoom/Events/opaevent_tac072612.

    ---------------------------------------------------------------------------

    Commission staff hosted an additional roundtable on August 9, 2012,

    to discuss SRO requirements for examinations of FCMs and Commission

    oversight of SRO examination programs. The roundtable also focused on

    the role of the independent public accountant in the FCM examination

    process, and proposals addressing various alternatives to the current

    system for segregating customer funds.

    In developing the proposals set forth in this release, the

    Commission also has been informed by efforts undertaken by industry

    participants. On February 29, 2012, the Futures Industry Association

    (``FIA'') initiated steps to educate customers on the extent of the

    protections provided under the current regulatory structure. FIA issued

    a list of Frequently Asked Questions (``FAQ'') prepared by members of

    the FIA Law and Compliance Division addressing the basics of

    segregation, collateral management and investments, capital

    requirements and other issues for FCMs and joint FCM/BDs, and

    clearinghouse guaranty funds.\19\ The FAQ is intended to provide

    existing and potential customers with a better understanding of the

    risks of engaging in futures trading and a clear explanation of the

    extent of the protections provided to customers and their funds under

    the Act and Commission regulations.

    ---------------------------------------------------------------------------

    \19\ The FIA's release addressing FAQs on the protection of

    customer funds is accessible on the FIA's Web site at http://www.futuresindustry.org/downloads/PCF-FAQs.PDF.

    ---------------------------------------------------------------------------

    FIA also issued a series of initial recommendations for the

    protection of customer funds.\20\ The recommendations were prepared by

    the Financial Management Committee, whose members include

    representatives of FIA member firms, DCOs and depository institutions.

    The initial recommendations address enhanced disclosure on the

    protection of customer funds, reporting on segregated funds balances by

    FCMs, FCM internal controls surrounding the holding and disbursement of

    customer funds, and revisions to Part 30 regulations to make the

    protections comparable to those provided for customers trading on

    designated contract markets.

    ---------------------------------------------------------------------------

    \20\ The FIA's initial recommendations are accessible on the

    FIA's Web site at http://www.futuresindustry.org/downloads/Initial_Recommendations_for_Customer_Funds_Protection.pdf.

    ---------------------------------------------------------------------------

    On July 13, 2012, the Commission approved new FCM financial

    requirements proposed by the National Futures Association

    (``NFA'').\21\ The NFA Financial Requirements Section 16 and its

    related Interpretive Notice entitled NFA Financial Requirements Section

    16: FCM Financial Practices and Excess Segregated Funds/Secured Amount

    Disbursements (collectively referred to as ``the Segregated Funds

    Provisions'') were developed in consultation with Commission staff.

    ---------------------------------------------------------------------------

    \21\ For more information relating to the new FCM financial

    requirements, see http://www.nfa.futures.org/news/newsNotice.asp?ArticleID=4072.

    ---------------------------------------------------------------------------

    NFA's Segregated Funds Provisions require each FCM to: (1) Maintain

    written policies and procedures governing the deposit of the FCM's

    proprietary funds (i.e., excess or residual funds) in customer

    segregated accounts and Part 30 secured accounts; (2) maintain a

    targeted amount of excess funds in segregate accounts and Part 30

    secured accounts; (3) file on a daily basis the FCM's segregation and

    Part 30 secured amount computations with NFA; (4) obtain the approval

    of senior management prior to a withdrawal that is not for the benefit

    of customers, whenever the withdrawal equals 25 percent or more of the

    excess segregated or Part 30 secured amount funds; (5) file a notice

    with NFA of any withdrawal that is not for the benefit of customers,

    whenever the withdrawal equals 25 percent or more of the excess

    segregated or Part 30 secured amount funds; (6) file detailed

    information regarding the depositories holding customer funds and the

    investments made with customer funds as of the 15th day (or the next

    business day if the 15th is not a business day) and the last business

    day of each month; and (7) file additional monthly net capital and

    leverage information with NFA.

    Significantly, NFA's Segregated Funds Provisions also require FCMs

    to compute their Part 30 secured amount requirement and compute their

    targeted excess Part 30 secured funds using the same Net Liquidating

    Equity Method that is required by the Act and Commission regulations

    for computing the segregation requirements for customers trading on

    U.S. contract markets under section 4d of the Act. FCMs are not

    permitted under the NFA rules to use the Alternative Method to compute

    the Part 30 secured amount requirement. The failure of an FCM to

    maintain its targeted amount of excess Part 30 funds computed using the

    Net

    [[Page 67871]]

    Liquidating Equity Method may result in NFA initiating a Membership

    Responsibility Action (``MRA'') against the firm.

    In addition, in setting the target amount of excess funds, the

    FCM's management must perform a due diligence inquiry and consider

    various factors relating, as applicable, to the nature of the FCM's

    business, including the type and general creditworthiness of the FCM's

    customers, the trading activity of the customers, the types and

    volatility of the markets and products traded by the FCM's customers,

    and the FCM's own liquidity and capital needs. The FCM's Board of

    Directors (or similar governing body), CEO or Chief Financial Officer

    (``CFO'') must approve in writing the FCM's targeted residual amount,

    any changes thereto, and any material changes in the FCM's written

    policies and procedures.

    The NFA Board of Directors also approved on August 16, 2012,

    amendments to NFA financial requirements for FCMs that will require

    each FCM to provide its DSRO with view-only access via the Internet to

    account information for each of the FCM's customer segregated funds

    account(s) maintained and held at a bank or trust company. The same

    requirement would apply to the FCM's customer secured account(s) held

    for customers trading on foreign futures exchanges.

    In addition, the NFA rule amendments provide that if a bank or

    trust company is unable to allow the FCM to provide its DSRO with view-

    only full access via the Internet, the bank or trust company will not

    be deemed an acceptable depository to hold customer segregated and

    secured accounts. NFA intends to expand its oversight of FCMs under the

    amended rules, once the amendments are implemented, to receive daily

    reports from all depositories for customer segregated and secured

    accounts, including FCMs that are clearing members of DCOs. NFA plans

    to develop a program to compare the balances reported by the

    depositories with the balances reported by the FCMs in their daily

    segregation reports. An immediate alert would be generated for any

    material discrepancies.

    E. Commission's Proposal

    The incidents outlined above, coupled with the information

    generated through the recent efforts undertaken by the Commission and

    industry participants, demonstrate the need for new rules and

    amendments to existing rules. In particular, an examination of FCM

    business operations--including the non-futures business of FCMs--and

    the currently regulatory framework evince a need for enhanced customer

    protections, risk management programs, disclosure requirements, and

    auditing and examination programs. The amendments proposed herein

    address these issues in several ways.

    First, recognizing problems surrounding the treatment of customer

    segregated funds and foreign futures or foreign options secured

    amounts, the Commission is proposing to amend several components of

    Parts 1, 22, and 30 of the Commission's regulations. The Commission

    believes that the proposed amendments will provide greater certainty to

    market participants that the customer funds entrusted to FCMs will be

    protected. Second, to address shortcomings in the risk management of

    FCMs, the Commission is proposing a new Sec. 1.11 that will establish

    robust risk management programs. Third, the Commission determined that

    the current regulatory framework should be re-oriented to implement a

    more risk-based, forward-looking perspective, affording the Commission

    and SROs with read-only access to accounts holding customer funds and

    additional information on depositories and the customer assets held in

    such depositories. The proposed amendments to Sec. Sec. 1.10, 1.12,

    1.20, 1.26, and 1.32 address those and other issues. Fourth, given the

    difficulties that can arise in an FCM's business, and the direct and

    significant impact on the FCM's regulatory capital that can result from

    such difficulties, the Commission is proposing to amend Sec.

    1.17(a)(4) to ensure that an FCM's capital and liquidity are sufficient

    to safeguard the continuation of operations at the FCM. Fifth, to

    effect the change in orientation needed in FCM examinations programs,

    as well as to assure quality control over program contents,

    administration and oversight, the Commission is proposing to amend

    Sec. 1.52, which, among other things, addresses the formation of Joint

    Audit Committees and the implementation of Joint Audit Programs. And

    sixth, recognizing the need to increase the information provided to

    customers concerning the risks of futures trading and the FCMs with

    which they may choose to conduct business, the Commission is proposing

    amendments to Sec. 1.55 that will enhance the disclosures provided by

    FCMs. These amendments are discussed in greater detail in the next

    Section.

    II. Section by Section Analysis of Proposed Commission Regulations and

    Proposed Amendments to Existing Commission Regulations

    A. Proposed Amendments to Sec. 1.10: Financial Reports of Futures

    Commission Merchants and Introducing Brokers

    Regulation 1.10 requires each FCM to file with the Commission and

    with the firm's DSRO an unaudited financial report each month. The

    financial report must be prepared using Form 1-FR-FCM. An FCM, however,

    that is dually-registered as a BD, may file a Financial and Operational

    Combined Uniform Single Report under the Securities Exchange Act of

    1934 (``FOCUS Report'') in lieu of the Form 1-FR-FCM. Each FCM also is

    required to file an annual report certified by an independent public

    accountant with the Commission and with its DSRO.

    The unaudited monthly and certified annual financial reports are

    required to contain basic financial statements including a statement of

    financial condition, a statement of income (loss), and a statement of

    changes in ownership equity. The financial statements also are required

    to include additional schedules designed to address specific regulatory

    objectives to demonstrate that the FCM is in compliance with minimum

    capital and customer funds segregation requirements. These additional

    schedules include a statement of changes in liabilities subordinated to

    claims of general creditors, a statement of the computation of the

    minimum capital requirements (``Capital Computation Schedule''), a

    statement of segregation requirements and funds in segregation for

    customers trading on U.S. commodity exchanges (``Segregation

    Schedule'') and a statement of secured amounts and funds held in

    separate accounts for foreign futures and foreign options customers

    (``Secured Amount Schedule''). In addition, the certified annual report

    must contain a reconciliation of material differences between the

    Capital Computation Schedule, the Segregation Schedule, and the Secured

    Amount Schedule contained in the certified annual report and the

    unaudited monthly report for the FCM's year-end month.

    The Forms 1-FR-FCM and the FOCUS Reports are necessary financial

    reporting for Commission and DSRO staff to assess the ongoing financial

    condition of an FCM and provide significant information regarding the

    operations of the firm that may impact the FCM's ability to maintain

    [[Page 67872]]

    compliance with Commission requirements and the protection of customer

    funds. The Form 1-FR-FCM and FOCUS Reports are filed electronically

    with the Commission and are subject to automated edits by the

    Commission's financial statement surveillance software. Alerts and edit

    checks, which may indicate a need for further analysis and follow-up by

    staff, are generated by the financial surveillance software and major

    issues are immediately and automatically forwarded to Commission staff

    for review.

    The Segregation Schedule and the Secured Amount Schedule generally

    indicate, respectively, the total amount of funds held by the FCM in

    segregated or secured accounts, the total amount of funds that the FCM

    must hold in segregated or secured accounts to meet its regulatory

    obligations to futures customers and foreign futures or foreign options

    customers, and whether the firm holds excess segregated or secured

    funds in the segregated or secured accounts as of the reporting date.

    The Commission is proposing to amend Sec. 1.10 to require each FCM to

    also disclose in the Segregation Schedule and in the Secured Amount

    Schedule \22\ a target amount of ``residual interest'' (denoting the

    FCM's proprietary funds) that the FCM is required to maintain in

    customer segregated accounts and secured accounts based upon its

    written policies and procedures for computing a targeted amount

    required under the new risk management provisions in Sec. 1.11

    discussed in Section II.B below.\23\ In addition to the target amount

    of residual interest, the FCM also will be required to report on the

    Segregation Schedule and the Secured Amount Schedule the sum of

    outstanding margin deficits of the relevant customers for each

    computation, to ensure that the residual interest is at all times in

    excess of such sum, demonstrating compliance with the newly proposed

    procedures in Sec. Sec. 1.22 and 1.23, which shall require residual

    interest to exceed the sum of such margin deficits.

    ---------------------------------------------------------------------------

    \22\ The Commission also proposes to revise the title of the

    ``Secured Amount Schedule'' by adding the term ``30.7 Customer'' to

    specify that the secured amount will include both U.S.-domiciled and

    foreign-domiciled customers consistent with the proposed amendments

    to Part 30 of the Commission Regulations discussed in Section II.R

    below.

    \23\ The NFA recently adopted a similar amendment to its rules,

    mandating that its member FCMs maintain written policies and

    procedures identifying a target amount that the FCM will seek to

    maintain as its residual interest in customer segregated and secured

    accounts. See NFA Notice I-12-14 (July 18, 2012), available at

    http://www.nfa.futures.org/news/newsNotice.asp?ArticleID=4072.

    ---------------------------------------------------------------------------

    As more fully discussed in Section II.B below, proposed Sec. 1.11

    will require each FCM that carries customer funds to determine a

    necessary level of excess segregated and secured funds that the firm

    should hold in segregated or secured accounts to ensure against

    becoming undersegregated or undersecured as a result of the withdrawal

    of proprietary funds from segregated or secured accounts. Each FCM is

    required under proposed Sec. 1.11 to compute or determine the

    necessary target of residual interest based upon appropriate due

    diligence and consideration of various factors relating to the nature

    of the FCM's business,\24\ including the type and general

    creditworthiness of the customer base, the amount of the undermargined

    customer accounts on any given day, and the volatility and liquidity of

    the markets and products traded by customers.

    ---------------------------------------------------------------------------

    \24\ The term ``Cleared Swaps Customer Collateral'' is defined

    in Sec. 22.1 to mean all money, securities, or other property

    received by a futures commission merchant or by a derivatives

    clearing organization from, for, or on behalf of a Cleared Swaps

    Customer to margin a Cleared Swap or the settlement value of a

    Cleared Swap, and includes any accruals on such Cleared Swap

    transactions.

    ---------------------------------------------------------------------------

    The disclosure of the targeted amount of the FCM's residual

    interest in segregated or secured accounts will allow the Commission

    and DSRO to assess the size of the target relative to both the total

    funds held in segregation or secured accounts and to compare the target

    to other FCMs. Such information will assist the Commission and DSROs in

    assessing the potential risk that a firm may become undersegregated or

    undersecured, and will enhance the Commission's and DSRO's ability to

    protect customer funds.

    The Commission also is proposing to revise Form 1-FR-FCM to adopt a

    new ``Statement of Cleared Swap Customer Segregation Requirements and

    Funds in Cleared Swap Customer Accounts Under Section 4d(f) of the

    Act'' (``Cleared Swaps Segregation Schedule''). The Commission is

    proposing the Cleared Swaps Segregation Schedule to implement

    provisions in section 724(a) of the Dodd-Frank Act.\25\ Section 724(a)

    amended section 4d of the Act, and requires an FCM to segregate from

    its own assets any money, securities and other property deposited by a

    Cleared Swaps Customer to margin its cleared swaps positions. As part

    of the implementation of section 724(a) of the Dodd-Frank Act, the

    Commission adopted Sec. 22.2(g) which requires an FCM to compute, as

    of the close of business each business day, a segregation computation

    demonstrating compliance with its obligation to hold sufficient funds

    in segregated accounts in an amount sufficient to cover the total Net

    Liquidating Equity of each of the FCM's Cleared Swaps Customers.\26\

    The proposed Cleared Swaps Segregation Schedule will be comparable to

    the current Segregation Schedule and will allow the Commission and the

    FCM's DSRO to obtain information on the FCM's holding of Cleared Swaps

    Customer Collateral to ensure that such funds are held in accordance

    with the provisions of Part 22 of the Commission's regulations and that

    the FCM is reporting that it has sufficient funds in segregated

    accounts to meet its obligations to all of its Cleared Swaps Customers

    computed under the Net Liquidating Equity Method.

    ---------------------------------------------------------------------------

    \25\ 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/LawRegulation/OTCDERIVATIVES/index.htm.

    \26\ See 77 FR 6336 (February 7, 2012).

    ---------------------------------------------------------------------------

    The Commission previously proposed a Cleared Swaps Segregation

    Schedule as part of its proposed regulations to adopt capital

    requirements for swap dealers and major swap participants.\27\ In light

    of the Commission's decision to revise the Cleared Swaps Segregation

    Schedule from the version that was published for comment as part of the

    Commission's proposed capital rules for swap dealers and major swap

    participants by requiring the FCM to separately disclose its targeted

    residual interest in Cleared Swaps Customer Accounts and the sum of

    margin deficits for such accounts, the Commission is republishing the

    Cleared Swaps Segregation Schedule as part of this proposal to provide

    the public with an opportunity to comment on the proposal.\28\

    ---------------------------------------------------------------------------

    \27\ See Capital Requirements of Swap Dealers and Major Swap

    Participants, 76 FR 27802 (May 12, 2011).

    \28\ Regulation 1.10(h) provides that a dually-registered FCM/BD

    may file a FOCUS Report in lieu of the Form 1-FR-FCM provided that

    all information that is required to be included in the Form 1-FR-FCM

    is included in the FOCUS Report. Currently, dual-registrant FCM/BDs

    include a Segregation Schedule and a Secured Amount Schedule in the

    FOCUS Report filings as supplemental schedules. If the Commission

    were to adopt a Cleared Swaps Segregation Schedule, dual-registrant

    FCM/BDs would have to include such schedule in their Focus Report

    filings.

    ---------------------------------------------------------------------------

    The Commission also is proposing to amend Sec. 1.10(g)(2) to

    provide that the Cleared Swaps Segregation Schedule is a public

    document. Regulation 1.10 currently provides that the Commission will

    treat the monthly Form 1-FR-FCM

    [[Page 67873]]

    reports and monthly FOCUS Reports as exempt from mandatory public

    disclosure for purposes of the Freedom of Information Act and the

    Government in the Sunshine Act, except for certain capital numbers and

    other financial information including the Segregation Schedules and the

    Secured Amount Schedules contained in the financial reports. The

    Commission is proposing to amend Sec. 1.10(g)(2) to provide that the

    Cleared Swaps Segregation Schedule is a public document in the same

    manner as the Segregation Schedule and Secured Amount Schedule, and is

    available by requesting copies from the Commission.

    Making the Cleared Swaps Segregation Schedule publicly available

    will benefit customers and potential customers by allowing them to

    review an FCM's compliance with its regulatory obligations and will

    provide a certain amount of detail as to how the FCM holds customer

    funds, which customers and potential customers will be able to assess

    from a risk perspective and also use to compare to other firms. This

    information, coupled with additional firm risk disclosures that the

    Commission is proposing in Sec. 1.55 and discussed in detail in

    Section II.P below, will provide customers with greater transparency

    regarding the risks of entrusting their funds and engaging in

    transactions with particular FCMs. Customers also will be able to view

    the total amount of the targeted residual interest each FCM holds and

    to assess for themselves the adequacy of the targeted residual interest

    and whether the FCM holds funds in excess of the targeted residual

    interest.

    The Commission also is proposing to amend several statements in the

    Form 1-FR-FCM. The Commission is proposing to amend the Statement of

    Financial Condition by adding a new line item 1.D. Line 1 currently

    separately details the amount of funds in segregation or separate

    accounts for futures customers and foreign futures or foreign option

    customers. Proposed line item 1.D. will set forth the amount of funds

    held by the FCM in segregated accounts for Cleared Swaps Customers.

    This amendment is necessary due to the adoption of the Part 22

    regulations, which require the segregation of Cleared Swaps Customer

    Collateral and the proposed adoption of the Cleared Swaps Segregation

    Schedule as part of the Form 1-FR-FCM.

    The Commission also is proposing to amend the Statement of

    Financial Condition by adding a new line item 22.F., which requires the

    separate disclosure of the FCM's liability to Cleared Swaps Customers.

    The Commission also is proposing to revise current line item 27.J. to

    require the FCM to disclose its obligation to retail forex customers.

    Currently, an FCM's obligation to retail forex customers is included

    with other miscellaneous liabilities and reported under current line

    item 27.J. ``Other.'' The separate reporting of an FCM's retail forex

    obligation will provide greater transparency on the Statement of

    Financial Condition regarding the firm's obligations to its retail

    counterparties in off-exchange foreign currency transactions, and is

    appropriate given the Commission's direct jurisdiction over such

    activities under section 2(c) of the Act when conducted by an FCM.

    The Commission also is proposing to amend Sec. 1.10(b)(1)(ii) to

    require that an FCM submit its certified annual report to the

    Commission and to its DSRO within 60 days of its year-end date.

    Currently, an FCM is required to submit the annual certified financial

    statements within 90 days of the firm's year-end date, except for FCMs

    that are dually-registered as FCM/BDs, which are require to submit the

    certified annual report within 60 days of the year-end date under both

    Commission and SEC regulations. Therefore, the proposal will only

    impact FCMs that are not dually-registered as BDs.

    The proposal will align the filing deadlines for both FCMs and dual

    registrant FCMs/BDs. The annual certified financial report is a key

    component of the Commission's and DSROs' financial surveillance

    program, as it represents that an independent entity has conducted an

    audit following U.S. generally accepted auditing standards for the

    purpose of expressing an opinion on the financial statements of the

    FCM. Requiring standalone FCMs to submit the certified financial

    statements within 60 days of the firm's year-end date will allow

    Commission and DSRO staff to review the financial statements on a more

    timely basis to identify and address accounting or auditing issues that

    may impact the financial condition of the FCM.

    In addition, the Commission notes that, pursuant to Sec.

    3.3(f)(2), the annual report of an FCM's CCO must be furnished

    electronically to the Commission simultaneously with the submission of

    Form 1-FR-FCM, as required under Sec. 1.10(b)(2)(ii); simultaneously

    with the FOCUS Report, as required under Sec. 1.10(h); or

    simultaneously with the financial condition report, as required under

    section 4s(f) of the Act, as applicable. Given the 60-day deadline

    proposed herein, the Commission is proposing a conforming amendment to

    Sec. 3.3(f)(2) to reflect the proposed 60-day deadline.

    The Commission is proposing to add a new requirement in Sec.

    1.10(b)(5) to require each FCM to file with the Commission on a monthly

    basis its balance sheet leverage ratio. FCMs currently are required to

    file the same leverage information with the NFA on a monthly basis. The

    Commission does not expect the imposition of this regulation to have

    any significant impact on the FCMs as the ratio is calculated from

    existing reported balances and already provided to NFA.

    The leverage ratio will provide information regarding the amount of

    assets supported by the FCM's capital base. The Commission views

    leverage information as an important element in assessing the financial

    condition of an FCM as a high degree of balance sheet leverage may

    indicate that the firm does not have the capital to support its

    investment decisions, particularly if such investments loose a

    significant amount of their value in a short period of time or require

    substantial margin payments or other payments to support.

    The Commission also is proposing to amend Sec. 1.10(c)(2)(i) to

    require that all monthly unaudited Forms 1-FR-FCM or FOCUS Reports be

    filed electronically with the Commission. The Commission also is

    proposing to amend Sec. 1.10(c)(2)(i) to require an FCM to file its

    certified financial statement in electronic format.

    FCMs currently file the monthly unaudited financial statements with

    the Commission using the WinJammer Online Filing System (``WinJammer'')

    electronic filing system, and the proposed amendments are simply

    codifying current practices.\29\ Annual certified financial reports

    currently are required to be filed in paper form, and are required to

    contain the manual signature of the public accountant that conducted

    the examination. Under the Commission's proposal, an FCM will use the

    WinJammer system to file its certified financial report as a ``PDF''

    document. The electronic filing of certified annual reports will ensure

    that such documents are received in a timely manner and will allow

    Commission staff to initiate prompt reviews of the public accountant's

    report to identify any accounting issues or material inadequacies that

    might have been identified during the examination. The

    [[Page 67874]]

    timely review of the certified financial statements will enhance

    customer protections as deficiencies and other accounting issues will

    be promptly identified and reviewed.

    ---------------------------------------------------------------------------

    \29\ WinJammer is a web-based application developed jointly by

    the Chicago Mercantile Exchange (``CME'') and the NFA. FCMs

    currently use WinJammer to transmit Forms 1-FR-FCM, FOCUS Reports,

    and other financial information and regulatory notices to the

    Commission and to the SROs.

    ---------------------------------------------------------------------------

    The Commission also is proposing a technical amendment to Sec.

    1.10(c)(1). Regulation 1.10(c)(1) provides that any report or

    information required to be provided to the Commission by an IB or FCM

    will be considered filed when received by the Commission Regional

    office with jurisdiction over the state in which the FCM has its

    principal place of business. To ensure that reports are filed

    expeditiously with the correct Commission Regional office, the

    Commission's proposed amendment to Sec. 1.10(c)(1) cross-references

    Sec. 140.02, which sets forth the jurisdiction of each of the

    Commission's three Regional offices.

    The Commission requests comment on all aspects the proposed

    amendments to Sec. 1.10. Specifically, the Commission requests

    comments on the following questions:

    Should other schedules in the Form 1-FR-FCM be amended to

    provide additional information to the Commission and the FCM's SROs?

    The Commission is proposing to require FCMs to submit to

    the Commission and the firm's DSRO a monthly computation of the FCM's

    balance sheet leverage. The proposal is consistent with the leverage

    computation set forth in the rules of the NFA. Are there other measures

    of leverage that the Commission should consider adopting? Are there

    other financial statement ratios in addition to leverage that the

    Commission should consider requiring FCMs to submit to the Commission

    and DSROs?

    B. Proposed Sec. 1.11: Risk Management Program for Futures Commission

    Merchants

    Proposed Sec. 1.11 requires each FCM that carries customer

    accounts \30\ to establish a risk management program designed to

    monitor and manage the risks associated with the FCM's activities as an

    FCM. It further provides: (1) That such risk management program consist

    of written policies and procedures; (2) that such policies and

    procedures be approved by the governing body of the FCM and be

    furnished to the Commission; and (3) that a risk management unit that

    is independent from the business unit be established to administer the

    risk management program.

    ---------------------------------------------------------------------------

    \30\ Proposed Sec. 1.11 contains an applicability provision in

    paragraph (a) that makes clear that the risk management program is

    only required of FCMs that accept money, securities, or property to

    margin or secure the trades or contracts of customers transacting in

    futures, options on futures, and swaps.

    ---------------------------------------------------------------------------

    Paragraph (b) of proposed Sec. 1.11 establishes definitions for

    the terms ``Customer,'' ``Customer Account,'' ``Business Unit,''

    ``Governing Body,'' ``Segregated Funds,'' and ``Senior Management.''

    ``Business Unit'' is defined to clearly delineate the separation of

    the risk management unit required by the proposed rule from the other

    personnel of an FCM.

    The term ``Customer'' is defined broadly to include futures

    customers (as defined in Sec. 1.3) trading futures contracts or

    options on futures contracts listed on designated contract markets,

    30.7 Customers (as proposed to be defined in Sec. 30.1) trading

    futures contract or options on futures contracts listed on foreign

    contract markets, and Cleared Swaps Customers (as defined in Sec.

    22.1) engaging in cleared swap transactions.

    The term ``Customer Funds'' is defined to mean funds deposited by

    futures customers, 30.7 Customers, and Cleared Swap Customers as margin

    or funds accruing to such customers from open futures or cleared swap

    transactions. Existing Commission regulations require FCMs to hold each

    of these types of customer deposited funds, as applicable, in separate

    accounts and to segregate such Customer Funds from the FCM's own funds

    and from each other type.

    The term ``Governing Body'' is defined as the sole proprietor, if

    the FCM is a sole proprietorship; a general partner, if the FCM is a

    partnership; the board of directors, if the FCM is a corporation; and

    the chief executive officer, chief financial officer, the manager, the

    managing member, or those members vested with the management authority

    if the FCM is a limited liability company or limited partnership.

    ``Senior Management'' is defined to mean any officer or officers

    specifically granted the authority and responsibility to fulfill the

    requirements of senior management by the Governing Body. These

    definitions, as used in proposed Sec. 1.11, are designed to ensure

    that there is accountability at the highest levels for the FCM's key

    internal controls and processes designed to protect the funds of the

    FCM's customers.

    The term ``Segregated Funds'' is defined to mean money, securities,

    or other property held by a futures commission merchant in separate

    accounts pursuant to Sec. 1.20 for futures customers, pursuant to

    Sec. 22.2 for cleared swaps customers, and pursuant to Sec. 30.7 for

    foreign futures and options customers. The definition makes clear that

    the requirements of Sec. 1.11 applies to all customer funds that may

    be held by an FCM.

    Proposed Sec. 1.11(c)(4) requires FCMs to provide copies of the

    risk management policies and procedures to the Commission and the FCM's

    DSRO in order to allow the Commission and DSROs to monitor the status

    of risk management practices among FCMs. Submission of such policies

    and procedures to the Commission without further comment or action by

    the Commission or Commission staff should not be construed as an

    endorsement of the completeness or effectiveness of the risk management

    policies and procedures and no FCM should make a representation to the

    contrary. The Commission invites comments on the submission of risk

    management policies and procedures and, more generally, on whether the

    provisions of Sec. 1.11 have achieved a sufficient level of detail for

    the purposes of designing a comprehensive risk management program.

    Proposed Sec. 1.11(e) provides for a non-exclusive list of the

    elements that must be a part of the risk management program of an FCM.

    Such policies and procedures should include: (1) identifying risks

    (including risks posed by affiliates, all lines of business of the FCM,

    and all other trading activity of the FCM) and setting of risk

    tolerance limits; (2) providing periodic risk exposure reports to

    senior management and the governing body; (3) operational risk

    controls; (4) capital controls; and (5) establishing a risk management

    program that takes into account risks associated with the safekeeping

    and segregation of customer funds.

    In regard to customer funds, the Commission notes that FCMs are

    required by the Act and Commission regulations to segregate and

    safeguard funds deposited by customers for trading futures and/or swap

    contracts. Recent events have emphasized that it is essential that FCMs

    maintain adequate systems of internal controls, involving the

    participation and review of the firm's senior management, in order to

    properly safeguard customer funds. Accordingly, proposed Sec.

    1.11(e)(3)(i) requires that the risk management policies and procedures

    of an FCM related to the risks associated with safekeeping and

    segregation of customer funds must include: (1) The evaluation and

    monitoring of depositories; \31\ (2)

    [[Page 67875]]

    account opening procedures that ensure the FCM obtains the

    acknowledgment required under Sec. 1.20 from the depository and that

    the account is properly titled as belonging to the customers of the

    FCM; \32\ (3) establishing and maintaining an adequate targeted amount

    of excess funds in customer accounts reasonably designed to ensure the

    FCM is at all times in compliance with the segregation requirements for

    customer funds under the Act and Commission regulations, as discussed

    further below; (4) controls ensuring that withdrawal of cash,

    securities, or other property from accounts holding customer funds not

    for the benefit of customers are in compliance with the Act and

    Commission regulations; \33\ (5) procedures for assessing the

    appropriateness of investing customer funds in accordance with Sec.

    1.25; \34\ (6) the valuation, marketability, and liquidity of customer

    funds and permitted investments made with customer funds; (7) the

    appropriate separation of duties of personnel responsible for

    compliance with the Act and Commission regulations relating to the

    protection and financial reporting of customer funds; \35\ (8)

    procedures for the timely recording of transactions in the firm's books

    and records; and (9) annual training of personnel responsible for

    compliance with the Act and Commission regulations relating to the

    protection and financial reporting of customer funds.

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    \31\ The evaluation process must include documented criteria

    that any depository will be assessed against in order to qualify to

    hold funds belonging to Customers. The criteria must address a

    depository's capitalization, creditworthiness, operational

    reliability, access to liquidity. The criteria must also address

    risks associated with concentration of Customer funds in any

    depository or group of depositories, the availability of deposit

    insurance, and the regulation and supervision of depositories. The

    evaluation criteria is intended to ensure that the FCM adopts an

    evaluation process which reviews potential depositories against

    substantive criteria relevant to the safe custody of Customer funds

    and that the FCM's process for evaluating and selecting depositories

    can be reviewed by regulators and auditors. The FCM also must

    maintain a documented process addressing the ongoing monitoring of

    selected depositories, including a thorough due diligence review of

    each depository at least annually.

    \32\ As required by Sec. 1.20, such account opening

    documentation is necessary to ensure that the depositories are aware

    of their obligations regarding the accounts and the statutory and

    regulatory protections afforded the funds held in the accounts due

    to their status as Segregated Funds.

    \33\ The controls must include the conditions for pre-approval

    and the notice to the Commission for such withdrawals required by

    proposed Sec. 1.23, Sec. 22.17, or Sec. 30.7, discussed below.

    \34\ The FCM's assessment must take into consideration the

    market, credit, counterparty, operational, and liquidity risks

    associated with the investments.

    \35\ The policies and procedures must provide for the separation

    of duties among personnel that are responsible for customer trading

    activities, and approving and overseeing cash receipts and

    disbursements (including investment and treasury operations). The

    policies and procedures must further require that any movement of

    funds to affiliated companies or parties be approved and documented.

    ---------------------------------------------------------------------------

    Regarding the proposed requirement that FCMs establish and maintain

    an adequate targeted amount of excess funds in customer accounts, the

    Commission notes that FCMs currently deposit proprietary funds into

    both customer segregated accounts and Part 30 secured accounts as a

    buffer to minimize the possibility of the firm being in violation of

    its segregated and secured fund obligations at any time. Under the

    proposal, senior management of the FCM must perform appropriate due

    diligence in setting the amount of this buffer and must consider the

    nature of the FCM's business including the type and general

    creditworthiness of its customer base, the types of markets and

    products traded by the firm's customers, the proprietary trading

    activities of the FCM, the volatility and liquidity of the markets and

    products traded by the customers and the FCM, the FCM's own liquidity

    and capital needs, and historical trends in customer segregation and

    secured account funds balances, customer debits and margin deficits.

    The FCM also must reassess the adequacy of the targeted residual

    interest quarterly.

    The Commission believes that each FCM must set the amount of excess

    segregated and secured funds required utilizing a quantitative and

    qualitative analysis that reasonably ensures compliance at all times

    with segregated and secured fund obligations. Such analysis must take

    into account the various factors that could affect segregated and

    secured balances, and must be sufficiently described in writing to

    allow the DSRO of the FCM and Commission to duplicate the calculations

    and test the assumptions. The analysis must provide a reasonable level

    of assurance that the excess is at an appropriate level for the

    FCM.\36\ A failure to adopt or maintain appropriate risk management

    policies and procedures or to implement, monitor and enforce controls

    required by Sec. 1.11 may result in a referral to the Commission's

    Division of Enforcement for appropriate action.

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    \36\ Separate from requiring the establishment of a target for

    residual interest, the Commission is further requiring, as discussed

    in more detail under Sections II.G, II.H, and II.I for Sec. Sec.

    1.20, 1.22, and 1.23, respectively, that residual interest at all

    times exceed the sum of outstanding margin deficits to provide a

    mechanism for ensuring compliance with the prohibition of the funds

    of one customer being used to margin or guarantee the positions of

    another customer under the Act and existing regulations.

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    Finally, to ensure the effectiveness of a risk management program,

    Sec. 1.11(e)(4) requires that the risk management program include a

    supervisory system that is reasonably designed to ensure that the risk

    management policies and procedures are diligently followed.

    Furthermore, Sec. 1.11(f) requires an annual review and testing of the

    adequacy of each FCM's risk management program by internal audit staff

    or a qualified external, third party service.

    The Commission requests comment on all aspects of proposed Sec.

    1.11. Specifically, the Commission requests comment on the following:

    Should the Commission have different risk management

    requirements for FCMs based upon some measureable criteria, such as

    size of the firm or type of customers? How would the Commission design

    such criteria to distinguish between firms? Which elements in proposed

    Sec. 1.11 should apply to smaller FCMs vs. larger FCMs? What elements

    should apply to all FCMs irrespective of the size of the firm?

    Does the proposed risk management program address the

    appropriate minimum elements that should be covered by an FCM risk

    management program?

    Regulation 3.3 requires the CCO of an FCM to provide an

    annual report to the Commission that must review each applicable

    requirement under the Act and Commission regulations, and with respect

    to each applicable requirement, identify the policies and procedures

    that are reasonably designed to ensure compliance with the requirement,

    and provide an assessment of the effectiveness of the policies and

    procedures.\37\ The annual report also must include a certification by

    the CCO that, to the best of his or her knowledge and reasonable

    belief, and under penalty of law, the information contained in the

    annual report is accurate and complete. The Commission requests comment

    on whether the standard for the CCO's certification in the annual

    report (i.e., based upon the CCO's knowledge and reasonable belief) is

    adequate for a certification of the FCM's compliance with policies and

    procedures for the safeguarding of customer funds. Should Sec. 1.11

    contain a separate CCO certification requirement

    [[Page 67876]]

    that would impose a higher duty of strict liability or some other

    higher obligation on a CCO?

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    \37\ Such report is mandated by Sec. 3.3 of the Commission's

    regulations; See Swap Dealer and Major Swap Participant

    Recordkeeping, Reporting, and Duties Rules; Futures Commission

    Merchant and Introducing Broker Conflicts of Interest Rules; and

    Chief Compliance Officer Rules for Swap Dealers, Major Swap

    Participants, and Futures Commission Merchants, 77 FR 20128, Apr. 3,

    2012 (promulgating final rules concerning the CCOs of FCMs, swap

    dealers, and major swap participants); see also Sec. 4d(d) of the

    Act, 7 U.S.C. 6d(d).

    ---------------------------------------------------------------------------

    Should the risk management program require an FCM to

    conduct quarterly or periodic audits to detect any breach of the

    policies and procedures that address the proper segregation of customer

    funds?

    Should the Commission establish a phased-in compliance

    provision for Sec. 1.11? If so, how long of a phase-in period should

    be provided? Should there be different phase-in periods for different

    provisions of the proposed regulation?

    C. Proposed Amendments to Sec. 1.12: Maintenance of Minimum Financial

    Requirements by Futures Commission Merchants and Introducing Brokers

    The regulatory notices required under Sec. 1.12 are intended to

    provide the Commission and SROs with prompt notice of potential adverse

    conditions at FCMs or IBs that may indicate or lead to a threat to the

    financial condition of the firm or the protection of customer funds

    held by the FCM. In adopting Sec. 1.12 in 1978, the Commission stated

    that the establishment of an early warning system was necessary because

    ``[a] fundamental purpose of the Act is to protect the public from

    financially irresponsible FCMs who handle customer funds.'' \38\

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    \38\ 43 FR 39956, 39967 (Sept. 8, 1978).

    ---------------------------------------------------------------------------

    Regulation 1.12 currently obligates FCMs and IBs to provide notice

    to the Commission and to the respective DSROs if certain specified

    reportable events occur. Reportable events include: failing to maintain

    the minimum level of required regulatory capital (Sec. 1.12 (a));

    failing to maintain current books and records (Sec. 1.12(c)); and

    failing to comply with the requirements to properly segregate customer

    funds (Sec. 1.12(h)). The Commission is proposing to amend Sec. 1.12

    to include several additional reportable events and to revise the

    process for submitting reportable events to the Commission and DSROs.

    Regulation 1.12(a) requires an FCM or IB that fails to maintain the

    minimum level of adjusted net capital required by Sec. 1.17 to provide

    immediate notice to the Commission and to the entity's DSRO. The notice

    must include additional information to adequately reflect the FCM's or

    IB's current capital condition as of any date that the entity is

    undercapitalized.

    The Commission is proposing to amend Sec. 1.12(a) to explicitly

    provide that if the FCM or IB cannot compute or document its actual

    capital at the time it knows that it is undercapitalized, it must still

    provide the written notice required by Sec. 1.12(a) immediately and

    cannot delay filing the notice until it has adequate information to

    compute its actual level of adjusted net capital. A purpose of the

    notice provision under Sec. 1.12(a) is to provide the Commission and

    the DSROs with immediate notice of the undercapitalized condition of an

    FCM or IB. If an FCM or IB were to delay alerting the Commission that

    it was undercapitalized due to the fact that it could not accurately

    assess its capital condition, it would frustrate the intent of the

    notice provision. It is imperative that an FCM or IB provide immediate

    notice if the firm is undercapitalized. Upon the filing of a notice,

    Commission and SRO staff will contact the FCM or IB to obtain greater

    details of the financial condition of the firm, including information

    regarding its current financial condition or issues associated with the

    firm's inability to accurately determine its current financial

    condition.

    Regulation 1.12(h) currently requires an FCM that fails to hold

    sufficient funds in segregated accounts to meet its obligations to

    futures customers, or that fails to hold sufficient funds in separate

    accounts for foreign futures or foreign options customers, to provide

    immediate notice to the Commission and to the FCM's DSRO. The

    Commission is proposing to amend paragraph (h) to include an explicit

    requirement that an FCM provide immediate notice to the Commission and

    to its DSRO if the FCM fails to hold sufficient funds in segregated

    accounts for Cleared Swaps Customers to meet its obligation to such

    customers.

    Commencing November 8, 2012, the compliance date for certain

    Commission Part 22 regulations, FCMs will be required under Sec. 22.2

    to hold a sufficient amount of funds in Cleared Swital numbers and

    other financial information including the Segregation Schedules and the

    Secured Amount Schedules contained in the financial reports. The

    Commission is proposing to amend Sec. 1.10(g)(2) to provide that the

    Cleared Swaps Segregation Schedule is a public document in the same

    manner as the Segregation Schedule and Secured Amount Schedule, and is

    available by requesting copies from the Commission.

    Making the Cleared Swaps Segregation Schedule publicly available

    will benefit customers and potential customers by allowing them to

    review an FCM's compliance with its regulatory obligations and will

    provide a certain amount of detail as to how the FCM holds customer

    funds, which customers and potential customers will be able to assess

    from a risk perspective and also use to compare to other firms. This

    information, coupled with additional firm risk disclosures that the

    Commission is proposing in Sec. 1.55 and discussed in detail in

    Section II.P below, will provide customers with greater transparency

    regarding the risks of entrusting their funds and engaging in

    transactions with particular FCMs. Customers also will be able to view

    the total amount of the targeted residual interest each FCM holds and

    to assess for themselves the adequacy of the targeted residual interest

    and whether the FCM holds funds in excess of the targeted residual

    interest.

    The Commission also is proposing to amend several statements in the

    Form 1-FR-FCM. The Commission is proposing to amend the Statement of

    Financial Condition by adding a new line item 1.D. Line 1 currently

    separately details the amount of funds in segregation or separate

    accounts for futures customers and foreign futures or foreign option

    customers. Proposed line item 1.D. will set forth the amount of funds

    held by the FCM in segregated accounts for Cleared Swaps Customers.

    This amendment is necessary due to the adoption of the Part 22

    regulations, which require the segregation of Cleared Swaps Customer

    Collateral and the proposed adoption of the Cleared Swaps Segregation

    Schedule as part of the Form 1-FR-FCM.

    The Commission also is proposing to amend the Statement of

    Financial Condition by adding a new line item 22.F., which requires the

    separate disclosure of the FCM's liability to Cleared Swaps Customers.

    The Commission also is proposing to revise current line item 27.J. to

    require the FCM to disclose its obligation to retail forex customers.

    Currently, an FCM's obligation to retail forex customers is included

    with other miscellaneous liabilities and reported under current line

    item 27.J. ``Other.'' The separate reporting of an FCM's retail forex

    obligation will provide greater transparency on the Statement of

    Financial Condition regarding the firm's obligations to its retail

    counterparties in off-exchange foreign currency transactions, and is

    appropriate given the Commission's direct jurisdiction over such

    activities under section 2(c) of the Act when conducted by an FCM.

    The Commission also is proposing to amend Sec. 1.10(b)(1)(ii) to

    require that an FCM submit its certified annual report to the

    Commission and to its DSRO within 60 days of its year-end date.

    Currently, an FCM is required to submit the annual certified financial

    statements within 90 days of the firm's year-end date, except for FCMs

    that are dually-registered as FCM/BDs, which are require to submit the

    certified annual report within 60 days of the year-end date under both

    Commission and SEC regulations. Therefore, the proposal will only

    impact FCMs that are not dually-registered as BDs.

    The proposal will align the filing deadlines for both FCMs and dual

    registrant FCMs/BDs. The annual certified financial report is a key

    component of the Commission's and DSROs' financial surveillance

    program, as it represents that an independent entity has conducted an

    audit following U.S. generally accepted auditing standards for the

    purpose of expressing an opinion on the financial statements of the

    FCM. Requiring standalone FCMs to submit the certified financial

    statements within 60 days of the firm's year-end date will allow

    Commission and DSRO staff to review the financial statements on a more

    timely basis to identify and address accounting or auditing issues that

    may impact the financial condition of the FCM.

    In addition, the Commission notes that, pursuant to Sec.

    3.3(f)(2), the annual report of an FCM's CCO must be furnished

    electronically to the Commission simultaneously with the submission of

    Form 1-FR-FCM, as required under Sec. 1.10(b)(2)(ii); simultaneously

    with the FOCUS Report, as required under Sec. 1.10(h); or

    simultaneously with the financial condition report, as required under

    section 4s(f) of the Act, as applicable. Given the 60-day deadline

    proposed herein, the Commission is proposing a conforming amendment to

    Sec. 3.3(f)(2) to reflect the proposed 60-day deadline.

    The Commission is proposing to add a new requirement in Sec.

    1.10(b)(5) to require each FCM to file with the Commission on a monthly

    basis its balance sheet leverage ratio. FCMs currently are required to

    file the same leverage information with the NFA on a monthly basis. The

    Commission does not expect the imposition of this regulation to have

    any significant impact on the FCMs as the ratio is calculated from

    existing reported balances and already provided to NFA.

    The leverage ratio will provide information regarding the amount of

    assets supported by the FCM's capital base. The Commission views

    leverage information as an important element in assessing the financial

    condition of an FCM as a high degree of balance sheet leverage may

    indicate that the firm does not have the capital to support its

    investment decisions, particularly if such investments loose a

    significant amount of their value in a short period of time or require

    substantial margin payments or other payments to support.

    The Commission also is proposing to amend Sec. 1.10(c)(2)(i) to

    require that all monthly unaudited Forms 1-FR-FCM or FOCUS Reports be

    filed electronically with the Commission. The Commission also is

    proposing to amend Sec. 1.10(c)(2)(i) to require an FCM to file its

    certified financial statement in electronic format.

    FCMs currently file the monthly unaudited financial statements with

    the Commission using the WinJammer Online Filing System (``WinJammer'')

    electronic filing system, and the proposed amendments are simply

    codifying current practices.\29\ Annual certified financial reports

    currently are required to be filed in paper form, and are required to

    contain the manual signature of the public accountant that conducted

    the examination. Under the Commission's proposal, an FCM will use the

    WinJammer system to file its certified financial report as a ``PDF''

    document. The electronic filing of certified annual reports will ensure

    that such documents are received in a timely manner and will allow

    Commission staff to initiate prompt reviews of the public accountant's

    report to identify any accounting issues or material inadequacies that

    might have been identified during the examination. The

    [[Page 67874]]

    timely review of the certified financial statements will enhance

    customer protections as deficiencies and other accounting issues will

    be promptly identified and reviewed.

    ---------------------------------------------------------------------------

    \29\ WinJammer is a web-based application developed jointly by

    the Chicago Mercantile Exchange (``CME'') and the NFA. FCMs

    currently use WinJammer to transmit Forms 1-FR-FCM, FOCUS Reports,

    and other financial information and regulatory notices to the

    Commission and to the SROs.

    ---------------------------------------------------------------------------

    The Commission also is proposing a technical amendment to Sec.

    1.10(c)(1). Regulation 1.10(c)(1) provides that any report or

    information required to be provided to the Commission by an IB or FCM

    will be considered filed when received by the Commission Regional

    office with jurisdiction over the state in which the FCM has its

    principal place of business. To ensure that reports are filed

    expeditiously with the correct Commission Regional office, the

    Commission's proposed amendment to Sec. 1.10(c)(1) cross-references

    Sec. 140.02, which sets forth the jurisdiction of each of the

    Commission's three Regional offices.

    The Commission requests comment on all aspects the proposed

    amendments to Sec. 1.10. Specifically, the Commission requests

    comments on the following questions:

    Should other schedules in the Form 1-FR-FCM be amended to

    provide additional information to the Commission and the FCM's SROs?

    The Commission is proposing to require FCMs to submit to

    the Commission and the firm's DSRO a monthly computation of the FCM's

    balance sheet leverage. The proposal is consistent with the leverage

    computation set forth in the rules of the NFA. Are there other measures

    of leverage that the Commission should consider adopting? Are there

    other financial statement ratios in addition to leverage that the

    Commission should consider requiring FCMs to submit to the Commission

    and DSROs?

    B. Proposed Sec. 1.11: Risk Management Program for Futures Commission

    Merchants

    Proposed Sec. 1.11 requires each FCM that carries customer

    accounts \30\ to establish a risk management program designed to

    monitor and manage the risks associated with the FCM's activities as an

    FCM. It further provides: (1) That such risk management program consist

    of written policies and procedures; (2) that such policies and

    procedures be approved by the governing body of the FCM and be

    furnished to the Commission; and (3) that a risk management unit that

    is independent from the business unit be established to administer the

    risk management program.

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    \30\ Proposed Sec. 1.11 contains an applicability provision in

    paragraph (a) that makes clear that the risk management program is

    only required of FCMs that accept money, securities, or property to

    margin or secure the trades or contracts of customers transacting in

    futures, options on futures, and swaps.

    ---------------------------------------------------------------------------

    Paragraph (b) of proposed Sec. 1.11 establishes definitions for

    the terms ``Customer,'' ``Customer Account,'' ``Business Unit,''

    ``Governing Body,'' ``Segregated Funds,'' and ``Senior Management.''

    ``Business Unit'' is defined to clearly delineate the separation of

    the risk management unit required by the proposed rule from the other

    personnel of an FCM.

    The term ``Customer'' is defined broadly to include futures

    customers (as defined in Sec. 1.3) trading futures contracts or

    options on futures contracts listed on designated contract markets,

    30.7 Customers (as proposed to be defined in Sec. 30.1) trading

    futures contract or options on futures contracts listed on foreign

    contract markets, and Cleared Swaps Customers (as defined in Sec.

    22.1) engaging in cleared swap transactions.

    The term ``Customer Funds'' is defined to mean funds deposited by

    futures customers, 30.7 Customers, and Cleared Swap Customers as margin

    or funds accruing to such customers from open futures or cleared swap

    transactions. Existing Commission regulations require FCMs to hold each

    of these types of customer deposited funds, as applicable, in separate

    accounts and to segregate such Customer Funds from the FCM's own funds

    and from each other type.

    The term ``Governing Body'' is defined as the sole proprietor, if

    the FCM is a sole proprietorship; a general partner, if the FCM is a

    partnership; the board of directors, if the FCM is a corporation; and

    the chief executive officer, chief financial officer, the manager, the

    managing member, or those members vested with the management authority

    if the FCM is a limited liability company or limited partnership.

    ``Senior Management'' is defined to mean any officer or officers

    specifically granted the authority and responsibility to fulfill the

    requirements of senior management by the Governing Body. These

    definitions, as used in proposed Sec. 1.11, are designed to ensure

    that there is accountability at the highest levels for the FCM's key

    internal controls and processes designed to protect the funds of the

    FCM's customers.

    The term ``Segregated Funds'' is defined to mean money, securities,

    or other property held by a futures commission merchant in separate

    accounts pursuant to Sec. 1.20 for futures customers, pursuant to

    Sec. 22.2 for cleared swaps customers, and pursuant to Sec. 30.7 for

    foreign futures and options customers. The definition makes clear that

    the requirements of Sec. 1.11 applies to all customer funds that may

    be held by an FCM.

    Proposed Sec. 1.11(c)(4) requires FCMs to provide copies of the

    risk management policies and procedures to the Commission and the FCM's

    DSRO in order to allow the Commission and DSROs to monitor the status

    of risk management practices among FCMs. Submission of such policies

    and procedures to the Commission without further comment or action by

    the Commission or Commission staff should not be construed as an

    endorsement of the completeness or effectiveness of the risk management

    policies and procedures and no FCM should make a representation to the

    contrary. The Commission invites comments on the submission of risk

    management policies and procedures and, more generally, on whether the

    provisions of Sec. 1.11 have achieved a sufficient level of detail for

    the purposes of designing a comprehensive risk management program.

    Proposed Sec. 1.11(e) provides for a non-exclusive list of the

    elements that must be a part of the risk management program of an FCM.

    Such policies and procedures should include: (1) identifying risks

    (including risks posed by affiliates, all lines of business of the FCM,

    and all other trading activity of the FCM) and setting of risk

    tolerance limits; (2) providing periodic risk exposure reports to

    senior management and the governing body; (3) operational risk

    controls; (4) capital controls; and (5) establishing a risk management

    program that takes into account risks associated with the safekeeping

    and segregation of customer funds.

    In regard to customer funds, the Commission notes that FCMs are

    required by the Act and Commission regulations to segregate and

    safeguard funds deposited by customers for trading futures and/or swap

    contracts. Recent events have emphasized that it is essential that FCMs

    maintain adequate systems of internal controls, involving the

    participation and review of the firm's senior management, in order to

    properly safeguard customer funds. Accordingly, proposed Sec.

    1.11(e)(3)(i) requires that the risk management policies and procedures

    of an FCM related to the risks associated with safekeeping and

    segregation of customer funds must include: (1) The evaluation and

    monitoring of depositories; \31\ (2)

    [[Page 67875]]

    account opening procedures that ensure the FCM obtains the

    acknowledgment required under Sec. 1.20 from the depository and that

    the account is properly titled as belonging to the customers of the

    FCM; \32\ (3) establishing and maintaining an adequate targeted amount

    of excess funds in customer accounts reasonably designed to ensure the

    FCM is at all times in compliance with the segregation requirements for

    customer funds under the Act and Commission regulations, as discussed

    further below; (4) controls ensuring that withdrawal of cash,

    securities, or other property from accounts holding customer funds not

    for the benefit of customers are in compliance with the Act and

    Commission regulations; \33\ (5) procedures for assessing the

    appropriateness of investing customer funds in accordance with Sec.

    1.25; \34\ (6) the valuation, marketability, and liquidity of customer

    funds and permitted investments made with customer funds; (7) the

    appropriate separation of duties of personnel responsible for

    compliance with the Act and Commission regulations relating to the

    protection and financial reporting of customer funds; \35\ (8)

    procedures for the timely recording of transactions in the firm's books

    and records; and (9) annual training of personnel responsible for

    compliance with the Act and Commission regulations relating to the

    protection and financial reporting of customer funds.

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    \31\ The evaluation process must include documented criteria

    that any depository will be assessed against in order to qualify to

    hold funds belonging to Customers. The criteria must address a

    depository's capitalization, creditworthiness, operational

    reliability, access to liquidity. The criteria must also address

    risks associated with concentration of Customer funds in any

    depository or group of depositories, the availability of deposit

    insurance, and the regulation and supervision of depositories. The

    evaluation criteria is intended to ensure that the FCM adopts an

    evaluation process which reviews potential depositories against

    substantive criteria relevant to the safe custody of Customer funds

    and that the FCM's process for evaluating and selecting depositories

    can be reviewed by regulators and auditors. The FCM also must

    maintain a documented process addressing the ongoing monitoring of

    selected depositories, including a thorough due diligence review of

    each depository at least annually.

    \32\ As required by Sec. 1.20, such account opening

    documentation is necessary to ensure that the depositories are aware

    of their obligations regarding the accounts and the statutory and

    regulatory protections afforded the funds held in the accounts due

    to their status as Segregated Funds.

    \33\ The controls must include the conditions for pre-approval

    and the notice to the Commission for such withdrawals required by

    proposed Sec. 1.23, Sec. 22.17, or Sec. 30.7, discussed below.

    \34\ The FCM's assessment must take into consideration the

    market, credit, counterparty, operational, and liquidity risks

    associated with the investments.

    \35\ The policies and procedures must provide for the separation

    of duties among personnel that are responsible for customer trading

    activities, and approving and overseeing cash receipts and

    disbursements (including investment and treasury operations). The

    policies and procedures must further require that any movement of

    funds to affiliated companies or parties be approved and documented.

    ---------------------------------------------------------------------------

    Regarding the proposed requirement that FCMs establish and maintain

    an adequate targeted amount of excess funds in customer accounts, the

    Commission notes that FCMs currently deposit proprietary funds into

    both customer segregated accounts and Part 30 secured accounts as a

    buffer to minimize the possibility of the firm being in violation of

    its segregated and secured fund obligations at any time. Under the

    proposal, senior management of the FCM must perform appropriate due

    diligence in setting the amount of this buffer and must consider the

    nature of the FCM's business including the type and general

    creditworthiness of its customer base, the types of markets and

    products traded by the firm's customers, the proprietary trading

    activities of the FCM, the volatility and liquidity of the markets and

    products traded by the customers and the FCM, the FCM's own liquidity

    and capital needs, and historical trends in customer segregation and

    secured account funds balances, customer debits and margin deficits.

    The FCM also must reassess the adequacy of the targeted residual

    interest quarterly.

    The Commission believes that each FCM must set the amount of excess

    segregated and secured funds required utilizing a quantitative and

    qualitative analysis that reasonably ensures compliance at all times

    with segregated and secured fund obligations. Such analysis must take

    into account the various factors that could affect segregated and

    secured balances, and must be sufficiently described in writing to

    allow the DSRO of the FCM and Commission to duplicate the calculations

    and test the assumptions. The analysis must provide a reasonable level

    of assurance that the excess is at an appropriate level for the

    FCM.\36\ A failure to adopt or maintain appropriate risk management

    policies and procedures or to implement, monitor and enforce controls

    required by Sec. 1.11 may result in a referral to the Commission's

    Division of Enforcement for appropriate action.

    ---------------------------------------------------------------------------

    \36\ Separate from requiring the establishment of a target for

    residual interest, the Commission is further requiring, as discussed

    in more detail under Sections II.G, II.H, and II.I for Sec. Sec.

    1.20, 1.22, and 1.23, respectively, that residual interest at all

    times exceed the sum of outstanding margin deficits to provide a

    mechanism for ensuring compliance with the prohibition of the funds

    of one customer being used to margin or guarantee the positions of

    another customer under the Act and existing regulations.

    ---------------------------------------------------------------------------

    Finally, to ensure the effectiveness of a risk management program,

    Sec. 1.11(e)(4) requires that the risk management program include a

    supervisory system that is reasonably designed to ensure that the risk

    management policies and procedures are diligently followed.

    Furthermore, Sec. 1.11(f) requires an annual review and testing of the

    adequacy of each FCM's risk management program by internal audit staff

    or a qualified external, third party service.

    The Commission requests comment on all aspects of proposed Sec.

    1.11. Specifically, the Commission requests comment on the following:

    Should the Commission have different risk management

    requirements for FCMs based upon some measureable criteria, such as

    size of the firm or type of customers? How would the Commission design

    such criteria to distinguish between firms? Which elements in proposed

    Sec. 1.11 should apply to smaller FCMs vs. larger FCMs? What elements

    should apply to all FCMs irrespective of the size of the firm?

    Does the proposed risk management program address the

    appropriate minimum elements that should be covered by an FCM risk

    management program?

    Regulation 3.3 requires the CCO of an FCM to provide an

    annual report to the Commission that must review each applicable

    requirement under the Act and Commission regulations, and with respect

    to each applicable requirement, identify the policies and procedures

    that are reasonably designed to ensure compliance with the requirement,

    and provide an assessment of the effectiveness of the policies and

    procedures.\37\ The annual report also must include a certification by

    the CCO that, to the best of his or her knowledge and reasonable

    belief, and under penalty of law, the information contained in the

    annual report is accurate and complete. The Commission requests comment

    on whether the standard for the CCO's certification in the annual

    report (i.e., based upon the CCO's knowledge and reasonable belief) is

    adequate for a certification of the FCM's compliance with policies and

    procedures for the safeguarding of customer funds. Should Sec. 1.11

    contain a separate CCO certification requirement

    [[Page 67876]]

    that would impose a higher duty of strict liability or some other

    higher obligation on a CCO?

    ---------------------------------------------------------------------------

    \37\ Such report is mandated by Sec. 3.3 of the Commission's

    regulations; See Swap Dealer and Major Swap Participant

    Recordkeeping, Reporting, and Duties Rules; Futures Commission

    Merchant and Introducing Broker Conflicts of Interest Rules; and

    Chief Compliance Officer Rules for Swap Dealers, Major Swap

    Participants, and Futures Commission Merchants, 77 FR 20128, Apr. 3,

    2012 (promulgating final rules concerning the CCOs of FCMs, swap

    dealers, and major swap participants); see also Sec. 4d(d) of the

    Act, 7 U.S.C. 6d(d).

    ---------------------------------------------------------------------------

    Should the risk management program require an FCM to

    conduct quarterly or periodic audits to detect any breach of the

    policies and procedures that address the proper segregation of customer

    funds?

    Should the Commission establish a phased-in compliance

    provision for Sec. 1.11? If so, how long of a phase-in period should

    be provided? Should there be different phase-in periods for different

    provisions of the proposed regulation?

    C. Proposed Amendments to Sec. 1.12: Maintenance of Minimum Financial

    Requirements by Futures Commission Merchants and Introducing Brokers

    The regulatory notices required under Sec. 1.12 are intended to

    provide the Commission and SROs with prompt notice of potential adverse

    conditions at FCMs or IBs that may indicate or lead to a threat to the

    financial condition of the firm or the protection of customer funds

    held by the FCM. In adopting Sec. 1.12 in 1978, the Commission stated

    that the establishment of an early warning system was necessary because

    ``[a] fundamental purpose of the Act is to protect the public from

    financially irresponsible FCMs who handle customer funds.'' \38\

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    \38\ 43 FR 39956, 39967 (Sept. 8, 1978).

    ---------------------------------------------------------------------------

    Regulation 1.12 currently obligates FCMs and IBs to provide notice

    to the Commission and to the respective DSROs if certain specified

    reportable events occur. Reportable events include: failing to maintain

    the minimum level of required regulatory capital (Sec. 1.12 (a));

    failing to maintain current books and records (Sec. 1.12(c)); and

    failing to comply with the requirements to properly segregate customer

    funds (Sec. 1.12(h)). The Commission is proposing to amend Sec. 1.12

    to include several additional reportable events and to revise the

    process for submitting reportable events to the Commission and DSROs.

    Regulation 1.12(a) requires an FCM or IB that fails to maintain the

    minimum level of adjusted net capital required by Sec. 1.17 to provide

    immediate notice to the Commission and to the entity's DSRO. The notice

    must include additional information to adequately reflect the FCM's or

    IB's current capital condition as of any date that the entity is

    undercapitalized.

    The Commission is proposing to amend Sec. 1.12(a) to explicitly

    provide that if the FCM or IB cannot compute or document its actual

    capital at the time it knows that it is undercapitalized, it must still

    provide the written notice required by Sec. 1.12(a) immediately and

    cannot delay filing the notice until it has adequate information to

    compute its actual level of adjusted net capital. A purpose of the

    notice provision under Sec. 1.12(a) is to provide the Commission and

    the DSROs with immediate notice of the undercapitalized condition of an

    FCM or IB. If an FCM or IB were to delay alerting the Commission that

    it was undercapitalized due to the fact that it could not accurately

    assess its capital condition, it would frustrate the intent of the

    notice provision. It is imperative that an FCM or IB provide immediate

    notice if the firm is undercapitalized. Upon the filing of a notice,

    Commission and SRO staff will contact the FCM or IB to obtain greater

    details of the financial condition of the firm, including information

    regarding its current financial condition or issues associated with the

    firm's inability to accurately determine its current financial

    condition.

    Regulation 1.12(h) currently requires an FCM that fails to hold

    sufficient funds in segregated accounts to meet its obligations to

    futures customers, or that fails to hold sufficient funds in separate

    accounts for foreign futures or foreign options customers, to provide

    immediate notice to the Commission and to the FCM's DSRO. The

    Commission is proposing to amend paragraph (h) to include an explicit

    requirement that an FCM provide immediate notice to the Commission and

    to its DSRO if the FCM fails to hold sufficient funds in segregated

    accounts for Cleared Swaps Customers to meet its obligation to such

    customers.

    Commencing November 8, 2012, the compliance date for certain

    Commission Part 22 regulations, FCMs will be required under Sec. 22.2

    to hold a sufficient amount of funds in Cleared Swaps Customer Accounts

    to meet the Net Liquidating Equity of each Cleared Swaps Customer.\39\

    Immediate notification of a failure to hold sufficient funds in

    segregation for Cleared Swaps Customers is essential for the Commission

    and DSROs to promptly assess the financial condition of an FCM and to

    determine if there are threats to the safety of the Cleared Swaps

    Customers' funds held by the FCM. The proposed amendment to Sec.

    1.12(h) also harmonizes the notice requirements whenever an FCM fails

    to hold sufficient funds for futures customers, 30.7 Customers, and

    Cleared Swaps Customers.

    ---------------------------------------------------------------------------

    \39\ 77 FR 6336 (Feb. 7, 2012).

    ---------------------------------------------------------------------------

    The Commission also is proposing to amend Sec. 1.12 by adding new

    paragraph (i) to require an FCM to provide notice whenever it discovers

    or is informed that it has invested funds held for customers in

    investments that are not permitted investments under Sec. 1.25, or if

    the FCM holds permitted investments in a manner that is not in

    compliance with the provisions of Sec. 1.25 (such as the investment

    concentration limits). The proposal will apply to funds held for

    futures customers, 30.7 Customers, and Cleared Swaps Customers.

    The protection of customer funds is a core element of the

    Commission's regulatory program. FCMs are entrusted with a

    responsibility to use customer funds only for the benefit of the

    depositing customers.\40\ FCMs are permitted, however, to invest

    customer funds pursuant to the standards and conditions set forth in

    Sec. 1.25. Regulation 1.25 contains a list of permitted investments

    and other criteria that are intended to allow an FCM to receive the

    benefit of investing customer funds while also preserving the principal

    and maintaining the liquidity of the customer funds.

    ---------------------------------------------------------------------------

    \40\ Regulation 1.20(a), 17 CFR 1.20(a).

    ---------------------------------------------------------------------------

    Requiring an FCM to provide prompt notice of a Sec. 1.25 violation

    will allow Commission and DSRO staff to assess whether customer funds

    are endangered and to work with the FCM to ensure that the

    impermissible investments are appropriately liquidated and customer

    funds remain intact. Commission and DSRO staff also will benefit from

    receiving notices of Sec. 1.25 violations in that the notices will

    provide information regarding new investments that FCMs may engage in

    that are not permitted investments under Sec. 1.25. Such information

    will be helpful for the Commission and DSRO in conducting reviews of

    other FCMs and in providing regulatory updates to the industry.\41\

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    \41\ The Commission further notes that investing customer funds

    in investments that are not permitted investments under Sec. 1.25,

    or holding investments in a manner that is otherwise not compliant

    with Sec. 1.25 does not change the legal status of the funds as

    customer funds in the event of the bankruptcy of the FCM.

    ---------------------------------------------------------------------------

    The Commission also is proposing to amend Sec. 1.12 to provide a

    new paragraph (j) that will require an FCM to provide immediate notice

    to the Commission and to the firm's DSRO if the FCM does not hold an

    amount of funds in segregated accounts for futures customers or for

    Cleared Swaps Customers, or if the FCM does not hold sufficient funds

    in separate accounts for 30.7 Customers, sufficient to meet the firm's

    targeted residual interest in one or more of these accounts as computed

    [[Page 67877]]

    under proposed Sec. 1.11, or if its residual interest in one or more

    of these accounts is less than the sum of outstanding margin deficits

    for such accounts. Proposed Sec. 1.11 will require each FCM that

    carries customer funds to calculate an appropriate amount of excess

    funds (i.e., proprietary funds) to hold in segregated or secured

    accounts to mitigate the FCM from being undersegregated or undersecured

    due to a withdrawal of proprietary funds from a segregated or secured

    account. The fact that an FCM is not holding a sufficient amount of

    excess funds in customer accounts to meet its targeted residual

    interest may be indicative of more severe financial or operational

    issues at the firm. In addition, if an FCM's residual interest is less

    than the sum of outstanding margin deficits in one such account, it is

    possible that funds of one customer in such account are at risk of

    margining or guaranteeing the open positions of another customer.

    Accordingly, the Commission is proposing to require an FCM to file

    immediate notice of such an event to allow Commission and DSRO staff to

    contact the FCM to assess the condition of the firm and the safety of

    customer funds.

    The Commission also is proposing new paragraphs (k) and (l) for

    Sec. 1.12. Paragraphs (k) and (l) will require an FCM to provide

    notice to the Commission and to the firm's DSRO in the event of a

    material adverse impact in the financial condition of the firm or a

    material change in the firm's operations. Proposed paragraph (k) will

    require an FCM to provide immediate notice if the FCM, its parent, or a

    material affiliate, experiences a material adverse impact to its

    creditworthiness or its ability to fund its obligations. Indications of

    a material adverse impact of an FCM's creditworthiness may include a

    bank or other financing entity withdrawing credit facilities, a credit

    rating downgrade, or the FCM being placed on ``credit watch'' by a

    credit rating agency. Proposed paragraph (l) will require an FCM to

    provide immediate notice of material changes in the operations of the

    firm, including: A change in senior management; the establishment or

    termination of a material line of business; a material change in the

    FCM's clearing arrangements; or a material change in the FCM's credit

    arrangements. Paragraph (l) is intended to provide the Commission with

    notice of material events, such as the departure of the FCM's CCO, CFO,

    or CEO.

    As noted above, Sec. 1.12 is intended to provide the Commission

    and DSROs with notice of potential issues that may impact the financial

    condition of an FCM or the safety of customer funds. The regulatory

    objective is for FCMs to provide material information to the Commission

    and DSROs as early as possible so that the Commission and DSROs can

    assess the information and communicate with the FCMs prior to a more

    serious issue developing that may impair the financial condition of the

    firms or the safety of customer funds. Proposed paragraphs (k) and (l)

    will provide the Commission and DSROs with notice of major events that

    will initiate a dialogue between the Commission, DSROs, and FCMs which

    will have the benefit of informing the Commission and DSROs of material

    events impacting FCMs. Such information would be used by the Commission

    and DSROs in setting the scope of the review and monitoring of the

    FCMs, including the determination of the risk of the firms for purposes

    of scheduling future examinations. Without paragraphs (k) and (l), the

    Commission and DSROs may not learn of material events at FCMs until the

    firms are subject to periodic examinations.

    The Commission is proposing to add a new paragraph (m) to Sec.

    1.12 that will require an FCM that receives a notice, examination

    report, or any other correspondence from the SEC or a SRO to file a

    copy of such notice, examination report, or correspondence with the

    Commission. In order to perform comprehensive oversight of an FCM, the

    Commission and the DSROs need to receive prompt notice of any concern

    or adverse action taken by the SEC or a securities SRO. The protection

    of futures customers funds are not immune from issues that arise from

    the securities operations or business of a dual registrant FCM/BD.

    Requiring an FCM to provide prompt notice to the Commission and the

    firm's DSRO of any notice, examination report, or correspondence that

    the firm receives from the SEC or a securities SRO will allow the

    Commission and the DSRO to identify potential threats to the safety of

    customer funds.

    The Commission is further proposing to amend the process that an

    FCM uses to file the notices required by Sec. 1.12. Currently, Sec.

    1.12 requires an FCM to provide the Commission and DSROs with

    telephonic and facsimile notice in some situations, and to provide

    written notice by mail in other situations. An FCM also is permitted,

    but not required, to file notices and written reports with the

    Commission and with its DSRO using an electronic filing system in

    accordance with instructions issued by or approved by the Commission.

    The Commission is proposing to amend Sec. 1.12(n) to require that

    all notices and reports filed by an FCM with the Commission or with the

    FCM's DSRO must be in writing and submitted using an electronic filing

    system. Each FCM currently uses WinJammer to file regulatory notices

    with the Commission and with the firm's DSRO. The WinJammer system

    provides for the most effective mechanism for ensuring that regulatory

    notices are promptly received by the Commission and by the DSROs.\42\

    The regulation further provides that if the FCM cannot file a notice

    due to the electronic system being inoperable or for any other reason,

    it must contact the Commission Regional office with jurisdiction over

    the firm and make arrangements for the filing of the regulatory notices

    by filing the notice with the Commission via electronic mail at a

    specially designated email address established by the Commission;

    fcmnotices@cftc.gov. The Commission also is proposing to amend Sec.

    1.12(n) to require that each notice filed by an FCM, IB, or SRO under

    Sec. 1.12 must include a discussion of what caused the reportable

    event, and what steps have been, or are being taken, to address the

    reportable event. The reporting entity, however, may not delay the

    reporting of a reportable event if it does not possess complete

    information on what caused the event, or the steps that have been taken

    or are being taken to address the event.

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    \42\ The Commission's proposed amendment to require the

    electronic filing of reports applies to both registered FCMs and

    applicants for registration as FCMs. Applicants for FCM registration

    currently file regulatory notices with NFA using WinJammer.

    ---------------------------------------------------------------------------

    The amendments to Sec. Sec. 1.12(b), (d), (e), (f) and (g) are

    necessary and technical in nature, and primarily revise internal cross-

    references to the filing requirements in Sec. 1.12(n).

    The Commission request comment on all aspects of the proposed

    amendments to Sec. 1.12. Specifically, the Commission requests comment

    on the following:

    Are there other reportable events that the Commission

    should consider adding to Sec. 1.12 that would benefit the Commission

    and the DSROs in the monitoring of the financial and operating

    conditions of FCMs?

    Should the Commission consider removing any of the

    reportable events listed in Sec. 1.12? If so, why?

    Should any of the reportable events be made public by the

    Commission, SROs, or FCMs? If so, which reportable events? What benefit

    would the public receive from the disclosure of the reportable events?

    What would be the costs of disclosing the reportable events to the

    FCMs? Are there any negative

    [[Page 67878]]

    impacts of disclosing the reportable events?

    Are the reporting standards in proposed paragraphs (k) and

    (l) adequately detailed and objective so that an FCM can determine when

    there is a reportable event? If not, what standards should the

    Commission use to define a reportable event under paragraphs (k) and

    (l)?

    D. Proposed Amendments to Sec. 1.15: Risk Assessment Reporting

    Requirement for Futures Commission Merchants

    Regulation 1.15 requires FCMs to submit certain risk assessment

    reports to the Commission. The risk assessment filings include FCM

    organizational charts; financial, operational, risk management

    policies, and systems maintained by the FCM; and fiscal year-end

    consolidated and consolidating financial information for the FCM and

    its highest level material affiliate.

    The Commission is proposing to amend Sec. 1.15(a)(4) to require

    each FCM that is subject to Sec. 1.15 to submit its risk assessment

    information to the Commission electronically in accordance with

    instructions issued by the Commission. The Commission intends for FCMs

    to file the risk assessment materials using the WinJammer electronic

    filing system. The Commission requests comments on its proposed

    amendments to Sec. 1.15.

    E. Proposed Amendments to Sec. 1.16: Qualifications and Reports of

    Accountants

    Regulation 1.16 sets forth the qualifications a public accountant

    must possess in order to conduct audits of Commission registrants.

    Currently, a public accountant must be registered and in good standing

    under the laws of the place of the public accountant's principal office

    in order to conduct examinations of FCMs.

    The Commission is proposing to amend Sec. 1.16(b)(1) to require

    that the public accountant be registered with the Public Company

    Accounting Oversight Board (``PCAOB'') in addition to being in good

    standing with the relevant state licensing authorities. In addition,

    the public accountant must have undergone an examination by the PCAOB

    and any deficiencies noted during such examination must have been

    remediated to the satisfaction of the PCAOB. Regulation Sec.

    1.16(b)(4) also will impose an obligation on an FCM's governing body to

    ensure that a public accountant is qualified to perform an audit of the

    FCM by assessing the firm's experience in auditing FCMs, the firm's

    experience and knowledge of the Act and Commission regulations, and the

    depth and experience of the firm's auditing staff.

    The Commission also is proposing to amend Sec. 1.16(c)(2) to

    require a public accountant to state in the audit opinion whether the

    audit was conducted in accordance with U.S. GAAS after full

    consideration of the auditing standards adopted by the PCAOB.

    Currently, all audits of the certified financial statements of FCMs

    must be performed under U.S. GAAS. However, as the Commission is now

    proposing that certified public accountants must be registered with the

    PCAOB, it is necessary to also require that the auditing standards

    promulgated by the PCAOB be considered and adhered to where applicable.

    PCAOB requires auditors opining on a public company financial

    statements to comply with all applicable auditing standards, including

    PCAOB standards; whereas U.S. GAAS is required for the audits of non-

    public companies.

    In 2003, the PCAOB adopted existing U.S. GAAS as interim standards,

    subject to periodic revision as the PCAOB deemed necessary. Since that

    time, the PCAOB has issued its own auditing standards in areas of the

    audit in which differentiated audit procedures or reporting

    requirements have been considered necessary. These areas largely

    pertain to audits of internal control over financial reporting as well

    as reports on those controls, audit documentation and engagement

    quality review. Generally speaking, the most significant difference

    between U.S. GAAS and PCAOB standards relates to the auditor's testing

    of internal controls over financial reporting which are meant to cover

    the auditor's opinion on the Sarbanes-Oxley Act Section 404 report on

    internal controls. From a regulatory perspective, an auditor's focus on

    internal controls is critical to helping to ensure that material errors

    in financial or regulatory reporting are identified on a timely basis,

    and the PCAOB standards provide more focus on the auditing standards in

    this regard. It should also be noted that auditors of BDs are now

    required to register with the PCAOB and follow PCAOB standards; thus,

    any dually-registered FCM/BDs will already have to comply with this

    requirement.

    The proposed amendments to Sec. Sec. 1.16(b)(1) and (c)(2) are

    designed to reasonably ensure the quality and competence of public

    accountants that engage in the audits of FCMs. FCMs are sophisticated

    financial market participants that are subject to extensive regulation.

    In addition, the complexity of FCM audits is increased substantially

    when a firm is engaged in proprietary trading or dually-registered as

    an FCM/BD. Public accountants must be knowledgeable regarding the

    business operations, regulatory obligations and financial reporting

    requirements for FCMs, and the governing body of the FCM must ensure

    that the public accountant has the knowledge, experience, and resources

    to conduct the audits. Also, requiring the public accountant to be

    registered with PCAOB will ensure that the public accountant is subject

    to periodic reviews to assess its compliance with industry standards.

    While the Commission does not expect the proposed PCAOB

    registration requirement to have a material impact on FCMs, it

    recognizes that not all FCMs currently use CPAs that are registered

    with the PCAOB or CPAs that have been subject to an examination by the

    PCAOB. Currently, 111 of the 116 FCMs are examined by CPAs that are

    registered with the PCAOB. Also, 12 CPAs that are registered with the

    PCAOB have not yet been subject to a PCAOB examination. These 12 CPAs

    conduct examinations of 20 FCMs. Therefore, currently 25 of the 116

    FCMs would not satisfy the proposed requirement that only PCAOB-

    registered CPAs that have been subject to at least one PCAOB review may

    be engaged to conduct an examination of the FCM's financial

    statements.\43\

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    \43\ The Commission further notes, however, that 7 of the 20

    FCMs are audited by a PCAOB-registered CPA that also conducts audits

    of BDs or public companies and, therefore, will be subject to PCAOB

    examination at a future date.

    ---------------------------------------------------------------------------

    The Commission is proposing a technical amendment to Sec. 1.16 to

    revise the definition of the term ``customer.'' Regulation 1.16 details

    the standards that a public accountant must meet in conducting a

    financial examination of an FCM. Currently, Sec. 1.16(a)(4) defines

    the term ``customer'' to include futures customers, Cleared Swaps

    Customers, and foreign futures or foreign options customers. The

    Commission is proposing to amend Sec. 1.16(a)(4) to revise the

    definition of customer to replace the term ``foreign futures or foreign

    options customer'' with the term ``30.7 Customer'' to make the

    provision consistent with the amendments contained in Part 30 of the

    Commission's regulations.

    The Commission also is proposing to amend paragraph (f)(1)(i)(C) of

    Sec. 1.16 to provide that any filing of a notice of the extension of

    time to file the audited financial reports must be submitted by the FCM

    to the Commission using an electronic filing system. The Commission

    intends for FCMs to use the WinJammer electronic filing system.

    [[Page 67879]]

    The Commission also is proposing to remove the requirement from

    Sec. 1.16(c)(1) that annual financial reports contain the manual

    signature of the public accountant. Under the proposed amendments to

    Sec. 1.10 discussed above, FCMs will be filing annual financial

    reports electronically, which will preclude the use of manual

    signature.

    The Commission requests comment on all aspects of proposed Sec.

    1.16. Specifically, the Commission request comment on the following:

    A purpose of the requirement that FCMs engage only CPAs

    that are registered with the PCAOB and have been reviewed by the PCAOB

    is to enhance the quality of the audit examination conducted by CPAs.

    Does the PCAOB registration and examination process enhance the quality

    of FCM audit engagements?

    Are there viable alternatives that the Commission should

    consider to enhance the quality of CPA FCM examinations in lieu of

    PCAOB registration and examination?

    Should the Commission consider allowing the non-PCAOB

    registered CPAs or PCAOB-registered CPAs that have not been subject to

    a PCAOB review to contractually engage for a peer review from a

    qualified CPA who is aware of the reason for the peer review as a

    short-term measure to allow the non-compliant CPAs to continue to

    conduct audits of FCMs?

    If the Commission adopts the PCAOB registration and

    examination requirement, how should the Commission implement the

    effective or compliance dates? What factors should the Commission

    consider in setting an effective date or compliance date for this

    provision?

    F. Proposed Amendments to Sec. 1.17: Minimum Financial Requirements

    for Futures Commission Merchants and Introducing Brokers

    The Commission is proposing to amend Sec. 1.17 by adding a new

    provision that will authorize the Commission to require an FCM to

    transfer its customer business and cease operating as an FCM if the FCM

    cannot immediately certify to the Commission, and demonstrate with

    verifiable evidence, that the FCM has sufficient access to liquidity to

    continue operating as a going concern. The Commission also is proposing

    to amend Sec. 1.17 to permit an FCM that is not a dually-registered

    FCM/BD to develop the framework proposed by the SEC, as set forth

    below, to establish, maintain and enforce written policies and

    procedures for determining creditworthiness, and upon a determination

    that a particular type of security has minimal credit risk, to apply

    lower deductions to such securities in computing the FCM's adjusted net

    capital.

    Section 4f(b) of the Act provides that no person may be registered

    as an FCM unless such person meets the minimum financial requirements

    that the Commission has established by regulation to ensure that an FCM

    meets its obligations at all times as an FCM to its customer and to

    market participants, including DCOs. The Commission's minimum capital

    requirements for FCMs are set forth in Sec. 1.17 and generally require

    an FCM to maintain adjusted net capital equal to or in excess of the

    greater of: $1 million; 8 percent of the risk maintenance margin

    required on customer and non-customer futures and options on futures

    positions carried by the FCM; \44\ the amount of adjusted net capital

    required by the NFA; or, for dual-registrants, the amount of net

    capital required by the SEC. The term ``adjusted net capital'' is

    generally defined as the FCM's net, liquid assets less all of the FCM's

    liabilities (except certain qualifying subordinated debt). In computing

    its adjusted net capital, an FCM is required to reduce the value of

    proprietary futures and securities positions included in its liquid

    assets by certain prescribed amounts or percentages of the market value

    (otherwise known as ``haircuts'') to discount for potential adverse

    market movements in the securities.

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    \44\ The term ``noncustomer'' is generally defined under Sec.

    1.17 as affiliates or management of an FCM.

    ---------------------------------------------------------------------------

    Commission Regulation 1.17(a)(4) currently provides that an FCM

    must cease operating as an FCM and transfer its customers positions to

    another FCM if the FCM is not in compliance with the minimum capital

    requirements, or is unable to demonstrate its compliance with the

    minimum capital requirements. The FCM, however, can initiate customer

    trades for liquidation purposes only. Regulation 1.17(a)(4) further

    provides that the Commission or the FCM's DSRO may grant the FCM up to

    a maximum of 10 days to come back into compliance with the minimum

    capital requirements without having to cease operating as an FCM or

    transferring customer accounts.

    The Commission is proposing to add an additional clause to Sec.

    1.17(a)(4), which will specify that the Commission may request

    certification in writing from an FCM that it has sufficient liquidity

    to continue operating as a going concern, and that if such

    certification is not provided immediately or the FCM is not able to

    demonstrate its access to liquidity with verifiable evidence, the FCM

    must transfer all customer accounts and immediately cease doing

    business as an FCM. The proposed liquidity provision is intended to

    cover circumstances that require immediate attention. The proposal is

    not intended to provide a mechanism for the Commission to require FCMs

    to demonstrate that they are a going concern for an extended period of

    time into the future. Rather, the purpose of the proposal is to provide

    the Commission with a means of addressing exigent circumstances by

    requiring an FCM to produce a written analysis showing the sources and

    uses of funds over a short period of time not to exceed one week.

    The Commission believes this clause provides additional protection

    to customers in the event of an imminent liquidity drain on a

    registrant, which may not be immediately reflected in its accounting or

    regulatory capital business records. Market events or other external

    indicators may come to the attention of the Commission which suggest an

    FCM is under severe liquidity stress, which demonstrates that although

    the firm is still able to demonstrate compliance with required

    regulatory capital, conditions are such that it will not be able to

    meet liquidity requirements out a period of time not to exceed one

    week. This provision will allow the Commission to essentially require

    an FCM on demand to be able to certify its access to liquidity

    sufficient to continue operating as a going concern for a period not to

    exceed one week. The inability of the FCM to satisfy this requirement

    will allow the Commission to direct the FCM to transfer customer

    accounts and cease doing business as an FCM.

    The Commission believes the ability to certify, and if requested,

    demonstrate with verifiable evidence, sufficient liquidity to operate

    as a going concern to meet immediate financial obligations, is a

    minimum financial requirement necessary to ensure an FCM will continue

    to meet its obligations as a registrant as set forth under Sec.

    4(f)(b) of the Act. The certification required must satisfy the same

    oath or affirmation requirements as those required for the submission

    of monthly financial reports under Sec. 1.10(d)(4), to ensure that it

    is made by an appropriate individual and that it is in writing under

    oath of the individual that it is true and correct to the best

    knowledge and belief of such individual. If a registrant certifies to

    the Commission its access to liquidity, but is not able to demonstrate

    with sufficient evidence such liquidity (for example such evidence may

    include confirmations by third parties of access

    [[Page 67880]]

    to credit lines with available credit or of unrestricted cash balances

    available to meet projected short term cash requirements), the

    Commission believes it would be prudent to require the registrant to

    transfer customer accounts. Circumstances related to a liquidity drain

    could also result in a breakdown of management controls and result in

    an erroneous or false certification, and in such circumstances, the

    protection of customers must be paramount. The Commission requests

    comment on the proposed additional clause to Sec. 1.17(a)(4).

    Regulation 1.17 further requires an FCM to take a haircut against

    the value of securities the FCM holds as investments of customer funds

    under Sec. 1.25. A primary purpose of these haircuts is to provide a

    margin of safety against losses that might be incurred by the FCM as a

    result of market fluctuations in the prices of, or lack of liquidity

    in, the security positions.

    For futures positions, an FCM that is a member of the clearing

    organization where the positions are cleared is required to take a

    haircut equal to the margin required by the clearing organization on

    such futures positions.\45\ For securities positions, Sec. 1.17

    incorporates by reference the securities haircuts that a BD is required

    to take in computing its net capital under the SEC's regulations.\46\

    The structure of the Commission's net capital rule referring to the

    SEC's net capital rule is a result of the Commission's determination to

    defer to the SEC in areas of its expertise, specifically with respect

    to market risk and appropriate haircuts on securities positions.\47\

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    aps Customer Accounts

    to meet the Net Liquidating Equity of each Cleared Swaps Customer.\39\

    Immediate notification of a failure to hold sufficient funds in

    segregation for Cleared Swaps Customers is essential for the Commission

    and DSROs to promptly assess the financial condition of an FCM and to

    determine if there are threats to the safety of the Cleared Swaps

    Customers' funds held by the FCM. The proposed amendment to Sec.

    1.12(h) also harmonizes the notice requirements whenever an FCM fails

    to hold sufficient funds for futures customers, 30.7 Customers, and

    Cleared Swaps Customers.

    ---------------------------------------------------------------------------

    \39\ 77 FR 6336 (Feb. 7, 2012).

    ---------------------------------------------------------------------------

    The Commission also is proposing to amend Sec. 1.12 by adding new

    paragraph (i) to require an FCM to provide notice whenever it discovers

    or is informed that it has invested funds held for customers in

    investments that are not permitted investments under Sec. 1.25, or if

    the FCM holds permitted investments in a manner that is not in

    compliance with the provisions of Sec. 1.25 (such as the investment

    concentration limits). The proposal will apply to funds held for

    futures customers, 30.7 Customers, and Cleared Swaps Customers.

    The protection of customer funds is a core element of the

    Commission's regulatory program. FCMs are entrusted with a

    responsibility to use customer funds only for the benefit of the

    depositing customers.\40\ FCMs are permitted, however, to invest

    customer funds pursuant to the standards and conditions set forth in

    Sec. 1.25. Regulation 1.25 contains a list of permitted investments

    and other criteria that are intended to allow an FCM to receive the

    benefit of investing customer funds while also preserving the principal

    and maintaining the liquidity of the customer funds.

    ---------------------------------------------------------------------------

    \40\ Regulation 1.20(a), 17 CFR 1.20(a).

    ---------------------------------------------------------------------------

    Requiring an FCM to provide prompt notice of a Sec. 1.25 violation

    will allow Commission and DSRO staff to assess whether customer funds

    are endangered and to work with the FCM to ensure that the

    impermissible investments are appropriately liquidated and customer

    funds remain intact. Commission and DSRO staff also will benefit from

    receiving notices of Sec. 1.25 violations in that the notices will

    provide information regarding new investments that FCMs may engage in

    that are not permitted investments under Sec. 1.25. Such information

    will be helpful for the Commission and DSRO in conducting reviews of

    other FCMs and in providing regulatory updates to the industry.\41\

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    \41\ The Commission further notes that investing customer funds

    in investments that are not permitted investments under Sec. 1.25,

    or holding investments in a manner that is otherwise not compliant

    with Sec. 1.25 does not change the legal status of the funds as

    customer funds in the event of the bankruptcy of the FCM.

    ---------------------------------------------------------------------------

    The Commission also is proposing to amend Sec. 1.12 to provide a

    new paragraph (j) that will require an FCM to provide immediate notice

    to the Commission and to the firm's DSRO if the FCM does not hold an

    amount of funds in segregated accounts for futures customers or for

    Cleared Swaps Customers, or if the FCM does not hold sufficient funds

    in separate accounts for 30.7 Customers, sufficient to meet the firm's

    targeted residual interest in one or more of these accounts as computed

    [[Page 67877]]

    under proposed Sec. 1.11, or if its residual interest in one or more

    of these accounts is less than the sum of outstanding margin deficits

    for such accounts. Proposed Sec. 1.11 will require each FCM that

    carries customer funds to calculate an appropriate amount of excess

    funds (i.e., proprietary funds) to hold in segregated or secured

    accounts to mitigate the FCM from being undersegregated or undersecured

    due to a withdrawal of proprietary funds from a segregated or secured

    account. The fact that an FCM is not holding a sufficient amount of

    excess funds in customer accounts to meet its targeted residual

    interest may be indicative of more severe financial or operational

    issues at the firm. In addition, if an FCM's residual interest is less

    than the sum of outstanding margin deficits in one such account, it is

    possible that funds of one customer in such account are at risk of

    margining or guaranteeing the open positions of another customer.

    Accordingly, the Commission is proposing to require an FCM to file

    immediate notice of such an event to allow Commission and DSRO staff to

    contact the FCM to assess the condition of the firm and the safety of

    customer funds.

    The Commission also is proposing new paragraphs (k) and (l) for

    Sec. 1.12. Paragraphs (k) and (l) will require an FCM to provide

    notice to the Commission and to the firm's DSRO in the event of a

    material adverse impact in the financial condition of the firm or a

    material change in the firm's operations. Proposed paragraph (k) will

    require an FCM to provide immediate notice if the FCM, its parent, or a

    material affiliate, experiences a material adverse impact to its

    creditworthiness or its ability to fund its obligations. Indications of

    a material adverse impact of an FCM's creditworthiness may include a

    bank or other financing entity withdrawing credit facilities, a credit

    rating downgrade, or the FCM being placed on ``credit watch'' by a

    credit rating agency. Proposed paragraph (l) will require an FCM to

    provide immediate notice of material changes in the operations of the

    firm, including: A change in senior management; the establishment or

    termination of a material line of business; a material change in the

    FCM's clearing arrangements; or a material change in the FCM's credit

    arrangements. Paragraph (l) is intended to provide the Commission with

    notice of material events, such as the departure of the FCM's CCO, CFO,

    or CEO.

    As noted above, Sec. 1.12 is intended to provide the Commission

    and DSROs with notice of potential issues that may impact the financial

    condition of an FCM or the safety of customer funds. The regulatory

    objective is for FCMs to provide material information to the Commission

    and DSROs as early as possible so that the Commission and DSROs can

    assess the information and communicate with the FCMs prior to a more

    serious issue developing that may impair the financial condition of the

    firms or the safety of customer funds. Proposed paragraphs (k) and (l)

    will provide the Commission and DSROs with notice of major events that

    will initiate a dialogue between the Commission, DSROs, and FCMs which

    will have the benefit of informing the Commission and DSROs of material

    events impacting FCMs. Such information would be used by the Commission

    and DSROs in setting the scope of the review and monitoring of the

    FCMs, including the determination of the risk of the firms for purposes

    of scheduling future examinations. Without paragraphs (k) and (l), the

    Commission and DSROs may not learn of material events at FCMs until the

    firms are subject to periodic examinations.

    The Commission is proposing to add a new paragraph (m) to Sec.

    1.12 that will require an FCM that receives a notice, examination

    report, or any other correspondence from the SEC or a SRO to file a

    copy of such notice, examination report, or correspondence with the

    Commission. In order to perform comprehensive oversight of an FCM, the

    Commission and the DSROs need to receive prompt notice of any concern

    or adverse action taken by the SEC or a securities SRO. The protection

    of futures customers funds are not immune from issues that arise from

    the securities operations or business of a dual registrant FCM/BD.

    Requiring an FCM to provide prompt notice to the Commission and the

    firm's DSRO of any notice, examination report, or correspondence that

    the firm receives from the SEC or a securities SRO will allow the

    Commission and the DSRO to identify potential threats to the safety of

    customer funds.

    The Commission is further proposing to amend the process that an

    FCM uses to file the notices required by Sec. 1.12. Currently, Sec.

    1.12 requires an FCM to provide the Commission and DSROs with

    telephonic and facsimile notice in some situations, and to provide

    written notice by mail in other situations. An FCM also is permitted,

    but not required, to file notices and written reports with the

    Commission and with its DSRO using an electronic filing system in

    accordance with instructions issued by or approved by the Commission.

    The Commission is proposing to amend Sec. 1.12(n) to require that

    all notices and reports filed by an FCM with the Commission or with the

    FCM's DSRO must be in writing and submitted using an electronic filing

    system. Each FCM currently uses WinJammer to file regulatory notices

    with the Commission and with the firm's DSRO. The WinJammer system

    provides for the most effective mechanism for ensuring that regulatory

    notices are promptly received by the Commission and by the DSROs.\42\

    The regulation further provides that if the FCM cannot file a notice

    due to the electronic system being inoperable or for any other reason,

    it must contact the Commission Regional office with jurisdiction over

    the firm and make arrangements for the filing of the regulatory notices

    by filing the notice with the Commission via electronic mail at a

    specially designated email address established by the Commission;

    fcmnotices@cftc.gov. The Commission also is proposing to amend Sec.

    1.12(n) to require that each notice filed by an FCM, IB, or SRO under

    Sec. 1.12 must include a discussion of what caused the reportable

    event, and what steps have been, or are being taken, to address the

    reportable event. The reporting entity, however, may not delay the

    reporting of a reportable event if it does not possess complete

    information on what caused the event, or the steps that have been taken

    or are being taken to address the event.

    ---------------------------------------------------------------------------

    \42\ The Commission's proposed amendment to require the

    electronic filing of reports applies to both registered FCMs and

    applicants for registration as FCMs. Applicants for FCM registration

    currently file regulatory notices with NFA using WinJammer.

    ---------------------------------------------------------------------------

    The amendments to Sec. Sec. 1.12(b), (d), (e), (f) and (g) are

    necessary and technical in nature, and primarily revise internal cross-

    references to the filing requirements in Sec. 1.12(n).

    The Commission request comment on all aspects of the proposed

    amendments to Sec. 1.12. Specifically, the Commission requests comment

    on the following:

    Are there other reportable events that the Commission

    should consider adding to Sec. 1.12 that would benefit the Commission

    and the DSROs in the monitoring of the financial and operating

    conditions of FCMs?

    Should the Commission consider removing any of the

    reportable events listed in Sec. 1.12? If so, why?

    Should any of the reportable events be made public by the

    Commission, SROs, or FCMs? If so, which reportable events? What benefit

    would the public receive from the disclosure of the reportable events?

    What would be the costs of disclosing the reportable events to the

    FCMs? Are there any negative

    [[Page 67878]]

    impacts of disclosing the reportable events?

    Are the reporting standards in proposed paragraphs (k) and

    (l) adequately detailed and objective so that an FCM can determine when

    there is a reportable event? If not, what standards should the

    Commission use to define a reportable event under paragraphs (k) and

    (l)?

    D. Proposed Amendments to Sec. 1.15: Risk Assessment Reporting

    Requirement for Futures Commission Merchants

    Regulation 1.15 requires FCMs to submit certain risk assessment

    reports to the Commission. The risk assessment filings include FCM

    organizational charts; financial, operational, risk management

    policies, and systems maintained by the FCM; and fiscal year-end

    consolidated and consolidating financial information for the FCM and

    its highest level material affiliate.

    The Commission is proposing to amend Sec. 1.15(a)(4) to require

    each FCM that is subject to Sec. 1.15 to submit its risk assessment

    information to the Commission electronically in accordance with

    instructions issued by the Commission. The Commission intends for FCMs

    to file the risk assessment materials using the WinJammer electronic

    filing system. The Commission requests comments on its proposed

    amendments to Sec. 1.15.

    E. Proposed Amendments to Sec. 1.16: Qualifications and Reports of

    Accountants

    Regulation 1.16 sets forth the qualifications a public accountant

    must possess in order to conduct audits of Commission registrants.

    Currently, a public accountant must be registered and in good standing

    under the laws of the place of the public accountant's principal office

    in order to conduct examinations of FCMs.

    The Commission is proposing to amend Sec. 1.16(b)(1) to require

    that the public accountant be registered with the Public Company

    Accounting Oversight Board (``PCAOB'') in addition to being in good

    standing with the relevant state licensing authorities. In addition,

    the public accountant must have undergone an examination by the PCAOB

    and any deficiencies noted during such examination must have been

    remediated to the satisfaction of the PCAOB. Regulation Sec.

    1.16(b)(4) also will impose an obligation on an FCM's governing body to

    ensure that a public accountant is qualified to perform an audit of the

    FCM by assessing the firm's experience in auditing FCMs, the firm's

    experience and knowledge of the Act and Commission regulations, and the

    depth and experience of the firm's auditing staff.

    The Commission also is proposing to amend Sec. 1.16(c)(2) to

    require a public accountant to state in the audit opinion whether the

    audit was conducted in accordance with U.S. GAAS after full

    consideration of the auditing standards adopted by the PCAOB.

    Currently, all audits of the certified financial statements of FCMs

    must be performed under U.S. GAAS. However, as the Commission is now

    proposing that certified public accountants must be registered with the

    PCAOB, it is necessary to also require that the auditing standards

    promulgated by the PCAOB be considered and adhered to where applicable.

    PCAOB requires auditors opining on a public company financial

    statements to comply with all applicable auditing standards, including

    PCAOB standards; whereas U.S. GAAS is required for the audits of non-

    public companies.

    In 2003, the PCAOB adopted existing U.S. GAAS as interim standards,

    subject to periodic revision as the PCAOB deemed necessary. Since that

    time, the PCAOB has issued its own auditing standards in areas of the

    audit in which differentiated audit procedures or reporting

    requirements have been considered necessary. These areas largely

    pertain to audits of internal control over financial reporting as well

    as reports on those controls, audit documentation and engagement

    quality review. Generally speaking, the most significant difference

    between U.S. GAAS and PCAOB standards relates to the auditor's testing

    of internal controls over financial reporting which are meant to cover

    the auditor's opinion on the Sarbanes-Oxley Act Section 404 report on

    internal controls. From a regulatory perspective, an auditor's focus on

    internal controls is critical to helping to ensure that material errors

    in financial or regulatory reporting are identified on a timely basis,

    and the PCAOB standards provide more focus on the auditing standards in

    this regard. It should also be noted that auditors of BDs are now

    required to register with the PCAOB and follow PCAOB standards; thus,

    any dually-registered FCM/BDs will already have to comply with this

    requirement.

    The proposed amendments to Sec. Sec. 1.16(b)(1) and (c)(2) are

    designed to reasonably ensure the quality and competence of public

    accountants that engage in the audits of FCMs. FCMs are sophisticated

    financial market participants that are subject to extensive regulation.

    In addition, the complexity of FCM audits is increased substantially

    when a firm is engaged in proprietary trading or dually-registered as

    an FCM/BD. Public accountants must be knowledgeable regarding the

    business operations, regulatory obligations and financial reporting

    requirements for FCMs, and the governing body of the FCM must ensure

    that the public accountant has the knowledge, experience, and resources

    to conduct the audits. Also, requiring the public accountant to be

    registered with PCAOB will ensure that the public accountant is subject

    to periodic reviews to assess its compliance with industry standards.

    While the Commission does not expect the proposed PCAOB

    registration requirement to have a material impact on FCMs, it

    recognizes that not all FCMs currently use CPAs that are registered

    with the PCAOB or CPAs that have been subject to an examination by the

    PCAOB. Currently, 111 of the 116 FCMs are examined by CPAs that are

    registered with the PCAOB. Also, 12 CPAs that are registered with the

    PCAOB have not yet been subject to a PCAOB examination. These 12 CPAs

    conduct examinations of 20 FCMs. Therefore, currently 25 of the 116

    FCMs would not satisfy the proposed requirement that only PCAOB-

    registered CPAs that have been subject to at least one PCAOB review may

    be engaged to conduct an examination of the FCM's financial

    statements.\43\

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    \43\ The Commission further notes, however, that 7 of the 20

    FCMs are audited by a PCAOB-registered CPA that also conducts audits

    of BDs or public companies and, therefore, will be subject to PCAOB

    examination at a future date.

    ---------------------------------------------------------------------------

    The Commission is proposing a technical amendment to Sec. 1.16 to

    revise the definition of the term ``customer.'' Regulation 1.16 details

    the standards that a public accountant must meet in conducting a

    financial examination of an FCM. Currently, Sec. 1.16(a)(4) defines

    the term ``customer'' to include futures customers, Cleared Swaps

    Customers, and foreign futures or foreign options customers. The

    Commission is proposing to amend Sec. 1.16(a)(4) to revise the

    definition of customer to replace the term ``foreign futures or foreign

    options customer'' with the term ``30.7 Customer'' to make the

    provision consistent with the amendments contained in Part 30 of the

    Commission's regulations.

    The Commission also is proposing to amend paragraph (f)(1)(i)(C) of

    Sec. 1.16 to provide that any filing of a notice of the extension of

    time to file the audited financial reports must be submitted by the FCM

    to the Commission using an electronic filing system. The Commission

    intends for FCMs to use the WinJammer electronic filing system.

    [[Page 67879]]

    The Commission also is proposing to remove the requirement from

    Sec. 1.16(c)(1) that annual financial reports contain the manual

    signature of the public accountant. Under the proposed amendments to

    Sec. 1.10 discussed above, FCMs will be filing annual financial

    reports electronically, which will preclude the use of manual

    signature.

    The Commission requests comment on all aspects of proposed Sec.

    1.16. Specifically, the Commission request comment on the following:

    A purpose of the requirement that FCMs engage only CPAs

    that are registered with the PCAOB and have been reviewed by the PCAOB

    is to enhance the quality of the audit examination conducted by CPAs.

    Does the PCAOB registration and examination process enhance the quality

    of FCM audit engagements?

    Are there viable alternatives that the Commission should

    consider to enhance the quality of CPA FCM examinations in lieu of

    PCAOB registration and examination?

    Should the Commission consider allowing the non-PCAOB

    registered CPAs or PCAOB-registered CPAs that have not been subject to

    a PCAOB review to contractually engage for a peer review from a

    qualified CPA who is aware of the reason for the peer review as a

    short-term measure to allow the non-compliant CPAs to continue to

    conduct audits of FCMs?

    If the Commission adopts the PCAOB registration and

    examination requirement, how should the Commission implement the

    effective or compliance dates? What factors should the Commission

    consider in setting an effective date or compliance date for this

    provision?

    F. Proposed Amendments to Sec. 1.17: Minimum Financial Requirements

    for Futures Commission Merchants and Introducing Brokers

    The Commission is proposing to amend Sec. 1.17 by adding a new

    provision that will authorize the Commission to require an FCM to

    transfer its customer business and cease operating as an FCM if the FCM

    cannot immediately certify to the Commission, and demonstrate with

    verifiable evidence, that the FCM has sufficient access to liquidity to

    continue operating as a going concern. The Commission also is proposing

    to amend Sec. 1.17 to permit an FCM that is not a dually-registered

    FCM/BD to develop the framework proposed by the SEC, as set forth

    below, to establish, maintain and enforce written policies and

    procedures for determining creditworthiness, and upon a determination

    that a particular type of security has minimal credit risk, to apply

    lower deductions to such securities in computing the FCM's adjusted net

    capital.

    Section 4f(b) of the Act provides that no person may be registered

    as an FCM unless such person meets the minimum financial requirements

    that the Commission has established by regulation to ensure that an FCM

    meets its obligations at all times as an FCM to its customer and to

    market participants, including DCOs. The Commission's minimum capital

    requirements for FCMs are set forth in Sec. 1.17 and generally require

    an FCM to maintain adjusted net capital equal to or in excess of the

    greater of: $1 million; 8 percent of the risk maintenance margin

    required on customer and non-customer futures and options on futures

    positions carried by the FCM; \44\ the amount of adjusted net capital

    required by the NFA; or, for dual-registrants, the amount of net

    capital required by the SEC. The term ``adjusted net capital'' is

    generally defined as the FCM's net, liquid assets less all of the FCM's

    liabilities (except certain qualifying subordinated debt). In computing

    its adjusted net capital, an FCM is required to reduce the value of

    proprietary futures and securities positions included in its liquid

    assets by certain prescribed amounts or percentages of the market value

    (otherwise known as ``haircuts'') to discount for potential adverse

    market movements in the securities.

    ---------------------------------------------------------------------------

    \44\ The term ``noncustomer'' is generally defined under Sec.

    1.17 as affiliates or management of an FCM.

    ---------------------------------------------------------------------------

    Commission Regulation 1.17(a)(4) currently provides that an FCM

    must cease operating as an FCM and transfer its customers positions to

    another FCM if the FCM is not in compliance with the minimum capital

    requirements, or is unable to demonstrate its compliance with the

    minimum capital requirements. The FCM, however, can initiate customer

    trades for liquidation purposes only. Regulation 1.17(a)(4) further

    provides that the Commission or the FCM's DSRO may grant the FCM up to

    a maximum of 10 days to come back into compliance with the minimum

    capital requirements without having to cease operating as an FCM or

    transferring customer accounts.

    The Commission is proposing to add an additional clause to Sec.

    1.17(a)(4), which will specify that the Commission may request

    certification in writing from an FCM that it has sufficient liquidity

    to continue operating as a going concern, and that if such

    certification is not provided immediately or the FCM is not able to

    demonstrate its access to liquidity with verifiable evidence, the FCM

    must transfer all customer accounts and immediately cease doing

    business as an FCM. The proposed liquidity provision is intended to

    cover circumstances that require immediate attention. The proposal is

    not intended to provide a mechanism for the Commission to require FCMs

    to demonstrate that they are a going concern for an extended period of

    time into the future. Rather, the purpose of the proposal is to provide

    the Commission with a means of addressing exigent circumstances by

    requiring an FCM to produce a written analysis showing the sources and

    uses of funds over a short period of time not to exceed one week.

    The Commission believes this clause provides additional protection

    to customers in the event of an imminent liquidity drain on a

    registrant, which may not be immediately reflected in its accounting or

    regulatory capital business records. Market events or other external

    indicators may come to the attention of the Commission which suggest an

    FCM is under severe liquidity stress, which demonstrates that although

    the firm is still able to demonstrate compliance with required

    regulatory capital, conditions are such that it will not be able to

    meet liquidity requirements out a period of time not to exceed one

    week. This provision will allow the Commission to essentially require

    an FCM on demand to be able to certify its access to liquidity

    sufficient to continue operating as a going concern for a period not to

    exceed one week. The inability of the FCM to satisfy this requirement

    will allow the Commission to direct the FCM to transfer customer

    accounts and cease doing business as an FCM.

    The Commission believes the ability to certify, and if requested,

    demonstrate with verifiable evidence, sufficient liquidity to operate

    as a going concern to meet immediate financial obligations, is a

    minimum financial requirement necessary to ensure an FCM will continue

    to meet its obligations as a registrant as set forth under Sec.

    4(f)(b) of the Act. The certification required must satisfy the same

    oath or affirmation requirements as those required for the submission

    of monthly financial reports under Sec. 1.10(d)(4), to ensure that it

    is made by an appropriate individual and that it is in writing under

    oath of the individual that it is true and correct to the best

    knowledge and belief of such individual. If a registrant certifies to

    the Commission its access to liquidity, but is not able to demonstrate

    with sufficient evidence such liquidity (for example such evidence may

    include confirmations by third parties of access

    [[Page 67880]]

    to credit lines with available credit or of unrestricted cash balances

    available to meet projected short term cash requirements), the

    Commission believes it would be prudent to require the registrant to

    transfer customer accounts. Circumstances related to a liquidity drain

    could also result in a breakdown of management controls and result in

    an erroneous or false certification, and in such circumstances, the

    protection of customers must be paramount. The Commission requests

    comment on the proposed additional clause to Sec. 1.17(a)(4).

    Regulation 1.17 further requires an FCM to take a haircut against

    the value of securities the FCM holds as investments of customer funds

    under Sec. 1.25. A primary purpose of these haircuts is to provide a

    margin of safety against losses that might be incurred by the FCM as a

    result of market fluctuations in the prices of, or lack of liquidity

    in, the security positions.

    For futures positions, an FCM that is a member of the clearing

    organization where the positions are cleared is required to take a

    haircut equal to the margin required by the clearing organization on

    such futures positions.\45\ For securities positions, Sec. 1.17

    incorporates by reference the securities haircuts that a BD is required

    to take in computing its net capital under the SEC's regulations.\46\

    The structure of the Commission's net capital rule referring to the

    SEC's net capital rule is a result of the Commission's determination to

    defer to the SEC in areas of its expertise, specifically with respect

    to market risk and appropriate haircuts on securities positions.\47\

    ---------------------------------------------------------------------------

    \45\ See Sec. 1.17(c)(5)(x)(A).

    \46\ Commission Regulations 1.17(c)(5)(v) and 1.32(b) both

    incorporate 17 CFR 240.15c3-1(c)(2)(vi) by reference.

    \47\ See 43 FR 15072 (Apr. 10, 1978) at 15077 and 43 FR 39956

    (Sept. 8, 1978) at 39963.

    ---------------------------------------------------------------------------

    The SEC capital rule currently applies a general or ``default''

    haircut of 15 percent of the market value of commercial paper,

    convertible debt instruments, and nonconvertible debt instruments if

    the securities are readily marketable, and 100 percent of the market

    value if the securities are not readily marketable. The SEC capital

    rule also provides for a lower haircut for commercial paper,

    convertible debt instruments, and nonconvertible debt instruments if

    the securities are rated in higher rating categories by at least two

    nationally recognized statistical rating organizations (``NRSROs''). To

    receive the benefit of a reduced haircut on commercial paper, the

    commercial paper must be rated in one of the three highest rating

    categories by at least two NRSROs. To receive the benefit of a reduced

    haircut on a nonconvertible debt security or a convertible debt

    security, the security must be rated in one of the four highest rating

    categories by at least two NRSROs.

    The SEC has proposed rule amendments to implement the Dodd-Frank

    Act requirement to remove references to credit ratings in its

    regulations and substitute a standard for creditworthiness deemed

    appropriate, including a proposed amendment to its net capital rule for

    BDs at 17 CFR 240.15c3-1.\48\ Under the SEC proposal, a BD may impose

    the default haircuts of 15 percent of the market value of readily

    marketable commercial paper, convertible debt, and nonconvertible debt

    instruments or 100 percent of the market value of nonmarketable

    commercial paper, convertible debt, and nonconvertible debt

    instruments. A BD, however, may impose lower haircut percentages for

    commercial paper, convertible debt, and nonconvertible debt instruments

    that are readily marketable, if the BD determines that the investments

    have only a minimal amount of credit risk pursuant to its written

    policies and procedures designed to assess the credit and liquidity

    risks applicable to a security.

    ---------------------------------------------------------------------------

    \48\ See 76 FR 26550 (May 6, 2011).

    ---------------------------------------------------------------------------

    Under the SEC proposal, the BD's written policies and procedures

    may assess a security's credit risk using the following factors, to the

    extent appropriate, instead of exclusively relying on NRSROs ratings:

    Credit spreads (i.e., whether it is possible to

    demonstrate that a position in commercial paper, nonconvertible debt,

    and preferred stock is subject to a minimal amount of credit risk based

    on the spread between the security's yield and the yield of Treasury or

    other securities, or based on credit default swap spreads that

    reference the security);

    Securities-related research (i.e., whether providers of

    securities-related research believe the issuer of the security will be

    able to meet its financial commitments, generally, or specifically,

    with respect to securities held by the broker-dealer);

    Internal or external credit risk assessments (i.e.,

    whether credit assessments developed internally by the broker-dealer or

    externally by a credit rating agency, irrespective of its status as an

    NRSRO, express a view as to the credit risk associated with a

    particular security);

    Default statistics (i.e., whether providers of credit

    information relating to securities express a view that specific

    securities have a probability of default consistent with other

    securities with a minimal amount of credit risk);

    Inclusion on an index (i.e., whether a security, or issuer

    of the security, is included as a component of a recognized index of

    instruments that are subject to a minimal amount of credit risk);

    Priorities and enhancements (i.e., the extent to which a

    security is covered by credit enhancements, such as

    overcollateralization and reserve accounts, or has priority under

    applicable bankruptcy or creditors' rights provisions);

    Price, yield and/or volume (i.e., whether the price and

    yield of a security or a credit default swap that references the

    security are consistent with other securities that the broker-dealer

    has determined are subject to a minimal amount of credit risk and

    whether the price resulted from active trading); and

    Asset class-specific factors (e.g., in the case of

    structured finance products, the quality of the underlying assets).

    A BD that maintains written policies and procedures and determines

    that the credit risk of a security is minimal is permitted under the

    SEC proposal to apply the lesser haircut requirement currently

    specified in the SEC capital rule for commercial paper (i.e., between

    zero and [frac12] of 1 percent), nonconvertible debt (i.e., between 2

    percent and 9 percent), and preferred stock (i.e., 10 percent).

    For FCMs that are dually-registered as BDs, any changes adopted by

    the SEC to these securities haircuts will be applicable under Sec.

    1.17(c)(5)(v) unless the Commission specifically provides an alternate

    treatment for FCMs.\49\ However, FCMs that are not dual registrants

    would be required to take the default haircuts of 15 percent for

    readily marketable securities. The Commission does not believe that it

    is appropriate to exclude standalone FCMs from using an internal

    process to assess the credit risk of certain securities. Therefore, the

    Commission's proposed amendment to Sec. 1.17(c)(v) will permit an FCM

    that is not a BD to develop the framework proposed by the SEC to

    establish, maintain and enforce written policies and procedures for

    determining creditworthiness, and upon a determination that a

    particular type of security has minimal credit risk, to apply lower

    deductions to such

    [[Page 67881]]

    securities. An FCM will be required to maintain its written policies

    and procedures in accordance with the general recordkeeping

    requirements of Sec. 1.31, and the implementation of the policies and

    procedures will be subject to review by the FCM's DSRO. An FCM that

    elects to develop written policies and procedures will be subject to

    review by its DSRO.

    ---------------------------------------------------------------------------

    \49\ See discussion adopting Sec. 1.17(c)(5)(vi) for options

    haircuts at 43 FR 39956 at 39964, with respect to the applicability

    of provisions incorporating by reference and referring to the rules

    of the SEC for securities broker dealers also registered as futures

    commission merchants.

    ---------------------------------------------------------------------------

    Regulation 1.17 also requires an FCM to reduce its capital (i.e.,

    take a capital charge) for customer, noncustomer, and omnibus accounts

    that are undermargined for more than a specified period of time.

    Regulation 1.17(c)(5)(viii) requires an FCM to take a capital charge if

    a customer account is undermargined for three business days after the

    margin call is issued. The capital charge is equal to the amount of

    funds necessary to restore the account to the initial margin

    requirement.

    Regulation 1.17(c)(5)(ix) requires an FCM to take a capital charge

    for noncustomer and omnibus accounts that are undermargined for two

    business days after the margin call is issued. The capital requirement

    for undermargined noncustomer and omnibus accounts is the amount of

    funds necessary to restore the account to the maintenance margin level.

    For purposes of these Commission regulations, a margin call is

    presumed to be issued by the FCM the day after an account becomes

    undermargined. Thus, if a customer's account is undermargined at the

    close of business on Monday, the FCM will issue a margin call on

    Tuesday, and the regulation requires the FCM to take an undermargined

    capital charge at the close of business on Friday if the margin call is

    not met. For noncustomer and omnibus accounts that were undermargined

    at the close of business on Monday, the FCM would take a capital charge

    as of the close of business on Thursday.

    The Commission is proposing to amend Sec. Sec. 1.17(c)(5)(viii)

    and (ix) to require an FCM to take capital charges for undermargined

    customer, noncustomer, and omnibus account that are undermargined for

    more than one business day after a margin call is issued. Therefore, an

    FCM will impose a capital charge as of the close of business on

    Wednesday for any customer, noncustomer, or omnibus account that did

    not fully satisfy a margin call that is issued by the FCM on Tuesday

    for an account that was undermargined as of the close of business on

    Monday.

    The timely collection of margin is a critical component of an FCM's

    risk management program and is intended to ensure that an FCM holds

    sufficient funds deposited by account owners to meet potential

    obligations to a DCO. As guarantor of the financial performance of the

    customer, noncustomer, and omnibus accounts that it carries, the FCM is

    financially responsible if the owner of an account cannot meet its

    margin obligations to the FCM and ultimately to a DCO. The timeframe

    for meeting margin calls currently provided in Sec. Sec.

    1.17(c)(5)(viii) and (ix) may have been appropriate when the capital

    rules were adopted in the 1970s when the use of checks and the mail

    system were more prevalent for depositing margin with an FCM. The

    Commission believes, however, that in today's markets, with the

    increasing use of technology, 24-hour-a-day trading, and the use of

    wire transfers to meet margin obligations, that the timeframe for

    taking a capital charge should be reduced both to incentivize FCMs to

    exercise prudent risk management and to strengthen the financial

    protection of FCMs, their customers, and the clearing systems by

    requiring the FCMs to reserve capital for undermargined customer,

    noncustomer, and omnibus accounts that fail to meet a margin call on a

    timely basis.

    The Commission also is proposing, as discussed in Section II.I

    below, to require an FCM to maintain a residual interest in customer

    segregated accounts in an amount sufficient to cover all customer

    accounts that are undermargined as of the close of business on the

    previous trading day, thereby ensuring that residual interest in

    customer segregated accounts exceeds the sum of outstanding margin

    calls for customers, and that the funds of one customer are not used to

    margin or guarantee the positions of another customer. The FCM may only

    maintain as residual interest cash and assets that qualify as permitted

    investments under Sec. 1.25. Margin deficits will be calculated as

    enough to restore the customer's account equity to the maintenance

    margin requirement on the account.

    The Commission also is proposing technical amendments to certain

    definitions in Sec. 1.17 to reflect proposed changes discussed in

    Section II.R below concerning the Sec. 30.7 secured amount

    calculation. The Sec. 1.17(b)(2) and (7) definitions of the terms

    ``customer'' and ``customer account'' are being proposed to be amended,

    the first to include ``30.7 Customer'' (which is a new definition being

    proposed in Sec. 30.1 to include foreign domiciled persons) and the

    second to remove surplus language due to the revised definition of

    ``customer.''

    The Commission requests comment on the proposed amendments to Sec.

    1.17. Specifically, the Commission requests comment on the following:

    Does the proposed amendment to require an FCM to certify

    that it has sufficient liquidity to operate as a going concern provide

    a sufficient and objective standard for FCMs to assess whether they are

    in compliance with the provision? Are there alternative standards or

    approaches that the Commission should consider to meet its objective of

    ensuring that an FCM has sufficient liquidity to meet its pending

    short-term obligations so that customer funds would not be put at risk

    in the event of the insolvency of the FCM?

    Should the Commission consider alternative timeframes for

    the imposition of a capital charge for undermargined accounts?

    G. Proposed Amendments to Sec. 1.20: Futures Customer Funds To Be

    Segregated and Separately Accounted for

    The Commission is proposing to reorganize the structure of Sec.

    1.20 by providing additional paragraph subdivisions to the existing

    specific requirements, applying headings to the regulation to assist in

    the reading and understanding of the regulation. The Commission also is

    proposing to add new provisions designed to enhance the protection of

    customer funds.

    Regulation 1.20 implements the provisions of section 4d(a)(2) of

    the Act, which provides, in relevant part, that an FCM must: (1)

    Separately account for all futures customer funds and segregate such

    funds as belonging to its futures customers; (2) not commingle futures

    customer funds with the FCM's proprietary funds; (3) not use the funds

    of one futures customer to margin or extend credit to any person other

    than to the futures customer that deposited the funds; and (4) deposit

    futures customer funds in any bank, trust company or DCO.

    Paragraph (a) of Sec. 1.20 sets forth the general principle under

    section 4d(a)(2) of the Act by requiring an FCM to separately account

    for all futures customer funds and to segregate such funds from the

    FCM's proprietary funds by depositing them under an account name that

    clearly shows that the funds are futures customer funds and segregated

    as required by the Act. Paragraph (g)(1) applies the same general

    principle to futures customer funds received by a DCO from its members.

    Paragraph (a) also requires each FCM to perform appropriate due

    diligence on all depositories in accordance with its risk management

    policies and procedures required under proposed

    [[Page 67882]]

    Sec. 1.11 to ensure that the depositories holding customer funds are

    financially sound. The FCM must annually update its due diligence.

    Paragraph (a) of Sec. 1.20 also provides that an FCM must be in

    compliance with its segregation obligations at all times. It is not

    sufficient for an FCM to be in compliance at the end of a business day,

    but to fail to meet its segregation obligations on an intra-day basis.

    If an FCM was not in compliance with the segregation requirements on an

    intra-day basis that would necessarily mean that the FCM was using the

    funds of one customer to margin positions of another customer or to

    cover losses of another customer.

    Paragraph (b) of Sec. 1.20 lists the permitted depositories for

    futures customer funds as any bank, trust company, derivatives clearing

    organization, or another FCM. These permitted depositories are listed

    in existing Sec. 1.20 and the Commission is not proposing to amend the

    list. Proposed paragraph (g)(2) lists the permitted depositories for

    futures funds received by a DCO as any bank or trust company, and

    clarifies that the term ``bank'' includes a Federal Reserve Bank. This

    proposed amendment implements section 806(a) of the Dodd-Frank Act,

    which provides that a Federal Reserve Bank may establish and maintain a

    deposit account for a ``financial market utility'' (in the present

    case, a DCO) that has been designated as systemically important.

    Paragraph (c) provides that an FCM may hold futures customer funds

    in depositories outside of the United States only in accordance with

    the current provisions of Sec. 1.49. Paragraph (g)(3) sets forth the

    same limitation for a DCO. Regulation 1.49 currently permits an FCM or

    DCO to hold futures customer funds in certain foreign depositories

    provided that the FCM or DCO holds sufficient funds in the United

    States to meet its U.S. dollar-denominated obligations to futures

    customers. Regulation 1.49 also requires specific futures customer

    authorization for an FCM or DCO to hold futures customer funds in

    certain foreign jurisdictions. The Commission is not proposing to amend

    Sec. 1.49 as part of this rulemaking.

    Proposed Sec. 1.20(e) prohibits an FCM from commingling futures

    customer funds with the FCM's proprietary funds, and prohibits the FCM

    from commingling funds deposited by futures customers with funds

    deposited by 30.7 Customers or Cleared Swaps Customers. Regulation

    1.20(e), however, does permit an FCM to commingle the funds of multiple

    futures customers in a single account or accounts for operational

    convenience. Similarly, proposed Sec. 1.20(g)(5) prohibits a DCO from

    commingling futures customer funds with the DCO's proprietary funds or

    with any proprietary account of any of its clearing members, and

    prohibits the DCO from commingling funds held for futures customers

    with funds deposited by clearing members on behalf of their Cleared

    Swaps Customers. DCOs would be permitted to commingle the funds of

    multiple futures customers in a single account or accounts for

    operational convenience.

    Proposed Sec. 1.20(f) restricts an FCM's use of customer funds. An

    FCM is prohibited from using one futures customer's funds to margin or

    secure another futures customer's positions. An FCM also is prohibited

    from using a futures customer's funds to extend credit to any other

    person. The FCM also may obligate futures customers' funds to a DCO or

    another FCM solely to purchase, margin, or guarantee futures and

    options positions of futures customers.

    The Commission is proposing a new paragraph (h) which states that

    all futures customer funds deposited with a bank or trust company must

    be available for immediate withdrawal upon demand by the FCM or DCO.

    Paragraph (h) codifies a long-standing interpretation of the

    Commission's Division of Swap Dealer and Intermediary Oversight and

    predecessor divisions derived from an administration determination by

    the Commission's predecessor, the Commodity Exchange Authority of the

    U.S. Department of Agriculture.\50\ The requirement, as proposed, is a

    practical necessity to the effective functioning of FCMs and futures

    markets. Should a depository have the ability to delay an FCM from

    withdrawing customer funds, the FCM may not be able to meet margin

    obligations to DCOs, or requests by futures customers for access to

    their funds. In addition, an inability of an FCM to have immediate

    access to the futures customer funds that it holds may adversely impact

    the transfer of futures customers positions in the event of the FCM's

    insolvency.\51\

    ---------------------------------------------------------------------------

    \50\ See Administrative Determination No. 29 of the Commodity

    Exchange Administration dated Sept. 28, 1937 stating, ``the deposit,

    by a futures commission merchant, of customers' funds * * * under

    conditions whereby such funds would not be subject to withdrawal

    upon demand would be repugnant to the spirit and purpose of the

    Commodity Exchange Act. All funds deposited in a bank should in all

    cases by subject to withdrawal on demand.''

    \51\ In the case of the bankruptcy of Lehman Brothers, for

    example, immediate access to customer funds allowed the commodity

    customer accounts to be effectively transferred to Barclays over the

    weekend of September 20-21, 2008, immediately following the

    commencement of the liquidation of the firm. This transfer was

    authorized in the hours immediately following the commencement of

    Lehman's liquidation, and was implemented in the hours immediately

    thereafter.

    ---------------------------------------------------------------------------

    The Commission is proposing a new paragraph (i), which

    mirrors what was recently adopted in Part 22 for Cleared Swaps

    Customers, by providing more detail implementing the Net Liquidating

    Equity Method of calculating segregation requirements. In addition,

    because a customer may have Net Liquidating Equity (i.e., a credit

    balance) in his or her account, requiring segregation of his or her

    funds, and still be undermargined relative to open positions, proposed

    paragraph (i) requires an FCM to record in the accounts of its futures

    customers the amount of margin required for such customers' open

    positions, and to calculate margin deficits for each such customer.

    Moreover, the Commission is proposing to require that an FCM maintain

    residual interest in segregated accounts in an amount that exceeds the

    sum of all futures customers' margin deficits. A margin deficit occurs

    when the value of the futures customer funds for a futures customer's

    account is less than the total amount of collateral required by DCOs

    for that account's contracts. Currently, the Commission requires FCMs

    to hold sufficient funds in segregated futures customer accounts to

    ensure that those accounts do not become undersegregated. Proposed new

    paragraph (i) will affirmatively require an FCM to maintain enough

    funds in the futures customer accounts to cover all margin deficits as

    well as to ensure that the accounts are not undersegregated. The

    Commission requests comments on all aspects of proposed new Sec.

    1.20(i), including the costs and benefits of this proposed regulation.

    The Commission specifically requests comment on the following:

    Will this proposal serve to increase the protections to

    customer funds in the event of an FCM bankruptcy?

    To what extent would this proposal increase costs to FCMs

    and/or futures customers?

    To what extent would this proposal benefit futures

    customers and/or FCMs?

    To what extent would this proposal increase or mitigate

    market risk?

    To what extent would this proposal lead to FCMs requiring

    customers to provide margin for their trades before placing them?

    To what extent is this likely to lead to a re-allocation

    of costs from customers with excess margin to undermargined customers?

    For purposes of margin deficit calculations, should the

    Commission

    [[Page 67883]]

    address issues surrounding the timing of when an FCM must have

    sufficient funds in the futures customer account to cover all margin

    deficits? If so, how should the Commission address such issues?

    In addition to the foregoing, the Commission also is proposing to

    revise requirements regarding the written acknowledgment letter that an

    FCM or DCO is required to obtain from a depository holding futures

    customer funds. Regulation 1.20 currently requires an FCM or DCO to

    obtain a written acknowledgment from each depository, unless the

    depository is a DCO that has rules approved by the Commission providing

    for the segregation of customer funds. The written acknowledgment must

    state that the depository was informed that the futures customer funds

    deposited belong to futures customers and are being held in accordance

    with the provisions of the Act and Commission regulations.

    The Commission previously proposed amendments to the acknowledgment

    letter regulations. On February 20, 2009, the Commission published

    proposed amendments to Sec. Sec. 1.20, 1.26, and 30.7 for public

    comment (the ``Original Proposal'').\52\ The Original Proposal set out

    specific representations that would have been required to be included

    in all acknowledgment letters in order to reaffirm and to clarify the

    obligations that depositories incur when accepting customer funds or

    secured amount funds.\53\

    ---------------------------------------------------------------------------

    \52\ 74 FR 7838 (February 20, 2009).

    \53\ The Commission notes that both the current and proposed

    definition of ``customer funds'' in Regulation 1.3(gg) do not

    include ``secured amount funds'' as defined in Regulation 30.7

    (i.e., funds deposited by foreign futures or foreign options

    customers). See 76 FR 33066, 33085 (June 7, 2011). However, as used

    in this notice, unless otherwise specified, the term ``customer

    funds'' is meant to include secured amount funds. The regulations

    adopted by this notice are also being amended to use the term

    ``customer'' as newly proposed (i.e., in this rulemaking the

    Commission is deleting references to ``commodity or option

    customers''. As necessary, the Commission distinguishes between the

    two types of funds in this notice by referring to ``customer

    segregated funds'' and ``customer secured amount funds.''

    ---------------------------------------------------------------------------

    In light of the comments on the Original Proposal, the Commission

    determined to re-propose the amendments with several changes made in

    response to comments (the ``Revised Proposal'').\54\ As part of the

    Revised Proposal, the Commission proposed the required use of standard

    template acknowledgment letters which were included as Appendix A to

    each of Sec. 1.20 and 1.26, and Appendix E to Part 30 of the

    Commission's regulations (referred to herein as the ``Template

    Letters'' or ``Acknowledgment Letters'').

    ---------------------------------------------------------------------------

    \54\ 75 FR 47738 (Aug. 9, 2010).

    ---------------------------------------------------------------------------

    The Commission received nine comment letters on the Revised

    Proposal.\55\ In general, the commenters were supportive of the

    Commission's Revised Proposal and, in particular, were very supportive

    of requiring the use of Template Letters. It was noted by certain

    commenters that use of a standard template will simplify the process of

    obtaining an Acknowledgment Letter.\56\ In addition, it was noted by

    commenters that uniformity of Acknowledgment Letters will provide

    consistency and legal certainty across the commodities and banking

    industries.\57\

    ---------------------------------------------------------------------------

    \55\ Letters were submitted by: Hunton & Williams on behalf of

    the Working Group of Commercial Energy Firms (``Energy Working

    Group''); International Derivatives Clearinghouse LLC (``IDCH'');

    Futures Industry Association (``FIA''); Harris, N.A. (``Harris'');

    Katten Muchin Rosenman LLP (``Katten''); CME Group Inc. (``CME'');

    The Minneapolis Grain Exchange (``MGEX''); JPMorgan Chase Bank, N.A.

    (``JP Morgan''); and The Federal Reserve Bank of Chicago, Financial

    Markets Group (``FRB Chicago'').

    \56\ See MGEX CL-00007 at 1; FIA CL-00003 at 2; Harris CL-00004

    at 1.

    \57\ See MGEX CL-00007 at 1; CME CL-00006 at 2; FRB Chicago CL-

    00010 at 1.

    ---------------------------------------------------------------------------

    The Commission is proposing revised amendments to the

    Acknowledgment Letters in this release to address several issues that

    have arisen as a result of the recent MF Global and Peregrine failures

    and the adverse impact on customers that had funds on deposit with

    these FCMs. The additional amendments are discussed below. The

    Commission also has revised the Acknowledgment Letters to address

    comments to the Revised Proposal. These revisions are discussed

    immediately below.

    1. Obligation To Obtain New Acknowledgment Letters

    Under the Revised Proposal, an FCM or DCO would be required to

    obtain a new Acknowledgment Letter within 60 days of changes in the

    name of any party to the Acknowledgment Letter or changes to the

    account number(s) under which customer funds are held. FIA stated that

    it is unduly burdensome to require the parties to execute a new

    Acknowledgment Letter in the event of a party changing its name within

    60 days of the event.\58\ FIA recommended instead including ``binding

    effect'' language in the Template Letters to ensure parties remain

    subject to the applicable provisions.\59\ If the Commission determines

    to adopt the amendment requirement, FIA requested that the time period

    be extended from 60 to 120 days because a change in name often occurs

    in the context of a merger or acquisition in which case the relevant

    party will be in the process of amending numerous agreements and

    related documentation.

    ---------------------------------------------------------------------------

    \58\ FIA CL-00003 at page 2.

    \59\ FIA suggests, for example, the following language: ``The

    terms of this letter shall remain binding upon the parties, their

    successors and assigns, including for the avoidance of doubt,

    regardless of the change in name of any party.'' FIA CL-00003 at

    page 2.

    ---------------------------------------------------------------------------

    The Commission has determined to add to the Template Letter the

    ``binding effect'' language as proposed by FIA, as this language will

    ensure the continued applicability of \45\ See Sec. 1.17(c)(5)(x)(A).

    \46\ Commission Regulations 1.17(c)(5)(v) and 1.32(b) both

    incorporate 17 CFR 240.15c3-1(c)(2)(vi) by reference.

    \47\ See 43 FR 15072 (Apr. 10, 1978) at 15077 and 43 FR 39956

    (Sept. 8, 1978) at 39963.

    ---------------------------------------------------------------------------

    The SEC capital rule currently applies a general or ``default''

    haircut of 15 percent of the market value of commercial paper,

    convertible debt instruments, and nonconvertible debt instruments if

    the securities are readily marketable, and 100 percent of the market

    value if the securities are not readily marketable. The SEC capital

    rule also provides for a lower haircut for commercial paper,

    convertible debt instruments, and nonconvertible debt instruments if

    the securities are rated in higher rating categories by at least two

    nationally recognized statistical rating organizations (``NRSROs''). To

    receive the benefit of a reduced haircut on commercial paper, the

    commercial paper must be rated in one of the three highest rating

    categories by at least two NRSROs. To receive the benefit of a reduced

    haircut on a nonconvertible debt security or a convertible debt

    security, the security must be rated in one of the four highest rating

    categories by at least two NRSROs.

    The SEC has proposed rule amendments to implement the Dodd-Frank

    Act requirement to remove references to credit ratings in its

    regulations and substitute a standard for creditworthiness deemed

    appropriate, including a proposed amendment to its net capital rule for

    BDs at 17 CFR 240.15c3-1.\48\ Under the SEC proposal, a BD may impose

    the default haircuts of 15 percent of the market value of readily

    marketable commercial paper, convertible debt, and nonconvertible debt

    instruments or 100 percent of the market value of nonmarketable

    commercial paper, convertible debt, and nonconvertible debt

    instruments. A BD, however, may impose lower haircut percentages for

    commercial paper, convertible debt, and nonconvertible debt instruments

    that are readily marketable, if the BD determines that the investments

    have only a minimal amount of credit risk pursuant to its written

    policies and procedures designed to assess the credit and liquidity

    risks applicable to a security.

    ---------------------------------------------------------------------------

    \48\ See 76 FR 26550 (May 6, 2011).

    ---------------------------------------------------------------------------

    Under the SEC proposal, the BD's written policies and procedures

    may assess a security's credit risk using the following factors, to the

    extent appropriate, instead of exclusively relying on NRSROs ratings:

    Credit spreads (i.e., whether it is possible to

    demonstrate that a position in commercial paper, nonconvertible debt,

    and preferred stock is subject to a minimal amount of credit risk based

    on the spread between the security's yield and the yield of Treasury or

    other securities, or based on credit default swap spreads that

    reference the security);

    Securities-related research (i.e., whether providers of

    securities-related research believe the issuer of the security will be

    able to meet its financial commitments, generally, or specifically,

    with respect to securities held by the broker-dealer);

    Internal or external credit risk assessments (i.e.,

    whether credit assessments developed internally by the broker-dealer or

    externally by a credit rating agency, irrespective of its status as an

    NRSRO, express a view as to the credit risk associated with a

    particular security);

    Default statistics (i.e., whether providers of credit

    information relating to securities express a view that specific

    securities have a probability of default consistent with other

    securities with a minimal amount of credit risk);

    Inclusion on an index (i.e., whether a security, or issuer

    of the security, is included as a component of a recognized index of

    instruments that are subject to a minimal amount of credit risk);

    Priorities and enhancements (i.e., the extent to which a

    security is covered by credit enhancements, such as

    overcollateralization and reserve accounts, or has priority under

    applicable bankruptcy or creditors' rights provisions);

    Price, yield and/or volume (i.e., whether the price and

    yield of a security or a credit default swap that references the

    security are consistent with other securities that the broker-dealer

    has determined are subject to a minimal amount of credit risk and

    whether the price resulted from active trading); and

    Asset class-specific factors (e.g., in the case of

    structured finance products, the quality of the underlying assets).

    A BD that maintains written policies and procedures and determines

    that the credit risk of a security is minimal is permitted under the

    SEC proposal to apply the lesser haircut requirement currently

    specified in the SEC capital rule for commercial paper (i.e., between

    zero and [frac12] of 1 percent), nonconvertible debt (i.e., between 2

    percent and 9 percent), and preferred stock (i.e., 10 percent).

    For FCMs that are dually-registered as BDs, any changes adopted by

    the SEC to these securities haircuts will be applicable under Sec.

    1.17(c)(5)(v) unless the Commission specifically provides an alternate

    treatment for FCMs.\49\ However, FCMs that are not dual registrants

    would be required to take the default haircuts of 15 percent for

    readily marketable securities. The Commission does not believe that it

    is appropriate to exclude standalone FCMs from using an internal

    process to assess the credit risk of certain securities. Therefore, the

    Commission's proposed amendment to Sec. 1.17(c)(v) will permit an FCM

    that is not a BD to develop the framework proposed by the SEC to

    establish, maintain and enforce written policies and procedures for

    determining creditworthiness, and upon a determination that a

    particular type of security has minimal credit risk, to apply lower

    deductions to such

    [[Page 67881]]

    securities. An FCM will be required to maintain its written policies

    and procedures in accordance with the general recordkeeping

    requirements of Sec. 1.31, and the implementation of the policies and

    procedures will be subject to review by the FCM's DSRO. An FCM that

    elects to develop written policies and procedures will be subject to

    review by its DSRO.

    ---------------------------------------------------------------------------

    \49\ See discussion adopting Sec. 1.17(c)(5)(vi) for options

    haircuts at 43 FR 39956 at 39964, with respect to the applicability

    of provisions incorporating by reference and referring to the rules

    of the SEC for securities broker dealers also registered as futures

    commission merchants.

    ---------------------------------------------------------------------------

    Regulation 1.17 also requires an FCM to reduce its capital (i.e.,

    take a capital charge) for customer, noncustomer, and omnibus accounts

    that are undermargined for more than a specified period of time.

    Regulation 1.17(c)(5)(viii) requires an FCM to take a capital charge if

    a customer account is undermargined for three business days after the

    margin call is issued. The capital charge is equal to the amount of

    funds necessary to restore the account to the initial margin

    requirement.

    Regulation 1.17(c)(5)(ix) requires an FCM to take a capital charge

    for noncustomer and omnibus accounts that are undermargined for two

    business days after the margin call is issued. The capital requirement

    for undermargined noncustomer and omnibus accounts is the amount of

    funds necessary to restore the account to the maintenance margin level.

    For purposes of these Commission regulations, a margin call is

    presumed to be issued by the FCM the day after an account becomes

    undermargined. Thus, if a customer's account is undermargined at the

    close of business on Monday, the FCM will issue a margin call on

    Tuesday, and the regulation requires the FCM to take an undermargined

    capital charge at the close of business on Friday if the margin call is

    not met. For noncustomer and omnibus accounts that were undermargined

    at the close of business on Monday, the FCM would take a capital charge

    as of the close of business on Thursday.

    The Commission is proposing to amend Sec. Sec. 1.17(c)(5)(viii)

    and (ix) to require an FCM to take capital charges for undermargined

    customer, noncustomer, and omnibus account that are undermargined for

    more than one business day after a margin call is issued. Therefore, an

    FCM will impose a capital charge as of the close of business on

    Wednesday for any customer, noncustomer, or omnibus account that did

    not fully satisfy a margin call that is issued by the FCM on Tuesday

    for an account that was undermargined as of the close of business on

    Monday.

    The timely collection of margin is a critical component of an FCM's

    risk management program and is intended to ensure that an FCM holds

    sufficient funds deposited by account owners to meet potential

    obligations to a DCO. As guarantor of the financial performance of the

    customer, noncustomer, and omnibus accounts that it carries, the FCM is

    financially responsible if the owner of an account cannot meet its

    margin obligations to the FCM and ultimately to a DCO. The timeframe

    for meeting margin calls currently provided in Sec. Sec.

    1.17(c)(5)(viii) and (ix) may have been appropriate when the capital

    rules were adopted in the 1970s when the use of checks and the mail

    system were more prevalent for depositing margin with an FCM. The

    Commission believes, however, that in today's markets, with the

    increasing use of technology, 24-hour-a-day trading, and the use of

    wire transfers to meet margin obligations, that the timeframe for

    taking a capital charge should be reduced both to incentivize FCMs to

    exercise prudent risk management and to strengthen the financial

    protection of FCMs, their customers, and the clearing systems by

    requiring the FCMs to reserve capital for undermargined customer,

    noncustomer, and omnibus accounts that fail to meet a margin call on a

    timely basis.

    The Commission also is proposing, as discussed in Section II.I

    below, to require an FCM to maintain a residual interest in customer

    segregated accounts in an amount sufficient to cover all customer

    accounts that are undermargined as of the close of business on the

    previous trading day, thereby ensuring that residual interest in

    customer segregated accounts exceeds the sum of outstanding margin

    calls for customers, and that the funds of one customer are not used to

    margin or guarantee the positions of another customer. The FCM may only

    maintain as residual interest cash and assets that qualify as permitted

    investments under Sec. 1.25. Margin deficits will be calculated as

    enough to restore the customer's account equity to the maintenance

    margin requirement on the account.

    The Commission also is proposing technical amendments to certain

    definitions in Sec. 1.17 to reflect proposed changes discussed in

    Section II.R below concerning the Sec. 30.7 secured amount

    calculation. The Sec. 1.17(b)(2) and (7) definitions of the terms

    ``customer'' and ``customer account'' are being proposed to be amended,

    the first to include ``30.7 Customer'' (which is a new definition being

    proposed in Sec. 30.1 to include foreign domiciled persons) and the

    second to remove surplus language due to the revised definition of

    ``customer.''

    The Commission requests comment on the proposed amendments to Sec.

    1.17. Specifically, the Commission requests comment on the following:

    Does the proposed amendment to require an FCM to certify

    that it has sufficient liquidity to operate as a going concern provide

    a sufficient and objective standard for FCMs to assess whether they are

    in compliance with the provision? Are there alternative standards or

    approaches that the Commission should consider to meet its objective of

    ensuring that an FCM has sufficient liquidity to meet its pending

    short-term obligations so that customer funds would not be put at risk

    in the event of the insolvency of the FCM?

    Should the Commission consider alternative timeframes for

    the imposition of a capital charge for undermargined accounts?

    G. Proposed Amendments to Sec. 1.20: Futures Customer Funds To Be

    Segregated and Separately Accounted for

    The Commission is proposing to reorganize the structure of Sec.

    1.20 by providing additional paragraph subdivisions to the existing

    specific requirements, applying headings to the regulation to assist in

    the reading and understanding of the regulation. The Commission also is

    proposing to add new provisions designed to enhance the protection of

    customer funds.

    Regulation 1.20 implements the provisions of section 4d(a)(2) of

    the Act, which provides, in relevant part, that an FCM must: (1)

    Separately account for all futures customer funds and segregate such

    funds as belonging to its futures customers; (2) not commingle futures

    customer funds with the FCM's proprietary funds; (3) not use the funds

    of one futures customer to margin or extend credit to any person other

    than to the futures customer that deposited the funds; and (4) deposit

    futures customer funds in any bank, trust company or DCO.

    Paragraph (a) of Sec. 1.20 sets forth the general principle under

    section 4d(a)(2) of the Act by requiring an FCM to separately account

    for all futures customer funds and to segregate such funds from the

    FCM's proprietary funds by depositing them under an account name that

    clearly shows that the funds are futures customer funds and segregated

    as required by the Act. Paragraph (g)(1) applies the same general

    principle to futures customer funds received by a DCO from its members.

    Paragraph (a) also requires each FCM to perform appropriate due

    diligence on all depositories in accordance with its risk management

    policies and procedures required under proposed

    [[Page 67882]]

    Sec. 1.11 to ensure that the depositories holding customer funds are

    financially sound. The FCM must annually update its due diligence.

    Paragraph (a) of Sec. 1.20 also provides that an FCM must be in

    compliance with its segregation obligations at all times. It is not

    sufficient for an FCM to be in compliance at the end of a business day,

    but to fail to meet its segregation obligations on an intra-day basis.

    If an FCM was not in compliance with the segregation requirements on an

    intra-day basis that would necessarily mean that the FCM was using the

    funds of one customer to margin positions of another customer or to

    cover losses of another customer.

    Paragraph (b) of Sec. 1.20 lists the permitted depositories for

    futures customer funds as any bank, trust company, derivatives clearing

    organization, or another FCM. These permitted depositories are listed

    in existing Sec. 1.20 and the Commission is not proposing to amend the

    list. Proposed paragraph (g)(2) lists the permitted depositories for

    futures funds received by a DCO as any bank or trust company, and

    clarifies that the term ``bank'' includes a Federal Reserve Bank. This

    proposed amendment implements section 806(a) of the Dodd-Frank Act,

    which provides that a Federal Reserve Bank may establish and maintain a

    deposit account for a ``financial market utility'' (in the present

    case, a DCO) that has been designated as systemically important.

    Paragraph (c) provides that an FCM may hold futures customer funds

    in depositories outside of the United States only in accordance with

    the current provisions of Sec. 1.49. Paragraph (g)(3) sets forth the

    same limitation for a DCO. Regulation 1.49 currently permits an FCM or

    DCO to hold futures customer funds in certain foreign depositories

    provided that the FCM or DCO holds sufficient funds in the United

    States to meet its U.S. dollar-denominated obligations to futures

    customers. Regulation 1.49 also requires specific futures customer

    authorization for an FCM or DCO to hold futures customer funds in

    certain foreign jurisdictions. The Commission is not proposing to amend

    Sec. 1.49 as part of this rulemaking.

    Proposed Sec. 1.20(e) prohibits an FCM from commingling futures

    customer funds with the FCM's proprietary funds, and prohibits the FCM

    from commingling funds deposited by futures customers with funds

    deposited by 30.7 Customers or Cleared Swaps Customers. Regulation

    1.20(e), however, does permit an FCM to commingle the funds of multiple

    futures customers in a single account or accounts for operational

    convenience. Similarly, proposed Sec. 1.20(g)(5) prohibits a DCO from

    commingling futures customer funds with the DCO's proprietary funds or

    with any proprietary account of any of its clearing members, and

    prohibits the DCO from commingling funds held for futures customers

    with funds deposited by clearing members on behalf of their Cleared

    Swaps Customers. DCOs would be permitted to commingle the funds of

    multiple futures customers in a single account or accounts for

    operational convenience.

    Proposed Sec. 1.20(f) restricts an FCM's use of customer funds. An

    FCM is prohibited from using one futures customer's funds to margin or

    secure another futures customer's positions. An FCM also is prohibited

    from using a futures customer's funds to extend credit to any other

    person. The FCM also may obligate futures customers' funds to a DCO or

    another FCM solely to purchase, margin, or guarantee futures and

    options positions of futures customers.

    The Commission is proposing a new paragraph (h) which states that

    all futures customer funds deposited with a bank or trust company must

    be available for immediate withdrawal upon demand by the FCM or DCO.

    Paragraph (h) codifies a long-standing interpretation of the

    Commission's Division of Swap Dealer and Intermediary Oversight and

    predecessor divisions derived from an administration determination by

    the Commission's predecessor, the Commodity Exchange Authority of the

    U.S. Department of Agriculture.\50\ The requirement, as proposed, is a

    practical necessity to the effective functioning of FCMs and futures

    markets. Should a depository have the ability to delay an FCM from

    withdrawing customer funds, the FCM may not be able to meet margin

    obligations to DCOs, or requests by futures customers for access to

    their funds. In addition, an inability of an FCM to have immediate

    access to the futures customer funds that it holds may adversely impact

    the transfer of futures customers positions in the event of the FCM's

    insolvency.\51\

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    \50\ See Administrative Determination No. 29 of the Commodity

    Exchange Administration dated Sept. 28, 1937 stating, ``the deposit,

    by a futures commission merchant, of customers' funds * * * under

    conditions whereby such funds would not be subject to withdrawal

    upon demand would be repugnant to the spirit and purpose of the

    Commodity Exchange Act. All funds deposited in a bank should in all

    cases by subject to withdrawal on demand.''

    \51\ In the case of the bankruptcy of Lehman Brothers, for

    example, immediate access to customer funds allowed the commodity

    customer accounts to be effectively transferred to Barclays over the

    weekend of September 20-21, 2008, immediately following the

    commencement of the liquidation of the firm. This transfer was

    authorized in the hours immediately following the commencement of

    Lehman's liquidation, and was implemented in the hours immediately

    thereafter.

    ---------------------------------------------------------------------------

    The Commission is proposing a new paragraph (i), which

    mirrors what was recently adopted in Part 22 for Cleared Swaps

    Customers, by providing more detail implementing the Net Liquidating

    Equity Method of calculating segregation requirements. In addition,

    because a customer may have Net Liquidating Equity (i.e., a credit

    balance) in his or her account, requiring segregation of his or her

    funds, and still be undermargined relative to open positions, proposed

    paragraph (i) requires an FCM to record in the accounts of its futures

    customers the amount of margin required for such customers' open

    positions, and to calculate margin deficits for each such customer.

    Moreover, the Commission is proposing to require that an FCM maintain

    residual interest in segregated accounts in an amount that exceeds the

    sum of all futures customers' margin deficits. A margin deficit occurs

    when the value of the futures customer funds for a futures customer's

    account is less than the total amount of collateral required by DCOs

    for that account's contracts. Currently, the Commission requires FCMs

    to hold sufficient funds in segregated futures customer accounts to

    ensure that those accounts do not become undersegregated. Proposed new

    paragraph (i) will affirmatively require an FCM to maintain enough

    funds in the futures customer accounts to cover all margin deficits as

    well as to ensure that the accounts are not undersegregated. The

    Commission requests comments on all aspects of proposed new Sec.

    1.20(i), including the costs and benefits of this proposed regulation.

    The Commission specifically requests comment on the following:

    Will this proposal serve to increase the protections to

    customer funds in the event of an FCM bankruptcy?

    To what extent would this proposal increase costs to FCMs

    and/or futures customers?

    To what extent would this proposal benefit futures

    customers and/or FCMs?

    To what extent would this proposal increase or mitigate

    market risk?

    To what extent would this proposal lead to FCMs requiring

    customers to provide margin for their trades before placing them?

    To what extent is this likely to lead to a re-allocation

    of costs from customers with excess margin to undermargined customers?

    For purposes of margin deficit calculations, should the

    Commission

    [[Page 67883]]

    address issues surrounding the timing of when an FCM must have

    sufficient funds in the futures customer account to cover all margin

    deficits? If so, how should the Commission address such issues?

    In addition to the foregoing, the Commission also is proposing to

    revise requirements regarding the written acknowledgment letter that an

    FCM or DCO is required to obtain from a depository holding futures

    customer funds. Regulation 1.20 currently requires an FCM or DCO to

    obtain a written acknowledgment from each depository, unless the

    depository is a DCO that has rules approved by the Commission providing

    for the segregation of customer funds. The written acknowledgment must

    state that the depository was informed that the futures customer funds

    deposited belong to futures customers and are being held in accordance

    with the provisions of the Act and Commission regulations.

    The Commission previously proposed amendments to the acknowledgment

    letter regulations. On February 20, 2009, the Commission published

    proposed amendments to Sec. Sec. 1.20, 1.26, and 30.7 for public

    comment (the ``Original Proposal'').\52\ The Original Proposal set out

    specific representations that would have been required to be included

    in all acknowledgment letters in order to reaffirm and to clarify the

    obligations that depositories incur when accepting customer funds or

    secured amount funds.\53\

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    \52\ 74 FR 7838 (February 20, 2009).

    \53\ The Commission notes that both the current and proposed

    definition of ``customer funds'' in Regulation 1.3(gg) do not

    include ``secured amount funds'' as defined in Regulation 30.7

    (i.e., funds deposited by foreign futures or foreign options

    customers). See 76 FR 33066, 33085 (June 7, 2011). However, as used

    in this notice, unless otherwise specified, the term ``customer

    funds'' is meant to include secured amount funds. The regulations

    adopted by this notice are also being amended to use the term

    ``customer'' as newly proposed (i.e., in this rulemaking the

    Commission is deleting references to ``commodity or option

    customers''. As necessary, the Commission distinguishes between the

    two types of funds in this notice by referring to ``customer

    segregated funds'' and ``customer secured amount funds.''

    ---------------------------------------------------------------------------

    In light of the comments on the Original Proposal, the Commission

    determined to re-propose the amendments with several changes made in

    response to comments (the ``Revised Proposal'').\54\ As part of the

    Revised Proposal, the Commission proposed the required use of standard

    template acknowledgment letters which were included as Appendix A to

    each of Sec. 1.20 and 1.26, and Appendix E to Part 30 of the

    Commission's regulations (referred to herein as the ``Template

    Letters'' or ``Acknowledgment Letters'').

    ---------------------------------------------------------------------------

    \54\ 75 FR 47738 (Aug. 9, 2010).

    ---------------------------------------------------------------------------

    The Commission received nine comment letters on the Revised

    Proposal.\55\ In general, the commenters were supportive of the

    Commission's Revised Proposal and, in particular, were very supportive

    of requiring the use of Template Letters. It was noted by certain

    commenters that use of a standard template will simplify the process of

    obtaining an Acknowledgment Letter.\56\ In addition, it was noted by

    commenters that uniformity of Acknowledgment Letters will provide

    consistency and legal certainty across the commodities and banking

    industries.\57\

    ---------------------------------------------------------------------------

    \55\ Letters were submitted by: Hunton & Williams on behalf of

    the Working Group of Commercial Energy Firms (``Energy Working

    Group''); International Derivatives Clearinghouse LLC (``IDCH'');

    Futures Industry Association (``FIA''); Harris, N.A. (``Harris'');

    Katten Muchin Rosenman LLP (``Katten''); CME Group Inc. (``CME'');

    The Minneapolis Grain Exchange (``MGEX''); JPMorgan Chase Bank, N.A.

    (``JP Morgan''); and The Federal Reserve Bank of Chicago, Financial

    Markets Group (``FRB Chicago'').

    \56\ See MGEX CL-00007 at 1; FIA CL-00003 at 2; Harris CL-00004

    at 1.

    \57\ See MGEX CL-00007 at 1; CME CL-00006 at 2; FRB Chicago CL-

    00010 at 1.

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    The Commission is proposing revised amendments to the

    Acknowledgment Letters in this release to address several issues that

    have arisen as a result of the recent MF Global and Peregrine failures

    and the adverse impact on customers that had funds on deposit with

    these FCMs. The additional amendments are discussed below. The

    Commission also has revised the Acknowledgment Letters to address

    comments to the Revised Proposal. These revisions are discussed

    immediately below.

    1. Obligation To Obtain New Acknowledgment Letters

    Under the Revised Proposal, an FCM or DCO would be required to

    obtain a new Acknowledgment Letter within 60 days of changes in the

    name of any party to the Acknowledgment Letter or changes to the

    account number(s) under which customer funds are held. FIA stated that

    it is unduly burdensome to require the parties to execute a new

    Acknowledgment Letter in the event of a party changing its name within

    60 days of the event.\58\ FIA recommended instead including ``binding

    effect'' language in the Template Letters to ensure parties remain

    subject to the applicable provisions.\59\ If the Commission determines

    to adopt the amendment requirement, FIA requested that the time period

    be extended from 60 to 120 days because a change in name often occurs

    in the context of a merger or acquisition in which case the relevant

    party will be in the process of amending numerous agreements and

    related documentation.

    ---------------------------------------------------------------------------

    \58\ FIA CL-00003 at page 2.

    \59\ FIA suggests, for example, the following language: ``The

    terms of this letter shall remain binding upon the parties, their

    successors and assigns, including for the avoidance of doubt,

    regardless of the change in name of any party.'' FIA CL-00003 at

    page 2.

    ---------------------------------------------------------------------------

    The Commission has determined to add to the Template Letter the

    ``binding effect'' language as proposed by FIA, as this language will

    ensure the continued applicability of the Acknowledgment Letter in the

    event of a name change to the parties. The Commission, however, is

    proposing to require that FCMs and DCOs file new Acknowledgment Letters

    in the event of a name, address, or other change as specified in the

    proposed rule because the Commission believes it is important to

    maintain current and accurate Acknowledgment Letters to provide clear

    legal status of the customer account, which will better protect

    customers in the event of a dispute regarding the legal status of the

    account. The Commission is proposing a 120-day time period for an FCM

    to obtain new Acknowledgment Letters. Given the use of the Template

    Letter, which is not open to negotiation, and electronic filing, the

    Commission believes that 120 days is a sufficient period of time for

    FCMs and DCOs to obtain and file the new Acknowledgment Letters.

    2. Technical Amendments to Acknowledgment Letter for Omnibus Accounts;

    Abbreviation of Account Names

    Regulation 1.20 provides that customer funds, when deposited with a

    depository, ``shall be deposited under an account name that clearly

    identifies them as such and shows that they are segregated as required

    by the Act and [Part 1 of the CFTC Regulations].'' FIA noted that the

    account naming convention used in the proposed forms of Template

    Letters \60\ may present certain issues with respect to Acknowledgment

    Letters obtained by FCMs maintaining customer funds with

    [[Page 67884]]

    another FCM through a customer omnibus account relationship.\61\ The

    first issue is with respect to operational limits on the number of

    characters available for account names. Secondly, naming conventions

    for such accounts typically include the words ``Customer Omnibus

    Account'' and the relevant account number. FIA accordingly requested

    the Commission to clarify that the Template Letters may be modified to

    permit the use of the words ``CFTC Regulated FCM Customer Omnibus

    Account'' to describe such accounts.

    ---------------------------------------------------------------------------

    \60\ Proposed Appendix A to Regulation 1.20 provides that the

    Account will be entitled ``[Name of Futures Commission Merchant or

    Derivatives Clearing Organization] CFTC Regulation 1.20 Customer

    Segregated Account.'' 75 FR 47738, 47743 (Aug. 9, 2010); Proposed

    Appendix A to Regulation 1.26 provides that the Account will be

    entitled ``[Name of Futures Commission Merchant or Derivatives

    Clearing Organization] CFTC Regulation 1.26 Customer Segregated

    Money Market Mutual Fund Account.'' 75 FR 47738, 47744 (Aug. 9,

    2010); and Proposed Appendix E to part 30 provides that the Account

    will be entitled ``[Name of Futures Commission Merchant] CFTC

    Regulation 30.7 Customer Secured Account.'' 75 FR 47738, 47745 (Aug.

    9, 2010).

    \61\ FIA CL-00003 at 4 and 5.

    ---------------------------------------------------------------------------

    The Commission has modified the proposed Template Letters to

    provide an option to add the words ``CFTC Regulated FCM Customer

    Omnibus Account'' to describe such accounts when applicable. In

    addition, the Commission is proposing that if the name of the account

    as set forth in the Template Letter is too long for a depository's

    system to include all characters, the depository may abbreviate the

    name in order to accommodate its system, provided that (i) it remains

    clear that the account is a CFTC regulated segregated/secured account

    held for the benefit of customers (e.g., ``segregated'' may be

    shortened to ``seg;'' ``customer'' may be shortened to ``cust;''

    ``account'' to ``acct;'' etc.), and (ii) when completing an

    Acknowledgment Letter, such letter must include both the long and short

    versions of the account name.

    3. Clarification Regarding Notice, Authentication, and Instruction

    Protocol for Commission Authorized Withdrawals

    Four of the commenters to the Revised Proposal addressed the need

    for the Commission to establish specific standards with respect to the

    notice, authentication and instruction protocol regarding Commission

    instructions for the immediate release of funds from a Customer

    Account.\62\

    ---------------------------------------------------------------------------

    \62\ In the Revised Proposal, the Template Letter provides that

    ``the Funds in the Account(s) shall be released immediately, * * *

    upon proper notice and instruction from an appropriate officer or

    employee * * * of the CFTC. [FCM/DCO] will not hold [depository]

    responsible for acting pursuant to any instruction from the CFTC

    upon which [depository] has relied after having taken reasonable

    measures to assure that such instruction was provided to

    [depository] by a duly authorized officer or employee of the CFTC.''

    ---------------------------------------------------------------------------

    The FRB Chicago pointed out that, as the Acknowledgment Letters

    will have been filed electronically with the Commission, the Commission

    will know all of the Depositories that have signed such letters, their

    location, and basic contact information. In light of this, the FRB

    Chicago suggests that the Commission could establish for each

    depository a basic but unique authentication identifier. The Commission

    believes this suggestion has merit, and it will consider implementing

    this type of data collection and identification as it works to

    implement the operational aspects of the electronic filing of

    Acknowledgment Letters.

    JP Morgan suggests that the Acknowledgment Letter include a notice

    provision with contact information for the depository so that the

    Commission has information on how best to contact the depository. The

    Commission agrees with this suggestion and has revised the Template

    Letters to indicate where depository contact information may be

    inserted as optional information. The Commission recognizes that such

    information may be subject to frequent change and, therefore, at this

    time, the Commission is not requiring that an amended Acknowledgment

    Letter be filed in the event there are changes to such contact

    information.

    Katten asserts that Depositories face legal uncertainty with

    respect to their release of customer funds in reliance on instructions

    from the Commission. Katten states that the Commission's reluctance to

    define ``proper notice'' or ``reasonable measures'' imposes on

    Depositories the conflicting obligations (i) to the Commission, to

    release customer funds ``immediately upon proper notice,'' and (ii) to

    its customer FCM, to take ``reasonable measures'' first to assure that

    such notice was ``duly authorized.''

    With respect to due authorization, Katten requests that the

    Commission reconsider its decision to permit an instruction to transfer

    customer funds to be made orally, with written confirmation to follow.

    Katten believes that the depository's obligation to take ``reasonable

    measures'' may require it to await written confirmation in any event.

    In addition, Katten believes that the proposed amendments to Sec. Sec.

    1.20, 1.26, 30.7 and 140.91 do not limit the identity of the Commission

    officers and employees that may issue a notice to a depository or the

    process that must be followed before such a notice is issued. Katten

    submits that a depository would have a reasonable basis to conclude

    that an instruction to transfer customer funds was duly authorized if

    the depository could be assured that any instruction to transfer

    customer funds would be issued only by the Director of the Division of

    Clearing and Intermediary Oversight (or the Director's designee).\63\

    Katten recommends that ``the Commission revise the proposed rules to

    confirm that any such instruction may be made only by the Commission or

    by the director of DCIO (or the director's designee) acting with the

    concurrence of the General Counsel (or Deputy General Counsel).'' \64\

    FIA requests, at a minimum, that the Commission define and limit the

    term ``appropriate officer or employee'' of the Commission (for

    example, authorization limited to Division Directors or other senior

    designated personnel such as Deputy Directors or Associate

    Directors).\65\

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    \63\ In October 2011, the Commission reorganized the Division of

    Clearing and Intermediary Oversight into two divisions, the Division

    of Clearing and Risk and the Division of Swap Dealer and

    Intermediary Oversight. With respect to a transfer of customer funds

    as contemplated in this rulemaking, instructions would come from

    either the Director of the Director of the Division of Clearing and

    Risk or the Director of the Division of Swap Dealer and Intermediary

    Oversight (or one of the Director's designees).

    \64\ See Katten CL-00005 at FN 3.

    \65\ FIA CL-00003 at page 3.

    ---------------------------------------------------------------------------

    With respect to a ``duly authorized officer or employee of the

    CFTC,'' the Commission has determined to provide that any such

    instruction to transfer customer funds may be made by the Director of

    the Division of Clearing and Risk (or the Director's designee), or by

    the Director of the Division of Swap Dealer and Intermediary Oversight

    (or the Director's designee). Accordingly, the Template Letter now

    specifies that such instructions may only be given by the Director of

    the Division of Clearing and Risk (or any successor division), the

    Director of the Division of Swap Dealer and Intermediary Oversight (or

    any successor division), or the designees of such Directors under

    delegated authority.\66\ With regard to the role of the General

    Counsel, the General Counsel will be consulted by the Director of the

    Division of Clearing and Risk (or any successor division), the Director

    of the Division of Swap Dealer and Intermediary Oversight (or any

    successor division), or the designees of such Directors prior to the

    exercise of the delegated authority.

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    \66\ The Commission will publish on its Web site the identity of

    the Director of the Division of Clearing and Risk, the Director of

    the Division of Swap Dealer and Intermediary Oversight, and the

    individual(s) who are authorized to serve as their designees. The

    Template Letters do not explicitly refer to instructions provided by

    ``the Commission'' because in exigent circumstances, it is not

    likely that action approved by a majority of Commissioners will be

    feasible.

    ---------------------------------------------------------------------------

    The Commission does not believe, as asserted by Katten, that

    ``reasonable measures'' may require the depository to await written

    confirmation. For example, due to the nature of the

    [[Page 67885]]

    exceptional circumstances that would prompt a call from the Commission,

    it is likely that the depository would already be aware of certain

    problems facing the FCM or DCO and would not be surprised to receive a

    phone call from a Division Director (or his or her designee). In

    addition, while the Commission believes it is desirable that any such

    instruction to release customer funds be in writing, or, if oral, to be

    confirmed in writing, the Commission is not limiting the manner of

    notice in the Template Letter given the potential exigencies of the

    situation and the need for flexibility in communication. For example,

    either the Commission or the depository could be experiencing

    unexpected technical problems in its respective email servers or

    facsimile machines. It is critical that the transfer of customer funds

    from a Segregated Account not be delayed as a result of technical or

    other operational issues.

    With respect to the release of customer funds ``immediately upon

    proper notice,'' Katten commented that it appreciates the Commission's

    recognition of the potential practical obstacles to immediate release

    (e.g., Fedwire is unavailable). However, Katten remains concerned that,

    in the absence of further guidance or clarification, the use of the

    term ``immediately'' may subject a depository to potential claims by

    either FCMs or the Commission in the event that there is a delay in the

    transfer of customer funds, even if such delay is the result of

    reasonable actions on the part of the depository or events beyond the

    control of the depository. In addition, FIA commented that it would

    like the Commission to confirm that its authority to require the

    transfer of customer funds would be expected to be used sparingly

    (i.e., ``only in exceptional circumstances'').

    After considering these comments, the Commission is proposing to

    retain the use of the word ``immediately'' in the Template Letter

    regarding instructions to a depository for release of customer funds.

    First, in response to FIA's comment, the Commission clarifies that the

    use of its authority to require the immediate release of customer funds

    would be in exceptional circumstances. As stated in the Revised

    Proposal, ``[t]he Commission would issue such an instruction only when,

    in the judgment of the Commission, it is necessary to do so for the

    protection of customer funds. For example, the prospective insolvency

    of the FCM could prompt an instruction from the Commission to release

    the customer funds.'' \67\ Next, the Commission notes that anything

    less than the term ``immediate'' could leave the timing open to

    interpretation, which could cause delays in the transfer of funds and

    have a potential impact on safety and soundness of customer funds and

    positions. In this regard, the Commission notes that customer funds in

    the Segregated Account have always been subject to withdrawal

    immediately upon demand by the FCM.\68\

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    \67\ 75 FR 47738, 47740. The Revised Proposal also noted that,

    as set forth in the Template Letter, in the event the FCM becomes

    subject to a voluntary or involuntary petition for relief under the

    U.S. Bankruptcy Code, the depository will have no obligation to

    release the customer funds except upon instruction from the

    bankruptcy trustee or pursuant to a court order. Id.

    \68\ See Amended Financial and Segregation Interpretation No.

    10, 70 FR 24768 (May 11, 2005) (``Thus any impediments or

    restrictions on the FCM's ability to obtain immediate and unfettered

    access to customer funds are not permitted. The immediate and

    unfettered access requirements is [sic] intended to prevent

    potential delay or interruption in securing required margin payments

    that, in times of significant market disruption, could magnify the

    impact of such market disruption and impair the liquidity of other

    FCMs and clearinghouses.'')

    ---------------------------------------------------------------------------

    4. Limiting the ``Merger'' Clause in the Acknowledgment Letter

    CME believes that the use of an integration clause (i.e., the

    statement that the Acknowledgment Letter ``constitutes the entire

    understanding of the parties with respect to its subject matter'') in

    the Template Letters is inappropriate and could have a number of

    serious and unintended consequences. For example, the parties to the

    Acknowledgment Letter could be prevented from relying upon and

    enforcing terms of applicable account (or similar) agreements that do

    not conflict with the Acknowledgment Letter. CME believes the term

    ``subject matter'' is ambiguous and could be interpreted very broadly

    thereby casting doubt on the validity and interpretation of existing

    agreements between the parties. The CME suggests the following more

    narrowly tailored language for the integration clause in the Template

    Letters: ``This letter agreement supersedes and replaces any prior

    agreement between the parties in connection with the Account(s),

    including but not limited to any prior Acknowledgment Letter, to the

    extent that such prior agreement is inconsistent with the terms

    hereof.''

    FIA agrees with the CME's comment that the scope of the ``merger

    clause'' in the Template Letters should be narrowed to make clear that

    these clauses do not invalidate the terms of other agreements that may

    have been entered into by the parties and that do not conflict with the

    Template Letters. The FRB Chicago also believes that this provision

    should be narrowed so that a bank's standard account opening

    agreements, corporate resolutions and other agreements incorporated by

    reference should govern the remainder of the account relationship, but

    not matters specific to section 4d of the Act. Should there be a

    conflict, the Acknowledgment Letter should govern matters specific to

    section 4d of the Act.

    The Commission agrees with the commenters that the scope of the

    ``merger clause'' language in the Template Letter \69\ should be

    narrowed. Accordingly, the Commission is replacing the clause with

    CME's suggested language above. In addition, in order to incorporate

    the comment of the FRB Chicago and to ensure that future agreements

    between the parties do not negate the Acknowledgment Letter, the

    Commission is adding the following sentence to the end of the new

    language: ``In the event of any conflict between this letter agreement

    and any other agreement between the parties in connection with the

    Account(s), this letter agreement shall govern with respect to matters

    specific to section 4d of the Act and the CFTC's regulations, as

    amended.''

    ---------------------------------------------------------------------------

    \69\ The merger clause language in the Revised Proposal's

    Template Letter reads as follows: ``This letter agreement

    constitutes the entire understanding of the parties with respect to

    its subject matter and supersedes and replaces all prior writings,

    including any applicable agreement between the parties in connection

    with the Account(s), with respect thereto.''

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    5. New Proposed Amendments to Acknowledgment Letters

    The Commission is also now proposing under Appendix A to Sec. 1.26

    and Appendix F to Sec. 30.7 an additional acknowledgment letter

    template form for money market mutual funds (to the extent they are

    permissible investments under Sec. 1.25). The template form for money

    market mutual funds is substantially the same as the Acknowledgment

    Letters. The Commission requests comment on all aspects of the template

    form.

    In addition, the Commission is proposing to add language to its

    proposed Acknowledgment Letters (under Sec. 1.20, Sec. 1.26 and Sec.

    30.7) authorizing and requiring the depository to grant--at all times--

    read-only electronic access to such accounts to the Commission and, in

    the case of an FCM, to the FCM's DSRO. Given recent events, the

    Commission believes such access is crucial to the protection of

    customer funds. The Commission is also proposing a substantive

    requirement for

    [[Page 67886]]

    this access in Sec. Sec. 1.20, 1.26 and 30.7 in addition to the

    language in the Acknowledgment Letters.

    The proposal for read-only access is not intended to require a

    depository to have the ability to provide the Commission or an FCM's

    DSRO with real-time information regarding an FCM's account balance. The

    Commission understands that depositories may not have the capability to

    provide customers or any other party with real-time account balances

    and position information. The conditions of the proposal would be

    satisfied if the depository had the capability to provide read-only

    access to account information as of the close of the prior business

    day.

    The Commission intends to continue to explore possible uses of

    technology to enhance its ability to protect customer funds. Read-only

    access will allow Commission staff to review an FCM's segregated

    account balances reported by depositories and to compare those balances

    to the FCM's reported account balances either as part of a review of

    the firm, or in circumstances where the Commission is concerned about

    the financial condition of the firm. The read-only access is an

    additional tool that Commission staff may use as part of its assessment

    of the financial condition of an FCM and the safety of customer funds.

    The Commission will continue to review how direct access to account

    balances and the use of technology can provide greater assurance as to

    the safety of customer funds held by an FCM.

    The Commission requests comment on all aspects of the proposed

    amendments to Sec. 1.20. Specifically, the Commission requests comment

    on the following:

    The proposal requires each depository to provide the

    Commission and an FCM's DSRO with direct, read-only access to the FCM's

    accounts held by the depository. What technology issues are raised by

    the Commission's proposal? How can the Commission adequately address

    such technology issues?

    What account information can depositories currently

    provide to the Commission and to DSROs via the internet on a read-only

    basis? Do all depositories (e.g., banks, trust companies, derivatives

    clearing organizations, or other FCMs) have the capability of using the

    Internet to provide account access to the Commission and DSROs? Are

    there other options for depositories to provide read-only access to FCM

    accounts other than the internet?

    How should the Commission implement this requirement? What

    timeframe would be appropriate to make the requirement effective?

    Please provide analysis with your comment.

    H. Proposed Amendments to Sec. 1.22: Use of Futures Customer Funds

    The Commission proposes to amend Sec. 1.22 by clarifying that the

    prohibition on the FCM's use of one futures customer's funds to margin

    or secure the positions of another futures customer, or to extend

    credit to another person, applies at all times.

    Regulation 1.22 provides that an FCM may not use the cash,

    securities or other property deposited by one futures customer to

    purchase, margin or settle the trades, contracts, or other positions of

    another futures customer, or to extend credit to any other person.

    Regulation 1.22 further provides that an FCM may not use the funds

    deposited by a futures customer to carry trades or positions, unless

    the trades or positions are traded through a designated contract

    market.

    The proposed amendment to clarify that the prohibition on the FCM's

    use of one futures customer's funds to margin positions of another

    futures customer is intended to remove any question as to the

    permissibility of being undersegregated at any point in time during the

    day. Section 4d(a)(2) requires an FCM to segregate futures customers'

    funds from its own funds, and prohibits an FCM from using the funds of

    one customer to margin or extend credit to any other futures customer

    or person. The Commission believes that section 4d(a)(2) is intended to

    provide a maximum level of protection to futures customer funds, which

    would be thwarted and inconsistent with the reading of the Act if an

    FCM only recognized this principle at the end of the trading day.

    Further, the Commission is proposing language providing a clear

    mechanism to ensure compliance with this prohibition, which is to

    require an FCM to maintain residual interest in segregated accounts in

    an amount which exceeds the sum of all margin deficits for futures

    customers. The Commission also is proposing that the sum of all margin

    deficits be reported on the Segregation Schedule (as discussed

    previously with respect to proposed amendments to Sec. 1.10) and also

    required to be reported on the daily segregation calculation (as

    discussed further herein with respect to proposed amendments to Sec.

    1.32), so that compliance review of this mechanism can be performed.

    I. Proposed Amendments to Sec. 1.23: Interest of Futures Commission

    Merchant in Segregated Futures Customer Funds; Additions and

    Withdrawals

    The Commission is proposing to amend Sec. 1.23 to require

    additional safeguards with respect to an FCM withdrawing futures

    customer funds from segregated accounts that are part of the FCM's

    residual interest in such accounts.

    Regulation 1.23 provides that an FCM may deposit unencumbered

    proprietary funds, including securities that qualify as permitted

    investments under Sec. 1.25, into segregated futures customer accounts

    in order to ensure that the firm always maintains sufficient funds in

    such accounts to meet its total obligations to futures customers. FCMs,

    by virtue of practical necessity, must keep proprietary funds in

    segregated futures customer accounts in order to act as a buffer

    between futures customers whose funds are commingled in such accounts.

    In the event that any futures customer were to experience losses such

    that the customer has insufficient funds to meet the margin

    requirements at clearing organizations associated with its positions,

    or if all of the funds deposited by the futures customer were depleted

    and the account had a debit balance, without proprietary funds of the

    FCMs being held in such accounts to absorb the debit balance as it

    accrued, funds of other futures customers would be used to guarantee

    the undermargined amount or the debit. For this reason, FCMs are

    permitted to deposit their own funds into segregated accounts and to

    maintain a residual financial interest in such accounts. Regulation

    1.23 further provides that an FCM's books and records must always

    reflect the firm's residual interest in the accounts of its futures

    customers.

    In addition, an FCM is permitted to withdraw funds from futures

    customer accounts for the FCM's proprietary use to the extent of the

    FCM's actual residual interest in such accounts. The withdrawal,

    however, may not result in the FCM failing to hold sufficient funds to

    meet its obligations to its futures customers, or in the funds of one

    futures customer margining or securing the positions of another futures

    customer. The Commission also is proposing that the residual amount

    maintained by an FCM be required to exceed the sum of margin deficits

    for futures customers, as discussed previously with respect to

    Sec. Sec. 1.20 and 1.22, to provide a clear mechanism to ensure that

    the funds of one futures customer are not used to margin or guarantee

    the positions of

    [[Page 67887]]

    another futures customer. Irrespective of the procedures permitting

    withdrawals of residual interest under the amendments proposed, the

    proposed amendments further make clear that no withdrawals may be made

    of residual interest to the extent of the sum of margin deficits.

    If an FCM does not have adequate internal controls governing the

    calculation and withdrawal of its residual interest from futures

    customer accounts, the FCM's actions may actually result in the

    withdrawal of futures customer funds and not the FCM's residual

    interest. Such a withdrawal would be a violation of section 4d(a)(2) of

    the Act.

    The Commission, therefore, is proposing to amend Sec. 1.23 to

    include additional safeguards applicable to an FCM's withdrawal of

    funds from the accounts of futures customers that are part of the FCM's

    residual interest in such accounts. Under proposed Sec. 1.23(a), an

    FCM will still have access to its own funds deposited into futures

    customer accounts to the extent of the FCM's residual interest therein,

    subject to the restriction on withdrawal of residual interest equal to

    the sum of margin deficits. However, proposed Sec. 1.23(b) will

    prohibit an FCM from withdrawing any of its residual interest or excess

    funds from futures customer accounts (any withdrawal not made for the

    benefit of futures customers would be considered a withdrawal of the

    FCM's residual interest) on any given business day unless the FCM had

    completed the daily calculation of funds in segregation pursuant to

    Sec. 1.32 as of the close of the previous business day, and the

    calculation showed that the FCM maintained excess segregated funds in

    the futures customer accounts as of the close of business on the

    previous business day. Proposed Sec. 1.23(b) further requires that the

    FCM adjust the excess segregated funds reported on the daily

    segregation calculation to reflect other factors, such as overnight and

    current day market activity and the extent of current customer

    undermargined or debit balances, to develop a reasonable basis to

    estimate the amount of excess funds that remain on deposit since the

    close of business on the previous day prior to initiating a withdrawal.

    The Commission also is proposing sevethe Acknowledgment Letter in the

    event of a name change to the parties. The Commission, however, is

    proposing to require that FCMs and DCOs file new Acknowledgment Letters

    in the event of a name, address, or other change as specified in the

    proposed rule because the Commission believes it is important to

    maintain current and accurate Acknowledgment Letters to provide clear

    legal status of the customer account, which will better protect

    customers in the event of a dispute regarding the legal status of the

    account. The Commission is proposing a 120-day time period for an FCM

    to obtain new Acknowledgment Letters. Given the use of the Template

    Letter, which is not open to negotiation, and electronic filing, the

    Commission believes that 120 days is a sufficient period of time for

    FCMs and DCOs to obtain and file the new Acknowledgment Letters.

    2. Technical Amendments to Acknowledgment Letter for Omnibus Accounts;

    Abbreviation of Account Names

    Regulation 1.20 provides that customer funds, when deposited with a

    depository, ``shall be deposited under an account name that clearly

    identifies them as such and shows that they are segregated as required

    by the Act and [Part 1 of the CFTC Regulations].'' FIA noted that the

    account naming convention used in the proposed forms of Template

    Letters \60\ may present certain issues with respect to Acknowledgment

    Letters obtained by FCMs maintaining customer funds with

    [[Page 67884]]

    another FCM through a customer omnibus account relationship.\61\ The

    first issue is with respect to operational limits on the number of

    characters available for account names. Secondly, naming conventions

    for such accounts typically include the words ``Customer Omnibus

    Account'' and the relevant account number. FIA accordingly requested

    the Commission to clarify that the Template Letters may be modified to

    permit the use of the words ``CFTC Regulated FCM Customer Omnibus

    Account'' to describe such accounts.

    ---------------------------------------------------------------------------

    \60\ Proposed Appendix A to Regulation 1.20 provides that the

    Account will be entitled ``[Name of Futures Commission Merchant or

    Derivatives Clearing Organization] CFTC Regulation 1.20 Customer

    Segregated Account.'' 75 FR 47738, 47743 (Aug. 9, 2010); Proposed

    Appendix A to Regulation 1.26 provides that the Account will be

    entitled ``[Name of Futures Commission Merchant or Derivatives

    Clearing Organization] CFTC Regulation 1.26 Customer Segregated

    Money Market Mutual Fund Account.'' 75 FR 47738, 47744 (Aug. 9,

    2010); and Proposed Appendix E to part 30 provides that the Account

    will be entitled ``[Name of Futures Commission Merchant] CFTC

    Regulation 30.7 Customer Secured Account.'' 75 FR 47738, 47745 (Aug.

    9, 2010).

    \61\ FIA CL-00003 at 4 and 5.

    ---------------------------------------------------------------------------

    The Commission has modified the proposed Template Letters to

    provide an option to add the words ``CFTC Regulated FCM Customer

    Omnibus Account'' to describe such accounts when applicable. In

    addition, the Commission is proposing that if the name of the account

    as set forth in the Template Letter is too long for a depository's

    system to include all characters, the depository may abbreviate the

    name in order to accommodate its system, provided that (i) it remains

    clear that the account is a CFTC regulated segregated/secured account

    held for the benefit of customers (e.g., ``segregated'' may be

    shortened to ``seg;'' ``customer'' may be shortened to ``cust;''

    ``account'' to ``acct;'' etc.), and (ii) when completing an

    Acknowledgment Letter, such letter must include both the long and short

    versions of the account name.

    3. Clarification Regarding Notice, Authentication, and Instruction

    Protocol for Commission Authorized Withdrawals

    Four of the commenters to the Revised Proposal addressed the need

    for the Commission to establish specific standards with respect to the

    notice, authentication and instruction protocol regarding Commission

    instructions for the immediate release of funds from a Customer

    Account.\62\

    ---------------------------------------------------------------------------

    \62\ In the Revised Proposal, the Template Letter provides that

    ``the Funds in the Account(s) shall be released immediately, * * *

    upon proper notice and instruction from an appropriate officer or

    employee * * * of the CFTC. [FCM/DCO] will not hold [depository]

    responsible for acting pursuant to any instruction from the CFTC

    upon which [depository] has relied after having taken reasonable

    measures to assure that such instruction was provided to

    [depository] by a duly authorized officer or employee of the CFTC.''

    ---------------------------------------------------------------------------

    The FRB Chicago pointed out that, as the Acknowledgment Letters

    will have been filed electronically with the Commission, the Commission

    will know all of the Depositories that have signed such letters, their

    location, and basic contact information. In light of this, the FRB

    Chicago suggests that the Commission could establish for each

    depository a basic but unique authentication identifier. The Commission

    believes this suggestion has merit, and it will consider implementing

    this type of data collection and identification as it works to

    implement the operational aspects of the electronic filing of

    Acknowledgment Letters.

    JP Morgan suggests that the Acknowledgment Letter include a notice

    provision with contact information for the depository so that the

    Commission has information on how best to contact the depository. The

    Commission agrees with this suggestion and has revised the Template

    Letters to indicate where depository contact information may be

    inserted as optional information. The Commission recognizes that such

    information may be subject to frequent change and, therefore, at this

    time, the Commission is not requiring that an amended Acknowledgment

    Letter be filed in the event there are changes to such contact

    information.

    Katten asserts that Depositories face legal uncertainty with

    respect to their release of customer funds in reliance on instructions

    from the Commission. Katten states that the Commission's reluctance to

    define ``proper notice'' or ``reasonable measures'' imposes on

    Depositories the conflicting obligations (i) to the Commission, to

    release customer funds ``immediately upon proper notice,'' and (ii) to

    its customer FCM, to take ``reasonable measures'' first to assure that

    such notice was ``duly authorized.''

    With respect to due authorization, Katten requests that the

    Commission reconsider its decision to permit an instruction to transfer

    customer funds to be made orally, with written confirmation to follow.

    Katten believes that the depository's obligation to take ``reasonable

    measures'' may require it to await written confirmation in any event.

    In addition, Katten believes that the proposed amendments to Sec. Sec.

    1.20, 1.26, 30.7 and 140.91 do not limit the identity of the Commission

    officers and employees that may issue a notice to a depository or the

    process that must be followed before such a notice is issued. Katten

    submits that a depository would have a reasonable basis to conclude

    that an instruction to transfer customer funds was duly authorized if

    the depository could be assured that any instruction to transfer

    customer funds would be issued only by the Director of the Division of

    Clearing and Intermediary Oversight (or the Director's designee).\63\

    Katten recommends that ``the Commission revise the proposed rules to

    confirm that any such instruction may be made only by the Commission or

    by the director of DCIO (or the director's designee) acting with the

    concurrence of the General Counsel (or Deputy General Counsel).'' \64\

    FIA requests, at a minimum, that the Commission define and limit the

    term ``appropriate officer or employee'' of the Commission (for

    example, authorization limited to Division Directors or other senior

    designated personnel such as Deputy Directors or Associate

    Directors).\65\

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    \63\ In October 2011, the Commission reorganized the Division of

    Clearing and Intermediary Oversight into two divisions, the Division

    of Clearing and Risk and the Division of Swap Dealer and

    Intermediary Oversight. With respect to a transfer of customer funds

    as contemplated in this rulemaking, instructions would come from

    either the Director of the Director of the Division of Clearing and

    Risk or the Director of the Division of Swap Dealer and Intermediary

    Oversight (or one of the Director's designees).

    \64\ See Katten CL-00005 at FN 3.

    \65\ FIA CL-00003 at page 3.

    ---------------------------------------------------------------------------

    With respect to a ``duly authorized officer or employee of the

    CFTC,'' the Commission has determined to provide that any such

    instruction to transfer customer funds may be made by the Director of

    the Division of Clearing and Risk (or the Director's designee), or by

    the Director of the Division of Swap Dealer and Intermediary Oversight

    (or the Director's designee). Accordingly, the Template Letter now

    specifies that such instructions may only be given by the Director of

    the Division of Clearing and Risk (or any successor division), the

    Director of the Division of Swap Dealer and Intermediary Oversight (or

    any successor division), or the designees of such Directors under

    delegated authority.\66\ With regard to the role of the General

    Counsel, the General Counsel will be consulted by the Director of the

    Division of Clearing and Risk (or any successor division), the Director

    of the Division of Swap Dealer and Intermediary Oversight (or any

    successor division), or the designees of such Directors prior to the

    exercise of the delegated authority.

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    \66\ The Commission will publish on its Web site the identity of

    the Director of the Division of Clearing and Risk, the Director of

    the Division of Swap Dealer and Intermediary Oversight, and the

    individual(s) who are authorized to serve as their designees. The

    Template Letters do not explicitly refer to instructions provided by

    ``the Commission'' because in exigent circumstances, it is not

    likely that action approved by a majority of Commissioners will be

    feasible.

    ---------------------------------------------------------------------------

    The Commission does not believe, as asserted by Katten, that

    ``reasonable measures'' may require the depository to await written

    confirmation. For example, due to the nature of the

    [[Page 67885]]

    exceptional circumstances that would prompt a call from the Commission,

    it is likely that the depository would already be aware of certain

    problems facing the FCM or DCO and would not be surprised to receive a

    phone call from a Division Director (or his or her designee). In

    addition, while the Commission believes it is desirable that any such

    instruction to release customer funds be in writing, or, if oral, to be

    confirmed in writing, the Commission is not limiting the manner of

    notice in the Template Letter given the potential exigencies of the

    situation and the need for flexibility in communication. For example,

    either the Commission or the depository could be experiencing

    unexpected technical problems in its respective email servers or

    facsimile machines. It is critical that the transfer of customer funds

    from a Segregated Account not be delayed as a result of technical or

    other operational issues.

    With respect to the release of customer funds ``immediately upon

    proper notice,'' Katten commented that it appreciates the Commission's

    recognition of the potential practical obstacles to immediate release

    (e.g., Fedwire is unavailable). However, Katten remains concerned that,

    in the absence of further guidance or clarification, the use of the

    term ``immediately'' may subject a depository to potential claims by

    either FCMs or the Commission in the event that there is a delay in the

    transfer of customer funds, even if such delay is the result of

    reasonable actions on the part of the depository or events beyond the

    control of the depository. In addition, FIA commented that it would

    like the Commission to confirm that its authority to require the

    transfer of customer funds would be expected to be used sparingly

    (i.e., ``only in exceptional circumstances'').

    After considering these comments, the Commission is proposing to

    retain the use of the word ``immediately'' in the Template Letter

    regarding instructions to a depository for release of customer funds.

    First, in response to FIA's comment, the Commission clarifies that the

    use of its authority to require the immediate release of customer funds

    would be in exceptional circumstances. As stated in the Revised

    Proposal, ``[t]he Commission would issue such an instruction only when,

    in the judgment of the Commission, it is necessary to do so for the

    protection of customer funds. For example, the prospective insolvency

    of the FCM could prompt an instruction from the Commission to release

    the customer funds.'' \67\ Next, the Commission notes that anything

    less than the term ``immediate'' could leave the timing open to

    interpretation, which could cause delays in the transfer of funds and

    have a potential impact on safety and soundness of customer funds and

    positions. In this regard, the Commission notes that customer funds in

    the Segregated Account have always been subject to withdrawal

    immediately upon demand by the FCM.\68\

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    \67\ 75 FR 47738, 47740. The Revised Proposal also noted that,

    as set forth in the Template Letter, in the event the FCM becomes

    subject to a voluntary or involuntary petition for relief under the

    U.S. Bankruptcy Code, the depository will have no obligation to

    release the customer funds except upon instruction from the

    bankruptcy trustee or pursuant to a court order. Id.

    \68\ See Amended Financial and Segregation Interpretation No.

    10, 70 FR 24768 (May 11, 2005) (``Thus any impediments or

    restrictions on the FCM's ability to obtain immediate and unfettered

    access to customer funds are not permitted. The immediate and

    unfettered access requirements is [sic] intended to prevent

    potential delay or interruption in securing required margin payments

    that, in times of significant market disruption, could magnify the

    impact of such market disruption and impair the liquidity of other

    FCMs and clearinghouses.'')

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    4. Limiting the ``Merger'' Clause in the Acknowledgment Letter

    CME believes that the use of an integration clause (i.e., the

    statement that the Acknowledgment Letter ``constitutes the entire

    understanding of the parties with respect to its subject matter'') in

    the Template Letters is inappropriate and could have a number of

    serious and unintended consequences. For example, the parties to the

    Acknowledgment Letter could be prevented from relying upon and

    enforcing terms of applicable account (or similar) agreements that do

    not conflict with the Acknowledgment Letter. CME believes the term

    ``subject matter'' is ambiguous and could be interpreted very broadly

    thereby casting doubt on the validity and interpretation of existing

    agreements between the parties. The CME suggests the following more

    narrowly tailored language for the integration clause in the Template

    Letters: ``This letter agreement supersedes and replaces any prior

    agreement between the parties in connection with the Account(s),

    including but not limited to any prior Acknowledgment Letter, to the

    extent that such prior agreement is inconsistent with the terms

    hereof.''

    FIA agrees with the CME's comment that the scope of the ``merger

    clause'' in the Template Letters should be narrowed to make clear that

    these clauses do not invalidate the terms of other agreements that may

    have been entered into by the parties and that do not conflict with the

    Template Letters. The FRB Chicago also believes that this provision

    should be narrowed so that a bank's standard account opening

    agreements, corporate resolutions and other agreements incorporated by

    reference should govern the remainder of the account relationship, but

    not matters specific to section 4d of the Act. Should there be a

    conflict, the Acknowledgment Letter should govern matters specific to

    section 4d of the Act.

    The Commission agrees with the commenters that the scope of the

    ``merger clause'' language in the Template Letter \69\ should be

    narrowed. Accordingly, the Commission is replacing the clause with

    CME's suggested language above. In addition, in order to incorporate

    the comment of the FRB Chicago and to ensure that future agreements

    between the parties do not negate the Acknowledgment Letter, the

    Commission is adding the following sentence to the end of the new

    language: ``In the event of any conflict between this letter agreement

    and any other agreement between the parties in connection with the

    Account(s), this letter agreement shall govern with respect to matters

    specific to section 4d of the Act and the CFTC's regulations, as

    amended.''

    ---------------------------------------------------------------------------

    \69\ The merger clause language in the Revised Proposal's

    Template Letter reads as follows: ``This letter agreement

    constitutes the entire understanding of the parties with respect to

    its subject matter and supersedes and replaces all prior writings,

    including any applicable agreement between the parties in connection

    with the Account(s), with respect thereto.''

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    5. New Proposed Amendments to Acknowledgment Letters

    The Commission is also now proposing under Appendix A to Sec. 1.26

    and Appendix F to Sec. 30.7 an additional acknowledgment letter

    template form for money market mutual funds (to the extent they are

    permissible investments under Sec. 1.25). The template form for money

    market mutual funds is substantially the same as the Acknowledgment

    Letters. The Commission requests comment on all aspects of the template

    form.

    In addition, the Commission is proposing to add language to its

    proposed Acknowledgment Letters (under Sec. 1.20, Sec. 1.26 and Sec.

    30.7) authorizing and requiring the depository to grant--at all times--

    read-only electronic access to such accounts to the Commission and, in

    the case of an FCM, to the FCM's DSRO. Given recent events, the

    Commission believes such access is crucial to the protection of

    customer funds. The Commission is also proposing a substantive

    requirement for

    [[Page 67886]]

    this access in Sec. Sec. 1.20, 1.26 and 30.7 in addition to the

    language in the Acknowledgment Letters.

    The proposal for read-only access is not intended to require a

    depository to have the ability to provide the Commission or an FCM's

    DSRO with real-time information regarding an FCM's account balance. The

    Commission understands that depositories may not have the capability to

    provide customers or any other party with real-time account balances

    and position information. The conditions of the proposal would be

    satisfied if the depository had the capability to provide read-only

    access to account information as of the close of the prior business

    day.

    The Commission intends to continue to explore possible uses of

    technology to enhance its ability to protect customer funds. Read-only

    access will allow Commission staff to review an FCM's segregated

    account balances reported by depositories and to compare those balances

    to the FCM's reported account balances either as part of a review of

    the firm, or in circumstances where the Commission is concerned about

    the financial condition of the firm. The read-only access is an

    additional tool that Commission staff may use as part of its assessment

    of the financial condition of an FCM and the safety of customer funds.

    The Commission will continue to review how direct access to account

    balances and the use of technology can provide greater assurance as to

    the safety of customer funds held by an FCM.

    The Commission requests comment on all aspects of the proposed

    amendments to Sec. 1.20. Specifically, the Commission requests comment

    on the following:

    The proposal requires each depository to provide the

    Commission and an FCM's DSRO with direct, read-only access to the FCM's

    accounts held by the depository. What technology issues are raised by

    the Commission's proposal? How can the Commission adequately address

    such technology issues?

    What account information can depositories currently

    provide to the Commission and to DSROs via the internet on a read-only

    basis? Do all depositories (e.g., banks, trust companies, derivatives

    clearing organizations, or other FCMs) have the capability of using the

    Internet to provide account access to the Commission and DSROs? Are

    there other options for depositories to provide read-only access to FCM

    accounts other than the internet?

    How should the Commission implement this requirement? What

    timeframe would be appropriate to make the requirement effective?

    Please provide analysis with your comment.

    H. Proposed Amendments to Sec. 1.22: Use of Futures Customer Funds

    The Commission proposes to amend Sec. 1.22 by clarifying that the

    prohibition on the FCM's use of one futures customer's funds to margin

    or secure the positions of another futures customer, or to extend

    credit to another person, applies at all times.

    Regulation 1.22 provides that an FCM may not use the cash,

    securities or other property deposited by one futures customer to

    purchase, margin or settle the trades, contracts, or other positions of

    another futures customer, or to extend credit to any other person.

    Regulation 1.22 further provides that an FCM may not use the funds

    deposited by a futures customer to carry trades or positions, unless

    the trades or positions are traded through a designated contract

    market.

    The proposed amendment to clarify that the prohibition on the FCM's

    use of one futures customer's funds to margin positions of another

    futures customer is intended to remove any question as to the

    permissibility of being undersegregated at any point in time during the

    day. Section 4d(a)(2) requires an FCM to segregate futures customers'

    funds from its own funds, and prohibits an FCM from using the funds of

    one customer to margin or extend credit to any other futures customer

    or person. The Commission believes that section 4d(a)(2) is intended to

    provide a maximum level of protection to futures customer funds, which

    would be thwarted and inconsistent with the reading of the Act if an

    FCM only recognized this principle at the end of the trading day.

    Further, the Commission is proposing language providing a clear

    mechanism to ensure compliance with this prohibition, which is to

    require an FCM to maintain residual interest in segregated accounts in

    an amount which exceeds the sum of all margin deficits for futures

    customers. The Commission also is proposing that the sum of all margin

    deficits be reported on the Segregation Schedule (as discussed

    previously with respect to proposed amendments to Sec. 1.10) and also

    required to be reported on the daily segregation calculation (as

    discussed further herein with respect to proposed amendments to Sec.

    1.32), so that compliance review of this mechanism can be performed.

    I. Proposed Amendments to Sec. 1.23: Interest of Futures Commission

    Merchant in Segregated Futures Customer Funds; Additions and

    Withdrawals

    The Commission is proposing to amend Sec. 1.23 to require

    additional safeguards with respect to an FCM withdrawing futures

    customer funds from segregated accounts that are part of the FCM's

    residual interest in such accounts.

    Regulation 1.23 provides that an FCM may deposit unencumbered

    proprietary funds, including securities that qualify as permitted

    investments under Sec. 1.25, into segregated futures customer accounts

    in order to ensure that the firm always maintains sufficient funds in

    such accounts to meet its total obligations to futures customers. FCMs,

    by virtue of practical necessity, must keep proprietary funds in

    segregated futures customer accounts in order to act as a buffer

    between futures customers whose funds are commingled in such accounts.

    In the event that any futures customer were to experience losses such

    that the customer has insufficient funds to meet the margin

    requirements at clearing organizations associated with its positions,

    or if all of the funds deposited by the futures customer were depleted

    and the account had a debit balance, without proprietary funds of the

    FCMs being held in such accounts to absorb the debit balance as it

    accrued, funds of other futures customers would be used to guarantee

    the undermargined amount or the debit. For this reason, FCMs are

    permitted to deposit their own funds into segregated accounts and to

    maintain a residual financial interest in such accounts. Regulation

    1.23 further provides that an FCM's books and records must always

    reflect the firm's residual interest in the accounts of its futures

    customers.

    In addition, an FCM is permitted to withdraw funds from futures

    customer accounts for the FCM's proprietary use to the extent of the

    FCM's actual residual interest in such accounts. The withdrawal,

    however, may not result in the FCM failing to hold sufficient funds to

    meet its obligations to its futures customers, or in the funds of one

    futures customer margining or securing the positions of another futures

    customer. The Commission also is proposing that the residual amount

    maintained by an FCM be required to exceed the sum of margin deficits

    for futures customers, as discussed previously with respect to

    Sec. Sec. 1.20 and 1.22, to provide a clear mechanism to ensure that

    the funds of one futures customer are not used to margin or guarantee

    the positions of

    [[Page 67887]]

    another futures customer. Irrespective of the procedures permitting

    withdrawals of residual interest under the amendments proposed, the

    proposed amendments further make clear that no withdrawals may be made

    of residual interest to the extent of the sum of margin deficits.

    If an FCM does not have adequate internal controls governing the

    calculation and withdrawal of its residual interest from futures

    customer accounts, the FCM's actions may actually result in the

    withdrawal of futures customer funds and not the FCM's residual

    interest. Such a withdrawal would be a violation of section 4d(a)(2) of

    the Act.

    The Commission, therefore, is proposing to amend Sec. 1.23 to

    include additional safeguards applicable to an FCM's withdrawal of

    funds from the accounts of futures customers that are part of the FCM's

    residual interest in such accounts. Under proposed Sec. 1.23(a), an

    FCM will still have access to its own funds deposited into futures

    customer accounts to the extent of the FCM's residual interest therein,

    subject to the restriction on withdrawal of residual interest equal to

    the sum of margin deficits. However, proposed Sec. 1.23(b) will

    prohibit an FCM from withdrawing any of its residual interest or excess

    funds from futures customer accounts (any withdrawal not made for the

    benefit of futures customers would be considered a withdrawal of the

    FCM's residual interest) on any given business day unless the FCM had

    completed the daily calculation of funds in segregation pursuant to

    Sec. 1.32 as of the close of the previous business day, and the

    calculation showed that the FCM maintained excess segregated funds in

    the futures customer accounts as of the close of business on the

    previous business day. Proposed Sec. 1.23(b) further requires that the

    FCM adjust the excess segregated funds reported on the daily

    segregation calculation to reflect other factors, such as overnight and

    current day market activity and the extent of current customer

    undermargined or debit balances, to develop a reasonable basis to

    estimate the amount of excess funds that remain on deposit since the

    close of business on the previous day prior to initiating a withdrawal.

    The Commission also is proposing several additional required layers

    of authorization and documentation if the withdrawal exceeds,

    individually or in the aggregate with other such withdrawals, 25

    percent of the FCM's residual interest. Proposed Sec. 1.23(c)

    prohibits an FCM from withdrawing more than 25 percent of its residual

    interest in futures customer accounts unless the FCM's CEO, CFO, or

    other senior official that is listed as a principal on the firm's Form

    7-R registration statement and is knowledgeable about the FCM's

    financial requirements (``Financial Principal'') pre-approves the

    withdrawal in writing.

    Regulation 1.23(c) will further require the FCM to immediately file

    a written notice with the Commission and with the firm's DSRO of any

    withdrawal that exceeds 25 percent of its residual interest. The

    written notice must be signed by the CEO, CFO, or Financial Principal

    that pre-approved the withdrawal, specifying the amount of the

    withdrawal, its purpose, its recipient(s), and contain an estimate of

    the residual interest after the withdrawal. The written notice also

    must contain a representation from the person that pre-approved the

    withdrawal that to such person's knowledge and reasonable belief, the

    FCM remains in compliance with its segregation obligations. The

    proposal further requires that the official in making this

    representation specifically consider any other factors that may cause a

    material change in the FCM's residual interest since the close of

    business on the previous business day, including known unsecured

    futures customer debits or deficits, current day market activity, and

    any other withdrawals. The written notice would be required to be filed

    with the Commission and with the FCM's DSRO electronically.

    Proposed Sec. 1.23(d) requires an FCM that has withdrawn funds

    from segregated futures customer accounts for its own purposes, and

    such withdrawal causes the firm to fall below its targeted residual

    interest in such accounts, to deposit proprietary funds into the

    accounts to restore the residual interest balance to the targeted

    amount. The FCM must deposit the proprietary funds into the segregated

    account prior to the close of the next business day. Alternatively, the

    FCM may revise its targeted residual interest amount, if appropriate,

    in accordance with its written policies and procedures for

    establishing, documenting, and maintaining its target residual

    interest, in accordance with the requirements of proposed Sec. 1.11.

    Should an FCM's residual interest, however, be exceeded by the sum of

    the FCM's futures customers' margin deficits, an amount necessary to

    restore residual interest to that sum must be deposited immediately.

    The Commission's proposal is consistent in most respects with NFA's

    recent rule amendments that require FCMs to maintain written policies

    and procedures regarding the withdrawal of proprietary funds from

    futures customers' segregated accounts discussed in Section I.D above.

    The proposal will continue to provide FCMs with flexibility to access

    the residual interest in segregated funds, but with the responsibility

    to ensure that any withdrawals of residual interest are, in fact, the

    firm's own funds. This responsibility exists currently by virtue of the

    language of section 4d(a)(2) of the Act and Sec. 1.23, however the

    processes necessary to ensure that the responsibility was carried out

    were not specified by regulation.

    By providing a prohibition on withdrawals until the segregation

    calculation is performed by the FCM and submitted to the Commission and

    to the DSRO, and further requiring written approvals by the FCM's

    senior officials prior to any withdrawals in excess of 25 percent of

    the prior day's residual interest with notice to the Commission and a

    DSRO, any withdrawal of funds in excess of the residual interest will

    be clear violations of proposed Sec. 1.23, and the responsibility for

    such violations will be clear from written pre-approvals made by the

    CEO, CFO or Financial Principal, or the lack thereof.

    J. Proposed Amendments to Sec. 1.25: Investment of Customer Funds

    The Commission is proposing to amend Sec. 1.25(b)(3)(v) to provide

    that the 25-percent counterparty concentration limit for reverse

    repurchase agreements applies not only to a single counterparty, but to

    all counterparties under common control or ownership. The Commission

    also is proposing to delete paragraph (b)(6) of Sec. 1.25 because the

    information that an FCM is required to record and maintain under

    paragraph (b)(6) is currently required by Sec. 1.27. Further, the

    Commission is proposing to amend Sec. 1.25(d) to clarify the

    conditions under which an FCM may deposit firm-owned securities into

    segregation.

    Regulation 1.25 sets forth the financial investments that an FCM or

    DCO may make with customer funds. As one of the permitted investments,

    FCMs and DCOs may use customer funds to purchase securities from a

    counterparty under an agreement for the resale of the securities back

    to the counterparty (``reverse repurchase agreements''). Regulation

    1.25 places conditions on such repurchase or reverse repurchase

    agreements, including limiting permitted counterparties to certain

    banks and government securities brokers or dealers, and prohibiting an

    FCM or DCO from entering into such

    [[Page 67888]]

    agreements with affiliate. Regulation 1.25(b)(3)(v) also imposes a

    counterparty concentration limit on reverse repurchase agreements that

    prohibits an FCM or DCO from purchasing securities from a single

    counterparty that exceeds 25 percent of the total assets held in

    segregation by the FCM or DCO.

    Under the proposed amendment to Sec. 1.25(b)(3)(v), an FCM or DCO

    must aggregate the value of the securities purchased from two or more

    different counterparties under repurchase agreements if the

    counterparties are under common control or ownership. The aggregate

    value of the securities purchased under the repurchase agreements from

    the counterparties must not exceed 25 percent of the total assets held

    in segregation by the FCM or DCO. The Commission believes that

    expanding the concentration limitation to counterparties under common

    control or ownership is consistent with the original intention of the

    concentration limitation, which was to minimize the potential losses or

    disruptions due to the default of a counterparty. If the counterparties

    are under common control or ownership, a default by one counterparty

    may adversely impact all of the counterparties.

    The Commission also is proposing to amend Sec. 1.25 by deleting

    paragraph (b)(6), which requires an FCM or DCO to prepare a record, on

    a daily basis, detailing the type of instruments in which customer

    funds were invested, the original costs of the investments, and the

    current market value of the investments. As noted above, the

    information that an FCM is required to record and maintain under

    paragraph (b)(6) is currently required by Sec. 1.27.

    Finally, the Commission is proposing to amend Sec. 1.25(d)(7) to

    recognize that a DCO designated as systemically important (``SIDCO'')

    by the Financial Stability Oversight Council may keep securities

    transferred to the SIDCO under a repurchase or reverse repurchase

    agreement in a safekeeping account with a Federal Reserve Bank, as

    authorized by section 806 of the Dodd-Frank Act.

    K. Proposed Amendments to Sec. 1.26: Deposit of Obligations Purchased

    With Futures Customer Funds

    As discussed above, the Commission has previously proposed to amend

    Sec. 1.26 along with Sec. 1.20 to require a template form of

    Acknowledgment Letter--in addition to other substantive requirements

    and obtaining and filing such Acknowledgment Letters--with respect to

    the deposit of instruments purchased with customer funds, including

    money market mutual funds. As discussed earlier with respect to Sec.

    1.20, the Commission received and analyzed comments on those proposals.

    As noted above, the Commission is herein proposing changes to the

    template Acknowledgment Letter set forth in Appendix A to Sec. 1.26

    for money market mutual funds, which incorporate revisions based on the

    Commission's analysis of prior comments, and is proposing new additions

    to such template. The Commission is also proposing new substantive

    requirements applicable to obtaining and filing such written

    Acknowledgment Letters. A new substantive requirement under Sec. 1.26,

    as proposed to be amended and included in the template form, is a

    requirement that depositories provide the Commission and, and in the

    case of an FCM, the FCM's DSRO--at all times--with read-only electronic

    access to all FCM and DCO accounts holding customer funds.

    L. Proposed Amendments to Sec. 1.29: Increment or Interest Resulting

    From Investment of Customer Funds

    The Commission is proposing to amend Sec. 1.29 to explicitly

    provide that an FCM bears sole responsibility for any losses resulting

    from the investment of customer funds in financial instruments

    permitted under Sec. 1.25.

    Regulation 1.29 provides that an FCM is not prohibited from keeping

    as its own any interest or other gain resulting from the investment of

    customer funds in financial instruments permitted under Sec. 1.25.

    Regulation 1.25 also provides that an FCM must manage the permitted

    investments consistent with the objectives of preserving principal and

    maintaining liquidity.

    The proposed amendment clarifies that an FCM is solely responsible

    for any losses that result from the investment of customer funds in the

    financial instruments listed under Sec. 1.25. An FCM may not charge or

    otherwise allocate any such losses to the accounts of the FCM's

    customers. To allocate losses on the investment of customer funds would

    result in the use of customer funds in a manner that is not consistent

    with section 4d(a)(2) and Sec. 1.20, which provides that customer fund

    can only be used for the benefit of futures customers and limits

    withdrawals from futures customer accounts, other than for the purpose

    of engaging in trading, to certain commissions, brokerage, interest,

    taxes, storage or other fees or charges lawfully accruing in connection

    with futures trading.

    The Commission requests comment on the proposed amendment to

    explicitly provide that losses resulting from the investment of

    customer funds may not be allocated by an FCM to customers. The

    Commission also requests comment on how any losses associated with bank

    deposits should be addressed. The Commodity Exchange Authority issued

    an Administrative Determination (``AD'') in 1971 that provides that an

    FCM may not be liable for losses resulting from the deposit of customer

    funds with a bank that subsequently closes or is unable to repay the

    FCM's deposit.\70\ The AD provides that an FCM would not be liable if

    it had used due care in selecting the bank, had not otherwise breached

    its fiduciary responsibilities toward the customers, and had fully

    complied with the requirements of the Act and the Commission

    regulations relating to the handling of customers' funds. The

    Commission requests comment on whether the regulations should be

    revised to impose an obligation on an FCM to repay customer funds in

    the event of a default by a bank holding customer funds. Should there

    be a distinction drawn between U.S.-domiciled and regulated banks and

    non-U.S.-domiciled banks?

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    \70\ Liability of Futures Commission Merchants and Clearing

    Associations, Administrative Determination No. 230 (Nov. 23, 1971).

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    M. Proposed Amendments to Sec. 1.30: Loans by Futures Commission

    Merchants: Treatment of Proceeds

    The Commission is proposing to amend Sec. 1.30 to provide that an

    FCM may not loan funds to finance a customer's trading account on an

    unsecured basis, or accept as collateral for the loan the customer's

    trading account.

    Regulation 1.30 provides that Commission regulations do not prevent

    an FCM from lending its own funds to a customer that has pledged

    securities and property, or from repledging or selling the customer's

    securities or property pursuant to specific written agreement of the

    customer. This provision generally allows customers to deposit non-cash

    collateral as initial and variation margin. Absent the provisions in

    Sec. 1.30, an FCM may be required to liquidate the non-cash collateral

    if the customer was subject to an initial or variation margin call.

    The Commission is proposing to amend Sec. 1.30 to prohibit an FCM

    from loaning funds to finance a customer's trading account on an

    unsecured basis, or from accepting a customer's trading account as

    collateral for the loan. The Commission believes that extending

    unsecured loans to customers is not a

    [[Page 67889]]

    common occurrence as the current capital requirements in Sec. 1.17

    would require the FCM to take a 100 percent capital charge on the

    unsecured receivables from the customers associated with such loans.

    Commission staff has, however, had to provide its views on whether a

    customer trading account may be used to collateralize a loan from the

    FCM.

    A trading account does not qualify as readily marketable securities

    that are generally required to collateralize a loan for the FCM to

    avoid the 100 percent unsecured receivable capital charge.\71\ Rules of

    the CME also prohibit an FCM from providing unsecured financing to a

    customer for margin purposes.\72\ The Commission is proposing to

    explicitly prohibit unsecured lending by FCMs to customers in the

    proposed amendments in Sec. 1.30. Should customers have liquidity

    needs sufficient to require unsecured lending, the Commission believes

    it to be prudent to require that such unsecured lending be done by a

    party other than the FCM carrying the customer account. This newly

    proposed prohibition comports with the Commission's existing regulatory

    requirement contained in Sec. 1.56 that provides that no FCM may

    represent that it will not call for or attempt to collect initial and

    maintenance margin as established by the rules of the applicable board

    of trade.

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    \71\ Regulation 1.17(c)(3).

    \72\ CME Rule 930.G.--Loans to Account Holders--provides that

    clearing members may not make loans to account holders to satisfy

    their performance bond requirements unless such loans are secured by

    readily marketable collateral that is otherwise unencumbered and

    which can be readily converted into cash.

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    N. Proposed Amendments to Sec. 1.32: Segregated Account: Daily

    Computation and Record

    The Commission is proposing to amend Sec. 1.32 to require

    additional safeguards with respect to futures customer funds on deposit

    in segregated accounts, and to require FCMs to provide twice each month

    a detailed listing to the Commission of depositories holding customer

    funds.

    Regulation 1.32 requires an FCM to prepare a daily record as of the

    close of business each day detailing the amount of funds the firm holds

    in segregated accounts for futures customers trading on designated

    contract markets, the amount of the firm's total obligation to such

    customers computed under the Net Liquidating Equity Method, and the

    amount of the FCM's residual interest in the futures customer

    segregated accounts. In addition, the daily record must detail the sum

    of the futures customers' margin deficits, to ensure that residual

    interest equals or exceeds such sum. In performing the calculation, an

    FCM is permitted to offset any futures customer's debit balance by the

    market value (less haircuts) of any readily marketable securities

    deposited by the particular customer with the debit balance as margin

    for the account. The amount of the securities haircuts are as set forth

    in SEC Rule 15c3-1(c)(vi).

    FCMs are required to perform the segregation calculation prior to

    noon on the next business day, and to retain a record of the

    calculation in accordance with Sec. 1.31. Both the CME and NFA require

    their respective member FCMs to file the segregation calculations with

    the CME and NFA, as appropriate, each business day. FCMs, however, are

    only required to file a segregation calculation with the Commission at

    month end as part of the Form 1-FR-FCM (or FOCUS Reports for dual-

    registrant FCM/BDs). Regulation 1.12, as discussed in Section II.C

    above, requires the FCM to provide immediate notice to the Commission

    and to the firm's DSRO if the FCM is undersegregated at any time.

    The Commission is proposing to amend Sec. 1.32 to require each FCM

    to file its segregation calculation with the Commission and with its

    DSRO each business day. The Commission also is proposing to amend Sec.

    1.32 to require FCMs to use the Segregation Schedule contained in the

    Form 1-FR-FCM (or FOCUS Report for dual-registrant FCM/BDs) to document

    its daily segregation calculation.

    As noted above, the CME and NFA require their respective member

    FCMs to file their segregation calculations with them on a daily basis.

    The CME and NFA also require the FCMs to document their segregation

    calculation using the Segregation Schedule contained in the Form 1-FR-

    FCM. Therefore, the additional requirement of filing a Segregation

    Schedule with the Commission is not a material change to the

    regulation.\73\

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    \73\ In fact, since FCMs file the Segregation Schedules with the

    CME and NFA via WinJammer, the Commission already has access to the

    filings, and the amendment will not require an FCM to change any of

    its operating procedures.

    ---------------------------------------------------------------------------

    The Commission believes that the filing of a Segregation Schedule

    by each FCM each day will significantly enhance its ability to monitor

    and protect customer funds. Commission staff will be able to determine

    almost immediately upon receipt of the Segregation Schedule whether a

    firm is undersegregated and immediately take steps to determine if the

    firm is experiencing financial difficulty or if customer funds are at

    risk.\74\ Commission staff also can coordinate the review of the daily

    segregation computations with the additional bank and other depository

    information that it will have access to under proposed Sec. 1.23.

    ---------------------------------------------------------------------------

    \74\ Each Form 1-FR-FCM and FOCUS Report is received by the

    Commission via WinJammer. The financial forms are automatically

    electronically reviewed within several minutes of being received by

    the Commission and if a firm is undersegregated an alert is

    immediately issued to Commission staff members via an email notice.

    ---------------------------------------------------------------------------

    In addition, the use of the Segregation Schedule provides a uniform

    way for each FCM to present its information to the Commission, in a

    format that both the Commission and FCMs are familiar with that will

    reduce significantly the possibility of a miscommunication regarding

    the information that is reported. The standardized Segregation Schedule

    will also facilitate the Commission's ability to compare one FCM to

    another, and to perform additional trend and other analysis to identify

    potential issues with the holding of customer funds. The filing of

    daily segregation records also will allow staff to monitor significant

    movements in the balances of segregated funds on a day-to-day basis.

    Proposed Sec. 1.32(d) provides that the Segregation Statement must

    be filed with the Commission and with the FCM's DSRO electronically

    using a form of user authentication assigned in accordance with

    procedures established or approved by the Commission. The Commission is

    not proposing to change the timeframe for the preparation of the

    Segregation Statements. The Segregation Statement must be filed by noon

    (based upon the location of the FCM) the next business day.

    The Commission also is proposing to amend Sec. 1.32(b) to provide

    that in determining the haircuts for commercial paper, convertible debt

    instruments, and nonconvertible debt instruments deposited by customers

    as margin, the FCM may develop written policies and procedures to

    assess the credit risk of the securities as proposed by the SEC and

    discussed more fully in Section II.F above. If the FCM's assessment of

    the credit risk is that it is minimal, the FCM may apply haircut

    percentages that are lower than the 15 percent default percentage under

    SEC Rule 15c3-1(c)(2)(vi).

    The Commission is further proposing to amend Sec. 1.32 by

    requiring each FCM to file detailed information regarding depositories

    and the substance of the investment of customer funds under Sec. 1.25.

    Proposed paragraphs (f) and (j) of Sec. 1.32 will require each FCM to

    submit

    [[Page 67890]]

    to the Commission and to the firm's DSRO a listing of every bank, trust

    company, DCO, other FCM, or other depository or custodian holding

    customer funds.

    The listing must specify separately for each depository the total

    amount of cash and Sec. 1.25 permitted investments held by the

    depository for the benefit of the FCM's customers. Specifically, each

    FCM must list the total amount of cash, United States government

    securities, United States agency obligations, municipal securities,

    certificates of deposit, money market mutual funds, commercial paper,

    and corporate notes held by each depository, computed at current market

    values. The listing also must specify: (1) If any of the depositories

    are affiliated with the FCM; (2) if any of the securities are held

    pursuant to an agreement to resell the securities to a counterparty

    (reverse repurchase agreement) and if so, how much; and (3) the

    depositories holding customer-owned securities and the total amount of

    customer-owned securities held by each of the depositories. The FCM is

    also required to disclose if any of the depositories are affiliated

    with the FCM.

    Each FCM is required to submit the listing of the detailed

    investments to the Commission and to the firm's DSRO twice each month.

    The filings must be made as of the 15th day of each month (or the next

    business day, if the 15th day of the month is not a business day) and

    the last business day of the month. The filings are due to the

    Commission and to the firm's DSRO by 11:59 p.m. on the next business

    day.

    Proposed paragraph (k) of Sec. 1.32 will require each FCM to

    retain the Segregation Statement prepared each business day and the

    detailed investment information, together with all supporting

    documentation, in accordance with Sec. 1.31.

    The Commission's proposal is similar to existing SRO practices and

    rules. The CME and NFA recently adopted rules requiring member FCMs to

    submit detailed information on how they invest customer funds and the

    depositories holding customer funds. The information required to be

    filed by FCMs with the CME and NFA is consistent with the information

    that FCMs are required to file with the Commission and DSROs under the

    proposed amendments to Sec. 1.32, with the exception that the current

    CME rule does not require member FCMs to submit information regarding

    the holding of customer-owned securities. The proposed timeframes for

    both preparing and filing both the Segregation Statements and the

    detailed investment information are consistent between the SRO rules

    and proposed Sec. 1.32.

    The Commission also notes that NFA will be publishing information

    on its Web site regarding how each FCM invests and holds customer

    funds. Commission staff is consulting with NFA and is assessing whether

    NFA should be the primary method for the public to obtain information

    on how FCMs hold and invest customer funds.

    The twice monthly filing of information on the investment of

    customer funds will provide the Commission and SROs with more timely

    detailed information regarding how FCMs are holding and investing

    customer funds, which will allow the Commission and SROs to more

    closely monitor customer funds to assess their safety. In this regard,

    the reporting of the use of depositories that are affiliated with the

    FCM will alert staff to review such relationships more closely to

    ensure that transactions are done in an appropriate arms-length manner

    and not to the benefit of the affiliated depository. Staff also can

    compare reported the reported investment balances with information

    maintained directly by the depositories using the on-line access that

    the depositories will be required to provide to Commission staff under

    Sec. 1.20 discussed above.

    The Commission request comment on all aspects of the proposed

    amendments to Sec. 1.32. Specifically, the Commission requests

    comments on the following:

    Should the Commission amend the regulations to require

    each FCM to disclose information regarding its investments of customer

    funds? If so, what information should be disclosed? What investment

    information would be of the most benefit to market participants in

    assessing whether to entrust funds to a particular FCM? How would the

    investment information be used by market participants?

    How frequently should investment information be disclosed?

    What format should be used to disclose the information? How should the

    information be disclosed? Should the information be posted on the FCM's

    internet web site?

    Should NFA act as the primary source for the disclosure of

    how FCMs hold and invest customer funds?

    O. Proposed Amendments to Sec. 1.52: Self-Regulatory Organization

    Adoption and Surveillance of Minimum Financial Requirements

    SROs are required by the Act and Commission regulations to monitor

    their member FCMs for compliance with the Commission's and SROs'

    minimum financial and related reporting requirements. Specifically, DCM

    Core Principle 11 provides, in relevant part, that a board of trade

    shall establish and enforce rules providing for the financial integrity

    of any member FCM and the protection of customer funds.\75\ In

    addition, section 17 of the Act requires NFA to establish minimum

    capital, segregation, and other financial requirements applicable to

    its member FCMs, and to audit and to enforce compliance with such

    requirements.\76\

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    \75\ 7 U.S.C. 7(d)(11).

    \76\ 7 U.S.C. 21(p).

    ---------------------------------------------------------------------------

    The Commission also has established in Sec. 1.52 minimum elements

    that each SRO financial surveillance program must contain to satisfy

    the statutory objectives of Core Principle 11 and section 17 of the

    Act. In this regard, Sec. 1.52 requires, in part, each SRO to adopt

    and to submit for Commission approval rules prescribing minimum

    financial and related reporting requirements for member FCMs. The rules

    of the SRO also must be the same as, or more stringent than, the

    Commission's requirements for financial statement reporting under Sec.

    1.10 and minimum net capital under Sec. 1.17.

    In addition, the Commission adopted final amendments to Sec. 1.52

    on May 10, 2012, to codify previously issued CFTC staff guidance

    regarding the minimum elements of an SRO financial surveillance

    program.\77\ The final amendments require an SRO to: (1) Maintain staff

    of an adequate size, training, experience, and independence to

    effectively implement a supervisory program; (2) maintain a program

    that provides for the ongoing surveillance of FCMs through review of

    financial statements and regulatory notices; (3) identify firms that

    pose a high degree of potential risk, including risk to customer funds;

    (4) conduct routine, periodic onsite examinations of FCMs; and (5)

    adequately document all aspects of the operation of the supervisory

    program, including the conduct of risk-based scope setting and the

    risk-based surveillance of high-risk member registrants, and the

    imposition of remedial and punitive actions for material violations.

    ---------------------------------------------------------------------------

    \77\ 77 FR 36611 (June 19, 2012).

    ---------------------------------------------------------------------------

    In order to effectively and efficiently allocate SRO resources over

    FCMs that are members of more than one SRO, Sec. 1.52(c) currently

    permits two or more SROs to enter into an agreement to establish a

    joint audit plan for purpose of assigning to one of the SROs (the DSRO)

    of the joint audit plan the function of monitoring ral additional required layers

    of authorization and documentation if the withdrawal exceeds,

    individually or in the aggregate with other such withdrawals, 25

    percent of the FCM's residual interest. Proposed Sec. 1.23(c)

    prohibits an FCM from withdrawing more than 25 percent of its residual

    interest in futures customer accounts unless the FCM's CEO, CFO, or

    other senior official that is listed as a principal on the firm's Form

    7-R registration statement and is knowledgeable about the FCM's

    financial requirements (``Financial Principal'') pre-approves the

    withdrawal in writing.

    Regulation 1.23(c) will further require the FCM to immediately file

    a written notice with the Commission and with the firm's DSRO of any

    withdrawal that exceeds 25 percent of its residual interest. The

    written notice must be signed by the CEO, CFO, or Financial Principal

    that pre-approved the withdrawal, specifying the amount of the

    withdrawal, its purpose, its recipient(s), and contain an estimate of

    the residual interest after the withdrawal. The written notice also

    must contain a representation from the person that pre-approved the

    withdrawal that to such person's knowledge and reasonable belief, the

    FCM remains in compliance with its segregation obligations. The

    proposal further requires that the official in making this

    representation specifically consider any other factors that may cause a

    material change in the FCM's residual interest since the close of

    business on the previous business day, including known unsecured

    futures customer debits or deficits, current day market activity, and

    any other withdrawals. The written notice would be required to be filed

    with the Commission and with the FCM's DSRO electronically.

    Proposed Sec. 1.23(d) requires an FCM that has withdrawn funds

    from segregated futures customer accounts for its own purposes, and

    such withdrawal causes the firm to fall below its targeted residual

    interest in such accounts, to deposit proprietary funds into the

    accounts to restore the residual interest balance to the targeted

    amount. The FCM must deposit the proprietary funds into the segregated

    account prior to the close of the next business day. Alternatively, the

    FCM may revise its targeted residual interest amount, if appropriate,

    in accordance with its written policies and procedures for

    establishing, documenting, and maintaining its target residual

    interest, in accordance with the requirements of proposed Sec. 1.11.

    Should an FCM's residual interest, however, be exceeded by the sum of

    the FCM's futures customers' margin deficits, an amount necessary to

    restore residual interest to that sum must be deposited immediately.

    The Commission's proposal is consistent in most respects with NFA's

    recent rule amendments that require FCMs to maintain written policies

    and procedures regarding the withdrawal of proprietary funds from

    futures customers' segregated accounts discussed in Section I.D above.

    The proposal will continue to provide FCMs with flexibility to access

    the residual interest in segregated funds, but with the responsibility

    to ensure that any withdrawals of residual interest are, in fact, the

    firm's own funds. This responsibility exists currently by virtue of the

    language of section 4d(a)(2) of the Act and Sec. 1.23, however the

    processes necessary to ensure that the responsibility was carried out

    were not specified by regulation.

    By providing a prohibition on withdrawals until the segregation

    calculation is performed by the FCM and submitted to the Commission and

    to the DSRO, and further requiring written approvals by the FCM's

    senior officials prior to any withdrawals in excess of 25 percent of

    the prior day's residual interest with notice to the Commission and a

    DSRO, any withdrawal of funds in excess of the residual interest will

    be clear violations of proposed Sec. 1.23, and the responsibility for

    such violations will be clear from written pre-approvals made by the

    CEO, CFO or Financial Principal, or the lack thereof.

    J. Proposed Amendments to Sec. 1.25: Investment of Customer Funds

    The Commission is proposing to amend Sec. 1.25(b)(3)(v) to provide

    that the 25-percent counterparty concentration limit for reverse

    repurchase agreements applies not only to a single counterparty, but to

    all counterparties under common control or ownership. The Commission

    also is proposing to delete paragraph (b)(6) of Sec. 1.25 because the

    information that an FCM is required to record and maintain under

    paragraph (b)(6) is currently required by Sec. 1.27. Further, the

    Commission is proposing to amend Sec. 1.25(d) to clarify the

    conditions under which an FCM may deposit firm-owned securities into

    segregation.

    Regulation 1.25 sets forth the financial investments that an FCM or

    DCO may make with customer funds. As one of the permitted investments,

    FCMs and DCOs may use customer funds to purchase securities from a

    counterparty under an agreement for the resale of the securities back

    to the counterparty (``reverse repurchase agreements''). Regulation

    1.25 places conditions on such repurchase or reverse repurchase

    agreements, including limiting permitted counterparties to certain

    banks and government securities brokers or dealers, and prohibiting an

    FCM or DCO from entering into such

    [[Page 67888]]

    agreements with affiliate. Regulation 1.25(b)(3)(v) also imposes a

    counterparty concentration limit on reverse repurchase agreements that

    prohibits an FCM or DCO from purchasing securities from a single

    counterparty that exceeds 25 percent of the total assets held in

    segregation by the FCM or DCO.

    Under the proposed amendment to Sec. 1.25(b)(3)(v), an FCM or DCO

    must aggregate the value of the securities purchased from two or more

    different counterparties under repurchase agreements if the

    counterparties are under common control or ownership. The aggregate

    value of the securities purchased under the repurchase agreements from

    the counterparties must not exceed 25 percent of the total assets held

    in segregation by the FCM or DCO. The Commission believes that

    expanding the concentration limitation to counterparties under common

    control or ownership is consistent with the original intention of the

    concentration limitation, which was to minimize the potential losses or

    disruptions due to the default of a counterparty. If the counterparties

    are under common control or ownership, a default by one counterparty

    may adversely impact all of the counterparties.

    The Commission also is proposing to amend Sec. 1.25 by deleting

    paragraph (b)(6), which requires an FCM or DCO to prepare a record, on

    a daily basis, detailing the type of instruments in which customer

    funds were invested, the original costs of the investments, and the

    current market value of the investments. As noted above, the

    information that an FCM is required to record and maintain under

    paragraph (b)(6) is currently required by Sec. 1.27.

    Finally, the Commission is proposing to amend Sec. 1.25(d)(7) to

    recognize that a DCO designated as systemically important (``SIDCO'')

    by the Financial Stability Oversight Council may keep securities

    transferred to the SIDCO under a repurchase or reverse repurchase

    agreement in a safekeeping account with a Federal Reserve Bank, as

    authorized by section 806 of the Dodd-Frank Act.

    K. Proposed Amendments to Sec. 1.26: Deposit of Obligations Purchased

    With Futures Customer Funds

    As discussed above, the Commission has previously proposed to amend

    Sec. 1.26 along with Sec. 1.20 to require a template form of

    Acknowledgment Letter--in addition to other substantive requirements

    and obtaining and filing such Acknowledgment Letters--with respect to

    the deposit of instruments purchased with customer funds, including

    money market mutual funds. As discussed earlier with respect to Sec.

    1.20, the Commission received and analyzed comments on those proposals.

    As noted above, the Commission is herein proposing changes to the

    template Acknowledgment Letter set forth in Appendix A to Sec. 1.26

    for money market mutual funds, which incorporate revisions based on the

    Commission's analysis of prior comments, and is proposing new additions

    to such template. The Commission is also proposing new substantive

    requirements applicable to obtaining and filing such written

    Acknowledgment Letters. A new substantive requirement under Sec. 1.26,

    as proposed to be amended and included in the template form, is a

    requirement that depositories provide the Commission and, and in the

    case of an FCM, the FCM's DSRO--at all times--with read-only electronic

    access to all FCM and DCO accounts holding customer funds.

    L. Proposed Amendments to Sec. 1.29: Increment or Interest Resulting

    From Investment of Customer Funds

    The Commission is proposing to amend Sec. 1.29 to explicitly

    provide that an FCM bears sole responsibility for any losses resulting

    from the investment of customer funds in financial instruments

    permitted under Sec. 1.25.

    Regulation 1.29 provides that an FCM is not prohibited from keeping

    as its own any interest or other gain resulting from the investment of

    customer funds in financial instruments permitted under Sec. 1.25.

    Regulation 1.25 also provides that an FCM must manage the permitted

    investments consistent with the objectives of preserving principal and

    maintaining liquidity.

    The proposed amendment clarifies that an FCM is solely responsible

    for any losses that result from the investment of customer funds in the

    financial instruments listed under Sec. 1.25. An FCM may not charge or

    otherwise allocate any such losses to the accounts of the FCM's

    customers. To allocate losses on the investment of customer funds would

    result in the use of customer funds in a manner that is not consistent

    with section 4d(a)(2) and Sec. 1.20, which provides that customer fund

    can only be used for the benefit of futures customers and limits

    withdrawals from futures customer accounts, other than for the purpose

    of engaging in trading, to certain commissions, brokerage, interest,

    taxes, storage or other fees or charges lawfully accruing in connection

    with futures trading.

    The Commission requests comment on the proposed amendment to

    explicitly provide that losses resulting from the investment of

    customer funds may not be allocated by an FCM to customers. The

    Commission also requests comment on how any losses associated with bank

    deposits should be addressed. The Commodity Exchange Authority issued

    an Administrative Determination (``AD'') in 1971 that provides that an

    FCM may not be liable for losses resulting from the deposit of customer

    funds with a bank that subsequently closes or is unable to repay the

    FCM's deposit.\70\ The AD provides that an FCM would not be liable if

    it had used due care in selecting the bank, had not otherwise breached

    its fiduciary responsibilities toward the customers, and had fully

    complied with the requirements of the Act and the Commission

    regulations relating to the handling of customers' funds. The

    Commission requests comment on whether the regulations should be

    revised to impose an obligation on an FCM to repay customer funds in

    the event of a default by a bank holding customer funds. Should there

    be a distinction drawn between U.S.-domiciled and regulated banks and

    non-U.S.-domiciled banks?

    ---------------------------------------------------------------------------

    \70\ Liability of Futures Commission Merchants and Clearing

    Associations, Administrative Determination No. 230 (Nov. 23, 1971).

    ---------------------------------------------------------------------------

    M. Proposed Amendments to Sec. 1.30: Loans by Futures Commission

    Merchants: Treatment of Proceeds

    The Commission is proposing to amend Sec. 1.30 to provide that an

    FCM may not loan funds to finance a customer's trading account on an

    unsecured basis, or accept as collateral for the loan the customer's

    trading account.

    Regulation 1.30 provides that Commission regulations do not prevent

    an FCM from lending its own funds to a customer that has pledged

    securities and property, or from repledging or selling the customer's

    securities or property pursuant to specific written agreement of the

    customer. This provision generally allows customers to deposit non-cash

    collateral as initial and variation margin. Absent the provisions in

    Sec. 1.30, an FCM may be required to liquidate the non-cash collateral

    if the customer was subject to an initial or variation margin call.

    The Commission is proposing to amend Sec. 1.30 to prohibit an FCM

    from loaning funds to finance a customer's trading account on an

    unsecured basis, or from accepting a customer's trading account as

    collateral for the loan. The Commission believes that extending

    unsecured loans to customers is not a

    [[Page 67889]]

    common occurrence as the current capital requirements in Sec. 1.17

    would require the FCM to take a 100 percent capital charge on the

    unsecured receivables from the customers associated with such loans.

    Commission staff has, however, had to provide its views on whether a

    customer trading account may be used to collateralize a loan from the

    FCM.

    A trading account does not qualify as readily marketable securities

    that are generally required to collateralize a loan for the FCM to

    avoid the 100 percent unsecured receivable capital charge.\71\ Rules of

    the CME also prohibit an FCM from providing unsecured financing to a

    customer for margin purposes.\72\ The Commission is proposing to

    explicitly prohibit unsecured lending by FCMs to customers in the

    proposed amendments in Sec. 1.30. Should customers have liquidity

    needs sufficient to require unsecured lending, the Commission believes

    it to be prudent to require that such unsecured lending be done by a

    party other than the FCM carrying the customer account. This newly

    proposed prohibition comports with the Commission's existing regulatory

    requirement contained in Sec. 1.56 that provides that no FCM may

    represent that it will not call for or attempt to collect initial and

    maintenance margin as established by the rules of the applicable board

    of trade.

    ---------------------------------------------------------------------------

    \71\ Regulation 1.17(c)(3).

    \72\ CME Rule 930.G.--Loans to Account Holders--provides that

    clearing members may not make loans to account holders to satisfy

    their performance bond requirements unless such loans are secured by

    readily marketable collateral that is otherwise unencumbered and

    which can be readily converted into cash.

    ---------------------------------------------------------------------------

    N. Proposed Amendments to Sec. 1.32: Segregated Account: Daily

    Computation and Record

    The Commission is proposing to amend Sec. 1.32 to require

    additional safeguards with respect to futures customer funds on deposit

    in segregated accounts, and to require FCMs to provide twice each month

    a detailed listing to the Commission of depositories holding customer

    funds.

    Regulation 1.32 requires an FCM to prepare a daily record as of the

    close of business each day detailing the amount of funds the firm holds

    in segregated accounts for futures customers trading on designated

    contract markets, the amount of the firm's total obligation to such

    customers computed under the Net Liquidating Equity Method, and the

    amount of the FCM's residual interest in the futures customer

    segregated accounts. In addition, the daily record must detail the sum

    of the futures customers' margin deficits, to ensure that residual

    interest equals or exceeds such sum. In performing the calculation, an

    FCM is permitted to offset any futures customer's debit balance by the

    market value (less haircuts) of any readily marketable securities

    deposited by the particular customer with the debit balance as margin

    for the account. The amount of the securities haircuts are as set forth

    in SEC Rule 15c3-1(c)(vi).

    FCMs are required to perform the segregation calculation prior to

    noon on the next business day, and to retain a record of the

    calculation in accordance with Sec. 1.31. Both the CME and NFA require

    their respective member FCMs to file the segregation calculations with

    the CME and NFA, as appropriate, each business day. FCMs, however, are

    only required to file a segregation calculation with the Commission at

    month end as part of the Form 1-FR-FCM (or FOCUS Reports for dual-

    registrant FCM/BDs). Regulation 1.12, as discussed in Section II.C

    above, requires the FCM to provide immediate notice to the Commission

    and to the firm's DSRO if the FCM is undersegregated at any time.

    The Commission is proposing to amend Sec. 1.32 to require each FCM

    to file its segregation calculation with the Commission and with its

    DSRO each business day. The Commission also is proposing to amend Sec.

    1.32 to require FCMs to use the Segregation Schedule contained in the

    Form 1-FR-FCM (or FOCUS Report for dual-registrant FCM/BDs) to document

    its daily segregation calculation.

    As noted above, the CME and NFA require their respective member

    FCMs to file their segregation calculations with them on a daily basis.

    The CME and NFA also require the FCMs to document their segregation

    calculation using the Segregation Schedule contained in the Form 1-FR-

    FCM. Therefore, the additional requirement of filing a Segregation

    Schedule with the Commission is not a material change to the

    regulation.\73\

    ---------------------------------------------------------------------------

    \73\ In fact, since FCMs file the Segregation Schedules with the

    CME and NFA via WinJammer, the Commission already has access to the

    filings, and the amendment will not require an FCM to change any of

    its operating procedures.

    ---------------------------------------------------------------------------

    The Commission believes that the filing of a Segregation Schedule

    by each FCM each day will significantly enhance its ability to monitor

    and protect customer funds. Commission staff will be able to determine

    almost immediately upon receipt of the Segregation Schedule whether a

    firm is undersegregated and immediately take steps to determine if the

    firm is experiencing financial difficulty or if customer funds are at

    risk.\74\ Commission staff also can coordinate the review of the daily

    segregation computations with the additional bank and other depository

    information that it will have access to under proposed Sec. 1.23.

    ---------------------------------------------------------------------------

    \74\ Each Form 1-FR-FCM and FOCUS Report is received by the

    Commission via WinJammer. The financial forms are automatically

    electronically reviewed within several minutes of being received by

    the Commission and if a firm is undersegregated an alert is

    immediately issued to Commission staff members via an email notice.

    ---------------------------------------------------------------------------

    In addition, the use of the Segregation Schedule provides a uniform

    way for each FCM to present its information to the Commission, in a

    format that both the Commission and FCMs are familiar with that will

    reduce significantly the possibility of a miscommunication regarding

    the information that is reported. The standardized Segregation Schedule

    will also facilitate the Commission's ability to compare one FCM to

    another, and to perform additional trend and other analysis to identify

    potential issues with the holding of customer funds. The filing of

    daily segregation records also will allow staff to monitor significant

    movements in the balances of segregated funds on a day-to-day basis.

    Proposed Sec. 1.32(d) provides that the Segregation Statement must

    be filed with the Commission and with the FCM's DSRO electronically

    using a form of user authentication assigned in accordance with

    procedures established or approved by the Commission. The Commission is

    not proposing to change the timeframe for the preparation of the

    Segregation Statements. The Segregation Statement must be filed by noon

    (based upon the location of the FCM) the next business day.

    The Commission also is proposing to amend Sec. 1.32(b) to provide

    that in determining the haircuts for commercial paper, convertible debt

    instruments, and nonconvertible debt instruments deposited by customers

    as margin, the FCM may develop written policies and procedures to

    assess the credit risk of the securities as proposed by the SEC and

    discussed more fully in Section II.F above. If the FCM's assessment of

    the credit risk is that it is minimal, the FCM may apply haircut

    percentages that are lower than the 15 percent default percentage under

    SEC Rule 15c3-1(c)(2)(vi).

    The Commission is further proposing to amend Sec. 1.32 by

    requiring each FCM to file detailed information regarding depositories

    and the substance of the investment of customer funds under Sec. 1.25.

    Proposed paragraphs (f) and (j) of Sec. 1.32 will require each FCM to

    submit

    [[Page 67890]]

    to the Commission and to the firm's DSRO a listing of every bank, trust

    company, DCO, other FCM, or other depository or custodian holding

    customer funds.

    The listing must specify separately for each depository the total

    amount of cash and Sec. 1.25 permitted investments held by the

    depository for the benefit of the FCM's customers. Specifically, each

    FCM must list the total amount of cash, United States government

    securities, United States agency obligations, municipal securities,

    certificates of deposit, money market mutual funds, commercial paper,

    and corporate notes held by each depository, computed at current market

    values. The listing also must specify: (1) If any of the depositories

    are affiliated with the FCM; (2) if any of the securities are held

    pursuant to an agreement to resell the securities to a counterparty

    (reverse repurchase agreement) and if so, how much; and (3) the

    depositories holding customer-owned securities and the total amount of

    customer-owned securities held by each of the depositories. The FCM is

    also required to disclose if any of the depositories are affiliated

    with the FCM.

    Each FCM is required to submit the listing of the detailed

    investments to the Commission and to the firm's DSRO twice each month.

    The filings must be made as of the 15th day of each month (or the next

    business day, if the 15th day of the month is not a business day) and

    the last business day of the month. The filings are due to the

    Commission and to the firm's DSRO by 11:59 p.m. on the next business

    day.

    Proposed paragraph (k) of Sec. 1.32 will require each FCM to

    retain the Segregation Statement prepared each business day and the

    detailed investment information, together with all supporting

    documentation, in accordance with Sec. 1.31.

    The Commission's proposal is similar to existing SRO practices and

    rules. The CME and NFA recently adopted rules requiring member FCMs to

    submit detailed information on how they invest customer funds and the

    depositories holding customer funds. The information required to be

    filed by FCMs with the CME and NFA is consistent with the information

    that FCMs are required to file with the Commission and DSROs under the

    proposed amendments to Sec. 1.32, with the exception that the current

    CME rule does not require member FCMs to submit information regarding

    the holding of customer-owned securities. The proposed timeframes for

    both preparing and filing both the Segregation Statements and the

    detailed investment information are consistent between the SRO rules

    and proposed Sec. 1.32.

    The Commission also notes that NFA will be publishing information

    on its Web site regarding how each FCM invests and holds customer

    funds. Commission staff is consulting with NFA and is assessing whether

    NFA should be the primary method for the public to obtain information

    on how FCMs hold and invest customer funds.

    The twice monthly filing of information on the investment of

    customer funds will provide the Commission and SROs with more timely

    detailed information regarding how FCMs are holding and investing

    customer funds, which will allow the Commission and SROs to more

    closely monitor customer funds to assess their safety. In this regard,

    the reporting of the use of depositories that are affiliated with the

    FCM will alert staff to review such relationships more closely to

    ensure that transactions are done in an appropriate arms-length manner

    and not to the benefit of the affiliated depository. Staff also can

    compare reported the reported investment balances with information

    maintained directly by the depositories using the on-line access that

    the depositories will be required to provide to Commission staff under

    Sec. 1.20 discussed above.

    The Commission request comment on all aspects of the proposed

    amendments to Sec. 1.32. Specifically, the Commission requests

    comments on the following:

    Should the Commission amend the regulations to require

    each FCM to disclose information regarding its investments of customer

    funds? If so, what information should be disclosed? What investment

    information would be of the most benefit to market participants in

    assessing whether to entrust funds to a particular FCM? How would the

    investment information be used by market participants?

    How frequently should investment information be disclosed?

    What format should be used to disclose the information? How should the

    information be disclosed? Should the information be posted on the FCM's

    internet web site?

    Should NFA act as the primary source for the disclosure of

    how FCMs hold and invest customer funds?

    O. Proposed Amendments to Sec. 1.52: Self-Regulatory Organization

    Adoption and Surveillance of Minimum Financial Requirements

    SROs are required by the Act and Commission regulations to monitor

    their member FCMs for compliance with the Commission's and SROs'

    minimum financial and related reporting requirements. Specifically, DCM

    Core Principle 11 provides, in relevant part, that a board of trade

    shall establish and enforce rules providing for the financial integrity

    of any member FCM and the protection of customer funds.\75\ In

    addition, section 17 of the Act requires NFA to establish minimum

    capital, segregation, and other financial requirements applicable to

    its member FCMs, and to audit and to enforce compliance with such

    requirements.\76\

    ---------------------------------------------------------------------------

    \75\ 7 U.S.C. 7(d)(11).

    \76\ 7 U.S.C. 21(p).

    ---------------------------------------------------------------------------

    The Commission also has established in Sec. 1.52 minimum elements

    that each SRO financial surveillance program must contain to satisfy

    the statutory objectives of Core Principle 11 and section 17 of the

    Act. In this regard, Sec. 1.52 requires, in part, each SRO to adopt

    and to submit for Commission approval rules prescribing minimum

    financial and related reporting requirements for member FCMs. The rules

    of the SRO also must be the same as, or more stringent than, the

    Commission's requirements for financial statement reporting under Sec.

    1.10 and minimum net capital under Sec. 1.17.

    In addition, the Commission adopted final amendments to Sec. 1.52

    on May 10, 2012, to codify previously issued CFTC staff guidance

    regarding the minimum elements of an SRO financial surveillance

    program.\77\ The final amendments require an SRO to: (1) Maintain staff

    of an adequate size, training, experience, and independence to

    effectively implement a supervisory program; (2) maintain a program

    that provides for the ongoing surveillance of FCMs through review of

    financial statements and regulatory notices; (3) identify firms that

    pose a high degree of potential risk, including risk to customer funds;

    (4) conduct routine, periodic onsite examinations of FCMs; and (5)

    adequately document all aspects of the operation of the supervisory

    program, including the conduct of risk-based scope setting and the

    risk-based surveillance of high-risk member registrants, and the

    imposition of remedial and punitive actions for material violations.

    ---------------------------------------------------------------------------

    \77\ 77 FR 36611 (June 19, 2012).

    ---------------------------------------------------------------------------

    In order to effectively and efficiently allocate SRO resources over

    FCMs that are members of more than one SRO, Sec. 1.52(c) currently

    permits two or more SROs to enter into an agreement to establish a

    joint audit plan for purpose of assigning to one of the SROs (the DSRO)

    of the joint audit plan the function of monitoring and examining member

    FCMs for compliance with

    [[Page 67891]]

    certain regulatory and financial reporting obligations. The audit plan

    must be submitted to the Commission for approval. The Commission may

    approve a joint audit plan, or part of such a plan, after notice and

    comment if the Commission determines that the plan: (1) Is necessary or

    appropriate to serve the public interest; (2) is for the protection and

    in the interest of customers; (3) reduces multiple monitoring and

    auditing for compliance with the minimum financial requirements; (4)

    reduces multiple reporting of financial information; (5) fosters

    cooperation and coordination; and (6) does not hinder the development

    of a registered futures association. Currently all active SROs are

    members of a joint audit plan that was approved by the Commission on

    March 18, 2009.\78\

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    \78\ The original signatories of the joint audit plan approved

    on March 18, 2009 are as follows: Board of Trade of the City of

    Chicago, Inc.; Board of Trade of Kansas City; CBOE Futures Exchange,

    LLC; Chicago Climate Futures Exchange, LLC; Chicago Mercantile

    Exchange Inc.; Commodity Exchange, Inc; ELX Futures, L.P.;

    HedgeStreet, Inc.; ICE Futures U.S., Inc.; INET Futures Exchange,

    L.L.C.; Minneapolis Grain Exchange; NASDAQ OMX Futures Exchange;

    National Futures Association; New York Mercantile Exchange, Inc.;

    NYSE Liffe US, L.L.C.; OneChicago, L.L.C.

    ---------------------------------------------------------------------------

    The Commission is proposing additional amendments to Sec. 1.52 in

    light of recent events that highlight a need for strengthening the

    minimum requirements that SROs must abide by in conducting financial

    surveillance to minimize the chances that FCMs that engage in unlawful

    activities that result, or could result, in the loss of customer funds

    or the inability of the firms to meet their financial obligations to

    market participants, including DCOs, go undetected. The proposed

    amendments to Sec. 1.52 revise the current supervisory program

    required to be established and implemented by SROs pursuant to existing

    Sec. 1.52(b) with respect to their FCM members. In addition, for SROs

    that choose to delegate their duties to oversee and examine FCMs that

    are members of two or more SROs to a DSRO pursuant to a plan

    established under existing Sec. 1.52(c) in lieu of each conducting its

    own oversight and examinations of such common FCM members, proposed

    Sec. 1.52 provides that the plan adopt certain requirements to assure

    the quality of the DSRO oversight and examinations conducted under the

    plan, both as to the substance of the oversight and examination program

    and the application of such program.

    Proposed Sec. 1.52(b) requires each SRO to adopt rules requiring

    its member FCMs to establish a risk management program that is at least

    as stringent as the risk management program required in proposed Sec.

    1.11. Proposed Sec. 1.11 is discussed in Section II.B above, and

    requires an FCM to establish a risk management program designed to

    monitor and manage risks associated with the activities of the FCM.

    Proposed Sec. 1.52 does not make significant changes to the

    existing SRO supervisory programs with respect to the oversight and

    examination of retail foreign exchange dealer and IB member

    registrants. However, with respect to the oversight and examination of

    FCMs, proposed Sec. 1.52 requires an SRO to adopt significant new

    requirements in its supervisory program. The supervisory program for

    FCMs will now explicitly require, among other things, controls testing

    as well as substantive testing, and the examination process for each

    FCM must be driven by the risk profile of each such FCM. In addition,

    the supervisory program must conform to U.S. GAAS after giving full

    consideration to those auditing standards as prescribed by the PCAOB.

    The supervisory program also must contain written standards addressing

    numerous aspects of the examination process over FCMs as provided in

    proposed Sec. 1.52(c)(2)(iii), including the examination of the risk

    assessment process, the examination of the planning process, and the

    quality control procedures to ensure that the examinations maintain the

    level of quality expected by the SRO.

    The Commission believes that an examination of an FCM must include

    a review and assessment of the firm's internal controls in order to

    identify where there may be potential weaknesses and to properly gauge

    the risks associated with such weaknesses including their potential

    impact on the financial condition of the firm and the protection of

    customer funds.

    The SRO also must engage an ``examinations expert'' under Sec.

    1.52(c)(2) to review its supervisory program and the application of the

    supervisory program at least once every two years. The term

    ``examinations expert'' is proposed to be defined under Sec. 1.52(a)

    as a nationally recognized accounting and auditing firm with

    substantial expertise in audits of FCMs, risk assessment and internal

    control reviews, and is someone acceptable to the Commission. The

    Commission is proposing to delegate to the Director of the Division of

    Swap Dealer and Intermediary Oversight the responsibility of assessing

    whether a particular entity is qualified and approved as an

    examinations expert to review the SRO's supervisory program

    The review will require the examinations expert to assess the

    sufficiency of the SRO's risk-based approach and the internal controls

    testing and also whether the supervisory program is being appropriately

    applied by the SRO in its examinations of its member FCMs. In addition,

    the review will require that the examinations expert provide an opinion

    as to whether the supervisory program is reasonably likely to identify

    a material deficiency in internal controls of the FCM or in any of the

    other items that are the subject of an examination conducted in

    accordance with the supervisory program. Furthermore, the review will

    require that the examinations expert also provide recommendations on

    new or best practices prescribed by industry sources that should be

    incorporated in the supervisory program. The SRO must receive a written

    report from the examinations expert describing, among other things, the

    items mentioned in this paragraph.

    Upon receipt of the written report, the SRO must provide such

    written report to the Commission. The SRO must update the supervisory

    program and coordinate with the Commission to resolve any issues raised

    by the written report and any Commission questions and comments before

    the updated supervisory program becomes the standard for the SRO's

    examinations of its registered FCM members. Proposed Sec.

    1.52(c)(2)(vi) also requires each SRO to submit an initial supervisory

    program within 120 days of the effective date of the regulation, or a

    longer period of time that Director of the Division of Swap Dealer and

    Intermediary Oversight (acting pursuant to authority delegated by the

    Commission) may approve. The initial supervisory program must contain

    an affirmation from the examinations expert regarding the evaluation of

    the supervisory program, including the sufficiency of the risk-based

    approach and the internal controls testing. The examinations expert

    also must opine as to whether the supervisory program is reasonably

    likely to identify a material weakness in internal controls over

    financial or regulatory reporting.

    Consistent with the current regulation, and in order to avoid

    duplicative examinations and oversight of FCMs, retail foreign exchange

    dealers, or IBs, proposed Sec. 1.52(d)(1) provides that when two or

    more SROs have a common member registrant, such SROs may voluntarily

    agree to establish a plan to delegate to a single DSRO the function of

    overseeing and examining such common member registrant otherwise

    required from each such SRO.

    [[Page 67892]]

    Proposed amendments to Sec. 1.52(d)(1) would further provide that

    while an SRO may delegate the functions of examining a member FCM for

    compliance with the minimum financial and reporting and risk management

    requirements, the delegating SRO retains responsibility for its member

    FCM's compliance with such requirements.

    If SROs choose to take advantage of the efficiency provided by a

    joint audit plan with respect to their oversight and examinations over

    common member FCMs, then the plan must satisfy the requirements of

    proposed Sec. 1.52(d)(2), which will assure the quality of the SROs,

    both as to the substance of the oversight and examination program and

    the application of such program. Proposed Sec. 1.52(d)(2) requires in

    such a plan that the SROs form a Joint Audit Committee and adopt a

    Joint Audit Program pursuant to which FCMs are overseen and examined by

    a DSRO.

    The Joint Audit Committee members will be subject to a number of

    duties according to proposed Sec. 1.52(d)(2). The most important of

    these is that the Joint Audit Committee members establish and maintain

    a Joint Audit Program that the DSROs must apply in their oversight and

    examinations of FCMs.

    The requirements for the establishment and maintenance of the Joint

    Audit Program are identical in many ways to the establishment and

    maintenance of the standalone supervisory program with respect to FCMs

    described in proposed Sec. Sec. 1.52(b) and (c). For example, the

    Joint Audit Program and the standalone supervisory program both require

    controls testing as well as substantive testing, and the examination

    process for each FCM must be driven by the risk profile of each such

    FCM. Both programs are required to be reviewed by an examinations

    expert every two years. Both must have standards addressing the items

    listed in proposed Sec. 1.52(c)(2)(iii), including the examination

    risk assessment, examination planning, and quality control to ensure

    that the examinations maintain the level of quality expected. The

    rationale for this approach is because one of the goals of proposed

    Sec. 1.52(d)(2) is to ensure that the SRO and examinations of FCMs is

    at least up to the same heightened standard, regardless of whether the

    oversight and examinations are conducted by the SRO itself or by a DSRO

    designated by the Joint Audit Committee.

    The proposed revisions to Sec. 1.52(d) would not nullify the

    existing joint audit plan approved by the Commission on March 18, 2009.

    Furthermore, the Commission believes that the new minimum requirements

    for a Joint Audit Program under proposed Sec. 1.52(d)(2) will not

    require revisions to the current joint audit plan. In this regard, the

    joint audit plan approved by the Commission includes a provision in

    paragraph 3 that provides that the minimum practices and procedures

    followed by each DSRO in the conduct of examinations of FCMs shall be

    established to conform with the requirements of Sec. 1.52, Commission

    staff interpretations, and any other Commission requirements

    hereinafter in effect relating to audits and financial reviews. The

    Commission believes that this provision would require the DSROs of the

    current joint audit plan to revise their Audit Program to meet the new

    requirements of proposed 1.52, but not require a new joint audit plan

    to be submitted to the Commission.\79\

    ---------------------------------------------------------------------------

    \79\ The Commission's view is only that the current agreement

    does not have to be revised as a result of the proposed amendments.

    The SRO members of the current joint audit plan, however, are not

    precluded from making any amendments or otherwise revising the joint

    audit program consistent with the terms included in the agreement

    for making such revisions.

    ---------------------------------------------------------------------------

    The members of the current joint audit plan would be required to

    establish, operate and maintain a Joint Audit Program under proposed

    Sec. 1.52(d)(2)(i). The members of the current joint audit plan also

    would be required to submit to the Commission for its review and

    comment a Joint Audit Program within 120 days (or such other time as

    the Commission may approve) of the effective date of the amendments to

    Sec. 1.52 under proposed Sec. 1.52(d)(2)(ii)(H). The Joint Audit

    Program must be accompanied by a written report from an examinations

    expert affirming that the examinations expert has evaluated the Joint

    Audit Program and the examinations expert's opinion as to whether the

    Joint Audit Program is reasonably likely to identify a material

    deficiency in internal controls over financial and regulatory

    reporting, and other items that are subject of an examination conducted

    in accordance with the Joint Audit Program.

    The Commission is proposing to delegate the responsibility for

    granting an extension of time to submit an initial Joint Audit Program

    to the Director of the Division of Swap Dealer and Intermediary

    Oversight. In this connection, the Commission anticipates that the

    Division of Swap Dealer and Intermediary Oversight will be performing

    ongoing consultation with SROs regarding the examination programs and,

    therefore, would be in position to assess the adequacy of, and

    necessity for, any request for an extension of the filing deadline. It

    is anticipated that the Director of the Division of Swap Dealer and

    Intermediary Oversight will grant requests for reasonable extensions of

    time for the submission of the Joint Audit Program.

    The Commission requests comments on all aspects of proposed Sec.

    1.52. The Commission also requests comments on the following:

    The Commission is proposing to require that the SRO and/or

    JAC program be subject to an evaluation by an examinations expert at

    least once every two years. The examinations expert is defined as a

    nationally recognized accounting and auditing firm. Is the proposed

    definition of the examinations expert sufficiently clear or detailed to

    identify which entities may qualify as an examinations expert? If not,

    how can the Commission make the definition more objective? Should the

    Commission consider entities other than accounting and auditing firms

    (such as consulting firms) to act as examinations experts?

    Is the requirement for the examinations expert to conduct

    an evaluation of the SRO or JAC program at least once every two years

    an appropriate timeframe? Should the Commission consider a shorter

    interval between evaluations? If so, why? Alternatively, should the

    Commission consider a longer interval between evaluations? If so, why?

    What criteria should the Commission consider in setting the interval?

    Should the Commission allow SRO or JAC programs that have minimal

    issues raised by the examinations expert be subject to a longer

    evaluation interval than programs that have more issues identified by

    the examinations expert? If so, how would the Commission implement such

    a program?

    Does the requirement for an examinations expert add

    sufficient value to the SRO or JAC program to justify the costs of such

    evaluations? Please provide detail in your response to assist the

    Commission in assessing the costs of such evaluations.

    Are there alternatives to the examinations expert's

    evaluation to assess the adequacy of the SRO and JAC program that the

    Commission should consider? Please provide detail in your response.

    The Commission is proposing that an SRO submit an initial

    supervisory program and that the members of a Joint Audit Committee

    submit an initial Joint Audit Program within 120 days of the effective

    date of the regulation. The initial supervisory program and the initial

    Joint Audit Program must include

    [[Page 67893]]

    a written report containing an affirmation from an examinations expert

    regarding the evaluation of the supervisory program or the Joint Audit

    Program, including the sufficiency of the risk-based approach and the

    internal controls testing. The examinations expert also must opine as

    to whether the supervisory program or the Joint Audit Program is

    reasonably likely to identify a material weakness in internal controls

    over financial or regulatory reporting. Is the proposed 120-day period

    a sufficient period of time for an SRO or JAC to obtain such report

    from an examinations expert and to submit its respective supervisory

    program or Joint Audit Program? If not, what is a sufficient period of

    time?

    P. Proposed Amendments to Sec. 1.55: Public Disclosures by Futures

    Commission Merchants

    The Commission is proposing to amend Sec. 1.55 to enhance the

    disclosures provided to customers and potential customers regarding the

    extent to which customer funds are protected when deposited with an FCM

    as margin or to guarantee performance for trading commodity interests.

    The Commission also is proposing to require each FCM to disclose

    certain firm specific information regarding the FCM's financial

    condition and operations to allow customers and potential customers to

    assess the risks of engaging the firm to conduct futures trading and

    the risks of entrusting their funds to the FCM.

    Regulation 1.55(a) currently requires an FCM, or an IB in the case

    of an introduced account, to provide each customer with a risk

    disclosure statement prior to opening the customer's account (``Risk

    Disclosure Statement').\80\ Regulation 1.55(b) provides a standard form

    Risk Disclosure Statement that each FCM or IB is required to provide to

    each prospective customer. The current Risk Disclosure Statement is

    primarily intended to provide a customer with disclosure of the market

    risks of engaging in futures trading and addresses, among other things,

    risks associated with leverage, market movements, and the inability to

    exit the market due to limit moves. The FCM or IB also is required to

    receive a signed acknowledgment from the customer stating that the

    customer received and understood the Risk Disclosure Statement.

    ---------------------------------------------------------------------------

    \80\ FCMs and IBs are not required to provide disclosure

    documents to institutional customers, defined as eligible contract

    participants under section 1a of the Act. See Sec. 1.55(f).

    ---------------------------------------------------------------------------

    The Commission is proposing to amend Sec. 1.55 to require FCMs to

    provide additional disclosures to prospective customers. Specifically,

    the Commission is proposing to add new provisions to paragraph (b) that

    will require the Risk Disclosure Statement to contain a statement that:

    (1) Customer funds are not protected by insurance in the event of the

    bankruptcy or insolvency of the FCM, or if customer funds are

    misappropriated in the event of fraud; (2) customer funds are not

    protected by SIPC, even if the FCM is a BD registered with the SEC; and

    (3) customer funds are not insured by a DCO in the event of the

    bankruptcy or insolvency of the FCM holding the customer funds. The

    proposed amendments also will require an FCM to disclose that each

    customer's funds are not held in an individual segregated account by an

    FCM, but rather are commingled in one or more accounts, and that FCMs

    may invest funds deposited by customers in investments listed in Sec.

    1.25. The proposed amendments also will require that each FCM disclose

    that funds deposited by customers may be deposited with affiliated

    entities of the FCM, including affiliated banks and brokers.

    The Commission also is proposing to revise the Risk Disclosure

    Statement required by Sec. 1.55(b) to include a new disclosure that

    informs a potential customer that each futures commission merchant is

    required by Commission regulations to make certain firm specific

    disclosures and financial information publicly available on the futures

    commission merchant's Web site to assist the customer with his or her

    assessment and selection of a futures commission merchant. The firm

    specific disclosures are detailed in proposed paragraph (k) of Sec.

    1.55 and are discussed below. The Risk Disclosure Statement also must

    include the futures commission merchant's Web site address where the

    additional firm specific and financial information may be obtained by

    the customer.

    The Commission is proposing the additional disclosures in response

    to the recent failures of MF Global and Peregrine. The Commission is

    concerned that the current Risk Disclosure Statement does not provide

    customers with adequate or complete information regarding the risks of

    engaging in trading through an FCM. Current disclosures in the Risk

    Disclosure Statement focus on the market risks of engaging in futures

    trading. However, the Commission understands that many of MF Global's

    former customers did not have adequate and meaningful information

    regarding the risks that their funds were exposed to beyond general

    market risks. Specifically, the Commission understands that some

    customers believed that their funds were covered by insurance or other

    protection. Some customers also believed that DCOs guaranteed customer

    funds in the event of a bankruptcy of an FCM.

    The proposed additional disclosures in the Risk Disclosure

    Statement are intended to provide customers with a greater

    understanding of the risks of entrusting their funds with an FCM. This

    includes disclosures regarding the meaning and operation of the term

    ``segregation'' under the Act and Commission regulations. In addition,

    the Commission believes that customers will benefit from an awareness

    that FCMs may use affiliated entities to hold customer funds.

    The Commission also is proposing that the Risk Disclosure Statement

    include a new provision that informs potential customers to the fact

    that additional firm specific disclosures and financial information

    about a particular FCM may be obtained from information maintained on

    each FCM's respective Web site. The content of the additional firm

    specific and financial disclosures are discussed below.

    The Commission also is proposing to amend Sec. 1.55, by adding new

    paragraphs (i) through (n) which will require an FCM to provide to each

    customer an additional disclosure document that will set forth firm

    specific information and address firm-specific risk factors to allow

    customers to have more information regarding the FCM and the risks

    associated with entrusting their funds to the FCM, or otherwise

    conducting business with or through the FCM (``Firm Specific Disclosure

    Document''). The additional risk information provided also will enable

    customers to make more meaningful judgments regarding the

    appropriateness of selecting an FCM by providing tools and information

    for the meaningful comparisons of business models and risks across

    FCMs. Such additional information will greatly enhance the due

    diligence that a customer can conduct both prior to opening an account

    and on an ongoing basis, as the proposal will require that the FCM

    update the risk disclosure information on a periodic basis. The

    Commission believes that the proposed Firm Specific Disclosure

    Document, coupled with the existing Risk Disclosure Statement, will

    provide customers with a more complete perspective regarding the risks

    of participating in the futures markets.

    [[Page 67894]]

    Under the proposal, in addition to providing general firm contact

    information, the Firm Specific Disclosure Document will contain the

    names, business contacts, and backgrounds for the FCM's senior

    management and members of the FCM's board of directors. The Firm

    Specific Disclosure Document also will include firm risk disclosures

    including: (1) A discussion of the significant types of business

    activities and product lines that the FCM engages in; (2) a discussion

    of the FCM's significant lines of business and the approximate amount

    of assets and capital devoted to each line of business; (3) a

    discussion of the material risks of the firm including the FCM's

    creditworthiness, leverage, capital and liquidity condition, and an

    explanation of how such risks may be material to customers that deposit

    funds for futures trading with the firm; and (4) a discussion of any

    material administrative, civil, criminal, or enforcement actions

    pending or any enforcement actions taken in the last three years.

    The proposed Firm Specific Disclosure Document also will require

    each FCM to disclose firm specific information regarding its operations

    in the futures marketplace. An FCM will be required to disclose the

    name of the firm's DSRO, and to provide an overview of customer funds

    segregation protections and limitations, and how it manages its

    collateral management and investments. Each FCM also will be required

    to disclose the clearinghouses and carrying brokers that its uses to

    conduct its business, as well as its policies and procedures concerning

    the choice of depositories, custodians and counterparties.

    The proposed Firm Specific Disclosure Document also will require

    the FCM to disclose certain financial and risk management information

    including the firm's total equity, regulatory capital, and net worth as

    of the most recent month end when the disclosure document is prepared.

    The FCM also is required to disclose information regarding: (1) The

    amount of the FCM's proprietary margin requirements as a percentage of

    the total segregated and secured funds that the FCM holds; (2) the

    number of customers that comprise 50 percent of the firm's total

    customer segregated and secured amount requirements; (3) the aggregate

    notional value, by asset class, of all non-hedged, principal over-the-

    counter transactions into which the FCM has entered; (4) the amount,

    generic source and purpose of any unsecured lines of credit (or similar

    short-term funding) the FCM has obtained but not yet drawn upon; (5)

    the aggregate amount of financing the FCM provides for customer

    transactions involving illiquid financial products for which it is

    difficult to obtain timely and accurate prices; (6) the percentage of

    customer receivables that the FCM had to write-off as uncollectable

    during the prior year compared to the current segregated and secured

    amount balances; and (7) a summary of the FCM's current risk practices,

    controls and procedures.

    An FCM is obligated to update the Firm Specific Disclosure Document

    as necessary to keep the information accurate, but at least on an

    annual basis. An FCM also is required to make the Firm Specific

    Disclosure Document available to its customers and the general public

    on its Web site. An FCM may, however, use an alternative electronic

    means to make the Firm Specific Disclosure Document available to its

    customers provided that the electronic version is presented in a format

    that is readily communicated to its customers. The Proposal further

    provides that an FCM shall provide a paper copy of the Firm Specific

    Disclosure Document to a customer upon the customer's request.

    The Commission also is proposing to amend Sec. 1.55 to require

    each FCM to disclose on its Web site to the general public financial

    information that is publicly available under existing Commission

    regulations. Specifically, proposed paragraph (o) of Sec. 1.55 will

    require each FCM to make available on its Web site the daily

    Segregation Schedule; the daily Secured Amount Schedule; and the daily

    Cleared Swaps Segregation Schedule. Each FCM will be required to

    maintain 12 months of the above segregation and secured schedules

    available on its Web site.

    Proposed paragraph (o) also requires each FCM to disclose on its

    Web site a summary schedule of the firm's adjusted net capital, net

    capital, and excess net capital for the 12 most recent month-end dates.

    Each FCM also will be required to disclose on its Web site the

    following statements and schedules from the most current year end

    annual report that is certified by an independent public accountant in

    accordance with Sec. 1.16: the Statement of Financial Condition; the

    Segregation Schedule; Secured Amount Schedule; the Cleared Swaps

    Segregation Schedule; and all footnotes related to the above statement

    and schedules.

    The information that the proposal requires each FCM to disclose on

    its Web site is information that is currently publicly available under

    Commission regulations, or proposed by this rulemaking in the case of

    the Cleared Swaps Segregation Schedule, to be public information.

    Regulation 1.10(g) currently provides that the Segregation Schedules

    and Secured Amount Schedules contained in the monthly unaudited Forms

    1-FR-FCM are public information. Regulation 1.10(g) further provides

    that the amounts of an FCM's adjusted net capital, minimum net capital

    requirement, and excess net capital as reported in the firm's unaudited

    monthly Form 1-FR-FCM are public information. Lastly, Sec. 1.10(g)

    providesand examining member

    FCMs for compliance with

    [[Page 67891]]

    certain regulatory and financial reporting obligations. The audit plan

    must be submitted to the Commission for approval. The Commission may

    approve a joint audit plan, or part of such a plan, after notice and

    comment if the Commission determines that the plan: (1) Is necessary or

    appropriate to serve the public interest; (2) is for the protection and

    in the interest of customers; (3) reduces multiple monitoring and

    auditing for compliance with the minimum financial requirements; (4)

    reduces multiple reporting of financial information; (5) fosters

    cooperation and coordination; and (6) does not hinder the development

    of a registered futures association. Currently all active SROs are

    members of a joint audit plan that was approved by the Commission on

    March 18, 2009.\78\

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    \78\ The original signatories of the joint audit plan approved

    on March 18, 2009 are as follows: Board of Trade of the City of

    Chicago, Inc.; Board of Trade of Kansas City; CBOE Futures Exchange,

    LLC; Chicago Climate Futures Exchange, LLC; Chicago Mercantile

    Exchange Inc.; Commodity Exchange, Inc; ELX Futures, L.P.;

    HedgeStreet, Inc.; ICE Futures U.S., Inc.; INET Futures Exchange,

    L.L.C.; Minneapolis Grain Exchange; NASDAQ OMX Futures Exchange;

    National Futures Association; New York Mercantile Exchange, Inc.;

    NYSE Liffe US, L.L.C.; OneChicago, L.L.C.

    ---------------------------------------------------------------------------

    The Commission is proposing additional amendments to Sec. 1.52 in

    light of recent events that highlight a need for strengthening the

    minimum requirements that SROs must abide by in conducting financial

    surveillance to minimize the chances that FCMs that engage in unlawful

    activities that result, or could result, in the loss of customer funds

    or the inability of the firms to meet their financial obligations to

    market participants, including DCOs, go undetected. The proposed

    amendments to Sec. 1.52 revise the current supervisory program

    required to be established and implemented by SROs pursuant to existing

    Sec. 1.52(b) with respect to their FCM members. In addition, for SROs

    that choose to delegate their duties to oversee and examine FCMs that

    are members of two or more SROs to a DSRO pursuant to a plan

    established under existing Sec. 1.52(c) in lieu of each conducting its

    own oversight and examinations of such common FCM members, proposed

    Sec. 1.52 provides that the plan adopt certain requirements to assure

    the quality of the DSRO oversight and examinations conducted under the

    plan, both as to the substance of the oversight and examination program

    and the application of such program.

    Proposed Sec. 1.52(b) requires each SRO to adopt rules requiring

    its member FCMs to establish a risk management program that is at least

    as stringent as the risk management program required in proposed Sec.

    1.11. Proposed Sec. 1.11 is discussed in Section II.B above, and

    requires an FCM to establish a risk management program designed to

    monitor and manage risks associated with the activities of the FCM.

    Proposed Sec. 1.52 does not make significant changes to the

    existing SRO supervisory programs with respect to the oversight and

    examination of retail foreign exchange dealer and IB member

    registrants. However, with respect to the oversight and examination of

    FCMs, proposed Sec. 1.52 requires an SRO to adopt significant new

    requirements in its supervisory program. The supervisory program for

    FCMs will now explicitly require, among other things, controls testing

    as well as substantive testing, and the examination process for each

    FCM must be driven by the risk profile of each such FCM. In addition,

    the supervisory program must conform to U.S. GAAS after giving full

    consideration to those auditing standards as prescribed by the PCAOB.

    The supervisory program also must contain written standards addressing

    numerous aspects of the examination process over FCMs as provided in

    proposed Sec. 1.52(c)(2)(iii), including the examination of the risk

    assessment process, the examination of the planning process, and the

    quality control procedures to ensure that the examinations maintain the

    level of quality expected by the SRO.

    The Commission believes that an examination of an FCM must include

    a review and assessment of the firm's internal controls in order to

    identify where there may be potential weaknesses and to properly gauge

    the risks associated with such weaknesses including their potential

    impact on the financial condition of the firm and the protection of

    customer funds.

    The SRO also must engage an ``examinations expert'' under Sec.

    1.52(c)(2) to review its supervisory program and the application of the

    supervisory program at least once every two years. The term

    ``examinations expert'' is proposed to be defined under Sec. 1.52(a)

    as a nationally recognized accounting and auditing firm with

    substantial expertise in audits of FCMs, risk assessment and internal

    control reviews, and is someone acceptable to the Commission. The

    Commission is proposing to delegate to the Director of the Division of

    Swap Dealer and Intermediary Oversight the responsibility of assessing

    whether a particular entity is qualified and approved as an

    examinations expert to review the SRO's supervisory program

    The review will require the examinations expert to assess the

    sufficiency of the SRO's risk-based approach and the internal controls

    testing and also whether the supervisory program is being appropriately

    applied by the SRO in its examinations of its member FCMs. In addition,

    the review will require that the examinations expert provide an opinion

    as to whether the supervisory program is reasonably likely to identify

    a material deficiency in internal controls of the FCM or in any of the

    other items that are the subject of an examination conducted in

    accordance with the supervisory program. Furthermore, the review will

    require that the examinations expert also provide recommendations on

    new or best practices prescribed by industry sources that should be

    incorporated in the supervisory program. The SRO must receive a written

    report from the examinations expert describing, among other things, the

    items mentioned in this paragraph.

    Upon receipt of the written report, the SRO must provide such

    written report to the Commission. The SRO must update the supervisory

    program and coordinate with the Commission to resolve any issues raised

    by the written report and any Commission questions and comments before

    the updated supervisory program becomes the standard for the SRO's

    examinations of its registered FCM members. Proposed Sec.

    1.52(c)(2)(vi) also requires each SRO to submit an initial supervisory

    program within 120 days of the effective date of the regulation, or a

    longer period of time that Director of the Division of Swap Dealer and

    Intermediary Oversight (acting pursuant to authority delegated by the

    Commission) may approve. The initial supervisory program must contain

    an affirmation from the examinations expert regarding the evaluation of

    the supervisory program, including the sufficiency of the risk-based

    approach and the internal controls testing. The examinations expert

    also must opine as to whether the supervisory program is reasonably

    likely to identify a material weakness in internal controls over

    financial or regulatory reporting.

    Consistent with the current regulation, and in order to avoid

    duplicative examinations and oversight of FCMs, retail foreign exchange

    dealers, or IBs, proposed Sec. 1.52(d)(1) provides that when two or

    more SROs have a common member registrant, such SROs may voluntarily

    agree to establish a plan to delegate to a single DSRO the function of

    overseeing and examining such common member registrant otherwise

    required from each such SRO.

    [[Page 67892]]

    Proposed amendments to Sec. 1.52(d)(1) would further provide that

    while an SRO may delegate the functions of examining a member FCM for

    compliance with the minimum financial and reporting and risk management

    requirements, the delegating SRO retains responsibility for its member

    FCM's compliance with such requirements.

    If SROs choose to take advantage of the efficiency provided by a

    joint audit plan with respect to their oversight and examinations over

    common member FCMs, then the plan must satisfy the requirements of

    proposed Sec. 1.52(d)(2), which will assure the quality of the SROs,

    both as to the substance of the oversight and examination program and

    the application of such program. Proposed Sec. 1.52(d)(2) requires in

    such a plan that the SROs form a Joint Audit Committee and adopt a

    Joint Audit Program pursuant to which FCMs are overseen and examined by

    a DSRO.

    The Joint Audit Committee members will be subject to a number of

    duties according to proposed Sec. 1.52(d)(2). The most important of

    these is that the Joint Audit Committee members establish and maintain

    a Joint Audit Program that the DSROs must apply in their oversight and

    examinations of FCMs.

    The requirements for the establishment and maintenance of the Joint

    Audit Program are identical in many ways to the establishment and

    maintenance of the standalone supervisory program with respect to FCMs

    described in proposed Sec. Sec. 1.52(b) and (c). For example, the

    Joint Audit Program and the standalone supervisory program both require

    controls testing as well as substantive testing, and the examination

    process for each FCM must be driven by the risk profile of each such

    FCM. Both programs are required to be reviewed by an examinations

    expert every two years. Both must have standards addressing the items

    listed in proposed Sec. 1.52(c)(2)(iii), including the examination

    risk assessment, examination planning, and quality control to ensure

    that the examinations maintain the level of quality expected. The

    rationale for this approach is because one of the goals of proposed

    Sec. 1.52(d)(2) is to ensure that the SRO and examinations of FCMs is

    at least up to the same heightened standard, regardless of whether the

    oversight and examinations are conducted by the SRO itself or by a DSRO

    designated by the Joint Audit Committee.

    The proposed revisions to Sec. 1.52(d) would not nullify the

    existing joint audit plan approved by the Commission on March 18, 2009.

    Furthermore, the Commission believes that the new minimum requirements

    for a Joint Audit Program under proposed Sec. 1.52(d)(2) will not

    require revisions to the current joint audit plan. In this regard, the

    joint audit plan approved by the Commission includes a provision in

    paragraph 3 that provides that the minimum practices and procedures

    followed by each DSRO in the conduct of examinations of FCMs shall be

    established to conform with the requirements of Sec. 1.52, Commission

    staff interpretations, and any other Commission requirements

    hereinafter in effect relating to audits and financial reviews. The

    Commission believes that this provision would require the DSROs of the

    current joint audit plan to revise their Audit Program to meet the new

    requirements of proposed 1.52, but not require a new joint audit plan

    to be submitted to the Commission.\79\

    ---------------------------------------------------------------------------

    \79\ The Commission's view is only that the current agreement

    does not have to be revised as a result of the proposed amendments.

    The SRO members of the current joint audit plan, however, are not

    precluded from making any amendments or otherwise revising the joint

    audit program consistent with the terms included in the agreement

    for making such revisions.

    ---------------------------------------------------------------------------

    The members of the current joint audit plan would be required to

    establish, operate and maintain a Joint Audit Program under proposed

    Sec. 1.52(d)(2)(i). The members of the current joint audit plan also

    would be required to submit to the Commission for its review and

    comment a Joint Audit Program within 120 days (or such other time as

    the Commission may approve) of the effective date of the amendments to

    Sec. 1.52 under proposed Sec. 1.52(d)(2)(ii)(H). The Joint Audit

    Program must be accompanied by a written report from an examinations

    expert affirming that the examinations expert has evaluated the Joint

    Audit Program and the examinations expert's opinion as to whether the

    Joint Audit Program is reasonably likely to identify a material

    deficiency in internal controls over financial and regulatory

    reporting, and other items that are subject of an examination conducted

    in accordance with the Joint Audit Program.

    The Commission is proposing to delegate the responsibility for

    granting an extension of time to submit an initial Joint Audit Program

    to the Director of the Division of Swap Dealer and Intermediary

    Oversight. In this connection, the Commission anticipates that the

    Division of Swap Dealer and Intermediary Oversight will be performing

    ongoing consultation with SROs regarding the examination programs and,

    therefore, would be in position to assess the adequacy of, and

    necessity for, any request for an extension of the filing deadline. It

    is anticipated that the Director of the Division of Swap Dealer and

    Intermediary Oversight will grant requests for reasonable extensions of

    time for the submission of the Joint Audit Program.

    The Commission requests comments on all aspects of proposed Sec.

    1.52. The Commission also requests comments on the following:

    The Commission is proposing to require that the SRO and/or

    JAC program be subject to an evaluation by an examinations expert at

    least once every two years. The examinations expert is defined as a

    nationally recognized accounting and auditing firm. Is the proposed

    definition of the examinations expert sufficiently clear or detailed to

    identify which entities may qualify as an examinations expert? If not,

    how can the Commission make the definition more objective? Should the

    Commission consider entities other than accounting and auditing firms

    (such as consulting firms) to act as examinations experts?

    Is the requirement for the examinations expert to conduct

    an evaluation of the SRO or JAC program at least once every two years

    an appropriate timeframe? Should the Commission consider a shorter

    interval between evaluations? If so, why? Alternatively, should the

    Commission consider a longer interval between evaluations? If so, why?

    What criteria should the Commission consider in setting the interval?

    Should the Commission allow SRO or JAC programs that have minimal

    issues raised by the examinations expert be subject to a longer

    evaluation interval than programs that have more issues identified by

    the examinations expert? If so, how would the Commission implement such

    a program?

    Does the requirement for an examinations expert add

    sufficient value to the SRO or JAC program to justify the costs of such

    evaluations? Please provide detail in your response to assist the

    Commission in assessing the costs of such evaluations.

    Are there alternatives to the examinations expert's

    evaluation to assess the adequacy of the SRO and JAC program that the

    Commission should consider? Please provide detail in your response.

    The Commission is proposing that an SRO submit an initial

    supervisory program and that the members of a Joint Audit Committee

    submit an initial Joint Audit Program within 120 days of the effective

    date of the regulation. The initial supervisory program and the initial

    Joint Audit Program must include

    [[Page 67893]]

    a written report containing an affirmation from an examinations expert

    regarding the evaluation of the supervisory program or the Joint Audit

    Program, including the sufficiency of the risk-based approach and the

    internal controls testing. The examinations expert also must opine as

    to whether the supervisory program or the Joint Audit Program is

    reasonably likely to identify a material weakness in internal controls

    over financial or regulatory reporting. Is the proposed 120-day period

    a sufficient period of time for an SRO or JAC to obtain such report

    from an examinations expert and to submit its respective supervisory

    program or Joint Audit Program? If not, what is a sufficient period of

    time?

    P. Proposed Amendments to Sec. 1.55: Public Disclosures by Futures

    Commission Merchants

    The Commission is proposing to amend Sec. 1.55 to enhance the

    disclosures provided to customers and potential customers regarding the

    extent to which customer funds are protected when deposited with an FCM

    as margin or to guarantee performance for trading commodity interests.

    The Commission also is proposing to require each FCM to disclose

    certain firm specific information regarding the FCM's financial

    condition and operations to allow customers and potential customers to

    assess the risks of engaging the firm to conduct futures trading and

    the risks of entrusting their funds to the FCM.

    Regulation 1.55(a) currently requires an FCM, or an IB in the case

    of an introduced account, to provide each customer with a risk

    disclosure statement prior to opening the customer's account (``Risk

    Disclosure Statement').\80\ Regulation 1.55(b) provides a standard form

    Risk Disclosure Statement that each FCM or IB is required to provide to

    each prospective customer. The current Risk Disclosure Statement is

    primarily intended to provide a customer with disclosure of the market

    risks of engaging in futures trading and addresses, among other things,

    risks associated with leverage, market movements, and the inability to

    exit the market due to limit moves. The FCM or IB also is required to

    receive a signed acknowledgment from the customer stating that the

    customer received and understood the Risk Disclosure Statement.

    ---------------------------------------------------------------------------

    \80\ FCMs and IBs are not required to provide disclosure

    documents to institutional customers, defined as eligible contract

    participants under section 1a of the Act. See Sec. 1.55(f).

    ---------------------------------------------------------------------------

    The Commission is proposing to amend Sec. 1.55 to require FCMs to

    provide additional disclosures to prospective customers. Specifically,

    the Commission is proposing to add new provisions to paragraph (b) that

    will require the Risk Disclosure Statement to contain a statement that:

    (1) Customer funds are not protected by insurance in the event of the

    bankruptcy or insolvency of the FCM, or if customer funds are

    misappropriated in the event of fraud; (2) customer funds are not

    protected by SIPC, even if the FCM is a BD registered with the SEC; and

    (3) customer funds are not insured by a DCO in the event of the

    bankruptcy or insolvency of the FCM holding the customer funds. The

    proposed amendments also will require an FCM to disclose that each

    customer's funds are not held in an individual segregated account by an

    FCM, but rather are commingled in one or more accounts, and that FCMs

    may invest funds deposited by customers in investments listed in Sec.

    1.25. The proposed amendments also will require that each FCM disclose

    that funds deposited by customers may be deposited with affiliated

    entities of the FCM, including affiliated banks and brokers.

    The Commission also is proposing to revise the Risk Disclosure

    Statement required by Sec. 1.55(b) to include a new disclosure that

    informs a potential customer that each futures commission merchant is

    required by Commission regulations to make certain firm specific

    disclosures and financial information publicly available on the futures

    commission merchant's Web site to assist the customer with his or her

    assessment and selection of a futures commission merchant. The firm

    specific disclosures are detailed in proposed paragraph (k) of Sec.

    1.55 and are discussed below. The Risk Disclosure Statement also must

    include the futures commission merchant's Web site address where the

    additional firm specific and financial information may be obtained by

    the customer.

    The Commission is proposing the additional disclosures in response

    to the recent failures of MF Global and Peregrine. The Commission is

    concerned that the current Risk Disclosure Statement does not provide

    customers with adequate or complete information regarding the risks of

    engaging in trading through an FCM. Current disclosures in the Risk

    Disclosure Statement focus on the market risks of engaging in futures

    trading. However, the Commission understands that many of MF Global's

    former customers did not have adequate and meaningful information

    regarding the risks that their funds were exposed to beyond general

    market risks. Specifically, the Commission understands that some

    customers believed that their funds were covered by insurance or other

    protection. Some customers also believed that DCOs guaranteed customer

    funds in the event of a bankruptcy of an FCM.

    The proposed additional disclosures in the Risk Disclosure

    Statement are intended to provide customers with a greater

    understanding of the risks of entrusting their funds with an FCM. This

    includes disclosures regarding the meaning and operation of the term

    ``segregation'' under the Act and Commission regulations. In addition,

    the Commission believes that customers will benefit from an awareness

    that FCMs may use affiliated entities to hold customer funds.

    The Commission also is proposing that the Risk Disclosure Statement

    include a new provision that informs potential customers to the fact

    that additional firm specific disclosures and financial information

    about a particular FCM may be obtained from information maintained on

    each FCM's respective Web site. The content of the additional firm

    specific and financial disclosures are discussed below.

    The Commission also is proposing to amend Sec. 1.55, by adding new

    paragraphs (i) through (n) which will require an FCM to provide to each

    customer an additional disclosure document that will set forth firm

    specific information and address firm-specific risk factors to allow

    customers to have more information regarding the FCM and the risks

    associated with entrusting their funds to the FCM, or otherwise

    conducting business with or through the FCM (``Firm Specific Disclosure

    Document''). The additional risk information provided also will enable

    customers to make more meaningful judgments regarding the

    appropriateness of selecting an FCM by providing tools and information

    for the meaningful comparisons of business models and risks across

    FCMs. Such additional information will greatly enhance the due

    diligence that a customer can conduct both prior to opening an account

    and on an ongoing basis, as the proposal will require that the FCM

    update the risk disclosure information on a periodic basis. The

    Commission believes that the proposed Firm Specific Disclosure

    Document, coupled with the existing Risk Disclosure Statement, will

    provide customers with a more complete perspective regarding the risks

    of participating in the futures markets.

    [[Page 67894]]

    Under the proposal, in addition to providing general firm contact

    information, the Firm Specific Disclosure Document will contain the

    names, business contacts, and backgrounds for the FCM's senior

    management and members of the FCM's board of directors. The Firm

    Specific Disclosure Document also will include firm risk disclosures

    including: (1) A discussion of the significant types of business

    activities and product lines that the FCM engages in; (2) a discussion

    of the FCM's significant lines of business and the approximate amount

    of assets and capital devoted to each line of business; (3) a

    discussion of the material risks of the firm including the FCM's

    creditworthiness, leverage, capital and liquidity condition, and an

    explanation of how such risks may be material to customers that deposit

    funds for futures trading with the firm; and (4) a discussion of any

    material administrative, civil, criminal, or enforcement actions

    pending or any enforcement actions taken in the last three years.

    The proposed Firm Specific Disclosure Document also will require

    each FCM to disclose firm specific information regarding its operations

    in the futures marketplace. An FCM will be required to disclose the

    name of the firm's DSRO, and to provide an overview of customer funds

    segregation protections and limitations, and how it manages its

    collateral management and investments. Each FCM also will be required

    to disclose the clearinghouses and carrying brokers that its uses to

    conduct its business, as well as its policies and procedures concerning

    the choice of depositories, custodians and counterparties.

    The proposed Firm Specific Disclosure Document also will require

    the FCM to disclose certain financial and risk management information

    including the firm's total equity, regulatory capital, and net worth as

    of the most recent month end when the disclosure document is prepared.

    The FCM also is required to disclose information regarding: (1) The

    amount of the FCM's proprietary margin requirements as a percentage of

    the total segregated and secured funds that the FCM holds; (2) the

    number of customers that comprise 50 percent of the firm's total

    customer segregated and secured amount requirements; (3) the aggregate

    notional value, by asset class, of all non-hedged, principal over-the-

    counter transactions into which the FCM has entered; (4) the amount,

    generic source and purpose of any unsecured lines of credit (or similar

    short-term funding) the FCM has obtained but not yet drawn upon; (5)

    the aggregate amount of financing the FCM provides for customer

    transactions involving illiquid financial products for which it is

    difficult to obtain timely and accurate prices; (6) the percentage of

    customer receivables that the FCM had to write-off as uncollectable

    during the prior year compared to the current segregated and secured

    amount balances; and (7) a summary of the FCM's current risk practices,

    controls and procedures.

    An FCM is obligated to update the Firm Specific Disclosure Document

    as necessary to keep the information accurate, but at least on an

    annual basis. An FCM also is required to make the Firm Specific

    Disclosure Document available to its customers and the general public

    on its Web site. An FCM may, however, use an alternative electronic

    means to make the Firm Specific Disclosure Document available to its

    customers provided that the electronic version is presented in a format

    that is readily communicated to its customers. The Proposal further

    provides that an FCM shall provide a paper copy of the Firm Specific

    Disclosure Document to a customer upon the customer's request.

    The Commission also is proposing to amend Sec. 1.55 to require

    each FCM to disclose on its Web site to the general public financial

    information that is publicly available under existing Commission

    regulations. Specifically, proposed paragraph (o) of Sec. 1.55 will

    require each FCM to make available on its Web site the daily

    Segregation Schedule; the daily Secured Amount Schedule; and the daily

    Cleared Swaps Segregation Schedule. Each FCM will be required to

    maintain 12 months of the above segregation and secured schedules

    available on its Web site.

    Proposed paragraph (o) also requires each FCM to disclose on its

    Web site a summary schedule of the firm's adjusted net capital, net

    capital, and excess net capital for the 12 most recent month-end dates.

    Each FCM also will be required to disclose on its Web site the

    following statements and schedules from the most current year end

    annual report that is certified by an independent public accountant in

    accordance with Sec. 1.16: the Statement of Financial Condition; the

    Segregation Schedule; Secured Amount Schedule; the Cleared Swaps

    Segregation Schedule; and all footnotes related to the above statement

    and schedules.

    The information that the proposal requires each FCM to disclose on

    its Web site is information that is currently publicly available under

    Commission regulations, or proposed by this rulemaking in the case of

    the Cleared Swaps Segregation Schedule, to be public information.

    Regulation 1.10(g) currently provides that the Segregation Schedules

    and Secured Amount Schedules contained in the monthly unaudited Forms

    1-FR-FCM are public information. Regulation 1.10(g) further provides

    that the amounts of an FCM's adjusted net capital, minimum net capital

    requirement, and excess net capital as reported in the firm's unaudited

    monthly Form 1-FR-FCM are public information. Lastly, Sec. 1.10(g)

    provides that the Statement of Financial Condition, Segregation

    Schedule, Secured Amount Schedule, and related footnote disclosures

    contained in an FCM's audited annual financial report are public

    documents.

    The Commission also is proposing in paragraph (o) of Sec. 1.55 to

    require each FCM to include a statement on its Web site that is

    available to the public that additional information, including

    information on how the FCM invests customer funds, may be obtained from

    the NFA. The FCM also is required to include a link on its Web site to

    the NFA web page which shows financial information for the FCM. Lastly,

    proposed paragraph (o) requires each FCM to include a statement

    regarding the Commission's reporting of select FCM financial

    information and a link to the Commission's Web site.

    The Commission is proposing paragraph (o) as it believes that

    customers will make more informed choices regarding which FCMs to use

    to carry their account and to entrust their funds to if they have the

    opportunity to have access to FCM financial information. Requiring FCMs

    to make the information available to the public on their respective Web

    sites will allow customers and potential customers with a convenient

    method of obtaining and reviewing the information to assist with their

    selection process. Customers will have the ability to compare and

    contrast financial data from all FCMs to assist with the decision

    making process of determining which firms meet their criteria for

    holding their funds.

    The Commission requests comment on all aspects of proposed

    amendments to Sec. 1.55. Specifically, the Commission requests comment

    on the following:

    Do the existing and proposed disclosures required to be

    included in the Risk Disclosure Statement and Firm Specific Disclosure

    Document adequately convey to retail and/or institutional investors the

    market and firm specific risks of engaging in futures trading and the

    risks of using an FCM to execute trades on customers' behalf and to

    hold customers' funds? If not, how should the Risk Disclosure

    [[Page 67895]]

    Statement and Firm Specific Disclosure Document be amended?

    Are there other disclosures that the Commission should

    require to be included in Risk Disclosure Statement? If so, what are

    the additional disclosures and how would such disclosures benefit

    customers?

    Are there other disclosures that the Commission should

    require to be included in a Firm Specific Disclosure Document? If so,

    what are the additional disclosures and how would such disclosures

    benefit customers?

    Are the proposed additional firm-specific disclosures too

    broad? If so, how should the Commission refine the disclosures to be

    more specific, yet provide the type of information that the Commission

    would like customers to receive?

    The Commission is proposing to require an FCM to disclose

    in the Firm Specific Disclosure Document the number of customers that

    comprise 50 percent of the FCM's customer fund balances for futures

    customers, Cleared Swaps Customers, and 30.7 Customers. Should the

    Commission consider additional or different percentages? If so, what

    should the percentages be and why?

    The Commission requests comment on how the new or revised

    Risk Disclosure Statement and Disclosure Documents should be provided

    to existing customers. Should FCMs be required to obtain new signature

    acknowledgments from existing customers for a revised Risk Disclosure

    Statement? How should existing customers be informed of the new Firm

    Specific Disclosure Statement? How can the Commission be assured that

    all existing customers have been informed of the new disclosure

    documents, and the availability of the FCM financial data?

    If FCMs are required to provide existing customers with

    new Risk Disclosure Statements, how should Commission address the

    implementation of the requirement? What would be an adequate period of

    time for FCMs to obtain new acknowledgment from existing customers?

    Q. Proposed Amendments to Part 22

    The Commission recently adopted final regulations in Part 22

    implementing the provisions of the Dodd Frank Act that provide for the

    protection of Cleared Swaps Customer contracts and collateral.\81\

    Although substantive differences in the segregation regimes between

    futures and cleared swaps at the clearing level exist under the final

    Part 22 regulations as adopted, requirements with respect to collateral

    which is not posted to clearinghouses and maintained by FCMs for

    Cleared Swaps Customers replicate or incorporate by reference the same

    regulatory requirements applicable to the segregation of futures

    customer funds under section 4d(a)(2) of the Act (for example, holding

    funds separate and apart from proprietary funds, limitations on the

    FCM's use of customer funds, titling of depository accounts,

    Acknowledgment Letter from depository requirements, and limitations on

    investment of swap customers' funds are currently contained in Part 22

    regulations).

    ---------------------------------------------------------------------------

    \81\ 77 FR 6336 (February 7, 2012).

    ---------------------------------------------------------------------------

    The determination that appropriate enhancements are necessary with

    respect to the regulatory requirements discussed above for segregated

    futures customer funds under section 4d(a)(2) of the Act is equally

    applicable to Cleared Swaps Customer Collateral. The written policies

    and procedures requirements proposed in Sec. 1.11 would be applicable

    to Cleared Swaps Customer Collateral, the new withdrawal limitations

    requirements proposed in Sec. 1.23 are proposed to be replicated in a

    new Sec. 22.17, and the changes to the daily segregation calculations

    and filing of such calculations, as well as requirements for detailed

    depository and investment information, are proposed to apply to Cleared

    Swaps Customer funds through proposed amendments to Sec. 22.2(g). In

    addition, changes discussed above regarding Sec. 1.17 with respect to

    securities haircuts are also proposed with respect to Sec. 22.2(f),

    which similarly incorporates by reference the applicable SEC securities

    haircuts. Finally, the proposed Sec. 1.20(i) requirement that an FCM

    maintain residual interest in segregated accounts in an amount that

    exceeds the sum of all futures customers' margin deficits is also

    proposed with respect to Cleared Swaps. As stated above, this

    requirement provides a clear mechanism for demonstrating FCM compliance

    with the prohibition under the Act and existing Commission regulations

    on using the collateral of one Cleared Swaps Customer to support the

    obligations of another Cleared Swaps Customer.

    R. Amendments to Sec. 1.3: Definitions; and Sec. 30.7: Treatment of

    Foreign Futures or Foreign Options Secured Amount

    Part 30 of the Commission's regulations were adopted in 1987 and

    govern trading on foreign futures markets.\82\ Regulation 30.7 requires

    an FCM to set aside in separate accounts for the benefit of its foreign

    futures or foreign options customers an amount of funds defined as the

    ``foreign futures or foreign options secured amount.'' The term

    ``foreign futures or foreign options secured amount'' is defined in

    Sec. 1.3(rr) as the amount of funds necessary to margin the foreign

    futures or foreign options positions held by the FCM for its foreign

    futures or foreign options customers, plus or minus any gains or losses

    on such open positions. The calculation of the foreign futures or

    foreign options secured amount is referred to as the ``Alternative

    Method.''

    ---------------------------------------------------------------------------

    \82\ 52 FR 28980 (Aug. 5, 1987).

    ---------------------------------------------------------------------------

    Foreign futures or foreign options customers receive substantially

    less protection for their account deposits under the Alternative Method

    than futures customers receive for their account deposits under section

    4d(a)(2) of the Act and Commission regulations. Section 4d(a)(2) of the

    Act and Commission regulations require an FCM to segregate in separate

    accounts sufficient funds to satisfy the full account equities of all

    of its futures customers trading on designated contract markets (i.e.,

    the Net Liquidating Equity Method). The regulatory objective of the Net

    Liquidating Equity Method is to ensure that an FCM has sufficient funds

    in segregated accounts to cover the full account equities of all of its

    futures customers. This would allow the FCM to transfer the futures

    customers' positions and margin collateral in the event of the

    insolvency of the FCM to another firm that was financial sound. If the

    FCM does not maintain sufficient funds in segregation to cover the full

    account equities, the futures customers may not be able to be

    transferred to another FCM, or the futures customers may be required to

    deposit margin funds with the transferee FCM to adequately margin the

    positions.

    In contrast, the Alternative Method only obligates an FCM to set

    aside an amount of funds in separate accounts sufficient to cover the

    margin required on open foreign futures and foreign options positions,

    plus or minus any unrealized gains or losses on such positions. Any

    funds deposited by foreign futures or foreign options customers in

    excess of the required amount to be set aside in separate accounts

    under the Alternative Method may be held by the FCM in operating cash

    accounts and may be used by the FCM as if it were its own capital.

    Therefore, an FCM is not required to set aside in separate accounts a

    sufficient

    [[Page 67896]]

    amount funds to repay the full account balances of each of its foreign

    futures or foreign options customers, and, in the event of an FCM

    insolvency, the foreign futures or foreign options customers may not

    recover 100 percent of the value of their accounts or be able to

    transfer their positions to another FCM.

    The Commission is proposing to amend the Part 30 regulations to

    eliminate the Alternative Method and to require FCMs to use the Net

    Liquidating Equity Method to compute the amount of funds they must set

    aside in separate accounts for the benefit of its foreign futures or

    foreign options customers. The amount of funds held for foreign futures

    and foreign options customers has grown dramatically in the last 10

    years. FCMs held approximately $36.4 billion for foreign futures or

    foreign options customers as of June 30, 2012, compared to a total of

    $7.9 billion held as of March 31, 2002 (an approximate 470 percent

    increase).\83\ In addition, the amount of funds held by FCMs for

    foreign futures or foreign options customers has increased relative to

    the amount of segregated funds held by FCMs during the last 10 years.

    Funds held for foreign futures or foreign options customers represented

    approximately 13 percent of the total customer funds held by FCMs as of

    March 31, 2002, and represented approximately 21 percent of total

    customer funds as of June 30, 2012.\84\

    ---------------------------------------------------------------------------

    \83\ The total amount of customer funds held by FCMs is

    available on the Commission's Web site at http://www.cftc.gov/MarketReports/FinancialDataforFCMs/index.htm.

    \84\ Id.

    ---------------------------------------------------------------------------

    Accordingly, the Commission is proposing to amend Sec. 1.3(rr) to

    define the term ``foreign futures or foreign options secured amount''

    to mean the amount of funds an FCM needs to satisfy the full account

    balances of each 30.7 Customer at all times (i.e., the Net Liquidating

    Equity Method).

    The term ``30.7 Customer'' is proposed to be defined in Sec. 30.1

    to mean both U.S.-domiciled customers and foreign-domiciled customers

    trading foreign futures or foreign options. As originally adopted, FCMs

    were only required to hold funds for U.S.-domiciled customers. The Net

    Liquidating Equity Method will require the FCM to set aside a

    sufficient amount of funds in secured accounts to repay the total

    account balances of all of its 30.7 Customers, which will align the

    requirement with the segregation requirements for both futures

    customers and Cleared Swaps Customers. The proposed amendments will

    significantly enhance the protection afforded to funds deposited by

    customers trading on foreign markets.

    The Commission also is proposing to substantively revise the

    regulations governing an FCM's holding of funds deposited by a customer

    for trading on foreign futures markets. The proposed amendments to the

    foreign futures or foreign options secured amount requirement establish

    many of the regulatory requirements that currently exist, or are

    proposed to be adopted under this rulemaking, with regard to segregated

    funds deposited by customers trading on a designated contract market

    under Part 1 and deposited by Cleared Swaps Customers under Part 22 of

    the Commission's Regulations.

    Regulation 30.7(a) requires an FCM to set aside in separate

    accounts sufficient funds to meet its current obligations to foreign

    futures or foreign option customers denominated as the ``foreign

    futures or foreign options secured amount.'' The term ``foreign futures

    or foreign options customer'' is defined in Sec. 30.1 to mean any

    person located in the United States, its territories, or possessions.

    The term ``foreign futures or foreign options secured amount'' is

    defined at Sec. 1.3(rr) and means an amount of money, securities, or

    other property sufficient to margin, guarantee, or secure open foreign

    futures contracts plus any unrealized gains or losses on such

    contracts, and any money securities or property representing premiums

    paid or received, and any other funds necessary to guarantee or secure,

    open foreign option transactions (i.e., the Alternative Method of

    computing the secured amount requirement). Thus, an FCM is not required

    to set aside in separate accounts all funds deposited by or otherwise

    belonging to foreign futures or foreign option customers. Funds

    deposited by foreign futures or foreign options customers that exceed

    the foreign futures or foreign options secured amount may be commingled

    with the FCM's proprietary funds and used by the FCM as part of its

    business capital.

    In addition, Sec. 30.7(b) requires only that an FCM set aside the

    required margin funds for foreign futures customers that are located

    within the United States, its territories, or possessions. Regulation

    30.7 permits the FCM to include foreign futures customers that are

    located outside of the United States, but the FCM is not obligated to

    include such foreign-domiciled customers.

    Furthermore, Commission staff previously issued guidance to FCMs

    stating that an FCM could carry positions other than foreign futures

    and foreign option positions in foreign futures or foreign options

    customers' accounts. Thus, FCMs could commingle and carry customers'

    non-foreign futures positions, such as foreign currency positions and

    over-the-counter positions, in such customers' foreign futures or

    foreign options account.

    The intent of the following amendments is to align the regulatory

    approach and customer protections by raising the requirements for

    foreign futures or foreign options secured amount to make it consistent

    with the FCM's segregation requirements for customers trading on

    designated contract market or engaging in cleared swap transactions.

    As stated above, the Commission is proposing to require FCMs to

    compute the foreign futures or foreign options secured amount using the

    Net Liquidating Equity Method by amending the definition in Sec.

    1.3(rr) of the term ``foreign futures or foreign options secured

    amount'' to match structurally the definition in Sec. 1.3(gg) of the

    term ``customer funds,'' which encompasses the Net Liquidating Equity

    Method of computing the amount of funds an FCM is required to maintain

    in customer segregated accounts. Specifically, the proposed definition

    of the term ``foreign futures or foreign options secured amount'' would

    be amended to mean all money, securities and property received by an

    FCM for, or on behalf of, ``30.7 Customers'' to margin, guarantee, or

    secure foreign futures contracts and foreign option transactions, and

    all funds accruing to ``30.7 Customers'' as a result of such foreign

    futures and foreign options transactions. The term ``30.7 Customer'' is

    proposed to be defined in Sec. 30.1 to mean any person, whether

    domiciled within or outside of the United States, that engages in

    foreign futures or foreign options transactions through the FCM.

    Requiring an FCM to set aside in separate accounts the funds

    deposited by both domestic and foreign-domiciled customers provides

    comparable customer protections to customers notwithstanding their

    place of domicile. In addition, requiring the FCM to hold U.S.-

    domiciled and foreign-domiciled customer funds in separate accounts

    under Sec. 30.7 ensures that such customers receive equal protections

    in the event of the bankruptcy of the firm. Part 190 of the

    Commission's regulations and the U.S. Bankruptcy Code \85\ provide that

    in the event of a commodity broker bankruptcy liquidation, customers in

    the account

    [[Page 67897]]

    class entitled to a preference to the amounts in set-aside accounts for

    customers trading on foreign boards of trade include both U.S.-

    domiciled and foreign-domiciled customers.\86\ The Commission is

    proposing to require funds to be set aside equally for U.S.-domiciled

    and foreign-domiciled customers trading on foreign boards of trade in

    the computation under Sec. 30.7 by establishing a new definition of

    30.7 Customers that includes existing foreign futures or foreign

    options customers (which are U.S.-domiciled persons trading foreign

    futures or foreign options) as well as any foreign-domiciled persons

    trading foreign futures or foreign options through the registered FCM.

    The secured amount definition, as proposed to be amended in Sec.

    1.3(rr), will reference ``30.7 Customers'' instead of ``foreign futures

    or foreign options customers,'' to ensure FCMs are required to set

    aside funds equal to the net liquidating equity of all such persons.

    Combined with the proposed amendment to require net liquidating equity,

    this should result in at all times an amount required to be set aside

    for all persons equal to the amount owed to such persons that would

    share in the account class for foreign futures in a commodity broker

    liquidation. The Commission is also proposing amendments in Sec. 1.10

    and Sec. 1.17 to reference ``30.7 Customers'' instead of foreign

    futures or foreign options customers in the title of the schedules

    prepared by an FCM.

    ---------------------------------------------------------------------------

    \85\ See 11 U.S.C. 761-766.

    \86\ Id. By definition, ``foreign future'' under section 761 of

    the Bankruptcy Code is not limited to transactions entered on

    foreign boards of trade on behalf of U.S. domiciled persons, and

    ``customer'' is not limited to U.S. domiciled persons. The result is

    that by the application of these definitions a preferential account

    class at a commodity broker for customers trading foreign futures

    would not be limited to U.S. domiciled customers.

    ---------------------------------------------------------------------------

    In addition, the Commission is proposing to add language to Sec.

    30.7(a) to provide an equivalent offset to that available in the

    futures customer segregation calculation under Sec. 1.32(b) for

    deficits in accounts secured by securities, subject to language

    updating the reference to applying securities haircuts in calculating

    the offset as discussed in Section II.F above. The result of these

    amendments as discussed should be accord between the methodologies

    applied in the 4d segregation calculation and the Sec. 30.7

    calculation.

    Consistent with proposed changes in Sec. 1.20(i) and Part 22, the

    Commission also is proposing to add language to Sec. 30.7(a) to

    provide that an FCM must hold residual interest in accounts set aside

    for the benefit of 30.7 Customers equal to the sum of all margin

    deficits for such accounts, to provide an equivalent clear mechanism

    for ensuring that the funds of one 30.7 Customer are not margining or

    guaranteeing the positions of another 30.7 Customer. Although this

    prohibition is not specified in the Act as it is with respect for

    futures customers and Cleared Swaps Customers, the Commission is

    proposing to the extent possible to replicate wherever practical and

    advisable customer protection provisions for futures customers and

    Cleared Swaps Customers to 30.7 Customers. As a result, most of the

    amendments proposed earlier in various provisions for these customers

    also are being proposed in Sec. 30.7.

    The Commission requests comment on the proposed amendments to Sec.

    30.7(a).

    Proposed paragraph (b) of Sec. 30.7 sets forth the permitted

    depositories for holding 30.7 Customer funds. The proposal does not

    alter the list of depositories that are currently permitted under Sec.

    30.7 to hold 30.7 Customers' funds: (1) A bank or trust company located

    in the United States; (2) a bank or trust company located outside of

    the United States that maintains in excess of $ 1 billion of regulatory

    capital; (3) an FCM registered with the Commission; (4) a DCO; (5) the

    clearing organization of a foreign board of trade; (6) a member of a

    foreign board of trade; and (7) the depositories used by the clearing

    organization of a foreign board of trade or a member of a foreign board

    of trade.

    Proposed Sec. 30.7(c) would limit the amount of 30.7 Customers'

    funds that an FCM could hold in non-U.S. jurisdictions. Under the

    proposal, an FCM must hold 30.7 Customer funds in the United States,

    except to the extent that the funds held outside of the United States

    are necessary to margin, guarantee, or secure (including any prefunding

    obligations) the foreign futures or foreign options positions of an

    FCM's 30.7 Customers. The Commission also is proposing to allow an FCM

    to deposit additional 30.7 Customer Funds equal to 10 percent of the

    total amount of funds required to be held by non-U.S. brokers or

    foreign clearing organizations for 30.7 Customers as a cushion to the

    required margin requirements, so that the FCM has a certain degree of

    flexibility in managing its daily cash movements and to ensure that the

    foreign futures or foreign options positions are not undermargined at

    foreign brokers or clearing organizations. The Commission recognizes

    that due to differences in time zones, trading hours, banking holidays,

    as well needs for cash transfers to foreign jurisdictions to settle and

    to be credited to accounts, a customer may not be able to immediately

    transfer funds to its FCM, and an FCM may not be able to immediately

    transfer funds to a foreign broker or foreign clearing organization to

    meet a margin call. The proposed cushion is intended to provide an FCM

    with sufficient flexibility to meet its customers' trading obligations

    on foreign markets, while also requiring as much of the total 30.7

    Customer funds to be held within the United States in order to minimize

    the impact of the repatriation risk in the event of an FCM insolvency.

    The Commission previously proposed changes to the form of the

    Acknowledgment Letter required from depositories holding funds set

    aside as the foreign futures or foreign options secured amount.\87\ The

    Commission here re-proposes in a revised paragraph (d) to Sec. 30.7

    the requirements for obtaining and submitting Acknowledgment Letters

    for Sec. 30.7 accounts, which proposed changes include further revised

    template forms of Acknowledgment Letter included as Appendices E and F.

    The proposed template forms, in addition to incorporating earlier

    proposed changes previously summarized with respect to the Sec. 1.20

    Acknowledgment Letters, have been further revised to include a

    depository's agreement to provide read-only account access to

    Commission or DSRO staff, in order for Commission or DSRO staff to

    directly verify balances as necessary. The Commission is also proposing

    subparagraphs (3), (4) and (5) of Sec. 30.7(d), which substantively

    require 24 hour a day direct read-only electronic access to the

    depository account by the Commission and the DSRO, require the

    depository to file the written Acknowledgment Letter directly with the

    Commission and the FCM's DSRO, and require the depository to provide

    confirmations to the Commission and the FCM's DSRO directly upon

    request. The Commission requests comment on the revised requirements

    for Acknowledgment Letters for Sec. 30.7 accounts as proposed in

    paragraph (d) and the new template forms of the Acknowledgment Letters

    proposed in Appendices E and F.

    ---------------------------------------------------------------------------

    \87\ See Acknowledgment Letters for Customer Funds and Secured

    Amount Funds, 75 FR 47738 (Aug. 9, 2010).

    ---------------------------------------------------------------------------

    As part of its participation in the public roundtable discussed in

    the Background section above, FIA recommended that the Commission

    eliminate the ability of FCMs to commingle funds from unregulated

    [[Page 67898]]

    transactions with funds for foreign futures and options trading in Part

    30 set aside accounts, except by Commission order, as is the case under

    4d(a)(2) of the Act for segregated funds. The Commission agrees with

    this recommendation. The comments cited in the release adopting Part 30

    with respect to back office operational difficulties of establishing

    multiple ``customer'' origins were persuasive at the time Part 30 was

    adopted.\88\ With the technological changes of intervening decades,

    however, these concerns should no longer dictate the advisability of

    commingling the funds of regulated foreign futures and foreign options

    transactions with unregulated transactions. Therefore, the Commission

    is proposing to amend Sec. 30.7 by adopting new paragraph (e), which

    will extend the prohibition against commingling to any funds of account

    holders of an FCM unrelated to trading foreign futures or foreign

    options, except as the Commission shall by order permit, under terms

    and conditions as specified. Should there be a need to permit

    commingling of funds, the Commission will continue to have the ability

    to permit such commingling under the formalities of processes

    associated with a Commission order. The Commission requests comment on

    this proposed amendment to Sec. 30.7(e).

    ---------------------------------------------------------------------------

    \88\ See 52 FR 28980 at 28985-28986.

    ---------------------------------------------------------------------------

    The Commission has proposed to adopt a new paragraph (f) and a new

    paragraph (k) in Sec. 30.7, to extend regulatory provisions from

    Sec. Sec. 1.20, 1.21, 1.22 and 1.24, that previously were applicable

    only to 4d segregated funds, to funds set aside as the foreign futures

    or foreign options secured amount under Sec. 30.7. The Commission

    requests comment on replicating these regulatory requirements

    applicable to segregated funds to funds set aside as the foreign

    futures or foreign options secured amount. These proposed requirements

    would make clear that FCMs would not be permitted to use funds set

    aside as the foreign futures or foreign options secured amount other

    than for the benefit of 30.7 Customers, and that funds set aside as the

    foreign futures or foreign options secured amount should not be

    invested in any obligations of clearing organizations or boards of

    trade, and that further, no funds placed at foreign brokers should be

    included as funds set aside as the foreign futures or foreign options

    secured amount unless those funds are on deposit to margin the foreign

    futures or foreign options trading of 30.7 Customers. In addition to

    extending these existing Commission regulations to Sec. 30.7 in

    proposed paragraphs (f) and (k), the Commission is also proposing a new

    requirement prohibiting a FCM from imposing any liens or allowing any

    liens to be imposed on funds set aside as the foreign futures or

    foreign options secured amount. The Commission has previously adopted a

    lien prohibition with respect to the segregation of Cleared Swaps

    Customer collateral at Sec. 22.2(d)(2) and therefore proposes to

    extend this lien prohibition to funds set aside as the foreign futures

    or foreign options secured amount in Sec. 30.7. The Commission

    requests comment on the proposed amendments providing limitations on

    use and permitted withdrawals as cont that the Statement of Financial Condition, Segregation

    Schedule, Secured Amount Schedule, and related footnote disclosures

    contained in an FCM's audited annual financial report are public

    documents.

    The Commission also is proposing in paragraph (o) of Sec. 1.55 to

    require each FCM to include a statement on its Web site that is

    available to the public that additional information, including

    information on how the FCM invests customer funds, may be obtained from

    the NFA. The FCM also is required to include a link on its Web site to

    the NFA web page which shows financial information for the FCM. Lastly,

    proposed paragraph (o) requires each FCM to include a statement

    regarding the Commission's reporting of select FCM financial

    information and a link to the Commission's Web site.

    The Commission is proposing paragraph (o) as it believes that

    customers will make more informed choices regarding which FCMs to use

    to carry their account and to entrust their funds to if they have the

    opportunity to have access to FCM financial information. Requiring FCMs

    to make the information available to the public on their respective Web

    sites will allow customers and potential customers with a convenient

    method of obtaining and reviewing the information to assist with their

    selection process. Customers will have the ability to compare and

    contrast financial data from all FCMs to assist with the decision

    making process of determining which firms meet their criteria for

    holding their funds.

    The Commission requests comment on all aspects of proposed

    amendments to Sec. 1.55. Specifically, the Commission requests comment

    on the following:

    Do the existing and proposed disclosures required to be

    included in the Risk Disclosure Statement and Firm Specific Disclosure

    Document adequately convey to retail and/or institutional investors the

    market and firm specific risks of engaging in futures trading and the

    risks of using an FCM to execute trades on customers' behalf and to

    hold customers' funds? If not, how should the Risk Disclosure

    [[Page 67895]]

    Statement and Firm Specific Disclosure Document be amended?

    Are there other disclosures that the Commission should

    require to be included in Risk Disclosure Statement? If so, what are

    the additional disclosures and how would such disclosures benefit

    customers?

    Are there other disclosures that the Commission should

    require to be included in a Firm Specific Disclosure Document? If so,

    what are the additional disclosures and how would such disclosures

    benefit customers?

    Are the proposed additional firm-specific disclosures too

    broad? If so, how should the Commission refine the disclosures to be

    more specific, yet provide the type of information that the Commission

    would like customers to receive?

    The Commission is proposing to require an FCM to disclose

    in the Firm Specific Disclosure Document the number of customers that

    comprise 50 percent of the FCM's customer fund balances for futures

    customers, Cleared Swaps Customers, and 30.7 Customers. Should the

    Commission consider additional or different percentages? If so, what

    should the percentages be and why?

    The Commission requests comment on how the new or revised

    Risk Disclosure Statement and Disclosure Documents should be provided

    to existing customers. Should FCMs be required to obtain new signature

    acknowledgments from existing customers for a revised Risk Disclosure

    Statement? How should existing customers be informed of the new Firm

    Specific Disclosure Statement? How can the Commission be assured that

    all existing customers have been informed of the new disclosure

    documents, and the availability of the FCM financial data?

    If FCMs are required to provide existing customers with

    new Risk Disclosure Statements, how should Commission address the

    implementation of the requirement? What would be an adequate period of

    time for FCMs to obtain new acknowledgment from existing customers?

    Q. Proposed Amendments to Part 22

    The Commission recently adopted final regulations in Part 22

    implementing the provisions of the Dodd Frank Act that provide for the

    protection of Cleared Swaps Customer contracts and collateral.\81\

    Although substantive differences in the segregation regimes between

    futures and cleared swaps at the clearing level exist under the final

    Part 22 regulations as adopted, requirements with respect to collateral

    which is not posted to clearinghouses and maintained by FCMs for

    Cleared Swaps Customers replicate or incorporate by reference the same

    regulatory requirements applicable to the segregation of futures

    customer funds under section 4d(a)(2) of the Act (for example, holding

    funds separate and apart from proprietary funds, limitations on the

    FCM's use of customer funds, titling of depository accounts,

    Acknowledgment Letter from depository requirements, and limitations on

    investment of swap customers' funds are currently contained in Part 22

    regulations).

    ---------------------------------------------------------------------------

    \81\ 77 FR 6336 (February 7, 2012).

    ---------------------------------------------------------------------------

    The determination that appropriate enhancements are necessary with

    respect to the regulatory requirements discussed above for segregated

    futures customer funds under section 4d(a)(2) of the Act is equally

    applicable to Cleared Swaps Customer Collateral. The written policies

    and procedures requirements proposed in Sec. 1.11 would be applicable

    to Cleared Swaps Customer Collateral, the new withdrawal limitations

    requirements proposed in Sec. 1.23 are proposed to be replicated in a

    new Sec. 22.17, and the changes to the daily segregation calculations

    and filing of such calculations, as well as requirements for detailed

    depository and investment information, are proposed to apply to Cleared

    Swaps Customer funds through proposed amendments to Sec. 22.2(g). In

    addition, changes discussed above regarding Sec. 1.17 with respect to

    securities haircuts are also proposed with respect to Sec. 22.2(f),

    which similarly incorporates by reference the applicable SEC securities

    haircuts. Finally, the proposed Sec. 1.20(i) requirement that an FCM

    maintain residual interest in segregated accounts in an amount that

    exceeds the sum of all futures customers' margin deficits is also

    proposed with respect to Cleared Swaps. As stated above, this

    requirement provides a clear mechanism for demonstrating FCM compliance

    with the prohibition under the Act and existing Commission regulations

    on using the collateral of one Cleared Swaps Customer to support the

    obligations of another Cleared Swaps Customer.

    R. Amendments to Sec. 1.3: Definitions; and Sec. 30.7: Treatment of

    Foreign Futures or Foreign Options Secured Amount

    Part 30 of the Commission's regulations were adopted in 1987 and

    govern trading on foreign futures markets.\82\ Regulation 30.7 requires

    an FCM to set aside in separate accounts for the benefit of its foreign

    futures or foreign options customers an amount of funds defined as the

    ``foreign futures or foreign options secured amount.'' The term

    ``foreign futures or foreign options secured amount'' is defined in

    Sec. 1.3(rr) as the amount of funds necessary to margin the foreign

    futures or foreign options positions held by the FCM for its foreign

    futures or foreign options customers, plus or minus any gains or losses

    on such open positions. The calculation of the foreign futures or

    foreign options secured amount is referred to as the ``Alternative

    Method.''

    ---------------------------------------------------------------------------

    \82\ 52 FR 28980 (Aug. 5, 1987).

    ---------------------------------------------------------------------------

    Foreign futures or foreign options customers receive substantially

    less protection for their account deposits under the Alternative Method

    than futures customers receive for their account deposits under section

    4d(a)(2) of the Act and Commission regulations. Section 4d(a)(2) of the

    Act and Commission regulations require an FCM to segregate in separate

    accounts sufficient funds to satisfy the full account equities of all

    of its futures customers trading on designated contract markets (i.e.,

    the Net Liquidating Equity Method). The regulatory objective of the Net

    Liquidating Equity Method is to ensure that an FCM has sufficient funds

    in segregated accounts to cover the full account equities of all of its

    futures customers. This would allow the FCM to transfer the futures

    customers' positions and margin collateral in the event of the

    insolvency of the FCM to another firm that was financial sound. If the

    FCM does not maintain sufficient funds in segregation to cover the full

    account equities, the futures customers may not be able to be

    transferred to another FCM, or the futures customers may be required to

    deposit margin funds with the transferee FCM to adequately margin the

    positions.

    In contrast, the Alternative Method only obligates an FCM to set

    aside an amount of funds in separate accounts sufficient to cover the

    margin required on open foreign futures and foreign options positions,

    plus or minus any unrealized gains or losses on such positions. Any

    funds deposited by foreign futures or foreign options customers in

    excess of the required amount to be set aside in separate accounts

    under the Alternative Method may be held by the FCM in operating cash

    accounts and may be used by the FCM as if it were its own capital.

    Therefore, an FCM is not required to set aside in separate accounts a

    sufficient

    [[Page 67896]]

    amount funds to repay the full account balances of each of its foreign

    futures or foreign options customers, and, in the event of an FCM

    insolvency, the foreign futures or foreign options customers may not

    recover 100 percent of the value of their accounts or be able to

    transfer their positions to another FCM.

    The Commission is proposing to amend the Part 30 regulations to

    eliminate the Alternative Method and to require FCMs to use the Net

    Liquidating Equity Method to compute the amount of funds they must set

    aside in separate accounts for the benefit of its foreign futures or

    foreign options customers. The amount of funds held for foreign futures

    and foreign options customers has grown dramatically in the last 10

    years. FCMs held approximately $36.4 billion for foreign futures or

    foreign options customers as of June 30, 2012, compared to a total of

    $7.9 billion held as of March 31, 2002 (an approximate 470 percent

    increase).\83\ In addition, the amount of funds held by FCMs for

    foreign futures or foreign options customers has increased relative to

    the amount of segregated funds held by FCMs during the last 10 years.

    Funds held for foreign futures or foreign options customers represented

    approximately 13 percent of the total customer funds held by FCMs as of

    March 31, 2002, and represented approximately 21 percent of total

    customer funds as of June 30, 2012.\84\

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    \83\ The total amount of customer funds held by FCMs is

    available on the Commission's Web site at http://www.cftc.gov/MarketReports/FinancialDataforFCMs/index.htm.

    \84\ Id.

    ---------------------------------------------------------------------------

    Accordingly, the Commission is proposing to amend Sec. 1.3(rr) to

    define the term ``foreign futures or foreign options secured amount''

    to mean the amount of funds an FCM needs to satisfy the full account

    balances of each 30.7 Customer at all times (i.e., the Net Liquidating

    Equity Method).

    The term ``30.7 Customer'' is proposed to be defined in Sec. 30.1

    to mean both U.S.-domiciled customers and foreign-domiciled customers

    trading foreign futures or foreign options. As originally adopted, FCMs

    were only required to hold funds for U.S.-domiciled customers. The Net

    Liquidating Equity Method will require the FCM to set aside a

    sufficient amount of funds in secured accounts to repay the total

    account balances of all of its 30.7 Customers, which will align the

    requirement with the segregation requirements for both futures

    customers and Cleared Swaps Customers. The proposed amendments will

    significantly enhance the protection afforded to funds deposited by

    customers trading on foreign markets.

    The Commission also is proposing to substantively revise the

    regulations governing an FCM's holding of funds deposited by a customer

    for trading on foreign futures markets. The proposed amendments to the

    foreign futures or foreign options secured amount requirement establish

    many of the regulatory requirements that currently exist, or are

    proposed to be adopted under this rulemaking, with regard to segregated

    funds deposited by customers trading on a designated contract market

    under Part 1 and deposited by Cleared Swaps Customers under Part 22 of

    the Commission's Regulations.

    Regulation 30.7(a) requires an FCM to set aside in separate

    accounts sufficient funds to meet its current obligations to foreign

    futures or foreign option customers denominated as the ``foreign

    futures or foreign options secured amount.'' The term ``foreign futures

    or foreign options customer'' is defined in Sec. 30.1 to mean any

    person located in the United States, its territories, or possessions.

    The term ``foreign futures or foreign options secured amount'' is

    defined at Sec. 1.3(rr) and means an amount of money, securities, or

    other property sufficient to margin, guarantee, or secure open foreign

    futures contracts plus any unrealized gains or losses on such

    contracts, and any money securities or property representing premiums

    paid or received, and any other funds necessary to guarantee or secure,

    open foreign option transactions (i.e., the Alternative Method of

    computing the secured amount requirement). Thus, an FCM is not required

    to set aside in separate accounts all funds deposited by or otherwise

    belonging to foreign futures or foreign option customers. Funds

    deposited by foreign futures or foreign options customers that exceed

    the foreign futures or foreign options secured amount may be commingled

    with the FCM's proprietary funds and used by the FCM as part of its

    business capital.

    In addition, Sec. 30.7(b) requires only that an FCM set aside the

    required margin funds for foreign futures customers that are located

    within the United States, its territories, or possessions. Regulation

    30.7 permits the FCM to include foreign futures customers that are

    located outside of the United States, but the FCM is not obligated to

    include such foreign-domiciled customers.

    Furthermore, Commission staff previously issued guidance to FCMs

    stating that an FCM could carry positions other than foreign futures

    and foreign option positions in foreign futures or foreign options

    customers' accounts. Thus, FCMs could commingle and carry customers'

    non-foreign futures positions, such as foreign currency positions and

    over-the-counter positions, in such customers' foreign futures or

    foreign options account.

    The intent of the following amendments is to align the regulatory

    approach and customer protections by raising the requirements for

    foreign futures or foreign options secured amount to make it consistent

    with the FCM's segregation requirements for customers trading on

    designated contract market or engaging in cleared swap transactions.

    As stated above, the Commission is proposing to require FCMs to

    compute the foreign futures or foreign options secured amount using the

    Net Liquidating Equity Method by amending the definition in Sec.

    1.3(rr) of the term ``foreign futures or foreign options secured

    amount'' to match structurally the definition in Sec. 1.3(gg) of the

    term ``customer funds,'' which encompasses the Net Liquidating Equity

    Method of computing the amount of funds an FCM is required to maintain

    in customer segregated accounts. Specifically, the proposed definition

    of the term ``foreign futures or foreign options secured amount'' would

    be amended to mean all money, securities and property received by an

    FCM for, or on behalf of, ``30.7 Customers'' to margin, guarantee, or

    secure foreign futures contracts and foreign option transactions, and

    all funds accruing to ``30.7 Customers'' as a result of such foreign

    futures and foreign options transactions. The term ``30.7 Customer'' is

    proposed to be defined in Sec. 30.1 to mean any person, whether

    domiciled within or outside of the United States, that engages in

    foreign futures or foreign options transactions through the FCM.

    Requiring an FCM to set aside in separate accounts the funds

    deposited by both domestic and foreign-domiciled customers provides

    comparable customer protections to customers notwithstanding their

    place of domicile. In addition, requiring the FCM to hold U.S.-

    domiciled and foreign-domiciled customer funds in separate accounts

    under Sec. 30.7 ensures that such customers receive equal protections

    in the event of the bankruptcy of the firm. Part 190 of the

    Commission's regulations and the U.S. Bankruptcy Code \85\ provide that

    in the event of a commodity broker bankruptcy liquidation, customers in

    the account

    [[Page 67897]]

    class entitled to a preference to the amounts in set-aside accounts for

    customers trading on foreign boards of trade include both U.S.-

    domiciled and foreign-domiciled customers.\86\ The Commission is

    proposing to require funds to be set aside equally for U.S.-domiciled

    and foreign-domiciled customers trading on foreign boards of trade in

    the computation under Sec. 30.7 by establishing a new definition of

    30.7 Customers that includes existing foreign futures or foreign

    options customers (which are U.S.-domiciled persons trading foreign

    futures or foreign options) as well as any foreign-domiciled persons

    trading foreign futures or foreign options through the registered FCM.

    The secured amount definition, as proposed to be amended in Sec.

    1.3(rr), will reference ``30.7 Customers'' instead of ``foreign futures

    or foreign options customers,'' to ensure FCMs are required to set

    aside funds equal to the net liquidating equity of all such persons.

    Combined with the proposed amendment to require net liquidating equity,

    this should result in at all times an amount required to be set aside

    for all persons equal to the amount owed to such persons that would

    share in the account class for foreign futures in a commodity broker

    liquidation. The Commission is also proposing amendments in Sec. 1.10

    and Sec. 1.17 to reference ``30.7 Customers'' instead of foreign

    futures or foreign options customers in the title of the schedules

    prepared by an FCM.

    ---------------------------------------------------------------------------

    \85\ See 11 U.S.C. 761-766.

    \86\ Id. By definition, ``foreign future'' under section 761 of

    the Bankruptcy Code is not limited to transactions entered on

    foreign boards of trade on behalf of U.S. domiciled persons, and

    ``customer'' is not limited to U.S. domiciled persons. The result is

    that by the application of these definitions a preferential account

    class at a commodity broker for customers trading foreign futures

    would not be limited to U.S. domiciled customers.

    ---------------------------------------------------------------------------

    In addition, the Commission is proposing to add language to Sec.

    30.7(a) to provide an equivalent offset to that available in the

    futures customer segregation calculation under Sec. 1.32(b) for

    deficits in accounts secured by securities, subject to language

    updating the reference to applying securities haircuts in calculating

    the offset as discussed in Section II.F above. The result of these

    amendments as discussed should be accord between the methodologies

    applied in the 4d segregation calculation and the Sec. 30.7

    calculation.

    Consistent with proposed changes in Sec. 1.20(i) and Part 22, the

    Commission also is proposing to add language to Sec. 30.7(a) to

    provide that an FCM must hold residual interest in accounts set aside

    for the benefit of 30.7 Customers equal to the sum of all margin

    deficits for such accounts, to provide an equivalent clear mechanism

    for ensuring that the funds of one 30.7 Customer are not margining or

    guaranteeing the positions of another 30.7 Customer. Although this

    prohibition is not specified in the Act as it is with respect for

    futures customers and Cleared Swaps Customers, the Commission is

    proposing to the extent possible to replicate wherever practical and

    advisable customer protection provisions for futures customers and

    Cleared Swaps Customers to 30.7 Customers. As a result, most of the

    amendments proposed earlier in various provisions for these customers

    also are being proposed in Sec. 30.7.

    The Commission requests comment on the proposed amendments to Sec.

    30.7(a).

    Proposed paragraph (b) of Sec. 30.7 sets forth the permitted

    depositories for holding 30.7 Customer funds. The proposal does not

    alter the list of depositories that are currently permitted under Sec.

    30.7 to hold 30.7 Customers' funds: (1) A bank or trust company located

    in the United States; (2) a bank or trust company located outside of

    the United States that maintains in excess of $ 1 billion of regulatory

    capital; (3) an FCM registered with the Commission; (4) a DCO; (5) the

    clearing organization of a foreign board of trade; (6) a member of a

    foreign board of trade; and (7) the depositories used by the clearing

    organization of a foreign board of trade or a member of a foreign board

    of trade.

    Proposed Sec. 30.7(c) would limit the amount of 30.7 Customers'

    funds that an FCM could hold in non-U.S. jurisdictions. Under the

    proposal, an FCM must hold 30.7 Customer funds in the United States,

    except to the extent that the funds held outside of the United States

    are necessary to margin, guarantee, or secure (including any prefunding

    obligations) the foreign futures or foreign options positions of an

    FCM's 30.7 Customers. The Commission also is proposing to allow an FCM

    to deposit additional 30.7 Customer Funds equal to 10 percent of the

    total amount of funds required to be held by non-U.S. brokers or

    foreign clearing organizations for 30.7 Customers as a cushion to the

    required margin requirements, so that the FCM has a certain degree of

    flexibility in managing its daily cash movements and to ensure that the

    foreign futures or foreign options positions are not undermargined at

    foreign brokers or clearing organizations. The Commission recognizes

    that due to differences in time zones, trading hours, banking holidays,

    as well needs for cash transfers to foreign jurisdictions to settle and

    to be credited to accounts, a customer may not be able to immediately

    transfer funds to its FCM, and an FCM may not be able to immediately

    transfer funds to a foreign broker or foreign clearing organization to

    meet a margin call. The proposed cushion is intended to provide an FCM

    with sufficient flexibility to meet its customers' trading obligations

    on foreign markets, while also requiring as much of the total 30.7

    Customer funds to be held within the United States in order to minimize

    the impact of the repatriation risk in the event of an FCM insolvency.

    The Commission previously proposed changes to the form of the

    Acknowledgment Letter required from depositories holding funds set

    aside as the foreign futures or foreign options secured amount.\87\ The

    Commission here re-proposes in a revised paragraph (d) to Sec. 30.7

    the requirements for obtaining and submitting Acknowledgment Letters

    for Sec. 30.7 accounts, which proposed changes include further revised

    template forms of Acknowledgment Letter included as Appendices E and F.

    The proposed template forms, in addition to incorporating earlier

    proposed changes previously summarized with respect to the Sec. 1.20

    Acknowledgment Letters, have been further revised to include a

    depository's agreement to provide read-only account access to

    Commission or DSRO staff, in order for Commission or DSRO staff to

    directly verify balances as necessary. The Commission is also proposing

    subparagraphs (3), (4) and (5) of Sec. 30.7(d), which substantively

    require 24 hour a day direct read-only electronic access to the

    depository account by the Commission and the DSRO, require the

    depository to file the written Acknowledgment Letter directly with the

    Commission and the FCM's DSRO, and require the depository to provide

    confirmations to the Commission and the FCM's DSRO directly upon

    request. The Commission requests comment on the revised requirements

    for Acknowledgment Letters for Sec. 30.7 accounts as proposed in

    paragraph (d) and the new template forms of the Acknowledgment Letters

    proposed in Appendices E and F.

    ---------------------------------------------------------------------------

    \87\ See Acknowledgment Letters for Customer Funds and Secured

    Amount Funds, 75 FR 47738 (Aug. 9, 2010).

    ---------------------------------------------------------------------------

    As part of its participation in the public roundtable discussed in

    the Background section above, FIA recommended that the Commission

    eliminate the ability of FCMs to commingle funds from unregulated

    [[Page 67898]]

    transactions with funds for foreign futures and options trading in Part

    30 set aside accounts, except by Commission order, as is the case under

    4d(a)(2) of the Act for segregated funds. The Commission agrees with

    this recommendation. The comments cited in the release adopting Part 30

    with respect to back office operational difficulties of establishing

    multiple ``customer'' origins were persuasive at the time Part 30 was

    adopted.\88\ With the technological changes of intervening decades,

    however, these concerns should no longer dictate the advisability of

    commingling the funds of regulated foreign futures and foreign options

    transactions with unregulated transactions. Therefore, the Commission

    is proposing to amend Sec. 30.7 by adopting new paragraph (e), which

    will extend the prohibition against commingling to any funds of account

    holders of an FCM unrelated to trading foreign futures or foreign

    options, except as the Commission shall by order permit, under terms

    and conditions as specified. Should there be a need to permit

    commingling of funds, the Commission will continue to have the ability

    to permit such commingling under the formalities of processes

    associated with a Commission order. The Commission requests comment on

    this proposed amendment to Sec. 30.7(e).

    ---------------------------------------------------------------------------

    \88\ See 52 FR 28980 at 28985-28986.

    ---------------------------------------------------------------------------

    The Commission has proposed to adopt a new paragraph (f) and a new

    paragraph (k) in Sec. 30.7, to extend regulatory provisions from

    Sec. Sec. 1.20, 1.21, 1.22 and 1.24, that previously were applicable

    only to 4d segregated funds, to funds set aside as the foreign futures

    or foreign options secured amount under Sec. 30.7. The Commission

    requests comment on replicating these regulatory requirements

    applicable to segregated funds to funds set aside as the foreign

    futures or foreign options secured amount. These proposed requirements

    would make clear that FCMs would not be permitted to use funds set

    aside as the foreign futures or foreign options secured amount other

    than for the benefit of 30.7 Customers, and that funds set aside as the

    foreign futures or foreign options secured amount should not be

    invested in any obligations of clearing organizations or boards of

    trade, and that further, no funds placed at foreign brokers should be

    included as funds set aside as the foreign futures or foreign options

    secured amount unless those funds are on deposit to margin the foreign

    futures or foreign options trading of 30.7 Customers. In addition to

    extending these existing Commission regulations to Sec. 30.7 in

    proposed paragraphs (f) and (k), the Commission is also proposing a new

    requirement prohibiting a FCM from imposing any liens or allowing any

    liens to be imposed on funds set aside as the foreign futures or

    foreign options secured amount. The Commission has previously adopted a

    lien prohibition with respect to the segregation of Cleared Swaps

    Customer collateral at Sec. 22.2(d)(2) and therefore proposes to

    extend this lien prohibition to funds set aside as the foreign futures

    or foreign options secured amount in Sec. 30.7. The Commission

    requests comment on the proposed amendments providing limitations on

    use and permitted withdrawals as contained in Sec. Sec. 30.7(f) and

    (k).

    As discussed in Section II.I above, the Commission has proposed new

    limitations on withdrawals of segregated funds in Sec. 1.23. The

    proposed amendments provide for an FCM's residual interest in

    segregated funds, and permits withdrawals from segregated funds for the

    proprietary use of the FCM to the extent of such residual interest,

    subject to the requirement that the withdrawal must not occur prior to

    the completion of the daily segregation computation for the prior day,

    and should the withdrawal (individually or aggregated with other

    withdrawals) exceed 25 percent of the prior day residual interest, the

    withdrawal must be subject to specific approvals by senior management

    and appropriately documented, and further subject to a complete

    prohibition on withdrawals of residual interest to the extent of margin

    deficits. The Commission has proposed paragraph (g) of Sec. 30.7 to

    apply the same restrictions on withdrawals of an FCM's residual

    interest in funds set aside as the foreign futures or foreign options

    secured amount. The Commission requests comment on proposed paragraph

    (g) of Sec. 30.7.

    Regulation 30.7(g) was recently adopted by the Commission to

    provide that the investment of Sec. 30.7 funds be subject to the

    investment limitations contained in Sec. 1.25.\89\ The Commission is

    proposing to now move this permitted investment requirement to a new

    paragraph Sec. 30.7(h), and further to adopt a new paragraph Sec.

    30.7(i), which makes clear that FCMs are solely responsible for any

    losses resulting from the permitted investment of funds set aside as

    the foreign futures or foreign options secured amount. The new

    paragraph Sec. 30.7(i) is intended to apply the same standard as is

    being proposed in the amendment to Sec. 1.29 for segregated funds

    discussed above. The Commission is also requesting comment on whether

    the investment of 30.7 property should be restricted in cases of

    jurisdictions where client asset protection of such property cannot be

    assured? If so, what assurances should be required? For example, in

    cases of jurisdictions where client asset protections can be waived,

    should the Commission require that the Commission or a DSRO be

    practicably able to audit for evidence of such waiver? What are the

    relevant costs and benefits of adopting any of these alternatives?

    ---------------------------------------------------------------------------

    \89\ 76 FR 78776 at 78802 (December 19, 2011).

    ---------------------------------------------------------------------------

    The Commission also is proposing in an amended paragraph (j) to

    Sec. 30.7 to clarify the circumstances under which an FCM may make

    secured loans to 30.7 Customers and to adopt the same restriction on

    unsecured lending to 30.7 Customers as has been proposed with respect

    to futures customers and 4d segregated funds in the proposed amendment

    to Sec. 1.30 discussed above. The Commission requests comment on

    applying this restriction in relation to 30.7 Customers.

    Finally, the Commission is proposing an amended paragraph (l) to

    Sec. 30.7 to require the daily computation of the foreign futures or

    foreign options secured amount and the filing of such daily computation

    with the Commission and DSROs, as well as to require the FCM to provide

    investment detail of the foreign futures or foreign options secured

    amount as of the middle and end of the month. The proposed amendments

    to paragraph (l) of Sec. 30.7 are intended to be consistent with the

    requirements for the daily segregation calculation for segregated

    customer funds and the provision of the segregation investment detail

    which are proposed in Sec. 1.32. The Commission requests comment on

    the proposed changes requiring the filing of the daily secured amount

    computation and the investment detail as proposed in Sec. 30.7(l).

    III. Consideration of Costs and Benefits

    The misuse or mishandling of customer funds at specific FCMs like

    MF Global or Peregrine not only imposes a burden on those customers

    whose funds have been misused, but also creates a burden to the public

    by eroding the trust of the American public in all market

    intermediaries. This loss of trust could deter market participants from

    the benefits of using regulated, transparent markets and clearing. The

    overarching purpose of this rule is to provide regulators the means by

    which to detect and deter the misuse or mishandling of customer funds

    by FCMs in order to produce the benefits that

    [[Page 67899]]

    accrue by virtue of avoiding similar defaults in the future and to

    prevent the costs, including lost customer funds, decreased market

    liquidity that follows from a crisis in confidence, and the potential

    for the failure of one FCM to cause instability in other clearing

    members.\90\

    ---------------------------------------------------------------------------

    \90\ The failure of one clearing member could lead to

    instability in other clearing members if the losses due to the first

    member's failure are large enough to exhaust the guarantee fund and

    require additional capital infusion from other clearing members.

    ---------------------------------------------------------------------------

    The Commission's proposal builds on recent efforts by the

    Commission and industry to better protect customer funds. As discussed

    above in section I.D., in December 2011 the Commission amended Sec.

    1.25 of its regulations to eliminate certain options for the

    permissible investments of customer funds.\91\ Two months later, the

    Commission approved a margin rule for cleared swap transactions

    referred to as ``LSOC'' (legal separation with operational commingling)

    in which each swaps customer's collateral is protected individually all

    the way to the clearinghouse.\92\ The Commission also convened a

    roundtable in late February 2012 to discuss what amendments should be

    made to Commission regulations in order to provide additional

    protection to customer funds. Further, in June 2012, the Commission

    finalized rules for DCMs and included amendments to Sec. 1.52 which

    codify staff guidance on minimum requirements for SROs regarding their

    financial surveillance of FCMs.\93\ With the recent default of another

    FCM, Peregrine, the Commission held two additional roundtables to

    discuss, among other things, technological approaches to mitigating the

    risk of fraud, and possible amendments to the Commission's rules

    regarding protection of customer funds.\94\

    ---------------------------------------------------------------------------

    \91\ In the final rule amending Sec. 1.25, the Commission

    stated, ``the Commission is narrowing the scope of investment

    choices in order to eliminate the potential use of portfolios of

    instruments that may pose an unacceptable level of risk to customer

    funds.'' See ``Investment of Customer Funds and Funds Held in an

    Account for Foreign Futures and Foreign Options Transactions,'' 76

    FR 78776, December 19, 2011.

    \92\ 77 FR 6336 (Feb. 7, 2012) (Protection of Cleared Swaps

    Customer Contracts and Collateral; Conforming Amendments to the

    Commodity Broker Bankruptcy Provisions).

    \93\ 77 FR 36612 (June 19, 2012) (Core Principles and Other

    Requirements for Designated Contract Markets).

    \94\ Public Meeting of the Technology Advisory Committee, July

    26, 2012. See http://www.cftc.gov/PressRoom/Events/opaevent_tac072612. Public Roundtable to Discuss Additional Customer

    Protections, August 9, 2012. See http://www.cftc.gov/PressRoom/Events/opaevent_cftcstaff080912.

    ---------------------------------------------------------------------------

    In this rulemaking, the Commission is proposing amendments to

    improve the protection of customer funds. The content of the

    Commission's proposal can be categorized in seven parts: (1) Requiring

    FCMs to implement extensive risk management programs including written

    policies and procedures related to various aspects of their handling of

    customer funds; (2) increasing reporting requirements for FCMs related

    to segregated customer funds, including daily reports to the Commission

    and DSRO; (3) requiring FCMs to establish target amounts of residual

    interest to be maintained in segregated accounts as well as creating

    restrictions and increased oversight for FCM withdrawals out of such

    residual interest in customer segregated accounts, specifically

    including clear sign off and accountability from senior management for

    such withdrawals; (4) strengthening requirements for the acknowledgment

    letters that FCMs and DCOs must obtain from their depositories; (5)

    eliminating the Alternative Method for calculating 30.7 Customer funds

    segregation requirements and requiring FCMs to include foreign

    investors' funds in segregated accounts; (6) strengthening the

    regulatory requirements applicable to SRO and DSRO oversight of FCMs,

    including regulating oversight provided under the function of a Joint

    Audit Committee that would establish standards for, and oversee the

    execution of, FCM audits; and (7) requiring FCMs to provide additional

    disclosures to investors.

    Statutory Mandate To Consider the Costs and Benefits of the

    Commission's Action: Commodity Exchange Act Section 15(a)

    Section 15(a) of the Act requires the Commission to consider the

    costs and benefits of its actions before promulgating a regulation

    under the Act or issuing certain orders. Section 15(a) further

    specifies that the costs and benefits shall be evaluated in light of

    the following 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 considers the costs and

    benefits resulting from its discretionary determinations with respect

    to the section 15(a) considerations.

    There are four considerations relevant to this proposal. These are:

    (1) Protection of market participants and the public; (2) efficiency,

    competitiveness and financial integrity of futures markets; (3) sound

    risk management practices; and (4) other public interest

    considerations. The Commission proposes that the amendments would not

    have any effect on price discovery.

    In the discussion that follows, the Commission provides an overview

    of the proposed rules in light of the three relevant 15(a) cost-benefit

    considerations previously identified, and then considers the costs and

    benefits of each section individually in light of the same 15(a) public

    interest considerations. The Commission concludes with additional

    requests for public comment on all aspects of its preliminary

    consideration of the costs and benefits of the rule proposals.

    Overview of the Costs and Benefits of the Proposed Rules and Amendments

    in Light of the 15(a) Considerations

    Protection of Market Participants and the Public

    As stated above, the Commission is proposing amendments to improve

    protection of customer funds. Each of the seven parts of the proposal

    \95\ would increase levels of protection for customer funds. Requiring

    FCMs to implement risk management programs that include documented

    policies and procedures regarding various aspects of handling customer

    funds would help protect customer funds by promoting robust internal

    risk controls and reducing the likelihood of errors or fraud that could

    jeopardize customer funds. In addition, by requiring each FCM to

    document certain policies and procedures, the proposed rules would

    enable the Commission, DSROs, and

    [[Page 67900]]

    other auditors to evaluate each FCM's compliance with their own

    policies and procedures. Moreover, the proposed requirement that FCMs

    establish a program for quarterly audits by independent or external

    people that is designed to identify any breach of the policies and

    procedures would help to ensure regular, independent validation that

    the procedures are followed diligently. Audits of this sort provide

    more thorough review of internal procedures than the Commission or

    DSROs would be able to perform regularly with existing resources, which

    would provide helpful scrutiny of each FCM's procedures on a regular

    basis. This, together with the proposed requirement that FCMs establish

    a program of governing supervision that is designed to ensure the

    policies required in Sec. 1.11 are followed, will tend to promote

    compliance with the FCM's own policies and procedures. And by promoting

    such compliance, the requirements would reduce the risk of operational

    errors, lax risk management, and fraud, and thus the risk of consequent

    loss of customer funds.

    ---------------------------------------------------------------------------

    \95\ The seven parts of the proposal are: (1) Requiring FCMs to

    implement risk management programs including extensive written

    policies and procedures related to various aspects of their handling

    of customer funds; (2) increasing reporting requirements for FCMs

    related to segregated customer funds, including daily reports to the

    Commission and DSROs; (3) requiring FCMs to establish target amounts

    of residual interest to be maintained in segregated accounts as well

    as creating restrictions and increased oversight for FCM withdrawals

    out of such residual interest in customer segregated accounts,

    including clear sign off and accountability from senior management

    for such withdrawals; (4) strengthening requirements for the

    acknowledgment letters that FCMs and DCOs must obtain from their

    depositories; (5) eliminating the Alternative Method for calculating

    30.7 Customer funds segregation requirements and requiring FCMs to

    include foreign-domiciled customers' funds in segregated accounts;

    (6) strengthening the regulatory requirements applicable to SRO and

    DSRO oversight of FCMs, including regulating oversight provided

    under the function of a Joint Audit Committee (Joint Audit Program)

    that would establish standards for, and oversee the execution of,

    FCM audits; and (7) requiring FCMs to provide additional disclosures

    to investors.

    ---------------------------------------------------------------------------

    Increasing reporting requirements for FCMs related to segregated

    customer funds would help the Commission and DSRO identify FCMs that

    should be monitored more closely in order to safeguard customer funds.

    Moreover, by making some additional reported information public, the

    proposed rules would facilitate additional market discipline that

    further promotes protection of customer funds.

    Creating restrictions and increased oversight for FCM withdrawals

    out of its residual interest in customer segregated accounts, and

    requiring sign off from senior management for large withdrawals would

    protect customers by helping to ensure that such withdrawals do not

    cause segregated account balances to drop below their segregation

    requirements. Moreover, it would promote effective oversight of

    customer segregated accounts by senior management by increasing their

    accountability for withdrawals that affect the balance of such

    accounts.

    The acknowledgments and commitments depositories would be required

    to make through proposed Sec. Sec. 1.20, 1.26, and 30.7 would provide

    additional protection for customer funds by, among other things,

    requiring depositories that accept customer funds to acknowledge that

    customer funds cannot be used to secure the FCM's obligations to the

    depository. Such an acknowledgment would provide additional protection

    of customer funds in the event of an FCM's default. In addition,

    depositories would agree in the acknowledgment letter to give the

    Commission and DSROs read-only electronic access to an FCM's segregated

    accounts, which would benefit customers by enabling the Commission and

    DSROs to monitor the accounts for discrepancies between the FCM's

    reports and the balances on deposit at various depositories. This would

    provide an additional mechanism by which customers would be protected

    against a shortfall in customer funds due to operational errors or

    fraud.

    Requiring FCMs to include foreign-domiciled investors' funds in

    segregated accounts ensures that all customers placing funds on deposit

    for use in trading foreign futures and foreign options will benefit

    from the same protections provided by the Act and Commission

    regulations. As discussed below, the Commission understands that most,

    if not all FCMs currently extend the same protections to U.S.-domiciled

    and to foreign-domiciled customers. However, incorporating foreign-

    domiciled customers within the protections provided to 30.7 Customers

    places regulatory weight behind the protections and ensures that FCMs

    are not permitted to cut corners with respect to protecting foreign-

    domiciled customers' funds during a time of financial strain.

    Similarly, eliminating the Alternative Method provides additional

    protection to customer funds by ensuring that FCMs are not allowed to

    reduce their segregation requirements for 30.7 Accounts during a time

    financial strain. As discussed below, this change would provide

    protection to both U.S-domiciled and foreign-domiciled customers with

    funds in 30.7 Accounts.

    The proposed provisions in Sec. 1.52 include additional

    requirements for both the supervisory program for SROs as well as for

    the formation of a Joint Audit Committee to oversee the implementation

    and operation of a Joint Audit Program that directs audits of FCMs by

    DSROs. By requiring both the SRO supervisory programs and the Joint

    Audit Program to comply with U.S. generally accepted audit standards,

    to develop written policies and procedures, to require controls testing

    as well as substantive testing, and to have an examinations expert

    review the programs at least once every two years, the proposed

    amendments would help to ensure that audits of FCMs by SROs or DSROs

    are thorough, effective, and continue to incorporate emerging best

    practices for such audits. As a consequence, the proposed amendments

    would help to ensure that audits are as effective as possible at

    identifying potential fraud, strengthening internal controls, and

    verifying the integrity of FCMs' financial reports, each of which tend

    to provide protection for FCMs' customers, counterparties, and

    investors.

    In addition the proposed Sec. 1.55 would require disclosure of

    firm-specific risks to customers. This additional information would

    assist them with due diligence when selecting an FCM and would help to

    ensure that they are aware of any changes at the FCM that could prompt

    them to reconsider their decision to deposit funds with the FCM. In

    doing so, the proposed rules would promote market discipline that

    incents FCMs to manage their risks carefully and would assist customers

    in understanding how their funds are held and what risks may be

    relevant to the safety of their funds.

    Efficiency, Competitiveness and Financial Integrity of Futures Markets

    The proposed amendments would increase the efficiency and financial

    integrity of the futures markets by ensuring that FCMs have strong risk

    management controls that are subject to multiple and enhanced external

    checks, by enhancing reporting requirements, facilitating increased

    oversight by the Commission and DSROs, by allowing FCMs flexibility in

    the development of newly required policies and procedures wherever the

    Commission has determined that such flexibility is appropriate, and by

    requiring FCMs to implement training regarding the handling of customer

    funds. In addition, the proposed rules include some requirements that

    many industry participants have requested as necessary for the adequate

    protection of customers and also highlighted as best practices already

    adopted within the industry. Requiring such standards to be adopted by

    all FCMs will promote the competitiveness of futures markets by

    ensuring a level playing field at a minimum level necessary for the

    protection of customers, and not allowing any FCMs to, at the expense

    of customers, maintain an unfair competitive advantage to their

    counterparts who utilize best practices and may have such protections

    already in place. There are also provisions in the proposal that permit

    FCMs that are not broker-dealers to implement certain securities net

    capital haircuts that have been proposed to apply to jointly registered

    FCM/BDs by the SEC, which similarly enhances competition by keeping a

    level playing field between sole FCMs and jointly registered FCM/BDs

    with respect to such requirements.

    More specifically, the proposed amendments to Sec. Sec. 1.10,

    1.11, 1.12, 1.32,

    [[Page 67901]]

    22.2, and 30.7 would increase reporting requirements for FCMs related

    to segregated customer funds, including daily, bi-monthly, and

    additional event-triggered reports to the Commission and DSROs. The

    expanded range and frequency of information that the Commission and

    DSRO would receive under the proposed regulations would enhance their

    ability to monitor each FCM's segregated accounts, which would promote

    the integrity of futures markets by helping to ensure proper handling

    of customer funds at FCMs.

    In addition, the proposed changes would facilitate increased

    oversight by the Commission and DSROs by including additional

    notification requirements, obligating FCMs to alert the Commission when

    certain events occur that could indicate an FCM's financial strength is

    deteriorating or that important operational errors have occurred. Such

    notifications would enable the Commission and DSROs to increase

    monitoring of such FCMs to ensure that customer funds are handled

    properly in such circumstances. The proposed rules would also require

    FCMs and DCOs to obtain an acknowledgment letter from depositories that

    would give the Commission and DSROs electronic access to view customer

    accounts at each depository. That would enable both the Commission and

    DSROs to verify the presence of customer funds which would provide a

    safeguard against fraud and would promote the integrity of markets for

    futures, cleared options, and cleared swaps.

    The proposed rules would also require FCMs to establish policies

    and procedures regarding several aspects of how they handle customer

    funds. The rules would give FCMs the flexibility, where appropriate, to

    develop policies and procedures tailored to the unique composition of

    their customer base, size, and other operational disincentives. This

    flexible approach protects FCMs from additional regulatory compliance

    costs that could otherwise result from rules requiring every FCM to

    operate in exactly the same way without sacrificing the additional

    accountability that results from written policies and procedures that

    the Commission or DSRO can review and use as the basis for FCM audits.

    The proposed requirement that FCMs would provide annual training to

    all finance, treasury, operations, regulatory, compliance, settlement

    and other relevant employees regarding the segregation requirements for

    segregated funds, for notices under Sec. 1.12, procedures for

    reporting non-compliance, and the consequences of failing to comply

    with requirements for segregated funds, would enhance the integrity of

    the futures markets by promoting a culture of compliance by the FCM's

    personnel. The training would help to ensure that FCM employees

    understand the relevant policies and procedures, that they are

    empowered and incented to abide by them, and that they know how to

    report non-compliance to appropriate authorities.

    Last, the proposing form of the rule would allow FCMs that are not

    dual registrants (i.e., are not both FCMs and BDs) to follow the same

    procedures as dual registrants when determining what regulatory capital

    haircut applies to certain types of securities in which the FCM invests

    its own capital or customer funds. This proposed change is needed as

    the SEC has proposed a change for broker-dealers which would permit

    joint registrants to possibly apply a lower regulatory haircut for

    certain securities, but which would not be applicable to sole FCMs

    without the proposal. Therefore, the proposal would ensure that sole

    FCMs are not competitively disadvantaged and are able to continue

    applying the same regulatory capital haircuts for such securities as

    joint registrants.

    Sound Risk Management

    The amendments proposed here, if adopted, would promote sound risk

    management by facilitating market discipline, enhancing internal

    controls, enabling the Commission and DSROs to monitor FCMs for

    compliance with those controls, by minimizing the risk that an FCM's

    financial strain could interfere with customers' ability to manage

    their positions, by requiring FCMs to notify the Commission in

    additional circumstances that could indicate emerging financial strain,

    and by requiring senior management to be involved in the process of

    setting targets for residual interest.

    The proposed reporting requirements would enhance market discipline

    by providing additional information to investors regarding the location

    of their funds, and the size of residual interest buffer that an FCM

    targets and maintains in its segregated accounts. This additional

    information would be valuable to customers selecting an FCM and

    monitoring the location of their funds deposited with the FCM which

    would promote market discipline. For example, if an FCM were to

    establish a low target for residual interest, or maintain a very low

    residual interest, market participants would likely recognize this as a

    practice that could increase risk to the funds they have on deposit at

    the FCM, and would likely either apply pressure to the FCM to raise

    their target, or take their business to a different FCM that maintains

    a larger residual interest in customer fund accounts. This market

    discipline would incent FCMs to maintain a level of residual interest

    that is adequate to ensure that a shortfall does not develop in the

    customer segregated accounts.

    The proposed rules would also enhance FCM internal controls by

    requiring them to establish a risk management program that includes

    policies and procedures related to various aspects of how segregated

    customer funds are handled. For example, FCMs would be required to

    establish procedures for continual monitoring of depositories where

    segregated customer funds are held, and would have to establish a

    process for evaluating the marketability, liquidity, and accuracy of

    pricing for Sec. 1.25 compliant investments.

    In addition, documented policies and procedures would benefit the

    FCM customers and the public by providing the Commission and DSROs

    greater ability to monitor and enforce procedures that FCMs perform to

    ensure that the protection of customer funds is achieved, with the

    effect that the Commission would have a greater ability to address and

    protect against operational errors and fraud that put customer funds at

    risk of loss.

    Further, through the proposed amendments to Sec. 1.17(a)(4), FCMs

    will need to manage their access to liquidity so as to be able to

    certify to the Commission, at its request, that they have sufficient

    access to liquidity to continue operating as a going concern. This

    proposal will provide the Commission with the flexibility to deal with

    emerging liquidity drains at FCMs which may endanger customers,

    potentially prior to instances of regulatory capital non-compliance,

    allowing customer positions and funds to be transferred intact and

    quickly to another FCM. This change would promote sound risk management

    practices by helping to ensure that customers maintain control of their

    positions without interruption.

    The proposed additions to notification requirements established in

    Sec. 1.12 would enhance the Commission's ability to identify

    situations that could lead to financial strain for the FCM, which makes

    it possible for the Commission to monitor further developments with

    that FCM more carefully and to begin planning earlier for the

    possibility that the FCM's customer positions may need to be

    transferred to other FCMs, in the event

    [[Page 67902]]

    that the FCM currently holding those positions defaults. Advance notice

    helps to ensure customers' positions are protected by enabling the

    Commission to work closely with DCOs and DSROs to identify other FCMs

    that have requisite capital to meet regulatory requirements if they

    were to take on additional customer positions, thus facilitating smooth

    transition of those positions in the event that it is necessary.

    Last, residual interest is an important aspect of protection for

    customer funds because it enables the FCM to ensure that it can meet

    all customer obligations at any time without using another customer's

    funds to do so. In general, the larger tained in Sec. Sec. 30.7(f) and

    (k).

    As discussed in Section II.I above, the Commission has proposed new

    limitations on withdrawals of segregated funds in Sec. 1.23. The

    proposed amendments provide for an FCM's residual interest in

    segregated funds, and permits withdrawals from segregated funds for the

    proprietary use of the FCM to the extent of such residual interest,

    subject to the requirement that the withdrawal must not occur prior to

    the completion of the daily segregation computation for the prior day,

    and should the withdrawal (individually or aggregated with other

    withdrawals) exceed 25 percent of the prior day residual interest, the

    withdrawal must be subject to specific approvals by senior management

    and appropriately documented, and further subject to a complete

    prohibition on withdrawals of residual interest to the extent of margin

    deficits. The Commission has proposed paragraph (g) of Sec. 30.7 to

    apply the same restrictions on withdrawals of an FCM's residual

    interest in funds set aside as the foreign futures or foreign options

    secured amount. The Commission requests comment on proposed paragraph

    (g) of Sec. 30.7.

    Regulation 30.7(g) was recently adopted by the Commission to

    provide that the investment of Sec. 30.7 funds be subject to the

    investment limitations contained in Sec. 1.25.\89\ The Commission is

    proposing to now move this permitted investment requirement to a new

    paragraph Sec. 30.7(h), and further to adopt a new paragraph Sec.

    30.7(i), which makes clear that FCMs are solely responsible for any

    losses resulting from the permitted investment of funds set aside as

    the foreign futures or foreign options secured amount. The new

    paragraph Sec. 30.7(i) is intended to apply the same standard as is

    being proposed in the amendment to Sec. 1.29 for segregated funds

    discussed above. The Commission is also requesting comment on whether

    the investment of 30.7 property should be restricted in cases of

    jurisdictions where client asset protection of such property cannot be

    assured? If so, what assurances should be required? For example, in

    cases of jurisdictions where client asset protections can be waived,

    should the Commission require that the Commission or a DSRO be

    practicably able to audit for evidence of such waiver? What are the

    relevant costs and benefits of adopting any of these alternatives?

    ---------------------------------------------------------------------------

    \89\ 76 FR 78776 at 78802 (December 19, 2011).

    ---------------------------------------------------------------------------

    The Commission also is proposing in an amended paragraph (j) to

    Sec. 30.7 to clarify the circumstances under which an FCM may make

    secured loans to 30.7 Customers and to adopt the same restriction on

    unsecured lending to 30.7 Customers as has been proposed with respect

    to futures customers and 4d segregated funds in the proposed amendment

    to Sec. 1.30 discussed above. The Commission requests comment on

    applying this restriction in relation to 30.7 Customers.

    Finally, the Commission is proposing an amended paragraph (l) to

    Sec. 30.7 to require the daily computation of the foreign futures or

    foreign options secured amount and the filing of such daily computation

    with the Commission and DSROs, as well as to require the FCM to provide

    investment detail of the foreign futures or foreign options secured

    amount as of the middle and end of the month. The proposed amendments

    to paragraph (l) of Sec. 30.7 are intended to be consistent with the

    requirements for the daily segregation calculation for segregated

    customer funds and the provision of the segregation investment detail

    which are proposed in Sec. 1.32. The Commission requests comment on

    the proposed changes requiring the filing of the daily secured amount

    computation and the investment detail as proposed in Sec. 30.7(l).

    III. Consideration of Costs and Benefits

    The misuse or mishandling of customer funds at specific FCMs like

    MF Global or Peregrine not only imposes a burden on those customers

    whose funds have been misused, but also creates a burden to the public

    by eroding the trust of the American public in all market

    intermediaries. This loss of trust could deter market participants from

    the benefits of using regulated, transparent markets and clearing. The

    overarching purpose of this rule is to provide regulators the means by

    which to detect and deter the misuse or mishandling of customer funds

    by FCMs in order to produce the benefits that

    [[Page 67899]]

    accrue by virtue of avoiding similar defaults in the future and to

    prevent the costs, including lost customer funds, decreased market

    liquidity that follows from a crisis in confidence, and the potential

    for the failure of one FCM to cause instability in other clearing

    members.\90\

    ---------------------------------------------------------------------------

    \90\ The failure of one clearing member could lead to

    instability in other clearing members if the losses due to the first

    member's failure are large enough to exhaust the guarantee fund and

    require additional capital infusion from other clearing members.

    ---------------------------------------------------------------------------

    The Commission's proposal builds on recent efforts by the

    Commission and industry to better protect customer funds. As discussed

    above in section I.D., in December 2011 the Commission amended Sec.

    1.25 of its regulations to eliminate certain options for the

    permissible investments of customer funds.\91\ Two months later, the

    Commission approved a margin rule for cleared swap transactions

    referred to as ``LSOC'' (legal separation with operational commingling)

    in which each swaps customer's collateral is protected individually all

    the way to the clearinghouse.\92\ The Commission also convened a

    roundtable in late February 2012 to discuss what amendments should be

    made to Commission regulations in order to provide additional

    protection to customer funds. Further, in June 2012, the Commission

    finalized rules for DCMs and included amendments to Sec. 1.52 which

    codify staff guidance on minimum requirements for SROs regarding their

    financial surveillance of FCMs.\93\ With the recent default of another

    FCM, Peregrine, the Commission held two additional roundtables to

    discuss, among other things, technological approaches to mitigating the

    risk of fraud, and possible amendments to the Commission's rules

    regarding protection of customer funds.\94\

    ---------------------------------------------------------------------------

    \91\ In the final rule amending Sec. 1.25, the Commission

    stated, ``the Commission is narrowing the scope of investment

    choices in order to eliminate the potential use of portfolios of

    instruments that may pose an unacceptable level of risk to customer

    funds.'' See ``Investment of Customer Funds and Funds Held in an

    Account for Foreign Futures and Foreign Options Transactions,'' 76

    FR 78776, December 19, 2011.

    \92\ 77 FR 6336 (Feb. 7, 2012) (Protection of Cleared Swaps

    Customer Contracts and Collateral; Conforming Amendments to the

    Commodity Broker Bankruptcy Provisions).

    \93\ 77 FR 36612 (June 19, 2012) (Core Principles and Other

    Requirements for Designated Contract Markets).

    \94\ Public Meeting of the Technology Advisory Committee, July

    26, 2012. See http://www.cftc.gov/PressRoom/Events/opaevent_tac072612. Public Roundtable to Discuss Additional Customer

    Protections, August 9, 2012. See http://www.cftc.gov/PressRoom/Events/opaevent_cftcstaff080912.

    ---------------------------------------------------------------------------

    In this rulemaking, the Commission is proposing amendments to

    improve the protection of customer funds. The content of the

    Commission's proposal can be categorized in seven parts: (1) Requiring

    FCMs to implement extensive risk management programs including written

    policies and procedures related to various aspects of their handling of

    customer funds; (2) increasing reporting requirements for FCMs related

    to segregated customer funds, including daily reports to the Commission

    and DSRO; (3) requiring FCMs to establish target amounts of residual

    interest to be maintained in segregated accounts as well as creating

    restrictions and increased oversight for FCM withdrawals out of such

    residual interest in customer segregated accounts, specifically

    including clear sign off and accountability from senior management for

    such withdrawals; (4) strengthening requirements for the acknowledgment

    letters that FCMs and DCOs must obtain from their depositories; (5)

    eliminating the Alternative Method for calculating 30.7 Customer funds

    segregation requirements and requiring FCMs to include foreign

    investors' funds in segregated accounts; (6) strengthening the

    regulatory requirements applicable to SRO and DSRO oversight of FCMs,

    including regulating oversight provided under the function of a Joint

    Audit Committee that would establish standards for, and oversee the

    execution of, FCM audits; and (7) requiring FCMs to provide additional

    disclosures to investors.

    Statutory Mandate To Consider the Costs and Benefits of the

    Commission's Action: Commodity Exchange Act Section 15(a)

    Section 15(a) of the Act requires the Commission to consider the

    costs and benefits of its actions before promulgating a regulation

    under the Act or issuing certain orders. Section 15(a) further

    specifies that the costs and benefits shall be evaluated in light of

    the following 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 considers the costs and

    benefits resulting from its discretionary determinations with respect

    to the section 15(a) considerations.

    There are four considerations relevant to this proposal. These are:

    (1) Protection of market participants and the public; (2) efficiency,

    competitiveness and financial integrity of futures markets; (3) sound

    risk management practices; and (4) other public interest

    considerations. The Commission proposes that the amendments would not

    have any effect on price discovery.

    In the discussion that follows, the Commission provides an overview

    of the proposed rules in light of the three relevant 15(a) cost-benefit

    considerations previously identified, and then considers the costs and

    benefits of each section individually in light of the same 15(a) public

    interest considerations. The Commission concludes with additional

    requests for public comment on all aspects of its preliminary

    consideration of the costs and benefits of the rule proposals.

    Overview of the Costs and Benefits of the Proposed Rules and Amendments

    in Light of the 15(a) Considerations

    Protection of Market Participants and the Public

    As stated above, the Commission is proposing amendments to improve

    protection of customer funds. Each of the seven parts of the proposal

    \95\ would increase levels of protection for customer funds. Requiring

    FCMs to implement risk management programs that include documented

    policies and procedures regarding various aspects of handling customer

    funds would help protect customer funds by promoting robust internal

    risk controls and reducing the likelihood of errors or fraud that could

    jeopardize customer funds. In addition, by requiring each FCM to

    document certain policies and procedures, the proposed rules would

    enable the Commission, DSROs, and

    [[Page 67900]]

    other auditors to evaluate each FCM's compliance with their own

    policies and procedures. Moreover, the proposed requirement that FCMs

    establish a program for quarterly audits by independent or external

    people that is designed to identify any breach of the policies and

    procedures would help to ensure regular, independent validation that

    the procedures are followed diligently. Audits of this sort provide

    more thorough review of internal procedures than the Commission or

    DSROs would be able to perform regularly with existing resources, which

    would provide helpful scrutiny of each FCM's procedures on a regular

    basis. This, together with the proposed requirement that FCMs establish

    a program of governing supervision that is designed to ensure the

    policies required in Sec. 1.11 are followed, will tend to promote

    compliance with the FCM's own policies and procedures. And by promoting

    such compliance, the requirements would reduce the risk of operational

    errors, lax risk management, and fraud, and thus the risk of consequent

    loss of customer funds.

    ---------------------------------------------------------------------------

    \95\ The seven parts of the proposal are: (1) Requiring FCMs to

    implement risk management programs including extensive written

    policies and procedures related to various aspects of their handling

    of customer funds; (2) increasing reporting requirements for FCMs

    related to segregated customer funds, including daily reports to the

    Commission and DSROs; (3) requiring FCMs to establish target amounts

    of residual interest to be maintained in segregated accounts as well

    as creating restrictions and increased oversight for FCM withdrawals

    out of such residual interest in customer segregated accounts,

    including clear sign off and accountability from senior management

    for such withdrawals; (4) strengthening requirements for the

    acknowledgment letters that FCMs and DCOs must obtain from their

    depositories; (5) eliminating the Alternative Method for calculating

    30.7 Customer funds segregation requirements and requiring FCMs to

    include foreign-domiciled customers' funds in segregated accounts;

    (6) strengthening the regulatory requirements applicable to SRO and

    DSRO oversight of FCMs, including regulating oversight provided

    under the function of a Joint Audit Committee (Joint Audit Program)

    that would establish standards for, and oversee the execution of,

    FCM audits; and (7) requiring FCMs to provide additional disclosures

    to investors.

    ---------------------------------------------------------------------------

    Increasing reporting requirements for FCMs related to segregated

    customer funds would help the Commission and DSRO identify FCMs that

    should be monitored more closely in order to safeguard customer funds.

    Moreover, by making some additional reported information public, the

    proposed rules would facilitate additional market discipline that

    further promotes protection of customer funds.

    Creating restrictions and increased oversight for FCM withdrawals

    out of its residual interest in customer segregated accounts, and

    requiring sign off from senior management for large withdrawals would

    protect customers by helping to ensure that such withdrawals do not

    cause segregated account balances to drop below their segregation

    requirements. Moreover, it would promote effective oversight of

    customer segregated accounts by senior management by increasing their

    accountability for withdrawals that affect the balance of such

    accounts.

    The acknowledgments and commitments depositories would be required

    to make through proposed Sec. Sec. 1.20, 1.26, and 30.7 would provide

    additional protection for customer funds by, among other things,

    requiring depositories that accept customer funds to acknowledge that

    customer funds cannot be used to secure the FCM's obligations to the

    depository. Such an acknowledgment would provide additional protection

    of customer funds in the event of an FCM's default. In addition,

    depositories would agree in the acknowledgment letter to give the

    Commission and DSROs read-only electronic access to an FCM's segregated

    accounts, which would benefit customers by enabling the Commission and

    DSROs to monitor the accounts for discrepancies between the FCM's

    reports and the balances on deposit at various depositories. This would

    provide an additional mechanism by which customers would be protected

    against a shortfall in customer funds due to operational errors or

    fraud.

    Requiring FCMs to include foreign-domiciled investors' funds in

    segregated accounts ensures that all customers placing funds on deposit

    for use in trading foreign futures and foreign options will benefit

    from the same protections provided by the Act and Commission

    regulations. As discussed below, the Commission understands that most,

    if not all FCMs currently extend the same protections to U.S.-domiciled

    and to foreign-domiciled customers. However, incorporating foreign-

    domiciled customers within the protections provided to 30.7 Customers

    places regulatory weight behind the protections and ensures that FCMs

    are not permitted to cut corners with respect to protecting foreign-

    domiciled customers' funds during a time of financial strain.

    Similarly, eliminating the Alternative Method provides additional

    protection to customer funds by ensuring that FCMs are not allowed to

    reduce their segregation requirements for 30.7 Accounts during a time

    financial strain. As discussed below, this change would provide

    protection to both U.S-domiciled and foreign-domiciled customers with

    funds in 30.7 Accounts.

    The proposed provisions in Sec. 1.52 include additional

    requirements for both the supervisory program for SROs as well as for

    the formation of a Joint Audit Committee to oversee the implementation

    and operation of a Joint Audit Program that directs audits of FCMs by

    DSROs. By requiring both the SRO supervisory programs and the Joint

    Audit Program to comply with U.S. generally accepted audit standards,

    to develop written policies and procedures, to require controls testing

    as well as substantive testing, and to have an examinations expert

    review the programs at least once every two years, the proposed

    amendments would help to ensure that audits of FCMs by SROs or DSROs

    are thorough, effective, and continue to incorporate emerging best

    practices for such audits. As a consequence, the proposed amendments

    would help to ensure that audits are as effective as possible at

    identifying potential fraud, strengthening internal controls, and

    verifying the integrity of FCMs' financial reports, each of which tend

    to provide protection for FCMs' customers, counterparties, and

    investors.

    In addition the proposed Sec. 1.55 would require disclosure of

    firm-specific risks to customers. This additional information would

    assist them with due diligence when selecting an FCM and would help to

    ensure that they are aware of any changes at the FCM that could prompt

    them to reconsider their decision to deposit funds with the FCM. In

    doing so, the proposed rules would promote market discipline that

    incents FCMs to manage their risks carefully and would assist customers

    in understanding how their funds are held and what risks may be

    relevant to the safety of their funds.

    Efficiency, Competitiveness and Financial Integrity of Futures Markets

    The proposed amendments would increase the efficiency and financial

    integrity of the futures markets by ensuring that FCMs have strong risk

    management controls that are subject to multiple and enhanced external

    checks, by enhancing reporting requirements, facilitating increased

    oversight by the Commission and DSROs, by allowing FCMs flexibility in

    the development of newly required policies and procedures wherever the

    Commission has determined that such flexibility is appropriate, and by

    requiring FCMs to implement training regarding the handling of customer

    funds. In addition, the proposed rules include some requirements that

    many industry participants have requested as necessary for the adequate

    protection of customers and also highlighted as best practices already

    adopted within the industry. Requiring such standards to be adopted by

    all FCMs will promote the competitiveness of futures markets by

    ensuring a level playing field at a minimum level necessary for the

    protection of customers, and not allowing any FCMs to, at the expense

    of customers, maintain an unfair competitive advantage to their

    counterparts who utilize best practices and may have such protections

    already in place. There are also provisions in the proposal that permit

    FCMs that are not broker-dealers to implement certain securities net

    capital haircuts that have been proposed to apply to jointly registered

    FCM/BDs by the SEC, which similarly enhances competition by keeping a

    level playing field between sole FCMs and jointly registered FCM/BDs

    with respect to such requirements.

    More specifically, the proposed amendments to Sec. Sec. 1.10,

    1.11, 1.12, 1.32,

    [[Page 67901]]

    22.2, and 30.7 would increase reporting requirements for FCMs related

    to segregated customer funds, including daily, bi-monthly, and

    additional event-triggered reports to the Commission and DSROs. The

    expanded range and frequency of information that the Commission and

    DSRO would receive under the proposed regulations would enhance their

    ability to monitor each FCM's segregated accounts, which would promote

    the integrity of futures markets by helping to ensure proper handling

    of customer funds at FCMs.

    In addition, the proposed changes would facilitate increased

    oversight by the Commission and DSROs by including additional

    notification requirements, obligating FCMs to alert the Commission when

    certain events occur that could indicate an FCM's financial strength is

    deteriorating or that important operational errors have occurred. Such

    notifications would enable the Commission and DSROs to increase

    monitoring of such FCMs to ensure that customer funds are handled

    properly in such circumstances. The proposed rules would also require

    FCMs and DCOs to obtain an acknowledgment letter from depositories that

    would give the Commission and DSROs electronic access to view customer

    accounts at each depository. That would enable both the Commission and

    DSROs to verify the presence of customer funds which would provide a

    safeguard against fraud and would promote the integrity of markets for

    futures, cleared options, and cleared swaps.

    The proposed rules would also require FCMs to establish policies

    and procedures regarding several aspects of how they handle customer

    funds. The rules would give FCMs the flexibility, where appropriate, to

    develop policies and procedures tailored to the unique composition of

    their customer base, size, and other operational disincentives. This

    flexible approach protects FCMs from additional regulatory compliance

    costs that could otherwise result from rules requiring every FCM to

    operate in exactly the same way without sacrificing the additional

    accountability that results from written policies and procedures that

    the Commission or DSRO can review and use as the basis for FCM audits.

    The proposed requirement that FCMs would provide annual training to

    all finance, treasury, operations, regulatory, compliance, settlement

    and other relevant employees regarding the segregation requirements for

    segregated funds, for notices under Sec. 1.12, procedures for

    reporting non-compliance, and the consequences of failing to comply

    with requirements for segregated funds, would enhance the integrity of

    the futures markets by promoting a culture of compliance by the FCM's

    personnel. The training would help to ensure that FCM employees

    understand the relevant policies and procedures, that they are

    empowered and incented to abide by them, and that they know how to

    report non-compliance to appropriate authorities.

    Last, the proposing form of the rule would allow FCMs that are not

    dual registrants (i.e., are not both FCMs and BDs) to follow the same

    procedures as dual registrants when determining what regulatory capital

    haircut applies to certain types of securities in which the FCM invests

    its own capital or customer funds. This proposed change is needed as

    the SEC has proposed a change for broker-dealers which would permit

    joint registrants to possibly apply a lower regulatory haircut for

    certain securities, but which would not be applicable to sole FCMs

    without the proposal. Therefore, the proposal would ensure that sole

    FCMs are not competitively disadvantaged and are able to continue

    applying the same regulatory capital haircuts for such securities as

    joint registrants.

    Sound Risk Management

    The amendments proposed here, if adopted, would promote sound risk

    management by facilitating market discipline, enhancing internal

    controls, enabling the Commission and DSROs to monitor FCMs for

    compliance with those controls, by minimizing the risk that an FCM's

    financial strain could interfere with customers' ability to manage

    their positions, by requiring FCMs to notify the Commission in

    additional circumstances that could indicate emerging financial strain,

    and by requiring senior management to be involved in the process of

    setting targets for residual interest.

    The proposed reporting requirements would enhance market discipline

    by providing additional information to investors regarding the location

    of their funds, and the size of residual interest buffer that an FCM

    targets and maintains in its segregated accounts. This additional

    information would be valuable to customers selecting an FCM and

    monitoring the location of their funds deposited with the FCM which

    would promote market discipline. For example, if an FCM were to

    establish a low target for residual interest, or maintain a very low

    residual interest, market participants would likely recognize this as a

    practice that could increase risk to the funds they have on deposit at

    the FCM, and would likely either apply pressure to the FCM to raise

    their target, or take their business to a different FCM that maintains

    a larger residual interest in customer fund accounts. This market

    discipline would incent FCMs to maintain a level of residual interest

    that is adequate to ensure that a shortfall does not develop in the

    customer segregated accounts.

    The proposed rules would also enhance FCM internal controls by

    requiring them to establish a risk management program that includes

    policies and procedures related to various aspects of how segregated

    customer funds are handled. For example, FCMs would be required to

    establish procedures for continual monitoring of depositories where

    segregated customer funds are held, and would have to establish a

    process for evaluating the marketability, liquidity, and accuracy of

    pricing for Sec. 1.25 compliant investments.

    In addition, documented policies and procedures would benefit the

    FCM customers and the public by providing the Commission and DSROs

    greater ability to monitor and enforce procedures that FCMs perform to

    ensure that the protection of customer funds is achieved, with the

    effect that the Commission would have a greater ability to address and

    protect against operational errors and fraud that put customer funds at

    risk of loss.

    Further, through the proposed amendments to Sec. 1.17(a)(4), FCMs

    will need to manage their access to liquidity so as to be able to

    certify to the Commission, at its request, that they have sufficient

    access to liquidity to continue operating as a going concern. This

    proposal will provide the Commission with the flexibility to deal with

    emerging liquidity drains at FCMs which may endanger customers,

    potentially prior to instances of regulatory capital non-compliance,

    allowing customer positions and funds to be transferred intact and

    quickly to another FCM. This change would promote sound risk management

    practices by helping to ensure that customers maintain control of their

    positions without interruption.

    The proposed additions to notification requirements established in

    Sec. 1.12 would enhance the Commission's ability to identify

    situations that could lead to financial strain for the FCM, which makes

    it possible for the Commission to monitor further developments with

    that FCM more carefully and to begin planning earlier for the

    possibility that the FCM's customer positions may need to be

    transferred to other FCMs, in the event

    [[Page 67902]]

    that the FCM currently holding those positions defaults. Advance notice

    helps to ensure customers' positions are protected by enabling the

    Commission to work closely with DCOs and DSROs to identify other FCMs

    that have requisite capital to meet regulatory requirements if they

    were to take on additional customer positions, thus facilitating smooth

    transition of those positions in the event that it is necessary.

    Last, residual interest is an important aspect of protection for

    customer funds because it enables the FCM to ensure that it can meet

    all customer obligations at any time without using another customer's

    funds to do so. In general, the larger the residual interest, the more

    secure customer funds are in this respect. By requiring that senior

    management set the target for residual interest, and that they conduct

    adequate due diligence in order to inform that decision, the proposed

    rule promotes both informed decision making about this important form

    of protection, and accountability among senior management for this

    decision, both of which are consistent with sound risk management

    practices.

    Other Public Interest Considerations

    As discussed above, the recent failures of MF Global and Peregrine,

    FCMs to which customers have entrusted their funds, sparked a crisis of

    confidence regarding the security of those funds. This crisis in

    confidence could deter market participants from using regulated,

    transparent markets and clearing which would create additional costs

    for market participants and losses in efficiency and safety that could

    create additional burdens for the public. The Commission anticipates

    that this rule will not only address the current crisis of confidence,

    but that it will produce benefits for the public by virtue of avoiding

    similar defaults in the future.

    These proposed amendments are not, however, without costs. The most

    significant costs created by the proposed amendments are those that

    increase the amount of capital that FCMs would be required to

    contribute to segregated accounts as part of establishing a target for

    their residual interest, incent them to hold additional capital,

    prevent them from holding excess segregated funds overseas, and that

    are created operationally by the formation of a risk management unit

    and adoption of new policies and procedures.

    Multiple proposed changes would incent or require FCMs to increase

    the amount of residual interest that they maintain in segregated

    accounts including: (1) Requiring FCMs to establish a target for

    residual interest that reflects proper due diligence on the part of

    senior management; (2) disclosing the FCMs' targeted residual interest

    publicly; and (3) requiring them to report to the Commission and their

    DSRO any time their residual interest drops below that target. In

    addition by restricting FCMs' ability to withdraw residual interest

    from segregated accounts and obligating FCMs to report to the

    Commission and their respective DSRO each time the residual interest

    drops below the target, the proposed regulations would incent FCMs to

    hold additional capital, which is also likely to be a significant cost.

    When FCMs hold excess customer funds overseas, such funds will

    likely be held at depositories that are themselves subject to foreign

    insolvency regimes, which may provide protections for customer funds

    that are less effective than those applicable under U.S. law. By

    prohibiting FCMs from holding excess customer funds overseas, the

    proposed regulations could reduce the returns that FCMs may obtain on

    invested customer funds.

    And last, the proposed requirements related to operational

    procedures are likely to create significant costs, particularly related

    to creating and documenting policies and procedures, as well as

    complying with ongoing training, due diligence, and audit requirements.

    However, in several cases the implementation costs of proposed changes

    would be minimal. For example, some proposed requirements would

    obligate FCMs to provide the Commission and DSROs more regular access

    to information that FCMs and their depositories are already required to

    maintain, or in some cases are already reporting to their DSROs. The

    Commission also anticipates that some of the changes proposed codify

    best practices for risk management that many FCMs and DCOs may already

    follow. In such cases, the costs of compliance would be mitigated by

    the compliance programs or best practices that the firm already has in

    place. Moreover, in other cases the proposed changes codify practices

    that are already required by SROs, and therefore would impose no

    additional costs.

    The initial and ongoing costs of the proposed rules for FCMs would

    vary significantly depending on the size of each FCM, the policies and

    procedures that they already have in place, and the frequency with

    which they experience certain events that would create additional costs

    under the proposed rules. The Commission estimates that the initial

    operational cost \96\ of implementing the proposed rules would be

    between $193,000 and $1,850,000 per FCM.\97\ And the initial cost to

    the SROs and DSROs would be between $41,100 and $63,500 per SRO or

    DSRO. The Commission estimates that the ongoing operational cost to

    FCMs would be between $287,000 and $2,300,000 per FCM per year.\98\ As

    described below in Sec. 1.52, the Commission does not have adequate

    information to determine the ongoing cost of the proposed requirements

    for SROs and DSROs.

    ---------------------------------------------------------------------------

    \96\ The Commission is not able to quantify the costs that would

    result from increased residual interest held in customer segregated

    accounts, from increased capital held by the FCM, or from lost

    investment opportunities due to restrictions on the amount of funds

    that may be held overseas. The Commission does not have sufficient

    data to estimate the amount of additional residual interest FCMs are

    likely to need as a consequence of proposed, the amount of

    additional capital they may hold for operational purposes, the cost

    of capital for FCMs, or the opportunity costs FCMs may experience

    because of restrictions on the amount of customer funds they can

    hold overseas, each of which would be necessary in order to estimate

    such costs.

    \97\ The lower bound assumes an FCM requires the minimum

    estimated number of personnel hours to be compliant with these new

    rules and that, when possible, they already have policies,

    procedures, and systems in place that would satisfy the proposed

    requirements. The upper bound assumes an FCM requires the maximum

    amount of personnel hours and do not have pre-existing policies,

    procedures, and systems in place that would satisfy the proposed

    requirements. The greatest amount of variation within in the range

    would depend on the number of new depositories an FCM must establish

    relationships with due to current depositories that would not be

    willing to sign the required acknowledgment letter. The lower bound

    assumes that an FCM does not need to establish any new relationships

    with depositories. The Commission estimates that the largest FCMs

    may have as many as 30 depositories, and as a conservative estimate,

    the Commission assumes for the upper bound that an FCM would have to

    establish new relationships with 15 depositories.

    \98\ As above, the lower bound assumes that an FCM requires the

    minimum estimated number of personnel hours to be compliant and that

    for event-triggered costs, the FCM bears the minimum number of

    possible events. The upper bound assumes an FCM requires the maximum

    number of personnel hours to be compliant. It also assumes an FCM

    has to notify the Commission pursuant to the proposed amendments in

    Sec. 1.12 five times per year, and that an FCM withdraws funds from

    residual interest for proprietary use 50 times per year. The

    estimate does not include additional costs that would result if FCMs

    increase the amount of residual interest or capital that they hold

    in response to the proposed rules, or certain operational costs that

    the Commission does not have sufficient information to estimate.

    ---------------------------------------------------------------------------

    In the sections that follow, the Commission considers the costs and

    benefits of the proposed changes, section by section, in light of the

    relevant 15(a) public interest, cost-benefit considerations.

    [[Page 67903]]

    Consideration of Costs and Benefits Related to Proposed Changes in Each

    Section

    Sec. 1.3(rr)--Definition of ``Foreign Futures or Foreign Options

    Secured Amount''

    Proposed Changes

    As described above in II.R, the proposed amendments to Sec.

    1.3(rr) would replace the term ``foreign futures or foreign options

    customers'' with the term ``30.7 Customers.'' The former only includes

    U.S.-domiciled customers, whereas the term ``30.7 Customers'' includes

    both U.S.-domiciled and foreign-domiciled customers who place funds in

    the care of an FCM for trading on foreign boards of trade. This change

    expands the range of funds that the FCM must include as part of the

    foreign options or foreign futures secured amount.

    In addition, the definition of ``foreign futures or foreign options

    secured amount'' currently means ``all money, securities and property

    held by or held for or on behalf of a futures commission merchant from,

    for, or on behalf of foreign futures or foreign options customers as

    defined in Sec. 30.1.'' The proposed definition would change the

    meaning of ``foreign futures or foreign options secured amount'' so

    that it is equal to the amount of funds an FCM needs in order to

    satisfy the full account balances of each of its customers at all

    times. This definitional change supports the shift in Sec. 30.7 from

    the ``Alternative Method'' to the ``Net Liquidating Equity Method'' of

    calculating the foreign futures or foreign options secured amount.

    Benefits and Costs

    These definitional changes would determine what funds are

    considered part of the ``foreign futures or foreign options secured

    amount.'' However, the costs and benefits of these changes are

    attributable to the substantive requirements related to the definitions

    and, therefore, are discussed in the cost and benefit considerations

    related to Sec. 30.7.

    Sec. 1.10--Financial Reports of Futures Commission Merchants and

    Introducing Brokers

    Proposed Changes

    As described above in II.A, the proposed amendments would make four

    changes. First, they would amend the 1-FR-FCM to create a new schedule

    called the ``Cleared Swap Segregation Schedule'' that would be included

    in the FCM's monthly report, together with the Segregation Schedule and

    Secured Amount Schedule. Second, it would make the Cleared Swap

    Segregation Schedule a public document.\99\ Third, the proposed

    amendments would require each of the Schedules to include the FCM's

    target for residual interest in the accounts relevant to that Schedule,

    as well as a calculation of any surplus or deficit in residual interest

    with respect to that target. And fourth, the proposed rule would

    require each FCM to submit to the Commission a monthly statement

    reporting the FCM's leverage.

    ---------------------------------------------------------------------------

    \99\ The Segregation Schedule and Secured Amount Schedule are

    already public documents.

    ---------------------------------------------------------------------------

    Benefits

    The proposal to include target residual interest and monthly

    calculation of the deviation from that target on the monthly Schedules

    provides important benefits with respect to the safety of customer

    funds. The data in the reports is public information. Public disclosure

    incentivizes FCMs to set a reasonable target for residual interest.

    Under proposed regulations, FCMs would have to notify the Commission

    and their respective DSRO each time they drop below their targeted

    residual interest, which gives them an incentive to set a low target,

    even if they intend to keep more residual interest in their accounts.

    However, by disclosing an FCM's targeted residual interest to the

    public, the proposed rule would enable customers and potential

    customers of an FCM to incorporate the size of the FCM's targeted

    residual interest, and the corresponding amount of protection to

    customers' funds provided by that level of residual interest, into

    their selection of an FCM. Holding all other considerations constant,

    FCMs that have higher targets relative to their segregation

    requirements would presumably be more attractive to customers than FCMs

    that target smaller levels of residual interest relative to their

    segregation requirements because of the additional protection of

    customer funds it provides. This additional information permits

    customers to weigh this consideration along with considerations of

    price in selecting an FCM. Last, by requiring FCMs to report their

    leverage monthly, the proposed amendments would assist the Commission

    in monitoring each FCM's overall risk profile, which would help the

    Commission to identify FCMs that should be monitored more closely for

    further developments that could weaken their financial position.

    Costs

    As stated above, all else equal, by requiring FCMs to include their

    residual interest target in the monthly report, and by making the

    contents of those reports public, the proposed rule would incent FCMs

    to set a higher target for their residual interest in customer

    segregated funds. However, maintaining a larger targeted residual

    interest would create some costs for FCMs. Proprietary funds deposited

    into customer segregated accounts by an FCM are only allowed to be

    invested in Sec. 1.25 investments and, therefore, are not available

    for other investments. In addition, placing additional capital in the

    customer segregated accounts reduces the amount of capital that an FCM

    has to meet operational needs, which would likely prompt the firm to

    raise or retain additional capital. Estimating the lost revenue that

    would result from the investment opportunities an FCM misses is not

    possible because the Commission is not able to estimate either the

    amount of increased residual interest that an FCM would, on average,

    maintain as the result of this proposed change, or the differential in

    return on investment between FCM funds placed into customer segregated

    accounts versus proprietary funds not held in such accounts. Similarly

    the Commission does not have adequate information to determine the

    average cost of capital for FCMs or the amount of additional capital

    that they would likely raise or retain as a consequence of this

    proposed change. The proposed requirement regarding monthly leverage

    statements will require FCMs to produce an additional report each

    month. The Commission anticipates that each FCM will incur a one-time

    cost in order to modify their systems to create the report, and then

    ongoing costs will be negligible because the report is likely to be

    automated. The Commission estimates that the one-time setup costs are

    likely to be between $2,800 and $5,700.\100\

    ---------------------------------------------------------------------------

    \100\ This assumes 40-80 hours of time from both a programmer

    and 20-40 hours from an intermediate accountant. The average

    compensation for a programmer is $53.64/hour [$82,518 per year/(2000

    hours per year)*1.3 = $53.64/hour]; $53.64*40= $2,145.47 and

    $53.64*80= $4,290.94. The average compensation for an intermediate

    accountant is $34.11/hour [$52,484.00 per year/(2000 hours per

    year)*1.3 is $34.11per hour]; $34.11*20= $682.29 and $34.11*40=

    $1,364.58. All figures are taken from the 2011 SIFMA Report on

    Management and Professional Earnings in the Securities Industry.

    ---------------------------------------------------------------------------

    Requests for Comment \101\

    ---------------------------------------------------------------------------

    \101\ The Commission has numbered its questions throughout the

    Cost Benefit Considerations section. When responding to specific

    questions, please reference the number of the question. In addition,

    commenters should provide analysis and empirical data to support

    their views on the costs and benefits associated with the proposed

    rule, and should provide information to the Commission that would

    enable it to replicate and verify any quantitative estimates.

    ---------------------------------------------------------------------------

    Question 1: The Commission requests comment regarding the costs and

    [[Page 67904]]

    benefits of these proposed rules, including making residual interest

    targets public information. Please explain and, if possible, quantify

    the relevant costs and benefits.

    Question 2: In addition, the Commission requests comment regarding

    the costs and benefits that would result from providing each FCM's

    daily calculation of residual interest public. Would the disclosure of

    an FCM's daily calculations of residual interest pose a risk to such

    FCM, the markets, to customers, or the public? If so, please explain.

    Or, conversely, would a lack of disclosure exacerbate risks to FCM

    customers or the public? If so, please explain.

    Question 3: Market participants have suggested that additional

    information from FCMs' daily, bi-monthly, and monthly reports should be

    disclosed to the public. What alternatives should the Commission

    consider in this respect? What would be the costs and benefits of that

    alternative?

    Question 4: In addition, the Commission requests information or

    data that would assist the Commission in quantifying the cost to FCMs

    of placing additional proprietary funds into the customer segregated

    account and the benefit to customers of having such additional funds in

    the segregated accounts.

    Sec. 1.11 Risk Management Program for Futures Commission Merchants

    Proposed Changes

    As discussed in II.B above, proposed Sec. 1.11 would require an

    FCM that carries accounts for customers to establish a risk management

    unit that is independent from the business unit and reports directly to

    senior management. In addition, it would require each FCM to establish

    and document a risk management program, approved by the governing body

    of the FCM, that, at a minimum: (a) Identifies risks and establishes

    risk tolerance limits related to various risks that are approved by

    senior management; (b) includes policies and procedures for detecting

    breaches of risk tolerance limits, and for reporting them to senior

    management; (c) provides risk exposure reports quarterly and whenever a

    material change in the risk exposure of the FCM is identified; (d)

    includes annual review and testing of the risk management program; and

    (e) meets specific requirements related to segregation risk,

    operational risk, and capital risk.

    Regarding segregation risk, the proposed rule would require that

    each FCM must establish written policies and procedures that require,

    at a minimum: (1) Documented criteria for selecting depositories that

    would hold segregated funds; (2) a program to monitor depositories on

    an ongoing basis; (3) an account opening process that ensures the

    depository acknowledges that funds in the account are customers' funds

    before any deposits are made to the account, and that also ensures

    accounts are titled appropriately; (4) a process for determining a

    residual interest target for the FCM that involves due diligence from

    senior management; (5) a process for the withdrawal of an FCM's

    residual interest when such a withdrawal is not made for the benefit of

    the FCM's customers; (6) a process for determining the appropriateness

    of investing funds in Sec. 1.25 compliant investments; (7) procedures

    to assure that securities and other non-cash collateral held as

    segregated funds are properly valued and readily marketable and highly

    liquid; (8) procedures that help to ensure appropriate separation of

    duties between those who account for funds and are responsible for

    statutory and regulatory compliance vs. those who act in other

    capacities with the company (e.g., those who are responsible for

    treasury functions); (9) a process for the timely recording of all

    transactions; and (10) a program for annual training of FCM employees

    regarding the requirements for handling customer funds.

    The proposed rule would require automated financial risk management

    controls that address operational risk, and written procedures

    reasonably designed to ensure that an FCM has sufficient capital to be

    in compliance with the Act and regulations and to meet its liquidity

    needs for the foreseeable future.

    Benefits

    Establishing a risk management unit with adequate authority;

    qualified personnel; and financial, operational and other resources to

    carry out the Risk Management Program would enhance protection of

    customer funds by mitigating the risk that the effectiveness of the

    Program is compromised by a lack of resources. Moreover, separation of

    the Risk Management Unit from the Business Unit mitigates the risk that

    conflicts of interest could interfere with the effectiveness of the

    risk management unit in avoiding situations that may lead to a loss of

    customer funds.

    Furthermore, by requiring that the risk management unit report

    directly to senior management, Sec. 1.11(d) would help ensure that the

    risk management unit's operations and concerns receive prompt attention

    from personnel who are able to address any problems that arise, and

    also minimizes the risk that conflicts of interest could cause a

    breakdown in communications that undermines the effectiveness of the

    risk management unit or the Risk Management Program. Each of these

    elements, by promoting the risk management unit's effectiveness, would

    help to ensure that the unit will identify and address emerging risks

    before such risks threaten the health of the FCM or the security of

    segregated customer funds.

    The Commission believes the establishment of the proposed risk

    management program would provide several benefits to FCMs, customers,

    and the public, in particular with respect to the protection of

    customer funds.

    a. The proposed requirement for FCMs to establish, as part of their

    risk management program, specific risk tolerance limits, would provide

    additional protection to FCMs by helping to ensure that they have a

    system in place to identify emergent risks to the business. By

    requiring an underlying methodology for establishing the limits, the

    proposed rule would promote reasoned decision making regarding the

    limits as they are set and updated. Quarterly review of the risk limits

    by senior management and annual review by the Governing Body would help

    to ensure that limits are current as the market, business, and customer

    base evolve, and also provide accountability for periodic evaluation of

    such risks at the most senior levels of the organization, which helps

    to ensure that senior leaders are proactively discussing and addressing

    the full range of risks that are facing the business. As a consequence,

    these measures would help ensure that an FCM is taking whatever steps

    are necessary in order to reduce and mitigate the effects of emerging

    risks. Moreover, customer funds held at the FCM may face elevated risk

    of loss due to misuse or operational errors during times of financial

    strain at the FCM. By protecting the health of the FCM, the proposed

    requirements mitigate the risk that financial strain at the FCM would

    lead to a loss of customer funds that it holds.

    b. By requiring policies and procedures for detecting breaches of

    the risk tolerance limits and notifying appropriate personnel, the

    proposed

    [[Page 67905]]

    rule would promote objectivity when monitoring of each risk that the

    policies address, thus mitigating the risk that poor individual

    judgment could cause important emerging risks to go unnoticed, or could

    prevent proper personnel from being notified, leading to a loss of

    customer funds.

    c. The contents of the proposed Risk Exposure Reports would help to

    ensure that attention is regularly given to an evaluation of each risk

    that is covered in the FCM's Risk Management Program and that senior

    management and the Governing Body of the FCM are made aware of the

    findings. They will also help to ensure that the Risk Management

    Program is continuously updated to reflect changing risks that face the

    business by requiring recommendations to be included in such reports,

    which promotes the effectiveness of the Program in protecting customer

    funds. Moreover, status updates on any incomplete implementation of

    previous recommendations from such reports provide accountability at

    the most senior levels of the FCM regarding implementation of

    initiatives to improve the Program.

    d. Similar to above, review and testing of the risk management

    program on an annual basis as well as whenever there is a material

    change in the business, would help to ensure that the Risk Management

    Program continues to evolve as the risks facing the business evolve,

    thus promoting the effectiveness of the program, which in turn, would

    help protect the FCM. By requiring an analysis of adherence to the

    program the proposed requirement would promote compliance with it. And

    requiring the review and testing to be conducted by staff that are

    independent of the Business Unit or by an external third party promotes

    objectivity and rigor in the findings that would result, and requiring

    senior management and the Governing Body of the FCM to review the

    findings promptly helps to ensure that any breaches of compliance or

    other findings of the review are addressed promptly and effectively. As

    above, each of these elements promotes protection for the FCM, which in

    turn, reduces the likelihood that risk to the FCM could cause elevated

    risk of operational errors that could result in a loss of customer

    funds.

    e. Regarding segregation risk, the requirements set forth in

    proposed Sec. 1.11 would benefit customers and the financial integrity

    of markets by requiring FCMs to implement rigorous internal controls

    designed to detect and mitigate the risk that operational errors or

    fraud could lead to a loss of customer funds. More specifically, and as

    discussed above, proposed Sec. 1.11 requires FCMs to establish written

    policies and procedures that address 12 components of segregation risk.

    The Commission addresses each of those components below.

    1. Proposed Sec. 1.11(e)(3)(i)(A) would establish a minimum set of

    factors that the FCM would have to incorporate into its due diligence

    standards and depositories would have to meet those standards in order

    to be eligible to be selected by the FCM to hold customer segregated

    funds. As a consequence, customers would have greater clarity about

    what factors were considered as their FCM selected individual

    depositories, leading to market discipline that encourages the

    protection of customer funds.

    Documenting the process would enable regulators to review and audit

    for rigor of the process and adherence to it. Such documentation would

    help regulators identify risk creating operational patterns or errors

    that could increase risk to customer funds before those risks are

    realized. In addition, documenting such criteria helps to ensure that

    the depository is evaluated against substantive criteria that are

    relevant to the safety of customer funds held by the depository as a

    precondition for placing customer funds there. The proposed

    requirement, by specifying certain criteria that must be included in

    the FCM's policies and procedures, would also promote market discipline

    by giving customers clarity about what factors, at a minimum, are

    considered as part of the FCM's program for evaluating potential

    depositories.

    Together, these benefits help to ensure that the FCM and depository

    have developed and adhere to procedures that minimize risk to customer

    funds, which reduces the risk that an FCM would experience a shortfall

    in their customer segregated funds account.

    2. Regulation 1.11(e)(3)(i)(B) would require each FCM to establish

    a program to monitor depositories on an ongoing basis. This would

    mitigate the risk of loss of customer funds resulting from depository

    default or malfeasance because FCMs would be better able to discern

    emerging problems at the depository in time to move such funds to

    another depository before the customer segregated funds are affected.

    In addition, as above, documenting such a program would enable the

    Commission and DSRO to evaluate the FCM's diligence in monitoring its

    depositories by auditing the FCM's compliance with its own procedures

    in this respect, which would again lead to more effective protection of

    customer funds.

    3. The proposal makes it clear that before an FCM is permitted to

    deposit any customer segregated funds at a depository, the depository

    must agree that, if instructed to do so by the Director of DSIO or the

    Director of DCR, it will make such transfers without delay. Requiring

    the acknowledgment letter to be signed before any funds are deposited

    removes uncertainty about whether the depository has been put on notice

    that it is required to move funds without delay when directed by the

    Director of DSIO or the Director of DCR. In the event of a default by

    an FCM, the Commission and relevant DCOs would he residual interest, the more

    secure customer funds are in this respect. By requiring that senior

    management set the target for residual interest, and that they conduct

    adequate due diligence in order to inform that decision, the proposed

    rule promotes both informed decision making about this important form

    of protection, and accountability among senior management for this

    decision, both of which are consistent with sound risk management

    practices.

    Other Public Interest Considerations

    As discussed above, the recent failures of MF Global and Peregrine,

    FCMs to which customers have entrusted their funds, sparked a crisis of

    confidence regarding the security of those funds. This crisis in

    confidence could deter market participants from using regulated,

    transparent markets and clearing which would create additional costs

    for market participants and losses in efficiency and safety that could

    create additional burdens for the public. The Commission anticipates

    that this rule will not only address the current crisis of confidence,

    but that it will produce benefits for the public by virtue of avoiding

    similar defaults in the future.

    These proposed amendments are not, however, without costs. The most

    significant costs created by the proposed amendments are those that

    increase the amount of capital that FCMs would be required to

    contribute to segregated accounts as part of establishing a target for

    their residual interest, incent them to hold additional capital,

    prevent them from holding excess segregated funds overseas, and that

    are created operationally by the formation of a risk management unit

    and adoption of new policies and procedures.

    Multiple proposed changes would incent or require FCMs to increase

    the amount of residual interest that they maintain in segregated

    accounts including: (1) Requiring FCMs to establish a target for

    residual interest that reflects proper due diligence on the part of

    senior management; (2) disclosing the FCMs' targeted residual interest

    publicly; and (3) requiring them to report to the Commission and their

    DSRO any time their residual interest drops below that target. In

    addition by restricting FCMs' ability to withdraw residual interest

    from segregated accounts and obligating FCMs to report to the

    Commission and their respective DSRO each time the residual interest

    drops below the target, the proposed regulations would incent FCMs to

    hold additional capital, which is also likely to be a significant cost.

    When FCMs hold excess customer funds overseas, such funds will

    likely be held at depositories that are themselves subject to foreign

    insolvency regimes, which may provide protections for customer funds

    that are less effective than those applicable under U.S. law. By

    prohibiting FCMs from holding excess customer funds overseas, the

    proposed regulations could reduce the returns that FCMs may obtain on

    invested customer funds.

    And last, the proposed requirements related to operational

    procedures are likely to create significant costs, particularly related

    to creating and documenting policies and procedures, as well as

    complying with ongoing training, due diligence, and audit requirements.

    However, in several cases the implementation costs of proposed changes

    would be minimal. For example, some proposed requirements would

    obligate FCMs to provide the Commission and DSROs more regular access

    to information that FCMs and their depositories are already required to

    maintain, or in some cases are already reporting to their DSROs. The

    Commission also anticipates that some of the changes proposed codify

    best practices for risk management that many FCMs and DCOs may already

    follow. In such cases, the costs of compliance would be mitigated by

    the compliance programs or best practices that the firm already has in

    place. Moreover, in other cases the proposed changes codify practices

    that are already required by SROs, and therefore would impose no

    additional costs.

    The initial and ongoing costs of the proposed rules for FCMs would

    vary significantly depending on the size of each FCM, the policies and

    procedures that they already have in place, and the frequency with

    which they experience certain events that would create additional costs

    under the proposed rules. The Commission estimates that the initial

    operational cost \96\ of implementing the proposed rules would be

    between $193,000 and $1,850,000 per FCM.\97\ And the initial cost to

    the SROs and DSROs would be between $41,100 and $63,500 per SRO or

    DSRO. The Commission estimates that the ongoing operational cost to

    FCMs would be between $287,000 and $2,300,000 per FCM per year.\98\ As

    described below in Sec. 1.52, the Commission does not have adequate

    information to determine the ongoing cost of the proposed requirements

    for SROs and DSROs.

    ---------------------------------------------------------------------------

    \96\ The Commission is not able to quantify the costs that would

    result from increased residual interest held in customer segregated

    accounts, from increased capital held by the FCM, or from lost

    investment opportunities due to restrictions on the amount of funds

    that may be held overseas. The Commission does not have sufficient

    data to estimate the amount of additional residual interest FCMs are

    likely to need as a consequence of proposed, the amount of

    additional capital they may hold for operational purposes, the cost

    of capital for FCMs, or the opportunity costs FCMs may experience

    because of restrictions on the amount of customer funds they can

    hold overseas, each of which would be necessary in order to estimate

    such costs.

    \97\ The lower bound assumes an FCM requires the minimum

    estimated number of personnel hours to be compliant with these new

    rules and that, when possible, they already have policies,

    procedures, and systems in place that would satisfy the proposed

    requirements. The upper bound assumes an FCM requires the maximum

    amount of personnel hours and do not have pre-existing policies,

    procedures, and systems in place that would satisfy the proposed

    requirements. The greatest amount of variation within in the range

    would depend on the number of new depositories an FCM must establish

    relationships with due to current depositories that would not be

    willing to sign the required acknowledgment letter. The lower bound

    assumes that an FCM does not need to establish any new relationships

    with depositories. The Commission estimates that the largest FCMs

    may have as many as 30 depositories, and as a conservative estimate,

    the Commission assumes for the upper bound that an FCM would have to

    establish new relationships with 15 depositories.

    \98\ As above, the lower bound assumes that an FCM requires the

    minimum estimated number of personnel hours to be compliant and that

    for event-triggered costs, the FCM bears the minimum number of

    possible events. The upper bound assumes an FCM requires the maximum

    number of personnel hours to be compliant. It also assumes an FCM

    has to notify the Commission pursuant to the proposed amendments in

    Sec. 1.12 five times per year, and that an FCM withdraws funds from

    residual interest for proprietary use 50 times per year. The

    estimate does not include additional costs that would result if FCMs

    increase the amount of residual interest or capital that they hold

    in response to the proposed rules, or certain operational costs that

    the Commission does not have sufficient information to estimate.

    ---------------------------------------------------------------------------

    In the sections that follow, the Commission considers the costs and

    benefits of the proposed changes, section by section, in light of the

    relevant 15(a) public interest, cost-benefit considerations.

    [[Page 67903]]

    Consideration of Costs and Benefits Related to Proposed Changes in Each

    Section

    Sec. 1.3(rr)--Definition of ``Foreign Futures or Foreign Options

    Secured Amount''

    Proposed Changes

    As described above in II.R, the proposed amendments to Sec.

    1.3(rr) would replace the term ``foreign futures or foreign options

    customers'' with the term ``30.7 Customers.'' The former only includes

    U.S.-domiciled customers, whereas the term ``30.7 Customers'' includes

    both U.S.-domiciled and foreign-domiciled customers who place funds in

    the care of an FCM for trading on foreign boards of trade. This change

    expands the range of funds that the FCM must include as part of the

    foreign options or foreign futures secured amount.

    In addition, the definition of ``foreign futures or foreign options

    secured amount'' currently means ``all money, securities and property

    held by or held for or on behalf of a futures commission merchant from,

    for, or on behalf of foreign futures or foreign options customers as

    defined in Sec. 30.1.'' The proposed definition would change the

    meaning of ``foreign futures or foreign options secured amount'' so

    that it is equal to the amount of funds an FCM needs in order to

    satisfy the full account balances of each of its customers at all

    times. This definitional change supports the shift in Sec. 30.7 from

    the ``Alternative Method'' to the ``Net Liquidating Equity Method'' of

    calculating the foreign futures or foreign options secured amount.

    Benefits and Costs

    These definitional changes would determine what funds are

    considered part of the ``foreign futures or foreign options secured

    amount.'' However, the costs and benefits of these changes are

    attributable to the substantive requirements related to the definitions

    and, therefore, are discussed in the cost and benefit considerations

    related to Sec. 30.7.

    Sec. 1.10--Financial Reports of Futures Commission Merchants and

    Introducing Brokers

    Proposed Changes

    As described above in II.A, the proposed amendments would make four

    changes. First, they would amend the 1-FR-FCM to create a new schedule

    called the ``Cleared Swap Segregation Schedule'' that would be included

    in the FCM's monthly report, together with the Segregation Schedule and

    Secured Amount Schedule. Second, it would make the Cleared Swap

    Segregation Schedule a public document.\99\ Third, the proposed

    amendments would require each of the Schedules to include the FCM's

    target for residual interest in the accounts relevant to that Schedule,

    as well as a calculation of any surplus or deficit in residual interest

    with respect to that target. And fourth, the proposed rule would

    require each FCM to submit to the Commission a monthly statement

    reporting the FCM's leverage.

    ---------------------------------------------------------------------------

    \99\ The Segregation Schedule and Secured Amount Schedule are

    already public documents.

    ---------------------------------------------------------------------------

    Benefits

    The proposal to include target residual interest and monthly

    calculation of the deviation from that target on the monthly Schedules

    provides important benefits with respect to the safety of customer

    funds. The data in the reports is public information. Public disclosure

    incentivizes FCMs to set a reasonable target for residual interest.

    Under proposed regulations, FCMs would have to notify the Commission

    and their respective DSRO each time they drop below their targeted

    residual interest, which gives them an incentive to set a low target,

    even if they intend to keep more residual interest in their accounts.

    However, by disclosing an FCM's targeted residual interest to the

    public, the proposed rule would enable customers and potential

    customers of an FCM to incorporate the size of the FCM's targeted

    residual interest, and the corresponding amount of protection to

    customers' funds provided by that level of residual interest, into

    their selection of an FCM. Holding all other considerations constant,

    FCMs that have higher targets relative to their segregation

    requirements would presumably be more attractive to customers than FCMs

    that target smaller levels of residual interest relative to their

    segregation requirements because of the additional protection of

    customer funds it provides. This additional information permits

    customers to weigh this consideration along with considerations of

    price in selecting an FCM. Last, by requiring FCMs to report their

    leverage monthly, the proposed amendments would assist the Commission

    in monitoring each FCM's overall risk profile, which would help the

    Commission to identify FCMs that should be monitored more closely for

    further developments that could weaken their financial position.

    Costs

    As stated above, all else equal, by requiring FCMs to include their

    residual interest target in the monthly report, and by making the

    contents of those reports public, the proposed rule would incent FCMs

    to set a higher target for their residual interest in customer

    segregated funds. However, maintaining a larger targeted residual

    interest would create some costs for FCMs. Proprietary funds deposited

    into customer segregated accounts by an FCM are only allowed to be

    invested in Sec. 1.25 investments and, therefore, are not available

    for other investments. In addition, placing additional capital in the

    customer segregated accounts reduces the amount of capital that an FCM

    has to meet operational needs, which would likely prompt the firm to

    raise or retain additional capital. Estimating the lost revenue that

    would result from the investment opportunities an FCM misses is not

    possible because the Commission is not able to estimate either the

    amount of increased residual interest that an FCM would, on average,

    maintain as the result of this proposed change, or the differential in

    return on investment between FCM funds placed into customer segregated

    accounts versus proprietary funds not held in such accounts. Similarly

    the Commission does not have adequate information to determine the

    average cost of capital for FCMs or the amount of additional capital

    that they would likely raise or retain as a consequence of this

    proposed change. The proposed requirement regarding monthly leverage

    statements will require FCMs to produce an additional report each

    month. The Commission anticipates that each FCM will incur a one-time

    cost in order to modify their systems to create the report, and then

    ongoing costs will be negligible because the report is likely to be

    automated. The Commission estimates that the one-time setup costs are

    likely to be between $2,800 and $5,700.\100\

    ---------------------------------------------------------------------------

    \100\ This assumes 40-80 hours of time from both a programmer

    and 20-40 hours from an intermediate accountant. The average

    compensation for a programmer is $53.64/hour [$82,518 per year/(2000

    hours per year)*1.3 = $53.64/hour]; $53.64*40= $2,145.47 and

    $53.64*80= $4,290.94. The average compensation for an intermediate

    accountant is $34.11/hour [$52,484.00 per year/(2000 hours per

    year)*1.3 is $34.11per hour]; $34.11*20= $682.29 and $34.11*40=

    $1,364.58. All figures are taken from the 2011 SIFMA Report on

    Management and Professional Earnings in the Securities Industry.

    ---------------------------------------------------------------------------

    Requests for Comment \101\

    ---------------------------------------------------------------------------

    \101\ The Commission has numbered its questions throughout the

    Cost Benefit Considerations section. When responding to specific

    questions, please reference the number of the question. In addition,

    commenters should provide analysis and empirical data to support

    their views on the costs and benefits associated with the proposed

    rule, and should provide information to the Commission that would

    enable it to replicate and verify any quantitative estimates.

    ---------------------------------------------------------------------------

    Question 1: The Commission requests comment regarding the costs and

    [[Page 67904]]

    benefits of these proposed rules, including making residual interest

    targets public information. Please explain and, if possible, quantify

    the relevant costs and benefits.

    Question 2: In addition, the Commission requests comment regarding

    the costs and benefits that would result from providing each FCM's

    daily calculation of residual interest public. Would the disclosure of

    an FCM's daily calculations of residual interest pose a risk to such

    FCM, the markets, to customers, or the public? If so, please explain.

    Or, conversely, would a lack of disclosure exacerbate risks to FCM

    customers or the public? If so, please explain.

    Question 3: Market participants have suggested that additional

    information from FCMs' daily, bi-monthly, and monthly reports should be

    disclosed to the public. What alternatives should the Commission

    consider in this respect? What would be the costs and benefits of that

    alternative?

    Question 4: In addition, the Commission requests information or

    data that would assist the Commission in quantifying the cost to FCMs

    of placing additional proprietary funds into the customer segregated

    account and the benefit to customers of having such additional funds in

    the segregated accounts.

    Sec. 1.11 Risk Management Program for Futures Commission Merchants

    Proposed Changes

    As discussed in II.B above, proposed Sec. 1.11 would require an

    FCM that carries accounts for customers to establish a risk management

    unit that is independent from the business unit and reports directly to

    senior management. In addition, it would require each FCM to establish

    and document a risk management program, approved by the governing body

    of the FCM, that, at a minimum: (a) Identifies risks and establishes

    risk tolerance limits related to various risks that are approved by

    senior management; (b) includes policies and procedures for detecting

    breaches of risk tolerance limits, and for reporting them to senior

    management; (c) provides risk exposure reports quarterly and whenever a

    material change in the risk exposure of the FCM is identified; (d)

    includes annual review and testing of the risk management program; and

    (e) meets specific requirements related to segregation risk,

    operational risk, and capital risk.

    Regarding segregation risk, the proposed rule would require that

    each FCM must establish written policies and procedures that require,

    at a minimum: (1) Documented criteria for selecting depositories that

    would hold segregated funds; (2) a program to monitor depositories on

    an ongoing basis; (3) an account opening process that ensures the

    depository acknowledges that funds in the account are customers' funds

    before any deposits are made to the account, and that also ensures

    accounts are titled appropriately; (4) a process for determining a

    residual interest target for the FCM that involves due diligence from

    senior management; (5) a process for the withdrawal of an FCM's

    residual interest when such a withdrawal is not made for the benefit of

    the FCM's customers; (6) a process for determining the appropriateness

    of investing funds in Sec. 1.25 compliant investments; (7) procedures

    to assure that securities and other non-cash collateral held as

    segregated funds are properly valued and readily marketable and highly

    liquid; (8) procedures that help to ensure appropriate separation of

    duties between those who account for funds and are responsible for

    statutory and regulatory compliance vs. those who act in other

    capacities with the company (e.g., those who are responsible for

    treasury functions); (9) a process for the timely recording of all

    transactions; and (10) a program for annual training of FCM employees

    regarding the requirements for handling customer funds.

    The proposed rule would require automated financial risk management

    controls that address operational risk, and written procedures

    reasonably designed to ensure that an FCM has sufficient capital to be

    in compliance with the Act and regulations and to meet its liquidity

    needs for the foreseeable future.

    Benefits

    Establishing a risk management unit with adequate authority;

    qualified personnel; and financial, operational and other resources to

    carry out the Risk Management Program would enhance protection of

    customer funds by mitigating the risk that the effectiveness of the

    Program is compromised by a lack of resources. Moreover, separation of

    the Risk Management Unit from the Business Unit mitigates the risk that

    conflicts of interest could interfere with the effectiveness of the

    risk management unit in avoiding situations that may lead to a loss of

    customer funds.

    Furthermore, by requiring that the risk management unit report

    directly to senior management, Sec. 1.11(d) would help ensure that the

    risk management unit's operations and concerns receive prompt attention

    from personnel who are able to address any problems that arise, and

    also minimizes the risk that conflicts of interest could cause a

    breakdown in communications that undermines the effectiveness of the

    risk management unit or the Risk Management Program. Each of these

    elements, by promoting the risk management unit's effectiveness, would

    help to ensure that the unit will identify and address emerging risks

    before such risks threaten the health of the FCM or the security of

    segregated customer funds.

    The Commission believes the establishment of the proposed risk

    management program would provide several benefits to FCMs, customers,

    and the public, in particular with respect to the protection of

    customer funds.

    a. The proposed requirement for FCMs to establish, as part of their

    risk management program, specific risk tolerance limits, would provide

    additional protection to FCMs by helping to ensure that they have a

    system in place to identify emergent risks to the business. By

    requiring an underlying methodology for establishing the limits, the

    proposed rule would promote reasoned decision making regarding the

    limits as they are set and updated. Quarterly review of the risk limits

    by senior management and annual review by the Governing Body would help

    to ensure that limits are current as the market, business, and customer

    base evolve, and also provide accountability for periodic evaluation of

    such risks at the most senior levels of the organization, which helps

    to ensure that senior leaders are proactively discussing and addressing

    the full range of risks that are facing the business. As a consequence,

    these measures would help ensure that an FCM is taking whatever steps

    are necessary in order to reduce and mitigate the effects of emerging

    risks. Moreover, customer funds held at the FCM may face elevated risk

    of loss due to misuse or operational errors during times of financial

    strain at the FCM. By protecting the health of the FCM, the proposed

    requirements mitigate the risk that financial strain at the FCM would

    lead to a loss of customer funds that it holds.

    b. By requiring policies and procedures for detecting breaches of

    the risk tolerance limits and notifying appropriate personnel, the

    proposed

    [[Page 67905]]

    rule would promote objectivity when monitoring of each risk that the

    policies address, thus mitigating the risk that poor individual

    judgment could cause important emerging risks to go unnoticed, or could

    prevent proper personnel from being notified, leading to a loss of

    customer funds.

    c. The contents of the proposed Risk Exposure Reports would help to

    ensure that attention is regularly given to an evaluation of each risk

    that is covered in the FCM's Risk Management Program and that senior

    management and the Governing Body of the FCM are made aware of the

    findings. They will also help to ensure that the Risk Management

    Program is continuously updated to reflect changing risks that face the

    business by requiring recommendations to be included in such reports,

    which promotes the effectiveness of the Program in protecting customer

    funds. Moreover, status updates on any incomplete implementation of

    previous recommendations from such reports provide accountability at

    the most senior levels of the FCM regarding implementation of

    initiatives to improve the Program.

    d. Similar to above, review and testing of the risk management

    program on an annual basis as well as whenever there is a material

    change in the business, would help to ensure that the Risk Management

    Program continues to evolve as the risks facing the business evolve,

    thus promoting the effectiveness of the program, which in turn, would

    help protect the FCM. By requiring an analysis of adherence to the

    program the proposed requirement would promote compliance with it. And

    requiring the review and testing to be conducted by staff that are

    independent of the Business Unit or by an external third party promotes

    objectivity and rigor in the findings that would result, and requiring

    senior management and the Governing Body of the FCM to review the

    findings promptly helps to ensure that any breaches of compliance or

    other findings of the review are addressed promptly and effectively. As

    above, each of these elements promotes protection for the FCM, which in

    turn, reduces the likelihood that risk to the FCM could cause elevated

    risk of operational errors that could result in a loss of customer

    funds.

    e. Regarding segregation risk, the requirements set forth in

    proposed Sec. 1.11 would benefit customers and the financial integrity

    of markets by requiring FCMs to implement rigorous internal controls

    designed to detect and mitigate the risk that operational errors or

    fraud could lead to a loss of customer funds. More specifically, and as

    discussed above, proposed Sec. 1.11 requires FCMs to establish written

    policies and procedures that address 12 components of segregation risk.

    The Commission addresses each of those components below.

    1. Proposed Sec. 1.11(e)(3)(i)(A) would establish a minimum set of

    factors that the FCM would have to incorporate into its due diligence

    standards and depositories would have to meet those standards in order

    to be eligible to be selected by the FCM to hold customer segregated

    funds. As a consequence, customers would have greater clarity about

    what factors were considered as their FCM selected individual

    depositories, leading to market discipline that encourages the

    protection of customer funds.

    Documenting the process would enable regulators to review and audit

    for rigor of the process and adherence to it. Such documentation would

    help regulators identify risk creating operational patterns or errors

    that could increase risk to customer funds before those risks are

    realized. In addition, documenting such criteria helps to ensure that

    the depository is evaluated against substantive criteria that are

    relevant to the safety of customer funds held by the depository as a

    precondition for placing customer funds there. The proposed

    requirement, by specifying certain criteria that must be included in

    the FCM's policies and procedures, would also promote market discipline

    by giving customers clarity about what factors, at a minimum, are

    considered as part of the FCM's program for evaluating potential

    depositories.

    Together, these benefits help to ensure that the FCM and depository

    have developed and adhere to procedures that minimize risk to customer

    funds, which reduces the risk that an FCM would experience a shortfall

    in their customer segregated funds account.

    2. Regulation 1.11(e)(3)(i)(B) would require each FCM to establish

    a program to monitor depositories on an ongoing basis. This would

    mitigate the risk of loss of customer funds resulting from depository

    default or malfeasance because FCMs would be better able to discern

    emerging problems at the depository in time to move such funds to

    another depository before the customer segregated funds are affected.

    In addition, as above, documenting such a program would enable the

    Commission and DSRO to evaluate the FCM's diligence in monitoring its

    depositories by auditing the FCM's compliance with its own procedures

    in this respect, which would again lead to more effective protection of

    customer funds.

    3. The proposal makes it clear that before an FCM is permitted to

    deposit any customer segregated funds at a depository, the depository

    must agree that, if instructed to do so by the Director of DSIO or the

    Director of DCR, it will make such transfers without delay. Requiring

    the acknowledgment letter to be signed before any funds are deposited

    removes uncertainty about whether the depository has been put on notice

    that it is required to move funds without delay when directed by the

    Director of DSIO or the Director of DCR. In the event of a default by

    an FCM, the Commission and relevant DCOs would immediately move

    customer funds in order to move open positions to a different FCM.

    4. The proposal requires senior management to conduct due diligence

    to understand various factors that could impact the amount of residual

    interest that would be prudent to maintain in the segregated funds

    account, and then reach a determination about a targeted amount. The

    benefit of such a requirement is that it would protect customer funds

    by creating accountability for senior management. Requiring such due

    diligence helps ensure that senior management is attentive to the

    causes of segregated funds account underfunding. The requirement allows

    both flexibility and accountability in that it allows FCMs to account

    for relevant factors that vary across firms when determining an

    appropriate target, rather than requiring all FCMs to maintain a common

    target for residual interest. However, by requiring them to establish

    such a target and to conduct due diligence in doing so, it allows the

    Commission and DSROs to audit the FCMs to ensure that they reached

    their target through a reasoned decision-making process, and ensures

    that the respective boards approve and are responsible for the target.

    Maintaining a target enhances market discipline by creating public

    accountability for an FCM. It communicates to customers that the FCM

    intends to maintain a certain residual interest in the account, and

    gives customers an opportunity to consider, when selecting an FCM, the

    additional security that varied levels of residual interest may provide

    for their funds.

    5. A process for the withdrawal of residual interest that is not

    for the benefit of customers would help to ensure good communication

    and that senior managers are appropriately involved in the decision to

    remove

    [[Page 67906]]

    residual interest from segregated customer accounts. Good

    communication, deliberate decision-making, and proper involvement of

    senior managers would promote accountability when an FCM is removing

    residual interest. These benefits are particularly important at times

    when FCMs experience financial stress because good communication,

    deliberate decision-making, and proper involvement of senior management

    in decisions related to residual interest may be more likely to fail at

    such times, creating risk to segregated customer funds. By requiring

    FCMs to establish and follow procedures for withdrawals of residual

    interest, the rule would help to ensure that such failures do not

    occur.

    An additional, related benefit is that by ensuring proper

    communication with and approval from relevant senior managers before

    such withdrawals occur, the proposed changes would enhance

    accountability among those managers for decisions that could create

    risk for segregated customer funds.

    6. FCMs have a range of potential investments that are compliant

    with Sec. 1.25. By requiring FCMs to establish a process for deciding

    how to invest those funds, the requirement would provide the Commission

    and DSRO with a standard by which such investment decisions could be

    judged, which would help prevent the FCM from investing primarily in

    the least credit-worthy Sec. 1.25 investments. FCMs have an incentive

    to invest customer funds in Sec. 1.25 compliant investments that offer

    the highest rate of return possible, but it is possible that the Sec.

    1.25 investments offering the highest rates of return are also less

    credit-worthy or less liquid than other Sec. 1.25 investments.

    Requiring FCMs to set up, document and follow a process for assessing

    the appropriateness of investing segregated funds in Sec. 1.25

    investments ensures that FCMs take steps not only to determine whether

    an investment complies with Sec. 1.25 as required by current

    regulation, but that the investment is also evaluated with respect to

    any risk it may pose to the FCM's primary responsibilities of

    preserving principal and maintaining liquidity when handling customer

    funds. In other words, this provision would help to prevent the

    possibility of a ``race to the bottom'' for FCMs investing in Sec.

    1.25 compliant assets.

    7. If the FCM is not able to get accurate pricing for Sec. 1.25

    assets, it is difficult to know whether or not sufficient funds are in

    the segregated account. A shortage (and thus, in the event of

    insolvency, a loss of customer funds) could occur simply because the

    FCM can't accurately estimate the value of the assets that are there,

    or it could also make it easier for the FCM to intentionally skew their

    reports regarding funds in the customer segregated accounts by making

    favorable assumptions about the value of assets that are difficult to

    price. Requiring the FCM to establish a program for assessing the ease

    of pricing for Sec. 1.25 assets helps reduce these risks and gives the

    Commission and DSRO an opportunity to understand the FCM's procedures

    and to enforce the FCM's compliance with them. This, in turn, promotes

    reasoned and disciplined decision-making with respect to the FCM's

    investment of customer funds in Sec. 1.25 investments. Establishing

    procedures to evaluate the liquidity of Sec. 1.25 instruments will

    help FCMs minimize the risk of such problems.

    8. Appropriate internal controls are critical to the prevention of

    fraud. The Commission understands that FCMs typically require that

    certain duties are performed by separate people or separate groups of

    people in order to ensure that a proper system of checks and

    verification remains in place.\102\ In particular, FCMs generally

    ensure that the individuals responsible for reporting and associated

    calculations are separate from the individuals responsible for

    operational transfers of funds. In the absence of such internal

    controls, one person or group of people with access to both movement

    and reporting of funds could transfer funds and then, for a time, hide

    those transfers from senior management, auditors, and the public.

    ---------------------------------------------------------------------------

    \102\ See ``Initial Recommendations for Customer Funds

    Protection'' by the FIA Futures Markets Financial Integrity Task

    Force.

    ---------------------------------------------------------------------------

    The proposed rule would help protect customer funds by establishing

    a regulatory requirement that all FCMs develop procedures to ensure

    that the individuals responsible for calculating and reporting

    segregation account requirements and segregation account funds do not

    share duties with those who are responsible for transferring or

    investing segregated funds. This should result in controls to prevent

    fraudulent fund transfers.

    9. The Commission regulations already require timely recording of

    transactions in Sec. 1.35(b), but this proposed addition would require

    that FCMs develop written policies and procedures ensure that they have

    a consistent process to achieve that outcome. Again, requiring FCMs to

    document their procedures helps protect customer funds by enabling the

    Commission and DSROs to audit for compliance, detecting and preventing

    operational issues that could pose risk to customer funds before those

    risks result in an actual loss to customer funds.

    10. Proper training of employees would help to ensure that

    employees understand the written procedures regarding segregated funds.

    The proposed training requirement provides flexibility for an FCM to

    determine whether it should develop the required training in house, or

    to pay a vendor to develop a training program. Training regarding the

    requirements of the Act and Commission regulations regarding handling

    customer funds will help to ensure that employees understand how the

    procedures and requirements related to customer funds apply to various

    situations they face in their work for the FCM. Training regarding the

    second and third points mentioned above will help to ensure that the

    Commission and DSRO are notified promptly whenever any of the

    circumstances covered in Sec. 1.12 occur, or whenever there is a

    breach of the FCM's own policies and procedures, even if the

    circumstances in Sec. 1.12 have not occurred. Moreover, by requiring

    broad participation in training focused on these points, the proposed

    requirement would protect customer funds by encouraging a culture of

    accountability and transparency through self-disclosure. Training

    regarding the consequences of failing to comply will help to ensure

    that employees understand the seriousness with which the Commission

    regards violation of these standards, thereby providing an incentive to

    diligently adhere to them. In addition, requiring FCMs to provide the

    training annually helps ensure that the critical content of this

    training is not lost due to the passing of time, or employee turnover.

    In addition, by requiring automated financial risk management

    controls, the proposed Risk Management Program would reduce operational

    risk that could result from ``fat finger'' errors when submitting

    trades, or from technological ``glitches'' using automated trading.

    Several events have demonstrated that such operational risks are

    difficult to predict, tend to emerge so quickly that non-automated

    forms of risk management may not be able to contain them, and can

    threaten an FCM's continued viability. Automated controls would help to

    reduce these operational risks, thereby providing additional protection

    to FCMs and mitigating the risk of loss to customer funds.

    Last, by requiring an FCM to develop and implement written policies

    that ensure it has sufficient capital and liquidity not only to comply

    with the

    [[Page 67907]]

    Act and Commission regulations but also to meet its foreseeable needs,

    the proposed rule would promote reasoned decision making regarding

    capital retention and allocation decisions because such decisions would

    have to be made according to the established policies and procedures,

    weighing the factors and inputs included therein. Moreover, written

    procedures could be used by the Commission and relevant SROs as the

    basis for audits to check for compliance with such procedures, which

    would help the Commission and relevant SRO identify operational

    problems that could lead to loss of customer funds.

    In many cases the proposed rules provide flexibility to FCMs by

    requiring that they develop and document their own policies and

    procedures rather than prescribing specific procedures for them. In so

    doing, the proposal gives FCMs an opportunity to tailor policies and

    procedures that accommodate their specific needs and operational

    patterns, which may vary from one FCM to another based on differences

    in their size, involvement in specific markets, and the characteristics

    of their investor base. This approach is likely to be less costly for

    FCMs when compared to the alternative of a more prescriptive approach

    because it is less likely to require changes to operational patterns if

    existing procedures are adequate to provide the same protections to

    customer funds. In addition, the flexibility of this approach benefits

    market participants and customers alike because it is the FCM that is

    in the best position to define the precise form of internal controls

    that will best protect customer funds from operational errors and

    fraud.

    In addition, as suggested above, requiring FCMs to document their

    policies and procedures regarding their Risk Management Program would

    enable the Commission and DSRO to audit for operational problems that

    could put customer funds at risk before those risks turn into actual

    losses. This would strengthen the critical first line of defense

    against operational errors and fraud.

    Costs

    The risk management unit, required by the proposed rule, would

    create certain personnel costs. The Commission estimates that such a

    unit would require between one and ten full-time staff depending on the

    size and complexity of the FCM. Therefore, the Commission estimates

    that the annual cost for the risk management unit would be between

    $171,000 and $1,934,000.\103\

    ---------------------------------------------------------------------------

    \103\ This assumes 2,000-10,000 hours per year from compliance

    attorneys (i.e., 1-5 full time compliance attorneys) and 0-10,000

    hours per year from a senior risk management specialist (i.e., 0-5

    full time senior risk management specialists). The average

    compensation for a compliance attorney is $85.35/hour [$131,303 per

    year/(2000 hours per year)*1.3 is $85.35 per hour]; $85.35*2000 =

    $170,693.90 and $85.35*10,000 = $853,469.50. The average

    compensation for a senior risk management specialist is $83.13/hour

    [$166,251.00 per year/(2000 hours per year)*1.3 is $83.13 per hour];

    $83.13*0 = $0 and $83.13*10,000 = $1,080,631.50.

    ---------------------------------------------------------------------------

    There are costs associated with the Risk Management Program

    proposed in Sec. 1.11.

    a. Each FCM would likely have to review its operations, business

    model, market conditions, customer base, and a number of other factors

    in order to identify the risks that it should be monitoring. In

    addition, each FCM would have to develop and document methodologies for

    establishing risk tolerance limits for each risk that they choose to

    monitor. Last, for each FCM, the risks and proposed limits for those

    risks would have to be reviewed and approved quarterly by its senior

    management and annually by the board. The Commission estimates that the

    initial cost for identifying relevant risks and developing and

    documenting methodologies for establishing thresholds would be between

    $28,800 and $68,400.\104\ The ongoing cost for reviewing the risks and

    limits and approving them would be between $27,900 and $99,700 per

    year.\105\

    ---------------------------------------------------------------------------

    \104\ For initial costs, this estimates initial costs of 50-250

    hours from compliance attorneys, 10-100 hours from risk management

    personnel, 36 hours (total) of time from the board, and 10-20 hours

    each from the CEO, CFO, COO, and CCO. The average compensation for a

    compliance attorney is $85.35/hour [$131,303 per year/(2000 hours

    per year)*1.3 is $85.35 per hour]; $85.35*50 = $4,267.35 and

    $85.35*250 = $21,336.77. The average compensation for a risk

    management specialist is $65.33/hour [$100,500 per year/(2000 hours

    per year)*1.3 is $65.33 per hour]; $65.33*10 = $653.25 and

    $65.33*100 = $6,532.50. The average compensation for a member of a

    firm's board of directors is estimated by the Commission to be

    $200.00/hour [$100,000 per year/(500 hours per year) is $200 per

    hour]; $200.00*36 = $7,200.00. The average compensation for a chief

    executive officer is estimated by the Commission to be $650.00/hour

    [$1,000,000 per year/(2000 hours per year)*1.3 is $650.00 per hour];

    $650.00*10 = $6,500.00 and $650.00*20 = $13,000. The average

    compensation for both a chief financial officer and a chief

    operations officer is estimated by the Commission to be $455.00/hour

    [$700,000 per year/(2000 hours per year)*1.3 is $455.00 per hour];

    $455.00*10 = $4,550.00 and $455.00*20 = $9,100.00. The average

    compensation for a chief compliance officer is $110.97/hour [

    $170,727 per year/(2000 hours per year)*1.3 = $110.97/hour];

    $110.97*10 = $3,329.18 and $110.97*20 = $11,097.26.

    \105\ For ongoing costs, this estimates annual costs of 20-200

    hours from compliance attorneys, 50-300 hours from risk management

    personnel, 48 hours (total) of time from the board, and 8-32 hours

    each from CEO, CFO, COO, and CCO. Using the same compensation

    figures listed above, this is $85.35 *20 = $1,706.94 and $85.35*200

    = $17,069.39 for a compliance attorney; $65.33*50 = $3266.25 and

    $65.33*300 = $19,597.50 for a risk management specialist; $200.00*48

    = $9,600.00 for the board; $650.00*8 = $5,200.00 and $650.00*32 =

    $20,800.00 for the CEO; $455.00*8 = $3,640.00 and $455.00*32 =

    $14,560.00 for both the CFO and COO; and $110.97*8 = $887.78 and

    $110.97*32 = $3,551.12 for the CCO. The compensations of an average

    CEO and CFO are estimates by the Commission; the compensation of the

    board of directors is based on the average compensation of the

    boards of several large FCMs. All other figures are taken from the

    2011 SIFMA Report on Management and Professional Earnings in the

    Securities Industry.

    ---------------------------------------------------------------------------

    b. Developing these policies and procedures for detecting breaches

    of the risk tolerance limits and notifying appropriate personnel would

    create an initial cost, but little ongoing cost since most of the

    monitoring costs are included in other elements (quarterly reports,

    annual audits, etc.). The Commission estimates that the initial cost to

    develop these policies and procedures is between $3,400 and

    $6,800.\106\

    ---------------------------------------------------------------------------

    \106\ This estimates 40-80 hours of time from a compliance

    attorney. The average compensation for a compliance attorney is

    $85.35/hour [$131,303 per year/(2000 hours per year)*1.3 is $85.35

    per hour]; $85.35*40 = $3,413.88 and $85.35*80 = $6,827.76. These

    figures are taken from the 2011 SIFMA Report on Management and

    Professional Earnings in the Securities Industry.

    ---------------------------------------------------------------------------

    c. Many of the activities necessary for completing the quarterly

    review of risk thresholds will overlap with the activities necessary

    for completing the Risk Exposure Reports. However, some additional time

    will be required to compile the Report and to incorporate information

    that is distinct from that which is required for the quarterly review

    of risk thresholds. In addition, the FCM's board and senior management

    are obligated to review the report. Therefore, the Commission estimates

    that each Risk Exposure Report will cost between $8,800 and $13,300 per

    year.\107\

    ---------------------------------------------------------------------------

    \107\ This estimates 20-50 hours of compliance attorney time,

    20-50 hours from risk management personnel, 12 hours of board time,

    and 2 hours from each of the CEO, CFO, COO, and CCO. The average

    compensation for a compliance attorney is $85.35/hour [$131,303 per

    year/(2000 hours per year)*1.3 is $85.35 per hour]; $85.35*20 =

    $1,706.94 and $85.35*50 = $4,267.35. The average compensation for a

    risk management specialist is $65.33/hour [$100,500 per year/(2000

    hours per year)*1.3 is $65.33 per hour]; $65.33*20 = $1,306.50 and

    $65.33*50 = $3,266.25. The average compensation for a member of a

    firm's board of directors is estimated by the Commission to be

    $200.00/hour [$100,000 per year/(500 hours per year) is $200 per

    hour]; $200.00*12 = $2,400.00. The average compensation for a chief

    executive officer is estimated by the Commission to be $650.00/hour

    [$1,000,000 per year/(2000 hours per year)*1.3 is $650.00 per hour];

    $650.00*2 = $1,300.00. The average compensation for both a chief

    financial officer and a chief operations officer is estimated by the

    Commission to be $455.00/hour [$700,000 per year/(2000 hours per

    year)*1.3 is $455.00 per hour]; $455.00*2 = $910.00. The average

    compensation for a chief compliance officer is $110.97/hour [

    $170,727 per year/(2000 hours per year)*1.3 = $110.97/hour];

    $110.97*2 = $221.95. The compensations of an average CEO and CFO are

    estimates by the Commission; the compensation of the board of

    directors is based on the average compensation of the boards of

    several large FCMs. All other figures are taken from the 2011 SIFMA

    Report on Management and Professional Earnings in the Securities

    Industry.

    ---------------------------------------------------------------------------

    [[Page 67908]]

    d. The Commission estimates that review and testing of the Risk

    Management Program will cost between $6,000 and $24,300.\108\ An FCM

    must conduct such a review and testing annually as well as any time it

    experiences a material change in the business that is reasonably likely

    to alter the risk profile of the FCM. The Commission does not have

    adequate information to estimate how frequently such a change in the

    business will occur, so it has assumed one review and testing per year.

    ---------------------------------------------------------------------------

    \108\ This assumes four weeks' worth of time from one to four

    intermediate compliance specialists. The average compensation of an

    intermediate compliance specialist is $37.90/hour [$58,303.00 per

    year/(2000 hours per year)*1.3 is $37.90]; $37.90*40 hours/week*1 =

    $6,063.51 and $37.90*40 hours/week*4 = $24,254.05. These figures are

    taken from the 2011 SIFMA Report on Management and Professional

    Earnings in the Securities Industry.

    ---------------------------------------------------------------------------

    e. Regarding the policies and procedures that are required to

    address segregation risk, proposed Sec. 1.11 would create three sets

    of costs: (1) costs related to developing and documenting all required

    policies and procedures; (2) initial implementation costs; and (3)

    ongoing costs.\109\

    ---------------------------------------------------------------------------

    \109\ Developing, documenting, and implementing the requisite

    policies and procedures would require personnel hours from

    compliance attorneys, senior management, and limited involvement

    from others such as risk management, HR, and IT. Those costs are

    would vary, perhaps significantly, depending on the extent to which

    each FCM already has compliant procedures in place and the extent to

    which such procedures may already be documented. However, the

    Commission has endeavored to estimate broad ranges of costs that

    would likely result from efforts to develop and document the

    requirements of Sec. 1.11, to implement compliant procedures, and

    then to sustain such procedures on an ongoing basis. And while the

    benefits are enumerated separately because their substantive

    benefits, in several cases, vary from one requirement to the next,

    the substantive costs are, in many cases, overlapping, and therefore

    the Commission has addressed them collectively.

    ---------------------------------------------------------------------------

    1. The Commission estimates that developing and documenting

    requisite policies and procedures would require one or more compliance

    attorneys to be heavily involved interpreting and explaining the Act

    and Commission requirements to other affected employees, guiding other

    subject matter experts in the development of compliant operations, and

    drafting the required documentation. Risk management personnel would

    also likely be involved in developing procedures to review banks and

    Sec. 1.25 investments as well as to support the due diligence that

    senior management will have to conduct in order to establish a target

    residual interest for the FCM. The CFO and other senior personnel

    reporting to the CFO would likely be involved with selecting a target

    for the firm's residual interest and developing procedures for making

    withdrawals of residual interest for proprietary use. The CEO and board

    would be involved in reviewing and approving the policies and

    procedures required under Sec. 1.11. The Commission estimates that the

    likely cost for developing and documenting the policies and procedures

    that would be required under the proposed Sec. 1.11 would be between

    $54,800 and $131,000.\110\

    ---------------------------------------------------------------------------

    \110\ This estimate assumes 400-1000 hours of time from one or

    more compliance attorneys re: all aspects of the requirements

    (interpreting, summarizing, guiding compliance discussions,

    drafting, etc.), 80-160 hours from a firm's chief compliance officer

    re: All aspects of the program, 10-100 hours from risk management

    personnel re: bank selection, monitoring, process to assess Sec.

    1.25 investment decisions, and due diligence to support targeted

    residual amount decision, 4-20 hours from a firm's chief financial

    officer re: selection of target for residual funds and process for

    withdrawal of segregated account funds not for the benefit of FCM

    customers, 2-4 hours from a firm's CEO, and 40-50 hours from board

    collectively re: discussion and approval of written policies and

    procedures. The average compensation for a compliance attorney is

    $85.35/hour [$131,303 per year/(2000 hours per year)*1.3 is $85.35

    per hour]; $85.35*400 = $34,140.00 and $85.35*1000 = $85,350.00. The

    average compensation for a chief compliance officer is $110.97/hour

    [ $170,727 per year/(2000 hours per year)*1.3 = $110.97/hour];

    $110.97*60 = $6,658.35 and $110.97*100 = $11,097.26. The average

    compensation for a risk management specialist is $65.33/hour

    [$100,500 per year/(2000 hours per year)*1.3 is $65.33 per hour];

    $65.33*10 = $653.25 and $65.33*100 = $6,532.50. The average

    compensation for a chief financial officer is estimated by the

    Commission to be $455.00/hour [$700,000 per year/(2000 hours per

    year)*1.3 is $455.00 per hour]; $455.00*4 = $1,820.00 and $455.00*20

    = $9,100.00. The average compensation for a chief executive officer

    is estimated by the Commission to be $650.00/hour [$1,000,000 per

    year/(2000 hours per year)*1.3 is $650.00 per hour]; $650.00*2 =

    $1,300.00 and $650.00*4 = $2,600.00. The average compensation for a

    member of a firm's board of directors is estimated by the Commission

    to be $200.00/hour [$100,000 per year/(500 hours per year) is $200

    per hour]; $200.00*40 = $8,00.00 and $200.00*50 = $10,000.00. The

    compensations of an average CEO and CFO are estimates by the

    Commission; the compensation of the board of directors is based on

    the average compensation of the boards of several large FCMs. All

    other figures are taken from the 2011 SIFMA Report on Management and

    Professional Earnings in the Securities Industry.

    ---------------------------------------------------------------------------

    2. The policies and procedures must not only be documented, they

    must be implemented, which will create some one-time costs that will

    depend significantly on the extent to which an FCM already practices

    some of the operational procedures that the Commission is requiring

    here. While the Commission expects that some FCMs are likely to have

    certain policies and procedures in place already that comply with Sec.

    1.11, the Commission does not have adequate information to determine to

    what extent this is true. Therefore, for the purposes of estimation we

    have estimated the one-time costs for an entity that does not yet have

    any of the required policies and procedures in place. The Commission

    anticipates that in such a circumstance, implementing new policies and

    procedures would require risk management personnel to conduct initial

    due diligence on depositories and existing as well as prospective Sec.

    1.25 investments. Human Resource (``HR'') personnel would have to

    revise job descriptions to comply with policies to separate critical

    functions related to handling of customer funds, and would also have to

    develop new annual training.\111\ One or more compliance attorneys

    would be involved ensuring that accounts are titled appropriately,

    securing requisite acknowledgment letters from depositories, setting up

    quarterly audits of policies and procedures, and providing general

    oversight of the implementation process. IT personnel will likely be

    required to automate certain aspects of the information collection that

    is necessary, and the CCO would likely be involved on virtually a full-

    time basis for some period of time as well, overseeing the

    implementation of critical new policies and procedures. The Commission

    estimates the cost for such an implementation would range between

    $90,800 and $275,300.\112\

    ---------------------------------------------------------------------------

    \111\ However, they are likely to outsource some pieces of the

    implementation (e.g. annual training would likely be developed by

    vendors to meet the needs of multiple market participants) which

    will mitigate associated costs. If a firm chooses to use training

    created by a vendor, that would likely reduce the HR one-time costs

    significantly.

    \112\ This estimate assumes 100-200 hours of risk management

    personnel time (from employees of varying levels of pay) conducting

    initial due diligence on depositories and evaluating Sec. 1.25

    investments, 800-1000 hours of human resources personnel time (400-

    500 at a junior level and 400-500 at a senior level) revising job

    descriptions to accommodate separation of roles and developing

    annual training, 20-400 hours of time from one or more compliance

    attorneys for retitling accounts, securing requisite

    acknowledgements from depositories, setting up quarterly audits, and

    customer funds in order to move open positions to a different FCM.

    4. The proposal requires senior management to conduct due diligence

    to understand various factors that could impact the amount of residual

    interest that would be prudent to maintain in the segregated funds

    account, and then reach a determination about a targeted amount. The

    benefit of such a requirement is that it would protect customer funds

    by creating accountability for senior management. Requiring such due

    diligence helps ensure that senior management is attentive to the

    causes of segregated funds account underfunding. The requirement allows

    both flexibility and accountability in that it allows FCMs to account

    for relevant factors that vary across firms when determining an

    appropriate target, rather than requiring all FCMs to maintain a common

    target for residual interest. However, by requiring them to establish

    such a target and to conduct due diligence in doing so, it allows the

    Commission and DSROs to audit the FCMs to ensure that they reached

    their target through a reasoned decision-making process, and ensures

    that the respective boards approve and are responsible for the target.

    Maintaining a target enhances market discipline by creating public

    accountability for an FCM. It communicates to customers that the FCM

    intends to maintain a certain residual interest in the account, and

    gives customers an opportunity to consider, when selecting an FCM, the

    additional security that varied levels of residual interest may provide

    for their funds.

    5. A process for the withdrawal of residual interest that is not

    for the benefit of customers would help to ensure good communication

    and that senior managers are appropriately involved in the decision to

    remove

    [[Page 67906]]

    residual interest from segregated customer accounts. Good

    communication, deliberate decision-making, and proper involvement of

    senior managers would promote accountability when an FCM is removing

    residual interest. These benefits are particularly important at times

    when FCMs experience financial stress because good communication,

    deliberate decision-making, and proper involvement of senior management

    in decisions related to residual interest may be more likely to fail at

    such times, creating risk to segregated customer funds. By requiring

    FCMs to establish and follow procedures for withdrawals of residual

    interest, the rule would help to ensure that such failures do not

    occur.

    An additional, related benefit is that by ensuring proper

    communication with and approval from relevant senior managers before

    such withdrawals occur, the proposed changes would enhance

    accountability among those managers for decisions that could create

    risk for segregated customer funds.

    6. FCMs have a range of potential investments that are compliant

    with Sec. 1.25. By requiring FCMs to establish a process for deciding

    how to invest those funds, the requirement would provide the Commission

    and DSRO with a standard by which such investment decisions could be

    judged, which would help prevent the FCM from investing primarily in

    the least credit-worthy Sec. 1.25 investments. FCMs have an incentive

    to invest customer funds in Sec. 1.25 compliant investments that offer

    the highest rate of return possible, but it is possible that the Sec.

    1.25 investments offering the highest rates of return are also less

    credit-worthy or less liquid than other Sec. 1.25 investments.

    Requiring FCMs to set up, document and follow a process for assessing

    the appropriateness of investing segregated funds in Sec. 1.25

    investments ensures that FCMs take steps not only to determine whether

    an investment complies with Sec. 1.25 as required by current

    regulation, but that the investment is also evaluated with respect to

    any risk it may pose to the FCM's primary responsibilities of

    preserving principal and maintaining liquidity when handling customer

    funds. In other words, this provision would help to prevent the

    possibility of a ``race to the bottom'' for FCMs investing in Sec.

    1.25 compliant assets.

    7. If the FCM is not able to get accurate pricing for Sec. 1.25

    assets, it is difficult to know whether or not sufficient funds are in

    the segregated account. A shortage (and thus, in the event of

    insolvency, a loss of customer funds) could occur simply because the

    FCM can't accurately estimate the value of the assets that are there,

    or it could also make it easier for the FCM to intentionally skew their

    reports regarding funds in the customer segregated accounts by making

    favorable assumptions about the value of assets that are difficult to

    price. Requiring the FCM to establish a program for assessing the ease

    of pricing for Sec. 1.25 assets helps reduce these risks and gives the

    Commission and DSRO an opportunity to understand the FCM's procedures

    and to enforce the FCM's compliance with them. This, in turn, promotes

    reasoned and disciplined decision-making with respect to the FCM's

    investment of customer funds in Sec. 1.25 investments. Establishing

    procedures to evaluate the liquidity of Sec. 1.25 instruments will

    help FCMs minimize the risk of such problems.

    8. Appropriate internal controls are critical to the prevention of

    fraud. The Commission understands that FCMs typically require that

    certain duties are performed by separate people or separate groups of

    people in order to ensure that a proper system of checks and

    verification remains in place.\102\ In particular, FCMs generally

    ensure that the individuals responsible for reporting and associated

    calculations are separate from the individuals responsible for

    operational transfers of funds. In the absence of such internal

    controls, one person or group of people with access to both movement

    and reporting of funds could transfer funds and then, for a time, hide

    those transfers from senior management, auditors, and the public.

    ---------------------------------------------------------------------------

    \102\ See ``Initial Recommendations for Customer Funds

    Protection'' by the FIA Futures Markets Financial Integrity Task

    Force.

    ---------------------------------------------------------------------------

    The proposed rule would help protect customer funds by establishing

    a regulatory requirement that all FCMs develop procedures to ensure

    that the individuals responsible for calculating and reporting

    segregation account requirements and segregation account funds do not

    share duties with those who are responsible for transferring or

    investing segregated funds. This should result in controls to prevent

    fraudulent fund transfers.

    9. The Commission regulations already require timely recording of

    transactions in Sec. 1.35(b), but this proposed addition would require

    that FCMs develop written policies and procedures ensure that they have

    a consistent process to achieve that outcome. Again, requiring FCMs to

    document their procedures helps protect customer funds by enabling the

    Commission and DSROs to audit for compliance, detecting and preventing

    operational issues that could pose risk to customer funds before those

    risks result in an actual loss to customer funds.

    10. Proper training of employees would help to ensure that

    employees understand the written procedures regarding segregated funds.

    The proposed training requirement provides flexibility for an FCM to

    determine whether it should develop the required training in house, or

    to pay a vendor to develop a training program. Training regarding the

    requirements of the Act and Commission regulations regarding handling

    customer funds will help to ensure that employees understand how the

    procedures and requirements related to customer funds apply to various

    situations they face in their work for the FCM. Training regarding the

    second and third points mentioned above will help to ensure that the

    Commission and DSRO are notified promptly whenever any of the

    circumstances covered in Sec. 1.12 occur, or whenever there is a

    breach of the FCM's own policies and procedures, even if the

    circumstances in Sec. 1.12 have not occurred. Moreover, by requiring

    broad participation in training focused on these points, the proposed

    requirement would protect customer funds by encouraging a culture of

    accountability and transparency through self-disclosure. Training

    regarding the consequences of failing to comply will help to ensure

    that employees understand the seriousness with which the Commission

    regards violation of these standards, thereby providing an incentive to

    diligently adhere to them. In addition, requiring FCMs to provide the

    training annually helps ensure that the critical content of this

    training is not lost due to the passing of time, or employee turnover.

    In addition, by requiring automated financial risk management

    controls, the proposed Risk Management Program would reduce operational

    risk that could result from ``fat finger'' errors when submitting

    trades, or from technological ``glitches'' using automated trading.

    Several events have demonstrated that such operational risks are

    difficult to predict, tend to emerge so quickly that non-automated

    forms of risk management may not be able to contain them, and can

    threaten an FCM's continued viability. Automated controls would help to

    reduce these operational risks, thereby providing additional protection

    to FCMs and mitigating the risk of loss to customer funds.

    Last, by requiring an FCM to develop and implement written policies

    that ensure it has sufficient capital and liquidity not only to comply

    with the

    [[Page 67907]]

    Act and Commission regulations but also to meet its foreseeable needs,

    the proposed rule would promote reasoned decision making regarding

    capital retention and allocation decisions because such decisions would

    have to be made according to the established policies and procedures,

    weighing the factors and inputs included therein. Moreover, written

    procedures could be used by the Commission and relevant SROs as the

    basis for audits to check for compliance with such procedures, which

    would help the Commission and relevant SRO identify operational

    problems that could lead to loss of customer funds.

    In many cases the proposed rules provide flexibility to FCMs by

    requiring that they develop and document their own policies and

    procedures rather than prescribing specific procedures for them. In so

    doing, the proposal gives FCMs an opportunity to tailor policies and

    procedures that accommodate their specific needs and operational

    patterns, which may vary from one FCM to another based on differences

    in their size, involvement in specific markets, and the characteristics

    of their investor base. This approach is likely to be less costly for

    FCMs when compared to the alternative of a more prescriptive approach

    because it is less likely to require changes to operational patterns if

    existing procedures are adequate to provide the same protections to

    customer funds. In addition, the flexibility of this approach benefits

    market participants and customers alike because it is the FCM that is

    in the best position to define the precise form of internal controls

    that will best protect customer funds from operational errors and

    fraud.

    In addition, as suggested above, requiring FCMs to document their

    policies and procedures regarding their Risk Management Program would

    enable the Commission and DSRO to audit for operational problems that

    could put customer funds at risk before those risks turn into actual

    losses. This would strengthen the critical first line of defense

    against operational errors and fraud.

    Costs

    The risk management unit, required by the proposed rule, would

    create certain personnel costs. The Commission estimates that such a

    unit would require between one and ten full-time staff depending on the

    size and complexity of the FCM. Therefore, the Commission estimates

    that the annual cost for the risk management unit would be between

    $171,000 and $1,934,000.\103\

    ---------------------------------------------------------------------------

    \103\ This assumes 2,000-10,000 hours per year from compliance

    attorneys (i.e., 1-5 full time compliance attorneys) and 0-10,000

    hours per year from a senior risk management specialist (i.e., 0-5

    full time senior risk management specialists). The average

    compensation for a compliance attorney is $85.35/hour [$131,303 per

    year/(2000 hours per year)*1.3 is $85.35 per hour]; $85.35*2000 =

    $170,693.90 and $85.35*10,000 = $853,469.50. The average

    compensation for a senior risk management specialist is $83.13/hour

    [$166,251.00 per year/(2000 hours per year)*1.3 is $83.13 per hour];

    $83.13*0 = $0 and $83.13*10,000 = $1,080,631.50.

    ---------------------------------------------------------------------------

    There are costs associated with the Risk Management Program

    proposed in Sec. 1.11.

    a. Each FCM would likely have to review its operations, business

    model, market conditions, customer base, and a number of other factors

    in order to identify the risks that it should be monitoring. In

    addition, each FCM would have to develop and document methodologies for

    establishing risk tolerance limits for each risk that they choose to

    monitor. Last, for each FCM, the risks and proposed limits for those

    risks would have to be reviewed and approved quarterly by its senior

    management and annually by the board. The Commission estimates that the

    initial cost for identifying relevant risks and developing and

    documenting methodologies for establishing thresholds would be between

    $28,800 and $68,400.\104\ The ongoing cost for reviewing the risks and

    limits and approving them would be between $27,900 and $99,700 per

    year.\105\

    ---------------------------------------------------------------------------

    \104\ For initial costs, this estimates initial costs of 50-250

    hours from compliance attorneys, 10-100 hours from risk management

    personnel, 36 hours (total) of time from the board, and 10-20 hours

    each from the CEO, CFO, COO, and CCO. The average compensation for a

    compliance attorney is $85.35/hour [$131,303 per year/(2000 hours

    per year)*1.3 is $85.35 per hour]; $85.35*50 = $4,267.35 and

    $85.35*250 = $21,336.77. The average compensation for a risk

    management specialist is $65.33/hour [$100,500 per year/(2000 hours

    per year)*1.3 is $65.33 per hour]; $65.33*10 = $653.25 and

    $65.33*100 = $6,532.50. The average compensation for a member of a

    firm's board of directors is estimated by the Commission to be

    $200.00/hour [$100,000 per year/(500 hours per year) is $200 per

    hour]; $200.00*36 = $7,200.00. The average compensation for a chief

    executive officer is estimated by the Commission to be $650.00/hour

    [$1,000,000 per year/(2000 hours per year)*1.3 is $650.00 per hour];

    $650.00*10 = $6,500.00 and $650.00*20 = $13,000. The average

    compensation for both a chief financial officer and a chief

    operations officer is estimated by the Commission to be $455.00/hour

    [$700,000 per year/(2000 hours per year)*1.3 is $455.00 per hour];

    $455.00*10 = $4,550.00 and $455.00*20 = $9,100.00. The average

    compensation for a chief compliance officer is $110.97/hour [

    $170,727 per year/(2000 hours per year)*1.3 = $110.97/hour];

    $110.97*10 = $3,329.18 and $110.97*20 = $11,097.26.

    \105\ For ongoing costs, this estimates annual costs of 20-200

    hours from compliance attorneys, 50-300 hours from risk management

    personnel, 48 hours (total) of time from the board, and 8-32 hours

    each from CEO, CFO, COO, and CCO. Using the same compensation

    figures listed above, this is $85.35 *20 = $1,706.94 and $85.35*200

    = $17,069.39 for a compliance attorney; $65.33*50 = $3266.25 and

    $65.33*300 = $19,597.50 for a risk management specialist; $200.00*48

    = $9,600.00 for the board; $650.00*8 = $5,200.00 and $650.00*32 =

    $20,800.00 for the CEO; $455.00*8 = $3,640.00 and $455.00*32 =

    $14,560.00 for both the CFO and COO; and $110.97*8 = $887.78 and

    $110.97*32 = $3,551.12 for the CCO. The compensations of an average

    CEO and CFO are estimates by the Commission; the compensation of the

    board of directors is based on the average compensation of the

    boards of several large FCMs. All other figures are taken from the

    2011 SIFMA Report on Management and Professional Earnings in the

    Securities Industry.

    ---------------------------------------------------------------------------

    b. Developing these policies and procedures for detecting breaches

    of the risk tolerance limits and notifying appropriate personnel would

    create an initial cost, but little ongoing cost since most of the

    monitoring costs are included in other elements (quarterly reports,

    annual audits, etc.). The Commission estimates that the initial cost to

    develop these policies and procedures is between $3,400 and

    $6,800.\106\

    ---------------------------------------------------------------------------

    \106\ This estimates 40-80 hours of time from a compliance

    attorney. The average compensation for a compliance attorney is

    $85.35/hour [$131,303 per year/(2000 hours per year)*1.3 is $85.35

    per hour]; $85.35*40 = $3,413.88 and $85.35*80 = $6,827.76. These

    figures are taken from the 2011 SIFMA Report on Management and

    Professional Earnings in the Securities Industry.

    ---------------------------------------------------------------------------

    c. Many of the activities necessary for completing the quarterly

    review of risk thresholds will overlap with the activities necessary

    for completing the Risk Exposure Reports. However, some additional time

    will be required to compile the Report and to incorporate information

    that is distinct from that which is required for the quarterly review

    of risk thresholds. In addition, the FCM's board and senior management

    are obligated to review the report. Therefore, the Commission estimates

    that each Risk Exposure Report will cost between $8,800 and $13,300 per

    year.\107\

    ---------------------------------------------------------------------------

    \107\ This estimates 20-50 hours of compliance attorney time,

    20-50 hours from risk management personnel, 12 hours of board time,

    and 2 hours from each of the CEO, CFO, COO, and CCO. The average

    compensation for a compliance attorney is $85.35/hour [$131,303 per

    year/(2000 hours per year)*1.3 is $85.35 per hour]; $85.35*20 =

    $1,706.94 and $85.35*50 = $4,267.35. The average compensation for a

    risk management specialist is $65.33/hour [$100,500 per year/(2000

    hours per year)*1.3 is $65.33 per hour]; $65.33*20 = $1,306.50 and

    $65.33*50 = $3,266.25. The average compensation for a member of a

    firm's board of directors is estimated by the Commission to be

    $200.00/hour [$100,000 per year/(500 hours per year) is $200 per

    hour]; $200.00*12 = $2,400.00. The average compensation for a chief

    executive officer is estimated by the Commission to be $650.00/hour

    [$1,000,000 per year/(2000 hours per year)*1.3 is $650.00 per hour];

    $650.00*2 = $1,300.00. The average compensation for both a chief

    financial officer and a chief operations officer is estimated by the

    Commission to be $455.00/hour [$700,000 per year/(2000 hours per

    year)*1.3 is $455.00 per hour]; $455.00*2 = $910.00. The average

    compensation for a chief compliance officer is $110.97/hour [

    $170,727 per year/(2000 hours per year)*1.3 = $110.97/hour];

    $110.97*2 = $221.95. The compensations of an average CEO and CFO are

    estimates by the Commission; the compensation of the board of

    directors is based on the average compensation of the boards of

    several large FCMs. All other figures are taken from the 2011 SIFMA

    Report on Management and Professional Earnings in the Securities

    Industry.

    ---------------------------------------------------------------------------

    [[Page 67908]]

    d. The Commission estimates that review and testing of the Risk

    Management Program will cost between $6,000 and $24,300.\108\ An FCM

    must conduct such a review and testing annually as well as any time it

    experiences a material change in the business that is reasonably likely

    to alter the risk profile of the FCM. The Commission does not have

    adequate information to estimate how frequently such a change in the

    business will occur, so it has assumed one review and testing per year.

    ---------------------------------------------------------------------------

    \108\ This assumes four weeks' worth of time from one to four

    intermediate compliance specialists. The average compensation of an

    intermediate compliance specialist is $37.90/hour [$58,303.00 per

    year/(2000 hours per year)*1.3 is $37.90]; $37.90*40 hours/week*1 =

    $6,063.51 and $37.90*40 hours/week*4 = $24,254.05. These figures are

    taken from the 2011 SIFMA Report on Management and Professional

    Earnings in the Securities Industry.

    ---------------------------------------------------------------------------

    e. Regarding the policies and procedures that are required to

    address segregation risk, proposed Sec. 1.11 would create three sets

    of costs: (1) costs related to developing and documenting all required

    policies and procedures; (2) initial implementation costs; and (3)

    ongoing costs.\109\

    ---------------------------------------------------------------------------

    \109\ Developing, documenting, and implementing the requisite

    policies and procedures would require personnel hours from

    compliance attorneys, senior management, and limited involvement

    from others such as risk management, HR, and IT. Those costs are

    would vary, perhaps significantly, depending on the extent to which

    each FCM already has compliant procedures in place and the extent to

    which such procedures may already be documented. However, the

    Commission has endeavored to estimate broad ranges of costs that

    would likely result from efforts to develop and document the

    requirements of Sec. 1.11, to implement compliant procedures, and

    then to sustain such procedures on an ongoing basis. And while the

    benefits are enumerated separately because their substantive

    benefits, in several cases, vary from one requirement to the next,

    the substantive costs are, in many cases, overlapping, and therefore

    the Commission has addressed them collectively.

    ---------------------------------------------------------------------------

    1. The Commission estimates that developing and documenting

    requisite policies and procedures would require one or more compliance

    attorneys to be heavily involved interpreting and explaining the Act

    and Commission requirements to other affected employees, guiding other

    subject matter experts in the development of compliant operations, and

    drafting the required documentation. Risk management personnel would

    also likely be involved in developing procedures to review banks and

    Sec. 1.25 investments as well as to support the due diligence that

    senior management will have to conduct in order to establish a target

    residual interest for the FCM. The CFO and other senior personnel

    reporting to the CFO would likely be involved with selecting a target

    for the firm's residual interest and developing procedures for making

    withdrawals of residual interest for proprietary use. The CEO and board

    would be involved in reviewing and approving the policies and

    procedures required under Sec. 1.11. The Commission estimates that the

    likely cost for developing and documenting the policies and procedures

    that would be required under the proposed Sec. 1.11 would be between

    $54,800 and $131,000.\110\

    ---------------------------------------------------------------------------

    \110\ This estimate assumes 400-1000 hours of time from one or

    more compliance attorneys re: all aspects of the requirements

    (interpreting, summarizing, guiding compliance discussions,

    drafting, etc.), 80-160 hours from a firm's chief compliance officer

    re: All aspects of the program, 10-100 hours from risk management

    personnel re: bank selection, monitoring, process to assess Sec.

    1.25 investment decisions, and due diligence to support targeted

    residual amount decision, 4-20 hours from a firm's chief financial

    officer re: selection of target for residual funds and process for

    withdrawal of segregated account funds not for the benefit of FCM

    customers, 2-4 hours from a firm's CEO, and 40-50 hours from board

    collectively re: discussion and approval of written policies and

    procedures. The average compensation for a compliance attorney is

    $85.35/hour [$131,303 per year/(2000 hours per year)*1.3 is $85.35

    per hour]; $85.35*400 = $34,140.00 and $85.35*1000 = $85,350.00. The

    average compensation for a chief compliance officer is $110.97/hour

    [ $170,727 per year/(2000 hours per year)*1.3 = $110.97/hour];

    $110.97*60 = $6,658.35 and $110.97*100 = $11,097.26. The average

    compensation for a risk management specialist is $65.33/hour

    [$100,500 per year/(2000 hours per year)*1.3 is $65.33 per hour];

    $65.33*10 = $653.25 and $65.33*100 = $6,532.50. The average

    compensation for a chief financial officer is estimated by the

    Commission to be $455.00/hour [$700,000 per year/(2000 hours per

    year)*1.3 is $455.00 per hour]; $455.00*4 = $1,820.00 and $455.00*20

    = $9,100.00. The average compensation for a chief executive officer

    is estimated by the Commission to be $650.00/hour [$1,000,000 per

    year/(2000 hours per year)*1.3 is $650.00 per hour]; $650.00*2 =

    $1,300.00 and $650.00*4 = $2,600.00. The average compensation for a

    member of a firm's board of directors is estimated by the Commission

    to be $200.00/hour [$100,000 per year/(500 hours per year) is $200

    per hour]; $200.00*40 = $8,00.00 and $200.00*50 = $10,000.00. The

    compensations of an average CEO and CFO are estimates by the

    Commission; the compensation of the board of directors is based on

    the average compensation of the boards of several large FCMs. All

    other figures are taken from the 2011 SIFMA Report on Management and

    Professional Earnings in the Securities Industry.

    ---------------------------------------------------------------------------

    2. The policies and procedures must not only be documented, they

    must be implemented, which will create some one-time costs that will

    depend significantly on the extent to which an FCM already practices

    some of the operational procedures that the Commission is requiring

    here. While the Commission expects that some FCMs are likely to have

    certain policies and procedures in place already that comply with Sec.

    1.11, the Commission does not have adequate information to determine to

    what extent this is true. Therefore, for the purposes of estimation we

    have estimated the one-time costs for an entity that does not yet have

    any of the required policies and procedures in place. The Commission

    anticipates that in such a circumstance, implementing new policies and

    procedures would require risk management personnel to conduct initial

    due diligence on depositories and existing as well as prospective Sec.

    1.25 investments. Human Resource (``HR'') personnel would have to

    revise job descriptions to comply with policies to separate critical

    functions related to handling of customer funds, and would also have to

    develop new annual training.\111\ One or more compliance attorneys

    would be involved ensuring that accounts are titled appropriately,

    securing requisite acknowledgment letters from depositories, setting up

    quarterly audits of policies and procedures, and providing general

    oversight of the implementation process. IT personnel will likely be

    required to automate certain aspects of the information collection that

    is necessary, and the CCO would likely be involved on virtually a full-

    time basis for some period of time as well, overseeing the

    implementation of critical new policies and procedures. The Commission

    estimates the cost for such an implementation would range between

    $90,800 and $275,300.\112\

    ---------------------------------------------------------------------------

    \111\ However, they are likely to outsource some pieces of the

    implementation (e.g. annual training would likely be developed by

    vendors to meet the needs of multiple market participants) which

    will mitigate associated costs. If a firm chooses to use training

    created by a vendor, that would likely reduce the HR one-time costs

    significantly.

    \112\ This estimate assumes 100-200 hours of risk management

    personnel time (from employees of varying levels of pay) conducting

    initial due diligence on depositories and evaluating Sec. 1.25

    investments, 800-1000 hours of human resources personnel time (400-

    500 at a junior level and 400-500 at a senior level) revising job

    descriptions to accommodate separation of roles and developing

    annual training, 20-400 hours of time from one or more compliance

    attorneys for retitling accounts, securing requisite

    acknowledgements from depositories, setting up quarterly audits, and

    general oversight of implementation of new policies and procedures,

    4-12 weeks of the time of a firm's Chief Compliance Officer, or 160-

    480 hours, and 160-800 hours of the time of IT personnel (140-700 at

    a junior to intermediate level and 20-100 at a senior level) as the

    firm will likely seek to automate some types of information

    collection and other steps necessary to support requirements. The

    average compensation for a senior risk management specialist is

    $108.06/hour [$166,251 per year/(2000 hours per year)*1.3 is $108.06

    per hour]; $108.06*100 = $10,806.00 and $108.06*500 = $54,030.00.

    The average compensation for a risk management specialist is $65.33/

    hour [$100,500 per year/(2000 hours per year)*1.3 is $65.33 per

    hour]; $65.33*100 = $6,532.50 and $65.33*500 = $32,665.00. The

    average compensation for a junior human resources representative is

    $40.95/hour [$62,989 per year/(2000 hours per year)*1.3 is $40.95

    per hour]; $40.95*800 = $32,760.00 and $40.95*1000 = $40,950.00. The

    average compensation for a senior human resources representative is

    $71.45/hour [$109,921 per year/(2000 hours per year)*1.3 is $71.45

    per hour]; $71.45*100 = $7,144.87 and $71.45*500 = $35,724.33. The

    average compensation for a compliance attorney is $85.35/hour

    [$131,303 per year/(2000 hours per year)*1.3 is $85.35 per hour];

    $85.35*20 = $1,706.94 and $85.35*400 = $34,138.78. The average

    compensation for a chief compliance officer is $110.97/hour [

    $170,727 per year/(2000 hours per year)*1.3 = $110.97/hour];

    $110.97*160 = $17,755.61 and $110.97*480 = $53,266.82. The average

    compensation for a programmer is $53.64/hour [$82,518 per year/(2000

    hours per year)*1.3 = $53.64/hour]; $53.64*140 = $7,509.14 and

    $53.64*700 = $37,545.69. The average compensation for a senior

    programmer is $74.56/hour [$114,714 per year/(2000 hours per

    year)*1.3 = $74.56/hour]; $74.56*20 = $1,491.28 and $74.56*100 =

    $7,456.41. All figures are taken from the 2011 SIFMA Report on

    Management and Professional Earnings in the Securities Industry.

    ---------------------------------------------------------------------------

    [[Page 67909]]

    3. The costs necessary to sustain the policies and procedures

    required under Sec. 1.11 are difficult to estimate because they would

    depend on variables such as the size of the firm, the program of

    governing supervision that they develop, and the degree of automation

    they achieve in their various ongoing processes (monitoring

    depositories, evaluating Sec. 1.25 investments, reevaluating residual

    funds target, etc.), and the degree to which their operations are

    already compliant with the policies and procedures they would develop

    pursuant to the proposed Sec. 1.11. However, as a lower bound, the

    ongoing costs would include expenses related to the time for: (1) The

    CCO to review quarterly audits and conduct due diligence that is

    necessary before providing certification of compliance with the Act,

    regulations and its policies and procedures with respect to segregated

    funds in the annual report; (2) risk management personnel to evaluate

    Sec. 1.25 investments for liquidity and marketability and to monitor

    depository institutions where customer segregated funds are held; (3)

    the CFO and other senior management to review and determine the

    continued appropriateness of the FCM's target for residual interest;

    and (4) HR personnel to organize and deliver annual training. The

    Commission estimates that the lower bound for these costs is

    approximately $20,000 and that costs may be higher, depending on the

    variables mentioned above.\113\

    ---------------------------------------------------------------------------

    \113\ This estimate assumes 20+ hours per year from the CCO for

    due diligence and certification of compliance on annual report and

    reviewing quarterly audits, 40+ hours each per year from junior and

    senior risk management personnel evaluating Sec. 1.25 investments

    for liquidity and marketability and monitoring depository

    institutions where customer segregated funds are held, 6+ hours per

    year from the CFO and other senior management for reviewing the

    target for the firm's residual interest, and 20+ hours each per year

    from junior and senior HR--organizing and delivering annual

    training, as well as at least a day's training for 20 employees, or

    160 hours from an average financial employee, such as a general

    intermediate trader. The average compensation for a chief compliance

    officer is $110.97/hour [$170,727 per year/(2000 hours per year)*1.3

    = $110.97/hour]; $110.97*20 = $2,219.45. The average compensation

    for a senior risk management specialist is $108.06/hour [$166,251

    per year/(2000 hours per year)*1.3 is $108.06 per hour]; $108.06*40

    = $4,322.53. The average compensation for a risk management

    specialist is $65.33/hour [$100,500 per year/(2000 hours per

    year)*1.3 is $65.33 per hour]; $65.33*40 = $2,613.00. The average

    compensation for a chief financial officer is estimated by the

    Commission to be $455.00 per/hour [$700,000 per year/(2000 hours per

    year)*1.3 is $455.00 per hour]; $455.00*6 = $2,730. The average

    compensation for a junior human resources representative is $40.94/

    hour [$62,989.00 per year/(2000 hours per year) = $40.94/hour];

    $40.94*20 = $818.86. The average compensation for a senior human

    resources representative is $71.45/hour [$109,921.00 per year/(2000

    hours per year) = $71.45/hour]; $71.45*20 = $1,428.97. The average

    compensation for a general intermediate trader is $36.48/hour

    [$56,130.00 per year/(2000 hours per year)*1.3 is $36.48 per hour];

    $36.48*160 = $5,837.52. The compensations of an average CFO is an

    estimate by the Commission. All other figures are taken from the

    2011 SIFMA Report on Management and Professional Earnings in the

    Securities Industry.

    ---------------------------------------------------------------------------

    In addition, FCMs would have to implement automated financial risk

    management controls that are reasonably designed to prevent entering of

    erroneous trades. The Commission anticipates that some, but not all,

    FCMs already have such systems in place. For those FCMs that do not yet

    have such systems in place, the Commission proposes that it would cost

    an FCM between $10,300 and $89,400 to implement such a system.\114\

    ---------------------------------------------------------------------------

    \114\ This estimates 150-1500 hours of mid-level IT programming

    time and 30-120 hours of senior level IT personnel time. The average

    compensation for a programmer is $53.64/hour [$82,518 per year/(2000

    hours per year)*1.3 = $53.64/hour]; $53.64*150 = $8,045.51 and

    $53.64*1500 = $80,455.05. The average compensation for a senior

    programmer is $74.56/hour [$114,714 per year/(2000 hours per

    year)*1.3 = $74.56/hour]; $74.56*30 = $2,236.92 and $74.56*120 =

    $8,947.69. All figures are taken from the 2011 SIFMA Report on

    Management and Professional Earnings in the Securities Industry.

    ---------------------------------------------------------------------------

    Sec. 1.12 Maintenance of Minimum Financial Requirements by Futures

    Commission Merchants and Introducing Brokers

    Proposed Changes

    As described in the section by section discussion at II.C, the

    proposed changes to Sec. 1.12 would alter the notice requirement so

    that it is no longer acceptable to give ``telephonic notice to be

    confirmed, in writing, by facsimile.'' Instead, all notices would be

    made in writing and submitted through an electronic medium acceptable

    to the Commission (currently, WinJammer).

    In addition, as described above in II.C, the proposed changes would

    require that if an FCM has a shortfall in net capital but is not sure

    of their financial condition, the FCM should not delay notifying the

    Commission about the shortfall in net capital. The FCM must communicate

    each piece of information (knowledge of the shortfall and knowledge of

    the financial condition of the FCM) to the Commission as soon as it is

    known.

    The proposed requirements in paragraphs (i), (j), (k) and (l) of

    Sec. 1.12 identify additional circumstances in which the FCM must

    provide immediate written notice to the Commission, relevant SRO and to

    the SEC if the FCM is also a broker-dealer. Those circumstances are:

    (1) If an FCM discovers that any of the funds in segregated accounts

    are invested in investments not permitted under Sec. 1.25; (2) if an

    FCM does not have sufficient funds in any of their segregated accounts

    to meet their targeted residual interest; (3) if the FCM experiences a

    material adverse impact to its creditworthiness or ability to fund its

    obligations; (4) whenever the FCM has a material change in operations

    including changes to senior management, lines of business, clearing

    arrangements, or credit arrangements that could have a negative impact

    on the FCM's liquidity; and (5) if the FCM receives a notice,

    examination report, or any other correspondence from a DSRO, the SEC,

    or a securities industry self-regulatory organization, the FCM must

    notify the Commission, and provide a copy of the communication as well

    as a copy of their response to the Commission.

    Last, proposed changes in paragraph (n) of Sec. 1.12 would require

    that every notice or report filed with the Commission pursuant to Sec.

    1.12 would include a discussion of how the reporting event originated

    and what steps have been, or are being taken, to address the event.

    Benefits

    The proposed changes requiring that notice to the Commission be

    given in written form via specified forms of electronic communication

    not only adapt the rule to account for modern forms of communication,

    but also reduce the possibility of notification being delayed in

    reaching appropriate Commission staff. The proposed requirement would

    ensure that such

    [[Page 67910]]

    notices are submitted to WinJammer, which forwards notices to

    appropriate personnel within the Commission via email within a matter

    of minutes, if not seconds.

    With respect to the proposed change in Sec. 1.12(a)(2), if an FCM

    knows that it does not have adequate capital to meet the requirements

    of Sec. 1.17 or other capital requirements, and is also not able to

    calculate or determine its financial condition, it is likely that the

    FCM is in a period of extraordinary stress. In these circumstances,

    time is of the essence for the solvency of the FCM and to the

    protection of its customers and counterparties. Therefore, it is

    important that the Commission, DSRO, and SEC (if the FCM is also a

    broker-dealer) be notified immediately so that they can begin assessing

    the FCM's condition, and if necessary, making preparations to allow the

    transfer of the customers' positions to another FCM in the event that

    the FCM currently holding those positions has insufficient regulatory

    capital. These preparations help to ensure that the customers' funds

    are protected in the event of the FCM's default, and that the positions

    of its customers are transferred expeditiously to another FCM where

    those customers may continue to hold and control those positions

    without interruption to the customer's positions.

    The situations enumerated in proposed Sec. Sec. 1.12(i) and (j)

    are more specific indicators of potential or existing problems in the

    customer segregated funds accounts. Notifying the Commission in such

    circumstances will enable it to monitor steps the FCM is taking to

    address a shortfall in targeted residual interest, or to direct the FCM

    as it takes steps to address improperly invested segregated funds. In

    either case, the Commission will be able to be much more closely

    involved in rectifying the situation and ensuring the continued

    protection of customer segregated funds.

    The situations enumerated in proposed Sec. Sec. 1.12(k) through

    (l) are circumstances indicating that the FCM is undergoing changes

    that could indicate or lead to financial strain. Alerting the

    Commission and relevant SRO in such circumstances will enable both to

    protect customer funds by monitoring the FCM more closely in order to

    ensure that any developing problems are identified quickly and

    addressed proactively by the FCM with the oversight of the Commission

    and relevant SRO.

    The proposed amendment requiring that the FCM notify the Commission

    whenever it receives a notice or results of an examination from the

    DSRO, SEC, or securities-industry self-regulatory body, would ensure

    that the Commission is aware of any significant developments affecting

    the FCM that have been observed or communicated by other regulatory

    bodies. Such communications could prompt the Commission to heighten its

    monitoring of specific FCMs, or create an opportunity for the

    Commission to work collaboratively and proactively with other

    regulators to address any concerns about how developments in the FCM's

    business could affect customer funds.

    The proposed requirement that notifications to the Commission

    pursuant to Sec. 1.12 include a discussion of what caused the

    reporting event and what has been, or is being done about the event

    would provide additional information to Commission staff that help them

    quickly gauge the potential severity of related problems that have been

    or are developing at the reporting FCM, IB, or SRO. It would also help

    Commission staff discern how effectively the reporting entity is

    responding to such problems, which could assist the staff in

    determining whether the situation is likely to be corrected quickly or

    to continue deteriorating.

    Costs

    As discussed above, the proposed rule requires that FCMs provide

    immediate notice to the Commission and its DSRO in five additional

    circumstances. These additional requirements create some minimal

    reporting costs when such circumstances arise. The Commission estimates

    that the total cost of completing and sending the requisite form is

    approximately $9,700 and $19,400 per form.\115\

    ---------------------------------------------------------------------------

    \115\ This estimates 8-16 hours of time from both the CCO and

    the CFO, 10-20 from the General Counsel, 20-40 from a compliance

    attorney, and 10-20 from a senior accountant. The average

    compensation for a chief compliance officer is $110.97/hour [

    $170,727 per year/(2000 hours per year)*1.3 = $110.97/hour];

    $110.97*2 = $221.95 and $110.97*4 = $443.89. The average

    compensation for a chief financial officer is estimated by the

    Commission to be $455.00/hour [$700,000 per year/(2000 hours per

    year)*1.3 is $455.00 per hour]; $455.00*2 = $910.00 and $455.00*4 =

    $1,820.00. The average compensation for a general counsel is

    estimated by the Commission to be $260.00/hour [$400,000 per year/

    (2000 hours per year)*1.3 is $260.00 per hour]; $260.00*10 =

    $2,600.00 and $260.00*20 = $5,200.00. The average compensation for a

    senior accountant is $44.18/hour [$67,971 per year/(2000 hours per

    year)*1.3 = $44.18/hour]; $44.18*10 = $441.81 and $44.18*20 =

    $883.62. These figures are taken from the 2011 SIFMA Report on

    Management and Professional Earnings in the Securities Industry.

    ---------------------------------------------------------------------------

    Ongoing monitoring for any of the five additional circumstances

    that require reporting to the Commission, relevant SRO, and to the SEC

    if the FCM is a broker-dealer will also create some costs. In its

    consideration of the proposed rule, the Commission assumes that FCMs

    will automate the process for monitoring residual interest for any

    shortfall against the firm's target. Furthermore, the Commission

    anticipates that FCMs will build on the systems that they already have

    in place to calculate residual interest once per day at the close of

    business. The incremental cost of modifying such systems to monitor

    residual interest compared to the target value on an ongoing basis is

    likely to be between $1,800 and $6,300.\116\ Identifying instances

    where their FCM has experienced a material adverse impact to its

    creditworthiness or ability to fund its obligations, as would be

    required by proposed Sec. 1.12(k), would likely require deliberation

    among senior leaders at the FCM. Such deliberations, however, would

    likely be prompted by observations that such leaders make in the

    ordinary course of business, and therefore would not require proactive

    monitoring. The Commission estimates that deliberations among senior

    leaders to determine whether there is evidence suggesting a material

    decrease in the FCM's creditworthiness has occurred would cost at least

    $6,600 per year.\117\

    ---------------------------------------------------------------------------

    \116\ This estimates 20-90 hours of personnel time from a

    programmer and 10-20 hours of personnel time from a senior

    programmer. The average compensation for a programmer is $53.64/hour

    [$82,518 per year/(2000 hours per year)*1.3 = $53.64/hour];

    $53.64*20 = $1,072.73 and $53.64*90 = $4,827.30. The average

    compensation for a senior programmer is $74.56/hour [$114,714 per

    year/(2000 hours per year)*1.3; $74.56*10 = $745.64 and $74.56*20 =

    $1,491.28. All figures are taken from the 2011 SIFMA Report on

    Management and Professional Earnings in the Securities Industry.

    \117\ This estimates at least 8 hours per year from the CFO, the

    CCO, and the General Counsel. The average compensation for a chief

    compliance officer is $110.97/hour [ $170,727 per year/(2000 hours

    per year)*1.3 = $110.97/hour]; $110.97*8 = $887.78. The average

    compensation for a chief financial officer is estimated by the

    Commission to be $455.00/hour [$700,000 per year/(2000 hours per

    year)*1.3 is $455.00 per hour]; $455.00*8 = $3,640. The average

    compensation for a general counsel is estimated by the Commission to

    be $260.00/hour $400,000.00 per year/(2000 hours per year)*1.3 is

    $260.00 per hour]; $260.00*8 = $2,100.00. The figure for the CCO is

    taken from the 2011 SIFMA Report on Management and Professional

    Earnings in the Securities Industry; other compensations are

    estimates by the Commission.

    ---------------------------------------------------------------------------

    Material changes to the FCM's leadership or business would create

    some incremental costs. Some of the material changes envisioned, such

    as changes in senior leadership, are discrete events that do not

    require monitoring in order to identify. On the other hand, events that

    constitute a material change in operations, credit arrangements, or

    ``any change that could adversely impact the firm's liquidity

    [[Page 67911]]

    resources,'' \118\ would only be reliably recognized as a material

    change by someone with a broad knowledge of the firm's operations and

    finances, so the Commission assumes that senior management would

    fulfill these requirements. However, identifying and addressing

    material changes to the business is a function that senior management

    already plays, and therefore monitoring for such changes would not

    create any incremental costs. The proposed rule would make it necessary

    for senior management, in addition to identifying changes to the

    business, to make a decision about whether or not those changes are

    material and therefore should be reported. The Commission proposes that

    the additional time senior management spends making determinations

    about the materiality of changes to the business, as defined by the

    proposed rule, would require approximately twenty hours of time from

    both the CCO and CFO. Therefore, the Commission estimates that the

    monitoring costs would be $11,300 and $22,600.\119\

    ---------------------------------------------------------------------------

    \118\ Sec. 1.12(l).

    \119\ This estimates 20-40 hours of time each from the CCO and

    CFO. The average compensation for a chief compliance officer is

    $110.97/hour [$170,727 per year/(2000 hours per year)*1.3 = $110.97/

    hour]; $110.97*20 = $2,219.45 and $110.97*40 = $4,438.90. The

    average compensation for a chief financial officer is estimated by

    the Commission to be $455.00/hour [$700,000 per year/(2000 hours per

    year)*1.3 is $455.00 per hour]; $455.00*20 = $9,100.00 and

    $455.00*40 = $18,200.00. The compensations of an average CFO is an

    estimate by the Commission. The figure for a CCO is taken from the

    2011 SIFMA Report on Management and Professional Earnings in the

    Securities Industry.

    ---------------------------------------------------------------------------

    The proposed requirement that notices or reports filed with the

    Commission pursuant to Sec. 1.12 include a discussion of how the

    reporting event originated and what has been, or is being done to

    address the reporting event, will increase the cost of such reports.

    The Commission anticipates that this requirement would prompt the CFO,

    General Counsel, and CCO of a reporting entity to invest additional

    time in developing and reviewing the report. The Commission anticipates

    that the incremental cost associated with the additional time spent by

    the CFO, General Counsel, and CCO would be between $3,300 and $6,600

    per report.\120\

    ---------------------------------------------------------------------------

    \120\ This estimates that the CFO, General Counsel, and CCO will

    each spend an additional 4-8 hours developing and reviewing the

    report. The average compensation for a chief financial officer is

    estimated by the Commission to be $455.00/hour [$700,000 per year/

    (2000 hours per year)*1.3 is $455.00 per hour]; $455.00*4 =

    $1,780.00 and $455.00*8 = $3,640.00. The average compensation for a

    general counsel is estimated by the Commission to be $260.00/hour

    [$400,000.00 per year/(2000 hours per year)*1.3 is $260.00 per

    hour]; $260.00*4 = $1,040.00 and $260.00*8 = $2,100.00. The average

    compensation for a chief compliance officer is $110.97/hour [

    $170,727 per year/(2000 hours per year)*1.3 = $110.97/hour];

    $110.97*4 = $443.88 and $110.97*8 = $887.78. The figure for the CCO

    is taken from the 2011 SIFMA Report on Management and Professional

    Earnings in the Securities Industry; other compensations are

    estimates by the Commission.

    ---------------------------------------------------------------------------

    Additional proposed changes would introduce only minimal, if any,

    additional costs. For example, all FCMs already use WinJammer to submit

    certain reports to DSROs and to the Commission, so there would not be

    any additional cost involved with Sec. 1.12(n)(3) requirement that

    such notices to be submitted through that platform rather than via

    fax.\121\ Nor is there any cost associated with this proposed change to

    Sec. 1.12(a)(1). The FCM is still required to disclose its financial

    condition to the Commission, DSRO and SEC (if applicable) as soon as it

    can be ascertained. The proposed change does not alter the information

    that the FCM must gather, calculate, or report. It merely requires that

    each of the two pieces of information relevant to the requirements in

    Sec. 1.12(a)(1-2) are submitted as soon as they are known.

    ---------------------------------------------------------------------------

    \121\ See NFA Interpretive Notice 9028--NFA Financial

    Requirements: The Electronic Filing of Financial Reports. Available

    at: http://prodwebvip.futures.org/nfamanual/NFAManual.aspx?RuleID=9028&Section=9. See also CME Advisory Notice:

    Enhanced Customer Protections & Rule Amendments, June 27, 2012.

    Available at: http://www.cmegroup.com/tools-information/lookups/advisories/clearing/AIB12-08.html.

    ---------------------------------------------------------------------------

    Request for Comment

    Question 5: The Commission requests additional information

    regarding the costs of these additional notification requirements.

    Specifically, how much time will information technology and compliance

    personnel have to invest in order to modify systems to calculate

    residual interest on a continual basis? How much time would be

    necessary to monitor for material changes in the business and what

    level of personnel would have to participate in that in order to draw

    reliable conclusions about whether or not a material event had

    occurred?

    Sec. 1.16 Qualifications and Reports of Accountants

    Proposed Changes

    As discussed above in II.E, the proposed changes would require that

    in order for an accountant to be qualified to conduct an audit of an

    FCM, that accountant would have to be registered with the Public

    Company Accounting Oversight Board (``PCAOB''),\122\ have undergone at

    least one examination by the PCAOB, and have addressed any deficiencies

    noted by the PCAOB within three years of the report noting such a

    deficiency.

    ---------------------------------------------------------------------------

    \122\ ``PCAOB is a nonprofit corporation established by Congress

    to oversee the audits of public companies in order to protect the

    interests of investors and further the public interest in the

    preparation of informative, accurate and independent audit reports.

    The PCAOB also oversees the audits of broker-dealers, including

    compliance reports filed pursuant to federal securities laws, to

    promote investor protection.'' See http://pcaobus.org/Pages/default.aspx.

    ---------------------------------------------------------------------------

    Second, the amendments would require that the governing body of the

    FCM ensure that the accountant engaged for an audit is duly qualified,

    and specifies certain qualifications that must be considered when

    evaluating an accountant for such purpose.

    Last, the Commission is proposing to require a public accountant to

    state in the audit opinion whether the audit was conducted in

    accordance with U.S. generally accepted auditing standards after full

    consideration of the auditing standards adopted by the PCAOB.

    Benefits

    By requiring accountants to be registered with PCAOB and to have

    undergone at least one examination by the same, the proposed rule would

    help to ensure that the accountant is qualified to audit publicly

    traded companies, which are often more complex than those that are

    privately held. As a consequence, the proposed requirement would

    promote selection of accounting firms that are more sophisticated and

    experienced than would necessarily be the case in the absence of the

    proposed amendment, which would help to ensure that the accountant is

    large enough to maintain independence in its examination and has

    adequate experience to deal with the unique aspects of an FCM's

    business model, operational processes, and financial records.

    Requiring the FCM's board to evaluate and approve accountants

    conducting audits for the FCM would tend to enhance protection of

    customer funds by increasing accountability among the board for any

    errors resulting from an accountant's lack of relevant experience.

    Consequently, the requirement would incent the board to choose auditors

    carefully, or to provide diligent oversight as senior management makes

    such selections. This would promote selection of highly qualified

    accountants, which would help to ensure that audits are as effective as

    possible in identifying problems with operational controls, potential

    indications of fraud, or other warning signs that could enable senior

    [[Page 67912]]

    management and the Commission or DSRO to protect customer funds more

    effectively.

    Costs

    The Commission anticipates that auditors that are registered with

    the PCAOB and that have undergone at least one examination by the PCAOB

    are likely to charge more for audits, than those that do not have those

    qualifications. However, the Commission does not have adequate

    information to estimate the difference in costs.

    Request for Comment

    Question 6: The Commission requests comment regarding the cost of

    audits for an FCM. Specifically, what is the range of costs and average

    cost of an audit conducted by auditors with the credentials required in

    the proposed rule? What is the range of costs and the average cost of

    an audit conducted by auditors without such qualifications?

    Sec. 1.17 Minimum Financial Requirements for Futures Commission

    Merchants And Introducing Brokers \123\

    ---------------------------------------------------------------------------

    \123\ CEA 4(d)(2), referenced in Sec. 1.17, states, ``It shall

    be unlawful for any person, including but not limited to any

    clearing agency of a contract market or derivatives transaction

    execution facility and any depository, that has received any money,

    securities, or property for deposit in a separate account as

    provided in paragraph (2) of this section, to hold, dispose of, or

    use any such money, securities, or property as belonging to the

    depositing futures commission merchant or any person other than the

    customers of such futures commission merchant.''

    ---------------------------------------------------------------------------

    Proposed Changes

    As dep>

    general oversight of implementation of new policies and procedures,

    4-12 weeks of the time of a firm's Chief Compliance Officer, or 160-

    480 hours, and 160-800 hours of the time of IT personnel (140-700 at

    a junior to intermediate level and 20-100 at a senior level) as the

    firm will likely seek to automate some types of information

    collection and other steps necessary to support requirements. The

    average compensation for a senior risk management specialist is

    $108.06/hour [$166,251 per year/(2000 hours per year)*1.3 is $108.06

    per hour]; $108.06*100 = $10,806.00 and $108.06*500 = $54,030.00.

    The average compensation for a risk management specialist is $65.33/

    hour [$100,500 per year/(2000 hours per year)*1.3 is $65.33 per

    hour]; $65.33*100 = $6,532.50 and $65.33*500 = $32,665.00. The

    average compensation for a junior human resources representative is

    $40.95/hour [$62,989 per year/(2000 hours per year)*1.3 is $40.95

    per hour]; $40.95*800 = $32,760.00 and $40.95*1000 = $40,950.00. The

    average compensation for a senior human resources representative is

    $71.45/hour [$109,921 per year/(2000 hours per year)*1.3 is $71.45

    per hour]; $71.45*100 = $7,144.87 and $71.45*500 = $35,724.33. The

    average compensation for a compliance attorney is $85.35/hour

    [$131,303 per year/(2000 hours per year)*1.3 is $85.35 per hour];

    $85.35*20 = $1,706.94 and $85.35*400 = $34,138.78. The average

    compensation for a chief compliance officer is $110.97/hour [

    $170,727 per year/(2000 hours per year)*1.3 = $110.97/hour];

    $110.97*160 = $17,755.61 and $110.97*480 = $53,266.82. The average

    compensation for a programmer is $53.64/hour [$82,518 per year/(2000

    hours per year)*1.3 = $53.64/hour]; $53.64*140 = $7,509.14 and

    $53.64*700 = $37,545.69. The average compensation for a senior

    programmer is $74.56/hour [$114,714 per year/(2000 hours per

    year)*1.3 = $74.56/hour]; $74.56*20 = $1,491.28 and $74.56*100 =

    $7,456.41. All figures are taken from the 2011 SIFMA Report on

    Management and Professional Earnings in the Securities Industry.

    ---------------------------------------------------------------------------

    [[Page 67909]]

    3. The costs necessary to sustain the policies and procedures

    required under Sec. 1.11 are difficult to estimate because they would

    depend on variables such as the size of the firm, the program of

    governing supervision that they develop, and the degree of automation

    they achieve in their various ongoing processes (monitoring

    depositories, evaluating Sec. 1.25 investments, reevaluating residual

    funds target, etc.), and the degree to which their operations are

    already compliant with the policies and procedures they would develop

    pursuant to the proposed Sec. 1.11. However, as a lower bound, the

    ongoing costs would include expenses related to the time for: (1) The

    CCO to review quarterly audits and conduct due diligence that is

    necessary before providing certification of compliance with the Act,

    regulations and its policies and procedures with respect to segregated

    funds in the annual report; (2) risk management personnel to evaluate

    Sec. 1.25 investments for liquidity and marketability and to monitor

    depository institutions where customer segregated funds are held; (3)

    the CFO and other senior management to review and determine the

    continued appropriateness of the FCM's target for residual interest;

    and (4) HR personnel to organize and deliver annual training. The

    Commission estimates that the lower bound for these costs is

    approximately $20,000 and that costs may be higher, depending on the

    variables mentioned above.\113\

    ---------------------------------------------------------------------------

    \113\ This estimate assumes 20+ hours per year from the CCO for

    due diligence and certification of compliance on annual report and

    reviewing quarterly audits, 40+ hours each per year from junior and

    senior risk management personnel evaluating Sec. 1.25 investments

    for liquidity and marketability and monitoring depository

    institutions where customer segregated funds are held, 6+ hours per

    year from the CFO and other senior management for reviewing the

    target for the firm's residual interest, and 20+ hours each per year

    from junior and senior HR--organizing and delivering annual

    training, as well as at least a day's training for 20 employees, or

    160 hours from an average financial employee, such as a general

    intermediate trader. The average compensation for a chief compliance

    officer is $110.97/hour [$170,727 per year/(2000 hours per year)*1.3

    = $110.97/hour]; $110.97*20 = $2,219.45. The average compensation

    for a senior risk management specialist is $108.06/hour [$166,251

    per year/(2000 hours per year)*1.3 is $108.06 per hour]; $108.06*40

    = $4,322.53. The average compensation for a risk management

    specialist is $65.33/hour [$100,500 per year/(2000 hours per

    year)*1.3 is $65.33 per hour]; $65.33*40 = $2,613.00. The average

    compensation for a chief financial officer is estimated by the

    Commission to be $455.00 per/hour [$700,000 per year/(2000 hours per

    year)*1.3 is $455.00 per hour]; $455.00*6 = $2,730. The average

    compensation for a junior human resources representative is $40.94/

    hour [$62,989.00 per year/(2000 hours per year) = $40.94/hour];

    $40.94*20 = $818.86. The average compensation for a senior human

    resources representative is $71.45/hour [$109,921.00 per year/(2000

    hours per year) = $71.45/hour]; $71.45*20 = $1,428.97. The average

    compensation for a general intermediate trader is $36.48/hour

    [$56,130.00 per year/(2000 hours per year)*1.3 is $36.48 per hour];

    $36.48*160 = $5,837.52. The compensations of an average CFO is an

    estimate by the Commission. All other figures are taken from the

    2011 SIFMA Report on Management and Professional Earnings in the

    Securities Industry.

    ---------------------------------------------------------------------------

    In addition, FCMs would have to implement automated financial risk

    management controls that are reasonably designed to prevent entering of

    erroneous trades. The Commission anticipates that some, but not all,

    FCMs already have such systems in place. For those FCMs that do not yet

    have such systems in place, the Commission proposes that it would cost

    an FCM between $10,300 and $89,400 to implement such a system.\114\

    ---------------------------------------------------------------------------

    \114\ This estimates 150-1500 hours of mid-level IT programming

    time and 30-120 hours of senior level IT personnel time. The average

    compensation for a programmer is $53.64/hour [$82,518 per year/(2000

    hours per year)*1.3 = $53.64/hour]; $53.64*150 = $8,045.51 and

    $53.64*1500 = $80,455.05. The average compensation for a senior

    programmer is $74.56/hour [$114,714 per year/(2000 hours per

    year)*1.3 = $74.56/hour]; $74.56*30 = $2,236.92 and $74.56*120 =

    $8,947.69. All figures are taken from the 2011 SIFMA Report on

    Management and Professional Earnings in the Securities Industry.

    ---------------------------------------------------------------------------

    Sec. 1.12 Maintenance of Minimum Financial Requirements by Futures

    Commission Merchants and Introducing Brokers

    Proposed Changes

    As described in the section by section discussion at II.C, the

    proposed changes to Sec. 1.12 would alter the notice requirement so

    that it is no longer acceptable to give ``telephonic notice to be

    confirmed, in writing, by facsimile.'' Instead, all notices would be

    made in writing and submitted through an electronic medium acceptable

    to the Commission (currently, WinJammer).

    In addition, as described above in II.C, the proposed changes would

    require that if an FCM has a shortfall in net capital but is not sure

    of their financial condition, the FCM should not delay notifying the

    Commission about the shortfall in net capital. The FCM must communicate

    each piece of information (knowledge of the shortfall and knowledge of

    the financial condition of the FCM) to the Commission as soon as it is

    known.

    The proposed requirements in paragraphs (i), (j), (k) and (l) of

    Sec. 1.12 identify additional circumstances in which the FCM must

    provide immediate written notice to the Commission, relevant SRO and to

    the SEC if the FCM is also a broker-dealer. Those circumstances are:

    (1) If an FCM discovers that any of the funds in segregated accounts

    are invested in investments not permitted under Sec. 1.25; (2) if an

    FCM does not have sufficient funds in any of their segregated accounts

    to meet their targeted residual interest; (3) if the FCM experiences a

    material adverse impact to its creditworthiness or ability to fund its

    obligations; (4) whenever the FCM has a material change in operations

    including changes to senior management, lines of business, clearing

    arrangements, or credit arrangements that could have a negative impact

    on the FCM's liquidity; and (5) if the FCM receives a notice,

    examination report, or any other correspondence from a DSRO, the SEC,

    or a securities industry self-regulatory organization, the FCM must

    notify the Commission, and provide a copy of the communication as well

    as a copy of their response to the Commission.

    Last, proposed changes in paragraph (n) of Sec. 1.12 would require

    that every notice or report filed with the Commission pursuant to Sec.

    1.12 would include a discussion of how the reporting event originated

    and what steps have been, or are being taken, to address the event.

    Benefits

    The proposed changes requiring that notice to the Commission be

    given in written form via specified forms of electronic communication

    not only adapt the rule to account for modern forms of communication,

    but also reduce the possibility of notification being delayed in

    reaching appropriate Commission staff. The proposed requirement would

    ensure that such

    [[Page 67910]]

    notices are submitted to WinJammer, which forwards notices to

    appropriate personnel within the Commission via email within a matter

    of minutes, if not seconds.

    With respect to the proposed change in Sec. 1.12(a)(2), if an FCM

    knows that it does not have adequate capital to meet the requirements

    of Sec. 1.17 or other capital requirements, and is also not able to

    calculate or determine its financial condition, it is likely that the

    FCM is in a period of extraordinary stress. In these circumstances,

    time is of the essence for the solvency of the FCM and to the

    protection of its customers and counterparties. Therefore, it is

    important that the Commission, DSRO, and SEC (if the FCM is also a

    broker-dealer) be notified immediately so that they can begin assessing

    the FCM's condition, and if necessary, making preparations to allow the

    transfer of the customers' positions to another FCM in the event that

    the FCM currently holding those positions has insufficient regulatory

    capital. These preparations help to ensure that the customers' funds

    are protected in the event of the FCM's default, and that the positions

    of its customers are transferred expeditiously to another FCM where

    those customers may continue to hold and control those positions

    without interruption to the customer's positions.

    The situations enumerated in proposed Sec. Sec. 1.12(i) and (j)

    are more specific indicators of potential or existing problems in the

    customer segregated funds accounts. Notifying the Commission in such

    circumstances will enable it to monitor steps the FCM is taking to

    address a shortfall in targeted residual interest, or to direct the FCM

    as it takes steps to address improperly invested segregated funds. In

    either case, the Commission will be able to be much more closely

    involved in rectifying the situation and ensuring the continued

    protection of customer segregated funds.

    The situations enumerated in proposed Sec. Sec. 1.12(k) through

    (l) are circumstances indicating that the FCM is undergoing changes

    that could indicate or lead to financial strain. Alerting the

    Commission and relevant SRO in such circumstances will enable both to

    protect customer funds by monitoring the FCM more closely in order to

    ensure that any developing problems are identified quickly and

    addressed proactively by the FCM with the oversight of the Commission

    and relevant SRO.

    The proposed amendment requiring that the FCM notify the Commission

    whenever it receives a notice or results of an examination from the

    DSRO, SEC, or securities-industry self-regulatory body, would ensure

    that the Commission is aware of any significant developments affecting

    the FCM that have been observed or communicated by other regulatory

    bodies. Such communications could prompt the Commission to heighten its

    monitoring of specific FCMs, or create an opportunity for the

    Commission to work collaboratively and proactively with other

    regulators to address any concerns about how developments in the FCM's

    business could affect customer funds.

    The proposed requirement that notifications to the Commission

    pursuant to Sec. 1.12 include a discussion of what caused the

    reporting event and what has been, or is being done about the event

    would provide additional information to Commission staff that help them

    quickly gauge the potential severity of related problems that have been

    or are developing at the reporting FCM, IB, or SRO. It would also help

    Commission staff discern how effectively the reporting entity is

    responding to such problems, which could assist the staff in

    determining whether the situation is likely to be corrected quickly or

    to continue deteriorating.

    Costs

    As discussed above, the proposed rule requires that FCMs provide

    immediate notice to the Commission and its DSRO in five additional

    circumstances. These additional requirements create some minimal

    reporting costs when such circumstances arise. The Commission estimates

    that the total cost of completing and sending the requisite form is

    approximately $9,700 and $19,400 per form.\115\

    ---------------------------------------------------------------------------

    \115\ This estimates 8-16 hours of time from both the CCO and

    the CFO, 10-20 from the General Counsel, 20-40 from a compliance

    attorney, and 10-20 from a senior accountant. The average

    compensation for a chief compliance officer is $110.97/hour [

    $170,727 per year/(2000 hours per year)*1.3 = $110.97/hour];

    $110.97*2 = $221.95 and $110.97*4 = $443.89. The average

    compensation for a chief financial officer is estimated by the

    Commission to be $455.00/hour [$700,000 per year/(2000 hours per

    year)*1.3 is $455.00 per hour]; $455.00*2 = $910.00 and $455.00*4 =

    $1,820.00. The average compensation for a general counsel is

    estimated by the Commission to be $260.00/hour [$400,000 per year/

    (2000 hours per year)*1.3 is $260.00 per hour]; $260.00*10 =

    $2,600.00 and $260.00*20 = $5,200.00. The average compensation for a

    senior accountant is $44.18/hour [$67,971 per year/(2000 hours per

    year)*1.3 = $44.18/hour]; $44.18*10 = $441.81 and $44.18*20 =

    $883.62. These figures are taken from the 2011 SIFMA Report on

    Management and Professional Earnings in the Securities Industry.

    ---------------------------------------------------------------------------

    Ongoing monitoring for any of the five additional circumstances

    that require reporting to the Commission, relevant SRO, and to the SEC

    if the FCM is a broker-dealer will also create some costs. In its

    consideration of the proposed rule, the Commission assumes that FCMs

    will automate the process for monitoring residual interest for any

    shortfall against the firm's target. Furthermore, the Commission

    anticipates that FCMs will build on the systems that they already have

    in place to calculate residual interest once per day at the close of

    business. The incremental cost of modifying such systems to monitor

    residual interest compared to the target value on an ongoing basis is

    likely to be between $1,800 and $6,300.\116\ Identifying instances

    where their FCM has experienced a material adverse impact to its

    creditworthiness or ability to fund its obligations, as would be

    required by proposed Sec. 1.12(k), would likely require deliberation

    among senior leaders at the FCM. Such deliberations, however, would

    likely be prompted by observations that such leaders make in the

    ordinary course of business, and therefore would not require proactive

    monitoring. The Commission estimates that deliberations among senior

    leaders to determine whether there is evidence suggesting a material

    decrease in the FCM's creditworthiness has occurred would cost at least

    $6,600 per year.\117\

    ---------------------------------------------------------------------------

    \116\ This estimates 20-90 hours of personnel time from a

    programmer and 10-20 hours of personnel time from a senior

    programmer. The average compensation for a programmer is $53.64/hour

    [$82,518 per year/(2000 hours per year)*1.3 = $53.64/hour];

    $53.64*20 = $1,072.73 and $53.64*90 = $4,827.30. The average

    compensation for a senior programmer is $74.56/hour [$114,714 per

    year/(2000 hours per year)*1.3; $74.56*10 = $745.64 and $74.56*20 =

    $1,491.28. All figures are taken from the 2011 SIFMA Report on

    Management and Professional Earnings in the Securities Industry.

    \117\ This estimates at least 8 hours per year from the CFO, the

    CCO, and the General Counsel. The average compensation for a chief

    compliance officer is $110.97/hour [ $170,727 per year/(2000 hours

    per year)*1.3 = $110.97/hour]; $110.97*8 = $887.78. The average

    compensation for a chief financial officer is estimated by the

    Commission to be $455.00/hour [$700,000 per year/(2000 hours per

    year)*1.3 is $455.00 per hour]; $455.00*8 = $3,640. The average

    compensation for a general counsel is estimated by the Commission to

    be $260.00/hour $400,000.00 per year/(2000 hours per year)*1.3 is

    $260.00 per hour]; $260.00*8 = $2,100.00. The figure for the CCO is

    taken from the 2011 SIFMA Report on Management and Professional

    Earnings in the Securities Industry; other compensations are

    estimates by the Commission.

    ---------------------------------------------------------------------------

    Material changes to the FCM's leadership or business would create

    some incremental costs. Some of the material changes envisioned, such

    as changes in senior leadership, are discrete events that do not

    require monitoring in order to identify. On the other hand, events that

    constitute a material change in operations, credit arrangements, or

    ``any change that could adversely impact the firm's liquidity

    [[Page 67911]]

    resources,'' \118\ would only be reliably recognized as a material

    change by someone with a broad knowledge of the firm's operations and

    finances, so the Commission assumes that senior management would

    fulfill these requirements. However, identifying and addressing

    material changes to the business is a function that senior management

    already plays, and therefore monitoring for such changes would not

    create any incremental costs. The proposed rule would make it necessary

    for senior management, in addition to identifying changes to the

    business, to make a decision about whether or not those changes are

    material and therefore should be reported. The Commission proposes that

    the additional time senior management spends making determinations

    about the materiality of changes to the business, as defined by the

    proposed rule, would require approximately twenty hours of time from

    both the CCO and CFO. Therefore, the Commission estimates that the

    monitoring costs would be $11,300 and $22,600.\119\

    ---------------------------------------------------------------------------

    \118\ Sec. 1.12(l).

    \119\ This estimates 20-40 hours of time each from the CCO and

    CFO. The average compensation for a chief compliance officer is

    $110.97/hour [$170,727 per year/(2000 hours per year)*1.3 = $110.97/

    hour]; $110.97*20 = $2,219.45 and $110.97*40 = $4,438.90. The

    average compensation for a chief financial officer is estimated by

    the Commission to be $455.00/hour [$700,000 per year/(2000 hours per

    year)*1.3 is $455.00 per hour]; $455.00*20 = $9,100.00 and

    $455.00*40 = $18,200.00. The compensations of an average CFO is an

    estimate by the Commission. The figure for a CCO is taken from the

    2011 SIFMA Report on Management and Professional Earnings in the

    Securities Industry.

    ---------------------------------------------------------------------------

    The proposed requirement that notices or reports filed with the

    Commission pursuant to Sec. 1.12 include a discussion of how the

    reporting event originated and what has been, or is being done to

    address the reporting event, will increase the cost of such reports.

    The Commission anticipates that this requirement would prompt the CFO,

    General Counsel, and CCO of a reporting entity to invest additional

    time in developing and reviewing the report. The Commission anticipates

    that the incremental cost associated with the additional time spent by

    the CFO, General Counsel, and CCO would be between $3,300 and $6,600

    per report.\120\

    ---------------------------------------------------------------------------

    \120\ This estimates that the CFO, General Counsel, and CCO will

    each spend an additional 4-8 hours developing and reviewing the

    report. The average compensation for a chief financial officer is

    estimated by the Commission to be $455.00/hour [$700,000 per year/

    (2000 hours per year)*1.3 is $455.00 per hour]; $455.00*4 =

    $1,780.00 and $455.00*8 = $3,640.00. The average compensation for a

    general counsel is estimated by the Commission to be $260.00/hour

    [$400,000.00 per year/(2000 hours per year)*1.3 is $260.00 per

    hour]; $260.00*4 = $1,040.00 and $260.00*8 = $2,100.00. The average

    compensation for a chief compliance officer is $110.97/hour [

    $170,727 per year/(2000 hours per year)*1.3 = $110.97/hour];

    $110.97*4 = $443.88 and $110.97*8 = $887.78. The figure for the CCO

    is taken from the 2011 SIFMA Report on Management and Professional

    Earnings in the Securities Industry; other compensations are

    estimates by the Commission.

    ---------------------------------------------------------------------------

    Additional proposed changes would introduce only minimal, if any,

    additional costs. For example, all FCMs already use WinJammer to submit

    certain reports to DSROs and to the Commission, so there would not be

    any additional cost involved with Sec. 1.12(n)(3) requirement that

    such notices to be submitted through that platform rather than via

    fax.\121\ Nor is there any cost associated with this proposed change to

    Sec. 1.12(a)(1). The FCM is still required to disclose its financial

    condition to the Commission, DSRO and SEC (if applicable) as soon as it

    can be ascertained. The proposed change does not alter the information

    that the FCM must gather, calculate, or report. It merely requires that

    each of the two pieces of information relevant to the requirements in

    Sec. 1.12(a)(1-2) are submitted as soon as they are known.

    ---------------------------------------------------------------------------

    \121\ See NFA Interpretive Notice 9028--NFA Financial

    Requirements: The Electronic Filing of Financial Reports. Available

    at: http://prodwebvip.futures.org/nfamanual/NFAManual.aspx?RuleID=9028&Section=9. See also CME Advisory Notice:

    Enhanced Customer Protections & Rule Amendments, June 27, 2012.

    Available at: http://www.cmegroup.com/tools-information/lookups/advisories/clearing/AIB12-08.html.

    ---------------------------------------------------------------------------

    Request for Comment

    Question 5: The Commission requests additional information

    regarding the costs of these additional notification requirements.

    Specifically, how much time will information technology and compliance

    personnel have to invest in order to modify systems to calculate

    residual interest on a continual basis? How much time would be

    necessary to monitor for material changes in the business and what

    level of personnel would have to participate in that in order to draw

    reliable conclusions about whether or not a material event had

    occurred?

    Sec. 1.16 Qualifications and Reports of Accountants

    Proposed Changes

    As discussed above in II.E, the proposed changes would require that

    in order for an accountant to be qualified to conduct an audit of an

    FCM, that accountant would have to be registered with the Public

    Company Accounting Oversight Board (``PCAOB''),\122\ have undergone at

    least one examination by the PCAOB, and have addressed any deficiencies

    noted by the PCAOB within three years of the report noting such a

    deficiency.

    ---------------------------------------------------------------------------

    \122\ ``PCAOB is a nonprofit corporation established by Congress

    to oversee the audits of public companies in order to protect the

    interests of investors and further the public interest in the

    preparation of informative, accurate and independent audit reports.

    The PCAOB also oversees the audits of broker-dealers, including

    compliance reports filed pursuant to federal securities laws, to

    promote investor protection.'' See http://pcaobus.org/Pages/default.aspx.

    ---------------------------------------------------------------------------

    Second, the amendments would require that the governing body of the

    FCM ensure that the accountant engaged for an audit is duly qualified,

    and specifies certain qualifications that must be considered when

    evaluating an accountant for such purpose.

    Last, the Commission is proposing to require a public accountant to

    state in the audit opinion whether the audit was conducted in

    accordance with U.S. generally accepted auditing standards after full

    consideration of the auditing standards adopted by the PCAOB.

    Benefits

    By requiring accountants to be registered with PCAOB and to have

    undergone at least one examination by the same, the proposed rule would

    help to ensure that the accountant is qualified to audit publicly

    traded companies, which are often more complex than those that are

    privately held. As a consequence, the proposed requirement would

    promote selection of accounting firms that are more sophisticated and

    experienced than would necessarily be the case in the absence of the

    proposed amendment, which would help to ensure that the accountant is

    large enough to maintain independence in its examination and has

    adequate experience to deal with the unique aspects of an FCM's

    business model, operational processes, and financial records.

    Requiring the FCM's board to evaluate and approve accountants

    conducting audits for the FCM would tend to enhance protection of

    customer funds by increasing accountability among the board for any

    errors resulting from an accountant's lack of relevant experience.

    Consequently, the requirement would incent the board to choose auditors

    carefully, or to provide diligent oversight as senior management makes

    such selections. This would promote selection of highly qualified

    accountants, which would help to ensure that audits are as effective as

    possible in identifying problems with operational controls, potential

    indications of fraud, or other warning signs that could enable senior

    [[Page 67912]]

    management and the Commission or DSRO to protect customer funds more

    effectively.

    Costs

    The Commission anticipates that auditors that are registered with

    the PCAOB and that have undergone at least one examination by the PCAOB

    are likely to charge more for audits, than those that do not have those

    qualifications. However, the Commission does not have adequate

    information to estimate the difference in costs.

    Request for Comment

    Question 6: The Commission requests comment regarding the cost of

    audits for an FCM. Specifically, what is the range of costs and average

    cost of an audit conducted by auditors with the credentials required in

    the proposed rule? What is the range of costs and the average cost of

    an audit conducted by auditors without such qualifications?

    Sec. 1.17 Minimum Financial Requirements for Futures Commission

    Merchants And Introducing Brokers \123\

    ---------------------------------------------------------------------------

    \123\ CEA 4(d)(2), referenced in Sec. 1.17, states, ``It shall

    be unlawful for any person, including but not limited to any

    clearing agency of a contract market or derivatives transaction

    execution facility and any depository, that has received any money,

    securities, or property for deposit in a separate account as

    provided in paragraph (2) of this section, to hold, dispose of, or

    use any such money, securities, or property as belonging to the

    depositing futures commission merchant or any person other than the

    customers of such futures commission merchant.''

    ---------------------------------------------------------------------------

    Proposed Changes

    As described in the section by section discussion at II.F, the

    Commission is proposing to amend Sec. 1.17 by adding a new provision

    that will authorize the Commission to require an FCM to cease operating

    as an FCM and transfer its customer accounts if the FCM is not able to

    certify and demonstrate sufficient access to liquidity to continue

    operating as a going concern.

    In addition, FCMs that are dual registrants (FCM and BD) are

    allowed to use the Securities and Exchange Commission's broker-dealer

    approach \124\ to evaluating the credit risk of securities that the FCM

    invests in and assigning smaller haircuts \125\ to those that are

    deemed to be a low credit risk, should the SEC adopt as final its

    proposed rule to eliminate references to credit ratings. The proposed

    change to Sec. 17(c)(5)(v) would allow FCMs that are not dual

    registrants to use the same approach. Reducing the haircut assigned to

    low credit risk securities that the FCM invests in (which would

    potentially include some investments compliant with the requirements of

    Sec. 1.25), reduces the capital charge that the FCM must take for

    investing in those securities.

    ---------------------------------------------------------------------------

    \124\ As stated above in II.F above, under the SEC proposal, a

    BD may impose the default haircuts of 15 percent of the market value

    of readily marketable commercial paper, convertible debt, and

    nonconvertible debt instruments or 100 percent of the market value

    of nonmarketable commercial paper, convertible debt, and

    nonconvertible debt instruments. A BD, however, may impose lower

    haircut percentages for commercial paper, convertible debt, and

    nonconvertible debt instruments that are readily marketable, if the

    BD determines that the investments have only a minimal amount of

    credit risk pursuant to its written policies and procedures designed

    to assess the credit and liquidity risks applicable to a security. A

    BD that maintains written policies and procedures and determines

    that the credit risk of a security is minimal is permitted under the

    SEC proposal to apply the lesser haircut requirement currently

    specified in the SEC capital rule for commercial paper (i.e.,

    between zero and \1/2\ of 1 percent), nonconvertible debt (i.e.,

    between 2 percent and 9 percent), and preferred stock (i.e., 10

    percent).

    \125\ As stated above in II.F, in computing its adjusted net

    capital, an FCM is required to reduce the value of proprietary

    futures and securities positions included in its liquid assets by

    certain prescribed amounts or percentages of the market value

    (otherwise known as ``haircuts'') to discount for potential adverse

    market movements in the securities.

    ---------------------------------------------------------------------------

    Last, the proposed amendments would change the period of time that

    an FCM can wait for margin payments from a customer before taking a

    capital charge from three days to one day.

    Benefits

    As discussed in II.F, an FCM's ability to meet capital requirements

    and segregation requirements is not necessarily a sufficient indicator

    of the FCM's continued viability as a going concern. If an FCM does not

    have access to liquidity to meet identifiable, imminent financial

    obligations, the FCM will likely default, regardless of the amount of

    capital that is recognized on its balance sheet. In such circumstances,

    transferring customer positions to another FCM before the current FCM

    enters into bankruptcy provides additional protection to customer

    funds. Once the FCM enters into bankruptcy, the transfer of customer

    positions may be slowed by the trustee's involvement, which could

    interrupt customers' ability to actively manage those positions. In

    addition, if the FCM enters into bankruptcy before transferring

    customers' positions, customer segregated funds may be subject to

    trustee fees. Transferring the positions before the FCM enters into

    bankruptcy, therefore, provides additional protection to customers by

    preserving their ability to continuously manage their accounts and by

    protecting their funds from being subject to trustee fees.

    By allowing FCMs that are not dual registrants to follow the same

    rules as those that are dual registrants, the change would harmonize

    the regulation of FCMs with respect to minimal financial requirements.

    This would place FCMs that are not dual registrants on a level playing

    field with those that are dual registrants, which contributes to the

    competitiveness of the financial markets.

    In Sec. 1.17(c)(5)(viii), the Commission proposes to reduce the

    period of time an FCM can wait to receive margin call payments from

    customers before taking a capital charge, which will incent FCMs to

    exercise increased diligence when seeking such payments, and therefore

    will likely prompt customers to provide such payments more quickly. As

    a consequence, the risk that a debit balance could develop in a

    customer's account due to tardy margin call payments would be reduced,

    and the amount of residual interest that the FCM would need to maintain

    in the segregated accounts in order to protect against the possibility

    that such debit balances could cause them to have less that is required

    in their segregated accounts would also be reduced. This provides

    benefits for the FCM by reducing the amount of capital that it must

    contribute to the customer segregated accounts, and for customers, by

    promoting more rapid margin call payments from other customers to

    support their own positions.

    Costs

    With respect to costs, the proposed amendment Sec. 1.17(a)(4),

    allowing the Commission to require an FCM to transfer its customer

    positions if the FCM is not able to immediately certify that its

    liquidity is adequate to continue as a going concern, would give the

    Commission the authority to force the FCM to transfer its customer

    positions to another FCM in such circumstances. This could create

    additional costs for the FCM in two different ways. First, it is

    possible that while the FCM may not be able to immediately certify that

    it has sufficient liquidity to continue as a going concern but may

    nevertheless obtain sufficient liquidity before its impending

    obligations become due. If the FCM is forced to transfer its positions

    before it obtains the liquidity necessary to demonstrate that it may

    continue as a going concern, the FCM will have lost its FCM business.

    Second, if the FCM is working on obtaining sufficient liquidity to

    continue as a going concern, it may be able to obtain such liquidity

    under more favorable terms if it has time to consider multiple offers.

    However, if the FCM has a

    [[Page 67913]]

    shortened timeline to consider offers before being forced to transfer

    its customer positions to another FCM, it may be forced to accept an

    offer that is less attractive than what otherwise would have been the

    case.

    Regarding the proposed amendment to Sec. 1.17(c)(5)(v) changing

    the haircutting procedures for FCMs, lowering the amount of capital

    that the FCM must hold reduces the buffer it has to absorb any losses

    that result from its own investments. However, the Commission proposes

    that even in the absence of the amendment proposed here dual

    registrants will be able to use the SEC's haircutting procedure.

    Therefore, only FCMs that are not dual registrants would be impacted by

    the proposed change to Sec. 1.17. Moreover, the Commission proposes

    that FCMs that are not dual registrants do not typically invest in

    securities that would be subject to reduced haircuts under the SEC's

    proposed rules, and therefore the change would not have a significant

    impact on the capital requirements for such FCMs.

    Reducing the period of time FCMs can wait for customers' margin

    call payments before taking a capital charge may increase the capital

    charge that FCMs take due to tardy margin call payments. As a

    consequence, proposed Sec. 1.17(c)(5)(viii) would likely force FCMs to

    hold more capital, or to more diligently collect margin from customers

    on a prompt basis. The Commission does not have adequate information to

    estimate the amount of additional capital that FCMs would likely be

    required to hold, or the cost of that capital, and therefore is not

    able to quantify this cost at this time.

    Request for Comment

    Question 7: The Commission requests comment regarding whether FCMs

    that are not dual registrants typically invest in securities that would

    be subject to reduced haircutting procedures under the SEC's proposed

    rules. If an FCM would be subject to reduced haircutting, please

    quantify the effect that such investments are likely to have on the

    capital requirements for such FCM.

    Question 8: In addition, the Commission requests information that

    would assist it in quantifying the costs and benefits associated with

    reducing the number of days an FCM can wait for margin call payments

    before taking a capital charge. Specifically, how much margin is

    typically owed by those customers?

    Question 9: The Commission also requests comment regarding the

    amount of additional capital that FCMs would likely be required to hold

    and the average cost of capital for an FCM. In addition, please provide

    data and calculations that would enable the Commission to replicate and

    validate the estimates you provide.

    Sec. 1.20 Futures Customer Funds To Be Segregated and Separately

    Accounted for

    Proposed Changes

    As described in the section by section discussion at II.G, the

    proposed amendments to Sec. 1.20 reorganize the section, but also

    alter the substance of the section's requirements in certain places.

    Proposed Sec. 1.20 includes a new Appendix A which is a template

    for the acknowledgment letter that FCMs and DCOs must obtain from their

    depositories. The proposed changes would require FCMs and DCOs to use

    the letter in Appendix A to provide the acknowledgment that they must

    obtain, and to clarify that the acknowledgment letter must be obtained

    before depositing any funds with a depository. The proposed amendments

    to Sec. 1.20 also requires FCMs and DCOs file the acknowledgment

    letter with the Commission promptly, and to update the acknowledgment

    letter whenever there are changes to the business name, address, or

    account numbers referenced in the letter. Last, proposed Sec. 1.20

    requires that customer funds deposited at a bank or trust company must

    be available for immediate withdrawal upon demand by the FCM or DCO,

    which effectively prevents them from placing funds into time-deposit

    accounts with depositories.

    Benefits

    Proposed Sec. 1.20(d)(2) would require that FCMs and DCOs use the

    template in Appendix A when obtaining written acknowledgments from

    their depositories holding futures customer funds. Through this change

    would require depositories accepting customer funds to: (1) Recognize

    that the funds are customer segregated funds subject to the Act and

    CFTC regulations; (2) agree not to use the funds to secure any

    obligation of the FCM to the depository; (3) agree to allow the CFTC

    and the FCM's SRO to examine accounts at any reasonable time; (4) agree

    to provide CFTC and SRO user login to have read-only access to

    segregated accounts 24 hours a day; (5) and agree to release funds in

    segregated accounts when instructed to do so by an appropriate officer

    of FCM, the Director of DSIO, or the Director of DCR.

    These acknowledgments and commitments would result in important

    benefits. First, by acknowledging that the funds are subject to the Act

    and CFTC regulations, the depository would become accountable for

    complying with relevant statutory and regulatory requirements related

    to its handling of those funds. Second, the depository would

    acknowledge that the FCM is not permitted to use customer funds as

    belonging to any person other than the customer which deposited them,

    which would also prohibit an FCM from using customer funds to secure

    its own obligations. By requiring the FCM or DCO to obtain a statement

    from depositories holding customer funds acknowledging these

    limitations on use, the proposed rule would ensure that each depository

    is aware that the customers' funds cannot be used to secure the FCM's

    obligations to the depository. Third, the letter constitutes written

    permission by the depository to allow CFTC or DSRO officials to examine

    the FCM's customer accounts at any reasonable time, and to view the

    those accounts online at any time. As a consequence, the letter would

    enable both the Commission and the DSRO to monitor actual balances at

    the depository more easily and regularly. This would increase the

    probability that any discrepancy between balances reported by the FCM

    on its daily customer segregation account reports, and balances

    actually held by the depository would be identified quickly by the

    Commission or the DSRO. Moreover, with standing authorization from the

    depository to examine customer segregated accounts, both the Commission

    and DSRO would be better able to move quickly to verify that there is a

    problem.

    The commitment to distribute funds when directed to do so by the

    Director of DSIO, the Director of DCR, or appropriate officials of the

    DSRO facilitates the immediate movement of customer funds, and avoids

    delay in the release such funds which expedites to the transfer the

    customers' positions or to return the customers' funds without delay.

    The acknowledgment letter also provides some assurances to the

    depository, namely, that it is not liable to the FCM for following

    instructions to distribute funds from customer segregated accounts at

    the direction of the Director of DSIO or the Director of DCR and that

    the depository is not responsible for the FCM's compliance with the Act

    or Commission regulations beyond what is expressly stated in this

    letter. The letter places depositories holding customer funds on notice

    that they must release customer funds without delay when directed to do

    so by

    [[Page 67914]]

    the Director of DSIO or the Director of DCR. The assurance that the FCM

    will not hold the depository liable for following instructions from the

    Director of DSIO or of DCR should reduce this potential cause for delay

    in time-critical situations. Moreover, under the proposed amendments,

    depositories must sign the acknowledgment letter in Appendix A in order

    to receive funds from an FCM or DCO. If some depositories were not

    willing to sign the letter, it would reduce the number of available

    depositories for FCMs and DCOs and may force them to move some existing

    depository accounts.

    The benefit of requiring FCMs and DCOs to obtain an acknowledgment

    letter from their depository prior to or contemporaneously with

    transferring any customer funds to that depository is that it ensures

    that all the protections provided for by the depository's consent to

    the terms of the letter are in place for the full time during which a

    depository holds customer segregated funds. In other words, it prevents

    the possibility of a gap in the protections created by the requirements

    of this section.

    By requiring FCMs and DCOs to submit the acknowledgment letters,

    signed by their depositories, to both the Commission and the relevant

    SRO, the proposed rules should make it easier for the Commission or

    relevant SRO to act quickly, when necessary, being confident that the

    correct legal permissions are in place. Additionally, requiring the

    letters to be retained for five years past the time when customer

    segregated funds are no longer held by each depository would ensure

    that proper documentation of all relevant acknowledgments and

    commitments is in the possession of each party that relies upon the

    existence of those commitments in order to effectuate the protections

    created by this section.

    Last, Sec. 1.12(h) requires that funds deposited by an FCM be

    available for immediate withdrawal. If an FCM places customer funds in

    time-deposit accounts the depository has the contractual right to

    require a period of notice from the FCM before distributing funds at

    the FCM's request. Under the proposed regulation, a period of notice

    would not be acceptable given the obligation that the FCM has to return

    customer funds to customers upon request. Moreover, placing funds in a

    time-deposit account could prevent the DCO, Commission, or Trustee from

    being able to effect the immediate movement of customer funds if

    required to do so in the event of a default by the FCM. Requiring that

    funds be available for immediate withdrawal at the request of the FCM

    ensures prompt access to customer funds by all concerned.

    Prohibiting FCMs from placing customer funds in time-deposit

    accounts would codify a long-standing staff interpretation that

    prohibits FCM's from placing customer funds in such accounts.\126\ The

    interpretation and proposed amendment prohibit such deposits because

    time-deposit accounts, by law, must retain the right to a certain

    number of days advance notice before allowing a customer to withdrawal

    funds. This delay could prevent an FCM from returning all customer

    funds in a prompt manner if those customers all demanded their funds

    and could prevent the DCO from porting open positions to another FCM in

    the event that the FCM currently holding those funds defaulted. The

    benefits of codifying the current staff interpretation are that it will

    provide additional clarity about the legal force of the requirement,

    and will put the requirement in a location where relevant market

    participants are much more likely to see it, which reduces the

    likelihood that FCMs would violate this prohibition unknowingly.

    ---------------------------------------------------------------------------

    \126\ See Administrative Determination No. 29 of the Commodity

    Exchange Administration dated Sept. 28, 1937 stating, ``the deposit,

    by a futures commission merchant, of customers' funds * * * under

    conditions whereby such funds would not be subject to withdrawal

    upon demand would be repugnant to the spirit and purpose of the

    Commodity Exchange Act. All funds deposited in a bank should in all

    cases by subject to withdrawal on demand.''

    ---------------------------------------------------------------------------

    Costs

    FCMs and DCOs are likely to bear some initial and ongoing costs as

    a result of the proposed amendment requiring them to use the template

    in Appendix A to obtain the acknowledgment letter from their

    depositories. Regarding initial costs, the letter includes new

    requirements that existing depositories want to discuss with the FCM or

    DCO's staff. In addition, some existing depositories may not be willing

    to sign the new letter, which would force the FCM or DCO to move any

    customer funds held by that depository to a different depository,

    creating certain due diligence and operational costs. The Commission

    estimates that the cost of obtaining a new acknowledgment letter from

    each existing depository is between $1,300 and $4,200.\127\ Based on

    conversations with industry participants, the Commission estimates that

    FCMs and DCOs would have approximately 1-30 depositories each, from

    which they must obtain a new acknowledgment letter. Therefore, the

    Commission estimates that the cost of obtaining new acknowledgment

    letters from existing depositories is between $2,700 and $82,000 per

    FCM or DCO.\128\ In addition, based on conversations with industry

    participants, the Commission estimates that identifying new potential

    depositories, conducting necessary due diligence, formalizing necessary

    agreements, opening accounts, and transferring funds to a new

    depository is likely to take between three to six months and is likely

    to require support from compliance attorneys, as well as operations,

    risk management, and administrative personnel. The Commission estimates

    that the cost of moving accounts from an existing depository that is

    not willing to sign the letter is between $50,000 and $102,000.\129\

    ---------------------------------------------------------------------------

    \127\ This estimate assumes 10-40 hours of time from a

    compliance attorney and 10-20 hours from an office services

    supervisor. The average compensation for a compliance attorney is

    $85.35/hour [$131,303 per year/(2000 hours per year)*1.3 is $85.35

    per hour]; $85.35*10 = $853.47 and $85.35*40 = $3,413.88. The

    average compensation for an office services supervisor is $40.15/

    hour [$61,776.00 per year/(2000 hours per year)*1.3 is $40.15 per

    hour]; $40.15*10 = $401.54 and $40.15*20 = $803.09. These figures

    are taken from the 2011 SIFMA Report on Management and Professional

    Earnings in the Securities Industry.

    \128\ Total figures are taken from previous calculation.

    ($1,255.01+$4,216.97)/2 = $2,735.99; $2,735.99*1 = $2,735.99 and

    $2,735.99*30 = $82,079.69.

    \129\ This estimate assumes one compliance attorney working

    full-time for 3-6 months, 50-200 hours from an office services

    supervisor, 80-160 hours of time from a risk management specialist,

    and 40-60 hours from an intermediate accountant. The average

    compensation for a compliance attorney is $85.35/hour [$131,303 per

    year/(2000 hours per year)*1.3 is $85.35 per hour]; $85.35*40 hours/

    week*4 weeks/month*3 months = $40,966.54 and $85.35*40 hours/week*4

    weeks/month*6 months = $81,933.07. The average compensation for an

    office services supervisor is $40.15/hour [$61,776.00 per year/(2000

    hours per year)*1.3 is $40.15 per hour]; $40.15*50 = $2,007.72 and

    $40.15*200 = $8,030.88. The average compensation for a risk

    management specialist is $65.33/hour [$100,500 per year/(2000 hours

    per year)*1.3 is $65.33 per hour]; $65.33*80 = $5,226.00 and

    $268.84*160 = $10,452.00. The average compensation for an

    intermediate accountant is $34.11/hour [$52,484.00 per year/(2000

    hours per year)*1.3 is $34.11 per hour]; $34.11*40 = $1,364.58 and

    $34.11*60 = $2,046.88. These figures are taken from the 2011 SIFMA

    Report on Management and Professional Earnings in the Securities

    Industry.

    ---------------------------------------------------------------------------

    Ongoing costs include those created by the additional requirements

    the FCM or DCO will have to explain to new depositories when obtaining

    the required letter. There may be additional operational costs involved

    with monitoring depositories for any change that would necessitate

    updating the letter. The per-entity cost of obtaining the letter from

    new depositories is likely to be the same as it would for obtaining the

    letter from existing depositories (i.e.,

    [[Page 67915]]

    $1,300 and $4,200). The Commission estimates that the ongoing cost

    associated with monitoring for changes that would require the

    acknowledgement letter to be updated is between $1,100 and $2,800 per

    year.\130\

    ---------------------------------------------------------------------------

    \130\ This assumes 20-50 hours per year from an office manager

    for monitoring costs. The average compensation for an office manager

    is $55.82/hour [$85,875 per year/(2000 hours per year)*1.3 = $55.82/

    hour]; $55.82*20 = $1,116.38 and $55.82*50 = $2,790.94. This figure

    is taken from the 2011 SIFMA Report on Management and Professional

    Earnings in the Securities Industry.

    ---------------------------------------------------------------------------

    The proposed requirement, embedded in the acknowledgment letter,

    that depositories provide to the Commission and DSRO online, read-only

    access to accounts where customer segregated funds are held, would

    create certain costs for depositories that would likely be passed onto

    FCMs. The NFA Board of Directors recently approved rule amendments that

    will require FCMs to provide their respective DSROs with on-line view-

    only access to customer segregated/secured amount bank account

    information. NFA has submitted the rule amendments to the Commission

    for approval.\131\ Therefore, the pending NFA rule and the Commission's

    proposed requirement would require banks and trust companies to provide

    the Commission and the DSROs with the same read-only access to account

    information. The Commission estimates that the cost of this additional

    access is between $270 and $540 per account.\132\

    ---------------------------------------------------------------------------

    \131\ A copy of the NFA rule submission is available on the NFA

    Web site, www.nfa.futures.org.

    \132\ This assumes 4-8 hours per account from a senior database

    administrator. The average compensation for a senior database

    administrator is $$68.09/hour [$104,755 per year/(2000 hours per

    year)*1.3 = $68.09/hour]; $68.09*4 hour = $272.36 and $68.09/hour *8

    hours = $554.73. This figure is taken from the 2011 SIFMA Report on

    Management and Professional Earnings in the Securities Industry.

    ---------------------------------------------------------------------------

    For all other depositories, the Commission believes that providing

    access read-only access to balances and transactions in cash accounts

    is possible with existing technology and therefore, for depositories

    that already provide such access to their customers, the cost of

    providing that access to the Commission and DSRO is likely to be

    relatively low. Based on conversations with industry participants, the

    Commission estimates that on average an FCM or DCO is likely to have

    approximately 5-30 accounts. The Commission estimates that the initial

    set-up cost of providing access to each account at depositories that

    already provide online access to their customers is approximately $270

    and $550 per account.\133\

    ---------------------------------------------------------------------------

    \133\ This assumes 4-8 hours per account from a senior database

    administrator. The average compensation for a senior database

    administrator is $$68.09/hour [ $104,755 per year/(2000 hours per

    year)*1.3 = $68.09/hour]; $68.09*4 hour = $272.36 and $68.09/hour *8

    hours = $554.73. This figure is taken from the 2011 SIFMA Report on

    Management and Professional Earnings in the Securities Industry.

    ---------------------------------------------------------------------------

    On the other hand, for depositories that do not currently provide

    such access to their customers, setting up the capability to provide it

    to the Commission and DSRO will require that the depository implement

    additional technology. The Commission does not have adequate data to

    estimate the cost for establishing such a system.

    The Commission proposes that the requirement embedded in the

    acknowledgment letter that depositories consent to release customer

    funds whenever requested to do so by the Director of DCR or Director of

    DSIO will not create any additional costs for FCMs, depositories, or

    market participants.

    The Commission does not anticipate any costs associated with

    proposed Sec. 1.20(h) prohibiting an FCM from placing customer funds

    in time-deposit accounts since it is codifying a current staff

    interpretation and FCMs already abide by this standard.

    The remaining requirements in proposed Sec. 1.20 are virtually

    identical to those in the existing rule, but are reorganized in order

    to improve readability. The changes that are merely the result of

    reorganizing identical requirements do not result in any costs for

    market participants.

    Request for Comment

    Question 10: The Commission requests data from which to estimate

    the initial and ongoing costs for a depository to establish the

    capability to provide read-only access to account balances and

    transaction history.

    Question 11: The Commission requests comment from the public

    regarding the initial and ongoing cost of services provided by vendors

    that have the ability to provide regular confirmation of balances at

    depositories on both a scheduled and unscheduled basis. Also, would

    such services be applicable to custodial accounts, and accounts held at

    non-bank depositories (e.g. other FCMs or Money Market Mutual Funds)?

    Question 12: The Commission requests comment regarding whether

    depositories currently have systems that provide their customers with

    continuous read-only access to accounts where securities are held that

    provide: (1) Real time or end of day balances for each segregated

    account; and (2) descriptions of the types of assets contained in each

    account with balances associated with each type of asset. How do the

    capabilities of systems that provide continuous read-only access to

    customers vary across different types of depositories, foreign or

    domestic (i.e. banks, FCMs, DCOs, or Money Market Mutual Funds)?

    Question 13: If depositories do not currently have the ability to

    provide continuous read-only access to accounts holding customer funds

    that display transactions and balances for those accounts, what costs

    would be required in order to create such a systscribed in the section by section discussion at II.F, the

    Commission is proposing to amend Sec. 1.17 by adding a new provision

    that will authorize the Commission to require an FCM to cease operating

    as an FCM and transfer its customer accounts if the FCM is not able to

    certify and demonstrate sufficient access to liquidity to continue

    operating as a going concern.

    In addition, FCMs that are dual registrants (FCM and BD) are

    allowed to use the Securities and Exchange Commission's broker-dealer

    approach \124\ to evaluating the credit risk of securities that the FCM

    invests in and assigning smaller haircuts \125\ to those that are

    deemed to be a low credit risk, should the SEC adopt as final its

    proposed rule to eliminate references to credit ratings. The proposed

    change to Sec. 17(c)(5)(v) would allow FCMs that are not dual

    registrants to use the same approach. Reducing the haircut assigned to

    low credit risk securities that the FCM invests in (which would

    potentially include some investments compliant with the requirements of

    Sec. 1.25), reduces the capital charge that the FCM must take for

    investing in those securities.

    ---------------------------------------------------------------------------

    \124\ As stated above in II.F above, under the SEC proposal, a

    BD may impose the default haircuts of 15 percent of the market value

    of readily marketable commercial paper, convertible debt, and

    nonconvertible debt instruments or 100 percent of the market value

    of nonmarketable commercial paper, convertible debt, and

    nonconvertible debt instruments. A BD, however, may impose lower

    haircut percentages for commercial paper, convertible debt, and

    nonconvertible debt instruments that are readily marketable, if the

    BD determines that the investments have only a minimal amount of

    credit risk pursuant to its written policies and procedures designed

    to assess the credit and liquidity risks applicable to a security. A

    BD that maintains written policies and procedures and determines

    that the credit risk of a security is minimal is permitted under the

    SEC proposal to apply the lesser haircut requirement currently

    specified in the SEC capital rule for commercial paper (i.e.,

    between zero and \1/2\ of 1 percent), nonconvertible debt (i.e.,

    between 2 percent and 9 percent), and preferred stock (i.e., 10

    percent).

    \125\ As stated above in II.F, in computing its adjusted net

    capital, an FCM is required to reduce the value of proprietary

    futures and securities positions included in its liquid assets by

    certain prescribed amounts or percentages of the market value

    (otherwise known as ``haircuts'') to discount for potential adverse

    market movements in the securities.

    ---------------------------------------------------------------------------

    Last, the proposed amendments would change the period of time that

    an FCM can wait for margin payments from a customer before taking a

    capital charge from three days to one day.

    Benefits

    As discussed in II.F, an FCM's ability to meet capital requirements

    and segregation requirements is not necessarily a sufficient indicator

    of the FCM's continued viability as a going concern. If an FCM does not

    have access to liquidity to meet identifiable, imminent financial

    obligations, the FCM will likely default, regardless of the amount of

    capital that is recognized on its balance sheet. In such circumstances,

    transferring customer positions to another FCM before the current FCM

    enters into bankruptcy provides additional protection to customer

    funds. Once the FCM enters into bankruptcy, the transfer of customer

    positions may be slowed by the trustee's involvement, which could

    interrupt customers' ability to actively manage those positions. In

    addition, if the FCM enters into bankruptcy before transferring

    customers' positions, customer segregated funds may be subject to

    trustee fees. Transferring the positions before the FCM enters into

    bankruptcy, therefore, provides additional protection to customers by

    preserving their ability to continuously manage their accounts and by

    protecting their funds from being subject to trustee fees.

    By allowing FCMs that are not dual registrants to follow the same

    rules as those that are dual registrants, the change would harmonize

    the regulation of FCMs with respect to minimal financial requirements.

    This would place FCMs that are not dual registrants on a level playing

    field with those that are dual registrants, which contributes to the

    competitiveness of the financial markets.

    In Sec. 1.17(c)(5)(viii), the Commission proposes to reduce the

    period of time an FCM can wait to receive margin call payments from

    customers before taking a capital charge, which will incent FCMs to

    exercise increased diligence when seeking such payments, and therefore

    will likely prompt customers to provide such payments more quickly. As

    a consequence, the risk that a debit balance could develop in a

    customer's account due to tardy margin call payments would be reduced,

    and the amount of residual interest that the FCM would need to maintain

    in the segregated accounts in order to protect against the possibility

    that such debit balances could cause them to have less that is required

    in their segregated accounts would also be reduced. This provides

    benefits for the FCM by reducing the amount of capital that it must

    contribute to the customer segregated accounts, and for customers, by

    promoting more rapid margin call payments from other customers to

    support their own positions.

    Costs

    With respect to costs, the proposed amendment Sec. 1.17(a)(4),

    allowing the Commission to require an FCM to transfer its customer

    positions if the FCM is not able to immediately certify that its

    liquidity is adequate to continue as a going concern, would give the

    Commission the authority to force the FCM to transfer its customer

    positions to another FCM in such circumstances. This could create

    additional costs for the FCM in two different ways. First, it is

    possible that while the FCM may not be able to immediately certify that

    it has sufficient liquidity to continue as a going concern but may

    nevertheless obtain sufficient liquidity before its impending

    obligations become due. If the FCM is forced to transfer its positions

    before it obtains the liquidity necessary to demonstrate that it may

    continue as a going concern, the FCM will have lost its FCM business.

    Second, if the FCM is working on obtaining sufficient liquidity to

    continue as a going concern, it may be able to obtain such liquidity

    under more favorable terms if it has time to consider multiple offers.

    However, if the FCM has a

    [[Page 67913]]

    shortened timeline to consider offers before being forced to transfer

    its customer positions to another FCM, it may be forced to accept an

    offer that is less attractive than what otherwise would have been the

    case.

    Regarding the proposed amendment to Sec. 1.17(c)(5)(v) changing

    the haircutting procedures for FCMs, lowering the amount of capital

    that the FCM must hold reduces the buffer it has to absorb any losses

    that result from its own investments. However, the Commission proposes

    that even in the absence of the amendment proposed here dual

    registrants will be able to use the SEC's haircutting procedure.

    Therefore, only FCMs that are not dual registrants would be impacted by

    the proposed change to Sec. 1.17. Moreover, the Commission proposes

    that FCMs that are not dual registrants do not typically invest in

    securities that would be subject to reduced haircuts under the SEC's

    proposed rules, and therefore the change would not have a significant

    impact on the capital requirements for such FCMs.

    Reducing the period of time FCMs can wait for customers' margin

    call payments before taking a capital charge may increase the capital

    charge that FCMs take due to tardy margin call payments. As a

    consequence, proposed Sec. 1.17(c)(5)(viii) would likely force FCMs to

    hold more capital, or to more diligently collect margin from customers

    on a prompt basis. The Commission does not have adequate information to

    estimate the amount of additional capital that FCMs would likely be

    required to hold, or the cost of that capital, and therefore is not

    able to quantify this cost at this time.

    Request for Comment

    Question 7: The Commission requests comment regarding whether FCMs

    that are not dual registrants typically invest in securities that would

    be subject to reduced haircutting procedures under the SEC's proposed

    rules. If an FCM would be subject to reduced haircutting, please

    quantify the effect that such investments are likely to have on the

    capital requirements for such FCM.

    Question 8: In addition, the Commission requests information that

    would assist it in quantifying the costs and benefits associated with

    reducing the number of days an FCM can wait for margin call payments

    before taking a capital charge. Specifically, how much margin is

    typically owed by those customers?

    Question 9: The Commission also requests comment regarding the

    amount of additional capital that FCMs would likely be required to hold

    and the average cost of capital for an FCM. In addition, please provide

    data and calculations that would enable the Commission to replicate and

    validate the estimates you provide.

    Sec. 1.20 Futures Customer Funds To Be Segregated and Separately

    Accounted for

    Proposed Changes

    As described in the section by section discussion at II.G, the

    proposed amendments to Sec. 1.20 reorganize the section, but also

    alter the substance of the section's requirements in certain places.

    Proposed Sec. 1.20 includes a new Appendix A which is a template

    for the acknowledgment letter that FCMs and DCOs must obtain from their

    depositories. The proposed changes would require FCMs and DCOs to use

    the letter in Appendix A to provide the acknowledgment that they must

    obtain, and to clarify that the acknowledgment letter must be obtained

    before depositing any funds with a depository. The proposed amendments

    to Sec. 1.20 also requires FCMs and DCOs file the acknowledgment

    letter with the Commission promptly, and to update the acknowledgment

    letter whenever there are changes to the business name, address, or

    account numbers referenced in the letter. Last, proposed Sec. 1.20

    requires that customer funds deposited at a bank or trust company must

    be available for immediate withdrawal upon demand by the FCM or DCO,

    which effectively prevents them from placing funds into time-deposit

    accounts with depositories.

    Benefits

    Proposed Sec. 1.20(d)(2) would require that FCMs and DCOs use the

    template in Appendix A when obtaining written acknowledgments from

    their depositories holding futures customer funds. Through this change

    would require depositories accepting customer funds to: (1) Recognize

    that the funds are customer segregated funds subject to the Act and

    CFTC regulations; (2) agree not to use the funds to secure any

    obligation of the FCM to the depository; (3) agree to allow the CFTC

    and the FCM's SRO to examine accounts at any reasonable time; (4) agree

    to provide CFTC and SRO user login to have read-only access to

    segregated accounts 24 hours a day; (5) and agree to release funds in

    segregated accounts when instructed to do so by an appropriate officer

    of FCM, the Director of DSIO, or the Director of DCR.

    These acknowledgments and commitments would result in important

    benefits. First, by acknowledging that the funds are subject to the Act

    and CFTC regulations, the depository would become accountable for

    complying with relevant statutory and regulatory requirements related

    to its handling of those funds. Second, the depository would

    acknowledge that the FCM is not permitted to use customer funds as

    belonging to any person other than the customer which deposited them,

    which would also prohibit an FCM from using customer funds to secure

    its own obligations. By requiring the FCM or DCO to obtain a statement

    from depositories holding customer funds acknowledging these

    limitations on use, the proposed rule would ensure that each depository

    is aware that the customers' funds cannot be used to secure the FCM's

    obligations to the depository. Third, the letter constitutes written

    permission by the depository to allow CFTC or DSRO officials to examine

    the FCM's customer accounts at any reasonable time, and to view the

    those accounts online at any time. As a consequence, the letter would

    enable both the Commission and the DSRO to monitor actual balances at

    the depository more easily and regularly. This would increase the

    probability that any discrepancy between balances reported by the FCM

    on its daily customer segregation account reports, and balances

    actually held by the depository would be identified quickly by the

    Commission or the DSRO. Moreover, with standing authorization from the

    depository to examine customer segregated accounts, both the Commission

    and DSRO would be better able to move quickly to verify that there is a

    problem.

    The commitment to distribute funds when directed to do so by the

    Director of DSIO, the Director of DCR, or appropriate officials of the

    DSRO facilitates the immediate movement of customer funds, and avoids

    delay in the release such funds which expedites to the transfer the

    customers' positions or to return the customers' funds without delay.

    The acknowledgment letter also provides some assurances to the

    depository, namely, that it is not liable to the FCM for following

    instructions to distribute funds from customer segregated accounts at

    the direction of the Director of DSIO or the Director of DCR and that

    the depository is not responsible for the FCM's compliance with the Act

    or Commission regulations beyond what is expressly stated in this

    letter. The letter places depositories holding customer funds on notice

    that they must release customer funds without delay when directed to do

    so by

    [[Page 67914]]

    the Director of DSIO or the Director of DCR. The assurance that the FCM

    will not hold the depository liable for following instructions from the

    Director of DSIO or of DCR should reduce this potential cause for delay

    in time-critical situations. Moreover, under the proposed amendments,

    depositories must sign the acknowledgment letter in Appendix A in order

    to receive funds from an FCM or DCO. If some depositories were not

    willing to sign the letter, it would reduce the number of available

    depositories for FCMs and DCOs and may force them to move some existing

    depository accounts.

    The benefit of requiring FCMs and DCOs to obtain an acknowledgment

    letter from their depository prior to or contemporaneously with

    transferring any customer funds to that depository is that it ensures

    that all the protections provided for by the depository's consent to

    the terms of the letter are in place for the full time during which a

    depository holds customer segregated funds. In other words, it prevents

    the possibility of a gap in the protections created by the requirements

    of this section.

    By requiring FCMs and DCOs to submit the acknowledgment letters,

    signed by their depositories, to both the Commission and the relevant

    SRO, the proposed rules should make it easier for the Commission or

    relevant SRO to act quickly, when necessary, being confident that the

    correct legal permissions are in place. Additionally, requiring the

    letters to be retained for five years past the time when customer

    segregated funds are no longer held by each depository would ensure

    that proper documentation of all relevant acknowledgments and

    commitments is in the possession of each party that relies upon the

    existence of those commitments in order to effectuate the protections

    created by this section.

    Last, Sec. 1.12(h) requires that funds deposited by an FCM be

    available for immediate withdrawal. If an FCM places customer funds in

    time-deposit accounts the depository has the contractual right to

    require a period of notice from the FCM before distributing funds at

    the FCM's request. Under the proposed regulation, a period of notice

    would not be acceptable given the obligation that the FCM has to return

    customer funds to customers upon request. Moreover, placing funds in a

    time-deposit account could prevent the DCO, Commission, or Trustee from

    being able to effect the immediate movement of customer funds if

    required to do so in the event of a default by the FCM. Requiring that

    funds be available for immediate withdrawal at the request of the FCM

    ensures prompt access to customer funds by all concerned.

    Prohibiting FCMs from placing customer funds in time-deposit

    accounts would codify a long-standing staff interpretation that

    prohibits FCM's from placing customer funds in such accounts.\126\ The

    interpretation and proposed amendment prohibit such deposits because

    time-deposit accounts, by law, must retain the right to a certain

    number of days advance notice before allowing a customer to withdrawal

    funds. This delay could prevent an FCM from returning all customer

    funds in a prompt manner if those customers all demanded their funds

    and could prevent the DCO from porting open positions to another FCM in

    the event that the FCM currently holding those funds defaulted. The

    benefits of codifying the current staff interpretation are that it will

    provide additional clarity about the legal force of the requirement,

    and will put the requirement in a location where relevant market

    participants are much more likely to see it, which reduces the

    likelihood that FCMs would violate this prohibition unknowingly.

    ---------------------------------------------------------------------------

    \126\ See Administrative Determination No. 29 of the Commodity

    Exchange Administration dated Sept. 28, 1937 stating, ``the deposit,

    by a futures commission merchant, of customers' funds * * * under

    conditions whereby such funds would not be subject to withdrawal

    upon demand would be repugnant to the spirit and purpose of the

    Commodity Exchange Act. All funds deposited in a bank should in all

    cases by subject to withdrawal on demand.''

    ---------------------------------------------------------------------------

    Costs

    FCMs and DCOs are likely to bear some initial and ongoing costs as

    a result of the proposed amendment requiring them to use the template

    in Appendix A to obtain the acknowledgment letter from their

    depositories. Regarding initial costs, the letter includes new

    requirements that existing depositories want to discuss with the FCM or

    DCO's staff. In addition, some existing depositories may not be willing

    to sign the new letter, which would force the FCM or DCO to move any

    customer funds held by that depository to a different depository,

    creating certain due diligence and operational costs. The Commission

    estimates that the cost of obtaining a new acknowledgment letter from

    each existing depository is between $1,300 and $4,200.\127\ Based on

    conversations with industry participants, the Commission estimates that

    FCMs and DCOs would have approximately 1-30 depositories each, from

    which they must obtain a new acknowledgment letter. Therefore, the

    Commission estimates that the cost of obtaining new acknowledgment

    letters from existing depositories is between $2,700 and $82,000 per

    FCM or DCO.\128\ In addition, based on conversations with industry

    participants, the Commission estimates that identifying new potential

    depositories, conducting necessary due diligence, formalizing necessary

    agreements, opening accounts, and transferring funds to a new

    depository is likely to take between three to six months and is likely

    to require support from compliance attorneys, as well as operations,

    risk management, and administrative personnel. The Commission estimates

    that the cost of moving accounts from an existing depository that is

    not willing to sign the letter is between $50,000 and $102,000.\129\

    ---------------------------------------------------------------------------

    \127\ This estimate assumes 10-40 hours of time from a

    compliance attorney and 10-20 hours from an office services

    supervisor. The average compensation for a compliance attorney is

    $85.35/hour [$131,303 per year/(2000 hours per year)*1.3 is $85.35

    per hour]; $85.35*10 = $853.47 and $85.35*40 = $3,413.88. The

    average compensation for an office services supervisor is $40.15/

    hour [$61,776.00 per year/(2000 hours per year)*1.3 is $40.15 per

    hour]; $40.15*10 = $401.54 and $40.15*20 = $803.09. These figures

    are taken from the 2011 SIFMA Report on Management and Professional

    Earnings in the Securities Industry.

    \128\ Total figures are taken from previous calculation.

    ($1,255.01+$4,216.97)/2 = $2,735.99; $2,735.99*1 = $2,735.99 and

    $2,735.99*30 = $82,079.69.

    \129\ This estimate assumes one compliance attorney working

    full-time for 3-6 months, 50-200 hours from an office services

    supervisor, 80-160 hours of time from a risk management specialist,

    and 40-60 hours from an intermediate accountant. The average

    compensation for a compliance attorney is $85.35/hour [$131,303 per

    year/(2000 hours per year)*1.3 is $85.35 per hour]; $85.35*40 hours/

    week*4 weeks/month*3 months = $40,966.54 and $85.35*40 hours/week*4

    weeks/month*6 months = $81,933.07. The average compensation for an

    office services supervisor is $40.15/hour [$61,776.00 per year/(2000

    hours per year)*1.3 is $40.15 per hour]; $40.15*50 = $2,007.72 and

    $40.15*200 = $8,030.88. The average compensation for a risk

    management specialist is $65.33/hour [$100,500 per year/(2000 hours

    per year)*1.3 is $65.33 per hour]; $65.33*80 = $5,226.00 and

    $268.84*160 = $10,452.00. The average compensation for an

    intermediate accountant is $34.11/hour [$52,484.00 per year/(2000

    hours per year)*1.3 is $34.11 per hour]; $34.11*40 = $1,364.58 and

    $34.11*60 = $2,046.88. These figures are taken from the 2011 SIFMA

    Report on Management and Professional Earnings in the Securities

    Industry.

    ---------------------------------------------------------------------------

    Ongoing costs include those created by the additional requirements

    the FCM or DCO will have to explain to new depositories when obtaining

    the required letter. There may be additional operational costs involved

    with monitoring depositories for any change that would necessitate

    updating the letter. The per-entity cost of obtaining the letter from

    new depositories is likely to be the same as it would for obtaining the

    letter from existing depositories (i.e.,

    [[Page 67915]]

    $1,300 and $4,200). The Commission estimates that the ongoing cost

    associated with monitoring for changes that would require the

    acknowledgement letter to be updated is between $1,100 and $2,800 per

    year.\130\

    ---------------------------------------------------------------------------

    \130\ This assumes 20-50 hours per year from an office manager

    for monitoring costs. The average compensation for an office manager

    is $55.82/hour [$85,875 per year/(2000 hours per year)*1.3 = $55.82/

    hour]; $55.82*20 = $1,116.38 and $55.82*50 = $2,790.94. This figure

    is taken from the 2011 SIFMA Report on Management and Professional

    Earnings in the Securities Industry.

    ---------------------------------------------------------------------------

    The proposed requirement, embedded in the acknowledgment letter,

    that depositories provide to the Commission and DSRO online, read-only

    access to accounts where customer segregated funds are held, would

    create certain costs for depositories that would likely be passed onto

    FCMs. The NFA Board of Directors recently approved rule amendments that

    will require FCMs to provide their respective DSROs with on-line view-

    only access to customer segregated/secured amount bank account

    information. NFA has submitted the rule amendments to the Commission

    for approval.\131\ Therefore, the pending NFA rule and the Commission's

    proposed requirement would require banks and trust companies to provide

    the Commission and the DSROs with the same read-only access to account

    information. The Commission estimates that the cost of this additional

    access is between $270 and $540 per account.\132\

    ---------------------------------------------------------------------------

    \131\ A copy of the NFA rule submission is available on the NFA

    Web site, www.nfa.futures.org.

    \132\ This assumes 4-8 hours per account from a senior database

    administrator. The average compensation for a senior database

    administrator is $$68.09/hour [$104,755 per year/(2000 hours per

    year)*1.3 = $68.09/hour]; $68.09*4 hour = $272.36 and $68.09/hour *8

    hours = $554.73. This figure is taken from the 2011 SIFMA Report on

    Management and Professional Earnings in the Securities Industry.

    ---------------------------------------------------------------------------

    For all other depositories, the Commission believes that providing

    access read-only access to balances and transactions in cash accounts

    is possible with existing technology and therefore, for depositories

    that already provide such access to their customers, the cost of

    providing that access to the Commission and DSRO is likely to be

    relatively low. Based on conversations with industry participants, the

    Commission estimates that on average an FCM or DCO is likely to have

    approximately 5-30 accounts. The Commission estimates that the initial

    set-up cost of providing access to each account at depositories that

    already provide online access to their customers is approximately $270

    and $550 per account.\133\

    ---------------------------------------------------------------------------

    \133\ This assumes 4-8 hours per account from a senior database

    administrator. The average compensation for a senior database

    administrator is $$68.09/hour [ $104,755 per year/(2000 hours per

    year)*1.3 = $68.09/hour]; $68.09*4 hour = $272.36 and $68.09/hour *8

    hours = $554.73. This figure is taken from the 2011 SIFMA Report on

    Management and Professional Earnings in the Securities Industry.

    ---------------------------------------------------------------------------

    On the other hand, for depositories that do not currently provide

    such access to their customers, setting up the capability to provide it

    to the Commission and DSRO will require that the depository implement

    additional technology. The Commission does not have adequate data to

    estimate the cost for establishing such a system.

    The Commission proposes that the requirement embedded in the

    acknowledgment letter that depositories consent to release customer

    funds whenever requested to do so by the Director of DCR or Director of

    DSIO will not create any additional costs for FCMs, depositories, or

    market participants.

    The Commission does not anticipate any costs associated with

    proposed Sec. 1.20(h) prohibiting an FCM from placing customer funds

    in time-deposit accounts since it is codifying a current staff

    interpretation and FCMs already abide by this standard.

    The remaining requirements in proposed Sec. 1.20 are virtually

    identical to those in the existing rule, but are reorganized in order

    to improve readability. The changes that are merely the result of

    reorganizing identical requirements do not result in any costs for

    market participants.

    Request for Comment

    Question 10: The Commission requests data from which to estimate

    the initial and ongoing costs for a depository to establish the

    capability to provide read-only access to account balances and

    transaction history.

    Question 11: The Commission requests comment from the public

    regarding the initial and ongoing cost of services provided by vendors

    that have the ability to provide regular confirmation of balances at

    depositories on both a scheduled and unscheduled basis. Also, would

    such services be applicable to custodial accounts, and accounts held at

    non-bank depositories (e.g. other FCMs or Money Market Mutual Funds)?

    Question 12: The Commission requests comment regarding whether

    depositories currently have systems that provide their customers with

    continuous read-only access to accounts where securities are held that

    provide: (1) Real time or end of day balances for each segregated

    account; and (2) descriptions of the types of assets contained in each

    account with balances associated with each type of asset. How do the

    capabilities of systems that provide continuous read-only access to

    customers vary across different types of depositories, foreign or

    domestic (i.e. banks, FCMs, DCOs, or Money Market Mutual Funds)?

    Question 13: If depositories do not currently have the ability to

    provide continuous read-only access to accounts holding customer funds

    that display transactions and balances for those accounts, what costs

    would be required in order to create such a system?

    Question 14: The Commission assumes that the costs and benefits

    enumerated above capture the range of costs and benefits that would be

    experienced by each type of depository. The Commission requests comment

    and quantification regarding any additional costs or benefits that

    would be experienced by certain types of depositories such FCMs, bank

    and trust companies, depositories of an international affiliate.

    Sec. 1.22 Use of Customer Funds Restricted

    Proposed Changes

    As described in the section by section discussion at II.H, the

    Commission recently approved amendments to the definition of the term

    ``commodity and/or options customer.'' \134\ In order to retain the

    meaning of the term ``commodity and/or options customer'' as it was

    originally defined, the Commission is replacing the term with ``futures

    customer.'' As above, the new term has the same meaning as the original

    definition of the term that it is replacing, and therefore there are no

    costs or benefits associated with this change.

    ---------------------------------------------------------------------------

    \134\ The final rulemaking is available on the Commission's Web

    site, www.cftc.gov.

    ---------------------------------------------------------------------------

    In addition, the proposed amendments to 1.22 clarify that the

    prohibition against use of a futures customer's funds to extend credit

    to, or to purchase, margin, or settle the contracts of another person

    applies at all times. Last, the proposed amendments would clarify that

    in order to comply with the prohibition against using one customer's

    funds to ``purchase, margin, or settle the trades, contracts, or

    commodity options of, or to secure or extend the credit'' \135\ of any

    other

    [[Page 67916]]

    person, the FCM would be required to ensure that its residual interest

    in futures customer funds exceeds the sum of all its futures customer

    margin deficits.

    ---------------------------------------------------------------------------

    \135\ See proposed Sec. 1.22. N.B., the current form of Sec.

    1.22 also includes a prohibition against using one customer's funds

    to ``to purchase, margin, or settle the trades, contracts, or

    commodity options of, or to secure or extend the credit of, any

    person other than such customer or commodity option customer.''

    ---------------------------------------------------------------------------

    Benefits

    The benefit of the proposal is that it protects customer funds by

    requiring continual customer segregation balancing thereby avoiding the

    potential that an FCM could employ end-of-day balancing to obscure a

    shortfall the FCM experienced in the middle of the day.

    Under current regulations it is not permitted for an FCM to use one

    customer's funds to purchase, margin, secure or settle positions for

    another customer. However, the current regulations do not specify how

    FCMs must comply with this requirement. The proposed rule would specify

    that FCMs must maintain residual interest in customer segregated

    accounts that is larger than the sum of all customer margin deficits,

    which would ensure that the FCM is not using one customer's funds to

    purchase, margin, secure, or settle positions for another customer.

    Furthermore, when combined with the reporting requirements in

    Sec. Sec. 1.10, 1.32, 22.2, and 30.7, which require the FCM to report

    both the sum of their customer margin deficits as well as their

    residual interest in customer segregated accounts, the proposed

    approach would provide the Commission and the public with sufficient

    information to verify that FCMs are not using one customer's funds to

    purchase, margin, secure or settle positions for another customer.

    Costs

    If the sum of an FCM's customer margin deficits is greater than the

    residual interest an FCM typically maintains in their customer

    accounts, then the FCM would have to increase the amount of residual

    interest it maintains in customer segregated accounts, which would

    reduce the range of investment options the FCM has for those additional

    funds and may prompt the FCM to maintain additional capital to meet

    operational needs. On the other hand, if an FCM typically maintains

    residual interest in customer segregated accounts that is greater than

    the sum of their customer margin deficits, then the proposed rule would

    not create any additional costs. In the past, the Commission has not

    required FCMs to report the sum of their customers' margin deficits.

    Therefore, the Commission does not have adequate information to

    determine whether FCMs typically hold residual interest that is greater

    than the sum of their customers' margin deficits and cannot estimate

    the cost of the proposed rule.

    Request for Comment

    Question 15: The Commission requests comment regarding whether FCMs

    typically maintain residual interest in their customer segregated

    accounts that is greater than the sum of their customer margin

    deficits, and data from which the Commission may quantify the average

    difference between the amount of residual interest an FCM maintains in

    customer segregated accounts and the sum of customer margin deficit.

    Question 16: How much additional residual interest would FCMs hold

    in their customer segregated accounts in order to comply with the

    proposed regulation? What is the opportunity cost to FCMs associated

    with increasing the amount of capital FCMs place in residual interest,

    and data that would allow the Commission to replicate and verify the

    calculated estimates provided.

    Question 17: The Commission request information regarding the

    additional amount of capital that FCMs would likely maintain in their

    customer segregated accounts, if any, to comply with the proposed

    regulation. What is the average cost of capital for an FCM? Please

    provide data and calculations that would allow the Commission to

    replicate and verify the cost of capital that you estimate?

    Sec. 1.23 Interest of Futures Commission Merchants in Segregated

    Funds; Additions and Withdrawals

    Proposed Changes

    As described in the section by section discussion at II.I, the

    proposed text changes the term ``customer funds'' to ``futures customer

    funds.'' This is a conforming change in order to retain the same

    meaning once the term ``customer'' is redefined in Sec. 1.3.\136\ The

    Commission anticipates that there are no costs or benefits associated

    with this change.

    ---------------------------------------------------------------------------

    \136\ The Commission recently approved final amendments to Sec.

    1.3 that revised the definition of the term ``customer'' to include

    commodity customers, options customers, and swap customers. A copy

    of the Federal Register release is available on the Commission's Web

    site, www.cftc.gov.

    ---------------------------------------------------------------------------

    The proposed Sec. 1.23 also places new restrictions regarding an

    FCM's withdrawal of residual interest funds for proprietary use. Under

    the proposed Sec. 1.23, an FCM cannot withdraw funds for proprietary

    use unless they have prepared the daily segregation calculation from

    the previous business day and must adjust for any activity or events

    that may have decreased residual interest since close of business the

    previous day. In addition, an FCM is only permitted to withdrawal more

    than 25% of its residual interest for proprietary use within one day if

    it: (1) Obtains a signature from the CEO, CFO or other senior official

    as described in Sec. 1.23(c)(1) confirming approval to make such a

    withdrawal; and (2) sends written notice to the CFTC and DSRO

    indicating that the requisite approvals from the CEO, CFO or other

    senior official has been obtained, providing reasons for the

    withdrawal, listing the names and amounts of funds provided to each

    recipient, and providing an affirmation from the signatory indicating

    that he or she has knowledge and reasonable belief that the FCM is

    still in compliance with segregation requirements after the withdrawal.

    In addition, if the FCM drops below its target threshold for

    residual interest because of a withdrawal of residual interest for

    proprietary use, the next day it must either replenish residual

    interest enough to surpass its target, or if senior leadership believes

    the original target is excessive, the FCM may revise its target in

    accordance with its policies and procedures established in proposed

    Sec. 1.11.

    Benefits

    The proposed restrictions on withdrawals of residual interest

    provide an additional layer of protection for customer funds contained

    in segregated accounts. An FCM may withdraw residual interest as long

    as it always maintains sufficient FCM funds in the account to cover any

    shortfall that exists in all of its customers' segregated accounts.

    However, as a practical matter, the segregation requirements fluctuate

    constantly with market movements, and customer surpluses or deficits

    also fluctuate depending on the speed with which customers meet margin

    calls. As a consequence, an FCM is not expected to have a precise,

    real-time knowledge of the amount of residual interest it has in a

    segregated account. The Commission recognizes that any precise, real-

    time, single calculation would almost immediately become obsolete as

    the value of customers' accounts and their obligations to the FCM

    continue to fluctuate. Moreover, a sufficient amount of residual

    interest to cover deficiencies in customers' accounts at one point in

    time may be inadequate to cover such deficiencies an hour later, or

    even a few minutes later. Therefore, it is important

    [[Page 67917]]

    for an FCM to maintain sufficient residual interest to cover both

    current deficiencies in customer accounts as well as any additional

    deficiencies that could develop over a relatively short period of time.

    Restrictions on withdrawals of residual interest help to ensure that

    the FCM does not withdraw too much residual interest, either knowingly

    or unknowingly, and jeopardize customer funds in the segregated

    account.

    Prohibiting any withdrawal of residual interest until the customer

    segregation account calculations are complete for the previous day and

    requiring the FCM take into account any subsequent developments in the

    market or the account that could impact the amount of residual interest

    before withdrawing funds protects customer funds by reducing the

    likelihood that lack of current information could cause the FCM to make

    a withdrawal from customer funds that is large enough to cause the

    account to fall below its segregated funds requirement.

    In addition, the proposed amendment would require several steps in

    order for an FCM to remove more than 25% of their residual interest in

    a single day. Large, single-day withdrawals of the FCM's residual

    interest in the customer segregated account could be an indication of

    current or impending capital or liquidity strains at the FCM. The

    additional steps ensure that senior management is knowledgeable of and

    accountable for such withdrawals, that no shortfall in the customer

    segregated accounts is created by the withdrawals and that the CFTC and

    DSRO are both alerted and can monitor the FCM and its segregated

    accounts closely over subsequent days and weeks. Additional monitoring,

    in turn, would help to ensure that the integrity and sufficiency of the

    FCM's customer segregated accounts are carefully protected. In

    addition, notifying the CFTC and DSRO gives both an opportunity to ask

    questions about the FCM's reasonable reliance on its estimations of the

    adequacy of its funds necessary to meet segregation requirements. Such

    questions may give the Commission and DSRO comfort that the transaction

    does not indicate any strain on the FCMs financial position, or

    conversely, may raise additional questions and alert the CFTC and DSRO

    to the need for heightened monitoring of the FCM or further

    investigation of its activities. Also, while the proposed regulations

    would reduce the risk that customer funds could be missing in the event

    of an FCM's bankruptcy, the proposed rule would establish a second

    layer of protection by ensuring that the Commission has records

    regarding the name and address of parties receiving funds from the

    distribution of residual interest.

    In addition, requiring an FCM to replenish its residual funds the

    following day any time a withdrawal causes it to drop below the FCM's

    target amount helps to ensure that residual interest is not used by the

    firm to address liquidity needs in other parts of the firm unless those

    needs are very short-term in nature (i.e., less than 24 hours).

    Costs

    These procedural requirements will create some costs for FCMs.

    Restricting an FCMs ability to withdraw residual interest until daily

    calculations have been completed may prevent the FCM from withdrawing

    funds quickly in order to meet certain operational needs, or to take

    advantage of specific investment opportunities. This restriction may

    also force the FCM to hold additional capital in order to reduce the

    potential that it would need funds from its residual interest in order

    to meet any operational needs. The Commission does not have adequate

    information to estimate the amount of additional capital that an FCM

    might be likely to hold, or the cost of capital for those funds.

    Moreover, calculating the opportunity cost for an FCM's potential

    missed opportunities is not possible since, by definition, they depend

    on the alternative opportunities available to the FCM and the

    Commission does not have adequate information to determine what those

    opportunities might be.

    In addition, abiding by the procedures for withdrawals of residual

    interest for proprietary use, whether the withdrawals are less than or

    greater than 25% of the FCM's residual interest, would create

    operational costs as these percentages must be calculated and requisite

    permissions will require time to obtain. The additional cost created by

    procedures that are required for additional withdrawals below 25% of

    the FCM's residual interest will depend significantly on the procedures

    the FCM develops, and the extent to which the FCM has already

    implemented similar procedures. The Commission does not have adequate

    information to estimate these incremental costs. If an FCM withdraws

    more than 25% in a given day they have to get certain signatures and

    have to send a notification to the Commission. It is also likely that

    the Commission would follow up with questions about the withdrawal. The

    Commission proposes that obtaining the necessary signatures, reviewing

    the notification sent to the Commission, and conducting any follow-up

    conversations would require time from an attorney and office staff

    personnel. Therefore, the Commission estimates that the additional cost

    to an FCM for complying with procedures to withdraw 25% or more of

    their residual interest in a single day is likely to be between $850

    and $1,100 each time an FCM needs to make such withdrawals.\137\

    ---------------------------------------------------------------------------

    \137\ This assumes 6-8 hours of a compliance attorney's time and

    6-8 hours of an office manager's time. The average compensation for

    a compliance attorney is $85.35/hour [$131,303 per year/(2000 hours

    per year)*1.3 is $85.35 per hour]; $85.35*6 = $512.08 and $85.35*8 =

    $682.78. The average compensation for an office manager is $55.82/

    hour [$85,875 per year/(2000 hours per year)*1.3 = $55.82/hour];

    $55.82*6 = $334.91 and $55.82*8 = $446.55. These figures are taken

    from the 2011 SIFMA Report on Management and Professional Earnings

    in the Securities Industry.

    ---------------------------------------------------------------------------

    Request for Comment

    Question 18: The Commission invites comment regarding the amount of

    additional capital that FCMs would likely hold because of restrictions

    on their ability to withdraw residual interest and the cost of capital

    for those funds.

    Question 19: In addition, the Commission requests comment regarding

    the extent to which FCMs already have procedures in place that would

    satisfy the requirements in Sec. Sec. 1.11 and 1.23 regarding

    withdrawals of residual interest. For an FCM that do not have such

    procedures in place already, please quantify the additional cost that

    the FCM will bear as a consequence of complying with any policies and

    procedures it may develop and implement in order to satisfy the

    requirements of Sec. Sec. 1.11 and 1.23 with respect to withdrawals of

    residual interest.

    Sec. 1.25 Investment of Customer Funds

    Proposed Changes

    As described in the section by section discussion at II.J, Sec.

    1.25 permits FCMs and DCOs to use customer funds to purchase securities

    from a counterparty under an agreement for the resale of the securities

    back to the counterparty. This type of transaction is often referred to

    as a ``repo,'' and in effect, is a collateralized loan by the FCM to

    its counterparty. Currently, Sec. 1.25(b)(3)(v) establishes a

    counterparty concentration limit, prohibiting FCMs and DCOs from using

    more than 25% of the total funds in the customer segregated account to

    conduct reverse repos with a single counterparty. The proposed

    amendment would expand the definition of a counterparty to include

    additional entities under common ownership or control. The proposed

    amendment

    [[Page 67918]]

    incorporates the Commission's interpretation of the existing rule, and

    therefore does not alter its meaning. Therefore, the Commission does

    not anticipate that the proposed amendment will create any costs or

    benefits.

    The additional proposed changes to Sec. 1.25 are conforming

    amendments proposed in order to harmonize this section with other

    amendments proposed in this release, and therefore do not create any

    additional costs or benefits.

    Sec. 1.26 Deposit of Instruments Purchased With Customer Funds

    Proposed Changes

    As described in the section by section discussion at II.K, proposed

    Sec. 1.26 would change the term ``commodity or option customers'' to

    ``futures customers.'' This is a conforming change in order to retain

    the same meaning once the term ``customer'' is redefined in Sec. 1.3.

    In addition, the other changes proposed for Sec. 1.26(a-b) require

    that FCMs and DCOs obtain a written acknowledgment letter from

    depositories in accordance with the requirements established in Sec.

    1.20. This change introduces significant additional specificity

    regarding the timing and content of the letter that FCMs and DCOs must

    obtain from their depositories. The specifics of those requirements, as

    well as the costs and benefits of them, are detailed in the discussion

    of costs and benefits for Sec. 1.20, discussed in the cost benefit

    considerations section related to Sec. 1.20.

    If, however, an FCM or DCO invests funds with a money market mutual

    fund and those funds are held directly by the money market mutual fund

    or its affiliate, then the FCM or DCO must use the acknowledgment

    letter proposed in Appendix A of Sec. 1.26 rather than the

    acknowledgment letters in the appendices of Sec. 1.20. The content of

    the letter in Sec. 1.26 is identical to those in Sec. 1.20 except

    that it includes three additional provisions related specifically to

    funds held by the money market mutual fund or its affiliate (``MMMF'').

    Specifically, it requires that: (1) the value of the fund must be

    computed and made available to the FCM or DCO by 9:00 a.m. of the

    following business day; (2) that the fund must be legally obligated to

    redeem shares and make payments to its customers (i.e. the FCM or DCO)

    by the following business day; and (3) the money market mutual fund

    does not have any agreements in place that would prevent the FCM or DCO

    from pledging or transferring fund shares.

    Benefits

    The benefits are largely the same as for the acknowledgment letters

    required in Sec. 1.20, described above in the cost benefit section

    related to Sec. 1.20. However, requiring FCMs and DCOs to have Money

    Market Mutual Funds (``MMMFs'') sign a different acknowledgment letter

    if customer funds are held directly with the money market mutual fund

    or its affiliate has some benefits.

    First, requiring the MMMF to compute the value of the fund and make

    that available to the FCM or DCO by 9:00 a.m. the following business

    day ensures that FCMs will have the information they need in order to

    produce their daily segregation calculations by 12:00 p.m. the

    following business day (i.e., three hours later), which is an existing

    requirement for FCMs.\138\ This is important not only because it

    enables the FCM to comply with the requirement to produce segregation

    calculations by 12:00 p.m. the following day, but because under the

    proposed rule, FCMs would not be allowed to withdraw residual interest

    until the daily segregation calculations are completed. Second, by

    requiring the fund to redeem shares and make payments to their

    customers by the following business day, the proposed requirement

    prohibits MMMFs from entering into any agreement with an FCM or DCO

    that gives the MMMF a contractual right to delay payment, thus

    preventing similar risks to what would occur if FCMs were allowed to

    place funds in time-deposit accounts. Last, by prohibiting the MMMF

    from imposing restrictions that would prevent the FCM or DCO from

    pledging or transferring fund shares, the letter would ensure that FCMs

    are able to use their shares as collateral at the DCO and that those

    shares could be transferred from one FCM to another in the event of the

    first FCM's default.

    ---------------------------------------------------------------------------

    \138\ See Sec. Sec. 1.32, 22.2, and 30.7.

    ---------------------------------------------------------------------------

    Costs

    As discussed above in the cost benefit considerations section

    related to Sec. 1.20 the NFA already requires electronic read-only

    access to customer accounts, so the Commission does not anticipate that

    providing the same access to the Commission will create additional

    costs.

    In addition, if an FCM or DCO currently has an account with a money

    market mutual fund that, either directly or through an affiliate, holds

    its own funds, and that fund is either not compliant with the

    additional provisions of the letter in Appendix A Sec. 1.26 or is

    unwilling to sign the proposed acknowledgment letter, the FCM or DCO

    would bear some costs related to identifying a compliant money market

    mutual fund, conducting due diligence, and moving its accounts to that

    fund. This would force the FCM or DCO to identify a new MMMF that is

    qualified to accept its customer funds, creating the same costs that

    are described above in the cost benefit considerations section related

    to Sec. 1.20.

    Request for Comment

    Question 20: The Commission requests comment regarding the

    likelihood that money market mutual funds holding segregated funds from

    FCMs or DCOs are not compliant with the additional terms contained in

    the proposed acknowledgment letter. In addition, what costs would an

    FCM or DCO bear when identifying a compliant money market mutual fund

    and transferring their customer funds to that money market?

    Question 21: In addition, the Commission requests comment regarding

    whether the requirements contained in the acknowledgment letter,

    discussed in Sec. 1.20, would impact money market mutual funds

    differently from any other depositories.

    Sec. 1.29 Gains and Losses Resulting From Investment of Customer Funds

    Proposed Changes

    As described in the section by section discussion at II.L, under

    the Commission's existing regulations, Sec. 1.29(a) states that FCMs

    or DCOs investing customer funds in Sec. 1.25 investments are entitled

    to the return on those investments. Proposed Sec. 1.29(b) provides

    that FCMs or DCOs investing customer segregated funds in instruments

    described in Sec. 1.25 also bear sole responsibility for the losses

    that result from those investments.

    Benefits and Costs of the Proposed Changes

    This change was recommended by FIA, which stated its belief that

    the FCM or DCO's responsibility for losses in Sec. 1.25 investments

    ``is clear and is implicit in the Act and the Commission's rules.''

    \139\ The Commission believes that market participants already

    recognize this and act accordingly. Therefore the Commission does not

    believe that

    [[Page 67919]]

    proposed Sec. 1.29(b) would create any additional costs.

    ---------------------------------------------------------------------------

    \139\ FIA, ``Initial Recommendations for Customer Funds

    Protection.'' Available at: http://www.futuresindustry.org/downloads/Initial_Recommendations_for_Customer_Funds_Protection.pdf.

    ---------------------------------------------------------------------------

    Sec. 1.30 Loans by Futures Commission Merchants; Treatment of Proceeds

    Proposed Changes

    As described in the section by section discussion at II.M, Sec.

    1.30 permits the FCM to lend its own funds to a customer on securities

    and property pledged by the customer, effectively performing a

    collateral transformation service. The proposed amendment to Sec. 1.30

    clarifies that, while an FCM may provide secured loans to a customer,

    it may not make loans to a customer on an unsecured basis or use a

    customer's futures or options positions as security for a loan from the

    FCM to that customer.

    Benefits

    The proposed prohibition against FCMs providing unsecured loans to

    customers reduces counterparty risk borne by the FCM position because

    it prevents the FCM from accumulating exposures to customers that have

    not margined their positions. In addition, the proposed rule would

    prohibit an FCM from using a customer's positions to secure loans made

    to customers, which would also reduce the FCM's counterparty risk. If

    an FCM used a customer's positions to secure a loan to that customer,

    the FCM would be using the same collateral to secure two different

    liabilities: the liability associated with the open position; and the

    liability associated with the unsecured loan. By prohibiting FCMs from

    using a customer's positions to secure a loan to that customer, the

    proposed rule would prevent the additional exposure that would

    otherwise result from using the same collateral to secure two different

    liabilities, which again, reduces the FCM's counterparty risk.

    In addition, to the extent that the proposed change would force

    customers to obtain such loans from another lender, it diversifies the

    counterparty risk across multiple entities. That benefits the FCM that

    would otherwise bear more concentrated customer risk, and likely would

    be good for the markets more generally because of the additional

    protection that it provides to any clearinghouse of which the FCM is a

    member.

    Costs

    Regarding costs associated with the proposed restriction--customers

    that need or prefer to use borrowed funds to meet their initial and

    maintenance margin requirements for certain positions would be forced

    to obtain loans necessary to fund their futures or options positions

    from another lender. That would increase the customer's operational

    costs since they would have to transfer funds from one institution to

    another and would have to administer both accounts. In addition, it is

    likely that lenders will conduct more due diligence than would be the

    case if the FCM were to loan the requisite funds, which will create

    additional costs related to such a loan, both for the customer and for

    the party lending the funds.

    Request for Comment

    Question 22: The Commission requests comment regarding how often

    FCMs currently make loans to customers on either a secured or unsecured

    basis, and what the processes and terms typify such loans (including

    details regarding the process for evaluating credit risk, size of such

    loans, payment terms, collateral, and any other details that commenters

    believe the Commission should consider).

    Question 23: In addition, the Commission requests information

    regarding the additional operational costs that customers would bear if

    they have to obtain a loan from an entity other than the FCM holding

    their funds in a customer segregated account. If possible, please

    quantify the additional costs.

    Sec. 1.32 Reporting of Segregated Account Computation and Details

    Regarding the Holding of Customer Funds

    Proposed Changes

    As described in the section by section discussion at II.N, The

    proposed changes would allow an FCM that is not a dual registrant to

    follow the same procedures as dual registrants (FCM/BDs) wheem?

    Question 14: The Commission assumes that the costs and benefits

    enumerated above capture the range of costs and benefits that would be

    experienced by each type of depository. The Commission requests comment

    and quantification regarding any additional costs or benefits that

    would be experienced by certain types of depositories such FCMs, bank

    and trust companies, depositories of an international affiliate.

    Sec. 1.22 Use of Customer Funds Restricted

    Proposed Changes

    As described in the section by section discussion at II.H, the

    Commission recently approved amendments to the definition of the term

    ``commodity and/or options customer.'' \134\ In order to retain the

    meaning of the term ``commodity and/or options customer'' as it was

    originally defined, the Commission is replacing the term with ``futures

    customer.'' As above, the new term has the same meaning as the original

    definition of the term that it is replacing, and therefore there are no

    costs or benefits associated with this change.

    ---------------------------------------------------------------------------

    \134\ The final rulemaking is available on the Commission's Web

    site, www.cftc.gov.

    ---------------------------------------------------------------------------

    In addition, the proposed amendments to 1.22 clarify that the

    prohibition against use of a futures customer's funds to extend credit

    to, or to purchase, margin, or settle the contracts of another person

    applies at all times. Last, the proposed amendments would clarify that

    in order to comply with the prohibition against using one customer's

    funds to ``purchase, margin, or settle the trades, contracts, or

    commodity options of, or to secure or extend the credit'' \135\ of any

    other

    [[Page 67916]]

    person, the FCM would be required to ensure that its residual interest

    in futures customer funds exceeds the sum of all its futures customer

    margin deficits.

    ---------------------------------------------------------------------------

    \135\ See proposed Sec. 1.22. N.B., the current form of Sec.

    1.22 also includes a prohibition against using one customer's funds

    to ``to purchase, margin, or settle the trades, contracts, or

    commodity options of, or to secure or extend the credit of, any

    person other than such customer or commodity option customer.''

    ---------------------------------------------------------------------------

    Benefits

    The benefit of the proposal is that it protects customer funds by

    requiring continual customer segregation balancing thereby avoiding the

    potential that an FCM could employ end-of-day balancing to obscure a

    shortfall the FCM experienced in the middle of the day.

    Under current regulations it is not permitted for an FCM to use one

    customer's funds to purchase, margin, secure or settle positions for

    another customer. However, the current regulations do not specify how

    FCMs must comply with this requirement. The proposed rule would specify

    that FCMs must maintain residual interest in customer segregated

    accounts that is larger than the sum of all customer margin deficits,

    which would ensure that the FCM is not using one customer's funds to

    purchase, margin, secure, or settle positions for another customer.

    Furthermore, when combined with the reporting requirements in

    Sec. Sec. 1.10, 1.32, 22.2, and 30.7, which require the FCM to report

    both the sum of their customer margin deficits as well as their

    residual interest in customer segregated accounts, the proposed

    approach would provide the Commission and the public with sufficient

    information to verify that FCMs are not using one customer's funds to

    purchase, margin, secure or settle positions for another customer.

    Costs

    If the sum of an FCM's customer margin deficits is greater than the

    residual interest an FCM typically maintains in their customer

    accounts, then the FCM would have to increase the amount of residual

    interest it maintains in customer segregated accounts, which would

    reduce the range of investment options the FCM has for those additional

    funds and may prompt the FCM to maintain additional capital to meet

    operational needs. On the other hand, if an FCM typically maintains

    residual interest in customer segregated accounts that is greater than

    the sum of their customer margin deficits, then the proposed rule would

    not create any additional costs. In the past, the Commission has not

    required FCMs to report the sum of their customers' margin deficits.

    Therefore, the Commission does not have adequate information to

    determine whether FCMs typically hold residual interest that is greater

    than the sum of their customers' margin deficits and cannot estimate

    the cost of the proposed rule.

    Request for Comment

    Question 15: The Commission requests comment regarding whether FCMs

    typically maintain residual interest in their customer segregated

    accounts that is greater than the sum of their customer margin

    deficits, and data from which the Commission may quantify the average

    difference between the amount of residual interest an FCM maintains in

    customer segregated accounts and the sum of customer margin deficit.

    Question 16: How much additional residual interest would FCMs hold

    in their customer segregated accounts in order to comply with the

    proposed regulation? What is the opportunity cost to FCMs associated

    with increasing the amount of capital FCMs place in residual interest,

    and data that would allow the Commission to replicate and verify the

    calculated estimates provided.

    Question 17: The Commission request information regarding the

    additional amount of capital that FCMs would likely maintain in their

    customer segregated accounts, if any, to comply with the proposed

    regulation. What is the average cost of capital for an FCM? Please

    provide data and calculations that would allow the Commission to

    replicate and verify the cost of capital that you estimate?

    Sec. 1.23 Interest of Futures Commission Merchants in Segregated

    Funds; Additions and Withdrawals

    Proposed Changes

    As described in the section by section discussion at II.I, the

    proposed text changes the term ``customer funds'' to ``futures customer

    funds.'' This is a conforming change in order to retain the same

    meaning once the term ``customer'' is redefined in Sec. 1.3.\136\ The

    Commission anticipates that there are no costs or benefits associated

    with this change.

    ---------------------------------------------------------------------------

    \136\ The Commission recently approved final amendments to Sec.

    1.3 that revised the definition of the term ``customer'' to include

    commodity customers, options customers, and swap customers. A copy

    of the Federal Register release is available on the Commission's Web

    site, www.cftc.gov.

    ---------------------------------------------------------------------------

    The proposed Sec. 1.23 also places new restrictions regarding an

    FCM's withdrawal of residual interest funds for proprietary use. Under

    the proposed Sec. 1.23, an FCM cannot withdraw funds for proprietary

    use unless they have prepared the daily segregation calculation from

    the previous business day and must adjust for any activity or events

    that may have decreased residual interest since close of business the

    previous day. In addition, an FCM is only permitted to withdrawal more

    than 25% of its residual interest for proprietary use within one day if

    it: (1) Obtains a signature from the CEO, CFO or other senior official

    as described in Sec. 1.23(c)(1) confirming approval to make such a

    withdrawal; and (2) sends written notice to the CFTC and DSRO

    indicating that the requisite approvals from the CEO, CFO or other

    senior official has been obtained, providing reasons for the

    withdrawal, listing the names and amounts of funds provided to each

    recipient, and providing an affirmation from the signatory indicating

    that he or she has knowledge and reasonable belief that the FCM is

    still in compliance with segregation requirements after the withdrawal.

    In addition, if the FCM drops below its target threshold for

    residual interest because of a withdrawal of residual interest for

    proprietary use, the next day it must either replenish residual

    interest enough to surpass its target, or if senior leadership believes

    the original target is excessive, the FCM may revise its target in

    accordance with its policies and procedures established in proposed

    Sec. 1.11.

    Benefits

    The proposed restrictions on withdrawals of residual interest

    provide an additional layer of protection for customer funds contained

    in segregated accounts. An FCM may withdraw residual interest as long

    as it always maintains sufficient FCM funds in the account to cover any

    shortfall that exists in all of its customers' segregated accounts.

    However, as a practical matter, the segregation requirements fluctuate

    constantly with market movements, and customer surpluses or deficits

    also fluctuate depending on the speed with which customers meet margin

    calls. As a consequence, an FCM is not expected to have a precise,

    real-time knowledge of the amount of residual interest it has in a

    segregated account. The Commission recognizes that any precise, real-

    time, single calculation would almost immediately become obsolete as

    the value of customers' accounts and their obligations to the FCM

    continue to fluctuate. Moreover, a sufficient amount of residual

    interest to cover deficiencies in customers' accounts at one point in

    time may be inadequate to cover such deficiencies an hour later, or

    even a few minutes later. Therefore, it is important

    [[Page 67917]]

    for an FCM to maintain sufficient residual interest to cover both

    current deficiencies in customer accounts as well as any additional

    deficiencies that could develop over a relatively short period of time.

    Restrictions on withdrawals of residual interest help to ensure that

    the FCM does not withdraw too much residual interest, either knowingly

    or unknowingly, and jeopardize customer funds in the segregated

    account.

    Prohibiting any withdrawal of residual interest until the customer

    segregation account calculations are complete for the previous day and

    requiring the FCM take into account any subsequent developments in the

    market or the account that could impact the amount of residual interest

    before withdrawing funds protects customer funds by reducing the

    likelihood that lack of current information could cause the FCM to make

    a withdrawal from customer funds that is large enough to cause the

    account to fall below its segregated funds requirement.

    In addition, the proposed amendment would require several steps in

    order for an FCM to remove more than 25% of their residual interest in

    a single day. Large, single-day withdrawals of the FCM's residual

    interest in the customer segregated account could be an indication of

    current or impending capital or liquidity strains at the FCM. The

    additional steps ensure that senior management is knowledgeable of and

    accountable for such withdrawals, that no shortfall in the customer

    segregated accounts is created by the withdrawals and that the CFTC and

    DSRO are both alerted and can monitor the FCM and its segregated

    accounts closely over subsequent days and weeks. Additional monitoring,

    in turn, would help to ensure that the integrity and sufficiency of the

    FCM's customer segregated accounts are carefully protected. In

    addition, notifying the CFTC and DSRO gives both an opportunity to ask

    questions about the FCM's reasonable reliance on its estimations of the

    adequacy of its funds necessary to meet segregation requirements. Such

    questions may give the Commission and DSRO comfort that the transaction

    does not indicate any strain on the FCMs financial position, or

    conversely, may raise additional questions and alert the CFTC and DSRO

    to the need for heightened monitoring of the FCM or further

    investigation of its activities. Also, while the proposed regulations

    would reduce the risk that customer funds could be missing in the event

    of an FCM's bankruptcy, the proposed rule would establish a second

    layer of protection by ensuring that the Commission has records

    regarding the name and address of parties receiving funds from the

    distribution of residual interest.

    In addition, requiring an FCM to replenish its residual funds the

    following day any time a withdrawal causes it to drop below the FCM's

    target amount helps to ensure that residual interest is not used by the

    firm to address liquidity needs in other parts of the firm unless those

    needs are very short-term in nature (i.e., less than 24 hours).

    Costs

    These procedural requirements will create some costs for FCMs.

    Restricting an FCMs ability to withdraw residual interest until daily

    calculations have been completed may prevent the FCM from withdrawing

    funds quickly in order to meet certain operational needs, or to take

    advantage of specific investment opportunities. This restriction may

    also force the FCM to hold additional capital in order to reduce the

    potential that it would need funds from its residual interest in order

    to meet any operational needs. The Commission does not have adequate

    information to estimate the amount of additional capital that an FCM

    might be likely to hold, or the cost of capital for those funds.

    Moreover, calculating the opportunity cost for an FCM's potential

    missed opportunities is not possible since, by definition, they depend

    on the alternative opportunities available to the FCM and the

    Commission does not have adequate information to determine what those

    opportunities might be.

    In addition, abiding by the procedures for withdrawals of residual

    interest for proprietary use, whether the withdrawals are less than or

    greater than 25% of the FCM's residual interest, would create

    operational costs as these percentages must be calculated and requisite

    permissions will require time to obtain. The additional cost created by

    procedures that are required for additional withdrawals below 25% of

    the FCM's residual interest will depend significantly on the procedures

    the FCM develops, and the extent to which the FCM has already

    implemented similar procedures. The Commission does not have adequate

    information to estimate these incremental costs. If an FCM withdraws

    more than 25% in a given day they have to get certain signatures and

    have to send a notification to the Commission. It is also likely that

    the Commission would follow up with questions about the withdrawal. The

    Commission proposes that obtaining the necessary signatures, reviewing

    the notification sent to the Commission, and conducting any follow-up

    conversations would require time from an attorney and office staff

    personnel. Therefore, the Commission estimates that the additional cost

    to an FCM for complying with procedures to withdraw 25% or more of

    their residual interest in a single day is likely to be between $850

    and $1,100 each time an FCM needs to make such withdrawals.\137\

    ---------------------------------------------------------------------------

    \137\ This assumes 6-8 hours of a compliance attorney's time and

    6-8 hours of an office manager's time. The average compensation for

    a compliance attorney is $85.35/hour [$131,303 per year/(2000 hours

    per year)*1.3 is $85.35 per hour]; $85.35*6 = $512.08 and $85.35*8 =

    $682.78. The average compensation for an office manager is $55.82/

    hour [$85,875 per year/(2000 hours per year)*1.3 = $55.82/hour];

    $55.82*6 = $334.91 and $55.82*8 = $446.55. These figures are taken

    from the 2011 SIFMA Report on Management and Professional Earnings

    in the Securities Industry.

    ---------------------------------------------------------------------------

    Request for Comment

    Question 18: The Commission invites comment regarding the amount of

    additional capital that FCMs would likely hold because of restrictions

    on their ability to withdraw residual interest and the cost of capital

    for those funds.

    Question 19: In addition, the Commission requests comment regarding

    the extent to which FCMs already have procedures in place that would

    satisfy the requirements in Sec. Sec. 1.11 and 1.23 regarding

    withdrawals of residual interest. For an FCM that do not have such

    procedures in place already, please quantify the additional cost that

    the FCM will bear as a consequence of complying with any policies and

    procedures it may develop and implement in order to satisfy the

    requirements of Sec. Sec. 1.11 and 1.23 with respect to withdrawals of

    residual interest.

    Sec. 1.25 Investment of Customer Funds

    Proposed Changes

    As described in the section by section discussion at II.J, Sec.

    1.25 permits FCMs and DCOs to use customer funds to purchase securities

    from a counterparty under an agreement for the resale of the securities

    back to the counterparty. This type of transaction is often referred to

    as a ``repo,'' and in effect, is a collateralized loan by the FCM to

    its counterparty. Currently, Sec. 1.25(b)(3)(v) establishes a

    counterparty concentration limit, prohibiting FCMs and DCOs from using

    more than 25% of the total funds in the customer segregated account to

    conduct reverse repos with a single counterparty. The proposed

    amendment would expand the definition of a counterparty to include

    additional entities under common ownership or control. The proposed

    amendment

    [[Page 67918]]

    incorporates the Commission's interpretation of the existing rule, and

    therefore does not alter its meaning. Therefore, the Commission does

    not anticipate that the proposed amendment will create any costs or

    benefits.

    The additional proposed changes to Sec. 1.25 are conforming

    amendments proposed in order to harmonize this section with other

    amendments proposed in this release, and therefore do not create any

    additional costs or benefits.

    Sec. 1.26 Deposit of Instruments Purchased With Customer Funds

    Proposed Changes

    As described in the section by section discussion at II.K, proposed

    Sec. 1.26 would change the term ``commodity or option customers'' to

    ``futures customers.'' This is a conforming change in order to retain

    the same meaning once the term ``customer'' is redefined in Sec. 1.3.

    In addition, the other changes proposed for Sec. 1.26(a-b) require

    that FCMs and DCOs obtain a written acknowledgment letter from

    depositories in accordance with the requirements established in Sec.

    1.20. This change introduces significant additional specificity

    regarding the timing and content of the letter that FCMs and DCOs must

    obtain from their depositories. The specifics of those requirements, as

    well as the costs and benefits of them, are detailed in the discussion

    of costs and benefits for Sec. 1.20, discussed in the cost benefit

    considerations section related to Sec. 1.20.

    If, however, an FCM or DCO invests funds with a money market mutual

    fund and those funds are held directly by the money market mutual fund

    or its affiliate, then the FCM or DCO must use the acknowledgment

    letter proposed in Appendix A of Sec. 1.26 rather than the

    acknowledgment letters in the appendices of Sec. 1.20. The content of

    the letter in Sec. 1.26 is identical to those in Sec. 1.20 except

    that it includes three additional provisions related specifically to

    funds held by the money market mutual fund or its affiliate (``MMMF'').

    Specifically, it requires that: (1) the value of the fund must be

    computed and made available to the FCM or DCO by 9:00 a.m. of the

    following business day; (2) that the fund must be legally obligated to

    redeem shares and make payments to its customers (i.e. the FCM or DCO)

    by the following business day; and (3) the money market mutual fund

    does not have any agreements in place that would prevent the FCM or DCO

    from pledging or transferring fund shares.

    Benefits

    The benefits are largely the same as for the acknowledgment letters

    required in Sec. 1.20, described above in the cost benefit section

    related to Sec. 1.20. However, requiring FCMs and DCOs to have Money

    Market Mutual Funds (``MMMFs'') sign a different acknowledgment letter

    if customer funds are held directly with the money market mutual fund

    or its affiliate has some benefits.

    First, requiring the MMMF to compute the value of the fund and make

    that available to the FCM or DCO by 9:00 a.m. the following business

    day ensures that FCMs will have the information they need in order to

    produce their daily segregation calculations by 12:00 p.m. the

    following business day (i.e., three hours later), which is an existing

    requirement for FCMs.\138\ This is important not only because it

    enables the FCM to comply with the requirement to produce segregation

    calculations by 12:00 p.m. the following day, but because under the

    proposed rule, FCMs would not be allowed to withdraw residual interest

    until the daily segregation calculations are completed. Second, by

    requiring the fund to redeem shares and make payments to their

    customers by the following business day, the proposed requirement

    prohibits MMMFs from entering into any agreement with an FCM or DCO

    that gives the MMMF a contractual right to delay payment, thus

    preventing similar risks to what would occur if FCMs were allowed to

    place funds in time-deposit accounts. Last, by prohibiting the MMMF

    from imposing restrictions that would prevent the FCM or DCO from

    pledging or transferring fund shares, the letter would ensure that FCMs

    are able to use their shares as collateral at the DCO and that those

    shares could be transferred from one FCM to another in the event of the

    first FCM's default.

    ---------------------------------------------------------------------------

    \138\ See Sec. Sec. 1.32, 22.2, and 30.7.

    ---------------------------------------------------------------------------

    Costs

    As discussed above in the cost benefit considerations section

    related to Sec. 1.20 the NFA already requires electronic read-only

    access to customer accounts, so the Commission does not anticipate that

    providing the same access to the Commission will create additional

    costs.

    In addition, if an FCM or DCO currently has an account with a money

    market mutual fund that, either directly or through an affiliate, holds

    its own funds, and that fund is either not compliant with the

    additional provisions of the letter in Appendix A Sec. 1.26 or is

    unwilling to sign the proposed acknowledgment letter, the FCM or DCO

    would bear some costs related to identifying a compliant money market

    mutual fund, conducting due diligence, and moving its accounts to that

    fund. This would force the FCM or DCO to identify a new MMMF that is

    qualified to accept its customer funds, creating the same costs that

    are described above in the cost benefit considerations section related

    to Sec. 1.20.

    Request for Comment

    Question 20: The Commission requests comment regarding the

    likelihood that money market mutual funds holding segregated funds from

    FCMs or DCOs are not compliant with the additional terms contained in

    the proposed acknowledgment letter. In addition, what costs would an

    FCM or DCO bear when identifying a compliant money market mutual fund

    and transferring their customer funds to that money market?

    Question 21: In addition, the Commission requests comment regarding

    whether the requirements contained in the acknowledgment letter,

    discussed in Sec. 1.20, would impact money market mutual funds

    differently from any other depositories.

    Sec. 1.29 Gains and Losses Resulting From Investment of Customer Funds

    Proposed Changes

    As described in the section by section discussion at II.L, under

    the Commission's existing regulations, Sec. 1.29(a) states that FCMs

    or DCOs investing customer funds in Sec. 1.25 investments are entitled

    to the return on those investments. Proposed Sec. 1.29(b) provides

    that FCMs or DCOs investing customer segregated funds in instruments

    described in Sec. 1.25 also bear sole responsibility for the losses

    that result from those investments.

    Benefits and Costs of the Proposed Changes

    This change was recommended by FIA, which stated its belief that

    the FCM or DCO's responsibility for losses in Sec. 1.25 investments

    ``is clear and is implicit in the Act and the Commission's rules.''

    \139\ The Commission believes that market participants already

    recognize this and act accordingly. Therefore the Commission does not

    believe that

    [[Page 67919]]

    proposed Sec. 1.29(b) would create any additional costs.

    ---------------------------------------------------------------------------

    \139\ FIA, ``Initial Recommendations for Customer Funds

    Protection.'' Available at: http://www.futuresindustry.org/downloads/Initial_Recommendations_for_Customer_Funds_Protection.pdf.

    ---------------------------------------------------------------------------

    Sec. 1.30 Loans by Futures Commission Merchants; Treatment of Proceeds

    Proposed Changes

    As described in the section by section discussion at II.M, Sec.

    1.30 permits the FCM to lend its own funds to a customer on securities

    and property pledged by the customer, effectively performing a

    collateral transformation service. The proposed amendment to Sec. 1.30

    clarifies that, while an FCM may provide secured loans to a customer,

    it may not make loans to a customer on an unsecured basis or use a

    customer's futures or options positions as security for a loan from the

    FCM to that customer.

    Benefits

    The proposed prohibition against FCMs providing unsecured loans to

    customers reduces counterparty risk borne by the FCM position because

    it prevents the FCM from accumulating exposures to customers that have

    not margined their positions. In addition, the proposed rule would

    prohibit an FCM from using a customer's positions to secure loans made

    to customers, which would also reduce the FCM's counterparty risk. If

    an FCM used a customer's positions to secure a loan to that customer,

    the FCM would be using the same collateral to secure two different

    liabilities: the liability associated with the open position; and the

    liability associated with the unsecured loan. By prohibiting FCMs from

    using a customer's positions to secure a loan to that customer, the

    proposed rule would prevent the additional exposure that would

    otherwise result from using the same collateral to secure two different

    liabilities, which again, reduces the FCM's counterparty risk.

    In addition, to the extent that the proposed change would force

    customers to obtain such loans from another lender, it diversifies the

    counterparty risk across multiple entities. That benefits the FCM that

    would otherwise bear more concentrated customer risk, and likely would

    be good for the markets more generally because of the additional

    protection that it provides to any clearinghouse of which the FCM is a

    member.

    Costs

    Regarding costs associated with the proposed restriction--customers

    that need or prefer to use borrowed funds to meet their initial and

    maintenance margin requirements for certain positions would be forced

    to obtain loans necessary to fund their futures or options positions

    from another lender. That would increase the customer's operational

    costs since they would have to transfer funds from one institution to

    another and would have to administer both accounts. In addition, it is

    likely that lenders will conduct more due diligence than would be the

    case if the FCM were to loan the requisite funds, which will create

    additional costs related to such a loan, both for the customer and for

    the party lending the funds.

    Request for Comment

    Question 22: The Commission requests comment regarding how often

    FCMs currently make loans to customers on either a secured or unsecured

    basis, and what the processes and terms typify such loans (including

    details regarding the process for evaluating credit risk, size of such

    loans, payment terms, collateral, and any other details that commenters

    believe the Commission should consider).

    Question 23: In addition, the Commission requests information

    regarding the additional operational costs that customers would bear if

    they have to obtain a loan from an entity other than the FCM holding

    their funds in a customer segregated account. If possible, please

    quantify the additional costs.

    Sec. 1.32 Reporting of Segregated Account Computation and Details

    Regarding the Holding of Customer Funds

    Proposed Changes

    As described in the section by section discussion at II.N, The

    proposed changes would allow an FCM that is not a dual registrant to

    follow the same procedures as dual registrants (FCM/BDs) when assessing

    a haircut to securities purchased with customer funds if the FCM

    determines that those securities have minimal credit risk. This is the

    same change as is proposed in Sec. 1.17 except that in Sec. 1.17 the

    proposed change refers to securities purchased by an FCM with its own

    capital, whereas the proposed change here would apply to securities

    purchased with customer funds. The change proposed here would create

    the same costs and benefits as described above in the cost benefit

    considerations section related to Sec. 1.17.

    In addition, the proposed changes would: (1) Require FCMs to report

    daily Segregation Statements to the Commission and their DSRO

    electronically by noon the following business day; (2) require that

    twice per month, each FCM submit a detailed list of depositories report

    listing of all the depositories and custodians where customers

    segregated funds are held, including the amount of customer funds held

    by each entity and a break-down of the different categories of Sec.

    1.25 investments held by each entity; and (3) require that the detailed

    list of depositories be submitted to the Commission electronically by

    11:59 p.m. the following business day and that both Segregation

    Statements and Detailed list of depositories be retained by the FCM in

    accordance with Sec. 1.31.

    Benefits

    Requiring FCMs to submit their daily calculations to the Commission

    and DSRO, together with the proposed amendments to Sec. Sec. 1.20 and

    1.26 giving the Commission and DSRO electronic access to view the

    balances of all depository accounts where customer segregated funds are

    held, will enable the Commission and DSRO to better protect customer

    funds by more closely monitoring for any discrepancies between the

    assets in segregated accounts reported by the FCM and their

    depositories. The ability of the Commission and DSRO to check for

    discrepancies more regularly, without notice, is likely to provide an

    additional disincentive to fraud. Moreover, it will enable both the

    Commission and DSROs to monitor for any trends that would indicate

    operational or financial problems are developing at the FCM, which

    would give the Commission an opportunity to enhance its supervision and

    to intervene, if necessary, to protect customer segregated funds.

    The detailed list of depositories would provide additional

    information to the Commission and DSRO beyond what would be available

    to both by virtue of the electronic read-only access that has been

    proposed in Sec. Sec. 1.20, 1.26, and 30.7. First, the detailed list

    of depositories will provide additional account detail including the

    types of securities and investments that constitute each account's

    assets rather than existing reports that only include the total value

    securities. Second, the reports will account for any pending

    transactions that would not necessarily be apparent when viewing a

    depository account online. Third, FCMs will, in these reports, provide

    to the Commission and DSRO a reconciled balance, which would not be

    available to the Commission or DSRO simply by viewing an FCM's

    depository accounts online. Each of these additional forms of

    information would enable the Commission and DSRO to provide better

    oversight and create additional accountability for the FCM.

    [[Page 67920]]

    Costs

    FCMs are already calculating segregated funds information daily and

    reporting the results to the NFA via WinJammer by noon the following

    day. Similarly, the detailed list of depositories that would be

    required to be submitted twice per month is already required by NFA to

    be produced and submitted to NFA via WinJammer.\140\ Requiring FCMs to

    submit these reports to the Commission via the same platform should not

    create any additional costs.

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    \140\ See Segregated Investment Detail Report at: http://www.nfa.futures.org/NFA-compliance/NFA-futures-commission-merchants/fcm-reporting.pdf.

    ---------------------------------------------------------------------------

    Sec. 1.52 Self-Regulatory Organization Adoption and Surveillance of

    Minimum Financial Requirements

    Proposed Changes

    As described in the section by section discussion at II.O, the

    proposed amendments to 1.52 would revise the supervisory program that

    SROs are required to create and adopt. In addition, for SROs that

    choose to delegate the function to examine FCMs that are members of two

    or more SROs to a DSRO, the amended rules would require a plan that

    establishes a Joint Audit Committee which, in turn, must propose,

    approve, and oversee the implementation of a Joint Audit Program. The

    amended rules specify a number of additional requirements for the SRO

    supervisory program as well as for the Joint Audit Program.

    Benefits

    Regarding SROs' supervisory programs, the proposed amendments would

    provide significant additional protection to FCMs' counterparties,

    investors, and customers by ensuring that SRO audits of member FCMs are

    thorough and effective. The proposed amendments would help to ensure

    thorough audits by requiring that an SRO's audit program be designed to

    address ``all areas of risk to which futures commission merchants can

    reasonably be foreseen to be subject,'' that the scope and focus of

    such audits would be determined by the risk profile that the SRO

    develops for each FCM, and that the audit itself include both controls

    testing as well as substantive testing. The last requirement, in

    particular, would help to ensure that audits give adequate attention to

    testing and review of internal controls, which are critical to help

    ensure that each FCM is not only compliant with capital and segregation

    requirements at the time of the audit, but that they continue to

    operate in such a manner after the audit is completed by preventing

    fraud or operational errors that could jeopardize the FCM and its

    customers.\141\

    ---------------------------------------------------------------------------

    \141\ While many auditors and market participants have noted the

    importance of controls testing, the Commission understands that

    currently, many audits tend to emphasize substantive testing and

    give lesser attention to controls testing. See Public Roundtable to

    Discuss Additional Customer Protections, August 9, 2012. A recording

    of the roundtable is available at: http://www.cftc.gov/PressRoom/Events/opaevent_cftcstaff080912. See [customer protection

    roundtable from 8/9].

    ---------------------------------------------------------------------------

    By requiring that the supervisory program for the SRO must be

    compliant with U.S. Generally Accepted Auditing Standards and standards

    prescribed by the Public Company Accounting Oversight Board, the

    proposed rules would ensure that the SROs' supervisory programs draw

    from established best practices, and that they address the full range

    of issues that would impact the effectiveness of the SRO's audits of

    FCMs. This benefit is enhanced by the proposed list of specific issues

    that each SRO must address in the standards they develop for their

    supervisory program. And by promoting audits that are thorough, the

    proposed rules would, again, promote protection of the FCM's

    counterparties, investors, and customers.

    By requiring that an examinations expert evaluate the SRO's

    supervisory program at least once every two years, and that the results

    of such examinations include a discussion and recommendation of any new

    or best practices, the proposed rules would ensure that the supervisory

    program and SRO audits continue to build on best practices, for audits,

    which further promotes thorough and effective audits of FCMs.

    The proposed rules for the Joint Audit Program would require the

    Joint Audit Program to: (1) Establish standards covering all the same

    issues; (2) require controls testing as well as substantive testing;

    (3) address all areas of risk to which the registered FCM can

    reasonably be foreseen to be subject; (4) conform to U.S. generally

    accepted auditing standards and as well as those prescribed by the

    Public Company Accounting Oversight Board; and (5) have an examinations

    expert evaluate the Joint Audit Program at least once every two years.

    Therefore, the proposed rules would produce identical benefits related

    to audits conducted by a DSRO.

    In addition, by requiring that the DSRO audits include examination

    of an FCM's compliance with rules and regulations governing minimum net

    capital, obligations to segregate customer funds, financial reporting

    requirements, etc., the proposed rule would ensure that these critical

    elements of the FCM's operations and finances are reviewed during each

    audit. Each of these elements safeguard customers. Additionally, by

    requiring the Joint Audit Committee to develop procedures to identify

    high risk firms and perform enhanced monitoring of such firms, the

    proposed rules would help to ensure that any risk to customer funds

    that begins to materialize (e.g. the FCM's residual interest begins to

    drop) is identified and corrected quickly, thus reducing the risk of a

    loss of customer funds.

    In addition, commenters at the Commission's August 9th roundtable

    on customer protection noted that when audits take several months to

    complete, the findings are less relevant when they are delivered to the

    business than they would have been if they were communicated more

    promptly.\142\ Therefore, by requiring that the Joint Audit Program

    maintain adequate levels of staff with adequate training and

    experience, the proposed requirements would facilitate timely

    completion of audits, which is likely to enhance the protection of

    customer funds by promoting more prompt identification and correction

    of weaknesses identified in such audits. Moreover, if auditors are not

    independent of the FCM they are auditing, their findings may be

    compromised by conflicts of interest. By requiring standards related to

    independence together with annual ethics training, the proposed rule

    would help to ensure that the results of any audit conducted by the

    DSRO are not compromised by the influence of any conflict of interests.

    Each of these, in turn, facilitate thorough, effective, and timely

    audits, which help protect the FCM's customers, counterparties, and

    investors by ensuring that the FCM's financial reports are accurate,

    and that internal controls are reviewed and tested.

    ---------------------------------------------------------------------------

    \142\ See Public Roundtable to Discuss Additional Customer

    Protections, August 9, 2012. A recording of the roundtable is

    available at: http://www.cftc.gov/PressRoom/Events/opaevent_cftcstaff080912 See [roundtable on Aug 9th].

    ---------------------------------------------------------------------------

    Costs

    SROs are already required to establish and operate supervisory

    programs for auditing FCMs. The proposed amendments require further

    detail and documentation with regard to specific elements of such

    supervisory programs. The Commission estimates that the cost for

    developing these policies and procedures would be between $20,700 and

    $31,000 per SRO.\143\

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    \143\ This estimate assumes 160-240 hours of time from both a

    compliance attorney and a senior accountant. The average

    compensation for a compliance attorney is $85.35/hour [$131,303 per

    year/(2000 hours per year)*1.3 is $85.35 per hour]; $85.35 *160 =

    $13,655.51 and $85.35 *240 = $20,483.27. The average compensation

    for a senior accountant is $44.18/hour [$67,971.00 per year/(2000

    hours per year)*1.3 is $44.18 per hour]; $44.18*160 = $7,068.98 and

    $44.18*240 = $10,603.48. These figures are taken from the 2011 SIFMA

    Report on Management and Professional Earnings in the Securities

    Industry.

    ---------------------------------------------------------------------------

    [[Page 67921]]

    The Joint Audit Committee would have to develop policies and

    procedures concerning the application of the Joint Audit Program in the

    examination of FCMs. The standards would have to, at minimum, conform

    to the U.S. GAAS and would also have to address the items in Sec.

    1.52(c)(2)(iii). The development of such policies and procedures is

    likely to require input from one attorney and one senior accountant at

    each SRO, and therefore the Commission estimates that such involvement

    will cost each SRO between $2,400 and $6,000.\144\ In addition, the

    work required to further develop Joint Audit Program is likely to be

    supported by full time staff at the DSRO. The Commission estimates that

    such support will cost the DSRO between $18,000 and $26,400.\145\ In

    addition the Joint Audit Program would be required to have an

    examinations expert review the policies and procedures they develop.

    ---------------------------------------------------------------------------

    \144\ This estimate assumes 20-50 hours of time from both a

    compliance attorney and an intermediate accountant. The average

    compensation for a compliance attorney is $85.35/hour [$131,303 per

    year/(2000 hours per year)*1.3 is $85.35 per hour]; $85.35*20 =

    $1,706.94 and $85.35*50 = $4,267.35. The average compensation for an

    intermediate accountant is $34.11/hour [$52,484.00 per year/(2000

    hours per year)*1.3 is $34.11 per hour]; $34.11*20 = $682.29 and

    $34.11*50 = $1,705.73. These figures are taken from the 2011 SIFMA

    Report on Management and Professional Earnings in the Securities

    Industry.

    \145\ This estimate assumes 320-400 hours from an office

    services supervisor and 40-80 hours from both a compliance attorney

    and a senior accountant. The average compensation for an office

    services supervisor is $40.15/hour [$61,776.00 per year/(2000 hours

    per year)*1.3 is $40.15 per hour]; $40.15*320 = $12,849.41 and

    $40.15*400 = $16,061.76. The average compensation for a compliance

    attorney is $85.35/hour [$131,303 per year/(2000 hours per year)*1.3

    is $85.35 per hour]; $85.35*40 = $3,413.88 and $85.35*80 =

    $6,827.76. The average compensation for a senior accountant is

    $44.18/hour [$67,971.00 per year/(2000 hours per year)*1.3 is $44.18

    per hour]; $44.18*40 = $1,767.25 and $44.18*80 = $3,534.49. These

    figures are taken from the 2011 SIFMA Report on Management and

    Professional Earnings in the Securities Industry.

    ---------------------------------------------------------------------------

    Ongoing costs to the SRO and Joint Audit Program would include fees

    charged by the examinations expert for a review every other year, the

    incremental cost of more extensive controls testing when auditing each

    FCM, and the incremental cost resulting from standards that the SRO

    develops to comply with the list of standards that must be addressed in

    the supervisory program.\146\ The Commission does not have adequate

    information to estimate the ongoing costs for biennial reviews by an

    examinations expert, or the incremental costs of additional controls

    testing or ongoing compliance with standards that the FCMs develop

    pursuant to Sec. 1.52(c)(2)(iii).

    ---------------------------------------------------------------------------

    \146\ See Sec. 1.52(c)(2)(iii).

    ---------------------------------------------------------------------------

    Request for Comment

    Question 24: The Commission requests comment regarding the costs

    associated with increased controls testing. To what extent do SROs

    currently conduct controls testing when auditing FCMs? What additional

    testing would likely be involved in order to comply with the proposed

    regulations?

    Question 25: In addition, the Commission requests comment regarding

    the costs for an expert examiner to conduct a review such as the one

    contemplated in the proposed rules.

    Question 26: Also, regarding costs associated with the Joint Audit

    Committee and Joint Audit Program, which costs are likely to be borne

    by the SROs and which are likely to be borne by the DSROs?

    Sec. 1.55 Public Disclosures by Futures Commission Merchants

    Proposed Changes

    As described in the section by section discussion at II.P, the

    proposed rules would add new provisions to the disclosure document that

    FCMs are required to provide to prospective customers, detailed in

    Sec. 1.55(b). The new provisions would require the disclosure document

    to contain a statement that: (1) Customer funds are not protected by

    insurance in the event of the bankruptcy or insolvency of the FCM, or

    if customer funds are misappropriated in the event of fraud; (2)

    customer funds are not protected by SIPC, even if the FCM is a BD

    registered with the SEC; (3) customer funds are not insured by a DCO in

    the event of the bankruptcy or insolvency of the FCM holding the

    customer funds; (4) each customer's funds are not held in an individual

    segregated account by an FCM, but rather are commingled in one or more

    accounts; (5) FCMs may invest funds deposited by customers in

    investments listed in Sec. 1.25; and (6) funds deposited by customers

    may be deposited with affiliated entities of the FCM, including

    affiliated banks and brokers.

    In addition, the proposed rule would require each FCM to provide a

    Firm Specific Disclosure Document that would address firm specific

    information regarding its business, operations, risk profile, and

    affiliates that would be material to a customer's decision to entrust

    funds to and do business with the FCM.

    As stated above, the Firm Specific Disclosure Document would be

    made available on the FCM's Web site and would provide material

    information about: (1) General firm contact information; (2) the names,

    business contacts, and backgrounds for the FCM's senior management and

    members of the FCM's board of directors; (3) a discussion of the

    significant types of business activities and product lines that the FCM

    engages in and the approximate percentage of the FCM's assets and

    capital devoted to each line of business; (4) the FCM's business on

    behalf of its customers, including types of accounts, markets traded,

    international businesses, and clearinghouses and carrying brokers used,

    and the futures commission merchant's policies and procedures

    concerning the choice of bank depositories, custodians, and other

    counterparties; (5) a discussion of the material risks of entrusting

    funds to the FCM and an explanation of how such risks may be material

    to its customers; \147\ (6) the name and Web site address of the FCM's

    DSRO and the location of annual audited financial statements; (7) a

    discussion of any material administrative, civil, criminal, or

    enforcement actions pending or any enforcement actions taken in the

    last three years (8) a basic overview of customer fund segregation, FCM

    collateral management and investments, and of FCMs and joint FCM/BDs;

    (9) information regarding how customers may file complaints about the

    FCM with the Commission or appropriate DSRO; (10) certain financial

    data from the most recent month-end when the disclosure document is

    prepared; and (11) a summary of the FCMs current risk practices,

    controls and procedures.

    ---------------------------------------------------------------------------

    \147\ The material risks addressed must include, without

    limitation, ``the nature of investments made by the futures

    commission merchant (including credit quality, weighted average

    maturity, and weighted average coupon); the futures commission

    merchant's creditworthiness, leverage, capital, liquidity, principal

    liabilities, balance sheet leverage and other lines of business;

    risks to the futures commission merchant created by its affiliates

    and their activities, including investment of customer funds in an

    affiliated entity; and any significant liabilities, contingent or

    otherwise, and material commitments.''

    ---------------------------------------------------------------------------

    FCMs would be required to update the Firm Specific Disclosure

    Document at least annually.

    As described in the section by section discussion at II.P, FCMs

    would also be

    [[Page 67922]]

    required to disclose on their Web sites their daily Segregation

    Schedule, daily Secured Amount Schedule, and daily Cleared Swaps

    Segregation Schedule. Each FCM would be required to maintain 12 months

    of the segregation and secured schedules on its Web site. Each FCM

    would also be required to disclose on its Web site as well as summary

    schedules of its adjusted net capital, net capital, and excess net

    capital for the 12 most recent month-end dates as well as the Statement

    of Financial Condition, Segregation Schedule, Secured Amount Schedule,

    Cleared Swaps Segregation Schedule, and all footnotes related to the

    above statements and schedules from its most current year end annual

    report that is certified by an independent public accountant.

    Benefits

    As explained above in the section by section discussion at II.P,

    current regulations require FCMs to provide a risk disclosure to

    potential customers before accepting customer funds. That risk

    disclosure statement is primarily intended to provide a customer with

    disclosure of the market risks of engaging in futures trading. The

    proposed additions to that disclosure would help to ensure that

    customers are aware of certain non-firm-specific risks that have been

    relevant in recent FCM bankruptcies and that could be relevant in the

    event of future FCM bankruptcies or insolvencies.

    The Firm Specific Disclosure Document that would be required by the

    proposed rules would address firm-specific risk, which would give

    potential customers additional information that they could use when

    conducting due diligence and selecting an FCM. By requiring that the

    disclosure address several specific topics, the proposed rule would

    ensure that certain topics that are relevant are addressed, even if

    potential customers might not otherwise think to ask about them when

    selecting or conducting due diligence on potential FCMs.

    Specifically, by requiring the disclosure to provide information

    about the business activities and product lines the FCM engages in, and

    the percentage of the FCM's assets and capital that are used in each

    type of activity, the proposed rules would assist customers in

    acquiring information that may assist them in determining the extent to

    which the FCM's business is focused on providing the types of services

    that the customer needs, and the extent to which other business

    interests could impact either the focus or stability of the FCM.

    By requiring that FCMs provide the policies and procedures by which

    it selects depositories, the proposed rules would assist potential and

    existing customers in evaluating the sufficiency of due diligence

    conducted by the FCM when selecting such depositories. This additional

    measure of transparency would incent FCMs to be rigorous in conducting

    such due diligence because potential or existing customers that are not

    satisfied with the FCM's policies and procedures in this respect could

    take their business elsewhere.

    Requiring FCMs to discuss their business on behalf of customers,

    the proposed rules would ensure that customers and potential customers

    are able to make a more thorough assessment of risks that the FCM or

    customer funds held by the FCM might bear due to the markets or

    businesses in which the FCM is active, the clearinghouses and carrying

    brokers it uses, or the depositories that hold funds on behalf of the

    FCM. Such an assessment could impact customers' decisions as they

    select the FCM(s) with which they will conduct business. Moreover,

    additional transparency would promote market discipline, which would

    provide additional incentive for FCMs to manage such risks diligently.

    By requiring FCMs to disclose material risks together with an

    explanation of how such risks may be material to its customers, the

    proposed rules would ensure that the FCM is responsible to identify and

    communicate such risks, which helps to ensure that potential and

    existing customers would be aware of those risks when placing or

    keeping funds on deposit with the FCM. In the absence of such a

    requirement, potential or existing customers may not know the FCM's

    business as well as the FCM does, and therefore may not ask about

    certain risks that are material to customers, may not have access to

    adequate information to determine the magnitude of such risks, or may

    not understand how certain risks could impact the FCM's customers.\148\

    The proposed amendment would make the FCM responsible both to identify

    and provide information regarding all material risks and to provide

    explanations that would help educate customers about how such risks

    could affect them.

    ---------------------------------------------------------------------------

    \148\ In the Public Roundtable to Discuss Additional Customer

    Protections on August 9, 2012, participants suggested that FCMs may

    not provide all customers and potential customers with equivalent

    access to firm-specific data. See http://www.cftc.gov/PressRoom/Events/opaevent_cftcstaff080912.

    As a result, larger customers may be able to conduct more

    thorough due diligence when selecting an FCM. The proposed

    requirements would help ensure that all customers have access to

    FCM-specific data that is helpful when evaluating the risks that

    would be relevant to customer funds entrusted to an FCM.

    ---------------------------------------------------------------------------

    Requiring FCMs to provide information regarding how they may file a

    complaint about the FCM with the Commission or the firm's DSRO would

    help to ensure that if customers perceive problems at an FCM, those

    concerns are communicated to the proper regulatory bodies, giving the

    Commission and DSRO an opportunity to investigate further, if

    appropriate. As a consequence, the required information would promote

    more effective oversight by the Commission and DSRO.

    By requiring that FCMs provide an overview of customer fund

    segregation and FCM collateral management and investment, the proposed

    rules would promote the protection of customer funds by enhancing

    market discipline through customer education. The proposed rules would

    help customers understand how statutory and regulatory requirements are

    designed to provide protections for their funds, and what steps FCMs

    must take in order to comply with such regulations. Educated customers,

    in turn, provide an additional layer of accountability for the FCM in

    complying with such requirements. Moreover, customers will be better

    able to understand public disclosures regarding disciplinary actions

    against FCMs, updates regarding material risks to customer funds,

    financial disclosures made by the FCM, and to make informed decisions

    in response.

    In particular, the disclosures proposed in Sec. 1.55(k)(10) could

    assist customers in evaluating fellow customer risk that they would

    bear at each FCM with which they consider doing business. By requiring

    FCMs to disclose specific financial data as of the most recent month-

    end when the disclosure document is produced, the proposed requirements

    would further ensure that all customers have access to data that would

    be helpful when considering potential risks associated with entrusting

    funds to the FCM.

    Requiring FCMs to disclose the dollar value of their proprietary

    trading margin requirements as a percentage of margin required for

    futures customers, Cleared Swap Customers, and 30.7 Customers would

    help customers understand the magnitude of risk created by the FCM's

    proprietary positions relative to the magnitude of risk created by

    customers' positions. This information could prompt customers to ask

    additional questions about the relationship between the risks created

    by the firm's

    [[Page 67923]]

    proprietary trading and trading on behalf of customers. It could also

    prompt questions about how the firm's operations related to proprietary

    trading may impact their operations related to customer accounts.

    By requiring FCMs to disclose the number of customers that

    constitute 50% of the FCMs total funds held for futures customers,

    Cleared Swaps Customers, and 30.7 Customers, customers would have

    additional insight into the potential exposure that the FCM could have

    due to a default by one of its largest customers.

    The aggregate notional value of non-hedged, principal over-the-

    counter transactions into which the FCM has entered, when calculated

    and reported for each class of swaps, would give customers some sense

    of the potential exposure the FCM has due to potential changes in the

    value of its proprietary portfolio.

    The aggregate amount of financing FCMs provide for customer

    transactions involving illiquid financial products would give customers

    additional insightn assessing

    a haircut to securities purchased with customer funds if the FCM

    determines that those securities have minimal credit risk. This is the

    same change as is proposed in Sec. 1.17 except that in Sec. 1.17 the

    proposed change refers to securities purchased by an FCM with its own

    capital, whereas the proposed change here would apply to securities

    purchased with customer funds. The change proposed here would create

    the same costs and benefits as described above in the cost benefit

    considerations section related to Sec. 1.17.

    In addition, the proposed changes would: (1) Require FCMs to report

    daily Segregation Statements to the Commission and their DSRO

    electronically by noon the following business day; (2) require that

    twice per month, each FCM submit a detailed list of depositories report

    listing of all the depositories and custodians where customers

    segregated funds are held, including the amount of customer funds held

    by each entity and a break-down of the different categories of Sec.

    1.25 investments held by each entity; and (3) require that the detailed

    list of depositories be submitted to the Commission electronically by

    11:59 p.m. the following business day and that both Segregation

    Statements and Detailed list of depositories be retained by the FCM in

    accordance with Sec. 1.31.

    Benefits

    Requiring FCMs to submit their daily calculations to the Commission

    and DSRO, together with the proposed amendments to Sec. Sec. 1.20 and

    1.26 giving the Commission and DSRO electronic access to view the

    balances of all depository accounts where customer segregated funds are

    held, will enable the Commission and DSRO to better protect customer

    funds by more closely monitoring for any discrepancies between the

    assets in segregated accounts reported by the FCM and their

    depositories. The ability of the Commission and DSRO to check for

    discrepancies more regularly, without notice, is likely to provide an

    additional disincentive to fraud. Moreover, it will enable both the

    Commission and DSROs to monitor for any trends that would indicate

    operational or financial prob