[Federal Register: March 13, 2002 (Volume 67, Number 49)]
[Rules and Regulations]
[Page 11223-11229]
From the Federal Register Online via GPO Access [wais.access.gpo.gov]
[DOCID:fr13mr02-6]

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COMMODITY FUTURES TRADING COMMISSION

17 CFR Parts 37, 38, 41, and 155

RIN 3038-AB83


Regulation To Restrict Dual Trading in Security Futures Products

AGENCY: Commodity Futures Trading Commission.

ACTION: Final rulemaking.

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SUMMARY: The Commodity Futures Trading Commission (``Commission'')
hereby adopts regulation 41.27 that restricts dual trading by floor
brokers in security futures products. Under the regulation, the dual
trading restriction affects floor brokers that trade security futures
products through open outcry on the trading floor of a designated
contract market (``DCM'') or registered derivatives transaction
execution facility (``DTF''). The regulation provides for certain
exceptions to the restriction, including provisions for the correction
of errors, customer consent, spread transactions, market emergencies,
and unique or special characteristics of an agreement, contract, or
transaction, or of the DCM or DTF.

EFFECTIVE DATE: April 12, 2002.

ADDRESSES: Commodity Futures Trading Commission, Three Lafayette
Centre, 1155 21st Street, NW., Washington, DC 20581, Attention: Office
of the Secretariat. Comments may be sent by facsimile transmission to
(202) 418-5521 or by e-mail to secretary@cftc.gov. Reference should be
made to ``Restriction of Dual Trading in Security Futures Products by
Floor Brokers.''

FOR FURTHER INFORMATION CONTACT: Stephen Braverman, Associate Director,
or Rachel Berdansky, Special Counsel, Division of Trading and Markets,
Commodity Futures Trading Commission, Three Lafayette Centre, 1155 21st
Street, NW., Washington, DC 20581, (202) 418-5490, Electronic mail:
sbraverman@cftc.gov or rberdansky@cftc.gov.

SUPPLEMENTARY INFORMATION:

I. Introduction

    On December 15, 2000, Congress passed the Commodity Futures
Modernization Act of 2000 (``CFMA''), which was signed by the President
and became effective on December 21, 2000. Among other things, the
CFMA, which substantially amended the Commodity Exchange Act (``Act''),
establishes two categories of markets subject to Commission regulatory
oversight, DCMs and DTFs.\1\ In addition, Title II of the CFMA repeals
the longstanding ban on single stock futures and directs the Commission
and the Securities and Exchange Commission (``SEC'') to implement a
joint regulatory framework for security futures products.
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    \1\ Appendix E of Pub. L. 106-554, 114 Stat. 2763 (2000). Prior
to its recent amendment, the Act referred to ``designated contract
markets'' as Commission-approved products traded on a board of
trade. The Act, as amended, however, uses the term ``designated
contract market'' to refer to the approved or licensed market on
which futures contracts and commodity options are traded. Regulation
41.27 refers to DCMs in this sense.
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    On July 11, 2001, the Commission published proposed regulation
41.27 (``proposing release''), which generally restricts floor brokers
from dual trading security futures products through open outcry during
the same trading session, in accordance with the statutory mandate of
section 4j(a) of the Act, as amended by section 251(c) of the CFMA.\2\
Section 4j(a), as amended, also requires that the Commission permit
exceptions to the dual trading restriction in order to ensure fairness
and orderly trading in security futures product markets.\3\ Moreover,
section 2(a)(D)(i) of the Act sets forth listing standards for security
futures products traded on a DCM or DTF. In particular, section
2(a)(D)(i)(VI) requires that security futures products be subject to
the dual trading restriction of section 4j of the Act and the
regulations thereunder or section 11(a) of the Securities Exchange Act
of 1934 (`` '34 Act'') and the regulations thereunder.\4\
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    \2\ See Proposed Regulation to Restrict Dual Trading in Security
Futures Products, 66 FR 36218.
    \3\ Section 4j of the Act, as amended, is different in scope
than its predecessor and the Commission regulation promulgated
thereunder. Commission regulation 155.5 restricted dual trading in
any contract market that exceeded certain volume thresholds unless
an exchange requested, and the Commission granted, a dual trading
exemption. As part of this rulemaking, the Commission is removing
regulation 155.5.
    \4\ With certain enumerated exceptions, section 11(a)(1) of the
'34 Act and SEC rule 11a-1 make it unlawful for any member of a
national securities exchange to effect any transaction for his or
her own account, the account of an associated person, or an account
with respect to which it or an associated person has discretion.
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    Section 5f of the Act provides that any board of trade that is
registered with the SEC as a national securities exchange or as a
national securities association, or as an alternative trading system,
shall be considered a DCM in security futures products, provided that
certain enumerated requirements are satisfied upon filing a notice with
the Commission. Section 5f(b)(1)(B), however, specifically exempts such
notice-registered entities from section 4j of the Act. Similarly,
section 6(g) of the '34 Act, as amended by section 202(a) of

[[Page 11224]]

the CFMA, provides that any board of trade that has been designated as
a contract market by the Commission or has registered with the
Commission as a DTF may register with the SEC as a national securities
exchange by filing notice with the SEC solely for the purposes of
trading security futures products, provided that certain enumerated
requirements are satisfied. DCMs and DTFs that notice register with the
SEC for the purpose of trading security futures products are exempt
from section 11(a)(1) of the '34 Act.
    The Commission received four comment letters on a variety of issues
regarding the proposing release.\5\ CME fully supported proposed
regulation 41.27, and stated that, ``the Commission's proposed dual
trading regulation for security futures products appropriately balances
customer protection with regulatory oversight.'' CBOT, AMEX, and NYBOT
raised several issues regarding the proposing release's definition of
``customer'' and ``dual trading,'' application of the dual trading
restriction under certain circumstances to electronic trading systems,
and the possible addition of a low volume exception. Those comments are
discussed, as appropriate, below.
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    \5\ Letters were received from: (1) Chicago Mercantile Exchange
(``CME''), (2) Board of Trade of the City of Chicago (``CBOT''), (3)
The American Stock Exchange (``AMEX''), and (4) Board of Trade of
the City of New York (``NYBOT'').
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II. Final Rule

A. Definitions

1. Customer
    Proposed regulation 41.27(a)(4) defined ``customer'' to mean an
account owner for which a trade is executed other than (i) an account
in which a floor broker's ownership interest or share of trading
profits is ten percent or more; (ii) an account for which a floor
broker has discretion; (iii) an account controlled by a person with
whom a floor broker has a relationship through membership in a broker
association; (iv) a house account for a floor broker's clearing member;
or (v) an account for another member present on the floor of a DCM or
DTF or an account controlled by such other member. To make the
regulation more consistent with section 11(a) of the '34 Act, the
Commission has modified the language of section 41.27(a)(4)(i) by
deleting the reference to ``ten percent or more.'' \6\ Thus,
Sec. 41.27(a)(4)(i), as adopted, provides, ``(c)ustomer means an
account owner for which a trade is executed other than (i) an account
in which such floor broker has any interest.'' \7\
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    \6\ See infra note 4.
    \7\ AMEX commented that the final regulation should delete the
``ten percent or more'' ownership provision because it limited the
definition of dual trading and was not included in section of 4j of
the Act, as amended.
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    CBOT and NYBOT commented regarding the proposed definition of
``customer'' in Sec. 41.27(a)(4). NYBOT commented that proposed
Sec. 41.27(a)(4)(iv) and (v) included two categories of non-customer
accounts, a house account for a floor broker's clearing member, and an
account for another member present on the floor of a DCM or DTF or an
account controlled by such other member, that were not considered non-
customer accounts under regulation 155.5.\8\ Specifically, NYBOT
believes that regulation 155.5 permitted a floor broker to trade
security futures products for a customer and for the house account of a
floor broker's clearing member or for another member present on the
floor during the same trading session.\9\
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    \8\ Similarly, CBOT commented that the inclusion of an account
for another member present on the floor of a DCM or DTF or an
account controlled by such other member as a non-customer account
differs from the treatment of such accounts under Regulation 155.5.
    \9\ NYBOT would like the Commission to remove an account for a
floor broker's clearing member, or an account for another member
present on the floor of a DCM or DTF or an account controlled by
such other member, from the list of non-customer accounts. CBOT
would include the house account for a floor broker's clearing member
as a non-customer account, but would like the Commission to create
an exception to the dual trading restriction for the accounts of all
other clearing members, members present on the floor, and members
not present on the floor.
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    After carefully reviewing regulation 155.5, the Commission believes
that although it intended that a house account for a floor broker's
clearing member and an account for another member present on the floor
or an account controlled by such other member be considered non-
customer accounts, the language in regulation 155.5 was ambiguous.
Accordingly, regulation 41.27 clearly expresses the Commission's intent
that floor brokers be prohibited from trading the same security futures
product for a customer and for a house account for a floor broker's
clearing member or for an account for another member present on the
floor or an account controlled by such member during the same trading
session. In this regard, the Commission believes that to allow
otherwise could disadvantage customers because a floor broker may be
motivated to obtain a better fill for its clearing member or for
another member present on the floor. Regulation 41.27, however, would
permit a floor broker to trade the same security futures product for
his or her own account and non-customer accounts enumerated under
regulation 41.27(a)(4)(i)-(v) during the same trading session.
    Additionally, the Commission requested comment as to whether
accounts for clearing members other than the house account of a floor
broker's clearing member and members not present on the floor should be
considered non-customer accounts for the purpose of regulation
41.27(a)(4). By defining these accounts as non-customer accounts, a
floor broker would be permitted to trade for these accounts and the
floor broker's personal account during the same trading session. NYBOT
and CBOT commented that accounts for clearing members other than the
house account of a floor broker's clearing member and members not
present on the floor, should not be included as non-customer accounts
in Sec. 41.27(a)(4).\10\ The Commission therefore has determined that
the accounts of clearing members other than the floor broker's clearing
member, and the accounts of members not present on the floor of a DCM
or DTEF, should be included as customer accounts for purposes of this
rule.
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    \10\ Both NYBOT and CBOT contend that if clearing members other
than the house account of a floor broker's clearing member and
members not present on the floor are included as non-customer
accounts in Sec. 41.27(a)(4), floor brokers would be limited to
trading security futures products during the same trading session
for such accounts and other non-customer accounts listed in
Sec. 41.27(a)(4)(i)-(v). In particular, CBOT believes that ``these
are not the types of brokers to whom other clearing firms or members
would be likely to direct their orders.''
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2. Dual Trading
    Section 41.27(a)(6) of the proposing release, which is renumbered
as Sec. 41.27(a)(5) in the final rule, defined ``dual trading'' as the
``execution of customer orders by a floor broker through open outcry
during the same trading session in which the floor broker executes,
directly or indirectly, either through open outcry or through a trading
system that electronically matches bids and offers, a transaction for
the same security futures product on the same designated contract
market or registered derivatives transaction execution facility for an
account'' of a non-customer.
    This definition referred to a floor broker executing ``directly or
indirectly'' a transaction for a non-customer account, but did not
explain what was meant by ``indirectly.'' Rather, in discussing the
various sections of the proposed rule, the proposing release noted that
the word ``indirectly'' was

[[Page 11225]]

intended to prevent a floor broker from executing a customer order and
during the same trading session initiating and passing an order for a
non-customer account identified by regulations 41.27(a)(4)(i)-(v) to
another broker for execution. CBOT commented that to avoid ambiguity,
the Commission should explicitly state what it means by ``indirect
execution'' in the final regulation, similar to the dual trading
definition in regulation 155.5(a)(4).\11\ The Commission agrees and has
made the appropriate change in the final regulation.
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    \11\ Regulation 155.5(a)(4) defined dual trading as ``the
execution of customer orders by a floor broker during the same
trading session in which the floor broker executes directly or
initiates and passes to another member for execution in the same
contract market. * * *'' (emphasis added).
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    Additionally, the Commission is amending the language of the dual
trading definition that describes an electronic trading system not
subject to the dual trading prohibition to make it more precise and
consistent with current practices. Specifically, the words ``a trading
system that electronically matches bids and offers'' has been amended
in Sec. 41.27(a)(5) of the regulation to read ``a trading system that
electronically matches bids and offers pursuant to a predetermined
algorithm.'' \12\
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    \12\ The ``dual trading'' definition set forth in
Sec. 41.27(a)(5) will now read:
    Dual trading means the execution of customer orders by a floor
broker through open outcry during the same trading session in which
the floor broker executes directly or by initiating and passing to
another member, either through open outcry or through a trading
system that electronically matches bids and offers pursuant to a
predetermined algorithm, a transaction for the same security futures
product on the same designated contract market or registered
derivatives transaction execution facility for an account described
in paragraphs (a)(4)(i)-(v) of this section.
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3. Other Definitions
    The proposing release also defined the terms ``trading session,''
``member,'' ``broker association,'' and ``security futures product.''
\13\ The term ``security futures product'' will be deleted from
Sec. 41.27(a) in the final regulation because of a final Commission
rulemaking subsequent to the proposing release that defined the
term.\14\ No comments were received regarding Sec. 41.27(a)(1)-(3) of
the proposing release and the Commission has determined to adopt those
sections as proposed.
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    \13\ See sections 41.27(a)(1), (2), (3), and (5) of the
proposing release, respectively.
    \14\ Regulation 41.1(i) provides that ``(s)ecurity futures
product shall have the meaning set forth in section 1a(32) of the
Act.'' 66 FR 44960, 44965 (August 27, 2001).
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B. Application of the Dual Trading Prohibition to Electronic Trading
Systems

    In the proposing release, the Commission stated that under the
plain language of section 4j of the Act, as amended, the dual trading
restriction would not apply to a DCM or DTF that trades security
futures products solely through an electronic trading system. This
interpretation takes into account the plain language of the statute,
which refers to ``floor brokers'' who ``execute'' orders.\15\ In
addition, this interpretation recognizes that a floor broker who
executes a customer order through open outcry has more control over
that order than a customer order entered into an electronic trading
system that matches bids and offers pursuant to a predetermined
algorithm where members do not have a time and place advantage. In the
latter instance, the floor broker does not have the ability to
influence or guide the order once it enters the system because the
order is matched pursuant to a predetermined algorithm.
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    \15\ Section 4j(b) defines dual trading as the ``execution of
customer orders by a floor broker during the same trading session in
which the floor broker executes any trade in the same contract [on a
designated contract market] or registered derivatives transaction
execution facility.''
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    The Commission also acknowledged in the proposing release that a
DCM or DTF may permit the simultaneous trading of security futures
products through open outcry on a trading floor and on an electronic
trading system for the same product, also known as ``side-by-side
trading.'' The Commission would permit a floor broker, during the same
trading session, to enter a bid or offer for a security futures product
for a customer account on an electronic trading system and to trade the
same product for non-customer accounts listed in Secs. 41.27(a)(4)(i)-
(v) through open outcry. However, recognizing the extent of control
that a floor broker exercises with respect to an open outcry customer
order, the Commission noted that a floor broker would be prohibited
during the same trading session from executing a customer order for a
particular security futures product through open outcry and entering a
bid or offer on an electronic trading system for the same product for
non-customer accounts.
    NYBOT and AMEX contend that the Act does not limit the dual trading
restriction to open outcry trading and commented that a dual trading
restriction also should be applicable to the trading of security
futures products on electronic trading systems. CBOT disagrees with
NYBOT and AMEX, and commented that it believes the Commission correctly
determined that under the Act a dual trading restriction is not
applicable to a DCM or DTF that trades security futures products solely
through an electronic trading system, because there is no floor broker
involved in the trade.\16\ CBOT, however, disagrees with the
Commission's application of the dual trading restriction with respect
to side-by-side trading. Specifically, CBOT does not believe that a
dual trading restriction should be applicable to side-by-side trading,
regardless of whether the customer order is executed though open outcry
or entered on an electronic trading system.
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    \16\ As stated earlier, the Commission noted in the proposing
release that the dual trading definition found in section 4j(b) of
the Act refers to ``floor brokers'' who ``execute'' customer orders.
Floor brokers execute customer orders on the trading floor, whereas
various registrants as well as unregistered individuals enter orders
into electronic trading systems that then match orders pursuant to a
predetermined algorithm where members do not have a time and place
advantage and relinquish the ability to influence or guide the order
once it enters the system. In this connection, the definition of
``floor broker'' found in section 1a(16) of the Act contemplates a
person ``in or surrounding * * * any pit, ring, or post * * * '' on
the floor of an exchange and not through a system that
electronically matches bids and offers.
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    The Commission is not persuaded by the comments that its
interpretation and application of the dual trading restriction is
inconsistent with the Act. In this connection, NYBOT commented that
``the definition of ``floor broker'' must be read in the light of the
evolution of the markets to electronic trading, and the dual trading
restrictions applied to all orders that are intermediated, regardless
of the ultimate mode of execution.'' In adopting the CFMA, however,
Congress did not substantively amend the definition of ``floor
broker,'' nor does the Act, as amended, include language demonstrating
that Congress intended to apply a dual trading restriction to security
futures products traded on an electronic trading system.
    Nonetheless, the Commission has separately determined, given the
possibility of further developments in electronic markets and
electronic trading systems, to adopt Sec. 41.27(b)(2).\17\ Section
41.27(b)(2) would require a DCM or DTF that operates an electronic
market or electronic trading system that

[[Page 11226]]

provides market participants with a time or place advantage, or the
ability to override a predetermined algorithm, to submit an appropriate
rule proposal to the Commission pursuant to the procedures enumerated
in regulation 40.5. Specifically, the proposed rule must prohibit
electronic market participants with a time or place advantage or with
the ability to override a predetermined algorithm from trading a
security futures product for accounts in which these same participants
have any interest during the same trading session that they also trade
the same security futures product for other accounts.\18\ The
Commission notes, however, that Sec. 41.27(b)(2) would not apply to
execution priorities or quantity guarantees granted to market makers
who perform that function, or to market participants who receive
execution priorities based on price improvement activity, in accordance
with rules governing the DCM or DTF.
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    \17\ Section 41.27(b) of the proposing release is renumbered as
Sec. 41.27(b)(1) in the final rule. In addition, a reference to
Sec. 41.27(e) has been added to this paragraph. Section 41.27(b)(1)
will now read:
    No floor broker shall engage in dual trading in a security
futures product on a designated contract market or registered
derivatives transaction execution facility, except as otherwise
provided under paragraphs (d), (e), and (f) of this section.
    \18\ An example of a time advantage would be providing certain
market participants with faster access to an electronic trading
system. An example of a place advantage would be granting certain
market participants with better access to the market or market
information. To date, however, no entity with electronic trading
system characteristics identified in section 41.27(b)(2) has sought
designation as a contract market or registration as a derivatives
transaction execution facility.
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C. Rules Implementing the Dual Trading Prohibition

    As the Commission indicated in the proposing release, prior to
listing a security futures product for trading on a trading floor where
bids and offers are executed through open outcry, a DCM or DTF must
adopt a rule prohibiting dual trading. Under regulation 41.27(c)(1), a
DCM must submit such a rule to the Commission in accordance with
regulation 40.6, along with a written certification that the rule
complies with the Act and the regulations promulgated there-under, or
must obtain Commission approval of such a rule pursuant to regulation
40.5. Under regulation 41.27(c)(2), a DTF must notify the Commission in
accordance with regulation 37.7(b) that it has adopted a rule
prohibiting dual trading or obtain Commission approval of such a rule
pursuant to regulation 37.7(c). No comments were received regarding
Sec. 41.27(c). Accordingly, the Commission is adopting Sec. 41.27(c) as
proposed.

D. Specific Permitted Exceptions to the Dual Trading Prohibition and
Unique or Special Characteristics of an Agreement, Contract, or
Transaction, or of the DCM or DTF

    Proposed regulation 41.27(d) would implement the directive of
sections 4j(a)(2)(A) and (B) of the Act to permit certain exceptions to
the dual trading restriction. Regulation 41.27(d)(1)-(4) provides
exceptions to the dual trading restriction to permit the correction of
errors resulting from the execution of a customer order, to permit a
customer to designate in writing a floor broker to dual trade while
executing orders for the customer's account, to permit a broker who
unsuccessfully attempts to leg into a spread transaction to take the
executed leg into his or her personal account and to offset such
position, and to address market conditions that result in a temporary
emergency. As the Commission indicated in the proposing release, a DCM
or DTF, prior to permitting such exceptions to a dual trading
prohibition, would have to adopt a rule permitting the specific
exceptions and submit the rule to the Commission or obtain Commission
approval pursuant to the rule submission procedures of regulations
41.27(e)(1) or (2).\19\
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    \19\ These procedures are identical to the procedures under
regulation 41.27(c)(1) and (2) for a DCM or DTF to submit a rule
prohibiting dual trading.
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    One comment was received regarding Sec. 41.27(d). CBOT encouraged
the Commission to add a low volume exception to regulation 41.27. The
CBOT believes that adding a low volume exception may assist fledgling
security futures products to become established before a trading
prohibition would become applicable, and would improve liquidity. CBOT
noted that section 11(c) of the '34 Act permits the SEC, upon
application of an exchange, to grant a low volume exemption from
section 11(a).
    At this time, the Commission does not have data on the trading
volume of security futures products upon which to base a threshold
amount to create a low volume exception. However, similar to section
11(c) of the '34 Act with respect to the SEC, section 4j(a)(2)(C) of
the Act affords the Commission broad authority to permit exceptions to
``further the public interest consistent with the promotion of market
efficiency, innovation, and expansion of investment opportunities.''
Specifically, Sec. 41.27(f) would allow DCMs and DTFs to permit,
pursuant to a rule, an exception to the dual trading prohibition to
address an agreement, contract, or transaction that presents a unique
or special characteristic, or to address a unique or special
characteristic of the specific DCM or DTF. Accordingly, an exchange
seeking a low volume exception to the dual trading restriction could
seek to implement such an exception by making a submission pursuant to
the procedures set forth in Sec. 41.27(f).
    The Commission did not receive any other comments regarding
Sec. 41.27(d) or (f) and is adopting those sections as proposed.

III. Amendments to Regulations 37.2, 38.2 and 41.34

    In order to facilitate the promulgation of proposed regulation
41.27, the Commission also is promulgating procedural amendments to
regulations 37.2 and 38.2. Regulations 37.2 and 38.2 generally exempt
DCMs and DTFs from certain Commission regulations and list those
regulations that are applicable under the Act. Regulation 41.27 is
hereby added to the list of regulations that remain applicable to DCMs
and DTFs pursuant to regulations 37.2 and 38.2.\20\
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    \20\ Amended Sec. 37.2 would provide:
    Contracts, agreements, or transactions traded on a derivatives
transaction execution facility registered as such with the
Commission under section 5a of the Act, the facility and the
facility's operator are exempt from all Commission regulations for
such activity, except for the requirements of this part 37 and
Secs. 1.3, 1.31, 1.59(d), 1.63(c), 15.05, 33.10, 41.27, part 40, and
part 190 of this chapter, and as applicable to the market, parts 15
through 21 of this chapter, which are applicable to a registered
derivatives transaction execution facility as though they were set
forth in this section and included specific reference to derivatives
transaction execution facilities. (emphasis added).
    Amended Sec. 38.2 would provide:
    Agreements, contracts, or transactions traded on a designated
contract market under section 6 of the Act, the contract market and
the contract market's operator are exempt from all Commission
regulations for such activity, except for the requirements of this
part 38 and Secs. 1.3, 1.12(e), 1.31, 1.38, 1.52, 1.59(d), 1.63(c),
1.67, 33.10, 41.27, parts 15 through 21, part 40, and part 190 of
this chapter. (emphasis added).
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    Additionally, the Commission is amending regulation 41.34(b) to
exempt notice designated contract markets in security futures products
(``SFPCMs'') from regulation 41.27.\21\ As discussed

[[Page 11227]]

earlier, section 5f(b)(1)(B) of the Act specifically exempts boards of
trade that register with the SEC as a national securities exchange, a
national securities association, or as an alternative trading system
from section 4j of the Act, upon filing notice with the Commission.\22\
Regulation 41.34(b) generally exempts SFPCMs from certain Commission
regulations. Therefore, because regulation 41.27 is being promulgated
pursuant to section 4j of the Act, the Commission is adding regulation
41.27 to the list of 41.34(b) exemptions.
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    \21\ Amended Sec. 41.34 provides:
    Any board of trade notice-designated as a contract market in
security futures products pursuant to Sec. 41.31 of this chapter
also shall be exempt from:
    (a) The following provisions of the Act, pursuant to section
5f(b)(1) of the Act:
    (1) Section 4(c)(c);
    (2) Section 4(c)(e);
    (3) Section 4(c)(g);
    (4) Section 4j;
    (5) Section 5;
    (6) Section 5c;
    (7) Section 6a;
    (8) Section 8(d);
    (9) Section 9(f);
    (10) Section 16 and;
    (b) The following provisions, pursuant to section 5f(b)(4) of
the Act:
    (1) Section 6(a);
    (2) Part 38 of this chapter;
    (3) Part 40 of this chapter; and
    (4) Section 41.27 of this chapter. (emphasis added).
    \22\ See section I. of the preamble for a more detailed
discussion.
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IV. Cost-Benefit Analysis

    Section 15(a) of the Act, as amended by the CFMA, requires the
Commission to consider the costs and benefits of its action before
issuing a new regulation under the Act. Section 15(a) does not require
the Commission to quantify the costs and benefits of a new regulation
or to determine whether the benefits of the proposed regulation
outweigh its costs. Rather, section 15(a) simply requires the
Commission to consider the costs and benefits of its action in light of
five broad areas of market and public concern: Protection of market
participants and the public; efficiency, competitiveness, and financial
integrity of futures markets; price discovery; sound risk management
practices; and other public interest considerations.
    The Commission's proposing release contained an analysis of the
consideration of the costs and benefits and solicited public comment
thereon.\23\ The Commission specifically invited commenters to submit
any data that they had quantifying the costs and benefits of the
proposed rules with their comment letters.\24\ The Commission did not
receive any comments on this issue.
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    \23\ 66 FR at 36221.
    \24\ Id.
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    Compliance with regulation 41.27 would impose costs on DCMs and
DTFs with respect to enacting and enforcing rules restricting dual
trading of security futures products traded through open outcry on a
trading floor. The costs of enacting and enforcing rules associated
with regulation 41.27 are either balanced or outweighed by the
increased protection of market participants and the public. The
Commission's exercise of its discretion in implementing the
Congressional directive to restrict dual trading, as set forth in
section 4j of the Act, would not unreasonably increase costs related to
efficiency, competitiveness, and financial integrity of financial
markets; price discovery; or sound risk management practices. After
considering these factors, the Commission has determined to adopt
regulation 41.27.

V. Related Matters

A. Regulatory Flexibility Act

    The Regulatory Flexibility Act (``RFA''), 5 U.S.C. 601 et seq.,
requires federal agencies, in promulgating regulations, to consider the
impact of those regulations on small entities. The regulation adopted
herein would affect DCMs, DTFs, and floor brokers. The Commission
previously has established certain definitions of ``small entities'' to
be used by the Commission in evaluating the impact of its regulations
on small entities in accordance with the RFA.\25\ In its previous
determinations, the Commission has concluded that contract markets are
not small entities for the purpose of the RFA.\26\ The Commission has
recently determined that DTFs, for reasons similar to those applicable
to contract markets, are not small entities for purposes of the
RFA.\27\
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    \25\ See 47 FR 18618-21 (Apr. 30, 1982).
    \26\ See 47 FR 18618 at 18619 (discussing contract markets).
    \27\ See A New Regulatory Framework for Trading Facilities,
Intermediaries and Clearing Organizations 66 FR 42256, 42268 (August
10, 2001).
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    As the Commission stated in its proposing release, certain floor
brokers would be affected by proposed regulation 41.27. The Commission,
however, believes that regulation 41.27 as adopted will not have a
significant economic impact on a substantial number of small entities.
The Commission requested comment on this issue, but received no
comments. Therefore, the Chairman, on behalf of the Commission, hereby
certifies, pursuant to 5 U.S.C. 605(b), that the rule amendments will
not have a significant impact on a substantial number of small
entities.

B. Paperwork Reduction Act of 1995

    This rule contains information collection requirements. As required
by the Paperwork Reduction Act of 1995, (44 U.S.C. 3507(d)) the
Commission has submitted a copy of this rule to the Office of
Management and Budget for its review. No comments were received in
response to the Commission's invitation in the proposing release to
comment on any potential paperwork burden associated with this
regulation.

List of Subjects in 17 CFR Parts 37, 38, 41, and 155

    Commodity futures, Contract markets, Reporting and recordkeeping
requirements, Security futures products.

PART 37--DERIVATIVES TRANSACTION EXECUTION FACILITIES

    1. The authority citation for Part 37 continues to read as follows:

    Authority: 7 U.S.C. 2, 5, 6, 6c, 7a and 12a.


    2. Section 37.2 is revised to read as follows:


Sec. 37.2  Exemption.

    Contracts, agreements, or transactions traded on a derivatives
transaction execution facility registered as such with the Commission
under section 5a of the Act, the facility and the facility's operator
are exempt from all Commission regulations for such activity, except
for the requirements of this part 37 and Secs. 1.3, 1.31, 1.59(d),
1.63(c), 15.05, 33.10, 41.27, part 40, and part 190 of this chapter,
and as applicable to the market, parts 15 through 21 of this chapter,
which are applicable to a registered derivatives transaction execution
facility as though they were set forth in this section and included
specific reference to derivatives transaction execution facilities.

PART 38--DESIGNATED CONTRACT MARKETS

    3. The authority citation for Part 38 continues to read as follows:

    Authority: 7 U.S.C. 2, 5, 6, 6c, 7a and 12a.


    4. Section 38.2 is revised to read as follows:


Sec. 38.2  Exemption.

    Agreements, contracts, or transactions traded on a designated
contract market under section 6 of the Act, the contract market and the
contract market's operator are exempt from all Commission regulations
for such activity, except for the requirements of this part 38 and
Secs. 1.3, 1.12(e), 1.31, 1.38, 1.52, 1.59(d), 1.63(c), 1.67, 33.10,
41.27, parts 15 through 21, part 40 and part 190 of this chapter.

PART 41--SECURITY FUTURES

    5. The authority citation for Part 41 is revised to read as
follows:

    Authority: 7 U.S.C. 1a, 2, 4, 6f, 6j, 7a-2, 7b, 12a.


    6. Section 41.27 is added as follows:

[[Page 11228]]

Sec. 41.27  Prohibition of Dual Trading In Security Futures Products By
Floor Brokers.

    (a) Definitions. For purposes of this section:
    (1) Trading session means hours during which a designated contract
market or registered derivatives transaction execution facility is
scheduled to trade continuously during a trading day, as set forth in
its rules, including any related post settlement trading session. A
designated contract market or registered derivatives transaction
execution facility may have more than one trading session during a
trading day.
    (2) Member shall have the meaning set forth in section 1a(24) of
the Act.
    (3) Broker association includes two or more designated contract
market or registered derivatives transaction execution facility members
with floor trading privileges of whom at least one is acting as a floor
broker who:
    (i) Engage in floor brokerage activity on behalf of the same
employer;
    (ii) Have an employer and employee relationship which relates to
floor brokerage activity;
    (iii) Share profits and losses associated with their brokerage or
trading activity; or
    (iv) Regularly share a deck of orders.
    (4) Customer means an account owner for which a trade is executed
other than:
    (i) An account in which such floor broker has any interest;
    (ii) An account for which a floor broker has discretion;
    (iii) An account controlled by a person with whom a floor broker
has a relationship through membership in a broker association;
    (iv) A house account of the floor broker's clearing member; or
    (v) An account for another member present on the floor of a
designated contract market or registered derivatives transaction
execution facility or an account controlled by such other member.
    (5) Dual trading means the execution of customer orders by a floor
broker through open outcry during the same trading session in which the
floor broker executes directly or by initiating and passing to another
member, either through open outcry or through a trading system that
electronically matches bids and offers pursuant to a predetermined
algorithm, a transaction for the same security futures product on the
same designated contract market or registered derivatives transaction
execution facility for an account described in paragraphs (a)(4)(i)-(v)
of this section.
    (b) Dual Trading Prohibition. (1) No floor broker shall engage in
dual trading in a security futures product on a designated contract
market or registered derivatives transaction execution facility, except
as otherwise provided under paragraphs (d), (e), and (f) of this
section.
    (2) A designated contract market or a registered derivatives
transaction execution facility operating an electronic market or
electronic trading system that provides market participants with a time
or place advantage or the ability to override a predetermined algorithm
must submit an appropriate rule proposal to the Commission consistent
with the procedures set forth in Sec. 40.5. The proposed rule must
prohibit electronic market participants with a time or place advantage
or the ability to override a predetermined algorithm from trading a
security futures product for accounts in which these same participants
have any interest during the same trading session that they also trade
the same security futures product for other accounts. This paragraph,
however, is not applicable with respect to execution priorities or
quantity guarantees granted to market makers who perform that function,
or to market participants who receive execution priorities based on
price improvement activity, in accordance with the rules governing the
designated contract market or registered derivatives transaction
execution facility.
    (c) Rules Prohibiting Dual Trading. (1) Designated contract
markets. Prior to listing a security futures product for trading on a
trading floor where bids and offers are executed through open outcry, a
designated contract market:
    (i) Must submit to the Commission in accordance with Sec. 40.6, a
rule prohibiting dual trading, together with a written certification
that the rule complies with the Act and the regulations thereunder,
including this section; or
    (ii) Must obtain Commission approval of such rule pursuant to
Sec. 40.5.
    (2) Registered derivatives transaction execution facilities. Prior
to listing a security futures product for trading on a trading floor
where bids and offers are executed through open outcry, a registered
derivatives transaction execution facility:
    (i) Must notify the Commission in accordance with Sec. 37.7(b) that
it has adopted a rule prohibiting dual trading; or
    (ii) Must obtain Commission approval of such rule pursuant to
Sec. 37.7(c).
    (d) Specific Permitted Exceptions. Notwithstanding the
applicability of a dual trading prohibition under paragraph (b) of this
section, dual trading may be permitted on a designated contract market
or a registered derivatives transaction execution facility pursuant to
one or more of the following specific exceptions:
    (1) Correction of errors. To offset trading errors resulting from
the execution of customer orders, provided, that the floor broker must
liquidate the position in his or her personal error account resulting
from that error through open outcry or through a trading system that
electronically matches bids and offers as soon as practicable, but,
except as provided herein, not later than the close of business on the
business day following the discovery of error. In the event that a
floor broker is unable to offset the error trade because the daily
price fluctuation limit is reached, a trading halt is imposed by the
designated contract market or registered derivatives transaction
execution facility, or an emergency is declared pursuant to the rules
of the designated contract market or registered derivatives transaction
execution facility, the floor broker must liquidate the position in his
or her personal error account resulting from that error as soon as
practicable thereafter.
    (2) Customer consent. To permit a customer to designate in writing
not less than once annually a specifically identified floor broker to
dual trade while executing orders for such customer's account. An
account controller acting pursuant to a power of attorney may designate
a dual trading broker on behalf of its customer, provided, that the
customer explicitly grants in writing to the individual account
controller the authority to select a dual trading broker.
    (3) Spread transactions. To permit a broker who unsuccessfully
attempts to leg into a spread transaction for a customer to take the
executed leg into his or her personal account and to offset such
position, provided, that a record is prepared and maintained to
demonstrate that the customer order was for a spread.
    (4) Market emergencies. To address emergency market conditions
resulting in a temporary emergency action as determined by a designated
contract market or registered derivatives transaction execution
facility.
    (e) Rules Permitting Specific Exceptions. (1) Designated contract
markets. Prior to permitting dual trading under any of the exceptions
provided in paragraphs (d)(1)-(4) of this section, a designated
contract market:
    (i) Must submit to the Commission in accordance with Sec. 40.6, a
rule permitting the exception(s), together

[[Page 11229]]

with a written certification that the rule complies with the Act and
the regulations thereunder, including this section; or
    (ii) Must obtain Commission approval of such rule pursuant to
Sec. 40.5.
    (2) Registered derivatives transaction execution facilities. Prior
to permitting dual trading under any of the exceptions provided in
paragraphs (d)(1)-(4) of this section, a registered derivatives
transaction execution facility:
    (i) Must notify the Commission in accordance with Sec. 37.7(b) that
it has adopted a rule permitting the exception(s); or
    (ii) Must obtain Commission approval of such rule pursuant to
Sec. 37.7(c).
    (f) Unique or Special Characteristics of Agreements, Contracts, or
Transactions, or of Designated Contract Markets or Registered
Derivatives Transaction Execution Facilities.
    Notwithstanding the applicability of a dual trading prohibition
under paragraph (b) of this section, dual trading may be permitted on a
designated contract market or registered derivatives transaction
execution facility to address unique or special characteristics of
agreements, contracts, or transactions, or of the designated contract
market or registered derivatives transaction execution facility as
provided herein. Any rule of a designated contract market or registered
derivatives transaction execution facility that would permit dual
trading when it would otherwise be prohibited, based on a unique or
special characteristic of agreements, contracts, or transactions, or of
the designated contract market or registered derivatives transaction
execution facility must be submitted to the Commission for prior
approval under the procedures set forth in Sec. 40.5. The rule
submission must include a detailed demonstration of why an exception is
warranted.

    7. Section 41.34 is revised to read as follows:


Sec. 41.34  Exempt Provisions.

    Any board of trade notice-designated as a contract market in
security futures products pursuant to Sec. 41.31 also shall be exempt
from:
    (a) The following provisions of the Act, pursuant to section
5f(b)(1) of the Act:
    (1) Section 4(c)(c);
    (2) Section 4(c)(e);
    (3) Section 4(c)(g);
    (4) Section 4j;
    (5) Section 5;
    (6) Section 5c;
    (7) Section 6a;
    (8) Section 8(d);
    (9) Section 9(f);
    (10) Section 16 and;
    (b) The following provisions, pursuant to section 5f(b)(4) of the
Act:
    (1) Section 6(a);
    (2) Part 38 of this chapter;
    (3) Part 40 of this chapter; and
    (4) Section 41.27.

PART 155--TRADING STANDARDS

    8. The authority citation for Part 155 continues to read as
follows:

    Authority: 7 U.S.C. 6b, 6c, 6g, 6j and 12a, unless otherwise
noted.


Sec. 155.5  [Removed and Reserved]

    9. Section 155.5 is removed and reserved.

    Issued in Washington, DC on March 1, 2002 by the Commission.
Catherine D. Dixon,
Assistant Secretary of the Commission.
[FR Doc. 02-5778 Filed 3-12-02; 8:45 am]
BILLING CODE 6351-01-P