[Federal Register: October 31, 2000 (Volume 65, Number 211)]
[Proposed Rules]
[Page 64904-64906]
From the Federal Register Online via GPO Access [wais.access.gpo.gov]



17 CFR Part 1

RIN 3038-AB52

Recordkeeping; Amendments to the Daily Computation of the Amount
of Customer Funds Required To Be Segregated

AGENCY: Commodity Futures Trading Commission.

ACTION: Proposed rules.


SUMMARY: The Commodity Futures Trading Commission (``Commission'') is
proposing to amend Commission Rule 1.32 to permit a futures commission
merchant (``FCM''), in computing the amount of customer funds required
to be held in segregated accounts pursuant to section 4d(2) of the
Commodity Exchange Act (``Act''), to offset a net liquidating deficit
or debit ledger balance in a customer's account with securities that
have a ``ready market'' as defined by Rule 15c3-1(c)(11) of the
Securities and Exchange Commission (``SEC'') and that are deposited as
margin by such customer.\1\ The proposal would limit the amount of the
offset to the market value of the securities, less the applicable
haircuts set forth in SEC Rule 15c3-1(c)(2)(vi). The FCM would also be
required to maintain a security interest in the securities, including a
written authorization to liquidate the securities at the FCM's
discretion, and to segregate the securities in a safekeeping account
with a bank, trust company, clearing organization of a contract market,
or another FCM.

    \1\ Commission regulations cited herein may be found at 17 CFR
Ch. I (2000). SEC regulations cited herein may be found at 17 CFR
Ch. II (2000). Section 4d(2) of the Act may be found at 7 U.S.C.
Sec. 6d(2) (1994).

DATES: Comments must be received on or before November 30, 2000.

ADDRESSES: Comments should be mailed to Jean A. Webb, Secretary,
Commodity Futures Trading Commission, Three Lafayette Centre, 1155 21st
Street, NW., Washington, DC 20581. In addition, comments may be sent by
facsimile to (202) 418-5521, or by electronic mail to
secretary@cftc.gov. Reference should be made to ``Recordkeeping--
Futures Commission Merchants' Daily Computation of the Customer
Segregated Amounts.''

FOR FURTHER INFORMATION CONTACT: Thomas J. Smith, Special Counsel,
Division of Trading and Markets, Commodity Futures Trading Commission,
Three Lafayette Centre, 1155 21st Street, NW., Washington, DC 20581;
telephone (202) 418-5495; electronic mail tsmith@cftc.gov; or Henry J.
Matecki, Financial Audit and Review Branch, Commodity Futures Trading
Commission, 300 S. Riverside Plaza, Room 1600-N, Chicago, IL 60606;
telephone (312) 886-3217; electronic mail hmatecki@cftc.gov.


I. Offsetting Customer Net Liquidating Deficits or Debit Ledger
Balances With Securities That Have a ``Ready Market''

A. Background

    Section 4d(2) of the Act requires, among other things, that an FCM
segregate from its own assets all money, securities, and other property
held for customers as margin for their commodity futures and option
contracts, as well as any gains accruing to such customers from open
futures and option positions. The statute also prohibits an FCM from
using the money, securities, or property of one customer to margin or
secure futures or option positions of another customer. The segregation
requirement is intended to: Protect customers who are dealing with an
FCM by assuring the FCM has funds available to readily liquidate its
obligations to its customers; assure an FCM has funds available to meet
its daily variation margin obligations to the clearing organizations of
contract markets; and prohibit an FCM from misappropriating customer
funds for its own purposes.
    Commission Regulations 1.20 through 1.30 implement the segregation
of funds provisions of Section 4d(2) of the Act. Rule 1.32, a related
recordkeeping regulation, requires each FCM to prepare a daily
computation which shows: (1) The amount of funds that an FCM is
required to segregate for customers who are trading on U.S. commodity
exchanges pursuant to the Act and the Commission's regulations; (2) the
amount of funds the FCM actually has in segregated accounts; and (3)
the amount, if any, of the FCM's residual interest in the customer
funds segregated. The computations required by Rule 1.32 are
hereinafter collectively referred to as the ``segregation
computation''. \2\

    \2\ Regulation 1.32 further requires that the FCM complete the
segregation computation for each trading day prior to 12:00 noon on
the next business day and that the computation, and all supporting
data, be maintained for a five-year period in accordance with
Commission Rule 1.31.

    In 1959, the Commodity Exchange Authority (``CEA''), the
predecessor agency of the Commission, issued Administrative
Determination No. 171 (``AD No. 171'') in which it expressed the
opinion that if an FCM elects to accept securities from a customer as
margin, the securities, for purposes of computing the segregation
computation, must be handled separately from the money deposited by, or
due to, other customers.\3\ The AD further provided that any net
liquidating deficit in the account of a customer who deposited
securities as margin was required to be covered by a deposit in
segregation of an equivalent amount of the FCM's own money. This
effectively required an FCM who held securities for a particular
customer to segregate for the full value of those securities even
though the customer's account liquidated to a deficit. For example, if
a customer had a credit ledger balance of $3,000 and a mark-to-market
loss on open positions of $4,200, that customer's account would
liquidate to a deficit of $1,200.\4\ If that customer also had
securities with a market value of $50,000 on deposit with the FCM as
margin for his commodity account, the FCM would be required to include
in its daily segregation computation, a $50,000 segregation requirement
for that customer. The FCM would not have been able to reduce the value
of the security by the $1,200 net liquidating deficit.

    \3\ Commodity Exchange Authority Administrative Determination
No. 171 (Aug. 13, 1959).
    \4\ A distinction is sometimes drawn between a net liquidating
deficit and a debit balance. A net liquidating deficit is an amount
owed to the FCM resulting from the combination of the customer's
debit or credit ledger balance and the mark-to-market gain or loss
on any open positions in the customer's account. A debit balance is
the amount owed to the FCM by the customer represented by the debit
ledger balance, and implies that there are no open positions in the
account. For purposes of this proposal, a net liquidating deficit
also includes customers' accounts with debit ledger balances and no
open positions.

    The rationale for this treatment was that securities, unlike cash,
are not fungible. Therefore, if an FCM became insolvent, a customer
whose securities could be identified to that customer might be in a
position to reclaim those securities free of any pro rata distribution.
If the customer who deposited these ``specifically identifiable''
securities had been

[[Page 64905]]

allowed to build up a deficit in his account and the FCM had not
deposited enough of its own money into segregation to cover the
deficit, the amount of money available in the segregated accounts to
pay other customers would be insufficient.
    The concerns raised by the CEA were subsequently addressed by the
passage of the Bankruptcy Reform Act of 1978 which provided that a
commodity futures customer could not reclaim specifically identifiable
property that would exceed such customer's pro rata share of the FCM's
bankruptcy estate.\5\ In recognition of this change, the Commission's
Division of Trading and Markets (``Division of T&M'') issued an
advisory wherein it set forth a no-action position applicable to FCMs
with respect to the segregation computation when customers' accounts
incur net liquidating deficits.\6\ In the advisory, the Division of T&M
stated that it would not recommend that the Commission commence an
enforcement action against an FCM based solely upon the FCM's use of
customer-owned U.S. Treasury Bills, U.S. Treasury Notes, or U.S.
Treasury Bonds (collectively ``Treasuries'') in connection with the
segregation computation provided that certain conditions were met,
including that: (1) The FCM maintained a security interest in the
Treasuries, which included written authorization to liquidate the
Treasuries at the FCM's discretion in order to protect the FCM and to
cover any deficit in the customer's account; and (2) the Treasuries
were segregated in safekeeping accounts with a bank, trust company,
clearing organization of a contract market, or another FCM as provided
by the Act and Commission regulations.

    \5\ The provisions of that statute relevant to the futures
industry have been amended since that time and current law is
codified in 11 U.S.C. 362, 546, 548, 556 and 761-766 (1994). The
Commission's bankruptcy Rules are contained in 17 CFR part 190
    \6\ Division of Trading and Markets Advisory on Treatment of
Government Securities Deposited as Customer Funds, reprinted in
[1980-1982 Transfer Binder] Comm. Fut. L. Rep. (CCH) para. 21,101
(Nov. 3, 1980) (the ``November 1980 Advisory'').

B. Proposed Rule Amendments

    The Joint Audit Committee (``JAC'') has asked the Commission to
amend Rule 1.32 to permit an FCM to offset a customer's net liquidating
deficit with securities deposited by such customer that have a ``ready
market'' as defined in SEC Rule 15c3-1(c)(11).\7\ The amount of the
offset would be limited to the market value of the securities, less
applicable haircuts set forth in SEC Rule 15c3-1(c)(2)(vi). \8\
Furthermore, an FCM would be required to maintain a security interest
in the securities, including the written authorization to liquidate the
securities at the FCM's discretion, and to segregate the securities in
a safekeeping account with a bank, trust company, clearing organization
of a contract market, or another FCM.

    \7\ The JAC is comprised of representatives of the audit and
compliance departments of the domestic SROs and the National Futures
Association. The JAC coordinates the industry's audit and ongoing
surveillance activities to promote a uniform framework of self-
    \8\ SEC Rule 15c3-1(c)(2)(vi) sets forth haircuts that a broker
or dealer is required to apply to investment securities in computing
its adjusted net capital. This Rule and the haircuts are
incorporated by reference in the Commission's net capital rule. See
Commission Rule 1.17(c)(2)(vi)(B).

    SEC Rule 15c3-1(c)(11) defines ``ready market'' to include a
recognized established securities market in which there exists
independent bona fide offers to buy and sell so that a price reasonably
related to the last sales price or current bona fide competitive bid
and offer quotations can be determined for a particular security almost
instantaneously and where payment will be received in settlement of a
sale at such price within a relatively short time conforming to trade
custom.\9\ Therefore, if adopted, the proposal would expand the
securities against which an FCM could offset a customer's liquidating
deficit from just Treasuries to any security which has a ready market
as defined in the SEC's rule. In the example set forth above, the FCM
would be required to segregate $48,800 for the customer ($50,000 in
securities less the $1,200 liquidating deficit), rather than $50,000 as
is currently required.

    \9\ The definition goes on to say that a ``ready market'' will
also be deemed to exist where securities have been accepted as
collateral for a loan by a bank as defined in section 3(a)(6) of the
Securities and Exchange Act of 1934 and where the broker or dealer
demonstrates to its Examining Authority that such securities
adequately secure such loans as that term is defined in Rule 15c3-
1(c)(5). This portion of the definition of a ``ready market'' is not
applicable to this proposal.

    The Commission believes that the proposal recognizes both the
economic and legal realities that exist in such a situation.
Economically, the FCM is liable to its customer for only $48,800, not
the amount represented by the current value of the securities it is
holding for the customer, and should be required to segregate only the
amount it owes its customer. Likewise, current bankruptcy rules
recognize this economic reality by permitting the FCM to liquidate the
securities, apply the proceeds against the liquidating deficit, and
return the net balance owed to the customer.\10\

    \10\ Of course should there be a shortfall in the funds
available to pay all customers, the net amount owed would be
included among the claims of all customers and be subject to pro
rata distribution of available assets.

    The Commission invites interested parties to comment on the
proposed amendments. In particular, the Commission is interested in
obtaining views regarding whether the types of securities that would be
permitted to offset customer net liquidating deficits should be further
restricted in any way, for example, to securities which are deemed
acceptable for margin, or performance bond, under exchange rules.\11\

    \11\ It should also be noted that the Commission requires an FCM
to set aside in special accounts a certain amount of funds for those
of its U.S.-domiciled customers who trade on non-U.S. commodity
markets. (See Commission Regulation 30.7, which identifies this as
the ``secured amount.'') Unlike section 4d(2) of the Act and
Commission Regulation 1.20, which require an FCM to segregate for
the total net liquidating equities in accounts of customers who are
trading on U.S. markets, Regulation 30.7 requires the FCM to set-
aside only an amount that equals the margin required on foreign
market open positions, plus or minus the mark-to-market gain or loss
on such positions. This is normally less than the net liquidating
equity in such accounts. However, an FCM is permitted to set-aside
funds for customers trading on foreign markets in an amount which is
calculated in the same manner as that done in determining section
4d(2) segregation requirements. If the FCM chooses to calculate its
foreign secured amount requirement using the same method as it uses
to calculate the segregation requirements under section 4d(2) of the
Act, then the FCM would be able to use the same type of offset as
permitted under the proposed change to Rule 1.32.

II. Related Matters

A. Regulatory Flexibility Act

    The Regulatory Flexibility Act (``RFA''), 5 U.S.C. 601-611,
requires that agencies, in proposing rules, consider the impact of
those rules on small businesses. The proposed rule amendments discussed
herein would affect FCMs. The Commission has previously determined
that, based upon the fiduciary nature of FCM/customer relationships, as
well as the requirement that FCMs meet minimum financial requirements,
FCMs should be excluded from the definition of small entity.\12\

    \12\ 47 FR 18618, 18619-18620 (April 30, 1982).

B. Paperwork Reduction Act

    The Paperwork Reduction Act of 1995, 44 U.S.C. 3501 et seq. (Supp.
I 1995), imposes certain requirements on federal agencies (including
the Commission) to review rules and rule amendments to evaluate the
information collection burden that they impose on the public. The
Commission believes that the proposed amendments to Rule

[[Page 64906]]

1.32 do not impose an information collection burden on the public.

List of Subjects in 17 CFR Part 1

    Brokers, Commodity Futures.

    In consideration of the foregoing and pursuant to the authority
contained in the Commodity Exchange Act and, in particular, sections
4d, 4f, 4g and 8a(5) thereof, 7 U.S.C. 6d, 6f, 6g and 12a(5), the
Commission hereby proposes to amend Chapter I of Title 17 of the Code
of Federal Regulations as follows:


    1. The authority citation for Part 1 continues to read as follows:

    Authority: 7 U.S.C. 1a, 2, 2a, 4, 4a, 6, 6a, 6b, 6c, 6d, 6e, 6f,
6g, 6h, 6i, 6j, 6k, 6l, 6m, 6n, 6o, 6p, 7, 7a, 7b, 8, 9, 12, 12a,
12c, 13a, 13a-1, 16, 16a, 19, 21, 23, and 24.

    2. Section 1.32 is proposed to be revised to read as follows:

Sec. 1.32  Segregated account; daily computation and record.

    (a) Each futures commission merchant must compute as of the close
of each business day:
    (1) The total amount of customer funds on deposit in segregated
accounts on behalf of commodity and option customers;
    (2) The amount of such customer funds required by the Act and these
regulations to be on deposit in segregated accounts on behalf of such
commodity and option customers; and
    (3) The amount of the futures commission merchant's residual
interest in such customer funds.
    (b) In computing the amount of funds required to be in segregated
accounts, a futures commission merchant may offset any net deficit in a
particular customer's account against the current market value of
readily marketable securities, less applicable percentage deductions
(i.e., ``securities haircuts'') as set forth in Rule 15c3-1(c)(2)(vi)
of the Securities and Exchange Commission (17 CFR 241.15c3-
1(c)(2)(vi)), held for the same customer's account. The futures
commission merchant must maintain a security interest in the
securities, including the written authorization to liquidate the
securities at the futures commission merchant's discretion, and must
segregate the securities in a safekeeping account with a bank, trust
company, clearing organization of a contract market, or another futures
commission merchant. For purposes of this section, a security will be
considered readily marketable if it is traded on a ``ready market'' as
defined in Rule 15c3-1(c)(11)(i) of the Securities and Exchange
Commission (17 CFR 240.15c3-1(c)(11)(i)).
    (c) The daily computations required by this section must be
completed by the futures commission merchant prior to noon on the next
business day and must be kept, together with all supporting data, in
accordance with the requirements of Sec. 1.31.

    Issued in Washington D.C. on October 25, 2000 by the Commission.
Jean A. Webb,
Secretary of the Commission.
[FR Doc. 00-27914 Filed 10-30-00; 8:45 am]

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