Action against Refco for Order-Taking and Recordkeeping Violations and for Failing to Supervise
On May 24, 1999, the Commission issued an order, simultaneously instituting and settling an administrative proceeding, finding that Refco, Inc., a registered futures commission merchant (FCM), violated provisions of the Commodity Exchange Act (CEA) and the Commission's regulations. The order found that Refco failed to comply with CFTC regulations regarding order-taking and recordkeeping in handling customer orders. The order also found that Refco failed to administer a proper supervisory system and failed to investigate indications of improper handling of trades. The matter arose from the activities of a registered introducing broker (IB) who placed orders for thousands of Treasury bond futures and option contracts per day for his customers through Refco. The IB placed a substantial number of those orders without providing account identification to Refco. After the orders were executed, the IB assigned those trades to customer accounts, directing positions as the IB chose, and sometimes moved trades between accounts after trades had been assigned and cleared. Refco consented to the issuance of the order without admitting or denying the findings contained in it. The CFTC ordered the company to cease and desist from further violations of the named provisions of the Act and to pay a total of $7 million. The CFTC ordered the company to pay $6 million of that amount as a civil monetary penalty and to use the remaining $1 million to fund a study of issues associated with order transmission and entry procedures for exchange-traded futures and options and the diligent supervision of the order and entry process by commodity professionals. Representatives of National Futures Association (NFA) and the Futures Industry Institute (FII) will oversee the study. This is the first CFTC order ever to contain such a provision.
Settlement with Merrill Lynch in Sumitomo Copper Complaint
In June 1999, the Commission settled an administrative enforcement action against Merrill Lynch International, Inc. (Merrill International), and Merrill Lynch Pierce Fenner & Smith (Brokers & Dealers), Ltd. (Merrill (B&D)). The settling respondents neither admitted nor denied the allegations in the complaint or the findings in the order. The CFTC ordered the companies to pay a civil monetary penalty of $15 million and to cease and desist from violating, and aiding and abetting violations of, the anti-manipulation provisions of the CEA. The order further requires the settling respondents to cooperate with the CFTC in proceedings and any investigations related to this matter and dismisses the action against Merrill Lynch & Co., Inc. The order finds that the firms aided and abetted Sumitomo Corporation of Japan and others: by providing more than one-half billion dollars of credit and finance which the manipulators used to purchase and hold a dominant position in futures contracts and London Metal Exchange warehouse stocks of copper; by providing trading facilities, accounts, and trading capacity through which the manipulators acquired their dominant position in a combination of futures contracts and warehouse stocks and through which the manipulators sold or lent a small portion of their holdings at artificially high absolute prices and artificially high backwardated spread differentials; and by providing trading advice which the manipulators used in the execution of their strategy of withholding their copper from the market. The order states that Merrill (B&D) and Merrill International possessed the requisite knowledge and intent to find that they aided and abetted the manipulator's violations. In addition, the order finds that Merrill (B&D) benefited from the manipulation by providing financing, trading facilities, and credit to the manipulators, and by earning profits through its proprietary trading.
Streamlined Procedures for New Contract Designation
In July, the Commission proposed far-reaching and fundamental changes to its approval procedures for new futures contracts offered on U.S. exchanges. The Commission proposed a two-year pilot program to permit the listing of futures and option contracts on U.S. exchanges prior to CFTC review and approval. The pilot program responds to the concerns of U.S. exchanges that the ability to list new contracts without delay is important to the continued competitiveness of the exchanges, particularly with foreign exchanges. The proposed pilot procedure would be available to any exchange that is already approved to trade at least one futures or option contract. Under the pilot program, exchanges would be required only to file the contract's terms and conditions with the CFTC by close of business on the day prior to first listing a new contract and could list trading months up to one year in the future. The exchange would also be required to file with the CFTC within 45 days of first listing the contract an application for approval of the contract. The procedure would not be available for certain contracts, including stock index contracts, which require prior concurrence by the Securities and Exchange Commission (SEC). Exchanges would have a choice of using the pilot procedure or the current procedures, including fast-track procedures introduced in 1997, for approval of new futures and option contracts. The Commission adopted the new contract listing procedures in final form on November 17, 1999.
Streamlined Contract Market Rule Review Procedures
In July, the Commission proposed further streamlining of its procedures for reviewing exchange rules. The Commission proposed to amend its procedures to allow additional categories of exchange rule amendments to be approved automatically, upon adoption by the exchange, and to permit such amendments to be submitted to the Commission in a single weekly, summary filing rather than in individual submissions. For certain other rules, the time for review would be reduced to three days. The Commission also reorganized, in a clearer and more accessible format, the Commission's rules on expedited approval procedures for proposed rule amendments to exchange contract terms and conditions. The proposed rules would reduce individual submissions to the Commission by U.S. exchanges and reduce the burdens associated with the review and approval process. In November 1999, the Commission proposed that futures exchanges be allowed to make new rules and rule amendments effective without prior Commission approval.
Agricultural Trade Option Proposal
In August 1999, the Commission proposed to revise rules governing the market for over-the-counter (OTC) options on agricultural commodities. Agricultural trade options are off-exchange options on specified domestic agricultural commodities offered to producers, processors or merchandisers in connection with their business. The rules permitting the offer and sale of agricultural trade options that were then current went into effect on June 15, 1998. Those rules, among other things, required physical delivery of the commodities subject to the options, required merchants offering these options to register with the Commission, required risk disclosure to customers, and placed certain restrictions on the types of options permitted. No one registered as an agricultural trade option merchant under the June 1998 rules. The Commission received comments from a number of groups in the agricultural sector supporting reconsideration of the rules as a means of increasing interest in the possible offer and sale of these instruments. After carefully reviewing the rules, the Commission proposed several changes to allow more flexibility in the types of options that could be offered by allowing cash settlement, streamlining the reporting and disclosure requirements, and generally bringing the rules more into line with practices in the cash markets. In December 1999 the Commission published final rules implementing these changes.
Revised Speculative Position Limits
In May 1999, the Commission increased speculative position limits for various domestic agricultural products and streamlined certain associated rules. Speculative limit rules limit the size of positions that speculators may hold in the U.S. futures markets and have been a key regulatory feature for over 60 years. The revised rules, which are part of the Commission's ongoing regulatory reform program, increase the accessibility and clarity of the rules, making compliance easier to achieve. The revised rules increase the Commission's speculative position limits only in the deferred trading months. The size of positions speculators are permitted to hold in the spot month remains unchanged. In addition, the revised rules simplify and reorganize associated policies, exemptions, and rules by incorporating them within a single section of the Commission's rulebook. In addition, the Commission adopted a new provision which requires a limited partner with greater than a 25 percent ownership interest in a small commodity pool whose operator is not registered with the Commission to aggregate his or her positions with the pool's positions. However, the limited partner is eligible for an exemption during deferred trading months.
International Futures Trading
The Commission amended its rules governing registration, exemption, and disclosure by IBs, commodity pool operators (CPOs), and commodity trading advisors (CTAs) trading foreign futures and option contracts on behalf of U.S. clients and pool participants. The revisions "level the playing field" by requiring IBs, CPOs, and CTAs to make the same disclosures to U.S. clients and pool participants regardless of whether the U.S. persons are trading on domestic or foreign exchanges, with less disclosure required for sophisticated investors. As part of this amendment, the Commission delegated to the NFA the authority to review disclosure documents filed under these rules. The Commission also modified the process by which a foreign person acting in the capacity of an IB, CTA, or CPO may apply for an exemption from registration under Rule 30.5.
The Commission also published proposed rule amendments that would clarify the circumstances in which members of a foreign board of trade must register with the Commission or obtain an exemption from registration. The proposed amendments will expand significantly the ability of U.S. persons to place orders directly with foreign futures and options brokers without having to sacrifice the global clearing services provided by a single U.S. FCM.
In addition, the Commission, in June 1999, instructed the staff to begin processing no-action requests from foreign boards of trade seeking to place trading terminals in the United States. The Commission committed to initiating simultaneously processes to address the comparative regulatory levels between U.S. and foreign electronic trading systems.
Electronic Recordkeeping and Signatures
As part of its continuing program to update its rules, the Commission adopted amendments to its recordkeeping requirements. The amendments allow recordkeepers to store most required records in either micrographic or electronic storage media for the full five-year maintenance period. The amendments harmonize many recordkeeping requirements for firms regulated by both the CFTC and the SEC. As a result, recordkeepers will have the flexibility necessary to maximize the cost reduction and time savings available from improved storage technology. The adoption of the rule is one in a series of steps the CFTC has taken to facilitate the use of electronic media technology where adequate measures exist to safeguard the public interest.
In another acknowledgement of the impact of technology on business processes, the Commission proposed in August 1999 to permit the use of electronic signatures in lieu of handwritten signatures in those instances where Commission regulations require the signature of a customer of an FCM or IB, a participant in a commodity pool, or a client of a CTA. The proposal is consistent with the approach taken by Congress and with the Uniform Electronic Transactions Act recently approved and recommended for adoption in all States by the National Conference of Commissioners of Uniform State Laws.
Year 2000 Efforts
The Commission developed plans for ensuring Year 2000 compliance externally by the industry and internally within the Commission. As part of its external Year 2000 efforts, the Commission published four advisories from January 1997 through June of 1999 that: define the steps to a sound Year 2000 preparedness plan (evaluation of hardware and software readiness, remediation, testing and contingency planning); clarify the duty of Commission registrants to be Year 2000 compliant; require auditors of FCMs to file with the Commission a special Year 2000 report as part of their annual report of financial conditions; require registrants to have written contingency plans in place by September 30, 1999; and provide guidance on developing such a plan. During FY 1999, the staff monitored the submission of approximately 200 reports by independent accountants and requested that the Joint Audit Committee, which is composed of representatives from the self-regulatory organizations (SROs), include a Year 2000 component in the audit requirement for exchange member firms.
The Commission monitored the SROs' Year 2000 efforts, conducted on-site visits with SRO Year 2000 teams, and maintained frequent contact with SRO Year 2000 personnel. In addition, the Commission forged a relationship with the FIA to help achieve industry-wide testing, contingency plans, and Year 2000 preparation. The Commission participates in the President's Council on Year 2000 Conversion, which is responsible for addressing the Year 2000 problem through a coordinated governmental approach. The Commission has also been engaged in international Year 2000 initiatives through its participation in IOSCO and the Joint Year 2000 Council.
Internally, Commission staff developed a "Business Continuity Contingency Plan" outlining the measures CFTC will take to prepare for possible Year 2000 problems and to request additional funds for Year 2000 compliance efforts. Under the Plan, staff members have worked to ensure that all physical plants and supporting systems will be operational on January 1, 2000, and, as an alternative, that staff will have remote access to all mission-critical systems.
Alternative Execution Procedures
In a June advisory, the Commission announced its intention to consider contract market proposals to adopt alternative execution, or block trading, procedures for large size or other types of orders on a case-by-case basis. Under a flexible approach to the requirements of the CEA and the Commission's regulations, each contract market would retain the discretion to permit alternative execution procedures. Additionally, each contract market would have the ability to develop procedures that reflect the particular characteristics and needs of its individual markets and market participants. In the Advisory, the Commission encouraged contract markets to solicit the input of, and coordinate with, various interested parties in developing such alternative execution procedures for large orders.
Proposed Rules on CTA Performance Data and Disclosure
The Commission issued proposed amendments to its rules on the computation, documentation, and disclosure of the past performance of trading programs offered to the public by CTAs. The issue of how best to compute the rate of return (ROR) for partially funded, or "notionally funded," accounts of CTAs has been a subject of discussion by the Commission and industry participants for many years. Central to this issue is the question of which amount should be used as the denominator in the ROR calculation: actual funds or the nominal account size agreed upon between the CTA and the client to establish the client's level of trading in the CTA's program. The Commission proposed rule revisions to provide that ROR be computed by dividing net performance by the nominal account size. Consistent with this proposed change in the computational method, the documentation and disclosure requirements in the proposed rules focus on conveying a numerical sense of the impact of partial funding on the leverage and volatility applicable to the client's account. The proposal also seeks to ensure that customers are not misled as to the amount of actual funds managed by a CTA.