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e9-29730

  • FR Doc E9-29730[Federal Register: December 16, 2009 (Volume 74, Number 240)]

    [Proposed Rules]

    [Page 66598-66601]

    From the Federal Register Online via GPO Access [wais.access.gpo.gov]

    [DOCID:fr16de09-25]

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    COMMODITY FUTURES TRADING COMMISSION

    17 CFR Part 190

    RIN 3038-AC90

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

    Bankruptcy

    AGENCY: Commodity Futures Trading Commission.

    ACTION: Notice of proposed rulemaking.

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    SUMMARY: The Commodity Futures Trading Commission (the ``Commission'')

    proposes amending its regulations (17 CFR Chapter 1, hereinafter, the

    ``Regulations'') regarding the operation of a commodity broker in

    bankruptcy, in order to permit the trustee in such bankruptcy to

    operate, with the written permission of the Commission, the business of

    such commodity broker in the ordinary course, including the purchase or

    sale of new commodity contracts on behalf of the customers of such

    commodity broker under appropriate circumstances, as determined by the

    Commission.

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

    ADDRESSES: You may submit comments, identified by RIN number, by any of

    the following methods:

    Federal eRulemaking Portal: http://www.regulations.gov.

    Follow the instructions for submitting comments.

    Agency Web Site: http://www.cftc.gov. Follow the

    instructions for submitting comments on the Web site.

    E-mail: secretary@cftc.gov. Include the RIN number in the

    subject line of the message.

    Fax: 202-418-5521.

    Mail: David A. Stawick, Secretary of the Commission,

    Commodity Futures Trading Commission, Three Lafayette Centre, 1155 21st

    Street, NW., Washington, DC 20581.

    Hand Delivery/Courier: Same as mail above.

    FOR FURTHER INFORMATION CONTACT: Robert B. Wasserman, Associate

    Director, Division of Clearing and Intermediary Oversight, 202-418-

    5092, rwasserman@cftc.gov; or Nancy Schnabel, Special Counsel, Division

    of Clearing and Intermediary Oversight, 202-418-5344,

    nschnabel@cftc.gov; Commodity Futures Trading Commission, Three

    Lafayette Centre, 1155 21st Street, NW., Washington, DC 20581.

    SUPPLEMENTARY INFORMATION

    I. Authority of the Commission To Promulgate and Amend Regulation

    190.04(d)

    The Commission is empowered by Section 20 of the Commodity Exchange

    Act (the ``Act'') to provide ``[n]otwithstanding title 11 of the United

    States Code * * * with respect to a commodity broker that is a debtor

    under chapter 7 of title 11 of the United States Code, by rule or

    regulation * * * (3) the method by which the business of such commodity

    broker is to be conducted or liquidated after the date of the filing of

    the petition under such chapter, including the payment and allocation

    of margin with respect to commodity contracts not specifically

    identifiable to a particular customer pending their orderly

    liquidation.'' \1\

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    \1\ 7 U.S.C. 24.

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    The Commission exercised such power to promulgate Regulation

    190.04(d), which specifies the procedures that a trustee must follow in

    liquidating open commodity contracts carried by a commodity broker in

    bankruptcy. Similarly, the Commission will exercise such power when

    amending Regulation 190.04(d).

    Currently, Regulation 190.04(d)(2) denies a trustee the authority

    to purchase or sell new commodity contracts on behalf of customers of a

    commodity broker in bankruptcy, except to: (1) Offset an open commodity

    contract; (2) transfer any transferable notice (received by either the

    trustee or the commodity broker) applicable to an open commodity

    contract; and (3) cover, in its discretion and with the approval of the

    Commission, inventory or commodity contracts of the commodity broker

    that cannot be immediately liquidated due to market conditions

    (including price limits).\2\

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    \2\ 17 CFR 190.04(d)(2).

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    [[Page 66599]]

    II. Proposed Amendment To Allow the Trustee To Operate, in the Ordinary

    Course, a Commodity Broker in Bankruptcy

    A. Background

    In the proposing release to the original Regulation Part 190 (the

    ``Proposing Release''), the Commission specified the purposes that it

    intended Regulation Part 190 to achieve, which included:

    [T]o limit the period during which the bankruptcy estate is at

    risk from fluctuations in value of the commodity contracts and other

    property contained therein; * * * to maximize recovery in kind; and

    * * * to provide an understandable and workable method for operating

    the estate pending liquidation.\3\

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    \3\ 46 FR 57535, 57536 (November 24, 1981).

    In the typical case, a commodity broker in bankruptcy would be

    insolvent. If a commodity broker is insolvent, then it would not have

    the capital necessary for operating its business, including for

    supporting the credit of its customers, or for otherwise performing on

    its obligations.\4\ Thus, preventing a trustee from purchasing or

    selling new commodity contracts, whether for the commodity broker or

    the customers thereof, would generally (i) minimize the risk of loss to

    customers of the commodity broker, and (ii) therefore, maximize the

    scope of recovery for such customers.

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    \4\ In general, commodity brokers are required to guarantee all

    customer positions that they carry, as well as to use their own

    capital to cover the debit balance of any customer in an omnibus

    segregated account that they maintain, in order to prevent the

    commodity broker from using the property belonging to other

    customers to margin, guarantee, or secure the positions of the

    customer incurring such debit. See Section 4d of the Act (7 U.S.C.

    6d). See also CFTC Letter No. 00-106 (November 22, 2000) (stating

    that a commodity broker that is a futures commission merchant

    (``FCM'') must cover any deficit in the customer segregated account

    with its own funds or property, and not the funds or property of

    other customers).

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    However, certain purchases or sales of new commodity contracts may

    actually reduce the risk of loss to customers of a commodity broker in

    bankruptcy. Therefore, when the Commission promulgated Regulation Part

    190 in 1983, the Commission created certain exceptions to Regulation

    190.04(d)(2), as described above. By creating such exceptions, the

    Commission acknowledged that the trustee must be allowed to purchase or

    sell new commodity contracts, whether for the commodity broker or the

    customers thereof, in order to: (1) Liquidate open commodity contracts;

    or (2) transfer an incipient delivery obligation of an open commodity

    contract. Facilitating such liquidation would limit the period in which

    the estate of the commodity broker is at risk for fluctuations in

    value. Permitting such transfer would tend to maximize recovery of

    customers of the commodity broker, by allowing the trustee to minimize

    or avoid claims for losses resulting from the inability of the estate

    of the commodity broker to fulfill obligations to take or effect

    delivery on open commodity contracts.

    In addition to the exceptions enumerated above, the Commission

    acknowledged that, if the trustee cannot immediately liquidate the

    inventory or open commodity contracts of a commodity broker in

    bankruptcy, because of market conditions (including price limits), then

    the trustee should be allowed to purchase or sell new commodity

    contracts, in order to cover or partially cover such inventory or

    commodity contracts. The Commission intended to permit such cover or

    partial cover in order to prevent, among other things, the ``material

    erosion in value'' of such inventory or commodity contracts, which

    would diminish the recovery of the customers of the commodity

    broker.\5\

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    \5\ In the Proposing Release, the Commission included the

    following version of Regulation 190.04(d)(2) (referenced in the

    Proposing Release as Regulation 190.04(d)(3)): Nothing in this Part

    shall be interpreted to permit the trustee to purchase new commodity

    contracts for customers of the debtor: Provided, however, That to

    prevent material erosion in value, the trustee may, in its

    discretion and with the approval of the Commission, cover uncovered

    inventory or commodity contracts of the debtor which cannot be

    liquidated immediately because of limit moves or other market

    conditions.

    46 FR 57353, 57561 (November 24, 1981). However, in the adopting

    release to Regulation Part 190 (the ``Adopting Release''), the

    Commission removed the reference to ``material erosion in value'' in

    proposed Regulation 190.04(d)(2), in response to a comment that such

    reference would ``have limited the cases in which cover transactions

    could be sought by the trustee.'' Nevertheless, the Commission

    reiterated in the Adopting Release that the primary purpose of

    Regulation 190.04(d)(2) was to prevent a ``material erosion in

    value'' of uncovered inventory or commodity contracts, by stating

    that ``the Commission * * * believes cover transactions would be

    limited to this purpose.'' 48 FR 8716, 8729 (March 1, 1983).

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    B. The Proposed Amendment

    The Commission is proposing to amend Regulation 190.04(d) to allow

    the trustee, under appropriate circumstances, to operate the business

    of a commodity broker in bankruptcy in the ordinary course, including

    the purchase or sale of new commodity contracts on behalf of the

    customers of the debtor (the ``Amendment''). The appropriateness of a

    particular set of circumstances would be determined by the Commission

    in its discretion, and such operation would require the written

    permission of the Commission. Pursuant to Regulation 190.10(d), the

    Commission has delegated all the functions of the Commission in

    Regulation Part 190, except one, to the Director of the Division of

    Clearing and Intermediary Oversight, and therefore, under this proposed

    amendment, the Director would also have the power to make such

    determination and to issue such written permission.\6\

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    \6\ Regulation 190.10(d) would apply to the proposed Amendment.

    Regulation 190.10(d) states:

    Until such time as the Commission orders otherwise, the

    Commission hereby delegates to the Director of the Division of

    Clearing and Intermediary Oversight, and to such members of the

    Commission's staff acting under his direction as he may designate,

    all the functions of the Commission set forth in this part except

    the authority to approve or disapprove a withdrawal or settlement of

    a commodity account by a public customer pursuant to Sec.

    190.06(g)(3).

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    C. Rationale for the Proposed Amendment

    Recently, events have demonstrated that a commodity broker may

    enter into bankruptcy while not insolvent.\7\ For example, on Friday,

    November 25, 2005, after the closing of the relevant markets, Refco,

    LLC (``Refco'') filed for relief under Subchapter IV of Chapter 7 of

    the Bankruptcy Code, primarily to satisfy a precondition for the sale

    of its FCM business to a third party. Previously, the United States

    Bankruptcy Court for the Southern District of New York (``District

    Court'') had approved the sale of that FCM business. According to the

    agreement governing the sale, the third party would give the parent

    entities of Refco (i) a specified sum and (ii) the opportunity to

    retain the net regulatory capital of Refco.\8\

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    \7\ The Bankruptcy Code permits a solvent entity to legally file

    for relief under Chapter 7 of the Bankruptcy Code. See Collier on

    Bankruptcy ] 109.03[2].

    \8\ See In re: Refco, LLC, No. 05-60134-rdd, Docket No. 5

    (Bankr. S.D.N.Y. Nov. 25, 2005).

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    Shortly after Refco filed for relief under Subchapter IV of Chapter

    7 of the Bankruptcy Code, the sale of its FCM business to a third party

    was consummated. Prior to the re-opening of the relevant markets on

    Sunday, November 27, 2005, all of the customer accounts of Refco,

    comprising one hundred percent of the net equity of each customer, were

    transferred to the third party.

    During the Refco proceedings, it was practicable to transfer

    customer accounts when all relevant markets were closed. However, it

    may not always be so practicable. For example, on Friday, September 19,

    2008, prior to the closing of the relevant markets, Lehman Brothers

    Inc. (``Lehman'') became the subject of a proceeding under the

    Securities Investor Protection

    [[Page 66600]]

    Act of 1970 (``SIPA''),\9\ primarily to satisfy a precondition for the

    sale of its securities broker-dealer business and its FCM business to a

    third party. On Saturday, September 20, 2008, the District Court

    approved the sale of such securities broker-dealer business and FCM

    business, in exchange for the third party giving the parent of Lehman a

    specified sum.\10\ Shortly after such approval, the sale was

    consummated. Soon after the consummation, the customer accounts of

    Lehman began to be transferred to the third party. However, because the

    Lehman proceedings under SIPA had commenced in District Court prior to

    the closing of the relevant markets, customers of Lehman would have

    been unable to manage their accounts, absent a provision in the Order

    issued by the District Court permitting the trustee to conduct business

    in the ordinary course.\11\

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    \9\ 15 U.S.C. 78aaa-111.

    \10\ See In re: Lehman Brothers Holdings Inc., et al., No. 08-

    13555, Docket No. 258 (Bankr. S.D.N.Y. Sept. 20, 2008).

    \11\ See S.I.P.C. v. Lehman Brothers, Inc., No. 08-8119, Docket

    No. 3 (S.D.N.Y. September 19, 2008).

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    The Commission is proposing the Amendment to enable customers to

    manage their accounts, after their commodity broker enters into

    bankruptcy and prior to the transfer of their accounts, in certain

    circumstances. As the Refco and Lehman proceedings illustrate, there

    may be cases where a transfer of customer accounts has been arranged

    pre-bankruptcy, and where a commodity broker in bankruptcy may

    nevertheless possess the capital necessary to continue operating its

    business in the ordinary course (e.g., to continue supporting the

    credit of its customers and performing on its other obligations),

    pending imminent transfer of customer accounts to another commodity

    broker. Therefore, permitting the trustee to operate such business in

    the ordinary course may advance the purpose of Regulation Part 190--

    namely, ``to provide an understandable and workable method for

    operating the estate pending liquidation.'' \12\ Thus, the proposed

    Amendment is consistent with the past practice of the Commission in

    creating exemptions to Regulation 190.04(d)(2) when necessary to

    advance the purposes of Regulation Part 190. Additionally, allowing

    customers to manage their accounts, as much as possible, as if the

    commodity broker had not entered into bankruptcy would be in the best

    interests of both the customers and the relevant markets in general.

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    \12\ 46 FR 57535, 57536 (November 24, 1981).

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    Whether a commodity broker in bankruptcy has sufficient capital to

    continue operating its business in the ordinary course is inherently a

    factual question. Therefore, the Commission reserves the power to limit

    the application of the proposed Amendment, in its discretion, by: (1)

    Requiring the trustee to obtain the written permission of the

    Commission; and (2) determining the circumstances under which the

    trustee may purchase or sell new commodity contracts on behalf of

    customers of the commodity broker in bankruptcy.

    In deciding whether to apply the proposed Amendment to a particular

    commodity broker in bankruptcy, the Commission may consider the

    following factors: (1) Whether the commodity broker has entered into an

    agreement providing for the imminent transfer of its customer accounts

    to an entity that is ready, willing and able to accept such transfer

    promptly; (2) whether the commodity broker has sufficient capital, at

    the time it becomes subject to bankruptcy proceedings, to continue

    operating its business in the ordinary course pending the transfer; and

    (3) whether a commodity broker will have sufficient capital, after the

    sale of its assets (including its FCM business), to continue operating

    its business in the ordinary course until all of its customer accounts

    have been transferred. The Commission anticipates that future

    bankruptcies of commodity brokers may present new factors for its

    consideration, and the proposed Amendment is therefore intended to

    provide the Commission with flexibility to consider such new factors in

    its discretion.

    III. Related Matters

    A. Regulatory Flexibility Act

    The Regulatory Flexibility Act (``RFA'') \13\ requires Federal

    agencies, in promulgating regulations, to consider the impact of those

    regulations on small businesses. As mentioned above, the proposed

    Amendment provides a limited exception to Regulation 190.04(d)(2), by

    permitting a trustee to operate, with the written permission of the

    Commission, the business of a commodity broker in bankruptcy in the

    ordinary course, including the purchase or sale of new commodity

    contracts on behalf of the customers of such commodity broker. The

    proposed Amendment does not impose a regulatory burden on either a

    commodity broker pre-bankruptcy or a trustee post-bankruptcy. Moreover,

    the proposed Amendment will affect only FCMs (including certain foreign

    futures commission merchants).\14\ The Commission has previously

    established certain definitions of ``small entities'' to be used by the

    Commission in evaluating the impact of its regulations on such entities

    in accordance with the RFA.\15\ The Commission has previously

    determined that FCMs are not small entities for the purpose of the

    RFA.\16\ Accordingly, pursuant to 5 U.S.C. 605(b), the Chairman

    certifies, on behalf of the Commission, that the proposed Amendment

    will not have a significant economic impact on a substantial number of

    small entities.

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    \13\ 5 U.S.C. 601 et seq.

    \14\ The proposed Amendment may apply, in the future, to other

    commodity brokers that execute trades and carry accounts for

    clearing on behalf of customers--namely, commodity options dealers

    and leverage transaction merchants. Currently, no such commodity

    brokers exist. Therefore, even if such commodity brokers would

    constitute ``small entities'' for purposes of the RFA, the proposed

    Amendment can have no current impact on such commodity brokers.

    However, it is unlikely that such commodity brokers would constitute

    ``small entities'' for purposes of the RFA. In defining ``small

    entities'' for the purpose of the RFA, the Commission excluded FCMs

    based on the fiduciary nature of FCM-customer relationships, as well

    as the minimum financial requirements that apply to FCMs. See 47 FR

    18618, 18619 (Apr. 30, 1982). Certain parts of this rationale would

    also be applicable to commodity options dealers, foreign futures

    commission merchants, and leverage transaction merchants.

    \15\ 47 FR 18618 (Apr. 30, 1982).

    \16\ Id. at 18619.

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    B. Paperwork Reduction Act

    The Paperwork Reduction Act (``PRA'') \17\ imposes certain

    requirements on Federal agencies in connection with their conducting or

    sponsoring any collection of information as defined by the PRA. The

    proposed Amendment does not require the new collection of information

    on the part of any entities that would be subject to the proposed

    Amendment. Accordingly, for purposes of the PRA, the Commission

    certifies that the proposed Amendment, if promulgated in final form,

    would not impose any new reporting or recordkeeping requirements.

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    \17\ 44 U.S.C. 3501 et seq.

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    C. Cost-Benefit Analysis

    Section 15(a) of the Act \18\ requires that the Commission, before

    promulgating a regulation under the Act or issuing an order, consider

    the costs and benefits of its action. By its terms, Section 15(a) of

    the Act does not require the Commission to quantify the costs and

    benefits of a new regulation or to determine whether the benefits of

    the regulation outweigh its costs. Rather,

    [[Page 66601]]

    Section 15(a) of the Act simply requires the Commission to ``consider

    the costs and benefits'' of its action.

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    \18\ 7 U.S.C. 19.

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    Section 15(a) of the Act further specifies that costs and benefits

    shall be evaluated in light of the following considerations: (1)

    Protection of market participants and the public; (2) efficiency,

    competitiveness, and financial integrity of futures markets; (3) price

    discovery; (4) sound risk management practices; and (5) other public

    interest considerations. Accordingly, the Commission could, in its

    discretion, give greater weight to any one of the five considerations

    and could, in its discretion, determine that, notwithstanding its

    costs, a particular regulation was necessary or appropriate to protect

    the public interest or to effectuate any of the provisions or to

    accomplish any of the purposes of the Act.

    The Commission has evaluated the costs and benefits of the proposed

    Amendment, in light of the specific considerations identified in

    Section 15(a) of the Act, as follows:

    1. Protection of Market Participants and the Public

    In the event of the bankruptcy of a commodity broker, the proposed

    Amendment would benefit the customers of such commodity broker, by

    providing them with the opportunity, under certain circumstances, to

    manage their accounts prior to the transfer of such accounts to a new

    commodity broker.

    2. Efficiency and Competition

    The proposed Amendment is not expected to have an effect on

    efficiency or competition.

    3. Financial Integrity of Futures Markets and Price Discovery

    As mentioned above, the proposed Amendment will promote financial

    integrity of the futures markets by providing customers of a commodity

    broker in bankruptcy with the opportunity, under certain circumstances,

    to manage their accounts prior to the transfer of such accounts to a

    new commodity broker.

    4. Sound Risk Management Practices

    The proposed Amendment is not expected to have a direct effect on

    the risk management practices of commodity brokers.

    5. Other Public Considerations

    Recent events, such as the Refco and Lehman proceedings, have

    demonstrated that the proposed Amendment is necessary and prudent.

    Accordingly, after considering the five factors enumerated in the

    Act, the Commission has determined to propose the regulations set forth

    below.

    List of Subjects in 17 CFR Part 190

    Bankruptcy, Brokers, Commodity futures.

    For the reasons stated in the preamble, the Commission proposes to

    amend 17 CFR part 190 as follows:

    PART 190--BANKRUPTCY

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

    follows:

    Authority: 7 U.S.C. 1a, 2, 4a, 6c, 6d, 6g, 7a, 12, 19, and 24,

    and 11 U.S.C. 362, 546, 548, 556, and 761-766, unless otherwise

    noted.

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

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

    * * * * *

    (d) * * *

    (3) Exception to liquidation only. Notwithstanding paragraph (d)(2)

    of this section, the trustee may, with the written permission of the

    Commission, operate the business of the debtor in the ordinary course,

    including the purchase or sale of new commodity contracts on behalf of

    the customers of the debtor under appropriate circumstances, as

    determined by the Commission.

    * * * * *

    Issued in Washington, DC, on December 9, 2009 by the Commission.

    David A. Stawick,

    Secretary of the Commission.

    [FR Doc. E9-29730 Filed 12-15-09; 8:45 am]

    Last Updated: December 16, 2009



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