[Federal Register: March 21, 1997 (Volume 62, Number 55)]
[Proposed Rules]
[Page 13564-13567]
From the Federal Register Online via GPO Access [wais.access.gpo.gov]



17 CFR Part 1

Securities Representing Investment of Customer Funds Held in
Segregated Accounts by Futures Commission Merchants

AGENCY: Commodity Futures Trading Commission.

ACTION: Proposed rules.


SUMMARY: The Commodity Futures Trading Commission (``Commission'') is
proposing to amend Rules 1.23, 1.25, and 1.27 to permit futures
commission merchants (``FCMs'') to increase or decrease the amount of
funds segregated for the benefit of commodity customers by making
direct transfers of permitted securities into and out of segregated
safekeeping accounts. The types of securities in which customer funds
can be invested and which will now be directly transferable are set
forth in Rule 1.25. Currently, FCMs can only make direct transfers of
cash to augment the customer segregated account.
    Furthermore, in order to provide additional assurance that there
will be a clear audit trail for such permitted transfers of securities,
Rule 1.27 is proposed to be amended to require that the description of
the investment securities, required by the rule, include the security
identification number developed by the Committee on Uniform Security
Identification Procedures (``CUSIP Number'').

DATES: Comments must be received on or before April 21, 1997.

ADDRESSES: Comments on the proposed rules should be sent to Jean A.
Webb, Secretary, Commodity Futures Trading Commission, Three Lafayette
Center, 1155 21st Street, N.W., Washington, D.C. 20581. Comments may be
sent by facsimile transmission to (202) 418-5528, or by electronic mail
to secretary@cftc.gov. Reference should be made to ``Securities
Representing Investment of Customer Funds.''

FOR FURTHER INFORMATION CONTACT: Paul H. Bjarnason, Chief Accountant,
or Lawrence B. Patent, Associate Chief Counsel, Division of Trading and
Markets (``Division''), Commodity Futures Trading Commission, Three
Lafayette Center, 1155 21st Street, N.W., Washington, D.C. 20581.
Telephone (202) 418-5430.

SUPPLEMENTARY INFORMATION: The Commission is proposing technical
amendments to Rules 1.23, 1.25, and 1.27.<SUP>1 These changes will
permit FCMs to transfer unencumbered securities directly from the
proprietary domain into a segregated safekeeping account at a bank or
trust company, if they are the types of securities that are permitted
investments of customer funds <SUP>2 under Rule 1.25, in order to
increase the amount of funds segregated for the benefit of commodity
customers. It will also permit an FCM to transfer such securities
directly from such a segregated safekeeping account to the proprietary
domain, to the extent the FCM has excess funds in segregation.

    \1\ Rules referred to herein can be found at 17 C.F.R. Ch. I
    \2\ The term ``customer funds'' is defined in Rule 1.3(gg).

I. Investment of Customers' Segregated Funds

A. Background

    Section 4d(2) of the Commodity Exchange Act and Rule 1.25 restrict
the types of securities in which customer funds can be invested by FCMs
to obligations of the United States, general obligations of any State
or any political subdivision thereof, and obligations fully guaranteed
as to principal and interest by the United States (``Qualified
Investments''). Rule 1.25 also requires all such investments to be
purchased from, and the proceeds of any sale to be deposited into, an
account or accounts used for the deposit of customer funds. Rule 1.23
currently allows an FCM to add to the funds segregated for customers
through transfers of cash into a segregated account and to reduce its
residual interest by cash withdrawals payable directly to the

    \3\ If adopted, the proposed changes will also require the
Division to revise Financial and Segregation Interpretation No. 7,
which includes the following statement:
    Under Regulations 1.23 and 1.25 such obligations must be: (1)
purchased with money deposited in an account used for the deposit of
customers' funds; (2) made through such an account; and (3) the
proceeds from any sale of such obligations must be redeposited in
such an account. Thus, all additions to and withdrawals from
customer segregated funds which represent topping up by the FCM to
cover actual or expected customer deficits must be in the form of
    1 Comm. Fut. L. Rep. (CCH) para. 7117, at 7124 (July 23, 1980).

    Current Commission rules and Division interpretations do not permit
FCMs to increase their interest in segregated funds by directly
transferring into a segregated account Qualified Investments which they
may own.

[[Page 13565]]

Current rules also prohibit FCMs from withdrawing Qualified Investments
from a segregated account and depositing them in their own account in
order to reduce their financial interest in segregated funds.
Consequently, all such additions to and withdrawals from segregated
accounts must currently be in the form of cash.
    FCMs and the Joint Audit Committee (``JAC'') <SUP>4 have claimed
that the current rules place an undue burden on FCMs. For example, in
the event an FCM desires to correct an expected or existing
undersegregated condition, in order to comply with the Commission's
existing segregation rules, if the FCM does not have cash readily
available to transfer into the segregated account, it would have to
sell its own Qualified Investments and, then, transfer the cash to the
segregated account. The cash could then be re-invested in Qualified
Securities. Conversely, when an FCM wishes to decrease its financial
interest in segregated funds, this entire process must be reversed.

    \4\ The JAC is comprised of representatives from each commodity
exchange and National Futures Association who coordinate the
industry's audit and ongoing surveillance activities to promote a
uniform framework of self-regulation.

    This additional step not only causes a delay in the transfer, but
additional transaction costs associated with buying and selling the
proprietary securities are incurred. These costs can be substantial,
not only as a result of the commissions or other fees incurred, but
also due to possibly unfavorable market conditions when buying and
selling like securities.
    The Commission believes the industry's proposal, as first suggested
to the Commission's staff during a JAC meeting, to allow direct
transfers of Qualified Securities into and out of the segregated
account, has merit. Customer protection would be directly enhanced by
reducing the amount of time required to effect a transfer of funds into
segregation and, with appropriate safeguards, should not diminish
existing segregation protections.
    The Commission has reviewed these proposed changes in light of the
Bankruptcy Reform Act of 1978 (``BRAct''), which appears to have
resolved any questions with respect to the status of customers'
segregated funds in the event of an FCM bankruptcy.<SUP>5 In the
Commission's view, the definition of customer property contained in
Section 761(10) <SUP>6 of the BRAct, together with the special priority
of distribution accorded to such property under Section 766(h) of the
BRAct, requires that, like cash, any securities held in a segregated
safekeeping account will not be used to satisfy the claim of a
noncustomer creditor of the FCM until all customer net equity claims
have been satisfied.

    \5\ See 11 U.S.C. 761-766.
    \6\ Section 761(10) defines ``customer property'' as follows:
    (10) Customer property' means cash, a security, or other
property, or proceeds of such cash, security, or property, at any
time received, acquired, or held by or for the account of the
debtor, from or for the account of a customer--
    (A) including--
    (i) property received, acquired, or held to margin, guarantee,
secure, purchase, or sell a commodity contract;
    (ii) profits or contractual or other rights accruing to a
customer as a result of a commodity contract;
    (iii) an open commodity contract;
    (iv) specifically identifiable customer property;
    (v) warehouse receipt or other document held by the debtor
evidencing ownership of or title to property to be delivered to
fulfill a commodity contract from or for the account of a customer;
    (vi) cash, a security, or other property received by the debtor
as payment for a commodity to be delivered to fulfill a commodity
contract from or for the account of a customer;
    (vii) a security held as property of the debtor to the extent
such security is necessary to meet a net equity claim based on a
security of the same class and series of an issuer;
    (viii) property that was unlawfully converted and that is
property of the state; and
    (ix) other property of the debtor that any applicable law, rule,
or regulation requires to be set aside or held for the benefit of a
customer, unless including such property as customer property would
not significantly increase customer property; but
    (B) not including property to the extent that a customer does
not have a claim against the debtor based on such property[.]

B. Proposed Amendments

    The Commission is proposing that Rules 1.23 and 1.25 be amended to
allow an FCM to deposit firm-owned unencumbered Qualified Investments
directly into segregated accounts held at qualifying banks or trust
companies and to withdraw, to the extent of the FCM's residual
financial interest in segregated funds, any Qualified Investments from
such segregated accounts.
    The Commission is proposing to permit an FCM to deposit Qualified
Investments owned by the FCM which are otherwise unencumbered into
customers' segregated accounts to overcome an undersegregated condition
or to increase its financial interest in segregated funds. Any
securities transferred into segregation must be owned directly by the
FCM itself, i.e., the FCM is not permitted to transfer in securities
owned by any other persons, including noncustomers.<SUP>7 Under this
proposal an FCM will also be permitted to withdraw Qualified
Investments from segregated accounts and deposit them into its own
accounts to decrease its residual financial interest in segregated

    \7\ Noncustomers are persons within the definition of a
proprietary person in Commission Rule 1.3(y) other than the FCM
itself or a general partner of the FCM. Examples of noncustomers are
associated persons, officers, directors, owners, contributors of 10
percent or more of the FCM's capital or controllers of 10 percent or
more of the FCM's shares, and affiliated companies. See Commission
Rule 1.17(b)(2)-(4).

    These proposed rule changes would permit the deposit and withdrawal
of Qualified Investments into and out of segregated accounts, in
effect, under essentially the same conditions and restrictions as cash.
There is no change in the conditions applicable to the transfer of
proprietary cash into or out of segregation.
    Rule 1.25, as proposed to be amended, would no longer require that
Qualified Investments which represent an investment of customers funds
be purchased from and the sales proceeds flow through a segregated
account. The proposed amendments would permit FCMs to deposit their own
Qualified Investments into a segregated account at a permitted
custodian. The amendments would also permit FCMs to withdraw any
Qualified Investments from segregation and deposit such securities in
their own account up to the extent of their residual financial interest
in customers' segregated funds.
    For purposes of Rules 1.26, 1.27, 1.28 and 1.29, all Qualified
Investments when deposited into a customers' segregated account will be
deemed to be securities and obligations which represent investments of
customers' funds until such time as the FCM withdraws or otherwise
disposes of such investments.
    The Commission is also proposing to amend Rule 1.27, which requires
FCMs to maintain records of Qualified Investments held in segregated
accounts. The Commission is proposing that the rule explicitly require
the record to include the CUSIP number of such securities as a part of
the description of such investments. The Commission believes that the
addition of the CUSIP number will impose no significant additional
burden on FCMs, and that many entities already incorporate the CUSIP
number in their record-keeping formats. Further, the CUSIP numbers are
provided by the counterparty financial institutions at the time of
purchase or sale of a security.
    The Commission is not proposing any other changes to Rule 1.27, but
wants to remind FCMs that Rule 1.27 requires them to include in the
investments record, among other information, the name of the person
through whom such investments were made and the name of the person to
or through whom such

[[Page 13566]]

investments were disposed of. Therefore, this record should clearly
identify Qualified Investments owned by the FCM which were deposited
into segregation and any investments withdrawn from segregation and
deposited in the FCM's own account. The Commission invites comments on
whether custodians for these purposes should be limited to banks and
trust companies not affiliated with the FCM.

II. Related Matters

A. Regulatory Flexibility Act

    The Regulatory Flexibility Act (``RFA''), 5 U.S.C. 601-611 (1988),
requires that agencies, in proposing rules, consider the impact of
those rules on small businesses. The rule amendments discussed herein
would affect registered FCMs. The Commission has previously established
certain definitions of ``small entities'' to be used by the Commission
in evaluating the impact of its rules on such entities in accordance
with RFA.<SUP>8 The Commission previously determined that registered
FCMs are not small entities for the purpose of the RFA.<SUP>9

    \8\ 47 FR 18618-18621 (April 30, 1982).
    \9\ 47 FR 18619-18620.

    Further, the amendments proposed herein do not impose any
significant new burdens upon FCMs. The proposed amendments facilitate
the use of firm-owned obligations to enhance funds segregated for
commodity customers by allowing the direct transfer of said obligations
into and out of segregated accounts. As a result, the Commission
anticipates that adoption of the proposed amendments will reduce the
burden of compliance with segregation requirements by FCMs.
Accordingly, pursuant to Section 3(a) of the RFA (5 U.S.C. 605(b)), the
Chairperson, on behalf of the Commission, certifies that these proposed
amendments would not have a significant economic impact on a
substantial number of small entities. The Commission nonetheless
invites comment from any registered FCM which believes that these rules
would have significant impact on its operations.

B. Paperwork Reduction Act

    The Paperwork Reduction Act of 1980 (Act), 44 U.S.C. 3501 et seq.,
imposes certain requirements on federal agencies (including the
Commission), in connection with their conducting or sponsoring any
collection of information as defined by the Paperwork Reduction Act.
The Commission believes these proposed amendments impose no burden.
While these proposed rule amendments have no burden, the group of rules
(3038-0024) of which the rules proposed to be amended are a part, has
the following burden:
    Average burden hours per response: 18.00.
    Number of Respondents: 1,662.00.
    Frequency of response: 19.00.
    Copies of the OMB approved information collection package
associated with these rules may be obtained from the Desk Officer,
CFTC, Office of Management and Budget, Room 10202, NEOB, Washington, DC
20503, (202) 395-7340.

List of Subjects in 17 CFR Part 1

    Brokers, Commodity futures, Consumer protection, Reporting and
recordkeeping requirements, Segregation requirements.

    In consideration of the foregoing and pursuant to the authority
contained in the Commodity Exchange Act and, in particular, Sections
4d, 4g and 8a(5) thereof, 7 U.S.C. 6d, 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 1.23 is revised to read as follows:

Sec. 1.23  Interest of futures commission merchant in segregated funds;
additions and withdrawals.

    The provision in Section 4d(2) of the Act and the provision in
Sec. 1.20(c) which prohibit the commingling of customer funds with the
funds of a futures commission merchant shall not be construed to
prevent a futures commission merchant from having a residual financial
interest in the customer funds segregated as required by the Act and
the regulations in this part and set apart for the benefit of commodity
or option customers, nor shall such provisions be construed to prevent
a futures commission merchant from adding to such segregated customer
funds such amount or amounts of money from its own funds or
unencumbered securities from its own inventory of the type set forth in
Sec. 1.25, as it may deem necessary to ensure any and all commodity or
option customers' accounts from becoming undersegregated at any time.
The books and records of a futures commission merchant shall at all
times accurately reflect its interest in the segregated funds. A
futures commission merchant may draw upon such segregated funds to its
own order, to the extent of its actual interest therein, including the
withdrawal of securities held in segregated safekeeping accounts held
by the bank or trust company custodians. Such withdrawal shall not
result in the customer funds of one commodity and/or option customer
being used to purchase, margin or carry the trades, contracts or
commodity options, or extend the credit of any other commodity
customer, option customer or other person.
    3. Section 1.25 is revised to read as follows:

Sec. 1.25  Investment of customer funds.

    No futures commission merchant and no clearing organization shall
invest customer funds except in obligations of the United States, in
general obligations of any State or of any political subdivision
thereof, or in obligations fully guaranteed as to principal and
interest by the United States. Such investments shall be made through
an account or accounts used for the deposit of customer funds and
proceeds from any sale of such obligations shall be deposited into such
account or accounts. However, this shall not prohibit a futures
commission merchant from directly depositing unencumbered securities,
of the type specified in this section, which it owns for its own
account into a segregated account or from transferring any such
securities from a segregated account to its own account up to the
extent of its residual financial interest in customers' segregated
funds: Provided, however, that such transfers are clearly recorded in
the record of investments required to be maintained by Sec. 1.27 and
such funds are held by bank or trust company custodians. Furthermore,
for purposes of Secs. 1.25, 1.26, 1.27, 1.28 and 1.29, investments
permitted by Sec. 1.25 that are owned by the futures commission
merchant and deposited into segregation shall be considered customer
funds until such investments are withdrawn from segregation.
    4. Section 1.27 is amended by revising paragraphs (a)(4) and (b)(2)
to read as follows:

Sec. 1.27  Record of investments.

    (a) * * *
    (4) A description of the obligations in which such investments were
made, including the CUSIP numbers;
* * * * *
    (b) * * *

[[Page 13567]]

    (2) A description of such documents, including the CUSIP numbers;
* * * * *
    Issued in Washington D.C. on March 17, 1997, by the Commission.
Jean A. Webb,
Secretary of the Commission.
[FR Doc. 97-7179 Filed 3-20-97; 8:45 am]

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