e9-29730

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

[Proposed Rules]

[Page 66598-66601]

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

[DOCID:fr16de09-25]

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COMMODITY FUTURES TRADING COMMISSION

17 CFR Part 190

RIN 3038-AC90

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

Bankruptcy

AGENCY: Commodity Futures Trading Commission.

ACTION: Notice of proposed rulemaking.

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

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

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

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

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

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

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

commodity broker under appropriate circumstances, as determined by the

Commission.

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

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

the following methods:

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

Follow the instructions for submitting comments.

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

instructions for submitting comments on the Web site.

E-mail: [email protected] Include the RIN number in the

subject line of the message.

Fax: 202-418-5521.

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

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

Street, NW., Washington, DC 20581.

Hand Delivery/Courier: Same as mail above.

FOR FURTHER INFORMATION CONTACT: Robert B. Wasserman, Associate

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

5092, [email protected]; or Nancy Schnabel, Special Counsel, Division

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

[email protected]; Commodity Futures Trading Commission, Three

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

SUPPLEMENTARY INFORMATION

I. Authority of the Commission To Promulgate and Amend Regulation

190.04(d)

The Commission is empowered by Section 20 of the Commodity Exchange

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

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

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

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

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

the petition under such chapter, including the payment and allocation

of margin with respect to commodity contracts not specifically

identifiable to a particular customer pending their orderly

liquidation.'' \1\

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

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The Commission exercised such power to promulgate Regulation

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

liquidating open commodity contracts carried by a commodity broker in

bankruptcy. Similarly, the Commission will exercise such power when

amending Regulation 190.04(d).

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

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

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

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

trustee or the commodity broker) applicable to an open commodity

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

Commission, inventory or commodity contracts of the commodity broker

that cannot be immediately liquidated due to market conditions

(including price limits).\2\

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

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[[Page 66599]]

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

Course, a Commodity Broker in Bankruptcy

A. Background

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

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

intended Regulation Part 190 to achieve, which included:

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

risk from fluctuations in value of the commodity contracts and other

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

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

the estate pending liquidation.\3\

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

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

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

the capital necessary for operating its business, including for

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

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

selling new commodity contracts, whether for the commodity broker or

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

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

scope of recovery for such customers.

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

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

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

segregated account that they maintain, in order to prevent the

commodity broker from using the property belonging to other

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

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

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

that a commodity broker that is a futures commission merchant

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

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

other customers).

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However, certain purchases or sales of new commodity contracts may

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

bankruptcy. Therefore, when the Commission promulgated Regulation Part

190 in 1983, the Commission created certain exceptions to Regulation

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

Commission acknowledged that the trustee must be allowed to purchase or

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

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

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

contract. Facilitating such liquidation would limit the period in which

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

value. Permitting such transfer would tend to maximize recovery of

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

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

of the commodity broker to fulfill obligations to take or effect

delivery on open commodity contracts.

In addition to the exceptions enumerated above, the Commission

acknowledged that, if the trustee cannot immediately liquidate the

inventory or open commodity contracts of a commodity broker in

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

the trustee should be allowed to purchase or sell new commodity

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

commodity contracts. The Commission intended to permit such cover or

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

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

would diminish the recovery of the customers of the commodity

broker.\5\

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

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

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

shall be interpreted to permit the trustee to purchase new commodity

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

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

discretion and with the approval of the Commission, cover uncovered

inventory or commodity contracts of the debtor which cannot be

liquidated immediately because of limit moves or other market

conditions.

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

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

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

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

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

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

reiterated in the Adopting Release that the primary purpose of

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

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

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

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

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B. The Proposed Amendment

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

the trustee, under appropriate circumstances, to operate the business

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

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

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

particular set of circumstances would be determined by the Commission

in its discretion, and such operation would require the written

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

Commission has delegated all the functions of the Commission in

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

Clearing and Intermediary Oversight, and therefore, under this proposed

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

determination and to issue such written permission.\6\

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

Regulation 190.10(d) states:

Until such time as the Commission orders otherwise, the

Commission hereby delegates to the Director of the Division of

Clearing and Intermediary Oversight, and to such members of the

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

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

the authority to approve or disapprove a withdrawal or settlement of

a commodity account by a public customer pursuant to Sec.

190.06(g)(3).

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C. Rationale for the Proposed Amendment

Recently, events have demonstrated that a commodity broker may

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

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

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

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

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

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

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

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

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

retain the net regulatory capital of Refco.\8\

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

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

Bankruptcy ] 109.03[2].

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

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

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Shortly after Refco filed for relief under Subchapter IV of Chapter

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

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

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

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

transferred to the third party.

During the Refco proceedings, it was practicable to transfer

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

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

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

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

Securities Investor Protection

[[Page 66600]]

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

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

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

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

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

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

consummated. Soon after the consummation, the customer accounts of

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

Lehman proceedings under SIPA had commenced in District Court prior to

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

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

issued by the District Court permitting the trustee to conduct business

in the ordinary course.\11\

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

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

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

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

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

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The Commission is proposing the Amendment to enable customers to

manage their accounts, after their commodity broker enters into

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

circumstances. As the Refco and Lehman proceedings illustrate, there

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

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

nevertheless possess the capital necessary to continue operating its

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

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

pending imminent transfer of customer accounts to another commodity

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

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

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

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

Amendment is consistent with the past practice of the Commission in

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

advance the purposes of Regulation Part 190. Additionally, allowing

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

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

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

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

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Whether a commodity broker in bankruptcy has sufficient capital to

continue operating its business in the ordinary course is inherently a

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

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

Requiring the trustee to obtain the written permission of the

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

trustee may purchase or sell new commodity contracts on behalf of

customers of the commodity broker in bankruptcy.

In deciding whether to apply the proposed Amendment to a particular

commodity broker in bankruptcy, the Commission may consider the

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

agreement providing for the imminent transfer of its customer accounts

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

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

the time it becomes subject to bankruptcy proceedings, to continue

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

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

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

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

have been transferred. The Commission anticipates that future

bankruptcies of commodity brokers may present new factors for its

consideration, and the proposed Amendment is therefore intended to

provide the Commission with flexibility to consider such new factors in

its discretion.

III. Related Matters

A. Regulatory Flexibility Act

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

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

regulations on small businesses. As mentioned above, the proposed

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

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

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

ordinary course, including the purchase or sale of new commodity

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

proposed Amendment does not impose a regulatory burden on either a

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

the proposed Amendment will affect only FCMs (including certain foreign

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

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

Commission in evaluating the impact of its regulations on such entities

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

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

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

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

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

small entities.

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

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

commodity brokers that execute trades and carry accounts for

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

and leverage transaction merchants. Currently, no such commodity

brokers exist. Therefore, even if such commodity brokers would

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

Amendment can have no current impact on such commodity brokers.

However, it is unlikely that such commodity brokers would constitute

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

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

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

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

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

also be applicable to commodity options dealers, foreign futures

commission merchants, and leverage transaction merchants.

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

\16\ Id. at 18619.

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B. Paperwork Reduction Act

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

requirements on Federal agencies in connection with their conducting or

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

proposed Amendment does not require the new collection of information

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

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

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

would not impose any new reporting or recordkeeping requirements.

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

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C. Cost-Benefit Analysis

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

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

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

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

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

the regulation outweigh its costs. Rather,

[[Page 66601]]

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

the costs and benefits'' of its action.

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

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

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

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

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

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

interest considerations. Accordingly, the Commission could, in its

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

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

costs, a particular regulation was necessary or appropriate to protect

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

accomplish any of the purposes of the Act.

The Commission has evaluated the costs and benefits of the proposed

Amendment, in light of the specific considerations identified in

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

1. Protection of Market Participants and the Public

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

Amendment would benefit the customers of such commodity broker, by

providing them with the opportunity, under certain circumstances, to

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

commodity broker.

2. Efficiency and Competition

The proposed Amendment is not expected to have an effect on

efficiency or competition.

3. Financial Integrity of Futures Markets and Price Discovery

As mentioned above, the proposed Amendment will promote financial

integrity of the futures markets by providing customers of a commodity

broker in bankruptcy with the opportunity, under certain circumstances,

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

new commodity broker.

4. Sound Risk Management Practices

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

the risk management practices of commodity brokers.

5. Other Public Considerations

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

demonstrated that the proposed Amendment is necessary and prudent.

Accordingly, after considering the five factors enumerated in the

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

below.

List of Subjects in 17 CFR Part 190

Bankruptcy, Brokers, Commodity futures.

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

amend 17 CFR part 190 as follows:

PART 190--BANKRUPTCY

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

follows:

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

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

noted.

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

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

* * * * *

(d) * * *

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

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

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

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

the customers of the debtor under appropriate circumstances, as

determined by the Commission.

* * * * *

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

David A. Stawick,

Secretary of the Commission.

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

Last Updated: December 16, 2009