2012-26435

Federal Register, Volume 77 Issue 220 (Wednesday, November 14, 2012)[Federal Register Volume 77, Number 220 (Wednesday, November 14, 2012)]

[Proposed Rules]

[Pages 67865-67971]

From the Federal Register Online via the Government Printing Office [www.gpo.gov]

[FR Doc No: 2012-26435]

[[Page 67865]]

Vol. 77

Wednesday,

No. 220

November 14, 2012

Part II

Commodity Futures Trading Commission

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17 CFR Parts 1, 3, 22 et al.

Enhancing Protections Afforded Customers and Customer Funds Held by

Futures Commission Merchants and Derivatives Clearing Organizations;

Proposed Rule

Federal Register / Vol. 77 , No. 220 / Wednesday, November 14, 2012 /

Proposed Rules

[[Page 67866]]

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COMMODITY FUTURES TRADING COMMISSION

17 CFR Parts 1, 3, 22, 30, and 140

RIN 3038-AD88

Enhancing Protections Afforded Customers and Customer Funds Held

by Futures Commission Merchants and Derivatives Clearing Organizations

AGENCY: Commodity Futures Trading Commission.

ACTION: Notice of proposed rulemaking.

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SUMMARY: The Commodity Futures Trading Commission (``Commission'' or

``CFTC'') is proposing to adopt new regulations and amend existing

regulations to require enhanced customer protections, risk management

programs, internal monitoring and controls, capital and liquidity

standards, customer disclosures, and auditing and examination programs

for futures commission merchants (``FCMs''). The proposal also

addresses certain related issues concerning derivatives clearing

organizations (``DCOs'') and chief compliance officers (``CCOs''). The

proposed rules will afford greater assurances to market participants

that: customer segregated funds and secured amounts are protected;

customers are provided with appropriate notice of the risks of futures

trading and of the FCMs with which they may choose to do business; FCMs

are monitoring and managing risks in a robust manner; the capital and

liquidity of FCMs are strengthened to safeguard their continued

operations; and the auditing and examination programs of the Commission

and the self-regulatory organizations (``SROs'') are monitoring the

activities of FCMs in a prudent and thorough manner.

DATES: Comments must be received on or before January 14, 2013.

ADDRESSES: You may submit comments, identified by RIN 3038-AD88, by any

of the following methods:

Agency Web site, via its Comments Online process: http://comments.cftc.gov. Follow the instructions for submitting comments

through the Web site.

Mail: Send to David A. Stawick, Secretary, Commodity

Futures Trading Commission, 1155 21st Street NW., Washington, DC 20581.

Hand delivery/Courier: Same as Mail above.

Federal eRulemaking Portal: http://www.regulations.gov/search/index.jsp.

Follow the instructions for submitting comments.

All comments must be submitted in English, or if not, accompanied

by an English translation. Comments will be posted as received to

http://www.cftc.gov. You should submit only information that you wish

to make available publicly. If you wish the Commission to consider

information that is exempt from disclosure under the Freedom of

Information Act, a petition for confidential treatment of the exempt

information may be submitted according to the procedures set forth in

Sec. 145.9 of the Commission's regulations.\1\

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\1\ Commission regulations referred to herein are found at 17

CFR Ch. 1 (2012). Commission regulations are accessible on the

Commission's Web site, www.cftc.gov.

_____________________________________-

The Commission reserves the right, but shall have no obligation, to

review, pre-screen, filter, redact, refuse or remove any or all of your

submission from www.cftc.gov that it may deem to be inappropriate for

publication, such as obscene language. All submissions that have been

redacted or removed that contain comments on the merits of the

rulemaking will be retained in the public comment file and will be

considered as required under the Administrative Procedure Act and other

applicable laws, and may be accessible under the Freedom of Information

Act.

FOR FURTHER INFORMATION CONTACT:

Division of Swap Dealer and Intermediary Oversight: Gary Barnett,

Director, 202-418-5977, [email protected]; Thomas Smith, Deputy

Director, 202-418-5495, [email protected]; Frank Fisanich, Chief Counsel,

202-418-5949, [email protected]; or Ward P. Griffin, Associate Chief

Counsel, 202-418-5425, [email protected], Three Lafayette Centre, 1155

21st Street NW., Washington, DC 20581, or Kevin Piccoli, Deputy

Director, 646-746-9834, [email protected], 140 Broadway, 19th Floor,

New York, NY 10005.

Division of Clearing and Risk: Robert B. Wasserman, Chief Counsel, 202-

418-5092, [email protected], Three Lafayette Centre, 1155 21st Street

NW., Washington, DC 20581.

Office of the Chief Economist: Camden Nunery, Economist,

[email protected], 202-418-5723, Three Lafayette Centre, 1155 21st

Street NW., Washington, DC 20581.

SUPPLEMENTARY INFORMATION:

I. Background

A. General Statutory and Current Regulatory Structure

The protection of customers--and the safeguarding of money,

securities or other property deposited by customers with an FCM--is a

fundamental component of the Commission's disclosure and financial

responsibility framework. Section 4d(a)(2) \2\ of the Commodity

Exchange Act (``Act'') \3\ requires each FCM to segregate from its own

assets all money, securities and other property deposited by futures

customers to margin, secure, or guarantee futures contracts and options

on futures contracts traded on designated contract markets.\4\ Section

4d(a)(2) further requires an FCM to treat and deal with futures

customer funds as belonging to the futures customer, and prohibits an

FCM from using the funds deposited by a futures customer to margin or

extend credit to any person other than the futures customer that

deposited the funds. Section 4d(f) of the Act, which was added by

section 724(a) of the Dodd-Frank Wall Street Reform and Consumer

Protection Act,\5\ requires each FCM to segregate from its own assets

all money, securities and other property deposited by Cleared Swaps

Customers to margin transactions in Cleared Swaps.\6\

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\2\ 7 U.S.C. 6d(a)(2).

\3\ 7 U.S.C. 1 et seq.

\4\ The term '' futures customer'' is defined in Sec. 1.3(iiii)

to include any person who uses a futures commission merchant as an

agent in connection with trading in any contract for the purchase or

sale of a commodity for future delivery or an option on such

contract (excluding any proprietary accounts under Sec. 1.3(y)).

The Commission adopted the definition of the term ``futures

customer'' on October 16, 2012 as part of the final rulemaking that

amended existing Commission regulations to incorporate swaps. The

Federal Register release adopting the final rules can be accessed at

http://www.cftc.gov/ucm/groups/public/@newsroom/documents/file/federalregister101612.pdf.

\5\ See Dodd-Frank Act, Public Law 111-203, 124 Stat. 1376

(2010). The text of the Dodd-Frank Act may be accessed at http://www.cftc.gov/LawRegulation/OTCDERIVATIVES/index.htm.

\6\ The term ``Cleared Swaps Customer'' is defined in Sec. 22.1

as any person entering into a Cleared Swap, but excludes: (1) Any

owner or holder of a Cleared Swaps Proprietary Account with respect

to the Cleared Swaps in such account; and (2) A clearing member of a

DCO with respect to Cleared Swaps cleared on that DCO.

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The Commission has adopted Sec. Sec. 1.20 through 1.30, and Sec.

1.32, to implement section 4d(a)(2) of the Act, and adopted Part 22 to

implement section 4d(f) of the Act. The purpose of these regulations is

to safeguard funds deposited by futures customers and Cleared Swaps

Customers, respectively.

Regulation 1.20 requires each FCM and DCO to separately account for

and to segregate from its own proprietary funds all money, securities,

or other property deposited by futures customers for trading on

designated contract markets. Regulation 1.20 also provides that an FCM

or DCO may deposit futures customer funds only with a bank, trust

company, and for FCMs only, a DCO or another FCM. The funds must be

deposited under an account

[[Page 67867]]

name that clearly identifies the funds as belonging to the futures

customers of the FCM or DCO and further shows that the funds are

segregated as required by section 4d(a)(2) of the Act and Commission

regulations. FCMs and DCOs also are required to obtain a written

acknowledgment from a depository stating that the depository was

informed that funds deposited are customer funds being held in

accordance with the Act.

FCMs and DCOs also are restricted in their use of futures customer

funds. Regulations 1.20 and 1.22 provide that the funds deposited by

one futures customer may not be used to margin or to secure the

contracts or option positions, or extend credit to any person, other

than the futures customer that deposited the funds. An FCM or DCO,

however, may for convenience commingle and hold funds deposited as

margin by multiple futures customers in the same account or accounts

with one of the recognized depositories. An FCM or DCO also may invest

futures customer funds in certain permitted investments under Sec.

1.25.

Part 22 of the Commission's regulations, which governs Cleared

Swaps transactions, implements section 4d(f) of the Act and parallels

many of the provisions in Part1 addressing the manner in which, and the

responsibilities imposed upon, an FCM holding funds for futures

customers trading on designated contract markets.\7\ Regulation 22.2

requires an FCM to treat and to deal with funds deposited by Cleared

Swaps Customers as belonging to such Cleared Swaps Customers and to

hold such funds separately from the FCM's own funds. Regulation 22.4

provides that an FCM may deposit Cleared Swaps Customer Collateral with

a bank, trust company, DCO, or another registered FCM. Regulation 22.6

requires that the account holding the Cleared Swaps Customers

Collateral must clearly identify the account as an account for Cleared

Swaps Customers of the FCM engaging in cleared swap transactions and

that the funds maintained in the account are subject to the segregation

provisions of section 4d(f) of the Act and Commission regulations.

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\7\ The Commission approved the part 22 regulations on January

11, 2012, with an effective date of April 9, 2012. Compliance with

the part 22 regulations is required by November 8, 2012. See,

Protection of Cleared Swaps Customer Contracts and Collateral;

Conforming Amendments to the Commodity Broker Bankruptcy Provisions,

77 FR 6336 (Feb. 7, 2012).

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Regulation 22.2(d) also prohibits an FCM from using the funds

deposited by one Cleared Swaps Customer to purchase, margin, or settle

cleared swap transactions of any person other the Cleared Swaps

Customer that deposited the funds. Further, Sec. 22.2(c) permits an

FCM to commingle the Cleared Swaps Customer Collateral of multiple

Cleared Swaps Customers into one or more accounts, and Sec. 22.2(e)(1)

permits an FCM to invest Cleared Swaps Customer Collateral in permitted

investments under Sec. 1.25.

In addition to holding funds for futures customers transacting on

designated contract markets and for Cleared Swaps Customers engaging in

cleared swap transactions, FCMs also hold funds for persons trading

futures contracts listed on foreign boards of trade. Section 4(b) of

the Act provides that the Commission may adopt rules and regulations

proscribing fraud and requiring minimum financial standards, the

disclosure of risk, the filing of reports, the keeping of books and

records, the safeguarding of the funds deposited by persons for trading

on foreign markets, and registration with the Commission by any person

located in the United States who engages in the offer or sale of any

contract of sale of a commodity for future delivery that is made

subject to the rules of a board of trade located outside of the United

States. Pursuant to the statutory authority of section 4(b), the

Commission adopted Part 30 of its regulations to address foreign

futures and foreign option transactions.

The segregation provisions for funds deposited by foreign futures

or foreign options customers to margin foreign futures or foreign

options transactions under Part 30, however, are significantly

different from the requirements set forth in Sec. 1.20 for futures

customers trading on designated contract markets and Part 22 for

Cleared Swaps Customers engaging in cleared swap transactions.

Regulation 30.7 provides that an FCM may deposit the funds belonging to

foreign futures or foreign options customers in an account or accounts

maintained at a bank or trust company located in the United States; a

bank or trust company located outside of the United States that has in

excess of $1 billion of regulatory capital; an FCM registered with the

Commission; a DCO; a member of a foreign board of trade; a foreign

clearing organization; or a depository selected by the member of a

foreign board of trade or foreign clearing organization. The account

with the depository must be titled to clearly specify that the account

holds funds belonging to the foreign futures or foreign options

customers of the FCM that are trading on foreign futures markets. An

FCM also is permitted to invest the funds deposited by foreign futures

or foreign option customers in accordance with Sec. 1.25.

However, unlike Sec. 1.20 and Part 22, which require an FCM to

hold a sufficient amount of funds in segregation to meet the total

account equities of all of the FCM's futures customers and Cleared

Swaps Customers at all times (i.e., the Net Liquidating Equity Method),

Sec. 30.7 requires an FCM to maintain in separate accounts an amount

of funds only sufficient to cover the margin required on open foreign

futures contracts, plus or minus any unrealized gains or losses on such

open positions, plus any funds representing premiums payable or

received on foreign options (including any additional funds necessary

to secure such options, plus or minus any unrealized gains or losses on

such options) (i.e., the ``Alternative Method''). Thus, under the Part

30 Alternative Method an FCM is not required to maintain a sufficient

amount of funds in such separate accounts to pay the full account

balances of all of its foreign futures or foreign options customers at

all times.

In addition to the segregation requirements of sections 4d(a)(2)

and 4d(f) of the Act, and the secured amount requirements in Part 30 of

the Commission's regulations, FCMs also are subject to minimum net

capital and financial reporting requirements that are intended to

ensure that such firms meet their financial obligations in a regulated

marketplace, including their financial obligations to customers and

DCOs. Each FCM is required to maintain a minimum level of ``adjusted

net capital,'' which is generally defined under Sec. 1.17 as the

firm's net equity as computed under generally accepted accounting

principles, less all of the firm's liabilities and further excluding

all assets that are not liquid or readily marketable. Regulation

1.17(c)(5) further requires an FCM to impose capital charges (i.e.,

deductions) on certain of its liquid assets to protect against possible

market risks in such assets.

FCMs also are subject to financial recordkeeping and reporting

requirements. FCMs that carry customer accounts are required under

Sec. 1.32 to prepare a schedule each business day demonstrating their

compliance with the segregation and secured amount requirements.

Regulation 1.32 requires the calculation to be performed by noon each

business day, reflecting the account balances and open positions as of

the close of business on the previous business day.

Each FCM also is required by Sec. 1.10 to file with the Commission

and with its

[[Page 67868]]

designated self-regulatory organization (``DSRO'') monthly unaudited

financial statements and an annual audited financial report, as well as

notices of certain predefined events.\8\ Regulation 1.12 requires an

FCM to file a notice with the Commission and with the firm's DSRO

whenever, among other things, the firm: (1) Fails to maintain

compliance with the Commission's capital requirements; (2) fails to

hold sufficient funds in segregated or secured amount accounts to meet

its regulatory requirements; (3) fails to maintain current books and

records; or (4) experiences a significant reduction in capital from the

previous month-end. The purpose of the regulatory notices is to alert

the Commission and the firm's DSRO as early as possible to potential

financial issues at the firm that may adversely impact the ability of

the FCM to comply with its obligations to safeguard customer funds, or

to meet its financial obligations to other FCMs or DCOs.

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\8\ The term ``self-regulatory organization'' is defined by

Sec. 1.3 to mean a contract market, a swap execution facility, or a

registered futures association. A DSRO is the SRO that is appointed

to be primarily responsible for conducting ongoing financial

surveillance of an FCM under a joint audit agreement submitted to

and approved by the Commission under Sec. 1.52.

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The statutory mandate to segregate customer funds--to treat them as

belonging to the customer and not use the funds inappropriately--takes

on greater meaning in light of the devastating events experienced over

the past year. Those events, which are discussed in greater detail

below, demonstrate that the risks of misfeasance and malfeasance, and

the risks of failing to maintain sufficient excess funds in

segregation: (i) Put customer funds at risk; and (ii) are exacerbated

by stresses on the business of the FCM. Many of those risks can be

mitigated significantly by better risk management systems and controls,

along with an increase in risk-oriented oversight and examination of

the FCMs.

Determining what is a ``sufficient'' amount of excess funds in

segregation for any particular FCM requires a full understanding of the

business of that FCM, including a proper analysis of the factors that

affect the actual amount of segregated funds held by the FCM relative

to the minimum amount of segregated funds it is required to hold.

Further, appropriate care must be taken to avoid withdrawing such

excess funds at times of great stress to cover needs unrelated to the

purposes for which excess segregated and secured funds are maintained.

In times of stress, excess funds may look like an easy liquidity source

to help cover other risks of the business; yet withdrawing it makes it

unavailable when it may be most needed. The recent market events

illustrate both the need to: (i) Require that care be taken about

monitoring excess segregated and secured funds, and the conditions

under and the extent to which such funds may be withdrawn; and (ii)

place appropriate risk management controls around the other risks of

the business to help relieve (A) the likelihood of an exigent event or,

(B) if such an event occurs, the likelihood of a failure to prepare for

such an event, which in either case could create pressures that result

in an inappropriate withdrawal of customer funds.

Although the Commission's existing regulations provide an essential

foundation to fostering a well-functioning marketplace, wherein

customers are protected and institutional risks are minimized, recent

events have demonstrated that additional measures are necessary to

effectuate the fundamental purposes of the statutory provisions

discussed above. Further, concurrently with the enhanced

responsibilities for FCMs that are proposed herein, the oversight and

examination systems must be enhanced to mitigate risks and effectuate

the statutory purposes.

B. Self-Regulatory Structure

The Commission's oversight structure provides that SROs are the

frontline regulators of FCMs, introducing brokers (``IBs''), commodity

pool operators, and commodity trading advisors. In 2000, Congress

affirmed the Commission's reliance on SROs by amending section 3 of the

Commodity Exchange Act to state: ``It is the purpose of this Act to

serve the public interests through a system of effective self-

regulation of trading facilities, clearing systems, market participants

and market professionals under the oversight of the Commission.''

As part of its oversight responsibility, an SRO is required to

conduct periodic examinations of member FCMs' compliance with

Commission and SRO financial and related reporting requirements,

including the FCMs' holding of customer funds in segregated and secured

accounts. The Commission oversees the SROs by examining them for the

performance of their duties. More recently, the Commission has moved to

conducting quarterly reviews of the SROs' FCM examination program in

which the Commission selects a small sample of the SRO's FCM work

papers to review. In addition, the Commission also conducts limited-

scope reviews of FCMs in a ``for cause'' situation that are sometimes

referred to as ``audits,'' but they are not full-scale audits as

accountants commonly use that term.

In addition, because there are multiple SROs who share the same

member FCMs, to avoid subjecting FCMs to duplicative examinations from

SROs, the Commission has a permissive system that allows the SROs to

agree how to allocate FCMs amongst them. An SRO who is allocated

certain FCMs for such examination is referred to as the DSRO of those

FCMs.

Under Commission regulations, FCMs must have their annual financial

statements audited by an independent certified public accountant

following U.S. Generally Accepted Auditing Standards (``U.S. GAAS'').

As part of this certified annual report, the independent accountant

also must conduct appropriate reviews and tests to identify any

material inadequacies in systems and controls that could violate the

Commission's segregation or secured amount requirements. Any such

inadequacies are required to be reported to the FCM's DSRO and to the

Commission.

C. Futures Commission Merchant Insolvencies and Failures of Risk

Management

Recent events demonstrate the need for revisions to the

Commission's customer protection regime. Since October 2011, two FCMs

have entered into insolvency proceedings. On October 31, 2011, MF

Global, Inc. (``MFGI''), which was dually-registered as an FCM with the

Commission and as a securities broker-dealer (``BD'') with the U.S.

Securities and Exchange Commission (``SEC''), was placed into a

liquidation proceeding under the Securities Investor Protection Act by

the Securities Investor Protection Corporation (``SIPC''). The trustee

appointed to oversee the liquidation of MFGI has reported a potential

$900 million shortfall of funds necessary to repay the account balances

due to customers trading futures on designated contract markets, and an

approximately $700 million shortfall in funds immediately available to

repay the account balances of customers trading on foreign futures

markets.\9\ The shortfall in customer segregated accounts is

attributable by the MFGI Trustee to significant transfers of funds out

of the customer accounts that were used by MFGI for various purposes

other than to meet obligations to or on

[[Page 67869]]

behalf of customers. The trustee also is attempting to recover

approximately $640 million of customer funds that was deposited by MFGI

with its London, U.K. affiliate, MFGUK, as margin funds for trading on

foreign markets. The MFGI trustee and the Special Administrators

handling the liquidation of MFGUK are disputing the legal status of the

funds and whether they are customer funds under English law. The

outcome of this dispute will have a significant impact on the amount of

funds that are returned to MFGI.

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\9\ See Report of the Trustee's Investigation and

Recommendations, In re MF Global Inc., No. 11-2790 (MG) SIPA (Bankr.

S.D.N.Y. Jun. 4, 2012).

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In addition, the Commission filed a civil injunctive complaint in

federal district court on July 10, 2012, against Peregrine Financial

Group, Inc. (``PFG''), a registered FCM and its Chief Executive Officer

(``CEO'') and sole owner, Russell R. Wasendorf, Sr., alleging that PFG

and Wasendorf, Sr. committed fraud by misappropriating customer funds,

violated customer fund segregation laws, and made false statements

regarding the amount of funds in customer segregated accounts in

financial statements filed with the Commission. The complaint states

that in July 2012 during an NFA examination PFG falsely represented

that it held in excess of $220 million of customer funds when in fact

it held approximately $5.1 million.\10\

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\10\ Complaint, U.S. Commodity Futures Trading Commission v.

Peregrine Financial Group, Inc., and Russell R. Wasendorf, Sr., No.

12-cv-5383 (N.D. Ill. July 10, 2012). A copy of the Commission's

complaint has been posted to the Commission's Web site.

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Recent incidents also have demonstrated the value of establishing

robust risk management systems within FCMs and enhanced early warning

systems to detect and address capital issues. In particular, problems

that arise through an FCM's non-futures-related business can have a

direct and significant impact on the FCM's regulatory capital, raising

questions as to whether the FCM will be able to maintain the minimum

financial requirements mandated by the Act and Commission

regulations.\11\

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\11\ See, e.g., Edward Krudy, Jed Horowitz and John McCrank,

``Knight's Future in Balance After Trading Disaster,'' Reuters (Aug.

3, 2012), available at http://in.reuters.com/article/2012/08/03/knightcapital-loss-idINL2E8J27QE20120803 (noting that a software

issue caused the firm to incur a $440 million trading loss, which

represented much of the firm's capital); Chris Dieterich and

Nathalie Tadena, ``Penson Worldwide's US Securities Accounts To Be

Acquired By Apex Clearing,'' available at http://online.wsj.com/article/BT-CO-20120531-717791.html (discussing circumstances that

led Penson to sell its futures business).

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These recent incidents have highlighted weaknesses in the customer

protection regime prescribed in the Commission's regulations and

through the self-regulatory system. In particular, questions have

arisen on the requirements surrounding the holding and investment of

customer funds, including the ability of FCMs to withdraw funds from

customer segregated accounts and Part 30 secured accounts.

Additionally, the incidents have underscored the need for additional

safeguards--such as robust risk management systems, strengthened early-

warning systems surrounding margin and capital requirements, and

enhanced public disclosures--to promote the protection of customer

funds and to minimize the systemic risk posed by certain actions of

market participants. Further questions have arisen on the system of

audits and examinations of FCMs, and whether the system functions

adequately to monitor FCMs' activities, verify segregated fund and

secured amount balances, and detect fraud. Consequently, the Commission

has taken steps to study and address the issues raised by the

incidents, and industry participants likewise have taken steps to

address the issues. Such steps are described in greater detail in the

next section.

D. Recent Commission Rulemakings and Other Initiatives Relating to

Customer Protection

Since late 2011, the Commission has promulgated rules directly

impacting the protection of customer funds. The Commission also has

studied the current regulatory framework surrounding customer

protection, particularly in light of the recent incidents outlined

above, in order to identify potential enhancements to the systems and

Commission regulations protecting customer funds. The Commission's

efforts have been informed, in part, by efforts undertaken by industry

participants. The proposed rule amendments set forth in this release

have been informed by the efforts detailed below.

In December 2011, the Commission adopted final rule amendments

revising the types of investments that an FCM or DCO can make with

customer funds under Sec. 1.25, for the purpose of affording greater

protection for such funds.\12\ Among other changes to Sec. Sec. 1.25

and 30.7, the final rule amendments removed from the list of permitted

investments: (1) corporate debt obligations not guaranteed by the

United States; (2) foreign sovereign debt; and (3) in-house and

affiliate transactions.

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\12\ See, Investment of Customer Funds and Funds Held in an

Account for Foreign Futures and Foreign Options Transactions, 76 FR

78776 (Dec. 19, 2011).

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In adopted the amendments to Sec. 1.25, the Commission was mindful

that customer segregated funds must be invested by FCMs and DCOs in a

manner that minimizes their exposure to credit, liquidity, and market

risks both to preserve their availability to customers and DCOs, and to

enable investments to be quickly converted to cash at a predictable

value in order to avoid systemic risk. The amendments are consistent

with the general prudential standard contained in Sec. 1.25, which

provides that all permitted investments must be ``consistent with the

objectives of preserving principal and maintaining liquidity.''

The Commission also approved final regulations that require DCOs to

collect initial customer margin from FCMs on a gross basis.\13\ Under

the final regulations, FCMs are no longer permitted to offset one

customer's margin requirement against another customer's margin

requirements and deposit only the net margin collateral with the DCO.

As a result of the rule change, a greater portion of customer initial

margin will be posted by FCMs to the DCOs.

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\13\ See Commission Regulation 39.12(g)(8)(i) and Derivatives

Clearing Organization General Provisions and Core Principles, 76 FR

69334 (Nov. 8, 2011).

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The Commission also approved a new margining regime for cleared

swaps positions.\14\ Under the traditional futures margining model,

DCOs hold an FCM's customer funds on a collective basis and are

permitted to use the collective margin funds held for the FCM's

customers to satisfy a margin deficiency caused by a single customer.

The Commission approved an alternative margin rule for cleared swap

transactions. Under the ``LSOC rule'' (legal segregation with

operational comingling), the DCOs that clear swaps transactions have

greater information regarding the margin collateral of individual Swaps

Customers, and each Swaps Customer's collateral is protected

individually all the way to the clearinghouse.

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\14\ See 77 FR 6336 (Feb. 7, 2012).

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The Commission also included customer protection enhancements in

the final rule for designated contract markets. These provisions codify

into rules staff guidance on minimum requirements for SROs regarding

their financial surveillance of FCMs.\15\ The rules require that a DCM

have arrangements and resources for effective

[[Page 67870]]

rule enforcement and trade and financial surveillance programs,

including the authority to collect information and examine books and

records of members and market participants. The rules also establish

minimum financial standards for both member FCMs and IBs and non-

intermediated market participants. The Commission expressly noted in

the preamble of the Adopting Release that ``a DCM's duty to set

financial standards for its FCM members involves setting capital

requirements, conducting surveillance of the potential future exposure

of each FCM as compared to its capital, and taking appropriate action

in light of the results of such surveillance.'' \16\ Further, the rules

mandate that DCMs adopt rules for the protection of customer funds,

including the segregation of customer and proprietary funds, the

custody of customer funds, the investment standards for customer funds,

intermediary default procedures and related recordkeeping.

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\15\ See Core Principles and Other Requirements for Designated

Contract Markets, 77 FR 36612 (June 19, 2012).

\16\ Id. at 36646.

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In addition to the rulemaking efforts outlined above, the

Commission has sought additional information through a series of

roundtables and other meetings. On February 29 and March 1, 2012, the

Commission solicited comments and held a public roundtable to solicit

input on customer protection issues from a broad cross-section of the

futures industry, including market participants, FCMs, DCOs, SROs,

securities regulators, foreign clearing organizations, and

academics.\17\ The roundtable focused on issues relating to the

advisability and practicality of modifying the segregation models for

customer funds; alternative models for the custody of customer

collateral; enhancing FCM controls over the disbursement of customer

funds; increasing transparency surrounding an FCM's holding and

investment of customer funds; and lessons learned from recent commodity

brokerage bankruptcy proceedings.

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\17\ Further information on the public roundtable, including

video recordings and transcripts of the discussions, have been

posted to the Commission's Web site. See http://www.cftc.gov/PressRoom/Events/opaevent_cftcstaff022912 (relating to Feb. 29,

2012); http://www.cftc.gov/PressRoom/Events/opaevent_cftcstaff030112 (relating to Mar. 1, 2012).

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The Commission also hosted a public meeting of the Technology

Advisory Committee (``TAC'') on July 26, 2012.\18\ Panelists and TAC

members discussed potential technological solutions directed at

enhancing the protection of customers funds by identifying and

exploring technological issues and possible solutions relating to the

ability of the Commission, SROs and customers to verify the location

and status of funds held in customer segregated accounts.

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\18\ Additional information, including documents submitted by

meeting participants, has been posted to the Commission's Web site.

See http://www.cftc.gov/PressRoom/Events/opaevent_tac072612.

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Commission staff hosted an additional roundtable on August 9, 2012,

to discuss SRO requirements for examinations of FCMs and Commission

oversight of SRO examination programs. The roundtable also focused on

the role of the independent public accountant in the FCM examination

process, and proposals addressing various alternatives to the current

system for segregating customer funds.

In developing the proposals set forth in this release, the

Commission also has been informed by efforts undertaken by industry

participants. On February 29, 2012, the Futures Industry Association

(``FIA'') initiated steps to educate customers on the extent of the

protections provided under the current regulatory structure. FIA issued

a list of Frequently Asked Questions (``FAQ'') prepared by members of

the FIA Law and Compliance Division addressing the basics of

segregation, collateral management and investments, capital

requirements and other issues for FCMs and joint FCM/BDs, and

clearinghouse guaranty funds.\19\ The FAQ is intended to provide

existing and potential customers with a better understanding of the

risks of engaging in futures trading and a clear explanation of the

extent of the protections provided to customers and their funds under

the Act and Commission regulations.

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\19\ The FIA's release addressing FAQs on the protection of

customer funds is accessible on the FIA's Web site at http://www.futuresindustry.org/downloads/PCF-FAQs.PDF.

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FIA also issued a series of initial recommendations for the

protection of customer funds.\20\ The recommendations were prepared by

the Financial Management Committee, whose members include

representatives of FIA member firms, DCOs and depository institutions.

The initial recommendations address enhanced disclosure on the

protection of customer funds, reporting on segregated funds balances by

FCMs, FCM internal controls surrounding the holding and disbursement of

customer funds, and revisions to Part 30 regulations to make the

protections comparable to those provided for customers trading on

designated contract markets.

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\20\ The FIA's initial recommendations are accessible on the

FIA's Web site at http://www.futuresindustry.org/downloads/Initial_Recommendations_for_Customer_Funds_Protection.pdf.

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On July 13, 2012, the Commission approved new FCM financial

requirements proposed by the National Futures Association

(``NFA'').\21\ The NFA Financial Requirements Section 16 and its

related Interpretive Notice entitled NFA Financial Requirements Section

16: FCM Financial Practices and Excess Segregated Funds/Secured Amount

Disbursements (collectively referred to as ``the Segregated Funds

Provisions'') were developed in consultation with Commission staff.

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\21\ For more information relating to the new FCM financial

requirements, see http://www.nfa.futures.org/news/newsNotice.asp?ArticleID=4072.

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NFA's Segregated Funds Provisions require each FCM to: (1) Maintain

written policies and procedures governing the deposit of the FCM's

proprietary funds (i.e., excess or residual funds) in customer

segregated accounts and Part 30 secured accounts; (2) maintain a

targeted amount of excess funds in segregate accounts and Part 30

secured accounts; (3) file on a daily basis the FCM's segregation and

Part 30 secured amount computations with NFA; (4) obtain the approval

of senior management prior to a withdrawal that is not for the benefit

of customers, whenever the withdrawal equals 25 percent or more of the

excess segregated or Part 30 secured amount funds; (5) file a notice

with NFA of any withdrawal that is not for the benefit of customers,

whenever the withdrawal equals 25 percent or more of the excess

segregated or Part 30 secured amount funds; (6) file detailed

information regarding the depositories holding customer funds and the

investments made with customer funds as of the 15th day (or the next

business day if the 15th is not a business day) and the last business

day of each month; and (7) file additional monthly net capital and

leverage information with NFA.

Significantly, NFA's Segregated Funds Provisions also require FCMs

to compute their Part 30 secured amount requirement and compute their

targeted excess Part 30 secured funds using the same Net Liquidating

Equity Method that is required by the Act and Commission regulations

for computing the segregation requirements for customers trading on

U.S. contract markets under section 4d of the Act. FCMs are not

permitted under the NFA rules to use the Alternative Method to compute

the Part 30 secured amount requirement. The failure of an FCM to

maintain its targeted amount of excess Part 30 funds computed using the

Net

[[Page 67871]]

Liquidating Equity Method may result in NFA initiating a Membership

Responsibility Action (``MRA'') against the firm.

In addition, in setting the target amount of excess funds, the

FCM's management must perform a due diligence inquiry and consider

various factors relating, as applicable, to the nature of the FCM's

business, including the type and general creditworthiness of the FCM's

customers, the trading activity of the customers, the types and

volatility of the markets and products traded by the FCM's customers,

and the FCM's own liquidity and capital needs. The FCM's Board of

Directors (or similar governing body), CEO or Chief Financial Officer

(``CFO'') must approve in writing the FCM's targeted residual amount,

any changes thereto, and any material changes in the FCM's written

policies and procedures.

The NFA Board of Directors also approved on August 16, 2012,

amendments to NFA financial requirements for FCMs that will require

each FCM to provide its DSRO with view-only access via the Internet to

account information for each of the FCM's customer segregated funds

account(s) maintained and held at a bank or trust company. The same

requirement would apply to the FCM's customer secured account(s) held

for customers trading on foreign futures exchanges.

In addition, the NFA rule amendments provide that if a bank or

trust company is unable to allow the FCM to provide its DSRO with view-

only full access via the Internet, the bank or trust company will not

be deemed an acceptable depository to hold customer segregated and

secured accounts. NFA intends to expand its oversight of FCMs under the

amended rules, once the amendments are implemented, to receive daily

reports from all depositories for customer segregated and secured

accounts, including FCMs that are clearing members of DCOs. NFA plans

to develop a program to compare the balances reported by the

depositories with the balances reported by the FCMs in their daily

segregation reports. An immediate alert would be generated for any

material discrepancies.

E. Commission's Proposal

The incidents outlined above, coupled with the information

generated through the recent efforts undertaken by the Commission and

industry participants, demonstrate the need for new rules and

amendments to existing rules. In particular, an examination of FCM

business operations--including the non-futures business of FCMs--and

the currently regulatory framework evince a need for enhanced customer

protections, risk management programs, disclosure requirements, and

auditing and examination programs. The amendments proposed herein

address these issues in several ways.

First, recognizing problems surrounding the treatment of customer

segregated funds and foreign futures or foreign options secured

amounts, the Commission is proposing to amend several components of

Parts 1, 22, and 30 of the Commission's regulations. The Commission

believes that the proposed amendments will provide greater certainty to

market participants that the customer funds entrusted to FCMs will be

protected. Second, to address shortcomings in the risk management of

FCMs, the Commission is proposing a new Sec. 1.11 that will establish

robust risk management programs. Third, the Commission determined that

the current regulatory framework should be re-oriented to implement a

more risk-based, forward-looking perspective, affording the Commission

and SROs with read-only access to accounts holding customer funds and

additional information on depositories and the customer assets held in

such depositories. The proposed amendments to Sec. Sec. 1.10, 1.12,

1.20, 1.26, and 1.32 address those and other issues. Fourth, given the

difficulties that can arise in an FCM's business, and the direct and

significant impact on the FCM's regulatory capital that can result from

such difficulties, the Commission is proposing to amend Sec.

1.17(a)(4) to ensure that an FCM's capital and liquidity are sufficient

to safeguard the continuation of operations at the FCM. Fifth, to

effect the change in orientation needed in FCM examinations programs,

as well as to assure quality control over program contents,

administration and oversight, the Commission is proposing to amend

Sec. 1.52, which, among other things, addresses the formation of Joint

Audit Committees and the implementation of Joint Audit Programs. And

sixth, recognizing the need to increase the information provided to

customers concerning the risks of futures trading and the FCMs with

which they may choose to conduct business, the Commission is proposing

amendments to Sec. 1.55 that will enhance the disclosures provided by

FCMs. These amendments are discussed in greater detail in the next

Section.

II. Section by Section Analysis of Proposed Commission Regulations and

Proposed Amendments to Existing Commission Regulations

A. Proposed Amendments to Sec. 1.10: Financial Reports of Futures

Commission Merchants and Introducing Brokers

Regulation 1.10 requires each FCM to file with the Commission and

with the firm's DSRO an unaudited financial report each month. The

financial report must be prepared using Form 1-FR-FCM. An FCM, however,

that is dually-registered as a BD, may file a Financial and Operational

Combined Uniform Single Report under the Securities Exchange Act of

1934 (``FOCUS Report'') in lieu of the Form 1-FR-FCM. Each FCM also is

required to file an annual report certified by an independent public

accountant with the Commission and with its DSRO.

The unaudited monthly and certified annual financial reports are

required to contain basic financial statements including a statement of

financial condition, a statement of income (loss), and a statement of

changes in ownership equity. The financial statements also are required

to include additional schedules designed to address specific regulatory

objectives to demonstrate that the FCM is in compliance with minimum

capital and customer funds segregation requirements. These additional

schedules include a statement of changes in liabilities subordinated to

claims of general creditors, a statement of the computation of the

minimum capital requirements (``Capital Computation Schedule''), a

statement of segregation requirements and funds in segregation for

customers trading on U.S. commodity exchanges (``Segregation

Schedule'') and a statement of secured amounts and funds held in

separate accounts for foreign futures and foreign options customers

(``Secured Amount Schedule''). In addition, the certified annual report

must contain a reconciliation of material differences between the

Capital Computation Schedule, the Segregation Schedule, and the Secured

Amount Schedule contained in the certified annual report and the

unaudited monthly report for the FCM's year-end month.

The Forms 1-FR-FCM and the FOCUS Reports are necessary financial

reporting for Commission and DSRO staff to assess the ongoing financial

condition of an FCM and provide significant information regarding the

operations of the firm that may impact the FCM's ability to maintain

[[Page 67872]]

compliance with Commission requirements and the protection of customer

funds. The Form 1-FR-FCM and FOCUS Reports are filed electronically

with the Commission and are subject to automated edits by the

Commission's financial statement surveillance software. Alerts and edit

checks, which may indicate a need for further analysis and follow-up by

staff, are generated by the financial surveillance software and major

issues are immediately and automatically forwarded to Commission staff

for review.

The Segregation Schedule and the Secured Amount Schedule generally

indicate, respectively, the total amount of funds held by the FCM in

segregated or secured accounts, the total amount of funds that the FCM

must hold in segregated or secured accounts to meet its regulatory

obligations to futures customers and foreign futures or foreign options

customers, and whether the firm holds excess segregated or secured

funds in the segregated or secured accounts as of the reporting date.

The Commission is proposing to amend Sec. 1.10 to require each FCM to

also disclose in the Segregation Schedule and in the Secured Amount

Schedule \22\ a target amount of ``residual interest'' (denoting the

FCM's proprietary funds) that the FCM is required to maintain in

customer segregated accounts and secured accounts based upon its

written policies and procedures for computing a targeted amount

required under the new risk management provisions in Sec. 1.11

discussed in Section II.B below.\23\ In addition to the target amount

of residual interest, the FCM also will be required to report on the

Segregation Schedule and the Secured Amount Schedule the sum of

outstanding margin deficits of the relevant customers for each

computation, to ensure that the residual interest is at all times in

excess of such sum, demonstrating compliance with the newly proposed

procedures in Sec. Sec. 1.22 and 1.23, which shall require residual

interest to exceed the sum of such margin deficits.

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\22\ The Commission also proposes to revise the title of the

``Secured Amount Schedule'' by adding the term ``30.7 Customer'' to

specify that the secured amount will include both U.S.-domiciled and

foreign-domiciled customers consistent with the proposed amendments

to Part 30 of the Commission Regulations discussed in Section II.R

below.

\23\ The NFA recently adopted a similar amendment to its rules,

mandating that its member FCMs maintain written policies and

procedures identifying a target amount that the FCM will seek to

maintain as its residual interest in customer segregated and secured

accounts. See NFA Notice I-12-14 (July 18, 2012), available at

http://www.nfa.futures.org/news/newsNotice.asp?ArticleID=4072.

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As more fully discussed in Section II.B below, proposed Sec. 1.11

will require each FCM that carries customer funds to determine a

necessary level of excess segregated and secured funds that the firm

should hold in segregated or secured accounts to ensure against

becoming undersegregated or undersecured as a result of the withdrawal

of proprietary funds from segregated or secured accounts. Each FCM is

required under proposed Sec. 1.11 to compute or determine the

necessary target of residual interest based upon appropriate due

diligence and consideration of various factors relating to the nature

of the FCM's business,\24\ including the type and general

creditworthiness of the customer base, the amount of the undermargined

customer accounts on any given day, and the volatility and liquidity of

the markets and products traded by customers.

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\24\ The term ``Cleared Swaps Customer Collateral'' is defined

in Sec. 22.1 to mean all money, securities, or other property

received by a futures commission merchant or by a derivatives

clearing organization from, for, or on behalf of a Cleared Swaps

Customer to margin a Cleared Swap or the settlement value of a

Cleared Swap, and includes any accruals on such Cleared Swap

transactions.

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The disclosure of the targeted amount of the FCM's residual

interest in segregated or secured accounts will allow the Commission

and DSRO to assess the size of the target relative to both the total

funds held in segregation or secured accounts and to compare the target

to other FCMs. Such information will assist the Commission and DSROs in

assessing the potential risk that a firm may become undersegregated or

undersecured, and will enhance the Commission's and DSRO's ability to

protect customer funds.

The Commission also is proposing to revise Form 1-FR-FCM to adopt a

new ``Statement of Cleared Swap Customer Segregation Requirements and

Funds in Cleared Swap Customer Accounts Under Section 4d(f) of the

Act'' (``Cleared Swaps Segregation Schedule''). The Commission is

proposing the Cleared Swaps Segregation Schedule to implement

provisions in section 724(a) of the Dodd-Frank Act.\25\ Section 724(a)

amended section 4d of the Act, and requires an FCM to segregate from

its own assets any money, securities and other property deposited by a

Cleared Swaps Customer to margin its cleared swaps positions. As part

of the implementation of section 724(a) of the Dodd-Frank Act, the

Commission adopted Sec. 22.2(g) which requires an FCM to compute, as

of the close of business each business day, a segregation computation

demonstrating compliance with its obligation to hold sufficient funds

in segregated accounts in an amount sufficient to cover the total Net

Liquidating Equity of each of the FCM's Cleared Swaps Customers.\26\

The proposed Cleared Swaps Segregation Schedule will be comparable to

the current Segregation Schedule and will allow the Commission and the

FCM's DSRO to obtain information on the FCM's holding of Cleared Swaps

Customer Collateral to ensure that such funds are held in accordance

with the provisions of Part 22 of the Commission's regulations and that

the FCM is reporting that it has sufficient funds in segregated

accounts to meet its obligations to all of its Cleared Swaps Customers

computed under the Net Liquidating Equity Method.

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\25\ See Dodd-Frank Wall Street Reform and Consumer Protection

Act, Public Law 111-203, 124 Stat. 1376 (2010). The text of the

Dodd-Frank Act may be accessed at http://www.cftc.gov/LawRegulation/OTCDERIVATIVES/index.htm.

\26\ See 77 FR 6336 (February 7, 2012).

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The Commission previously proposed a Cleared Swaps Segregation

Schedule as part of its proposed regulations to adopt capital

requirements for swap dealers and major swap participants.\27\ In light

of the Commission's decision to revise the Cleared Swaps Segregation

Schedule from the version that was published for comment as part of the

Commission's proposed capital rules for swap dealers and major swap

participants by requiring the FCM to separately disclose its targeted

residual interest in Cleared Swaps Customer Accounts and the sum of

margin deficits for such accounts, the Commission is republishing the

Cleared Swaps Segregation Schedule as part of this proposal to provide

the public with an opportunity to comment on the proposal.\28\

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\27\ See Capital Requirements of Swap Dealers and Major Swap

Participants, 76 FR 27802 (May 12, 2011).

\28\ Regulation 1.10(h) provides that a dually-registered FCM/BD

may file a FOCUS Report in lieu of the Form 1-FR-FCM provided that

all information that is required to be included in the Form 1-FR-FCM

is included in the FOCUS Report. Currently, dual-registrant FCM/BDs

include a Segregation Schedule and a Secured Amount Schedule in the

FOCUS Report filings as supplemental schedules. If the Commission

were to adopt a Cleared Swaps Segregation Schedule, dual-registrant

FCM/BDs would have to include such schedule in their Focus Report

filings.

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The Commission also is proposing to amend Sec. 1.10(g)(2) to

provide that the Cleared Swaps Segregation Schedule is a public

document. Regulation 1.10 currently provides that the Commission will

treat the monthly Form 1-FR-FCM

[[Page 67873]]

reports and monthly FOCUS Reports as exempt from mandatory public

disclosure for purposes of the Freedom of Information Act and the

Government in the Sunshine Act, except for certain capital numbers and

other financial information including the Segregation Schedules and the

Secured Amount Schedules contained in the financial reports. The

Commission is proposing to amend Sec. 1.10(g)(2) to provide that the

Cleared Swaps Segregation Schedule is a public document in the same

manner as the Segregation Schedule and Secured Amount Schedule, and is

available by requesting copies from the Commission.

Making the Cleared Swaps Segregation Schedule publicly available

will benefit customers and potential customers by allowing them to

review an FCM's compliance with its regulatory obligations and will

provide a certain amount of detail as to how the FCM holds customer

funds, which customers and potential customers will be able to assess

from a risk perspective and also use to compare to other firms. This

information, coupled with additional firm risk disclosures that the

Commission is proposing in Sec. 1.55 and discussed in detail in

Section II.P below, will provide customers with greater transparency

regarding the risks of entrusting their funds and engaging in

transactions with particular FCMs. Customers also will be able to view

the total amount of the targeted residual interest each FCM holds and

to assess for themselves the adequacy of the targeted residual interest

and whether the FCM holds funds in excess of the targeted residual

interest.

The Commission also is proposing to amend several statements in the

Form 1-FR-FCM. The Commission is proposing to amend the Statement of

Financial Condition by adding a new line item 1.D. Line 1 currently

separately details the amount of funds in segregation or separate

accounts for futures customers and foreign futures or foreign option

customers. Proposed line item 1.D. will set forth the amount of funds

held by the FCM in segregated accounts for Cleared Swaps Customers.

This amendment is necessary due to the adoption of the Part 22

regulations, which require the segregation of Cleared Swaps Customer

Collateral and the proposed adoption of the Cleared Swaps Segregation

Schedule as part of the Form 1-FR-FCM.

The Commission also is proposing to amend the Statement of

Financial Condition by adding a new line item 22.F., which requires the

separate disclosure of the FCM's liability to Cleared Swaps Customers.

The Commission also is proposing to revise current line item 27.J. to

require the FCM to disclose its obligation to retail forex customers.

Currently, an FCM's obligation to retail forex customers is included

with other miscellaneous liabilities and reported under current line

item 27.J. ``Other.'' The separate reporting of an FCM's retail forex

obligation will provide greater transparency on the Statement of

Financial Condition regarding the firm's obligations to its retail

counterparties in off-exchange foreign currency transactions, and is

appropriate given the Commission's direct jurisdiction over such

activities under section 2(c) of the Act when conducted by an FCM.

The Commission also is proposing to amend Sec. 1.10(b)(1)(ii) to

require that an FCM submit its certified annual report to the

Commission and to its DSRO within 60 days of its year-end date.

Currently, an FCM is required to submit the annual certified financial

statements within 90 days of the firm's year-end date, except for FCMs

that are dually-registered as FCM/BDs, which are require to submit the

certified annual report within 60 days of the year-end date under both

Commission and SEC regulations. Therefore, the proposal will only

impact FCMs that are not dually-registered as BDs.

The proposal will align the filing deadlines for both FCMs and dual

registrant FCMs/BDs. The annual certified financial report is a key

component of the Commission's and DSROs' financial surveillance

program, as it represents that an independent entity has conducted an

audit following U.S. generally accepted auditing standards for the

purpose of expressing an opinion on the financial statements of the

FCM. Requiring standalone FCMs to submit the certified financial

statements within 60 days of the firm's year-end date will allow

Commission and DSRO staff to review the financial statements on a more

timely basis to identify and address accounting or auditing issues that

may impact the financial condition of the FCM.

In addition, the Commission notes that, pursuant to Sec.

3.3(f)(2), the annual report of an FCM's CCO must be furnished

electronically to the Commission simultaneously with the submission of

Form 1-FR-FCM, as required under Sec. 1.10(b)(2)(ii); simultaneously

with the FOCUS Report, as required under Sec. 1.10(h); or

simultaneously with the financial condition report, as required under

section 4s(f) of the Act, as applicable. Given the 60-day deadline

proposed herein, the Commission is proposing a conforming amendment to

Sec. 3.3(f)(2) to reflect the proposed 60-day deadline.

The Commission is proposing to add a new requirement in Sec.

1.10(b)(5) to require each FCM to file with the Commission on a monthly

basis its balance sheet leverage ratio. FCMs currently are required to

file the same leverage information with the NFA on a monthly basis. The

Commission does not expect the imposition of this regulation to have

any significant impact on the FCMs as the ratio is calculated from

existing reported balances and already provided to NFA.

The leverage ratio will provide information regarding the amount of

assets supported by the FCM's capital base. The Commission views

leverage information as an important element in assessing the financial

condition of an FCM as a high degree of balance sheet leverage may

indicate that the firm does not have the capital to support its

investment decisions, particularly if such investments loose a

significant amount of their value in a short period of time or require

substantial margin payments or other payments to support.

The Commission also is proposing to amend Sec. 1.10(c)(2)(i) to

require that all monthly unaudited Forms 1-FR-FCM or FOCUS Reports be

filed electronically with the Commission. The Commission also is

proposing to amend Sec. 1.10(c)(2)(i) to require an FCM to file its

certified financial statement in electronic format.

FCMs currently file the monthly unaudited financial statements with

the Commission using the WinJammer Online Filing System (``WinJammer'')

electronic filing system, and the proposed amendments are simply

codifying current practices.\29\ Annual certified financial reports

currently are required to be filed in paper form, and are required to

contain the manual signature of the public accountant that conducted

the examination. Under the Commission's proposal, an FCM will use the

WinJammer system to file its certified financial report as a ``PDF''

document. The electronic filing of certified annual reports will ensure

that such documents are received in a timely manner and will allow

Commission staff to initiate prompt reviews of the public accountant's

report to identify any accounting issues or material inadequacies that

might have been identified during the examination. The

[[Page 67874]]

timely review of the certified financial statements will enhance

customer protections as deficiencies and other accounting issues will

be promptly identified and reviewed.

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\29\ WinJammer is a web-based application developed jointly by

the Chicago Mercantile Exchange (``CME'') and the NFA. FCMs

currently use WinJammer to transmit Forms 1-FR-FCM, FOCUS Reports,

and other financial information and regulatory notices to the

Commission and to the SROs.

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The Commission also is proposing a technical amendment to Sec.

1.10(c)(1). Regulation 1.10(c)(1) provides that any report or

information required to be provided to the Commission by an IB or FCM

will be considered filed when received by the Commission Regional

office with jurisdiction over the state in which the FCM has its

principal place of business. To ensure that reports are filed

expeditiously with the correct Commission Regional office, the

Commission's proposed amendment to Sec. 1.10(c)(1) cross-references

Sec. 140.02, which sets forth the jurisdiction of each of the

Commission's three Regional offices.

The Commission requests comment on all aspects the proposed

amendments to Sec. 1.10. Specifically, the Commission requests

comments on the following questions:

Should other schedules in the Form 1-FR-FCM be amended to

provide additional information to the Commission and the FCM's SROs?

The Commission is proposing to require FCMs to submit to

the Commission and the firm's DSRO a monthly computation of the FCM's

balance sheet leverage. The proposal is consistent with the leverage

computation set forth in the rules of the NFA. Are there other measures

of leverage that the Commission should consider adopting? Are there

other financial statement ratios in addition to leverage that the

Commission should consider requiring FCMs to submit to the Commission

and DSROs?

B. Proposed Sec. 1.11: Risk Management Program for Futures Commission

Merchants

Proposed Sec. 1.11 requires each FCM that carries customer

accounts \30\ to establish a risk management program designed to

monitor and manage the risks associated with the FCM's activities as an

FCM. It further provides: (1) That such risk management program consist

of written policies and procedures; (2) that such policies and

procedures be approved by the governing body of the FCM and be

furnished to the Commission; and (3) that a risk management unit that

is independent from the business unit be established to administer the

risk management program.

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\30\ Proposed Sec. 1.11 contains an applicability provision in

paragraph (a) that makes clear that the risk management program is

only required of FCMs that accept money, securities, or property to

margin or secure the trades or contracts of customers transacting in

futures, options on futures, and swaps.

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Paragraph (b) of proposed Sec. 1.11 establishes definitions for

the terms ``Customer,'' ``Customer Account,'' ``Business Unit,''

``Governing Body,'' ``Segregated Funds,'' and ``Senior Management.''

``Business Unit'' is defined to clearly delineate the separation of

the risk management unit required by the proposed rule from the other

personnel of an FCM.

The term ``Customer'' is defined broadly to include futures

customers (as defined in Sec. 1.3) trading futures contracts or

options on futures contracts listed on designated contract markets,

30.7 Customers (as proposed to be defined in Sec. 30.1) trading

futures contract or options on futures contracts listed on foreign

contract markets, and Cleared Swaps Customers (as defined in Sec.

22.1) engaging in cleared swap transactions.

The term ``Customer Funds'' is defined to mean funds deposited by

futures customers, 30.7 Customers, and Cleared Swap Customers as margin

or funds accruing to such customers from open futures or cleared swap

transactions. Existing Commission regulations require FCMs to hold each

of these types of customer deposited funds, as applicable, in separate

accounts and to segregate such Customer Funds from the FCM's own funds

and from each other type.

The term ``Governing Body'' is defined as the sole proprietor, if

the FCM is a sole proprietorship; a general partner, if the FCM is a

partnership; the board of directors, if the FCM is a corporation; and

the chief executive officer, chief financial officer, the manager, the

managing member, or those members vested with the management authority

if the FCM is a limited liability company or limited partnership.

``Senior Management'' is defined to mean any officer or officers

specifically granted the authority and responsibility to fulfill the

requirements of senior management by the Governing Body. These

definitions, as used in proposed Sec. 1.11, are designed to ensure

that there is accountability at the highest levels for the FCM's key

internal controls and processes designed to protect the funds of the

FCM's customers.

The term ``Segregated Funds'' is defined to mean money, securities,

or other property held by a futures commission merchant in separate

accounts pursuant to Sec. 1.20 for futures customers, pursuant to

Sec. 22.2 for cleared swaps customers, and pursuant to Sec. 30.7 for

foreign futures and options customers. The definition makes clear that

the requirements of Sec. 1.11 applies to all customer funds that may

be held by an FCM.

Proposed Sec. 1.11(c)(4) requires FCMs to provide copies of the

risk management policies and procedures to the Commission and the FCM's

DSRO in order to allow the Commission and DSROs to monitor the status

of risk management practices among FCMs. Submission of such policies

and procedures to the Commission without further comment or action by

the Commission or Commission staff should not be construed as an

endorsement of the completeness or effectiveness of the risk management

policies and procedures and no FCM should make a representation to the

contrary. The Commission invites comments on the submission of risk

management policies and procedures and, more generally, on whether the

provisions of Sec. 1.11 have achieved a sufficient level of detail for

the purposes of designing a comprehensive risk management program.

Proposed Sec. 1.11(e) provides for a non-exclusive list of the

elements that must be a part of the risk management program of an FCM.

Such policies and procedures should include: (1) identifying risks

(including risks posed by affiliates, all lines of business of the FCM,

and all other trading activity of the FCM) and setting of risk

tolerance limits; (2) providing periodic risk exposure reports to

senior management and the governing body; (3) operational risk

controls; (4) capital controls; and (5) establishing a risk management

program that takes into account risks associated with the safekeeping

and segregation of customer funds.

In regard to customer funds, the Commission notes that FCMs are

required by the Act and Commission regulations to segregate and

safeguard funds deposited by customers for trading futures and/or swap

contracts. Recent events have emphasized that it is essential that FCMs

maintain adequate systems of internal controls, involving the

participation and review of the firm's senior management, in order to

properly safeguard customer funds. Accordingly, proposed Sec.

1.11(e)(3)(i) requires that the risk management policies and procedures

of an FCM related to the risks associated with safekeeping and

segregation of customer funds must include: (1) The evaluation and

monitoring of depositories; \31\ (2)

[[Page 67875]]

account opening procedures that ensure the FCM obtains the

acknowledgment required under Sec. 1.20 from the depository and that

the account is properly titled as belonging to the customers of the

FCM; \32\ (3) establishing and maintaining an adequate targeted amount

of excess funds in customer accounts reasonably designed to ensure the

FCM is at all times in compliance with the segregation requirements for

customer funds under the Act and Commission regulations, as discussed

further below; (4) controls ensuring that withdrawal of cash,

securities, or other property from accounts holding customer funds not

for the benefit of customers are in compliance with the Act and

Commission regulations; \33\ (5) procedures for assessing the

appropriateness of investing customer funds in accordance with Sec.

1.25; \34\ (6) the valuation, marketability, and liquidity of customer

funds and permitted investments made with customer funds; (7) the

appropriate separation of duties of personnel responsible for

compliance with the Act and Commission regulations relating to the

protection and financial reporting of customer funds; \35\ (8)

procedures for the timely recording of transactions in the firm's books

and records; and (9) annual training of personnel responsible for

compliance with the Act and Commission regulations relating to the

protection and financial reporting of customer funds.

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\31\ The evaluation process must include documented criteria

that any depository will be assessed against in order to qualify to

hold funds belonging to Customers. The criteria must address a

depository's capitalization, creditworthiness, operational

reliability, access to liquidity. The criteria must also address

risks associated with concentration of Customer funds in any

depository or group of depositories, the availability of deposit

insurance, and the regulation and supervision of depositories. The

evaluation criteria is intended to ensure that the FCM adopts an

evaluation process which reviews potential depositories against

substantive criteria relevant to the safe custody of Customer funds

and that the FCM's process for evaluating and selecting depositories

can be reviewed by regulators and auditors. The FCM also must

maintain a documented process addressing the ongoing monitoring of

selected depositories, including a thorough due diligence review of

each depository at least annually.

\32\ As required by Sec. 1.20, such account opening

documentation is necessary to ensure that the depositories are aware

of their obligations regarding the accounts and the statutory and

regulatory protections afforded the funds held in the accounts due

to their status as Segregated Funds.

\33\ The controls must include the conditions for pre-approval

and the notice to the Commission for such withdrawals required by

proposed Sec. 1.23, Sec. 22.17, or Sec. 30.7, discussed below.

\34\ The FCM's assessment must take into consideration the

market, credit, counterparty, operational, and liquidity risks

associated with the investments.

\35\ The policies and procedures must provide for the separation

of duties among personnel that are responsible for customer trading

activities, and approving and overseeing cash receipts and

disbursements (including investment and treasury operations). The

policies and procedures must further require that any movement of

funds to affiliated companies or parties be approved and documented.

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Regarding the proposed requirement that FCMs establish and maintain

an adequate targeted amount of excess funds in customer accounts, the

Commission notes that FCMs currently deposit proprietary funds into

both customer segregated accounts and Part 30 secured accounts as a

buffer to minimize the possibility of the firm being in violation of

its segregated and secured fund obligations at any time. Under the

proposal, senior management of the FCM must perform appropriate due

diligence in setting the amount of this buffer and must consider the

nature of the FCM's business including the type and general

creditworthiness of its customer base, the types of markets and

products traded by the firm's customers, the proprietary trading

activities of the FCM, the volatility and liquidity of the markets and

products traded by the customers and the FCM, the FCM's own liquidity

and capital needs, and historical trends in customer segregation and

secured account funds balances, customer debits and margin deficits.

The FCM also must reassess the adequacy of the targeted residual

interest quarterly.

The Commission believes that each FCM must set the amount of excess

segregated and secured funds required utilizing a quantitative and

qualitative analysis that reasonably ensures compliance at all times

with segregated and secured fund obligations. Such analysis must take

into account the various factors that could affect segregated and

secured balances, and must be sufficiently described in writing to

allow the DSRO of the FCM and Commission to duplicate the calculations

and test the assumptions. The analysis must provide a reasonable level

of assurance that the excess is at an appropriate level for the

FCM.\36\ A failure to adopt or maintain appropriate risk management

policies and procedures or to implement, monitor and enforce controls

required by Sec. 1.11 may result in a referral to the Commission's

Division of Enforcement for appropriate action.

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\36\ Separate from requiring the establishment of a target for

residual interest, the Commission is further requiring, as discussed

in more detail under Sections II.G, II.H, and II.I for Sec. Sec.

1.20, 1.22, and 1.23, respectively, that residual interest at all

times exceed the sum of outstanding margin deficits to provide a

mechanism for ensuring compliance with the prohibition of the funds

of one customer being used to margin or guarantee the positions of

another customer under the Act and existing regulations.

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Finally, to ensure the effectiveness of a risk management program,

Sec. 1.11(e)(4) requires that the risk management program include a

supervisory system that is reasonably designed to ensure that the risk

management policies and procedures are diligently followed.

Furthermore, Sec. 1.11(f) requires an annual review and testing of the

adequacy of each FCM's risk management program by internal audit staff

or a qualified external, third party service.

The Commission requests comment on all aspects of proposed Sec.

1.11. Specifically, the Commission requests comment on the following:

Should the Commission have different risk management

requirements for FCMs based upon some measureable criteria, such as

size of the firm or type of customers? How would the Commission design

such criteria to distinguish between firms? Which elements in proposed

Sec. 1.11 should apply to smaller FCMs vs. larger FCMs? What elements

should apply to all FCMs irrespective of the size of the firm?

Does the proposed risk management program address the

appropriate minimum elements that should be covered by an FCM risk

management program?

Regulation 3.3 requires the CCO of an FCM to provide an

annual report to the Commission that must review each applicable

requirement under the Act and Commission regulations, and with respect

to each applicable requirement, identify the policies and procedures

that are reasonably designed to ensure compliance with the requirement,

and provide an assessment of the effectiveness of the policies and

procedures.\37\ The annual report also must include a certification by

the CCO that, to the best of his or her knowledge and reasonable

belief, and under penalty of law, the information contained in the

annual report is accurate and complete. The Commission requests comment

on whether the standard for the CCO's certification in the annual

report (i.e., based upon the CCO's knowledge and reasonable belief) is

adequate for a certification of the FCM's compliance with policies and

procedures for the safeguarding of customer funds. Should Sec. 1.11

contain a separate CCO certification requirement

[[Page 67876]]

that would impose a higher duty of strict liability or some other

higher obligation on a CCO?

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\37\ Such report is mandated by Sec. 3.3 of the Commission's

regulations; See Swap Dealer and Major Swap Participant

Recordkeeping, Reporting, and Duties Rules; Futures Commission

Merchant and Introducing Broker Conflicts of Interest Rules; and

Chief Compliance Officer Rules for Swap Dealers, Major Swap

Participants, and Futures Commission Merchants, 77 FR 20128, Apr. 3,

2012 (promulgating final rules concerning the CCOs of FCMs, swap

dealers, and major swap participants); see also Sec. 4d(d) of the

Act, 7 U.S.C. 6d(d).

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Should the risk management program require an FCM to

conduct quarterly or periodic audits to detect any breach of the

policies and procedures that address the proper segregation of customer

funds?

Should the Commission establish a phased-in compliance

provision for Sec. 1.11? If so, how long of a phase-in period should

be provided? Should there be different phase-in periods for different

provisions of the proposed regulation?

C. Proposed Amendments to Sec. 1.12: Maintenance of Minimum Financial

Requirements by Futures Commission Merchants and Introducing Brokers

The regulatory notices required under Sec. 1.12 are intended to

provide the Commission and SROs with prompt notice of potential adverse

conditions at FCMs or IBs that may indicate or lead to a threat to the

financial condition of the firm or the protection of customer funds

held by the FCM. In adopting Sec. 1.12 in 1978, the Commission stated

that the establishment of an early warning system was necessary because

``[a] fundamental purpose of the Act is to protect the public from

financially irresponsible FCMs who handle customer funds.'' \38\

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\38\ 43 FR 39956, 39967 (Sept. 8, 1978).

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Regulation 1.12 currently obligates FCMs and IBs to provide notice

to the Commission and to the respective DSROs if certain specified

reportable events occur. Reportable events include: failing to maintain

the minimum level of required regulatory capital (Sec. 1.12 (a));

failing to maintain current books and records (Sec. 1.12(c)); and

failing to comply with the requirements to properly segregate customer

funds (Sec. 1.12(h)). The Commission is proposing to amend Sec. 1.12

to include several additional reportable events and to revise the

process for submitting reportable events to the Commission and DSROs.

Regulation 1.12(a) requires an FCM or IB that fails to maintain the

minimum level of adjusted net capital required by Sec. 1.17 to provide

immediate notice to the Commission and to the entity's DSRO. The notice

must include additional information to adequately reflect the FCM's or

IB's current capital condition as of any date that the entity is

undercapitalized.

The Commission is proposing to amend Sec. 1.12(a) to explicitly

provide that if the FCM or IB cannot compute or document its actual

capital at the time it knows that it is undercapitalized, it must still

provide the written notice required by Sec. 1.12(a) immediately and

cannot delay filing the notice until it has adequate information to

compute its actual level of adjusted net capital. A purpose of the

notice provision under Sec. 1.12(a) is to provide the Commission and

the DSROs with immediate notice of the undercapitalized condition of an

FCM or IB. If an FCM or IB were to delay alerting the Commission that

it was undercapitalized due to the fact that it could not accurately

assess its capital condition, it would frustrate the intent of the

notice provision. It is imperative that an FCM or IB provide immediate

notice if the firm is undercapitalized. Upon the filing of a notice,

Commission and SRO staff will contact the FCM or IB to obtain greater

details of the financial condition of the firm, including information

regarding its current financial condition or issues associated with the

firm's inability to accurately determine its current financial

condition.

Regulation 1.12(h) currently requires an FCM that fails to hold

sufficient funds in segregated accounts to meet its obligations to

futures customers, or that fails to hold sufficient funds in separate

accounts for foreign futures or foreign options customers, to provide

immediate notice to the Commission and to the FCM's DSRO. The

Commission is proposing to amend paragraph (h) to include an explicit

requirement that an FCM provide immediate notice to the Commission and

to its DSRO if the FCM fails to hold sufficient funds in segregated

accounts for Cleared Swaps Customers to meet its obligation to such

customers.

Commencing November 8, 2012, the compliance date for certain

Commission Part 22 regulations, FCMs will be required under Sec. 22.2

to hold a sufficient amount of funds in Cleared Swaps Customer Accounts

to meet the Net Liquidating Equity of each Cleared Swaps Customer.\39\

Immediate notification of a failure to hold sufficient funds in

segregation for Cleared Swaps Customers is essential for the Commission

and DSROs to promptly assess the financial condition of an FCM and to

determine if there are threats to the safety of the Cleared Swaps

Customers' funds held by the FCM. The proposed amendment to Sec.

1.12(h) also harmonizes the notice requirements whenever an FCM fails

to hold sufficient funds for futures customers, 30.7 Customers, and

Cleared Swaps Customers.

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\39\ 77 FR 6336 (Feb. 7, 2012).

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The Commission also is proposing to amend Sec. 1.12 by adding new

paragraph (i) to require an FCM to provide notice whenever it discovers

or is informed that it has invested funds held for customers in

investments that are not permitted investments under Sec. 1.25, or if

the FCM holds permitted investments in a manner that is not in

compliance with the provisions of Sec. 1.25 (such as the investment

concentration limits). The proposal will apply to funds held for

futures customers, 30.7 Customers, and Cleared Swaps Customers.

The protection of customer funds is a core element of the

Commission's regulatory program. FCMs are entrusted with a

responsibility to use customer funds only for the benefit of the

depositing customers.\40\ FCMs are permitted, however, to invest

customer funds pursuant to the standards and conditions set forth in

Sec. 1.25. Regulation 1.25 contains a list of permitted investments

and other criteria that are intended to allow an FCM to receive the

benefit of investing customer funds while also preserving the principal

and maintaining the liquidity of the customer funds.

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\40\ Regulation 1.20(a), 17 CFR 1.20(a).

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Requiring an FCM to provide prompt notice of a Sec. 1.25 violation

will allow Commission and DSRO staff to assess whether customer funds

are endangered and to work with the FCM to ensure that the

impermissible investments are appropriately liquidated and customer

funds remain intact. Commission and DSRO staff also will benefit from

receiving notices of Sec. 1.25 violations in that the notices will

provide information regarding new investments that FCMs may engage in

that are not permitted investments under Sec. 1.25. Such information

will be helpful for the Commission and DSRO in conducting reviews of

other FCMs and in providing regulatory updates to the industry.\41\

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\41\ The Commission further notes that investing customer funds

in investments that are not permitted investments under Sec. 1.25,

or holding investments in a manner that is otherwise not compliant

with Sec. 1.25 does not change the legal status of the funds as

customer funds in the event of the bankruptcy of the FCM.

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The Commission also is proposing to amend Sec. 1.12 to provide a

new paragraph (j) that will require an FCM to provide immediate notice

to the Commission and to the firm's DSRO if the FCM does not hold an

amount of funds in segregated accounts for futures customers or for

Cleared Swaps Customers, or if the FCM does not hold sufficient funds

in separate accounts for 30.7 Customers, sufficient to meet the firm's

targeted residual interest in one or more of these accounts as computed

[[Page 67877]]

under proposed Sec. 1.11, or if its residual interest in one or more

of these accounts is less than the sum of outstanding margin deficits

for such accounts. Proposed Sec. 1.11 will require each FCM that

carries customer funds to calculate an appropriate amount of excess

funds (i.e., proprietary funds) to hold in segregated or secured

accounts to mitigate the FCM from being undersegregated or undersecured

due to a withdrawal of proprietary funds from a segregated or secured

account. The fact that an FCM is not holding a sufficient amount of

excess funds in customer accounts to meet its targeted residual

interest may be indicative of more severe financial or operational

issues at the firm. In addition, if an FCM's residual interest is less

than the sum of outstanding margin deficits in one such account, it is

possible that funds of one customer in such account are at risk of

margining or guaranteeing the open positions of another customer.

Accordingly, the Commission is proposing to require an FCM to file

immediate notice of such an event to allow Commission and DSRO staff to

contact the FCM to assess the condition of the firm and the safety of

customer funds.

The Commission also is proposing new paragraphs (k) and (l) for

Sec. 1.12. Paragraphs (k) and (l) will require an FCM to provide

notice to the Commission and to the firm's DSRO in the event of a

material adverse impact in the financial condition of the firm or a

material change in the firm's operations. Proposed paragraph (k) will

require an FCM to provide immediate notice if the FCM, its parent, or a

material affiliate, experiences a material adverse impact to its

creditworthiness or its ability to fund its obligations. Indications of

a material adverse impact of an FCM's creditworthiness may include a

bank or other financing entity withdrawing credit facilities, a credit

rating downgrade, or the FCM being placed on ``credit watch'' by a

credit rating agency. Proposed paragraph (l) will require an FCM to

provide immediate notice of material changes in the operations of the

firm, including: A change in senior management; the establishment or

termination of a material line of business; a material change in the

FCM's clearing arrangements; or a material change in the FCM's credit

arrangements. Paragraph (l) is intended to provide the Commission with

notice of material events, such as the departure of the FCM's CCO, CFO,

or CEO.

As noted above, Sec. 1.12 is intended to provide the Commission

and DSROs with notice of potential issues that may impact the financial

condition of an FCM or the safety of customer funds. The regulatory

objective is for FCMs to provide material information to the Commission

and DSROs as early as possible so that the Commission and DSROs can

assess the information and communicate with the FCMs prior to a more

serious issue developing that may impair the financial condition of the

firms or the safety of customer funds. Proposed paragraphs (k) and (l)

will provide the Commission and DSROs with notice of major events that

will initiate a dialogue between the Commission, DSROs, and FCMs which

will have the benefit of informing the Commission and DSROs of material

events impacting FCMs. Such information would be used by the Commission

and DSROs in setting the scope of the review and monitoring of the

FCMs, including the determination of the risk of the firms for purposes

of scheduling future examinations. Without paragraphs (k) and (l), the

Commission and DSROs may not learn of material events at FCMs until the

firms are subject to periodic examinations.

The Commission is proposing to add a new paragraph (m) to Sec.

1.12 that will require an FCM that receives a notice, examination

report, or any other correspondence from the SEC or a SRO to file a

copy of such notice, examination report, or correspondence with the

Commission. In order to perform comprehensive oversight of an FCM, the

Commission and the DSROs need to receive prompt notice of any concern

or adverse action taken by the SEC or a securities SRO. The protection

of futures customers funds are not immune from issues that arise from

the securities operations or business of a dual registrant FCM/BD.

Requiring an FCM to provide prompt notice to the Commission and the

firm's DSRO of any notice, examination report, or correspondence that

the firm receives from the SEC or a securities SRO will allow the

Commission and the DSRO to identify potential threats to the safety of

customer funds.

The Commission is further proposing to amend the process that an

FCM uses to file the notices required by Sec. 1.12. Currently, Sec.

1.12 requires an FCM to provide the Commission and DSROs with

telephonic and facsimile notice in some situations, and to provide

written notice by mail in other situations. An FCM also is permitted,

but not required, to file notices and written reports with the

Commission and with its DSRO using an electronic filing system in

accordance with instructions issued by or approved by the Commission.

The Commission is proposing to amend Sec. 1.12(n) to require that

all notices and reports filed by an FCM with the Commission or with the

FCM's DSRO must be in writing and submitted using an electronic filing

system. Each FCM currently uses WinJammer to file regulatory notices

with the Commission and with the firm's DSRO. The WinJammer system

provides for the most effective mechanism for ensuring that regulatory

notices are promptly received by the Commission and by the DSROs.\42\

The regulation further provides that if the FCM cannot file a notice

due to the electronic system being inoperable or for any other reason,

it must contact the Commission Regional office with jurisdiction over

the firm and make arrangements for the filing of the regulatory notices

by filing the notice with the Commission via electronic mail at a

specially designated email address established by the Commission;

[email protected] The Commission also is proposing to amend Sec.

1.12(n) to require that each notice filed by an FCM, IB, or SRO under

Sec. 1.12 must include a discussion of what caused the reportable

event, and what steps have been, or are being taken, to address the

reportable event. The reporting entity, however, may not delay the

reporting of a reportable event if it does not possess complete

information on what caused the event, or the steps that have been taken

or are being taken to address the event.

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\42\ The Commission's proposed amendment to require the

electronic filing of reports applies to both registered FCMs and

applicants for registration as FCMs. Applicants for FCM registration

currently file regulatory notices with NFA using WinJammer.

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The amendments to Sec. Sec. 1.12(b), (d), (e), (f) and (g) are

necessary and technical in nature, and primarily revise internal cross-

references to the filing requirements in Sec. 1.12(n).

The Commission request comment on all aspects of the proposed

amendments to Sec. 1.12. Specifically, the Commission requests comment

on the following:

Are there other reportable events that the Commission

should consider adding to Sec. 1.12 that would benefit the Commission

and the DSROs in the monitoring of the financial and operating

conditions of FCMs?

Should the Commission consider removing any of the

reportable events listed in Sec. 1.12? If so, why?

Should any of the reportable events be made public by the

Commission, SROs, or FCMs? If so, which reportable events? What benefit

would the public receive from the disclosure of the reportable events?

What would be the costs of disclosing the reportable events to the

FCMs? Are there any negative

[[Page 67878]]

impacts of disclosing the reportable events?

Are the reporting standards in proposed paragraphs (k) and

(l) adequately detailed and objective so that an FCM can determine when

there is a reportable event? If not, what standards should the

Commission use to define a reportable event under paragraphs (k) and

(l)?

D. Proposed Amendments to Sec. 1.15: Risk Assessment Reporting

Requirement for Futures Commission Merchants

Regulation 1.15 requires FCMs to submit certain risk assessment

reports to the Commission. The risk assessment filings include FCM

organizational charts; financial, operational, risk management

policies, and systems maintained by the FCM; and fiscal year-end

consolidated and consolidating financial information for the FCM and

its highest level material affiliate.

The Commission is proposing to amend Sec. 1.15(a)(4) to require

each FCM that is subject to Sec. 1.15 to submit its risk assessment

information to the Commission electronically in accordance with

instructions issued by the Commission. The Commission intends for FCMs

to file the risk assessment materials using the WinJammer electronic

filing system. The Commission requests comments on its proposed

amendments to Sec. 1.15.

E. Proposed Amendments to Sec. 1.16: Qualifications and Reports of

Accountants

Regulation 1.16 sets forth the qualifications a public accountant

must possess in order to conduct audits of Commission registrants.

Currently, a public accountant must be registered and in good standing

under the laws of the place of the public accountant's principal office

in order to conduct examinations of FCMs.

The Commission is proposing to amend Sec. 1.16(b)(1) to require

that the public accountant be registered with the Public Company

Accounting Oversight Board (``PCAOB'') in addition to being in good

standing with the relevant state licensing authorities. In addition,

the public accountant must have undergone an examination by the PCAOB

and any deficiencies noted during such examination must have been

remediated to the satisfaction of the PCAOB. Regulation Sec.

1.16(b)(4) also will impose an obligation on an FCM's governing body to

ensure that a public accountant is qualified to perform an audit of the

FCM by assessing the firm's experience in auditing FCMs, the firm's

experience and knowledge of the Act and Commission regulations, and the

depth and experience of the firm's auditing staff.

The Commission also is proposing to amend Sec. 1.16(c)(2) to

require a public accountant to state in the audit opinion whether the

audit was conducted in accordance with U.S. GAAS after full

consideration of the auditing standards adopted by the PCAOB.

Currently, all audits of the certified financial statements of FCMs

must be performed under U.S. GAAS. However, as the Commission is now

proposing that certified public accountants must be registered with the

PCAOB, it is necessary to also require that the auditing standards

promulgated by the PCAOB be considered and adhered to where applicable.

PCAOB requires auditors opining on a public company financial

statements to comply with all applicable auditing standards, including

PCAOB standards; whereas U.S. GAAS is required for the audits of non-

public companies.

In 2003, the PCAOB adopted existing U.S. GAAS as interim standards,

subject to periodic revision as the PCAOB deemed necessary. Since that

time, the PCAOB has issued its own auditing standards in areas of the

audit in which differentiated audit procedures or reporting

requirements have been considered necessary. These areas largely

pertain to audits of internal control over financial reporting as well

as reports on those controls, audit documentation and engagement

quality review. Generally speaking, the most significant difference

between U.S. GAAS and PCAOB standards relates to the auditor's testing

of internal controls over financial reporting which are meant to cover

the auditor's opinion on the Sarbanes-Oxley Act Section 404 report on

internal controls. From a regulatory perspective, an auditor's focus on

internal controls is critical to helping to ensure that material errors

in financial or regulatory reporting are identified on a timely basis,

and the PCAOB standards provide more focus on the auditing standards in

this regard. It should also be noted that auditors of BDs are now

required to register with the PCAOB and follow PCAOB standards; thus,

any dually-registered FCM/BDs will already have to comply with this

requirement.

The proposed amendments to Sec. Sec. 1.16(b)(1) and (c)(2) are

designed to reasonably ensure the quality and competence of public

accountants that engage in the audits of FCMs. FCMs are sophisticated

financial market participants that are subject to extensive regulation.

In addition, the complexity of FCM audits is increased substantially

when a firm is engaged in proprietary trading or dually-registered as

an FCM/BD. Public accountants must be knowledgeable regarding the

business operations, regulatory obligations and financial reporting

requirements for FCMs, and the governing body of the FCM must ensure

that the public accountant has the knowledge, experience, and resources

to conduct the audits. Also, requiring the public accountant to be

registered with PCAOB will ensure that the public accountant is subject

to periodic reviews to assess its compliance with industry standards.

While the Commission does not expect the proposed PCAOB

registration requirement to have a material impact on FCMs, it

recognizes that not all FCMs currently use CPAs that are registered

with the PCAOB or CPAs that have been subject to an examination by the

PCAOB. Currently, 111 of the 116 FCMs are examined by CPAs that are

registered with the PCAOB. Also, 12 CPAs that are registered with the

PCAOB have not yet been subject to a PCAOB examination. These 12 CPAs

conduct examinations of 20 FCMs. Therefore, currently 25 of the 116

FCMs would not satisfy the proposed requirement that only PCAOB-

registered CPAs that have been subject to at least one PCAOB review may

be engaged to conduct an examination of the FCM's financial

statements.\43\

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\43\ The Commission further notes, however, that 7 of the 20

FCMs are audited by a PCAOB-registered CPA that also conducts audits

of BDs or public companies and, therefore, will be subject to PCAOB

examination at a future date.

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The Commission is proposing a technical amendment to Sec. 1.16 to

revise the definition of the term ``customer.'' Regulation 1.16 details

the standards that a public accountant must meet in conducting a

financial examination of an FCM. Currently, Sec. 1.16(a)(4) defines

the term ``customer'' to include futures customers, Cleared Swaps

Customers, and foreign futures or foreign options customers. The

Commission is proposing to amend Sec. 1.16(a)(4) to revise the

definition of customer to replace the term ``foreign futures or foreign

options customer'' with the term ``30.7 Customer'' to make the

provision consistent with the amendments contained in Part 30 of the

Commission's regulations.

The Commission also is proposing to amend paragraph (f)(1)(i)(C) of

Sec. 1.16 to provide that any filing of a notice of the extension of

time to file the audited financial reports must be submitted by the FCM

to the Commission using an electronic filing system. The Commission

intends for FCMs to use the WinJammer electronic filing system.

[[Page 67879]]

The Commission also is proposing to remove the requirement from

Sec. 1.16(c)(1) that annual financial reports contain the manual

signature of the public accountant. Under the proposed amendments to

Sec. 1.10 discussed above, FCMs will be filing annual financial

reports electronically, which will preclude the use of manual

signature.

The Commission requests comment on all aspects of proposed Sec.

1.16. Specifically, the Commission request comment on the following:

A purpose of the requirement that FCMs engage only CPAs

that are registered with the PCAOB and have been reviewed by the PCAOB

is to enhance the quality of the audit examination conducted by CPAs.

Does the PCAOB registration and examination process enhance the quality

of FCM audit engagements?

Are there viable alternatives that the Commission should

consider to enhance the quality of CPA FCM examinations in lieu of

PCAOB registration and examination?

Should the Commission consider allowing the non-PCAOB

registered CPAs or PCAOB-registered CPAs that have not been subject to

a PCAOB review to contractually engage for a peer review from a

qualified CPA who is aware of the reason for the peer review as a

short-term measure to allow the non-compliant CPAs to continue to

conduct audits of FCMs?

If the Commission adopts the PCAOB registration and

examination requirement, how should the Commission implement the

effective or compliance dates? What factors should the Commission

consider in setting an effective date or compliance date for this

provision?

F. Proposed Amendments to Sec. 1.17: Minimum Financial Requirements

for Futures Commission Merchants and Introducing Brokers

The Commission is proposing to amend Sec. 1.17 by adding a new

provision that will authorize the Commission to require an FCM to

transfer its customer business and cease operating as an FCM if the FCM

cannot immediately certify to the Commission, and demonstrate with

verifiable evidence, that the FCM has sufficient access to liquidity to

continue operating as a going concern. The Commission also is proposing

to amend Sec. 1.17 to permit an FCM that is not a dually-registered

FCM/BD to develop the framework proposed by the SEC, as set forth

below, to establish, maintain and enforce written policies and

procedures for determining creditworthiness, and upon a determination

that a particular type of security has minimal credit risk, to apply

lower deductions to such securities in computing the FCM's adjusted net

capital.

Section 4f(b) of the Act provides that no person may be registered

as an FCM unless such person meets the minimum financial requirements

that the Commission has established by regulation to ensure that an FCM

meets its obligations at all times as an FCM to its customer and to

market participants, including DCOs. The Commission's minimum capital

requirements for FCMs are set forth in Sec. 1.17 and generally require

an FCM to maintain adjusted net capital equal to or in excess of the

greater of: $1 million; 8 percent of the risk maintenance margin

required on customer and non-customer futures and options on futures

positions carried by the FCM; \44\ the amount of adjusted net capital

required by the NFA; or, for dual-registrants, the amount of net

capital required by the SEC. The term ``adjusted net capital'' is

generally defined as the FCM's net, liquid assets less all of the FCM's

liabilities (except certain qualifying subordinated debt). In computing

its adjusted net capital, an FCM is required to reduce the value of

proprietary futures and securities positions included in its liquid

assets by certain prescribed amounts or percentages of the market value

(otherwise known as ``haircuts'') to discount for potential adverse

market movements in the securities.

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\44\ The term ``noncustomer'' is generally defined under Sec.

1.17 as affiliates or management of an FCM.

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Commission Regulation 1.17(a)(4) currently provides that an FCM

must cease operating as an FCM and transfer its customers positions to

another FCM if the FCM is not in compliance with the minimum capital

requirements, or is unable to demonstrate its compliance with the

minimum capital requirements. The FCM, however, can initiate customer

trades for liquidation purposes only. Regulation 1.17(a)(4) further

provides that the Commission or the FCM's DSRO may grant the FCM up to

a maximum of 10 days to come back into compliance with the minimum

capital requirements without having to cease operating as an FCM or

transferring customer accounts.

The Commission is proposing to add an additional clause to Sec.

1.17(a)(4), which will specify that the Commission may request

certification in writing from an FCM that it has sufficient liquidity

to continue operating as a going concern, and that if such

certification is not provided immediately or the FCM is not able to

demonstrate its access to liquidity with verifiable evidence, the FCM

must transfer all customer accounts and immediately cease doing

business as an FCM. The proposed liquidity provision is intended to

cover circumstances that require immediate attention. The proposal is

not intended to provide a mechanism for the Commission to require FCMs

to demonstrate that they are a going concern for an extended period of

time into the future. Rather, the purpose of the proposal is to provide

the Commission with a means of addressing exigent circumstances by

requiring an FCM to produce a written analysis showing the sources and

uses of funds over a short period of time not to exceed one week.

The Commission believes this clause provides additional protection

to customers in the event of an imminent liquidity drain on a

registrant, which may not be immediately reflected in its accounting or

regulatory capital business records. Market events or other external

indicators may come to the attention of the Commission which suggest an

FCM is under severe liquidity stress, which demonstrates that although

the firm is still able to demonstrate compliance with required

regulatory capital, conditions are such that it will not be able to

meet liquidity requirements out a period of time not to exceed one

week. This provision will allow the Commission to essentially require

an FCM on demand to be able to certify its access to liquidity

sufficient to continue operating as a going concern for a period not to

exceed one week. The inability of the FCM to satisfy this requirement

will allow the Commission to direct the FCM to transfer customer

accounts and cease doing business as an FCM.

The Commission believes the ability to certify, and if requested,

demonstrate with verifiable evidence, sufficient liquidity to operate

as a going concern to meet immediate financial obligations, is a

minimum financial requirement necessary to ensure an FCM will continue

to meet its obligations as a registrant as set forth under Sec.

4(f)(b) of the Act. The certification required must satisfy the same

oath or affirmation requirements as those required for the submission

of monthly financial reports under Sec. 1.10(d)(4), to ensure that it

is made by an appropriate individual and that it is in writing under

oath of the individual that it is true and correct to the best

knowledge and belief of such individual. If a registrant certifies to

the Commission its access to liquidity, but is not able to demonstrate

with sufficient evidence such liquidity (for example such evidence may

include confirmations by third parties of access

[[Page 67880]]

to credit lines with available credit or of unrestricted cash balances

available to meet projected short term cash requirements), the

Commission believes it would be prudent to require the registrant to

transfer customer accounts. Circumstances related to a liquidity drain

could also result in a breakdown of management controls and result in

an erroneous or false certification, and in such circumstances, the

protection of customers must be paramount. The Commission requests

comment on the proposed additional clause to Sec. 1.17(a)(4).

Regulation 1.17 further requires an FCM to take a haircut against

the value of securities the FCM holds as investments of customer funds

under Sec. 1.25. A primary purpose of these haircuts is to provide a

margin of safety against losses that might be incurred by the FCM as a

result of market fluctuations in the prices of, or lack of liquidity

in, the security positions.

For futures positions, an FCM that is a member of the clearing

organization where the positions are cleared is required to take a

haircut equal to the margin required by the clearing organization on

such futures positions.\45\ For securities positions, Sec. 1.17

incorporates by reference the securities haircuts that a BD is required

to take in computing its net capital under the SEC's regulations.\46\

The structure of the Commission's net capital rule referring to the

SEC's net capital rule is a result of the Commission's determination to

defer to the SEC in areas of its expertise, specifically with respect

to market risk and appropriate haircuts on securities positions.\47\

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\45\ See Sec. 1.17(c)(5)(x)(A).

\46\ Commission Regulations 1.17(c)(5)(v) and 1.32(b) both

incorporate 17 CFR 240.15c3-1(c)(2)(vi) by reference.

\47\ See 43 FR 15072 (Apr. 10, 1978) at 15077 and 43 FR 39956

(Sept. 8, 1978) at 39963.

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The SEC capital rule currently applies a general or ``default''

haircut of 15 percent of the market value of commercial paper,

convertible debt instruments, and nonconvertible debt instruments if

the securities are readily marketable, and 100 percent of the market

value if the securities are not readily marketable. The SEC capital

rule also provides for a lower haircut for commercial paper,

convertible debt instruments, and nonconvertible debt instruments if

the securities are rated in higher rating categories by at least two

nationally recognized statistical rating organizations (``NRSROs''). To

receive the benefit of a reduced haircut on commercial paper, the

commercial paper must be rated in one of the three highest rating

categories by at least two NRSROs. To receive the benefit of a reduced

haircut on a nonconvertible debt security or a convertible debt

security, the security must be rated in one of the four highest rating

categories by at least two NRSROs.

The SEC has proposed rule amendments to implement the Dodd-Frank

Act requirement to remove references to credit ratings in its

regulations and substitute a standard for creditworthiness deemed

appropriate, including a proposed amendment to its net capital rule for

BDs at 17 CFR 240.15c3-1.\48\ Under the SEC proposal, a BD may impose

the default haircuts of 15 percent of the market value of readily

marketable commercial paper, convertible debt, and nonconvertible debt

instruments or 100 percent of the market value of nonmarketable

commercial paper, convertible debt, and nonconvertible debt

instruments. A BD, however, may impose lower haircut percentages for

commercial paper, convertible debt, and nonconvertible debt instruments

that are readily marketable, if the BD determines that the investments

have only a minimal amount of credit risk pursuant to its written

policies and procedures designed to assess the credit and liquidity

risks applicable to a security.

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\48\ See 76 FR 26550 (May 6, 2011).

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Under the SEC proposal, the BD's written policies and procedures

may assess a security's credit risk using the following factors, to the

extent appropriate, instead of exclusively relying on NRSROs ratings:

Credit spreads (i.e., whether it is possible to

demonstrate that a position in commercial paper, nonconvertible debt,

and preferred stock is subject to a minimal amount of credit risk based

on the spread between the security's yield and the yield of Treasury or

other securities, or based on credit default swap spreads that

reference the security);

Securities-related research (i.e., whether providers of

securities-related research believe the issuer of the security will be

able to meet its financial commitments, generally, or specifically,

with respect to securities held by the broker-dealer);

Internal or external credit risk assessments (i.e.,

whether credit assessments developed internally by the broker-dealer or

externally by a credit rating agency, irrespective of its status as an

NRSRO, express a view as to the credit risk associated with a

particular security);

Default statistics (i.e., whether providers of credit

information relating to securities express a view that specific

securities have a probability of default consistent with other

securities with a minimal amount of credit risk);

Inclusion on an index (i.e., whether a security, or issuer

of the security, is included as a component of a recognized index of

instruments that are subject to a minimal amount of credit risk);

Priorities and enhancements (i.e., the extent to which a

security is covered by credit enhancements, such as

overcollateralization and reserve accounts, or has priority under

applicable bankruptcy or creditors' rights provisions);

Price, yield and/or volume (i.e., whether the price and

yield of a security or a credit default swap that references the

security are consistent with other securities that the broker-dealer

has determined are subject to a minimal amount of credit risk and

whether the price resulted from active trading); and

Asset class-specific factors (e.g., in the case of

structured finance products, the quality of the underlying assets).

A BD that maintains written policies and procedures and determines

that the credit risk of a security is minimal is permitted under the

SEC proposal to apply the lesser haircut requirement currently

specified in the SEC capital rule for commercial paper (i.e., between

zero and [frac12] of 1 percent), nonconvertible debt (i.e., between 2

percent and 9 percent), and preferred stock (i.e., 10 percent).

For FCMs that are dually-registered as BDs, any changes adopted by

the SEC to these securities haircuts will be applicable under Sec.

1.17(c)(5)(v) unless the Commission specifically provides an alternate

treatment for FCMs.\49\ However, FCMs that are not dual registrants

would be required to take the default haircuts of 15 percent for

readily marketable securities. The Commission does not believe that it

is appropriate to exclude standalone FCMs from using an internal

process to assess the credit risk of certain securities. Therefore, the

Commission's proposed amendment to Sec. 1.17(c)(v) will permit an FCM

that is not a BD to develop the framework proposed by the SEC to

establish, maintain and enforce written policies and procedures for

determining creditworthiness, and upon a determination that a

particular type of security has minimal credit risk, to apply lower

deductions to such

[[Page 67881]]

securities. An FCM will be required to maintain its written policies

and procedures in accordance with the general recordkeeping

requirements of Sec. 1.31, and the implementation of the policies and

procedures will be subject to review by the FCM's DSRO. An FCM that

elects to develop written policies and procedures will be subject to

review by its DSRO.

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\49\ See discussion adopting Sec. 1.17(c)(5)(vi) for options

haircuts at 43 FR 39956 at 39964, with respect to the applicability

of provisions incorporating by reference and referring to the rules

of the SEC for securities broker dealers also registered as futures

commission merchants.

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Regulation 1.17 also requires an FCM to reduce its capital (i.e.,

take a capital charge) for customer, noncustomer, and omnibus accounts

that are undermargined for more than a specified period of time.

Regulation 1.17(c)(5)(viii) requires an FCM to take a capital charge if

a customer account is undermargined for three business days after the

margin call is issued. The capital charge is equal to the amount of

funds necessary to restore the account to the initial margin

requirement.

Regulation 1.17(c)(5)(ix) requires an FCM to take a capital charge

for noncustomer and omnibus accounts that are undermargined for two

business days after the margin call is issued. The capital requirement

for undermargined noncustomer and omnibus accounts is the amount of

funds necessary to restore the account to the maintenance margin level.

For purposes of these Commission regulations, a margin call is

presumed to be issued by the FCM the day after an account becomes

undermargined. Thus, if a customer's account is undermargined at the

close of business on Monday, the FCM will issue a margin call on

Tuesday, and the regulation requires the FCM to take an undermargined

capital charge at the close of business on Friday if the margin call is

not met. For noncustomer and omnibus accounts that were undermargined

at the close of business on Monday, the FCM would take a capital charge

as of the close of business on Thursday.

The Commission is proposing to amend Sec. Sec. 1.17(c)(5)(viii)

and (ix) to require an FCM to take capital charges for undermargined

customer, noncustomer, and omnibus account that are undermargined for

more than one business day after a margin call is issued. Therefore, an

FCM will impose a capital charge as of the close of business on

Wednesday for any customer, noncustomer, or omnibus account that did

not fully satisfy a margin call that is issued by the FCM on Tuesday

for an account that was undermargined as of the close of business on

Monday.

The timely collection of margin is a critical component of an FCM's

risk management program and is intended to ensure that an FCM holds

sufficient funds deposited by account owners to meet potential

obligations to a DCO. As guarantor of the financial performance of the

customer, noncustomer, and omnibus accounts that it carries, the FCM is

financially responsible if the owner of an account cannot meet its

margin obligations to the FCM and ultimately to a DCO. The timeframe

for meeting margin calls currently provided in Sec. Sec.

1.17(c)(5)(viii) and (ix) may have been appropriate when the capital

rules were adopted in the 1970s when the use of checks and the mail

system were more prevalent for depositing margin with an FCM. The

Commission believes, however, that in today's markets, with the

increasing use of technology, 24-hour-a-day trading, and the use of

wire transfers to meet margin obligations, that the timeframe for

taking a capital charge should be reduced both to incentivize FCMs to

exercise prudent risk management and to strengthen the financial

protection of FCMs, their customers, and the clearing systems by

requiring the FCMs to reserve capital for undermargined customer,

noncustomer, and omnibus accounts that fail to meet a margin call on a

timely basis.

The Commission also is proposing, as discussed in Section II.I

below, to require an FCM to maintain a residual interest in customer

segregated accounts in an amount sufficient to cover all customer

accounts that are undermargined as of the close of business on the

previous trading day, thereby ensuring that residual interest in

customer segregated accounts exceeds the sum of outstanding margin

calls for customers, and that the funds of one customer are not used to

margin or guarantee the positions of another customer. The FCM may only

maintain as residual interest cash and assets that qualify as permitted

investments under Sec. 1.25. Margin deficits will be calculated as

enough to restore the customer's account equity to the maintenance

margin requirement on the account.

The Commission also is proposing technical amendments to certain

definitions in Sec. 1.17 to reflect proposed changes discussed in

Section II.R below concerning the Sec. 30.7 secured amount

calculation. The Sec. 1.17(b)(2) and (7) definitions of the terms

``customer'' and ``customer account'' are being proposed to be amended,

the first to include ``30.7 Customer'' (which is a new definition being

proposed in Sec. 30.1 to include foreign domiciled persons) and the

second to remove surplus language due to the revised definition of

``customer.''

The Commission requests comment on the proposed amendments to Sec.

1.17. Specifically, the Commission requests comment on the following:

Does the proposed amendment to require an FCM to certify

that it has sufficient liquidity to operate as a going concern provide

a sufficient and objective standard for FCMs to assess whether they are

in compliance with the provision? Are there alternative standards or

approaches that the Commission should consider to meet its objective of

ensuring that an FCM has sufficient liquidity to meet its pending

short-term obligations so that customer funds would not be put at risk

in the event of the insolvency of the FCM?

Should the Commission consider alternative timeframes for

the imposition of a capital charge for undermargined accounts?

G. Proposed Amendments to Sec. 1.20: Futures Customer Funds To Be

Segregated and Separately Accounted for

The Commission is proposing to reorganize the structure of Sec.

1.20 by providing additional paragraph subdivisions to the existing

specific requirements, applying headings to the regulation to assist in

the reading and understanding of the regulation. The Commission also is

proposing to add new provisions designed to enhance the protection of

customer funds.

Regulation 1.20 implements the provisions of section 4d(a)(2) of

the Act, which provides, in relevant part, that an FCM must: (1)

Separately account for all futures customer funds and segregate such

funds as belonging to its futures customers; (2) not commingle futures

customer funds with the FCM's proprietary funds; (3) not use the funds

of one futures customer to margin or extend credit to any person other

than to the futures customer that deposited the funds; and (4) deposit

futures customer funds in any bank, trust company or DCO.

Paragraph (a) of Sec. 1.20 sets forth the general principle under

section 4d(a)(2) of the Act by requiring an FCM to separately account

for all futures customer funds and to segregate such funds from the

FCM's proprietary funds by depositing them under an account name that

clearly shows that the funds are futures customer funds and segregated

as required by the Act. Paragraph (g)(1) applies the same general

principle to futures customer funds received by a DCO from its members.

Paragraph (a) also requires each FCM to perform appropriate due

diligence on all depositories in accordance with its risk management

policies and procedures required under proposed

[[Page 67882]]

Sec. 1.11 to ensure that the depositories holding customer funds are

financially sound. The FCM must annually update its due diligence.

Paragraph (a) of Sec. 1.20 also provides that an FCM must be in

compliance with its segregation obligations at all times. It is not

sufficient for an FCM to be in compliance at the end of a business day,

but to fail to meet its segregation obligations on an intra-day basis.

If an FCM was not in compliance with the segregation requirements on an

intra-day basis that would necessarily mean that the FCM was using the

funds of one customer to margin positions of another customer or to

cover losses of another customer.

Paragraph (b) of Sec. 1.20 lists the permitted depositories for

futures customer funds as any bank, trust company, derivatives clearing

organization, or another FCM. These permitted depositories are listed

in existing Sec. 1.20 and the Commission is not proposing to amend the

list. Proposed paragraph (g)(2) lists the permitted depositories for

futures funds received by a DCO as any bank or trust company, and

clarifies that the term ``bank'' includes a Federal Reserve Bank. This

proposed amendment implements section 806(a) of the Dodd-Frank Act,

which provides that a Federal Reserve Bank may establish and maintain a

deposit account for a ``financial market utility'' (in the present

case, a DCO) that has been designated as systemically important.

Paragraph (c) provides that an FCM may hold futures customer funds

in depositories outside of the United States only in accordance with

the current provisions of Sec. 1.49. Paragraph (g)(3) sets forth the

same limitation for a DCO. Regulation 1.49 currently permits an FCM or

DCO to hold futures customer funds in certain foreign depositories

provided that the FCM or DCO holds sufficient funds in the United

States to meet its U.S. dollar-denominated obligations to futures

customers. Regulation 1.49 also requires specific futures customer

authorization for an FCM or DCO to hold futures customer funds in

certain foreign jurisdictions. The Commission is not proposing to amend

Sec. 1.49 as part of this rulemaking.

Proposed Sec. 1.20(e) prohibits an FCM from commingling futures

customer funds with the FCM's proprietary funds, and prohibits the FCM

from commingling funds deposited by futures customers with funds

deposited by 30.7 Customers or Cleared Swaps Customers. Regulation

1.20(e), however, does permit an FCM to commingle the funds of multiple

futures customers in a single account or accounts for operational

convenience. Similarly, proposed Sec. 1.20(g)(5) prohibits a DCO from

commingling futures customer funds with the DCO's proprietary funds or

with any proprietary account of any of its clearing members, and

prohibits the DCO from commingling funds held for futures customers

with funds deposited by clearing members on behalf of their Cleared

Swaps Customers. DCOs would be permitted to commingle the funds of

multiple futures customers in a single account or accounts for

operational convenience.

Proposed Sec. 1.20(f) restricts an FCM's use of customer funds. An

FCM is prohibited from using one futures customer's funds to margin or

secure another futures customer's positions. An FCM also is prohibited

from using a futures customer's funds to extend credit to any other

person. The FCM also may obligate futures customers' funds to a DCO or

another FCM solely to purchase, margin, or guarantee futures and

options positions of futures customers.

The Commission is proposing a new paragraph (h) which states that

all futures customer funds deposited with a bank or trust company must

be available for immediate withdrawal upon demand by the FCM or DCO.

Paragraph (h) codifies a long-standing interpretation of the

Commission's Division of Swap Dealer and Intermediary Oversight and

predecessor divisions derived from an administration determination by

the Commission's predecessor, the Commodity Exchange Authority of the

U.S. Department of Agriculture.\50\ The requirement, as proposed, is a

practical necessity to the effective functioning of FCMs and futures

markets. Should a depository have the ability to delay an FCM from

withdrawing customer funds, the FCM may not be able to meet margin

obligations to DCOs, or requests by futures customers for access to

their funds. In addition, an inability of an FCM to have immediate

access to the futures customer funds that it holds may adversely impact

the transfer of futures customers positions in the event of the FCM's

insolvency.\51\

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\50\ See Administrative Determination No. 29 of the Commodity

Exchange Administration dated Sept. 28, 1937 stating, ``the deposit,

by a futures commission merchant, of customers' funds * * * under

conditions whereby such funds would not be subject to withdrawal

upon demand would be repugnant to the spirit and purpose of the

Commodity Exchange Act. All funds deposited in a bank should in all

cases by subject to withdrawal on demand.''

\51\ In the case of the bankruptcy of Lehman Brothers, for

example, immediate access to customer funds allowed the commodity

customer accounts to be effectively transferred to Barclays over the

weekend of September 20-21, 2008, immediately following the

commencement of the liquidation of the firm. This transfer was

authorized in the hours immediately following the commencement of

Lehman's liquidation, and was implemented in the hours immediately

thereafter.

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The Commission is proposing a new paragraph (i), which

mirrors what was recently adopted in Part 22 for Cleared Swaps

Customers, by providing more detail implementing the Net Liquidating

Equity Method of calculating segregation requirements. In addition,

because a customer may have Net Liquidating Equity (i.e., a credit

balance) in his or her account, requiring segregation of his or her

funds, and still be undermargined relative to open positions, proposed

paragraph (i) requires an FCM to record in the accounts of its futures

customers the amount of margin required for such customers' open

positions, and to calculate margin deficits for each such customer.

Moreover, the Commission is proposing to require that an FCM maintain

residual interest in segregated accounts in an amount that exceeds the

sum of all futures customers' margin deficits. A margin deficit occurs

when the value of the futures customer funds for a futures customer's

account is less than the total amount of collateral required by DCOs

for that account's contracts. Currently, the Commission requires FCMs

to hold sufficient funds in segregated futures customer accounts to

ensure that those accounts do not become undersegregated. Proposed new

paragraph (i) will affirmatively require an FCM to maintain enough

funds in the futures customer accounts to cover all margin deficits as

well as to ensure that the accounts are not undersegregated. The

Commission requests comments on all aspects of proposed new Sec.

1.20(i), including the costs and benefits of this proposed regulation.

The Commission specifically requests comment on the following:

Will this proposal serve to increase the protections to

customer funds in the event of an FCM bankruptcy?

To what extent would this proposal increase costs to FCMs

and/or futures customers?

To what extent would this proposal benefit futures

customers and/or FCMs?

To what extent would this proposal increase or mitigate

market risk?

To what extent would this proposal lead to FCMs requiring

customers to provide margin for their trades before placing them?

To what extent is this likely to lead to a re-allocation

of costs from customers with excess margin to undermargined customers?

For purposes of margin deficit calculations, should the

Commission

[[Page 67883]]

address issues surrounding the timing of when an FCM must have

sufficient funds in the futures customer account to cover all margin

deficits? If so, how should the Commission address such issues?

In addition to the foregoing, the Commission also is proposing to

revise requirements regarding the written acknowledgment letter that an

FCM or DCO is required to obtain from a depository holding futures

customer funds. Regulation 1.20 currently requires an FCM or DCO to

obtain a written acknowledgment from each depository, unless the

depository is a DCO that has rules approved by the Commission providing

for the segregation of customer funds. The written acknowledgment must

state that the depository was informed that the futures customer funds

deposited belong to futures customers and are being held in accordance

with the provisions of the Act and Commission regulations.

The Commission previously proposed amendments to the acknowledgment

letter regulations. On February 20, 2009, the Commission published

proposed amendments to Sec. Sec. 1.20, 1.26, and 30.7 for public

comment (the ``Original Proposal'').\52\ The Original Proposal set out

specific representations that would have been required to be included

in all acknowledgment letters in order to reaffirm and to clarify the

obligations that depositories incur when accepting customer funds or

secured amount funds.\53\

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\52\ 74 FR 7838 (February 20, 2009).

\53\ The Commission notes that both the current and proposed

definition of ``customer funds'' in Regulation 1.3(gg) do not

include ``secured amount funds'' as defined in Regulation 30.7

(i.e., funds deposited by foreign futures or foreign options

customers). See 76 FR 33066, 33085 (June 7, 2011). However, as used

in this notice, unless otherwise specified, the term ``customer

funds'' is meant to include secured amount funds. The regulations

adopted by this notice are also being amended to use the term

``customer'' as newly proposed (i.e., in this rulemaking the

Commission is deleting references to ``commodity or option

customers''. As necessary, the Commission distinguishes between the

two types of funds in this notice by referring to ``customer

segregated funds'' and ``customer secured amount funds.''

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In light of the comments on the Original Proposal, the Commission

determined to re-propose the amendments with several changes made in

response to comments (the ``Revised Proposal'').\54\ As part of the

Revised Proposal, the Commission proposed the required use of standard

template acknowledgment letters which were included as Appendix A to

each of Sec. 1.20 and 1.26, and Appendix E to Part 30 of the

Commission's regulations (referred to herein as the ``Template

Letters'' or ``Acknowledgment Letters'').

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\54\ 75 FR 47738 (Aug. 9, 2010).

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The Commission received nine comment letters on the Revised

Proposal.\55\ In general, the commenters were supportive of the

Commission's Revised Proposal and, in particular, were very supportive

of requiring the use of Template Letters. It was noted by certain

commenters that use of a standard template will simplify the process of

obtaining an Acknowledgment Letter.\56\ In addition, it was noted by

commenters that uniformity of Acknowledgment Letters will provide

consistency and legal certainty across the commodities and banking

industries.\57\

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\55\ Letters were submitted by: Hunton & Williams on behalf of

the Working Group of Commercial Energy Firms (``Energy Working

Group''); International Derivatives Clearinghouse LLC (``IDCH'');

Futures Industry Association (``FIA''); Harris, N.A. (``Harris'');

Katten Muchin Rosenman LLP (``Katten''); CME Group Inc. (``CME'');

The Minneapolis Grain Exchange (``MGEX''); JPMorgan Chase Bank, N.A.

(``JP Morgan''); and The Federal Reserve Bank of Chicago, Financial

Markets Group (``FRB Chicago'').

\56\ See MGEX CL-00007 at 1; FIA CL-00003 at 2; Harris CL-00004

at 1.

\57\ See MGEX CL-00007 at 1; CME CL-00006 at 2; FRB Chicago CL-

00010 at 1.

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The Commission is proposing revised amendments to the

Acknowledgment Letters in this release to address several issues that

have arisen as a result of the recent MF Global and Peregrine failures

and the adverse impact on customers that had funds on deposit with

these FCMs. The additional amendments are discussed below. The

Commission also has revised the Acknowledgment Letters to address

comments to the Revised Proposal. These revisions are discussed

immediately below.

1. Obligation To Obtain New Acknowledgment Letters

Under the Revised Proposal, an FCM or DCO would be required to

obtain a new Acknowledgment Letter within 60 days of changes in the

name of any party to the Acknowledgment Letter or changes to the

account number(s) under which customer funds are held. FIA stated that

it is unduly burdensome to require the parties to execute a new

Acknowledgment Letter in the event of a party changing its name within

60 days of the event.\58\ FIA recommended instead including ``binding

effect'' language in the Template Letters to ensure parties remain

subject to the applicable provisions.\59\ If the Commission determines

to adopt the amendment requirement, FIA requested that the time period

be extended from 60 to 120 days because a change in name often occurs

in the context of a merger or acquisition in which case the relevant

party will be in the process of amending numerous agreements and

related documentation.

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\58\ FIA CL-00003 at page 2.

\59\ FIA suggests, for example, the following language: ``The

terms of this letter shall remain binding upon the parties, their

successors and assigns, including for the avoidance of doubt,

regardless of the change in name of any party.'' FIA CL-00003 at

page 2.

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The Commission has determined to add to the Template Letter the

``binding effect'' language as proposed by FIA, as this language will

ensure the continued applicability of the Acknowledgment Letter in the

event of a name change to the parties. The Commission, however, is

proposing to require that FCMs and DCOs file new Acknowledgment Letters

in the event of a name, address, or other change as specified in the

proposed rule because the Commission believes it is important to

maintain current and accurate Acknowledgment Letters to provide clear

legal status of the customer account, which will better protect

customers in the event of a dispute regarding the legal status of the

account. The Commission is proposing a 120-day time period for an FCM

to obtain new Acknowledgment Letters. Given the use of the Template

Letter, which is not open to negotiation, and electronic filing, the

Commission believes that 120 days is a sufficient period of time for

FCMs and DCOs to obtain and file the new Acknowledgment Letters.

2. Technical Amendments to Acknowledgment Letter for Omnibus Accounts;

Abbreviation of Account Names

Regulation 1.20 provides that customer funds, when deposited with a

depository, ``shall be deposited under an account name that clearly

identifies them as such and shows that they are segregated as required

by the Act and [Part 1 of the CFTC Regulations].'' FIA noted that the

account naming convention used in the proposed forms of Template

Letters \60\ may present certain issues with respect to Acknowledgment

Letters obtained by FCMs maintaining customer funds with

[[Page 67884]]

another FCM through a customer omnibus account relationship.\61\ The

first issue is with respect to operational limits on the number of

characters available for account names. Secondly, naming conventions

for such accounts typically include the words ``Customer Omnibus

Account'' and the relevant account number. FIA accordingly requested

the Commission to clarify that the Template Letters may be modified to

permit the use of the words ``CFTC Regulated FCM Customer Omnibus

Account'' to describe such accounts.

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\60\ Proposed Appendix A to Regulation 1.20 provides that the

Account will be entitled ``[Name of Futures Commission Merchant or

Derivatives Clearing Organization] CFTC Regulation 1.20 Customer

Segregated Account.'' 75 FR 47738, 47743 (Aug. 9, 2010); Proposed

Appendix A to Regulation 1.26 provides that the Account will be

entitled ``[Name of Futures Commission Merchant or Derivatives

Clearing Organization] CFTC Regulation 1.26 Customer Segregated

Money Market Mutual Fund Account.'' 75 FR 47738, 47744 (Aug. 9,

2010); and Proposed Appendix E to part 30 provides that the Account

will be entitled ``[Name of Futures Commission Merchant] CFTC

Regulation 30.7 Customer Secured Account.'' 75 FR 47738, 47745 (Aug.

9, 2010).

\61\ FIA CL-00003 at 4 and 5.

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The Commission has modified the proposed Template Letters to

provide an option to add the words ``CFTC Regulated FCM Customer

Omnibus Account'' to describe such accounts when applicable. In

addition, the Commission is proposing that if the name of the account

as set forth in the Template Letter is too long for a depository's

system to include all characters, the depository may abbreviate the

name in order to accommodate its system, provided that (i) it remains

clear that the account is a CFTC regulated segregated/secured account

held for the benefit of customers (e.g., ``segregated'' may be

shortened to ``seg;'' ``customer'' may be shortened to ``cust;''

``account'' to ``acct;'' etc.), and (ii) when completing an

Acknowledgment Letter, such letter must include both the long and short

versions of the account name.

3. Clarification Regarding Notice, Authentication, and Instruction

Protocol for Commission Authorized Withdrawals

Four of the commenters to the Revised Proposal addressed the need

for the Commission to establish specific standards with respect to the

notice, authentication and instruction protocol regarding Commission

instructions for the immediate release of funds from a Customer

Account.\62\

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\62\ In the Revised Proposal, the Template Letter provides that

``the Funds in the Account(s) shall be released immediately, * * *

upon proper notice and instruction from an appropriate officer or

employee * * * of the CFTC. [FCM/DCO] will not hold [depository]

responsible for acting pursuant to any instruction from the CFTC

upon which [depository] has relied after having taken reasonable

measures to assure that such instruction was provided to

[depository] by a duly authorized officer or employee of the CFTC.''

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The FRB Chicago pointed out that, as the Acknowledgment Letters

will have been filed electronically with the Commission, the Commission

will know all of the Depositories that have signed such letters, their

location, and basic contact information. In light of this, the FRB

Chicago suggests that the Commission could establish for each

depository a basic but unique authentication identifier. The Commission

believes this suggestion has merit, and it will consider implementing

this type of data collection and identification as it works to

implement the operational aspects of the electronic filing of

Acknowledgment Letters.

JP Morgan suggests that the Acknowledgment Letter include a notice

provision with contact information for the depository so that the

Commission has information on how best to contact the depository. The

Commission agrees with this suggestion and has revised the Template

Letters to indicate where depository contact information may be

inserted as optional information. The Commission recognizes that such

information may be subject to frequent change and, therefore, at this

time, the Commission is not requiring that an amended Acknowledgment

Letter be filed in the event there are changes to such contact

information.

Katten asserts that Depositories face legal uncertainty with

respect to their release of customer funds in reliance on instructions

from the Commission. Katten states that the Commission's reluctance to

define ``proper notice'' or ``reasonable measures'' imposes on

Depositories the conflicting obligations (i) to the Commission, to

release customer funds ``immediately upon proper notice,'' and (ii) to

its customer FCM, to take ``reasonable measures'' first to assure that

such notice was ``duly authorized.''

With respect to due authorization, Katten requests that the

Commission reconsider its decision to permit an instruction to transfer

customer funds to be made orally, with written confirmation to follow.

Katten believes that the depository's obligation to take ``reasonable

measures'' may require it to await written confirmation in any event.

In addition, Katten believes that the proposed amendments to Sec. Sec.

1.20, 1.26, 30.7 and 140.91 do not limit the identity of the Commission

officers and employees that may issue a notice to a depository or the

process that must be followed before such a notice is issued. Katten

submits that a depository would have a reasonable basis to conclude

that an instruction to transfer customer funds was duly authorized if

the depository could be assured that any instruction to transfer

customer funds would be issued only by the Director of the Division of

Clearing and Intermediary Oversight (or the Director's designee).\63\

Katten recommends that ``the Commission revise the proposed rules to

confirm that any such instruction may be made only by the Commission or

by the director of DCIO (or the director's designee) acting with the

concurrence of the General Counsel (or Deputy General Counsel).'' \64\

FIA requests, at a minimum, that the Commission define and limit the

term ``appropriate officer or employee'' of the Commission (for

example, authorization limited to Division Directors or other senior

designated personnel such as Deputy Directors or Associate

Directors).\65\

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\63\ In October 2011, the Commission reorganized the Division of

Clearing and Intermediary Oversight into two divisions, the Division

of Clearing and Risk and the Division of Swap Dealer and

Intermediary Oversight. With respect to a transfer of customer funds

as contemplated in this rulemaking, instructions would come from

either the Director of the Director of the Division of Clearing and

Risk or the Director of the Division of Swap Dealer and Intermediary

Oversight (or one of the Director's designees).

\64\ See Katten CL-00005 at FN 3.

\65\ FIA CL-00003 at page 3.

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With respect to a ``duly authorized officer or employee of the

CFTC,'' the Commission has determined to provide that any such

instruction to transfer customer funds may be made by the Director of

the Division of Clearing and Risk (or the Director's designee), or by

the Director of the Division of Swap Dealer and Intermediary Oversight

(or the Director's designee). Accordingly, the Template Letter now

specifies that such instructions may only be given by the Director of

the Division of Clearing and Risk (or any successor division), the

Director of the Division of Swap Dealer and Intermediary Oversight (or

any successor division), or the designees of such Directors under

delegated authority.\66\ With regard to the role of the General

Counsel, the General Counsel will be consulted by the Director of the

Division of Clearing and Risk (or any successor division), the Director

of the Division of Swap Dealer and Intermediary Oversight (or any

successor division), or the designees of such Directors prior to the

exercise of the delegated authority.

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\66\ The Commission will publish on its Web site the identity of

the Director of the Division of Clearing and Risk, the Director of

the Division of Swap Dealer and Intermediary Oversight, and the

individual(s) who are authorized to serve as their designees. The

Template Letters do not explicitly refer to instructions provided by

``the Commission'' because in exigent circumstances, it is not

likely that action approved by a majority of Commissioners will be

feasible.

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The Commission does not believe, as asserted by Katten, that

``reasonable measures'' may require the depository to await written

confirmation. For example, due to the nature of the

[[Page 67885]]

exceptional circumstances that would prompt a call from the Commission,

it is likely that the depository would already be aware of certain

problems facing the FCM or DCO and would not be surprised to receive a

phone call from a Division Director (or his or her designee). In

addition, while the Commission believes it is desirable that any such

instruction to release customer funds be in writing, or, if oral, to be

confirmed in writing, the Commission is not limiting the manner of

notice in the Template Letter given the potential exigencies of the

situation and the need for flexibility in communication. For example,

either the Commission or the depository could be experiencing

unexpected technical problems in its respective email servers or

facsimile machines. It is critical that the transfer of customer funds

from a Segregated Account not be delayed as a result of technical or

other operational issues.

With respect to the release of customer funds ``immediately upon

proper notice,'' Katten commented that it appreciates the Commission's

recognition of the potential practical obstacles to immediate release

(e.g., Fedwire is unavailable). However, Katten remains concerned that,

in the absence of further guidance or clarification, the use of the

term ``immediately'' may subject a depository to potential claims by

either FCMs or the Commission in the event that there is a delay in the

transfer of customer funds, even if such delay is the result of

reasonable actions on the part of the depository or events beyond the

control of the depository. In addition, FIA commented that it would

like the Commission to confirm that its authority to require the

transfer of customer funds would be expected to be used sparingly

(i.e., ``only in exceptional circumstances'').

After considering these comments, the Commission is proposing to

retain the use of the word ``immediately'' in the Template Letter

regarding instructions to a depository for release of customer funds.

First, in response to FIA's comment, the Commission clarifies that the

use of its authority to require the immediate release of customer funds

would be in exceptional circumstances. As stated in the Revised

Proposal, ``[t]he Commission would issue such an instruction only when,

in the judgment of the Commission, it is necessary to do so for the

protection of customer funds. For example, the prospective insolvency

of the FCM could prompt an instruction from the Commission to release

the customer funds.'' \67\ Next, the Commission notes that anything

less than the term ``immediate'' could leave the timing open to

interpretation, which could cause delays in the transfer of funds and

have a potential impact on safety and soundness of customer funds and

positions. In this regard, the Commission notes that customer funds in

the Segregated Account have always been subject to withdrawal

immediately upon demand by the FCM.\68\

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\67\ 75 FR 47738, 47740. The Revised Proposal also noted that,

as set forth in the Template Letter, in the event the FCM becomes

subject to a voluntary or involuntary petition for relief under the

U.S. Bankruptcy Code, the depository will have no obligation to

release the customer funds except upon instruction from the

bankruptcy trustee or pursuant to a court order. Id.

\68\ See Amended Financial and Segregation Interpretation No.

10, 70 FR 24768 (May 11, 2005) (``Thus any impediments or

restrictions on the FCM's ability to obtain immediate and unfettered

access to customer funds are not permitted. The immediate and

unfettered access requirements is [sic] intended to prevent

potential delay or interruption in securing required margin payments

that, in times of significant market disruption, could magnify the

impact of such market disruption and impair the liquidity of other

FCMs and clearinghouses.'')

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4. Limiting the ``Merger'' Clause in the Acknowledgment Letter

CME believes that the use of an integration clause (i.e., the

statement that the Acknowledgment Letter ``constitutes the entire

understanding of the parties with respect to its subject matter'') in

the Template Letters is inappropriate and could have a number of

serious and unintended consequences. For example, the parties to the

Acknowledgment Letter could be prevented from relying upon and

enforcing terms of applicable account (or similar) agreements that do

not conflict with the Acknowledgment Letter. CME believes the term

``subject matter'' is ambiguous and could be interpreted very broadly

thereby casting doubt on the validity and interpretation of existing

agreements between the parties. The CME suggests the following more

narrowly tailored language for the integration clause in the Template

Letters: ``This letter agreement supersedes and replaces any prior

agreement between the parties in connection with the Account(s),

including but not limited to any prior Acknowledgment Letter, to the

extent that such prior agreement is inconsistent with the terms

hereof.''

FIA agrees with the CME's comment that the scope of the ``merger

clause'' in the Template Letters should be narrowed to make clear that

these clauses do not invalidate the terms of other agreements that may

have been entered into by the parties and that do not conflict with the

Template Letters. The FRB Chicago also believes that this provision

should be narrowed so that a bank's standard account opening

agreements, corporate resolutions and other agreements incorporated by

reference should govern the remainder of the account relationship, but

not matters specific to section 4d of the Act. Should there be a

conflict, the Acknowledgment Letter should govern matters specific to

section 4d of the Act.

The Commission agrees with the commenters that the scope of the

``merger clause'' language in the Template Letter \69\ should be

narrowed. Accordingly, the Commission is replacing the clause with

CME's suggested language above. In addition, in order to incorporate

the comment of the FRB Chicago and to ensure that future agreements

between the parties do not negate the Acknowledgment Letter, the

Commission is adding the following sentence to the end of the new

language: ``In the event of any conflict between this letter agreement

and any other agreement between the parties in connection with the

Account(s), this letter agreement shall govern with respect to matters

specific to section 4d of the Act and the CFTC's regulations, as

amended.''

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\69\ The merger clause language in the Revised Proposal's

Template Letter reads as follows: ``This letter agreement

constitutes the entire understanding of the parties with respect to

its subject matter and supersedes and replaces all prior writings,

including any applicable agreement between the parties in connection

with the Account(s), with respect thereto.''

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5. New Proposed Amendments to Acknowledgment Letters

The Commission is also now proposing under Appendix A to Sec. 1.26

and Appendix F to Sec. 30.7 an additional acknowledgment letter

template form for money market mutual funds (to the extent they are

permissible investments under Sec. 1.25). The template form for money

market mutual funds is substantially the same as the Acknowledgment

Letters. The Commission requests comment on all aspects of the template

form.

In addition, the Commission is proposing to add language to its

proposed Acknowledgment Letters (under Sec. 1.20, Sec. 1.26 and Sec.

30.7) authorizing and requiring the depository to grant--at all times--

read-only electronic access to such accounts to the Commission and, in

the case of an FCM, to the FCM's DSRO. Given recent events, the

Commission believes such access is crucial to the protection of

customer funds. The Commission is also proposing a substantive

requirement for

[[Page 67886]]

this access in Sec. Sec. 1.20, 1.26 and 30.7 in addition to the

language in the Acknowledgment Letters.

The proposal for read-only access is not intended to require a

depository to have the ability to provide the Commission or an FCM's

DSRO with real-time information regarding an FCM's account balance. The

Commission understands that depositories may not have the capability to

provide customers or any other party with real-time account balances

and position information. The conditions of the proposal would be

satisfied if the depository had the capability to provide read-only

access to account information as of the close of the prior business

day.

The Commission intends to continue to explore possible uses of

technology to enhance its ability to protect customer funds. Read-only

access will allow Commission staff to review an FCM's segregated

account balances reported by depositories and to compare those balances

to the FCM's reported account balances either as part of a review of

the firm, or in circumstances where the Commission is concerned about

the financial condition of the firm. The read-only access is an

additional tool that Commission staff may use as part of its assessment

of the financial condition of an FCM and the safety of customer funds.

The Commission will continue to review how direct access to account

balances and the use of technology can provide greater assurance as to

the safety of customer funds held by an FCM.

The Commission requests comment on all aspects of the proposed

amendments to Sec. 1.20. Specifically, the Commission requests comment

on the following:

The proposal requires each depository to provide the

Commission and an FCM's DSRO with direct, read-only access to the FCM's

accounts held by the depository. What technology issues are raised by

the Commission's proposal? How can the Commission adequately address

such technology issues?

What account information can depositories currently

provide to the Commission and to DSROs via the internet on a read-only

basis? Do all depositories (e.g., banks, trust companies, derivatives

clearing organizations, or other FCMs) have the capability of using the

Internet to provide account access to the Commission and DSROs? Are

there other options for depositories to provide read-only access to FCM

accounts other than the internet?

How should the Commission implement this requirement? What

timeframe would be appropriate to make the requirement effective?

Please provide analysis with your comment.

H. Proposed Amendments to Sec. 1.22: Use of Futures Customer Funds

The Commission proposes to amend Sec. 1.22 by clarifying that the

prohibition on the FCM's use of one futures customer's funds to margin

or secure the positions of another futures customer, or to extend

credit to another person, applies at all times.

Regulation 1.22 provides that an FCM may not use the cash,

securities or other property deposited by one futures customer to

purchase, margin or settle the trades, contracts, or other positions of

another futures customer, or to extend credit to any other person.

Regulation 1.22 further provides that an FCM may not use the funds

deposited by a futures customer to carry trades or positions, unless

the trades or positions are traded through a designated contract

market.

The proposed amendment to clarify that the prohibition on the FCM's

use of one futures customer's funds to margin positions of another

futures customer is intended to remove any question as to the

permissibility of being undersegregated at any point in time during the

day. Section 4d(a)(2) requires an FCM to segregate futures customers'

funds from its own funds, and prohibits an FCM from using the funds of

one customer to margin or extend credit to any other futures customer

or person. The Commission believes that section 4d(a)(2) is intended to

provide a maximum level of protection to futures customer funds, which

would be thwarted and inconsistent with the reading of the Act if an

FCM only recognized this principle at the end of the trading day.

Further, the Commission is proposing language providing a clear

mechanism to ensure compliance with this prohibition, which is to

require an FCM to maintain residual interest in segregated accounts in

an amount which exceeds the sum of all margin deficits for futures

customers. The Commission also is proposing that the sum of all margin

deficits be reported on the Segregation Schedule (as discussed

previously with respect to proposed amendments to Sec. 1.10) and also

required to be reported on the daily segregation calculation (as

discussed further herein with respect to proposed amendments to Sec.

1.32), so that compliance review of this mechanism can be performed.

I. Proposed Amendments to Sec. 1.23: Interest of Futures Commission

Merchant in Segregated Futures Customer Funds; Additions and

Withdrawals

The Commission is proposing to amend Sec. 1.23 to require

additional safeguards with respect to an FCM withdrawing futures

customer funds from segregated accounts that are part of the FCM's

residual interest in such accounts.

Regulation 1.23 provides that an FCM may deposit unencumbered

proprietary funds, including securities that qualify as permitted

investments under Sec. 1.25, into segregated futures customer accounts

in order to ensure that the firm always maintains sufficient funds in

such accounts to meet its total obligations to futures customers. FCMs,

by virtue of practical necessity, must keep proprietary funds in

segregated futures customer accounts in order to act as a buffer

between futures customers whose funds are commingled in such accounts.

In the event that any futures customer were to experience losses such

that the customer has insufficient funds to meet the margin

requirements at clearing organizations associated with its positions,

or if all of the funds deposited by the futures customer were depleted

and the account had a debit balance, without proprietary funds of the

FCMs being held in such accounts to absorb the debit balance as it

accrued, funds of other futures customers would be used to guarantee

the undermargined amount or the debit. For this reason, FCMs are

permitted to deposit their own funds into segregated accounts and to

maintain a residual financial interest in such accounts. Regulation

1.23 further provides that an FCM's books and records must always

reflect the firm's residual interest in the accounts of its futures

customers.

In addition, an FCM is permitted to withdraw funds from futures

customer accounts for the FCM's proprietary use to the extent of the

FCM's actual residual interest in such accounts. The withdrawal,

however, may not result in the FCM failing to hold sufficient funds to

meet its obligations to its futures customers, or in the funds of one

futures customer margining or securing the positions of another futures

customer. The Commission also is proposing that the residual amount

maintained by an FCM be required to exceed the sum of margin deficits

for futures customers, as discussed previously with respect to

Sec. Sec. 1.20 and 1.22, to provide a clear mechanism to ensure that

the funds of one futures customer are not used to margin or guarantee

the positions of

[[Page 67887]]

another futures customer. Irrespective of the procedures permitting

withdrawals of residual interest under the amendments proposed, the

proposed amendments further make clear that no withdrawals may be made

of residual interest to the extent of the sum of margin deficits.

If an FCM does not have adequate internal controls governing the

calculation and withdrawal of its residual interest from futures

customer accounts, the FCM's actions may actually result in the

withdrawal of futures customer funds and not the FCM's residual

interest. Such a withdrawal would be a violation of section 4d(a)(2) of

the Act.

The Commission, therefore, is proposing to amend Sec. 1.23 to

include additional safeguards applicable to an FCM's withdrawal of

funds from the accounts of futures customers that are part of the FCM's

residual interest in such accounts. Under proposed Sec. 1.23(a), an

FCM will still have access to its own funds deposited into futures

customer accounts to the extent of the FCM's residual interest therein,

subject to the restriction on withdrawal of residual interest equal to

the sum of margin deficits. However, proposed Sec. 1.23(b) will

prohibit an FCM from withdrawing any of its residual interest or excess

funds from futures customer accounts (any withdrawal not made for the

benefit of futures customers would be considered a withdrawal of the

FCM's residual interest) on any given business day unless the FCM had

completed the daily calculation of funds in segregation pursuant to

Sec. 1.32 as of the close of the previous business day, and the

calculation showed that the FCM maintained excess segregated funds in

the futures customer accounts as of the close of business on the

previous business day. Proposed Sec. 1.23(b) further requires that the

FCM adjust the excess segregated funds reported on the daily

segregation calculation to reflect other factors, such as overnight and

current day market activity and the extent of current customer

undermargined or debit balances, to develop a reasonable basis to

estimate the amount of excess funds that remain on deposit since the

close of business on the previous day prior to initiating a withdrawal.

The Commission also is proposing several additional required layers

of authorization and documentation if the withdrawal exceeds,

individually or in the aggregate with other such withdrawals, 25

percent of the FCM's residual interest. Proposed Sec. 1.23(c)

prohibits an FCM from withdrawing more than 25 percent of its residual

interest in futures customer accounts unless the FCM's CEO, CFO, or

other senior official that is listed as a principal on the firm's Form

7-R registration statement and is knowledgeable about the FCM's

financial requirements (``Financial Principal'') pre-approves the

withdrawal in writing.

Regulation 1.23(c) will further require the FCM to immediately file

a written notice with the Commission and with the firm's DSRO of any

withdrawal that exceeds 25 percent of its residual interest. The

written notice must be signed by the CEO, CFO, or Financial Principal

that pre-approved the withdrawal, specifying the amount of the

withdrawal, its purpose, its recipient(s), and contain an estimate of

the residual interest after the withdrawal. The written notice also

must contain a representation from the person that pre-approved the

withdrawal that to such person's knowledge and reasonable belief, the

FCM remains in compliance with its segregation obligations. The

proposal further requires that the official in making this

representation specifically consider any other factors that may cause a

material change in the FCM's residual interest since the close of

business on the previous business day, including known unsecured

futures customer debits or deficits, current day market activity, and

any other withdrawals. The written notice would be required to be filed

with the Commission and with the FCM's DSRO electronically.

Proposed Sec. 1.23(d) requires an FCM that has withdrawn funds

from segregated futures customer accounts for its own purposes, and

such withdrawal causes the firm to fall below its targeted residual

interest in such accounts, to deposit proprietary funds into the

accounts to restore the residual interest balance to the targeted

amount. The FCM must deposit the proprietary funds into the segregated

account prior to the close of the next business day. Alternatively, the

FCM may revise its targeted residual interest amount, if appropriate,

in accordance with its written policies and procedures for

establishing, documenting, and maintaining its target residual

interest, in accordance with the requirements of proposed Sec. 1.11.

Should an FCM's residual interest, however, be exceeded by the sum of

the FCM's futures customers' margin deficits, an amount necessary to

restore residual interest to that sum must be deposited immediately.

The Commission's proposal is consistent in most respects with NFA's

recent rule amendments that require FCMs to maintain written policies

and procedures regarding the withdrawal of proprietary funds from

futures customers' segregated accounts discussed in Section I.D above.

The proposal will continue to provide FCMs with flexibility to access

the residual interest in segregated funds, but with the responsibility

to ensure that any withdrawals of residual interest are, in fact, the

firm's own funds. This responsibility exists currently by virtue of the

language of section 4d(a)(2) of the Act and Sec. 1.23, however the

processes necessary to ensure that the responsibility was carried out

were not specified by regulation.

By providing a prohibition on withdrawals until the segregation

calculation is performed by the FCM and submitted to the Commission and

to the DSRO, and further requiring written approvals by the FCM's

senior officials prior to any withdrawals in excess of 25 percent of

the prior day's residual interest with notice to the Commission and a

DSRO, any withdrawal of funds in excess of the residual interest will

be clear violations of proposed Sec. 1.23, and the responsibility for

such violations will be clear from written pre-approvals made by the

CEO, CFO or Financial Principal, or the lack thereof.

J. Proposed Amendments to Sec. 1.25: Investment of Customer Funds

The Commission is proposing to amend Sec. 1.25(b)(3)(v) to provide

that the 25-percent counterparty concentration limit for reverse

repurchase agreements applies not only to a single counterparty, but to

all counterparties under common control or ownership. The Commission

also is proposing to delete paragraph (b)(6) of Sec. 1.25 because the

information that an FCM is required to record and maintain under

paragraph (b)(6) is currently required by Sec. 1.27. Further, the

Commission is proposing to amend Sec. 1.25(d) to clarify the

conditions under which an FCM may deposit firm-owned securities into

segregation.

Regulation 1.25 sets forth the financial investments that an FCM or

DCO may make with customer funds. As one of the permitted investments,

FCMs and DCOs may use customer funds to purchase securities from a

counterparty under an agreement for the resale of the securities back

to the counterparty (``reverse repurchase agreements''). Regulation

1.25 places conditions on such repurchase or reverse repurchase

agreements, including limiting permitted counterparties to certain

banks and government securities brokers or dealers, and prohibiting an

FCM or DCO from entering into such

[[Page 67888]]

agreements with affiliate. Regulation 1.25(b)(3)(v) also imposes a

counterparty concentration limit on reverse repurchase agreements that

prohibits an FCM or DCO from purchasing securities from a single

counterparty that exceeds 25 percent of the total assets held in

segregation by the FCM or DCO.

Under the proposed amendment to Sec. 1.25(b)(3)(v), an FCM or DCO

must aggregate the value of the securities purchased from two or more

different counterparties under repurchase agreements if the

counterparties are under common control or ownership. The aggregate

value of the securities purchased under the repurchase agreements from

the counterparties must not exceed 25 percent of the total assets held

in segregation by the FCM or DCO. The Commission believes that

expanding the concentration limitation to counterparties under common

control or ownership is consistent with the original intention of the

concentration limitation, which was to minimize the potential losses or

disruptions due to the default of a counterparty. If the counterparties

are under common control or ownership, a default by one counterparty

may adversely impact all of the counterparties.

The Commission also is proposing to amend Sec. 1.25 by deleting

paragraph (b)(6), which requires an FCM or DCO to prepare a record, on

a daily basis, detailing the type of instruments in which customer

funds were invested, the original costs of the investments, and the

current market value of the investments. As noted above, the

information that an FCM is required to record and maintain under

paragraph (b)(6) is currently required by Sec. 1.27.

Finally, the Commission is proposing to amend Sec. 1.25(d)(7) to

recognize that a DCO designated as systemically important (``SIDCO'')

by the Financial Stability Oversight Council may keep securities

transferred to the SIDCO under a repurchase or reverse repurchase

agreement in a safekeeping account with a Federal Reserve Bank, as

authorized by section 806 of the Dodd-Frank Act.

K. Proposed Amendments to Sec. 1.26: Deposit of Obligations Purchased

With Futures Customer Funds

As discussed above, the Commission has previously proposed to amend

Sec. 1.26 along with Sec. 1.20 to require a template form of

Acknowledgment Letter--in addition to other substantive requirements

and obtaining and filing such Acknowledgment Letters--with respect to

the deposit of instruments purchased with customer funds, including

money market mutual funds. As discussed earlier with respect to Sec.

1.20, the Commission received and analyzed comments on those proposals.

As noted above, the Commission is herein proposing changes to the

template Acknowledgment Letter set forth in Appendix A to Sec. 1.26

for money market mutual funds, which incorporate revisions based on the

Commission's analysis of prior comments, and is proposing new additions

to such template. The Commission is also proposing new substantive

requirements applicable to obtaining and filing such written

Acknowledgment Letters. A new substantive requirement under Sec. 1.26,

as proposed to be amended and included in the template form, is a

requirement that depositories provide the Commission and, and in the

case of an FCM, the FCM's DSRO--at all times--with read-only electronic

access to all FCM and DCO accounts holding customer funds.

L. Proposed Amendments to Sec. 1.29: Increment or Interest Resulting

From Investment of Customer Funds

The Commission is proposing to amend Sec. 1.29 to explicitly

provide that an FCM bears sole responsibility for any losses resulting

from the investment of customer funds in financial instruments

permitted under Sec. 1.25.

Regulation 1.29 provides that an FCM is not prohibited from keeping

as its own any interest or other gain resulting from the investment of

customer funds in financial instruments permitted under Sec. 1.25.

Regulation 1.25 also provides that an FCM must manage the permitted

investments consistent with the objectives of preserving principal and

maintaining liquidity.

The proposed amendment clarifies that an FCM is solely responsible

for any losses that result from the investment of customer funds in the

financial instruments listed under Sec. 1.25. An FCM may not charge or

otherwise allocate any such losses to the accounts of the FCM's

customers. To allocate losses on the investment of customer funds would

result in the use of customer funds in a manner that is not consistent

with section 4d(a)(2) and Sec. 1.20, which provides that customer fund

can only be used for the benefit of futures customers and limits

withdrawals from futures customer accounts, other than for the purpose

of engaging in trading, to certain commissions, brokerage, interest,

taxes, storage or other fees or charges lawfully accruing in connection

with futures trading.

The Commission requests comment on the proposed amendment to

explicitly provide that losses resulting from the investment of

customer funds may not be allocated by an FCM to customers. The

Commission also requests comment on how any losses associated with bank

deposits should be addressed. The Commodity Exchange Authority issued

an Administrative Determination (``AD'') in 1971 that provides that an

FCM may not be liable for losses resulting from the deposit of customer

funds with a bank that subsequently closes or is unable to repay the

FCM's deposit.\70\ The AD provides that an FCM would not be liable if

it had used due care in selecting the bank, had not otherwise breached

its fiduciary responsibilities toward the customers, and had fully

complied with the requirements of the Act and the Commission

regulations relating to the handling of customers' funds. The

Commission requests comment on whether the regulations should be

revised to impose an obligation on an FCM to repay customer funds in

the event of a default by a bank holding customer funds. Should there

be a distinction drawn between U.S.-domiciled and regulated banks and

non-U.S.-domiciled banks?

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\70\ Liability of Futures Commission Merchants and Clearing

Associations, Administrative Determination No. 230 (Nov. 23, 1971).

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M. Proposed Amendments to Sec. 1.30: Loans by Futures Commission

Merchants: Treatment of Proceeds

The Commission is proposing to amend Sec. 1.30 to provide that an

FCM may not loan funds to finance a customer's trading account on an

unsecured basis, or accept as collateral for the loan the customer's

trading account.

Regulation 1.30 provides that Commission regulations do not prevent

an FCM from lending its own funds to a customer that has pledged

securities and property, or from repledging or selling the customer's

securities or property pursuant to specific written agreement of the

customer. This provision generally allows customers to deposit non-cash

collateral as initial and variation margin. Absent the provisions in

Sec. 1.30, an FCM may be required to liquidate the non-cash collateral

if the customer was subject to an initial or variation margin call.

The Commission is proposing to amend Sec. 1.30 to prohibit an FCM

from loaning funds to finance a customer's trading account on an

unsecured basis, or from accepting a customer's trading account as

collateral for the loan. The Commission believes that extending

unsecured loans to customers is not a

[[Page 67889]]

common occurrence as the current capital requirements in Sec. 1.17

would require the FCM to take a 100 percent capital charge on the

unsecured receivables from the customers associated with such loans.

Commission staff has, however, had to provide its views on whether a

customer trading account may be used to collateralize a loan from the

FCM.

A trading account does not qualify as readily marketable securities

that are generally required to collateralize a loan for the FCM to

avoid the 100 percent unsecured receivable capital charge.\71\ Rules of

the CME also prohibit an FCM from providing unsecured financing to a

customer for margin purposes.\72\ The Commission is proposing to

explicitly prohibit unsecured lending by FCMs to customers in the

proposed amendments in Sec. 1.30. Should customers have liquidity

needs sufficient to require unsecured lending, the Commission believes

it to be prudent to require that such unsecured lending be done by a

party other than the FCM carrying the customer account. This newly

proposed prohibition comports with the Commission's existing regulatory

requirement contained in Sec. 1.56 that provides that no FCM may

represent that it will not call for or attempt to collect initial and

maintenance margin as established by the rules of the applicable board

of trade.

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\71\ Regulation 1.17(c)(3).

\72\ CME Rule 930.G.--Loans to Account Holders--provides that

clearing members may not make loans to account holders to satisfy

their performance bond requirements unless such loans are secured by

readily marketable collateral that is otherwise unencumbered and

which can be readily converted into cash.

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N. Proposed Amendments to Sec. 1.32: Segregated Account: Daily

Computation and Record

The Commission is proposing to amend Sec. 1.32 to require

additional safeguards with respect to futures customer funds on deposit

in segregated accounts, and to require FCMs to provide twice each month

a detailed listing to the Commission of depositories holding customer

funds.

Regulation 1.32 requires an FCM to prepare a daily record as of the

close of business each day detailing the amount of funds the firm holds

in segregated accounts for futures customers trading on designated

contract markets, the amount of the firm's total obligation to such

customers computed under the Net Liquidating Equity Method, and the

amount of the FCM's residual interest in the futures customer

segregated accounts. In addition, the daily record must detail the sum

of the futures customers' margin deficits, to ensure that residual

interest equals or exceeds such sum. In performing the calculation, an

FCM is permitted to offset any futures customer's debit balance by the

market value (less haircuts) of any readily marketable securities

deposited by the particular customer with the debit balance as margin

for the account. The amount of the securities haircuts are as set forth

in SEC Rule 15c3-1(c)(vi).

FCMs are required to perform the segregation calculation prior to

noon on the next business day, and to retain a record of the

calculation in accordance with Sec. 1.31. Both the CME and NFA require

their respective member FCMs to file the segregation calculations with

the CME and NFA, as appropriate, each business day. FCMs, however, are

only required to file a segregation calculation with the Commission at

month end as part of the Form 1-FR-FCM (or FOCUS Reports for dual-

registrant FCM/BDs). Regulation 1.12, as discussed in Section II.C

above, requires the FCM to provide immediate notice to the Commission

and to the firm's DSRO if the FCM is undersegregated at any time.

The Commission is proposing to amend Sec. 1.32 to require each FCM

to file its segregation calculation with the Commission and with its

DSRO each business day. The Commission also is proposing to amend Sec.

1.32 to require FCMs to use the Segregation Schedule contained in the

Form 1-FR-FCM (or FOCUS Report for dual-registrant FCM/BDs) to document

its daily segregation calculation.

As noted above, the CME and NFA require their respective member

FCMs to file their segregation calculations with them on a daily basis.

The CME and NFA also require the FCMs to document their segregation

calculation using the Segregation Schedule contained in the Form 1-FR-

FCM. Therefore, the additional requirement of filing a Segregation

Schedule with the Commission is not a material change to the

regulation.\73\

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\73\ In fact, since FCMs file the Segregation Schedules with the

CME and NFA via WinJammer, the Commission already has access to the

filings, and the amendment will not require an FCM to change any of

its operating procedures.

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The Commission believes that the filing of a Segregation Schedule

by each FCM each day will significantly enhance its ability to monitor

and protect customer funds. Commission staff will be able to determine

almost immediately upon receipt of the Segregation Schedule whether a

firm is undersegregated and immediately take steps to determine if the

firm is experiencing financial difficulty or if customer funds are at

risk.\74\ Commission staff also can coordinate the review of the daily

segregation computations with the additional bank and other depository

information that it will have access to under proposed Sec. 1.23.

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\74\ Each Form 1-FR-FCM and FOCUS Report is received by the

Commission via WinJammer. The financial forms are automatically

electronically reviewed within several minutes of being received by

the Commission and if a firm is undersegregated an alert is

immediately issued to Commission staff members via an email notice.

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In addition, the use of the Segregation Schedule provides a uniform

way for each FCM to present its information to the Commission, in a

format that both the Commission and FCMs are familiar with that will

reduce significantly the possibility of a miscommunication regarding

the information that is reported. The standardized Segregation Schedule

will also facilitate the Commission's ability to compare one FCM to

another, and to perform additional trend and other analysis to identify

potential issues with the holding of customer funds. The filing of

daily segregation records also will allow staff to monitor significant

movements in the balances of segregated funds on a day-to-day basis.

Proposed Sec. 1.32(d) provides that the Segregation Statement must

be filed with the Commission and with the FCM's DSRO electronically

using a form of user authentication assigned in accordance with

procedures established or approved by the Commission. The Commission is

not proposing to change the timeframe for the preparation of the

Segregation Statements. The Segregation Statement must be filed by noon

(based upon the location of the FCM) the next business day.

The Commission also is proposing to amend Sec. 1.32(b) to provide

that in determining the haircuts for commercial paper, convertible debt

instruments, and nonconvertible debt instruments deposited by customers

as margin, the FCM may develop written policies and procedures to

assess the credit risk of the securities as proposed by the SEC and

discussed more fully in Section II.F above. If the FCM's assessment of

the credit risk is that it is minimal, the FCM may apply haircut

percentages that are lower than the 15 percent default percentage under

SEC Rule 15c3-1(c)(2)(vi).

The Commission is further proposing to amend Sec. 1.32 by

requiring each FCM to file detailed information regarding depositories

and the substance of the investment of customer funds under Sec. 1.25.

Proposed paragraphs (f) and (j) of Sec. 1.32 will require each FCM to

submit

[[Page 67890]]

to the Commission and to the firm's DSRO a listing of every bank, trust

company, DCO, other FCM, or other depository or custodian holding

customer funds.

The listing must specify separately for each depository the total

amount of cash and Sec. 1.25 permitted investments held by the

depository for the benefit of the FCM's customers. Specifically, each

FCM must list the total amount of cash, United States government

securities, United States agency obligations, municipal securities,

certificates of deposit, money market mutual funds, commercial paper,

and corporate notes held by each depository, computed at current market

values. The listing also must specify: (1) If any of the depositories

are affiliated with the FCM; (2) if any of the securities are held

pursuant to an agreement to resell the securities to a counterparty

(reverse repurchase agreement) and if so, how much; and (3) the

depositories holding customer-owned securities and the total amount of

customer-owned securities held by each of the depositories. The FCM is

also required to disclose if any of the depositories are affiliated

with the FCM.

Each FCM is required to submit the listing of the detailed

investments to the Commission and to the firm's DSRO twice each month.

The filings must be made as of the 15th day of each month (or the next

business day, if the 15th day of the month is not a business day) and

the last business day of the month. The filings are due to the

Commission and to the firm's DSRO by 11:59 p.m. on the next business

day.

Proposed paragraph (k) of Sec. 1.32 will require each FCM to

retain the Segregation Statement prepared each business day and the

detailed investment information, together with all supporting

documentation, in accordance with Sec. 1.31.

The Commission's proposal is similar to existing SRO practices and

rules. The CME and NFA recently adopted rules requiring member FCMs to

submit detailed information on how they invest customer funds and the

depositories holding customer funds. The information required to be

filed by FCMs with the CME and NFA is consistent with the information

that FCMs are required to file with the Commission and DSROs under the

proposed amendments to Sec. 1.32, with the exception that the current

CME rule does not require member FCMs to submit information regarding

the holding of customer-owned securities. The proposed timeframes for

both preparing and filing both the Segregation Statements and the

detailed investment information are consistent between the SRO rules

and proposed Sec. 1.32.

The Commission also notes that NFA will be publishing information

on its Web site regarding how each FCM invests and holds customer

funds. Commission staff is consulting with NFA and is assessing whether

NFA should be the primary method for the public to obtain information

on how FCMs hold and invest customer funds.

The twice monthly filing of information on the investment of

customer funds will provide the Commission and SROs with more timely

detailed information regarding how FCMs are holding and investing

customer funds, which will allow the Commission and SROs to more

closely monitor customer funds to assess their safety. In this regard,

the reporting of the use of depositories that are affiliated with the

FCM will alert staff to review such relationships more closely to

ensure that transactions are done in an appropriate arms-length manner

and not to the benefit of the affiliated depository. Staff also can

compare reported the reported investment balances with information

maintained directly by the depositories using the on-line access that

the depositories will be required to provide to Commission staff under

Sec. 1.20 discussed above.

The Commission request comment on all aspects of the proposed

amendments to Sec. 1.32. Specifically, the Commission requests

comments on the following:

Should the Commission amend the regulations to require

each FCM to disclose information regarding its investments of customer

funds? If so, what information should be disclosed? What investment

information would be of the most benefit to market participants in

assessing whether to entrust funds to a particular FCM? How would the

investment information be used by market participants?

How frequently should investment information be disclosed?

What format should be used to disclose the information? How should the

information be disclosed? Should the information be posted on the FCM's

internet web site?

Should NFA act as the primary source for the disclosure of

how FCMs hold and invest customer funds?

O. Proposed Amendments to Sec. 1.52: Self-Regulatory Organization

Adoption and Surveillance of Minimum Financial Requirements

SROs are required by the Act and Commission regulations to monitor

their member FCMs for compliance with the Commission's and SROs'

minimum financial and related reporting requirements. Specifically, DCM

Core Principle 11 provides, in relevant part, that a board of trade

shall establish and enforce rules providing for the financial integrity

of any member FCM and the protection of customer funds.\75\ In

addition, section 17 of the Act requires NFA to establish minimum

capital, segregation, and other financial requirements applicable to

its member FCMs, and to audit and to enforce compliance with such

requirements.\76\

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\75\ 7 U.S.C. 7(d)(11).

\76\ 7 U.S.C. 21(p).

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The Commission also has established in Sec. 1.52 minimum elements

that each SRO financial surveillance program must contain to satisfy

the statutory objectives of Core Principle 11 and section 17 of the

Act. In this regard, Sec. 1.52 requires, in part, each SRO to adopt

and to submit for Commission approval rules prescribing minimum

financial and related reporting requirements for member FCMs. The rules

of the SRO also must be the same as, or more stringent than, the

Commission's requirements for financial statement reporting under Sec.

1.10 and minimum net capital under Sec. 1.17.

In addition, the Commission adopted final amendments to Sec. 1.52

on May 10, 2012, to codify previously issued CFTC staff guidance

regarding the minimum elements of an SRO financial surveillance

program.\77\ The final amendments require an SRO to: (1) Maintain staff

of an adequate size, training, experience, and independence to

effectively implement a supervisory program; (2) maintain a program

that provides for the ongoing surveillance of FCMs through review of

financial statements and regulatory notices; (3) identify firms that

pose a high degree of potential risk, including risk to customer funds;

(4) conduct routine, periodic onsite examinations of FCMs; and (5)

adequately document all aspects of the operation of the supervisory

program, including the conduct of risk-based scope setting and the

risk-based surveillance of high-risk member registrants, and the

imposition of remedial and punitive actions for material violations.

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\77\ 77 FR 36611 (June 19, 2012).

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In order to effectively and efficiently allocate SRO resources over

FCMs that are members of more than one SRO, Sec. 1.52(c) currently

permits two or more SROs to enter into an agreement to establish a

joint audit plan for purpose of assigning to one of the SROs (the DSRO)

of the joint audit plan the function of monitoring and examining member

FCMs for compliance with

[[Page 67891]]

certain regulatory and financial reporting obligations. The audit plan

must be submitted to the Commission for approval. The Commission may

approve a joint audit plan, or part of such a plan, after notice and

comment if the Commission determines that the plan: (1) Is necessary or

appropriate to serve the public interest; (2) is for the protection and

in the interest of customers; (3) reduces multiple monitoring and

auditing for compliance with the minimum financial requirements; (4)

reduces multiple reporting of financial information; (5) fosters

cooperation and coordination; and (6) does not hinder the development

of a registered futures association. Currently all active SROs are

members of a joint audit plan that was approved by the Commission on

March 18, 2009.\78\

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\78\ The original signatories of the joint audit plan approved

on March 18, 2009 are as follows: Board of Trade of the City of

Chicago, Inc.; Board of Trade of Kansas City; CBOE Futures Exchange,

LLC; Chicago Climate Futures Exchange, LLC; Chicago Mercantile

Exchange Inc.; Commodity Exchange, Inc; ELX Futures, L.P.;

HedgeStreet, Inc.; ICE Futures U.S., Inc.; INET Futures Exchange,

L.L.C.; Minneapolis Grain Exchange; NASDAQ OMX Futures Exchange;

National Futures Association; New York Mercantile Exchange, Inc.;

NYSE Liffe US, L.L.C.; OneChicago, L.L.C.

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The Commission is proposing additional amendments to Sec. 1.52 in

light of recent events that highlight a need for strengthening the

minimum requirements that SROs must abide by in conducting financial

surveillance to minimize the chances that FCMs that engage in unlawful

activities that result, or could result, in the loss of customer funds

or the inability of the firms to meet their financial obligations to

market participants, including DCOs, go undetected. The proposed

amendments to Sec. 1.52 revise the current supervisory program

required to be established and implemented by SROs pursuant to existing

Sec. 1.52(b) with respect to their FCM members. In addition, for SROs

that choose to delegate their duties to oversee and examine FCMs that

are members of two or more SROs to a DSRO pursuant to a plan

established under existing Sec. 1.52(c) in lieu of each conducting its

own oversight and examinations of such common FCM members, proposed

Sec. 1.52 provides that the plan adopt certain requirements to assure

the quality of the DSRO oversight and examinations conducted under the

plan, both as to the substance of the oversight and examination program

and the application of such program.

Proposed Sec. 1.52(b) requires each SRO to adopt rules requiring

its member FCMs to establish a risk management program that is at least

as stringent as the risk management program required in proposed Sec.

1.11. Proposed Sec. 1.11 is discussed in Section II.B above, and

requires an FCM to establish a risk management program designed to

monitor and manage risks associated with the activities of the FCM.

Proposed Sec. 1.52 does not make significant changes to the

existing SRO supervisory programs with respect to the oversight and

examination of retail foreign exchange dealer and IB member

registrants. However, with respect to the oversight and examination of

FCMs, proposed Sec. 1.52 requires an SRO to adopt significant new

requirements in its supervisory program. The supervisory program for

FCMs will now explicitly require, among other things, controls testing

as well as substantive testing, and the examination process for each

FCM must be driven by the risk profile of each such FCM. In addition,

the supervisory program must conform to U.S. GAAS after giving full

consideration to those auditing standards as prescribed by the PCAOB.

The supervisory program also must contain written standards addressing

numerous aspects of the examination process over FCMs as provided in

proposed Sec. 1.52(c)(2)(iii), including the examination of the risk

assessment process, the examination of the planning process, and the

quality control procedures to ensure that the examinations maintain the

level of quality expected by the SRO.

The Commission believes that an examination of an FCM must include

a review and assessment of the firm's internal controls in order to

identify where there may be potential weaknesses and to properly gauge

the risks associated with such weaknesses including their potential

impact on the financial condition of the firm and the protection of

customer funds.

The SRO also must engage an ``examinations expert'' under Sec.

1.52(c)(2) to review its supervisory program and the application of the

supervisory program at least once every two years. The term

``examinations expert'' is proposed to be defined under Sec. 1.52(a)

as a nationally recognized accounting and auditing firm with

substantial expertise in audits of FCMs, risk assessment and internal

control reviews, and is someone acceptable to the Commission. The

Commission is proposing to delegate to the Director of the Division of

Swap Dealer and Intermediary Oversight the responsibility of assessing

whether a particular entity is qualified and approved as an

examinations expert to review the SRO's supervisory program

The review will require the examinations expert to assess the

sufficiency of the SRO's risk-based approach and the internal controls

testing and also whether the supervisory program is being appropriately

applied by the SRO in its examinations of its member FCMs. In addition,

the review will require that the examinations expert provide an opinion

as to whether the supervisory program is reasonably likely to identify

a material deficiency in internal controls of the FCM or in any of the

other items that are the subject of an examination conducted in

accordance with the supervisory program. Furthermore, the review will

require that the examinations expert also provide recommendations on

new or best practices prescribed by industry sources that should be

incorporated in the supervisory program. The SRO must receive a written

report from the examinations expert describing, among other things, the

items mentioned in this paragraph.

Upon receipt of the written report, the SRO must provide such

written report to the Commission. The SRO must update the supervisory

program and coordinate with the Commission to resolve any issues raised

by the written report and any Commission questions and comments before

the updated supervisory program becomes the standard for the SRO's

examinations of its registered FCM members. Proposed Sec.

1.52(c)(2)(vi) also requires each SRO to submit an initial supervisory

program within 120 days of the effective date of the regulation, or a

longer period of time that Director of the Division of Swap Dealer and

Intermediary Oversight (acting pursuant to authority delegated by the

Commission) may approve. The initial supervisory program must contain

an affirmation from the examinations expert regarding the evaluation of

the supervisory program, including the sufficiency of the risk-based

approach and the internal controls testing. The examinations expert

also must opine as to whether the supervisory program is reasonably

likely to identify a material weakness in internal controls over

financial or regulatory reporting.

Consistent with the current regulation, and in order to avoid

duplicative examinations and oversight of FCMs, retail foreign exchange

dealers, or IBs, proposed Sec. 1.52(d)(1) provides that when two or

more SROs have a common member registrant, such SROs may voluntarily

agree to establish a plan to delegate to a single DSRO the function of

overseeing and examining such common member registrant otherwise

required from each such SRO.

[[Page 67892]]

Proposed amendments to Sec. 1.52(d)(1) would further provide that

while an SRO may delegate the functions of examining a member FCM for

compliance with the minimum financial and reporting and risk management

requirements, the delegating SRO retains responsibility for its member

FCM's compliance with such requirements.

If SROs choose to take advantage of the efficiency provided by a

joint audit plan with respect to their oversight and examinations over

common member FCMs, then the plan must satisfy the requirements of

proposed Sec. 1.52(d)(2), which will assure the quality of the SROs,

both as to the substance of the oversight and examination program and

the application of such program. Proposed Sec. 1.52(d)(2) requires in

such a plan that the SROs form a Joint Audit Committee and adopt a

Joint Audit Program pursuant to which FCMs are overseen and examined by

a DSRO.

The Joint Audit Committee members will be subject to a number of

duties according to proposed Sec. 1.52(d)(2). The most important of

these is that the Joint Audit Committee members establish and maintain

a Joint Audit Program that the DSROs must apply in their oversight and

examinations of FCMs.

The requirements for the establishment and maintenance of the Joint

Audit Program are identical in many ways to the establishment and

maintenance of the standalone supervisory program with respect to FCMs

described in proposed Sec. Sec. 1.52(b) and (c). For example, the

Joint Audit Program and the standalone supervisory program both require

controls testing as well as substantive testing, and the examination

process for each FCM must be driven by the risk profile of each such

FCM. Both programs are required to be reviewed by an examinations

expert every two years. Both must have standards addressing the items

listed in proposed Sec. 1.52(c)(2)(iii), including the examination

risk assessment, examination planning, and quality control to ensure

that the examinations maintain the level of quality expected. The

rationale for this approach is because one of the goals of proposed

Sec. 1.52(d)(2) is to ensure that the SRO and examinations of FCMs is

at least up to the same heightened standard, regardless of whether the

oversight and examinations are conducted by the SRO itself or by a DSRO

designated by the Joint Audit Committee.

The proposed revisions to Sec. 1.52(d) would not nullify the

existing joint audit plan approved by the Commission on March 18, 2009.

Furthermore, the Commission believes that the new minimum requirements

for a Joint Audit Program under proposed Sec. 1.52(d)(2) will not

require revisions to the current joint audit plan. In this regard, the

joint audit plan approved by the Commission includes a provision in

paragraph 3 that provides that the minimum practices and procedures

followed by each DSRO in the conduct of examinations of FCMs shall be

established to conform with the requirements of Sec. 1.52, Commission

staff interpretations, and any other Commission requirements

hereinafter in effect relating to audits and financial reviews. The

Commission believes that this provision would require the DSROs of the

current joint audit plan to revise their Audit Program to meet the new

requirements of proposed 1.52, but not require a new joint audit plan

to be submitted to the Commission.\79\

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\79\ The Commission's view is only that the current agreement

does not have to be revised as a result of the proposed amendments.

The SRO members of the current joint audit plan, however, are not

precluded from making any amendments or otherwise revising the joint

audit program consistent with the terms included in the agreement

for making such revisions.

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The members of the current joint audit plan would be required to

establish, operate and maintain a Joint Audit Program under proposed

Sec. 1.52(d)(2)(i). The members of the current joint audit plan also

would be required to submit to the Commission for its review and

comment a Joint Audit Program within 120 days (or such other time as

the Commission may approve) of the effective date of the amendments to

Sec. 1.52 under proposed Sec. 1.52(d)(2)(ii)(H). The Joint Audit

Program must be accompanied by a written report from an examinations

expert affirming that the examinations expert has evaluated the Joint

Audit Program and the examinations expert's opinion as to whether the

Joint Audit Program is reasonably likely to identify a material

deficiency in internal controls over financial and regulatory

reporting, and other items that are subject of an examination conducted

in accordance with the Joint Audit Program.

The Commission is proposing to delegate the responsibility for

granting an extension of time to submit an initial Joint Audit Program

to the Director of the Division of Swap Dealer and Intermediary

Oversight. In this connection, the Commission anticipates that the

Division of Swap Dealer and Intermediary Oversight will be performing

ongoing consultation with SROs regarding the examination programs and,

therefore, would be in position to assess the adequacy of, and

necessity for, any request for an extension of the filing deadline. It

is anticipated that the Director of the Division of Swap Dealer and

Intermediary Oversight will grant requests for reasonable extensions of

time for the submission of the Joint Audit Program.

The Commission requests comments on all aspects of proposed Sec.

1.52. The Commission also requests comments on the following:

The Commission is proposing to require that the SRO and/or

JAC program be subject to an evaluation by an examinations expert at

least once every two years. The examinations expert is defined as a

nationally recognized accounting and auditing firm. Is the proposed

definition of the examinations expert sufficiently clear or detailed to

identify which entities may qualify as an examinations expert? If not,

how can the Commission make the definition more objective? Should the

Commission consider entities other than accounting and auditing firms

(such as consulting firms) to act as examinations experts?

Is the requirement for the examinations expert to conduct

an evaluation of the SRO or JAC program at least once every two years

an appropriate timeframe? Should the Commission consider a shorter

interval between evaluations? If so, why? Alternatively, should the

Commission consider a longer interval between evaluations? If so, why?

What criteria should the Commission consider in setting the interval?

Should the Commission allow SRO or JAC programs that have minimal

issues raised by the examinations expert be subject to a longer

evaluation interval than programs that have more issues identified by

the examinations expert? If so, how would the Commission implement such

a program?

Does the requirement for an examinations expert add

sufficient value to the SRO or JAC program to justify the costs of such

evaluations? Please provide detail in your response to assist the

Commission in assessing the costs of such evaluations.

Are there alternatives to the examinations expert's

evaluation to assess the adequacy of the SRO and JAC program that the

Commission should consider? Please provide detail in your response.

The Commission is proposing that an SRO submit an initial

supervisory program and that the members of a Joint Audit Committee

submit an initial Joint Audit Program within 120 days of the effective

date of the regulation. The initial supervisory program and the initial

Joint Audit Program must include

[[Page 67893]]

a written report containing an affirmation from an examinations expert

regarding the evaluation of the supervisory program or the Joint Audit

Program, including the sufficiency of the risk-based approach and the

internal controls testing. The examinations expert also must opine as

to whether the supervisory program or the Joint Audit Program is

reasonably likely to identify a material weakness in internal controls

over financial or regulatory reporting. Is the proposed 120-day period

a sufficient period of time for an SRO or JAC to obtain such report

from an examinations expert and to submit its respective supervisory

program or Joint Audit Program? If not, what is a sufficient period of

time?

P. Proposed Amendments to Sec. 1.55: Public Disclosures by Futures

Commission Merchants

The Commission is proposing to amend Sec. 1.55 to enhance the

disclosures provided to customers and potential customers regarding the

extent to which customer funds are protected when deposited with an FCM

as margin or to guarantee performance for trading commodity interests.

The Commission also is proposing to require each FCM to disclose

certain firm specific information regarding the FCM's financial

condition and operations to allow customers and potential customers to

assess the risks of engaging the firm to conduct futures trading and

the risks of entrusting their funds to the FCM.

Regulation 1.55(a) currently requires an FCM, or an IB in the case

of an introduced account, to provide each customer with a risk

disclosure statement prior to opening the customer's account (``Risk

Disclosure Statement').\80\ Regulation 1.55(b) provides a standard form

Risk Disclosure Statement that each FCM or IB is required to provide to

each prospective customer. The current Risk Disclosure Statement is

primarily intended to provide a customer with disclosure of the market

risks of engaging in futures trading and addresses, among other things,

risks associated with leverage, market movements, and the inability to

exit the market due to limit moves. The FCM or IB also is required to

receive a signed acknowledgment from the customer stating that the

customer received and understood the Risk Disclosure Statement.

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\80\ FCMs and IBs are not required to provide disclosure

documents to institutional customers, defined as eligible contract

participants under section 1a of the Act. See Sec. 1.55(f).

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The Commission is proposing to amend Sec. 1.55 to require FCMs to

provide additional disclosures to prospective customers. Specifically,

the Commission is proposing to add new provisions to paragraph (b) that

will require the Risk Disclosure Statement to contain a statement that:

(1) Customer funds are not protected by insurance in the event of the

bankruptcy or insolvency of the FCM, or if customer funds are

misappropriated in the event of fraud; (2) customer funds are not

protected by SIPC, even if the FCM is a BD registered with the SEC; and

(3) customer funds are not insured by a DCO in the event of the

bankruptcy or insolvency of the FCM holding the customer funds. The

proposed amendments also will require an FCM to disclose that each

customer's funds are not held in an individual segregated account by an

FCM, but rather are commingled in one or more accounts, and that FCMs

may invest funds deposited by customers in investments listed in Sec.

1.25. The proposed amendments also will require that each FCM disclose

that funds deposited by customers may be deposited with affiliated

entities of the FCM, including affiliated banks and brokers.

The Commission also is proposing to revise the Risk Disclosure

Statement required by Sec. 1.55(b) to include a new disclosure that

informs a potential customer that each futures commission merchant is

required by Commission regulations to make certain firm specific

disclosures and financial information publicly available on the futures

commission merchant's Web site to assist the customer with his or her

assessment and selection of a futures commission merchant. The firm

specific disclosures are detailed in proposed paragraph (k) of Sec.

1.55 and are discussed below. The Risk Disclosure Statement also must

include the futures commission merchant's Web site address where the

additional firm specific and financial information may be obtained by

the customer.

The Commission is proposing the additional disclosures in response

to the recent failures of MF Global and Peregrine. The Commission is

concerned that the current Risk Disclosure Statement does not provide

customers with adequate or complete information regarding the risks of

engaging in trading through an FCM. Current disclosures in the Risk

Disclosure Statement focus on the market risks of engaging in futures

trading. However, the Commission understands that many of MF Global's

former customers did not have adequate and meaningful information

regarding the risks that their funds were exposed to beyond general

market risks. Specifically, the Commission understands that some

customers believed that their funds were covered by insurance or other

protection. Some customers also believed that DCOs guaranteed customer

funds in the event of a bankruptcy of an FCM.

The proposed additional disclosures in the Risk Disclosure

Statement are intended to provide customers with a greater

understanding of the risks of entrusting their funds with an FCM. This

includes disclosures regarding the meaning and operation of the term

``segregation'' under the Act and Commission regulations. In addition,

the Commission believes that customers will benefit from an awareness

that FCMs may use affiliated entities to hold customer funds.

The Commission also is proposing that the Risk Disclosure Statement

include a new provision that informs potential customers to the fact

that additional firm specific disclosures and financial information

about a particular FCM may be obtained from information maintained on

each FCM's respective Web site. The content of the additional firm

specific and financial disclosures are discussed below.

The Commission also is proposing to amend Sec. 1.55, by adding new

paragraphs (i) through (n) which will require an FCM to provide to each

customer an additional disclosure document that will set forth firm

specific information and address firm-specific risk factors to allow

customers to have more information regarding the FCM and the risks

associated with entrusting their funds to the FCM, or otherwise

conducting business with or through the FCM (``Firm Specific Disclosure

Document''). The additional risk information provided also will enable

customers to make more meaningful judgments regarding the

appropriateness of selecting an FCM by providing tools and information

for the meaningful comparisons of business models and risks across

FCMs. Such additional information will greatly enhance the due

diligence that a customer can conduct both prior to opening an account

and on an ongoing basis, as the proposal will require that the FCM

update the risk disclosure information on a periodic basis. The

Commission believes that the proposed Firm Specific Disclosure

Document, coupled with the existing Risk Disclosure Statement, will

provide customers with a more complete perspective regarding the risks

of participating in the futures markets.

[[Page 67894]]

Under the proposal, in addition to providing general firm contact

information, the Firm Specific Disclosure Document will contain the

names, business contacts, and backgrounds for the FCM's senior

management and members of the FCM's board of directors. The Firm

Specific Disclosure Document also will include firm risk disclosures

including: (1) A discussion of the significant types of business

activities and product lines that the FCM engages in; (2) a discussion

of the FCM's significant lines of business and the approximate amount

of assets and capital devoted to each line of business; (3) a

discussion of the material risks of the firm including the FCM's

creditworthiness, leverage, capital and liquidity condition, and an

explanation of how such risks may be material to customers that deposit

funds for futures trading with the firm; and (4) a discussion of any

material administrative, civil, criminal, or enforcement actions

pending or any enforcement actions taken in the last three years.

The proposed Firm Specific Disclosure Document also will require

each FCM to disclose firm specific information regarding its operations

in the futures marketplace. An FCM will be required to disclose the

name of the firm's DSRO, and to provide an overview of customer funds

segregation protections and limitations, and how it manages its

collateral management and investments. Each FCM also will be required

to disclose the clearinghouses and carrying brokers that its uses to

conduct its business, as well as its policies and procedures concerning

the choice of depositories, custodians and counterparties.

The proposed Firm Specific Disclosure Document also will require

the FCM to disclose certain financial and risk management information

including the firm's total equity, regulatory capital, and net worth as

of the most recent month end when the disclosure document is prepared.

The FCM also is required to disclose information regarding: (1) The

amount of the FCM's proprietary margin requirements as a percentage of

the total segregated and secured funds that the FCM holds; (2) the

number of customers that comprise 50 percent of the firm's total

customer segregated and secured amount requirements; (3) the aggregate

notional value, by asset class, of all non-hedged, principal over-the-

counter transactions into which the FCM has entered; (4) the amount,

generic source and purpose of any unsecured lines of credit (or similar

short-term funding) the FCM has obtained but not yet drawn upon; (5)

the aggregate amount of financing the FCM provides for customer

transactions involving illiquid financial products for which it is

difficult to obtain timely and accurate prices; (6) the percentage of

customer receivables that the FCM had to write-off as uncollectable

during the prior year compared to the current segregated and secured

amount balances; and (7) a summary of the FCM's current risk practices,

controls and procedures.

An FCM is obligated to update the Firm Specific Disclosure Document

as necessary to keep the information accurate, but at least on an

annual basis. An FCM also is required to make the Firm Specific

Disclosure Document available to its customers and the general public

on its Web site. An FCM may, however, use an alternative electronic

means to make the Firm Specific Disclosure Document available to its

customers provided that the electronic version is presented in a format

that is readily communicated to its customers. The Proposal further

provides that an FCM shall provide a paper copy of the Firm Specific

Disclosure Document to a customer upon the customer's request.

The Commission also is proposing to amend Sec. 1.55 to require

each FCM to disclose on its Web site to the general public financial

information that is publicly available under existing Commission

regulations. Specifically, proposed paragraph (o) of Sec. 1.55 will

require each FCM to make available on its Web site the daily

Segregation Schedule; the daily Secured Amount Schedule; and the daily

Cleared Swaps Segregation Schedule. Each FCM will be required to

maintain 12 months of the above segregation and secured schedules

available on its Web site.

Proposed paragraph (o) also requires each FCM to disclose on its

Web site a summary schedule of the firm's adjusted net capital, net

capital, and excess net capital for the 12 most recent month-end dates.

Each FCM also will be required to disclose on its Web site the

following statements and schedules from the most current year end

annual report that is certified by an independent public accountant in

accordance with Sec. 1.16: the Statement of Financial Condition; the

Segregation Schedule; Secured Amount Schedule; the Cleared Swaps

Segregation Schedule; and all footnotes related to the above statement

and schedules.

The information that the proposal requires each FCM to disclose on

its Web site is information that is currently publicly available under

Commission regulations, or proposed by this rulemaking in the case of

the Cleared Swaps Segregation Schedule, to be public information.

Regulation 1.10(g) currently provides that the Segregation Schedules

and Secured Amount Schedules contained in the monthly unaudited Forms

1-FR-FCM are public information. Regulation 1.10(g) further provides

that the amounts of an FCM's adjusted net capital, minimum net capital

requirement, and excess net capital as reported in the firm's unaudited

monthly Form 1-FR-FCM are public information. Lastly, Sec. 1.10(g)

provides that the Statement of Financial Condition, Segregation

Schedule, Secured Amount Schedule, and related footnote disclosures

contained in an FCM's audited annual financial report are public

documents.

The Commission also is proposing in paragraph (o) of Sec. 1.55 to

require each FCM to include a statement on its Web site that is

available to the public that additional information, including

information on how the FCM invests customer funds, may be obtained from

the NFA. The FCM also is required to include a link on its Web site to

the NFA web page which shows financial information for the FCM. Lastly,

proposed paragraph (o) requires each FCM to include a statement

regarding the Commission's reporting of select FCM financial

information and a link to the Commission's Web site.

The Commission is proposing paragraph (o) as it believes that

customers will make more informed choices regarding which FCMs to use

to carry their account and to entrust their funds to if they have the

opportunity to have access to FCM financial information. Requiring FCMs

to make the information available to the public on their respective Web

sites will allow customers and potential customers with a convenient

method of obtaining and reviewing the information to assist with their

selection process. Customers will have the ability to compare and

contrast financial data from all FCMs to assist with the decision

making process of determining which firms meet their criteria for

holding their funds.

The Commission requests comment on all aspects of proposed

amendments to Sec. 1.55. Specifically, the Commission requests comment

on the following:

Do the existing and proposed disclosures required to be

included in the Risk Disclosure Statement and Firm Specific Disclosure

Document adequately convey to retail and/or institutional investors the

market and firm specific risks of engaging in futures trading and the

risks of using an FCM to execute trades on customers' behalf and to

hold customers' funds? If not, how should the Risk Disclosure

[[Page 67895]]

Statement and Firm Specific Disclosure Document be amended?

Are there other disclosures that the Commission should

require to be included in Risk Disclosure Statement? If so, what are

the additional disclosures and how would such disclosures benefit

customers?

Are there other disclosures that the Commission should

require to be included in a Firm Specific Disclosure Document? If so,

what are the additional disclosures and how would such disclosures

benefit customers?

Are the proposed additional firm-specific disclosures too

broad? If so, how should the Commission refine the disclosures to be

more specific, yet provide the type of information that the Commission

would like customers to receive?

The Commission is proposing to require an FCM to disclose

in the Firm Specific Disclosure Document the number of customers that

comprise 50 percent of the FCM's customer fund balances for futures

customers, Cleared Swaps Customers, and 30.7 Customers. Should the

Commission consider additional or different percentages? If so, what

should the percentages be and why?

The Commission requests comment on how the new or revised

Risk Disclosure Statement and Disclosure Documents should be provided

to existing customers. Should FCMs be required to obtain new signature

acknowledgments from existing customers for a revised Risk Disclosure

Statement? How should existing customers be informed of the new Firm

Specific Disclosure Statement? How can the Commission be assured that

all existing customers have been informed of the new disclosure

documents, and the availability of the FCM financial data?

If FCMs are required to provide existing customers with

new Risk Disclosure Statements, how should Commission address the

implementation of the requirement? What would be an adequate period of

time for FCMs to obtain new acknowledgment from existing customers?

Q. Proposed Amendments to Part 22

The Commission recently adopted final regulations in Part 22

implementing the provisions of the Dodd Frank Act that provide for the

protection of Cleared Swaps Customer contracts and collateral.\81\

Although substantive differences in the segregation regimes between

futures and cleared swaps at the clearing level exist under the final

Part 22 regulations as adopted, requirements with respect to collateral

which is not posted to clearinghouses and maintained by FCMs for

Cleared Swaps Customers replicate or incorporate by reference the same

regulatory requirements applicable to the segregation of futures

customer funds under section 4d(a)(2) of the Act (for example, holding

funds separate and apart from proprietary funds, limitations on the

FCM's use of customer funds, titling of depository accounts,

Acknowledgment Letter from depository requirements, and limitations on

investment of swap customers' funds are currently contained in Part 22

regulations).

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\81\ 77 FR 6336 (February 7, 2012).

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The determination that appropriate enhancements are necessary with

respect to the regulatory requirements discussed above for segregated

futures customer funds under section 4d(a)(2) of the Act is equally

applicable to Cleared Swaps Customer Collateral. The written policies

and procedures requirements proposed in Sec. 1.11 would be applicable

to Cleared Swaps Customer Collateral, the new withdrawal limitations

requirements proposed in Sec. 1.23 are proposed to be replicated in a

new Sec. 22.17, and the changes to the daily segregation calculations

and filing of such calculations, as well as requirements for detailed

depository and investment information, are proposed to apply to Cleared

Swaps Customer funds through proposed amendments to Sec. 22.2(g). In

addition, changes discussed above regarding Sec. 1.17 with respect to

securities haircuts are also proposed with respect to Sec. 22.2(f),

which similarly incorporates by reference the applicable SEC securities

haircuts. Finally, the proposed Sec. 1.20(i) requirement that an FCM

maintain residual interest in segregated accounts in an amount that

exceeds the sum of all futures customers' margin deficits is also

proposed with respect to Cleared Swaps. As stated above, this

requirement provides a clear mechanism for demonstrating FCM compliance

with the prohibition under the Act and existing Commission regulations

on using the collateral of one Cleared Swaps Customer to support the

obligations of another Cleared Swaps Customer.

R. Amendments to Sec. 1.3: Definitions; and Sec. 30.7: Treatment of

Foreign Futures or Foreign Options Secured Amount

Part 30 of the Commission's regulations were adopted in 1987 and

govern trading on foreign futures markets.\82\ Regulation 30.7 requires

an FCM to set aside in separate accounts for the benefit of its foreign

futures or foreign options customers an amount of funds defined as the

``foreign futures or foreign options secured amount.'' The term

``foreign futures or foreign options secured amount'' is defined in

Sec. 1.3(rr) as the amount of funds necessary to margin the foreign

futures or foreign options positions held by the FCM for its foreign

futures or foreign options customers, plus or minus any gains or losses

on such open positions. The calculation of the foreign futures or

foreign options secured amount is referred to as the ``Alternative

Method.''

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\82\ 52 FR 28980 (Aug. 5, 1987).

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Foreign futures or foreign options customers receive substantially

less protection for their account deposits under the Alternative Method

than futures customers receive for their account deposits under section

4d(a)(2) of the Act and Commission regulations. Section 4d(a)(2) of the

Act and Commission regulations require an FCM to segregate in separate

accounts sufficient funds to satisfy the full account equities of all

of its futures customers trading on designated contract markets (i.e.,

the Net Liquidating Equity Method). The regulatory objective of the Net

Liquidating Equity Method is to ensure that an FCM has sufficient funds

in segregated accounts to cover the full account equities of all of its

futures customers. This would allow the FCM to transfer the futures

customers' positions and margin collateral in the event of the

insolvency of the FCM to another firm that was financial sound. If the

FCM does not maintain sufficient funds in segregation to cover the full

account equities, the futures customers may not be able to be

transferred to another FCM, or the futures customers may be required to

deposit margin funds with the transferee FCM to adequately margin the

positions.

In contrast, the Alternative Method only obligates an FCM to set

aside an amount of funds in separate accounts sufficient to cover the

margin required on open foreign futures and foreign options positions,

plus or minus any unrealized gains or losses on such positions. Any

funds deposited by foreign futures or foreign options customers in

excess of the required amount to be set aside in separate accounts

under the Alternative Method may be held by the FCM in operating cash

accounts and may be used by the FCM as if it were its own capital.

Therefore, an FCM is not required to set aside in separate accounts a

sufficient

[[Page 67896]]

amount funds to repay the full account balances of each of its foreign

futures or foreign options customers, and, in the event of an FCM

insolvency, the foreign futures or foreign options customers may not

recover 100 percent of the value of their accounts or be able to

transfer their positions to another FCM.

The Commission is proposing to amend the Part 30 regulations to

eliminate the Alternative Method and to require FCMs to use the Net

Liquidating Equity Method to compute the amount of funds they must set

aside in separate accounts for the benefit of its foreign futures or

foreign options customers. The amount of funds held for foreign futures

and foreign options customers has grown dramatically in the last 10

years. FCMs held approximately $36.4 billion for foreign futures or

foreign options customers as of June 30, 2012, compared to a total of

$7.9 billion held as of March 31, 2002 (an approximate 470 percent

increase).\83\ In addition, the amount of funds held by FCMs for

foreign futures or foreign options customers has increased relative to

the amount of segregated funds held by FCMs during the last 10 years.

Funds held for foreign futures or foreign options customers represented

approximately 13 percent of the total customer funds held by FCMs as of

March 31, 2002, and represented approximately 21 percent of total

customer funds as of June 30, 2012.\84\

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\83\ The total amount of customer funds held by FCMs is

available on the Commission's Web site at http://www.cftc.gov/MarketReports/FinancialDataforFCMs/index.htm.

\84\ Id.

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Accordingly, the Commission is proposing to amend Sec. 1.3(rr) to

define the term ``foreign futures or foreign options secured amount''

to mean the amount of funds an FCM needs to satisfy the full account

balances of each 30.7 Customer at all times (i.e., the Net Liquidating

Equity Method).

The term ``30.7 Customer'' is proposed to be defined in Sec. 30.1

to mean both U.S.-domiciled customers and foreign-domiciled customers

trading foreign futures or foreign options. As originally adopted, FCMs

were only required to hold funds for U.S.-domiciled customers. The Net

Liquidating Equity Method will require the FCM to set aside a

sufficient amount of funds in secured accounts to repay the total

account balances of all of its 30.7 Customers, which will align the

requirement with the segregation requirements for both futures

customers and Cleared Swaps Customers. The proposed amendments will

significantly enhance the protection afforded to funds deposited by

customers trading on foreign markets.

The Commission also is proposing to substantively revise the

regulations governing an FCM's holding of funds deposited by a customer

for trading on foreign futures markets. The proposed amendments to the

foreign futures or foreign options secured amount requirement establish

many of the regulatory requirements that currently exist, or are

proposed to be adopted under this rulemaking, with regard to segregated

funds deposited by customers trading on a designated contract market

under Part 1 and deposited by Cleared Swaps Customers under Part 22 of

the Commission's Regulations.

Regulation 30.7(a) requires an FCM to set aside in separate

accounts sufficient funds to meet its current obligations to foreign

futures or foreign option customers denominated as the ``foreign

futures or foreign options secured amount.'' The term ``foreign futures

or foreign options customer'' is defined in Sec. 30.1 to mean any

person located in the United States, its territories, or possessions.

The term ``foreign futures or foreign options secured amount'' is

defined at Sec. 1.3(rr) and means an amount of money, securities, or

other property sufficient to margin, guarantee, or secure open foreign

futures contracts plus any unrealized gains or losses on such

contracts, and any money securities or property representing premiums

paid or received, and any other funds necessary to guarantee or secure,

open foreign option transactions (i.e., the Alternative Method of

computing the secured amount requirement). Thus, an FCM is not required

to set aside in separate accounts all funds deposited by or otherwise

belonging to foreign futures or foreign option customers. Funds

deposited by foreign futures or foreign options customers that exceed

the foreign futures or foreign options secured amount may be commingled

with the FCM's proprietary funds and used by the FCM as part of its

business capital.

In addition, Sec. 30.7(b) requires only that an FCM set aside the

required margin funds for foreign futures customers that are located

within the United States, its territories, or possessions. Regulation

30.7 permits the FCM to include foreign futures customers that are

located outside of the United States, but the FCM is not obligated to

include such foreign-domiciled customers.

Furthermore, Commission staff previously issued guidance to FCMs

stating that an FCM could carry positions other than foreign futures

and foreign option positions in foreign futures or foreign options

customers' accounts. Thus, FCMs could commingle and carry customers'

non-foreign futures positions, such as foreign currency positions and

over-the-counter positions, in such customers' foreign futures or

foreign options account.

The intent of the following amendments is to align the regulatory

approach and customer protections by raising the requirements for

foreign futures or foreign options secured amount to make it consistent

with the FCM's segregation requirements for customers trading on

designated contract market or engaging in cleared swap transactions.

As stated above, the Commission is proposing to require FCMs to

compute the foreign futures or foreign options secured amount using the

Net Liquidating Equity Method by amending the definition in Sec.

1.3(rr) of the term ``foreign futures or foreign options secured

amount'' to match structurally the definition in Sec. 1.3(gg) of the

term ``customer funds,'' which encompasses the Net Liquidating Equity

Method of computing the amount of funds an FCM is required to maintain

in customer segregated accounts. Specifically, the proposed definition

of the term ``foreign futures or foreign options secured amount'' would

be amended to mean all money, securities and property received by an

FCM for, or on behalf of, ``30.7 Customers'' to margin, guarantee, or

secure foreign futures contracts and foreign option transactions, and

all funds accruing to ``30.7 Customers'' as a result of such foreign

futures and foreign options transactions. The term ``30.7 Customer'' is

proposed to be defined in Sec. 30.1 to mean any person, whether

domiciled within or outside of the United States, that engages in

foreign futures or foreign options transactions through the FCM.

Requiring an FCM to set aside in separate accounts the funds

deposited by both domestic and foreign-domiciled customers provides

comparable customer protections to customers notwithstanding their

place of domicile. In addition, requiring the FCM to hold U.S.-

domiciled and foreign-domiciled customer funds in separate accounts

under Sec. 30.7 ensures that such customers receive equal protections

in the event of the bankruptcy of the firm. Part 190 of the

Commission's regulations and the U.S. Bankruptcy Code \85\ provide that

in the event of a commodity broker bankruptcy liquidation, customers in

the account

[[Page 67897]]

class entitled to a preference to the amounts in set-aside accounts for

customers trading on foreign boards of trade include both U.S.-

domiciled and foreign-domiciled customers.\86\ The Commission is

proposing to require funds to be set aside equally for U.S.-domiciled

and foreign-domiciled customers trading on foreign boards of trade in

the computation under Sec. 30.7 by establishing a new definition of

30.7 Customers that includes existing foreign futures or foreign

options customers (which are U.S.-domiciled persons trading foreign

futures or foreign options) as well as any foreign-domiciled persons

trading foreign futures or foreign options through the registered FCM.

The secured amount definition, as proposed to be amended in Sec.

1.3(rr), will reference ``30.7 Customers'' instead of ``foreign futures

or foreign options customers,'' to ensure FCMs are required to set

aside funds equal to the net liquidating equity of all such persons.

Combined with the proposed amendment to require net liquidating equity,

this should result in at all times an amount required to be set aside

for all persons equal to the amount owed to such persons that would

share in the account class for foreign futures in a commodity broker

liquidation. The Commission is also proposing amendments in Sec. 1.10

and Sec. 1.17 to reference ``30.7 Customers'' instead of foreign

futures or foreign options customers in the title of the schedules

prepared by an FCM.

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\85\ See 11 U.S.C. 761-766.

\86\ Id. By definition, ``foreign future'' under section 761 of

the Bankruptcy Code is not limited to transactions entered on

foreign boards of trade on behalf of U.S. domiciled persons, and

``customer'' is not limited to U.S. domiciled persons. The result is

that by the application of these definitions a preferential account

class at a commodity broker for customers trading foreign futures

would not be limited to U.S. domiciled customers.

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In addition, the Commission is proposing to add language to Sec.

30.7(a) to provide an equivalent offset to that available in the

futures customer segregation calculation under Sec. 1.32(b) for

deficits in accounts secured by securities, subject to language

updating the reference to applying securities haircuts in calculating

the offset as discussed in Section II.F above. The result of these

amendments as discussed should be accord between the methodologies

applied in the 4d segregation calculation and the Sec. 30.7

calculation.

Consistent with proposed changes in Sec. 1.20(i) and Part 22, the

Commission also is proposing to add language to Sec. 30.7(a) to

provide that an FCM must hold residual interest in accounts set aside

for the benefit of 30.7 Customers equal to the sum of all margin

deficits for such accounts, to provide an equivalent clear mechanism

for ensuring that the funds of one 30.7 Customer are not margining or

guaranteeing the positions of another 30.7 Customer. Although this

prohibition is not specified in the Act as it is with respect for

futures customers and Cleared Swaps Customers, the Commission is

proposing to the extent possible to replicate wherever practical and

advisable customer protection provisions for futures customers and

Cleared Swaps Customers to 30.7 Customers. As a result, most of the

amendments proposed earlier in various provisions for these customers

also are being proposed in Sec. 30.7.

The Commission requests comment on the proposed amendments to Sec.

30.7(a).

Proposed paragraph (b) of Sec. 30.7 sets forth the permitted

depositories for holding 30.7 Customer funds. The proposal does not

alter the list of depositories that are currently permitted under Sec.

30.7 to hold 30.7 Customers' funds: (1) A bank or trust company located

in the United States; (2) a bank or trust company located outside of

the United States that maintains in excess of $ 1 billion of regulatory

capital; (3) an FCM registered with the Commission; (4) a DCO; (5) the

clearing organization of a foreign board of trade; (6) a member of a

foreign board of trade; and (7) the depositories used by the clearing

organization of a foreign board of trade or a member of a foreign board

of trade.

Proposed Sec. 30.7(c) would limit the amount of 30.7 Customers'

funds that an FCM could hold in non-U.S. jurisdictions. Under the

proposal, an FCM must hold 30.7 Customer funds in the United States,

except to the extent that the funds held outside of the United States

are necessary to margin, guarantee, or secure (including any prefunding

obligations) the foreign futures or foreign options positions of an

FCM's 30.7 Customers. The Commission also is proposing to allow an FCM

to deposit additional 30.7 Customer Funds equal to 10 percent of the

total amount of funds required to be held by non-U.S. brokers or

foreign clearing organizations for 30.7 Customers as a cushion to the

required margin requirements, so that the FCM has a certain degree of

flexibility in managing its daily cash movements and to ensure that the

foreign futures or foreign options positions are not undermargined at

foreign brokers or clearing organizations. The Commission recognizes

that due to differences in time zones, trading hours, banking holidays,

as well needs for cash transfers to foreign jurisdictions to settle and

to be credited to accounts, a customer may not be able to immediately

transfer funds to its FCM, and an FCM may not be able to immediately

transfer funds to a foreign broker or foreign clearing organization to

meet a margin call. The proposed cushion is intended to provide an FCM

with sufficient flexibility to meet its customers' trading obligations

on foreign markets, while also requiring as much of the total 30.7

Customer funds to be held within the United States in order to minimize

the impact of the repatriation risk in the event of an FCM insolvency.

The Commission previously proposed changes to the form of the

Acknowledgment Letter required from depositories holding funds set

aside as the foreign futures or foreign options secured amount.\87\ The

Commission here re-proposes in a revised paragraph (d) to Sec. 30.7

the requirements for obtaining and submitting Acknowledgment Letters

for Sec. 30.7 accounts, which proposed changes include further revised

template forms of Acknowledgment Letter included as Appendices E and F.

The proposed template forms, in addition to incorporating earlier

proposed changes previously summarized with respect to the Sec. 1.20

Acknowledgment Letters, have been further revised to include a

depository's agreement to provide read-only account access to

Commission or DSRO staff, in order for Commission or DSRO staff to

directly verify balances as necessary. The Commission is also proposing

subparagraphs (3), (4) and (5) of Sec. 30.7(d), which substantively

require 24 hour a day direct read-only electronic access to the

depository account by the Commission and the DSRO, require the

depository to file the written Acknowledgment Letter directly with the

Commission and the FCM's DSRO, and require the depository to provide

confirmations to the Commission and the FCM's DSRO directly upon

request. The Commission requests comment on the revised requirements

for Acknowledgment Letters for Sec. 30.7 accounts as proposed in

paragraph (d) and the new template forms of the Acknowledgment Letters

proposed in Appendices E and F.

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\87\ See Acknowledgment Letters for Customer Funds and Secured

Amount Funds, 75 FR 47738 (Aug. 9, 2010).

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As part of its participation in the public roundtable discussed in

the Background section above, FIA recommended that the Commission

eliminate the ability of FCMs to commingle funds from unregulated

[[Page 67898]]

transactions with funds for foreign futures and options trading in Part

30 set aside accounts, except by Commission order, as is the case under

4d(a)(2) of the Act for segregated funds. The Commission agrees with

this recommendation. The comments cited in the release adopting Part 30

with respect to back office operational difficulties of establishing

multiple ``customer'' origins were persuasive at the time Part 30 was

adopted.\88\ With the technological changes of intervening decades,

however, these concerns should no longer dictate the advisability of

commingling the funds of regulated foreign futures and foreign options

transactions with unregulated transactions. Therefore, the Commission

is proposing to amend Sec. 30.7 by adopting new paragraph (e), which

will extend the prohibition against commingling to any funds of account

holders of an FCM unrelated to trading foreign futures or foreign

options, except as the Commission shall by order permit, under terms

and conditions as specified. Should there be a need to permit

commingling of funds, the Commission will continue to have the ability

to permit such commingling under the formalities of processes

associated with a Commission order. The Commission requests comment on

this proposed amendment to Sec. 30.7(e).

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\88\ See 52 FR 28980 at 28985-28986.

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The Commission has proposed to adopt a new paragraph (f) and a new

paragraph (k) in Sec. 30.7, to extend regulatory provisions from

Sec. Sec. 1.20, 1.21, 1.22 and 1.24, that previously were applicable

only to 4d segregated funds, to funds set aside as the foreign futures

or foreign options secured amount under Sec. 30.7. The Commission

requests comment on replicating these regulatory requirements

applicable to segregated funds to funds set aside as the foreign

futures or foreign options secured amount. These proposed requirements

would make clear that FCMs would not be permitted to use funds set

aside as the foreign futures or foreign options secured amount other

than for the benefit of 30.7 Customers, and that funds set aside as the

foreign futures or foreign options secured amount should not be

invested in any obligations of clearing organizations or boards of

trade, and that further, no funds placed at foreign brokers should be

included as funds set aside as the foreign futures or foreign options

secured amount unless those funds are on deposit to margin the foreign

futures or foreign options trading of 30.7 Customers. In addition to

extending these existing Commission regulations to Sec. 30.7 in

proposed paragraphs (f) and (k), the Commission is also proposing a new

requirement prohibiting a FCM from imposing any liens or allowing any

liens to be imposed on funds set aside as the foreign futures or

foreign options secured amount. The Commission has previously adopted a

lien prohibition with respect to the segregation of Cleared Swaps

Customer collateral at Sec. 22.2(d)(2) and therefore proposes to

extend this lien prohibition to funds set aside as the foreign futures

or foreign options secured amount in Sec. 30.7. The Commission

requests comment on the proposed amendments providing limitations on

use and permitted withdrawals as contained in Sec. Sec. 30.7(f) and

(k).

As discussed in Section II.I above, the Commission has proposed new

limitations on withdrawals of segregated funds in Sec. 1.23. The

proposed amendments provide for an FCM's residual interest in

segregated funds, and permits withdrawals from segregated funds for the

proprietary use of the FCM to the extent of such residual interest,

subject to the requirement that the withdrawal must not occur prior to

the completion of the daily segregation computation for the prior day,

and should the withdrawal (individually or aggregated with other

withdrawals) exceed 25 percent of the prior day residual interest, the

withdrawal must be subject to specific approvals by senior management

and appropriately documented, and further subject to a complete

prohibition on withdrawals of residual interest to the extent of margin

deficits. The Commission has proposed paragraph (g) of Sec. 30.7 to

apply the same restrictions on withdrawals of an FCM's residual

interest in funds set aside as the foreign futures or foreign options

secured amount. The Commission requests comment on proposed paragraph

(g) of Sec. 30.7.

Regulation 30.7(g) was recently adopted by the Commission to

provide that the investment of Sec. 30.7 funds be subject to the

investment limitations contained in Sec. 1.25.\89\ The Commission is

proposing to now move this permitted investment requirement to a new

paragraph Sec. 30.7(h), and further to adopt a new paragraph Sec.

30.7(i), which makes clear that FCMs are solely responsible for any

losses resulting from the permitted investment of funds set aside as

the foreign futures or foreign options secured amount. The new

paragraph Sec. 30.7(i) is intended to apply the same standard as is

being proposed in the amendment to Sec. 1.29 for segregated funds

discussed above. The Commission is also requesting comment on whether

the investment of 30.7 property should be restricted in cases of

jurisdictions where client asset protection of such property cannot be

assured? If so, what assurances should be required? For example, in

cases of jurisdictions where client asset protections can be waived,

should the Commission require that the Commission or a DSRO be

practicably able to audit for evidence of such waiver? What are the

relevant costs and benefits of adopting any of these alternatives?

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\89\ 76 FR 78776 at 78802 (December 19, 2011).

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The Commission also is proposing in an amended paragraph (j) to

Sec. 30.7 to clarify the circumstances under which an FCM may make

secured loans to 30.7 Customers and to adopt the same restriction on

unsecured lending to 30.7 Customers as has been proposed with respect

to futures customers and 4d segregated funds in the proposed amendment

to Sec. 1.30 discussed above. The Commission requests comment on

applying this restriction in relation to 30.7 Customers.

Finally, the Commission is proposing an amended paragraph (l) to

Sec. 30.7 to require the daily computation of the foreign futures or

foreign options secured amount and the filing of such daily computation

with the Commission and DSROs, as well as to require the FCM to provide

investment detail of the foreign futures or foreign options secured

amount as of the middle and end of the month. The proposed amendments

to paragraph (l) of Sec. 30.7 are intended to be consistent with the

requirements for the daily segregation calculation for segregated

customer funds and the provision of the segregation investment detail

which are proposed in Sec. 1.32. The Commission requests comment on

the proposed changes requiring the filing of the daily secured amount

computation and the investment detail as proposed in Sec. 30.7(l).

III. Consideration of Costs and Benefits

The misuse or mishandling of customer funds at specific FCMs like

MF Global or Peregrine not only imposes a burden on those customers

whose funds have been misused, but also creates a burden to the public

by eroding the trust of the American public in all market

intermediaries. This loss of trust could deter market participants from

the benefits of using regulated, transparent markets and clearing. The

overarching purpose of this rule is to provide regulators the means by

which to detect and deter the misuse or mishandling of customer funds

by FCMs in order to produce the benefits that

[[Page 67899]]

accrue by virtue of avoiding similar defaults in the future and to

prevent the costs, including lost customer funds, decreased market

liquidity that follows from a crisis in confidence, and the potential

for the failure of one FCM to cause instability in other clearing

members.\90\

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\90\ The failure of one clearing member could lead to

instability in other clearing members if the losses due to the first

member's failure are large enough to exhaust the guarantee fund and

require additional capital infusion from other clearing members.

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The Commission's proposal builds on recent efforts by the

Commission and industry to better protect customer funds. As discussed

above in section I.D., in December 2011 the Commission amended Sec.

1.25 of its regulations to eliminate certain options for the

permissible investments of customer funds.\91\ Two months later, the

Commission approved a margin rule for cleared swap transactions

referred to as ``LSOC'' (legal separation with operational commingling)

in which each swaps customer's collateral is protected individually all

the way to the clearinghouse.\92\ The Commission also convened a

roundtable in late February 2012 to discuss what amendments should be

made to Commission regulations in order to provide additional

protection to customer funds. Further, in June 2012, the Commission

finalized rules for DCMs and included amendments to Sec. 1.52 which

codify staff guidance on minimum requirements for SROs regarding their

financial surveillance of FCMs.\93\ With the recent default of another

FCM, Peregrine, the Commission held two additional roundtables to

discuss, among other things, technological approaches to mitigating the

risk of fraud, and possible amendments to the Commission's rules

regarding protection of customer funds.\94\

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\91\ In the final rule amending Sec. 1.25, the Commission

stated, ``the Commission is narrowing the scope of investment

choices in order to eliminate the potential use of portfolios of

instruments that may pose an unacceptable level of risk to customer

funds.'' See ``Investment of Customer Funds and Funds Held in an

Account for Foreign Futures and Foreign Options Transactions,'' 76

FR 78776, December 19, 2011.

\92\ 77 FR 6336 (Feb. 7, 2012) (Protection of Cleared Swaps

Customer Contracts and Collateral; Conforming Amendments to the

Commodity Broker Bankruptcy Provisions).

\93\ 77 FR 36612 (June 19, 2012) (Core Principles and Other

Requirements for Designated Contract Markets).

\94\ Public Meeting of the Technology Advisory Committee, July

26, 2012. See http://www.cftc.gov/PressRoom/Events/opaevent_tac072612. Public Roundtable to Discuss Additional Customer

Protections, August 9, 2012. See http://www.cftc.gov/PressRoom/Events/opaevent_cftcstaff080912.

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In this rulemaking, the Commission is proposing amendments to

improve the protection of customer funds. The content of the

Commission's proposal can be categorized in seven parts: (1) Requiring

FCMs to implement extensive risk management programs including written

policies and procedures related to various aspects of their handling of

customer funds; (2) increasing reporting requirements for FCMs related

to segregated customer funds, including daily reports to the Commission

and DSRO; (3) requiring FCMs to establish target amounts of residual

interest to be maintained in segregated accounts as well as creating

restrictions and increased oversight for FCM withdrawals out of such

residual interest in customer segregated accounts, specifically

including clear sign off and accountability from senior management for

such withdrawals; (4) strengthening requirements for the acknowledgment

letters that FCMs and DCOs must obtain from their depositories; (5)

eliminating the Alternative Method for calculating 30.7 Customer funds

segregation requirements and requiring FCMs to include foreign

investors' funds in segregated accounts; (6) strengthening the

regulatory requirements applicable to SRO and DSRO oversight of FCMs,

including regulating oversight provided under the function of a Joint

Audit Committee that would establish standards for, and oversee the

execution of, FCM audits; and (7) requiring FCMs to provide additional

disclosures to investors.

Statutory Mandate To Consider the Costs and Benefits of the

Commission's Action: Commodity Exchange Act Section 15(a)

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

costs and benefits of its actions before promulgating a regulation

under the Act or issuing certain orders. Section 15(a) further

specifies that the costs and benefits shall be evaluated in light of

the following five broad areas of market and public concern: (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. The Commission considers the costs and

benefits resulting from its discretionary determinations with respect

to the section 15(a) considerations.

There are four considerations relevant to this proposal. These are:

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

competitiveness and financial integrity of futures markets; (3) sound

risk management practices; and (4) other public interest

considerations. The Commission proposes that the amendments would not

have any effect on price discovery.

In the discussion that follows, the Commission provides an overview

of the proposed rules in light of the three relevant 15(a) cost-benefit

considerations previously identified, and then considers the costs and

benefits of each section individually in light of the same 15(a) public

interest considerations. The Commission concludes with additional

requests for public comment on all aspects of its preliminary

consideration of the costs and benefits of the rule proposals.

Overview of the Costs and Benefits of the Proposed Rules and Amendments

in Light of the 15(a) Considerations

Protection of Market Participants and the Public

As stated above, the Commission is proposing amendments to improve

protection of customer funds. Each of the seven parts of the proposal

\95\ would increase levels of protection for customer funds. Requiring

FCMs to implement risk management programs that include documented

policies and procedures regarding various aspects of handling customer

funds would help protect customer funds by promoting robust internal

risk controls and reducing the likelihood of errors or fraud that could

jeopardize customer funds. In addition, by requiring each FCM to

document certain policies and procedures, the proposed rules would

enable the Commission, DSROs, and

[[Page 67900]]

other auditors to evaluate each FCM's compliance with their own

policies and procedures. Moreover, the proposed requirement that FCMs

establish a program for quarterly audits by independent or external

people that is designed to identify any breach of the policies and

procedures would help to ensure regular, independent validation that

the procedures are followed diligently. Audits of this sort provide

more thorough review of internal procedures than the Commission or

DSROs would be able to perform regularly with existing resources, which

would provide helpful scrutiny of each FCM's procedures on a regular

basis. This, together with the proposed requirement that FCMs establish

a program of governing supervision that is designed to ensure the

policies required in Sec. 1.11 are followed, will tend to promote

compliance with the FCM's own policies and procedures. And by promoting

such compliance, the requirements would reduce the risk of operational

errors, lax risk management, and fraud, and thus the risk of consequent

loss of customer funds.

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\95\ The seven parts of the proposal are: (1) Requiring FCMs to

implement risk management programs including extensive written

policies and procedures related to various aspects of their handling

of customer funds; (2) increasing reporting requirements for FCMs

related to segregated customer funds, including daily reports to the

Commission and DSROs; (3) requiring FCMs to establish target amounts

of residual interest to be maintained in segregated accounts as well

as creating restrictions and increased oversight for FCM withdrawals

out of such residual interest in customer segregated accounts,

including clear sign off and accountability from senior management

for such withdrawals; (4) strengthening requirements for the

acknowledgment letters that FCMs and DCOs must obtain from their

depositories; (5) eliminating the Alternative Method for calculating

30.7 Customer funds segregation requirements and requiring FCMs to

include foreign-domiciled customers' funds in segregated accounts;

(6) strengthening the regulatory requirements applicable to SRO and

DSRO oversight of FCMs, including regulating oversight provided

under the function of a Joint Audit Committee (Joint Audit Program)

that would establish standards for, and oversee the execution of,

FCM audits; and (7) requiring FCMs to provide additional disclosures

to investors.

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Increasing reporting requirements for FCMs related to segregated

customer funds would help the Commission and DSRO identify FCMs that

should be monitored more closely in order to safeguard customer funds.

Moreover, by making some additional reported information public, the

proposed rules would facilitate additional market discipline that

further promotes protection of customer funds.

Creating restrictions and increased oversight for FCM withdrawals

out of its residual interest in customer segregated accounts, and

requiring sign off from senior management for large withdrawals would

protect customers by helping to ensure that such withdrawals do not

cause segregated account balances to drop below their segregation

requirements. Moreover, it would promote effective oversight of

customer segregated accounts by senior management by increasing their

accountability for withdrawals that affect the balance of such

accounts.

The acknowledgments and commitments depositories would be required

to make through proposed Sec. Sec. 1.20, 1.26, and 30.7 would provide

additional protection for customer funds by, among other things,

requiring depositories that accept customer funds to acknowledge that

customer funds cannot be used to secure the FCM's obligations to the

depository. Such an acknowledgment would provide additional protection

of customer funds in the event of an FCM's default. In addition,

depositories would agree in the acknowledgment letter to give the

Commission and DSROs read-only electronic access to an FCM's segregated

accounts, which would benefit customers by enabling the Commission and

DSROs to monitor the accounts for discrepancies between the FCM's

reports and the balances on deposit at various depositories. This would

provide an additional mechanism by which customers would be protected

against a shortfall in customer funds due to operational errors or

fraud.

Requiring FCMs to include foreign-domiciled investors' funds in

segregated accounts ensures that all customers placing funds on deposit

for use in trading foreign futures and foreign options will benefit

from the same protections provided by the Act and Commission

regulations. As discussed below, the Commission understands that most,

if not all FCMs currently extend the same protections to U.S.-domiciled

and to foreign-domiciled customers. However, incorporating foreign-

domiciled customers within the protections provided to 30.7 Customers

places regulatory weight behind the protections and ensures that FCMs

are not permitted to cut corners with respect to protecting foreign-

domiciled customers' funds during a time of financial strain.

Similarly, eliminating the Alternative Method provides additional

protection to customer funds by ensuring that FCMs are not allowed to

reduce their segregation requirements for 30.7 Accounts during a time

financial strain. As discussed below, this change would provide

protection to both U.S-domiciled and foreign-domiciled customers with

funds in 30.7 Accounts.

The proposed provisions in Sec. 1.52 include additional

requirements for both the supervisory program for SROs as well as for

the formation of a Joint Audit Committee to oversee the implementation

and operation of a Joint Audit Program that directs audits of FCMs by

DSROs. By requiring both the SRO supervisory programs and the Joint

Audit Program to comply with U.S. generally accepted audit standards,

to develop written policies and procedures, to require controls testing

as well as substantive testing, and to have an examinations expert

review the programs at least once every two years, the proposed

amendments would help to ensure that audits of FCMs by SROs or DSROs

are thorough, effective, and continue to incorporate emerging best

practices for such audits. As a consequence, the proposed amendments

would help to ensure that audits are as effective as possible at

identifying potential fraud, strengthening internal controls, and

verifying the integrity of FCMs' financial reports, each of which tend

to provide protection for FCMs' customers, counterparties, and

investors.

In addition the proposed Sec. 1.55 would require disclosure of

firm-specific risks to customers. This additional information would

assist them with due diligence when selecting an FCM and would help to

ensure that they are aware of any changes at the FCM that could prompt

them to reconsider their decision to deposit funds with the FCM. In

doing so, the proposed rules would promote market discipline that

incents FCMs to manage their risks carefully and would assist customers

in understanding how their funds are held and what risks may be

relevant to the safety of their funds.

Efficiency, Competitiveness and Financial Integrity of Futures Markets

The proposed amendments would increase the efficiency and financial

integrity of the futures markets by ensuring that FCMs have strong risk

management controls that are subject to multiple and enhanced external

checks, by enhancing reporting requirements, facilitating increased

oversight by the Commission and DSROs, by allowing FCMs flexibility in

the development of newly required policies and procedures wherever the

Commission has determined that such flexibility is appropriate, and by

requiring FCMs to implement training regarding the handling of customer

funds. In addition, the proposed rules include some requirements that

many industry participants have requested as necessary for the adequate

protection of customers and also highlighted as best practices already

adopted within the industry. Requiring such standards to be adopted by

all FCMs will promote the competitiveness of futures markets by

ensuring a level playing field at a minimum level necessary for the

protection of customers, and not allowing any FCMs to, at the expense

of customers, maintain an unfair competitive advantage to their

counterparts who utilize best practices and may have such protections

already in place. There are also provisions in the proposal that permit

FCMs that are not broker-dealers to implement certain securities net

capital haircuts that have been proposed to apply to jointly registered

FCM/BDs by the SEC, which similarly enhances competition by keeping a

level playing field between sole FCMs and jointly registered FCM/BDs

with respect to such requirements.

More specifically, the proposed amendments to Sec. Sec. 1.10,

1.11, 1.12, 1.32,

[[Page 67901]]

22.2, and 30.7 would increase reporting requirements for FCMs related

to segregated customer funds, including daily, bi-monthly, and

additional event-triggered reports to the Commission and DSROs. The

expanded range and frequency of information that the Commission and

DSRO would receive under the proposed regulations would enhance their

ability to monitor each FCM's segregated accounts, which would promote

the integrity of futures markets by helping to ensure proper handling

of customer funds at FCMs.

In addition, the proposed changes would facilitate increased

oversight by the Commission and DSROs by including additional

notification requirements, obligating FCMs to alert the Commission when

certain events occur that could indicate an FCM's financial strength is

deteriorating or that important operational errors have occurred. Such

notifications would enable the Commission and DSROs to increase

monitoring of such FCMs to ensure that customer funds are handled

properly in such circumstances. The proposed rules would also require

FCMs and DCOs to obtain an acknowledgment letter from depositories that

would give the Commission and DSROs electronic access to view customer

accounts at each depository. That would enable both the Commission and

DSROs to verify the presence of customer funds which would provide a

safeguard against fraud and would promote the integrity of markets for

futures, cleared options, and cleared swaps.

The proposed rules would also require FCMs to establish policies

and procedures regarding several aspects of how they handle customer

funds. The rules would give FCMs the flexibility, where appropriate, to

develop policies and procedures tailored to the unique composition of

their customer base, size, and other operational disincentives. This

flexible approach protects FCMs from additional regulatory compliance

costs that could otherwise result from rules requiring every FCM to

operate in exactly the same way without sacrificing the additional

accountability that results from written policies and procedures that

the Commission or DSRO can review and use as the basis for FCM audits.

The proposed requirement that FCMs would provide annual training to

all finance, treasury, operations, regulatory, compliance, settlement

and other relevant employees regarding the segregation requirements for

segregated funds, for notices under Sec. 1.12, procedures for

reporting non-compliance, and the consequences of failing to comply

with requirements for segregated funds, would enhance the integrity of

the futures markets by promoting a culture of compliance by the FCM's

personnel. The training would help to ensure that FCM employees

understand the relevant policies and procedures, that they are

empowered and incented to abide by them, and that they know how to

report non-compliance to appropriate authorities.

Last, the proposing form of the rule would allow FCMs that are not

dual registrants (i.e., are not both FCMs and BDs) to follow the same

procedures as dual registrants when determining what regulatory capital

haircut applies to certain types of securities in which the FCM invests

its own capital or customer funds. This proposed change is needed as

the SEC has proposed a change for broker-dealers which would permit

joint registrants to possibly apply a lower regulatory haircut for

certain securities, but which would not be applicable to sole FCMs

without the proposal. Therefore, the proposal would ensure that sole

FCMs are not competitively disadvantaged and are able to continue

applying the same regulatory capital haircuts for such securities as

joint registrants.

Sound Risk Management

The amendments proposed here, if adopted, would promote sound risk

management by facilitating market discipline, enhancing internal

controls, enabling the Commission and DSROs to monitor FCMs for

compliance with those controls, by minimizing the risk that an FCM's

financial strain could interfere with customers' ability to manage

their positions, by requiring FCMs to notify the Commission in

additional circumstances that could indicate emerging financial strain,

and by requiring senior management to be involved in the process of

setting targets for residual interest.

The proposed reporting requirements would enhance market discipline

by providing additional information to investors regarding the location

of their funds, and the size of residual interest buffer that an FCM

targets and maintains in its segregated accounts. This additional

information would be valuable to customers selecting an FCM and

monitoring the location of their funds deposited with the FCM which

would promote market discipline. For example, if an FCM were to

establish a low target for residual interest, or maintain a very low

residual interest, market participants would likely recognize this as a

practice that could increase risk to the funds they have on deposit at

the FCM, and would likely either apply pressure to the FCM to raise

their target, or take their business to a different FCM that maintains

a larger residual interest in customer fund accounts. This market

discipline would incent FCMs to maintain a level of residual interest

that is adequate to ensure that a shortfall does not develop in the

customer segregated accounts.

The proposed rules would also enhance FCM internal controls by

requiring them to establish a risk management program that includes

policies and procedures related to various aspects of how segregated

customer funds are handled. For example, FCMs would be required to

establish procedures for continual monitoring of depositories where

segregated customer funds are held, and would have to establish a

process for evaluating the marketability, liquidity, and accuracy of

pricing for Sec. 1.25 compliant investments.

In addition, documented policies and procedures would benefit the

FCM customers and the public by providing the Commission and DSROs

greater ability to monitor and enforce procedures that FCMs perform to

ensure that the protection of customer funds is achieved, with the

effect that the Commission would have a greater ability to address and

protect against operational errors and fraud that put customer funds at

risk of loss.

Further, through the proposed amendments to Sec. 1.17(a)(4), FCMs

will need to manage their access to liquidity so as to be able to

certify to the Commission, at its request, that they have sufficient

access to liquidity to continue operating as a going concern. This

proposal will provide the Commission with the flexibility to deal with

emerging liquidity drains at FCMs which may endanger customers,

potentially prior to instances of regulatory capital non-compliance,

allowing customer positions and funds to be transferred intact and

quickly to another FCM. This change would promote sound risk management

practices by helping to ensure that customers maintain control of their

positions without interruption.

The proposed additions to notification requirements established in

Sec. 1.12 would enhance the Commission's ability to identify

situations that could lead to financial strain for the FCM, which makes

it possible for the Commission to monitor further developments with

that FCM more carefully and to begin planning earlier for the

possibility that the FCM's customer positions may need to be

transferred to other FCMs, in the event

[[Page 67902]]

that the FCM currently holding those positions defaults. Advance notice

helps to ensure customers' positions are protected by enabling the

Commission to work closely with DCOs and DSROs to identify other FCMs

that have requisite capital to meet regulatory requirements if they

were to take on additional customer positions, thus facilitating smooth

transition of those positions in the event that it is necessary.

Last, residual interest is an important aspect of protection for

customer funds because it enables the FCM to ensure that it can meet

all customer obligations at any time without using another customer's

funds to do so. In general, the larger the residual interest, the more

secure customer funds are in this respect. By requiring that senior

management set the target for residual interest, and that they conduct

adequate due diligence in order to inform that decision, the proposed

rule promotes both informed decision making about this important form

of protection, and accountability among senior management for this

decision, both of which are consistent with sound risk management

practices.

Other Public Interest Considerations

As discussed above, the recent failures of MF Global and Peregrine,

FCMs to which customers have entrusted their funds, sparked a crisis of

confidence regarding the security of those funds. This crisis in

confidence could deter market participants from using regulated,

transparent markets and clearing which would create additional costs

for market participants and losses in efficiency and safety that could

create additional burdens for the public. The Commission anticipates

that this rule will not only address the current crisis of confidence,

but that it will produce benefits for the public by virtue of avoiding

similar defaults in the future.

These proposed amendments are not, however, without costs. The most

significant costs created by the proposed amendments are those that

increase the amount of capital that FCMs would be required to

contribute to segregated accounts as part of establishing a target for

their residual interest, incent them to hold additional capital,

prevent them from holding excess segregated funds overseas, and that

are created operationally by the formation of a risk management unit

and adoption of new policies and procedures.

Multiple proposed changes would incent or require FCMs to increase

the amount of residual interest that they maintain in segregated

accounts including: (1) Requiring FCMs to establish a target for

residual interest that reflects proper due diligence on the part of

senior management; (2) disclosing the FCMs' targeted residual interest

publicly; and (3) requiring them to report to the Commission and their

DSRO any time their residual interest drops below that target. In

addition by restricting FCMs' ability to withdraw residual interest

from segregated accounts and obligating FCMs to report to the

Commission and their respective DSRO each time the residual interest

drops below the target, the proposed regulations would incent FCMs to

hold additional capital, which is also likely to be a significant cost.

When FCMs hold excess customer funds overseas, such funds will

likely be held at depositories that are themselves subject to foreign

insolvency regimes, which may provide protections for customer funds

that are less effective than those applicable under U.S. law. By

prohibiting FCMs from holding excess customer funds overseas, the

proposed regulations could reduce the returns that FCMs may obtain on

invested customer funds.

And last, the proposed requirements related to operational

procedures are likely to create significant costs, particularly related

to creating and documenting policies and procedures, as well as

complying with ongoing training, due diligence, and audit requirements.

However, in several cases the implementation costs of proposed changes

would be minimal. For example, some proposed requirements would

obligate FCMs to provide the Commission and DSROs more regular access

to information that FCMs and their depositories are already required to

maintain, or in some cases are already reporting to their DSROs. The

Commission also anticipates that some of the changes proposed codify

best practices for risk management that many FCMs and DCOs may already

follow. In such cases, the costs of compliance would be mitigated by

the compliance programs or best practices that the firm already has in

place. Moreover, in other cases the proposed changes codify practices

that are already required by SROs, and therefore would impose no

additional costs.

The initial and ongoing costs of the proposed rules for FCMs would

vary significantly depending on the size of each FCM, the policies and

procedures that they already have in place, and the frequency with

which they experience certain events that would create additional costs

under the proposed rules. The Commission estimates that the initial

operational cost \96\ of implementing the proposed rules would be

between $193,000 and $1,850,000 per FCM.\97\ And the initial cost to

the SROs and DSROs would be between $41,100 and $63,500 per SRO or

DSRO. The Commission estimates that the ongoing operational cost to

FCMs would be between $287,000 and $2,300,000 per FCM per year.\98\ As

described below in Sec. 1.52, the Commission does not have adequate

information to determine the ongoing cost of the proposed requirements

for SROs and DSROs.

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\96\ The Commission is not able to quantify the costs that would

result from increased residual interest held in customer segregated

accounts, from increased capital held by the FCM, or from lost

investment opportunities due to restrictions on the amount of funds

that may be held overseas. The Commission does not have sufficient

data to estimate the amount of additional residual interest FCMs are

likely to need as a consequence of proposed, the amount of

additional capital they may hold for operational purposes, the cost

of capital for FCMs, or the opportunity costs FCMs may experience

because of restrictions on the amount of customer funds they can

hold overseas, each of which would be necessary in order to estimate

such costs.

\97\ The lower bound assumes an FCM requires the minimum

estimated number of personnel hours to be compliant with these new

rules and that, when possible, they already have policies,

procedures, and systems in place that would satisfy the proposed

requirements. The upper bound assumes an FCM requires the maximum

amount of personnel hours and do not have pre-existing policies,

procedures, and systems in place that would satisfy the proposed

requirements. The greatest amount of variation within in the range

would depend on the number of new depositories an FCM must establish

relationships with due to current depositories that would not be

willing to sign the required acknowledgment letter. The lower bound

assumes that an FCM does not need to establish any new relationships

with depositories. The Commission estimates that the largest FCMs

may have as many as 30 depositories, and as a conservative estimate,

the Commission assumes for the upper bound that an FCM would have to

establish new relationships with 15 depositories.

\98\ As above, the lower bound assumes that an FCM requires the

minimum estimated number of personnel hours to be compliant and that

for event-triggered costs, the FCM bears the minimum number of

possible events. The upper bound assumes an FCM requires the maximum

number of personnel hours to be compliant. It also assumes an FCM

has to notify the Commission pursuant to the proposed amendments in

Sec. 1.12 five times per year, and that an FCM withdraws funds from

residual interest for proprietary use 50 times per year. The

estimate does not include additional costs that would result if FCMs

increase the amount of residual interest or capital that they hold

in response to the proposed rules, or certain operational costs that

the Commission does not have sufficient information to estimate.

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In the sections that follow, the Commission considers the costs and

benefits of the proposed changes, section by section, in light of the

relevant 15(a) public interest, cost-benefit considerations.

[[Page 67903]]

Consideration of Costs and Benefits Related to Proposed Changes in Each

Section

Sec. 1.3(rr)--Definition of ``Foreign Futures or Foreign Options

Secured Amount''

Proposed Changes

As described above in II.R, the proposed amendments to Sec.

1.3(rr) would replace the term ``foreign futures or foreign options

customers'' with the term ``30.7 Customers.'' The former only includes

U.S.-domiciled customers, whereas the term ``30.7 Customers'' includes

both U.S.-domiciled and foreign-domiciled customers who place funds in

the care of an FCM for trading on foreign boards of trade. This change

expands the range of funds that the FCM must include as part of the

foreign options or foreign futures secured amount.

In addition, the definition of ``foreign futures or foreign options

secured amount'' currently means ``all money, securities and property

held by or held for or on behalf of a futures commission merchant from,

for, or on behalf of foreign futures or foreign options customers as

defined in Sec. 30.1.'' The proposed definition would change the

meaning of ``foreign futures or foreign options secured amount'' so

that it is equal to the amount of funds an FCM needs in order to

satisfy the full account balances of each of its customers at all

times. This definitional change supports the shift in Sec. 30.7 from

the ``Alternative Method'' to the ``Net Liquidating Equity Method'' of

calculating the foreign futures or foreign options secured amount.

Benefits and Costs

These definitional changes would determine what funds are

considered part of the ``foreign futures or foreign options secured

amount.'' However, the costs and benefits of these changes are

attributable to the substantive requirements related to the definitions

and, therefore, are discussed in the cost and benefit considerations

related to Sec. 30.7.

Sec. 1.10--Financial Reports of Futures Commission Merchants and

Introducing Brokers

Proposed Changes

As described above in II.A, the proposed amendments would make four

changes. First, they would amend the 1-FR-FCM to create a new schedule

called the ``Cleared Swap Segregation Schedule'' that would be included

in the FCM's monthly report, together with the Segregation Schedule and

Secured Amount Schedule. Second, it would make the Cleared Swap

Segregation Schedule a public document.\99\ Third, the proposed

amendments would require each of the Schedules to include the FCM's

target for residual interest in the accounts relevant to that Schedule,

as well as a calculation of any surplus or deficit in residual interest

with respect to that target. And fourth, the proposed rule would

require each FCM to submit to the Commission a monthly statement

reporting the FCM's leverage.

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\99\ The Segregation Schedule and Secured Amount Schedule are

already public documents.

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Benefits

The proposal to include target residual interest and monthly

calculation of the deviation from that target on the monthly Schedules

provides important benefits with respect to the safety of customer

funds. The data in the reports is public information. Public disclosure

incentivizes FCMs to set a reasonable target for residual interest.

Under proposed regulations, FCMs would have to notify the Commission

and their respective DSRO each time they drop below their targeted

residual interest, which gives them an incentive to set a low target,

even if they intend to keep more residual interest in their accounts.

However, by disclosing an FCM's targeted residual interest to the

public, the proposed rule would enable customers and potential

customers of an FCM to incorporate the size of the FCM's targeted

residual interest, and the corresponding amount of protection to

customers' funds provided by that level of residual interest, into

their selection of an FCM. Holding all other considerations constant,

FCMs that have higher targets relative to their segregation

requirements would presumably be more attractive to customers than FCMs

that target smaller levels of residual interest relative to their

segregation requirements because of the additional protection of

customer funds it provides. This additional information permits

customers to weigh this consideration along with considerations of

price in selecting an FCM. Last, by requiring FCMs to report their

leverage monthly, the proposed amendments would assist the Commission

in monitoring each FCM's overall risk profile, which would help the

Commission to identify FCMs that should be monitored more closely for

further developments that could weaken their financial position.

Costs

As stated above, all else equal, by requiring FCMs to include their

residual interest target in the monthly report, and by making the

contents of those reports public, the proposed rule would incent FCMs

to set a higher target for their residual interest in customer

segregated funds. However, maintaining a larger targeted residual

interest would create some costs for FCMs. Proprietary funds deposited

into customer segregated accounts by an FCM are only allowed to be

invested in Sec. 1.25 investments and, therefore, are not available

for other investments. In addition, placing additional capital in the

customer segregated accounts reduces the amount of capital that an FCM

has to meet operational needs, which would likely prompt the firm to

raise or retain additional capital. Estimating the lost revenue that

would result from the investment opportunities an FCM misses is not

possible because the Commission is not able to estimate either the

amount of increased residual interest that an FCM would, on average,

maintain as the result of this proposed change, or the differential in

return on investment between FCM funds placed into customer segregated

accounts versus proprietary funds not held in such accounts. Similarly

the Commission does not have adequate information to determine the

average cost of capital for FCMs or the amount of additional capital

that they would likely raise or retain as a consequence of this

proposed change. The proposed requirement regarding monthly leverage

statements will require FCMs to produce an additional report each

month. The Commission anticipates that each FCM will incur a one-time

cost in order to modify their systems to create the report, and then

ongoing costs will be negligible because the report is likely to be

automated. The Commission estimates that the one-time setup costs are

likely to be between $2,800 and $5,700.\100\

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\100\ This assumes 40-80 hours of time from both a programmer

and 20-40 hours from an intermediate accountant. The average

compensation for a programmer is $53.64/hour [$82,518 per year/(2000

hours per year)*1.3 = $53.64/hour]; $53.64*40= $2,145.47 and

$53.64*80= $4,290.94. The average compensation for an intermediate

accountant is $34.11/hour [$52,484.00 per year/(2000 hours per

year)*1.3 is $34.11per hour]; $34.11*20= $682.29 and $34.11*40=

$1,364.58. All figures are taken from the 2011 SIFMA Report on

Management and Professional Earnings in the Securities Industry.

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Requests for Comment \101\

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\101\ The Commission has numbered its questions throughout the

Cost Benefit Considerations section. When responding to specific

questions, please reference the number of the question. In addition,

commenters should provide analysis and empirical data to support

their views on the costs and benefits associated with the proposed

rule, and should provide information to the Commission that would

enable it to replicate and verify any quantitative estimates.

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Question 1: The Commission requests comment regarding the costs and

[[Page 67904]]

benefits of these proposed rules, including making residual interest

targets public information. Please explain and, if possible, quantify

the relevant costs and benefits.

Question 2: In addition, the Commission requests comment regarding

the costs and benefits that would result from providing each FCM's

daily calculation of residual interest public. Would the disclosure of

an FCM's daily calculations of residual interest pose a risk to such

FCM, the markets, to customers, or the public? If so, please explain.

Or, conversely, would a lack of disclosure exacerbate risks to FCM

customers or the public? If so, please explain.

Question 3: Market participants have suggested that additional

information from FCMs' daily, bi-monthly, and monthly reports should be

disclosed to the public. What alternatives should the Commission

consider in this respect? What would be the costs and benefits of that

alternative?

Question 4: In addition, the Commission requests information or

data that would assist the Commission in quantifying the cost to FCMs

of placing additional proprietary funds into the customer segregated

account and the benefit to customers of having such additional funds in

the segregated accounts.

Sec. 1.11 Risk Management Program for Futures Commission Merchants

Proposed Changes

As discussed in II.B above, proposed Sec. 1.11 would require an

FCM that carries accounts for customers to establish a risk management

unit that is independent from the business unit and reports directly to

senior management. In addition, it would require each FCM to establish

and document a risk management program, approved by the governing body

of the FCM, that, at a minimum: (a) Identifies risks and establishes

risk tolerance limits related to various risks that are approved by

senior management; (b) includes policies and procedures for detecting

breaches of risk tolerance limits, and for reporting them to senior

management; (c) provides risk exposure reports quarterly and whenever a

material change in the risk exposure of the FCM is identified; (d)

includes annual review and testing of the risk management program; and

(e) meets specific requirements related to segregation risk,

operational risk, and capital risk.

Regarding segregation risk, the proposed rule would require that

each FCM must establish written policies and procedures that require,

at a minimum: (1) Documented criteria for selecting depositories that

would hold segregated funds; (2) a program to monitor depositories on

an ongoing basis; (3) an account opening process that ensures the

depository acknowledges that funds in the account are customers' funds

before any deposits are made to the account, and that also ensures

accounts are titled appropriately; (4) a process for determining a

residual interest target for the FCM that involves due diligence from

senior management; (5) a process for the withdrawal of an FCM's

residual interest when such a withdrawal is not made for the benefit of

the FCM's customers; (6) a process for determining the appropriateness

of investing funds in Sec. 1.25 compliant investments; (7) procedures

to assure that securities and other non-cash collateral held as

segregated funds are properly valued and readily marketable and highly

liquid; (8) procedures that help to ensure appropriate separation of

duties between those who account for funds and are responsible for

statutory and regulatory compliance vs. those who act in other

capacities with the company (e.g., those who are responsible for

treasury functions); (9) a process for the timely recording of all

transactions; and (10) a program for annual training of FCM employees

regarding the requirements for handling customer funds.

The proposed rule would require automated financial risk management

controls that address operational risk, and written procedures

reasonably designed to ensure that an FCM has sufficient capital to be

in compliance with the Act and regulations and to meet its liquidity

needs for the foreseeable future.

Benefits

Establishing a risk management unit with adequate authority;

qualified personnel; and financial, operational and other resources to

carry out the Risk Management Program would enhance protection of

customer funds by mitigating the risk that the effectiveness of the

Program is compromised by a lack of resources. Moreover, separation of

the Risk Management Unit from the Business Unit mitigates the risk that

conflicts of interest could interfere with the effectiveness of the

risk management unit in avoiding situations that may lead to a loss of

customer funds.

Furthermore, by requiring that the risk management unit report

directly to senior management, Sec. 1.11(d) would help ensure that the

risk management unit's operations and concerns receive prompt attention

from personnel who are able to address any problems that arise, and

also minimizes the risk that conflicts of interest could cause a

breakdown in communications that undermines the effectiveness of the

risk management unit or the Risk Management Program. Each of these

elements, by promoting the risk management unit's effectiveness, would

help to ensure that the unit will identify and address emerging risks

before such risks threaten the health of the FCM or the security of

segregated customer funds.

The Commission believes the establishment of the proposed risk

management program would provide several benefits to FCMs, customers,

and the public, in particular with respect to the protection of

customer funds.

a. The proposed requirement for FCMs to establish, as part of their

risk management program, specific risk tolerance limits, would provide

additional protection to FCMs by helping to ensure that they have a

system in place to identify emergent risks to the business. By

requiring an underlying methodology for establishing the limits, the

proposed rule would promote reasoned decision making regarding the

limits as they are set and updated. Quarterly review of the risk limits

by senior management and annual review by the Governing Body would help

to ensure that limits are current as the market, business, and customer

base evolve, and also provide accountability for periodic evaluation of

such risks at the most senior levels of the organization, which helps

to ensure that senior leaders are proactively discussing and addressing

the full range of risks that are facing the business. As a consequence,

these measures would help ensure that an FCM is taking whatever steps

are necessary in order to reduce and mitigate the effects of emerging

risks. Moreover, customer funds held at the FCM may face elevated risk

of loss due to misuse or operational errors during times of financial

strain at the FCM. By protecting the health of the FCM, the proposed

requirements mitigate the risk that financial strain at the FCM would

lead to a loss of customer funds that it holds.

b. By requiring policies and procedures for detecting breaches of

the risk tolerance limits and notifying appropriate personnel, the

proposed

[[Page 67905]]

rule would promote objectivity when monitoring of each risk that the

policies address, thus mitigating the risk that poor individual

judgment could cause important emerging risks to go unnoticed, or could

prevent proper personnel from being notified, leading to a loss of

customer funds.

c. The contents of the proposed Risk Exposure Reports would help to

ensure that attention is regularly given to an evaluation of each risk

that is covered in the FCM's Risk Management Program and that senior

management and the Governing Body of the FCM are made aware of the

findings. They will also help to ensure that the Risk Management

Program is continuously updated to reflect changing risks that face the

business by requiring recommendations to be included in such reports,

which promotes the effectiveness of the Program in protecting customer

funds. Moreover, status updates on any incomplete implementation of

previous recommendations from such reports provide accountability at

the most senior levels of the FCM regarding implementation of

initiatives to improve the Program.

d. Similar to above, review and testing of the risk management

program on an annual basis as well as whenever there is a material

change in the business, would help to ensure that the Risk Management

Program continues to evolve as the risks facing the business evolve,

thus promoting the effectiveness of the program, which in turn, would

help protect the FCM. By requiring an analysis of adherence to the

program the proposed requirement would promote compliance with it. And

requiring the review and testing to be conducted by staff that are

independent of the Business Unit or by an external third party promotes

objectivity and rigor in the findings that would result, and requiring

senior management and the Governing Body of the FCM to review the

findings promptly helps to ensure that any breaches of compliance or

other findings of the review are addressed promptly and effectively. As

above, each of these elements promotes protection for the FCM, which in

turn, reduces the likelihood that risk to the FCM could cause elevated

risk of operational errors that could result in a loss of customer

funds.

e. Regarding segregation risk, the requirements set forth in

proposed Sec. 1.11 would benefit customers and the financial integrity

of markets by requiring FCMs to implement rigorous internal controls

designed to detect and mitigate the risk that operational errors or

fraud could lead to a loss of customer funds. More specifically, and as

discussed above, proposed Sec. 1.11 requires FCMs to establish written

policies and procedures that address 12 components of segregation risk.

The Commission addresses each of those components below.

1. Proposed Sec. 1.11(e)(3)(i)(A) would establish a minimum set of

factors that the FCM would have to incorporate into its due diligence

standards and depositories would have to meet those standards in order

to be eligible to be selected by the FCM to hold customer segregated

funds. As a consequence, customers would have greater clarity about

what factors were considered as their FCM selected individual

depositories, leading to market discipline that encourages the

protection of customer funds.

Documenting the process would enable regulators to review and audit

for rigor of the process and adherence to it. Such documentation would

help regulators identify risk creating operational patterns or errors

that could increase risk to customer funds before those risks are

realized. In addition, documenting such criteria helps to ensure that

the depository is evaluated against substantive criteria that are

relevant to the safety of customer funds held by the depository as a

precondition for placing customer funds there. The proposed

requirement, by specifying certain criteria that must be included in

the FCM's policies and procedures, would also promote market discipline

by giving customers clarity about what factors, at a minimum, are

considered as part of the FCM's program for evaluating potential

depositories.

Together, these benefits help to ensure that the FCM and depository

have developed and adhere to procedures that minimize risk to customer

funds, which reduces the risk that an FCM would experience a shortfall

in their customer segregated funds account.

2. Regulation 1.11(e)(3)(i)(B) would require each FCM to establish

a program to monitor depositories on an ongoing basis. This would

mitigate the risk of loss of customer funds resulting from depository

default or malfeasance because FCMs would be better able to discern

emerging problems at the depository in time to move such funds to

another depository before the customer segregated funds are affected.

In addition, as above, documenting such a program would enable the

Commission and DSRO to evaluate the FCM's diligence in monitoring its

depositories by auditing the FCM's compliance with its own procedures

in this respect, which would again lead to more effective protection of

customer funds.

3. The proposal makes it clear that before an FCM is permitted to

deposit any customer segregated funds at a depository, the depository

must agree that, if instructed to do so by the Director of DSIO or the

Director of DCR, it will make such transfers without delay. Requiring

the acknowledgment letter to be signed before any funds are deposited

removes uncertainty about whether the depository has been put on notice

that it is required to move funds without delay when directed by the

Director of DSIO or the Director of DCR. In the event of a default by

an FCM, the Commission and relevant DCOs would immediately move

customer funds in order to move open positions to a different FCM.

4. The proposal requires senior management to conduct due diligence

to understand various factors that could impact the amount of residual

interest that would be prudent to maintain in the segregated funds

account, and then reach a determination about a targeted amount. The

benefit of such a requirement is that it would protect customer funds

by creating accountability for senior management. Requiring such due

diligence helps ensure that senior management is attentive to the

causes of segregated funds account underfunding. The requirement allows

both flexibility and accountability in that it allows FCMs to account

for relevant factors that vary across firms when determining an

appropriate target, rather than requiring all FCMs to maintain a common

target for residual interest. However, by requiring them to establish

such a target and to conduct due diligence in doing so, it allows the

Commission and DSROs to audit the FCMs to ensure that they reached

their target through a reasoned decision-making process, and ensures

that the respective boards approve and are responsible for the target.

Maintaining a target enhances market discipline by creating public

accountability for an FCM. It communicates to customers that the FCM

intends to maintain a certain residual interest in the account, and

gives customers an opportunity to consider, when selecting an FCM, the

additional security that varied levels of residual interest may provide

for their funds.

5. A process for the withdrawal of residual interest that is not

for the benefit of customers would help to ensure good communication

and that senior managers are appropriately involved in the decision to

remove

[[Page 67906]]

residual interest from segregated customer accounts. Good

communication, deliberate decision-making, and proper involvement of

senior managers would promote accountability when an FCM is removing

residual interest. These benefits are particularly important at times

when FCMs experience financial stress because good communication,

deliberate decision-making, and proper involvement of senior management

in decisions related to residual interest may be more likely to fail at

such times, creating risk to segregated customer funds. By requiring

FCMs to establish and follow procedures for withdrawals of residual

interest, the rule would help to ensure that such failures do not

occur.

An additional, related benefit is that by ensuring proper

communication with and approval from relevant senior managers before

such withdrawals occur, the proposed changes would enhance

accountability among those managers for decisions that could create

risk for segregated customer funds.

6. FCMs have a range of potential investments that are compliant

with Sec. 1.25. By requiring FCMs to establish a process for deciding

how to invest those funds, the requirement would provide the Commission

and DSRO with a standard by which such investment decisions could be

judged, which would help prevent the FCM from investing primarily in

the least credit-worthy Sec. 1.25 investments. FCMs have an incentive

to invest customer funds in Sec. 1.25 compliant investments that offer

the highest rate of return possible, but it is possible that the Sec.

1.25 investments offering the highest rates of return are also less

credit-worthy or less liquid than other Sec. 1.25 investments.

Requiring FCMs to set up, document and follow a process for assessing

the appropriateness of investing segregated funds in Sec. 1.25

investments ensures that FCMs take steps not only to determine whether

an investment complies with Sec. 1.25 as required by current

regulation, but that the investment is also evaluated with respect to

any risk it may pose to the FCM's primary responsibilities of

preserving principal and maintaining liquidity when handling customer

funds. In other words, this provision would help to prevent the

possibility of a ``race to the bottom'' for FCMs investing in Sec.

1.25 compliant assets.

7. If the FCM is not able to get accurate pricing for Sec. 1.25

assets, it is difficult to know whether or not sufficient funds are in

the segregated account. A shortage (and thus, in the event of

insolvency, a loss of customer funds) could occur simply because the

FCM can't accurately estimate the value of the assets that are there,

or it could also make it easier for the FCM to intentionally skew their

reports regarding funds in the customer segregated accounts by making

favorable assumptions about the value of assets that are difficult to

price. Requiring the FCM to establish a program for assessing the ease

of pricing for Sec. 1.25 assets helps reduce these risks and gives the

Commission and DSRO an opportunity to understand the FCM's procedures

and to enforce the FCM's compliance with them. This, in turn, promotes

reasoned and disciplined decision-making with respect to the FCM's

investment of customer funds in Sec. 1.25 investments. Establishing

procedures to evaluate the liquidity of Sec. 1.25 instruments will

help FCMs minimize the risk of such problems.

8. Appropriate internal controls are critical to the prevention of

fraud. The Commission understands that FCMs typically require that

certain duties are performed by separate people or separate groups of

people in order to ensure that a proper system of checks and

verification remains in place.\102\ In particular, FCMs generally

ensure that the individuals responsible for reporting and associated

calculations are separate from the individuals responsible for

operational transfers of funds. In the absence of such internal

controls, one person or group of people with access to both movement

and reporting of funds could transfer funds and then, for a time, hide

those transfers from senior management, auditors, and the public.

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\102\ See ``Initial Recommendations for Customer Funds

Protection'' by the FIA Futures Markets Financial Integrity Task

Force.

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The proposed rule would help protect customer funds by establishing

a regulatory requirement that all FCMs develop procedures to ensure

that the individuals responsible for calculating and reporting

segregation account requirements and segregation account funds do not

share duties with those who are responsible for transferring or

investing segregated funds. This should result in controls to prevent

fraudulent fund transfers.

9. The Commission regulations already require timely recording of

transactions in Sec. 1.35(b), but this proposed addition would require

that FCMs develop written policies and procedures ensure that they have

a consistent process to achieve that outcome. Again, requiring FCMs to

document their procedures helps protect customer funds by enabling the

Commission and DSROs to audit for compliance, detecting and preventing

operational issues that could pose risk to customer funds before those

risks result in an actual loss to customer funds.

10. Proper training of employees would help to ensure that

employees understand the written procedures regarding segregated funds.

The proposed training requirement provides flexibility for an FCM to

determine whether it should develop the required training in house, or

to pay a vendor to develop a training program. Training regarding the

requirements of the Act and Commission regulations regarding handling

customer funds will help to ensure that employees understand how the

procedures and requirements related to customer funds apply to various

situations they face in their work for the FCM. Training regarding the

second and third points mentioned above will help to ensure that the

Commission and DSRO are notified promptly whenever any of the

circumstances covered in Sec. 1.12 occur, or whenever there is a

breach of the FCM's own policies and procedures, even if the

circumstances in Sec. 1.12 have not occurred. Moreover, by requiring

broad participation in training focused on these points, the proposed

requirement would protect customer funds by encouraging a culture of

accountability and transparency through self-disclosure. Training

regarding the consequences of failing to comply will help to ensure

that employees understand the seriousness with which the Commission

regards violation of these standards, thereby providing an incentive to

diligently adhere to them. In addition, requiring FCMs to provide the

training annually helps ensure that the critical content of this

training is not lost due to the passing of time, or employee turnover.

In addition, by requiring automated financial risk management

controls, the proposed Risk Management Program would reduce operational

risk that could result from ``fat finger'' errors when submitting

trades, or from technological ``glitches'' using automated trading.

Several events have demonstrated that such operational risks are

difficult to predict, tend to emerge so quickly that non-automated

forms of risk management may not be able to contain them, and can

threaten an FCM's continued viability. Automated controls would help to

reduce these operational risks, thereby providing additional protection

to FCMs and mitigating the risk of loss to customer funds.

Last, by requiring an FCM to develop and implement written policies

that ensure it has sufficient capital and liquidity not only to comply

with the

[[Page 67907]]

Act and Commission regulations but also to meet its foreseeable needs,

the proposed rule would promote reasoned decision making regarding

capital retention and allocation decisions because such decisions would

have to be made according to the established policies and procedures,

weighing the factors and inputs included therein. Moreover, written

procedures could be used by the Commission and relevant SROs as the

basis for audits to check for compliance with such procedures, which

would help the Commission and relevant SRO identify operational

problems that could lead to loss of customer funds.

In many cases the proposed rules provide flexibility to FCMs by

requiring that they develop and document their own policies and

procedures rather than prescribing specific procedures for them. In so

doing, the proposal gives FCMs an opportunity to tailor policies and

procedures that accommodate their specific needs and operational

patterns, which may vary from one FCM to another based on differences

in their size, involvement in specific markets, and the characteristics

of their investor base. This approach is likely to be less costly for

FCMs when compared to the alternative of a more prescriptive approach

because it is less likely to require changes to operational patterns if

existing procedures are adequate to provide the same protections to

customer funds. In addition, the flexibility of this approach benefits

market participants and customers alike because it is the FCM that is

in the best position to define the precise form of internal controls

that will best protect customer funds from operational errors and

fraud.

In addition, as suggested above, requiring FCMs to document their

policies and procedures regarding their Risk Management Program would

enable the Commission and DSRO to audit for operational problems that

could put customer funds at risk before those risks turn into actual

losses. This would strengthen the critical first line of defense

against operational errors and fraud.

Costs

The risk management unit, required by the proposed rule, would

create certain personnel costs. The Commission estimates that such a

unit would require between one and ten full-time staff depending on the

size and complexity of the FCM. Therefore, the Commission estimates

that the annual cost for the risk management unit would be between

$171,000 and $1,934,000.\103\

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\103\ This assumes 2,000-10,000 hours per year from compliance

attorneys (i.e., 1-5 full time compliance attorneys) and 0-10,000

hours per year from a senior risk management specialist (i.e., 0-5

full time senior risk management specialists). The average

compensation for a compliance attorney is $85.35/hour [$131,303 per

year/(2000 hours per year)*1.3 is $85.35 per hour]; $85.35*2000 =

$170,693.90 and $85.35*10,000 = $853,469.50. The average

compensation for a senior risk management specialist is $83.13/hour

[$166,251.00 per year/(2000 hours per year)*1.3 is $83.13 per hour];

$83.13*0 = $0 and $83.13*10,000 = $1,080,631.50.

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There are costs associated with the Risk Management Program

proposed in Sec. 1.11.

a. Each FCM would likely have to review its operations, business

model, market conditions, customer base, and a number of other factors

in order to identify the risks that it should be monitoring. In

addition, each FCM would have to develop and document methodologies for

establishing risk tolerance limits for each risk that they choose to

monitor. Last, for each FCM, the risks and proposed limits for those

risks would have to be reviewed and approved quarterly by its senior

management and annually by the board. The Commission estimates that the

initial cost for identifying relevant risks and developing and

documenting methodologies for establishing thresholds would be between

$28,800 and $68,400.\104\ The ongoing cost for reviewing the risks and

limits and approving them would be between $27,900 and $99,700 per

year.\105\

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\104\ For initial costs, this estimates initial costs of 50-250

hours from compliance attorneys, 10-100 hours from risk management

personnel, 36 hours (total) of time from the board, and 10-20 hours

each from the CEO, CFO, COO, and CCO. The average compensation for a

compliance attorney is $85.35/hour [$131,303 per year/(2000 hours

per year)*1.3 is $85.35 per hour]; $85.35*50 = $4,267.35 and

$85.35*250 = $21,336.77. The average compensation for a risk

management specialist is $65.33/hour [$100,500 per year/(2000 hours

per year)*1.3 is $65.33 per hour]; $65.33*10 = $653.25 and

$65.33*100 = $6,532.50. The average compensation for a member of a

firm's board of directors is estimated by the Commission to be

$200.00/hour [$100,000 per year/(500 hours per year) is $200 per

hour]; $200.00*36 = $7,200.00. The average compensation for a chief

executive officer is estimated by the Commission to be $650.00/hour

[$1,000,000 per year/(2000 hours per year)*1.3 is $650.00 per hour];

$650.00*10 = $6,500.00 and $650.00*20 = $13,000. The average

compensation for both a chief financial officer and a chief

operations officer is estimated by the Commission to be $455.00/hour

[$700,000 per year/(2000 hours per year)*1.3 is $455.00 per hour];

$455.00*10 = $4,550.00 and $455.00*20 = $9,100.00. The average

compensation for a chief compliance officer is $110.97/hour [

$170,727 per year/(2000 hours per year)*1.3 = $110.97/hour];

$110.97*10 = $3,329.18 and $110.97*20 = $11,097.26.

\105\ For ongoing costs, this estimates annual costs of 20-200

hours from compliance attorneys, 50-300 hours from risk management

personnel, 48 hours (total) of time from the board, and 8-32 hours

each from CEO, CFO, COO, and CCO. Using the same compensation

figures listed above, this is $85.35 *20 = $1,706.94 and $85.35*200

= $17,069.39 for a compliance attorney; $65.33*50 = $3266.25 and

$65.33*300 = $19,597.50 for a risk management specialist; $200.00*48

= $9,600.00 for the board; $650.00*8 = $5,200.00 and $650.00*32 =

$20,800.00 for the CEO; $455.00*8 = $3,640.00 and $455.00*32 =

$14,560.00 for both the CFO and COO; and $110.97*8 = $887.78 and

$110.97*32 = $3,551.12 for the CCO. The compensations of an average

CEO and CFO are estimates by the Commission; the compensation of the

board of directors is based on the average compensation of the

boards of several large FCMs. All other figures are taken from the

2011 SIFMA Report on Management and Professional Earnings in the

Securities Industry.

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b. Developing these policies and procedures for detecting breaches

of the risk tolerance limits and notifying appropriate personnel would

create an initial cost, but little ongoing cost since most of the

monitoring costs are included in other elements (quarterly reports,

annual audits, etc.). The Commission estimates that the initial cost to

develop these policies and procedures is between $3,400 and

$6,800.\106\

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\106\ This estimates 40-80 hours of time from a compliance

attorney. The average compensation for a compliance attorney is

$85.35/hour [$131,303 per year/(2000 hours per year)*1.3 is $85.35

per hour]; $85.35*40 = $3,413.88 and $85.35*80 = $6,827.76. These

figures are taken from the 2011 SIFMA Report on Management and

Professional Earnings in the Securities Industry.

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c. Many of the activities necessary for completing the quarterly

review of risk thresholds will overlap with the activities necessary

for completing the Risk Exposure Reports. However, some additional time

will be required to compile the Report and to incorporate information

that is distinct from that which is required for the quarterly review

of risk thresholds. In addition, the FCM's board and senior management

are obligated to review the report. Therefore, the Commission estimates

that each Risk Exposure Report will cost between $8,800 and $13,300 per

year.\107\

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\107\ This estimates 20-50 hours of compliance attorney time,

20-50 hours from risk management personnel, 12 hours of board time,

and 2 hours from each of the CEO, CFO, COO, and CCO. The average

compensation for a compliance attorney is $85.35/hour [$131,303 per

year/(2000 hours per year)*1.3 is $85.35 per hour]; $85.35*20 =

$1,706.94 and $85.35*50 = $4,267.35. The average compensation for a

risk management specialist is $65.33/hour [$100,500 per year/(2000

hours per year)*1.3 is $65.33 per hour]; $65.33*20 = $1,306.50 and

$65.33*50 = $3,266.25. The average compensation for a member of a

firm's board of directors is estimated by the Commission to be

$200.00/hour [$100,000 per year/(500 hours per year) is $200 per

hour]; $200.00*12 = $2,400.00. The average compensation for a chief

executive officer is estimated by the Commission to be $650.00/hour

[$1,000,000 per year/(2000 hours per year)*1.3 is $650.00 per hour];

$650.00*2 = $1,300.00. The average compensation for both a chief

financial officer and a chief operations officer is estimated by the

Commission to be $455.00/hour [$700,000 per year/(2000 hours per

year)*1.3 is $455.00 per hour]; $455.00*2 = $910.00. The average

compensation for a chief compliance officer is $110.97/hour [

$170,727 per year/(2000 hours per year)*1.3 = $110.97/hour];

$110.97*2 = $221.95. The compensations of an average CEO and CFO are

estimates by the Commission; the compensation of the board of

directors is based on the average compensation of the boards of

several large FCMs. All other figures are taken from the 2011 SIFMA

Report on Management and Professional Earnings in the Securities

Industry.

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[[Page 67908]]

d. The Commission estimates that review and testing of the Risk

Management Program will cost between $6,000 and $24,300.\108\ An FCM

must conduct such a review and testing annually as well as any time it

experiences a material change in the business that is reasonably likely

to alter the risk profile of the FCM. The Commission does not have

adequate information to estimate how frequently such a change in the

business will occur, so it has assumed one review and testing per year.

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\108\ This assumes four weeks' worth of time from one to four

intermediate compliance specialists. The average compensation of an

intermediate compliance specialist is $37.90/hour [$58,303.00 per

year/(2000 hours per year)*1.3 is $37.90]; $37.90*40 hours/week*1 =

$6,063.51 and $37.90*40 hours/week*4 = $24,254.05. These figures are

taken from the 2011 SIFMA Report on Management and Professional

Earnings in the Securities Industry.

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e. Regarding the policies and procedures that are required to

address segregation risk, proposed Sec. 1.11 would create three sets

of costs: (1) costs related to developing and documenting all required

policies and procedures; (2) initial implementation costs; and (3)

ongoing costs.\109\

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\109\ Developing, documenting, and implementing the requisite

policies and procedures would require personnel hours from

compliance attorneys, senior management, and limited involvement

from others such as risk management, HR, and IT. Those costs are

would vary, perhaps significantly, depending on the extent to which

each FCM already has compliant procedures in place and the extent to

which such procedures may already be documented. However, the

Commission has endeavored to estimate broad ranges of costs that

would likely result from efforts to develop and document the

requirements of Sec. 1.11, to implement compliant procedures, and

then to sustain such procedures on an ongoing basis. And while the

benefits are enumerated separately because their substantive

benefits, in several cases, vary from one requirement to the next,

the substantive costs are, in many cases, overlapping, and therefore

the Commission has addressed them collectively.

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1. The Commission estimates that developing and documenting

requisite policies and procedures would require one or more compliance

attorneys to be heavily involved interpreting and explaining the Act

and Commission requirements to other affected employees, guiding other

subject matter experts in the development of compliant operations, and

drafting the required documentation. Risk management personnel would

also likely be involved in developing procedures to review banks and

Sec. 1.25 investments as well as to support the due diligence that

senior management will have to conduct in order to establish a target

residual interest for the FCM. The CFO and other senior personnel

reporting to the CFO would likely be involved with selecting a target

for the firm's residual interest and developing procedures for making

withdrawals of residual interest for proprietary use. The CEO and board

would be involved in reviewing and approving the policies and

procedures required under Sec. 1.11. The Commission estimates that the

likely cost for developing and documenting the policies and procedures

that would be required under the proposed Sec. 1.11 would be between

$54,800 and $131,000.\110\

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\110\ This estimate assumes 400-1000 hours of time from one or

more compliance attorneys re: all aspects of the requirements

(interpreting, summarizing, guiding compliance discussions,

drafting, etc.), 80-160 hours from a firm's chief compliance officer

re: All aspects of the program, 10-100 hours from risk management

personnel re: bank selection, monitoring, process to assess Sec.

1.25 investment decisions, and due diligence to support targeted

residual amount decision, 4-20 hours from a firm's chief financial

officer re: selection of target for residual funds and process for

withdrawal of segregated account funds not for the benefit of FCM

customers, 2-4 hours from a firm's CEO, and 40-50 hours from board

collectively re: discussion and approval of written policies and

procedures. The average compensation for a compliance attorney is

$85.35/hour [$131,303 per year/(2000 hours per year)*1.3 is $85.35

per hour]; $85.35*400 = $34,140.00 and $85.35*1000 = $85,350.00. The

average compensation for a chief compliance officer is $110.97/hour

[ $170,727 per year/(2000 hours per year)*1.3 = $110.97/hour];

$110.97*60 = $6,658.35 and $110.97*100 = $11,097.26. The average

compensation for a risk management specialist is $65.33/hour

[$100,500 per year/(2000 hours per year)*1.3 is $65.33 per hour];

$65.33*10 = $653.25 and $65.33*100 = $6,532.50. The average

compensation for a chief financial officer is estimated by the

Commission to be $455.00/hour [$700,000 per year/(2000 hours per

year)*1.3 is $455.00 per hour]; $455.00*4 = $1,820.00 and $455.00*20

= $9,100.00. The average compensation for a chief executive officer

is estimated by the Commission to be $650.00/hour [$1,000,000 per

year/(2000 hours per year)*1.3 is $650.00 per hour]; $650.00*2 =

$1,300.00 and $650.00*4 = $2,600.00. The average compensation for a

member of a firm's board of directors is estimated by the Commission

to be $200.00/hour [$100,000 per year/(500 hours per year) is $200

per hour]; $200.00*40 = $8,00.00 and $200.00*50 = $10,000.00. The

compensations of an average CEO and CFO are estimates by the

Commission; the compensation of the board of directors is based on

the average compensation of the boards of several large FCMs. All

other figures are taken from the 2011 SIFMA Report on Management and

Professional Earnings in the Securities Industry.

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2. The policies and procedures must not only be documented, they

must be implemented, which will create some one-time costs that will

depend significantly on the extent to which an FCM already practices

some of the operational procedures that the Commission is requiring

here. While the Commission expects that some FCMs are likely to have

certain policies and procedures in place already that comply with Sec.

1.11, the Commission does not have adequate information to determine to

what extent this is true. Therefore, for the purposes of estimation we

have estimated the one-time costs for an entity that does not yet have

any of the required policies and procedures in place. The Commission

anticipates that in such a circumstance, implementing new policies and

procedures would require risk management personnel to conduct initial

due diligence on depositories and existing as well as prospective Sec.

1.25 investments. Human Resource (``HR'') personnel would have to

revise job descriptions to comply with policies to separate critical

functions related to handling of customer funds, and would also have to

develop new annual training.\111\ One or more compliance attorneys

would be involved ensuring that accounts are titled appropriately,

securing requisite acknowledgment letters from depositories, setting up

quarterly audits of policies and procedures, and providing general

oversight of the implementation process. IT personnel will likely be

required to automate certain aspects of the information collection that

is necessary, and the CCO would likely be involved on virtually a full-

time basis for some period of time as well, overseeing the

implementation of critical new policies and procedures. The Commission

estimates the cost for such an implementation would range between

$90,800 and $275,300.\112\

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\111\ However, they are likely to outsource some pieces of the

implementation (e.g. annual training would likely be developed by

vendors to meet the needs of multiple market participants) which

will mitigate associated costs. If a firm chooses to use training

created by a vendor, that would likely reduce the HR one-time costs

significantly.

\112\ This estimate assumes 100-200 hours of risk management

personnel time (from employees of varying levels of pay) conducting

initial due diligence on depositories and evaluating Sec. 1.25

investments, 800-1000 hours of human resources personnel time (400-

500 at a junior level and 400-500 at a senior level) revising job

descriptions to accommodate separation of roles and developing

annual training, 20-400 hours of time from one or more compliance

attorneys for retitling accounts, securing requisite

acknowledgements from depositories, setting up quarterly audits, and

general oversight of implementation of new policies and procedures,

4-12 weeks of the time of a firm's Chief Compliance Officer, or 160-

480 hours, and 160-800 hours of the time of IT personnel (140-700 at

a junior to intermediate level and 20-100 at a senior level) as the

firm will likely seek to automate some types of information

collection and other steps necessary to support requirements. The

average compensation for a senior risk management specialist is

$108.06/hour [$166,251 per year/(2000 hours per year)*1.3 is $108.06

per hour]; $108.06*100 = $10,806.00 and $108.06*500 = $54,030.00.

The average compensation for a risk management specialist is $65.33/

hour [$100,500 per year/(2000 hours per year)*1.3 is $65.33 per

hour]; $65.33*100 = $6,532.50 and $65.33*500 = $32,665.00. The

average compensation for a junior human resources representative is

$40.95/hour [$62,989 per year/(2000 hours per year)*1.3 is $40.95

per hour]; $40.95*800 = $32,760.00 and $40.95*1000 = $40,950.00. The

average compensation for a senior human resources representative is

$71.45/hour [$109,921 per year/(2000 hours per year)*1.3 is $71.45

per hour]; $71.45*100 = $7,144.87 and $71.45*500 = $35,724.33. The

average compensation for a compliance attorney is $85.35/hour

[$131,303 per year/(2000 hours per year)*1.3 is $85.35 per hour];

$85.35*20 = $1,706.94 and $85.35*400 = $34,138.78. The average

compensation for a chief compliance officer is $110.97/hour [

$170,727 per year/(2000 hours per year)*1.3 = $110.97/hour];

$110.97*160 = $17,755.61 and $110.97*480 = $53,266.82. The average

compensation for a programmer is $53.64/hour [$82,518 per year/(2000

hours per year)*1.3 = $53.64/hour]; $53.64*140 = $7,509.14 and

$53.64*700 = $37,545.69. The average compensation for a senior

programmer is $74.56/hour [$114,714 per year/(2000 hours per

year)*1.3 = $74.56/hour]; $74.56*20 = $1,491.28 and $74.56*100 =

$7,456.41. All figures are taken from the 2011 SIFMA Report on

Management and Professional Earnings in the Securities Industry.

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[[Page 67909]]

3. The costs necessary to sustain the policies and procedures

required under Sec. 1.11 are difficult to estimate because they would

depend on variables such as the size of the firm, the program of

governing supervision that they develop, and the degree of automation

they achieve in their various ongoing processes (monitoring

depositories, evaluating Sec. 1.25 investments, reevaluating residual

funds target, etc.), and the degree to which their operations are

already compliant with the policies and procedures they would develop

pursuant to the proposed Sec. 1.11. However, as a lower bound, the

ongoing costs would include expenses related to the time for: (1) The

CCO to review quarterly audits and conduct due diligence that is

necessary before providing certification of compliance with the Act,

regulations and its policies and procedures with respect to segregated

funds in the annual report; (2) risk management personnel to evaluate

Sec. 1.25 investments for liquidity and marketability and to monitor

depository institutions where customer segregated funds are held; (3)

the CFO and other senior management to review and determine the

continued appropriateness of the FCM's target for residual interest;

and (4) HR personnel to organize and deliver annual training. The

Commission estimates that the lower bound for these costs is

approximately $20,000 and that costs may be higher, depending on the

variables mentioned above.\113\

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\113\ This estimate assumes 20+ hours per year from the CCO for

due diligence and certification of compliance on annual report and

reviewing quarterly audits, 40+ hours each per year from junior and

senior risk management personnel evaluating Sec. 1.25 investments

for liquidity and marketability and monitoring depository

institutions where customer segregated funds are held, 6+ hours per

year from the CFO and other senior management for reviewing the

target for the firm's residual interest, and 20+ hours each per year

from junior and senior HR--organizing and delivering annual

training, as well as at least a day's training for 20 employees, or

160 hours from an average financial employee, such as a general

intermediate trader. The average compensation for a chief compliance

officer is $110.97/hour [$170,727 per year/(2000 hours per year)*1.3

= $110.97/hour]; $110.97*20 = $2,219.45. The average compensation

for a senior risk management specialist is $108.06/hour [$166,251

per year/(2000 hours per year)*1.3 is $108.06 per hour]; $108.06*40

= $4,322.53. The average compensation for a risk management

specialist is $65.33/hour [$100,500 per year/(2000 hours per

year)*1.3 is $65.33 per hour]; $65.33*40 = $2,613.00. The average

compensation for a chief financial officer is estimated by the

Commission to be $455.00 per/hour [$700,000 per year/(2000 hours per

year)*1.3 is $455.00 per hour]; $455.00*6 = $2,730. The average

compensation for a junior human resources representative is $40.94/

hour [$62,989.00 per year/(2000 hours per year) = $40.94/hour];

$40.94*20 = $818.86. The average compensation for a senior human

resources representative is $71.45/hour [$109,921.00 per year/(2000

hours per year) = $71.45/hour]; $71.45*20 = $1,428.97. The average

compensation for a general intermediate trader is $36.48/hour

[$56,130.00 per year/(2000 hours per year)*1.3 is $36.48 per hour];

$36.48*160 = $5,837.52. The compensations of an average CFO is an

estimate by the Commission. All other figures are taken from the

2011 SIFMA Report on Management and Professional Earnings in the

Securities Industry.

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In addition, FCMs would have to implement automated financial risk

management controls that are reasonably designed to prevent entering of

erroneous trades. The Commission anticipates that some, but not all,

FCMs already have such systems in place. For those FCMs that do not yet

have such systems in place, the Commission proposes that it would cost

an FCM between $10,300 and $89,400 to implement such a system.\114\

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\114\ This estimates 150-1500 hours of mid-level IT programming

time and 30-120 hours of senior level IT personnel time. The average

compensation for a programmer is $53.64/hour [$82,518 per year/(2000

hours per year)*1.3 = $53.64/hour]; $53.64*150 = $8,045.51 and

$53.64*1500 = $80,455.05. The average compensation for a senior

programmer is $74.56/hour [$114,714 per year/(2000 hours per

year)*1.3 = $74.56/hour]; $74.56*30 = $2,236.92 and $74.56*120 =

$8,947.69. All figures are taken from the 2011 SIFMA Report on

Management and Professional Earnings in the Securities Industry.

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Sec. 1.12 Maintenance of Minimum Financial Requirements by Futures

Commission Merchants and Introducing Brokers

Proposed Changes

As described in the section by section discussion at II.C, the

proposed changes to Sec. 1.12 would alter the notice requirement so

that it is no longer acceptable to give ``telephonic notice to be

confirmed, in writing, by facsimile.'' Instead, all notices would be

made in writing and submitted through an electronic medium acceptable

to the Commission (currently, WinJammer).

In addition, as described above in II.C, the proposed changes would

require that if an FCM has a shortfall in net capital but is not sure

of their financial condition, the FCM should not delay notifying the

Commission about the shortfall in net capital. The FCM must communicate

each piece of information (knowledge of the shortfall and knowledge of

the financial condition of the FCM) to the Commission as soon as it is

known.

The proposed requirements in paragraphs (i), (j), (k) and (l) of

Sec. 1.12 identify additional circumstances in which the FCM must

provide immediate written notice to the Commission, relevant SRO and to

the SEC if the FCM is also a broker-dealer. Those circumstances are:

(1) If an FCM discovers that any of the funds in segregated accounts

are invested in investments not permitted under Sec. 1.25; (2) if an

FCM does not have sufficient funds in any of their segregated accounts

to meet their targeted residual interest; (3) if the FCM experiences a

material adverse impact to its creditworthiness or ability to fund its

obligations; (4) whenever the FCM has a material change in operations

including changes to senior management, lines of business, clearing

arrangements, or credit arrangements that could have a negative impact

on the FCM's liquidity; and (5) if the FCM receives a notice,

examination report, or any other correspondence from a DSRO, the SEC,

or a securities industry self-regulatory organization, the FCM must

notify the Commission, and provide a copy of the communication as well

as a copy of their response to the Commission.

Last, proposed changes in paragraph (n) of Sec. 1.12 would require

that every notice or report filed with the Commission pursuant to Sec.

1.12 would include a discussion of how the reporting event originated

and what steps have been, or are being taken, to address the event.

Benefits

The proposed changes requiring that notice to the Commission be

given in written form via specified forms of electronic communication

not only adapt the rule to account for modern forms of communication,

but also reduce the possibility of notification being delayed in

reaching appropriate Commission staff. The proposed requirement would

ensure that such

[[Page 67910]]

notices are submitted to WinJammer, which forwards notices to

appropriate personnel within the Commission via email within a matter

of minutes, if not seconds.

With respect to the proposed change in Sec. 1.12(a)(2), if an FCM

knows that it does not have adequate capital to meet the requirements

of Sec. 1.17 or other capital requirements, and is also not able to

calculate or determine its financial condition, it is likely that the

FCM is in a period of extraordinary stress. In these circumstances,

time is of the essence for the solvency of the FCM and to the

protection of its customers and counterparties. Therefore, it is

important that the Commission, DSRO, and SEC (if the FCM is also a

broker-dealer) be notified immediately so that they can begin assessing

the FCM's condition, and if necessary, making preparations to allow the

transfer of the customers' positions to another FCM in the event that

the FCM currently holding those positions has insufficient regulatory

capital. These preparations help to ensure that the customers' funds

are protected in the event of the FCM's default, and that the positions

of its customers are transferred expeditiously to another FCM where

those customers may continue to hold and control those positions

without interruption to the customer's positions.

The situations enumerated in proposed Sec. Sec. 1.12(i) and (j)

are more specific indicators of potential or existing problems in the

customer segregated funds accounts. Notifying the Commission in such

circumstances will enable it to monitor steps the FCM is taking to

address a shortfall in targeted residual interest, or to direct the FCM

as it takes steps to address improperly invested segregated funds. In

either case, the Commission will be able to be much more closely

involved in rectifying the situation and ensuring the continued

protection of customer segregated funds.

The situations enumerated in proposed Sec. Sec. 1.12(k) through

(l) are circumstances indicating that the FCM is undergoing changes

that could indicate or lead to financial strain. Alerting the

Commission and relevant SRO in such circumstances will enable both to

protect customer funds by monitoring the FCM more closely in order to

ensure that any developing problems are identified quickly and

addressed proactively by the FCM with the oversight of the Commission

and relevant SRO.

The proposed amendment requiring that the FCM notify the Commission

whenever it receives a notice or results of an examination from the

DSRO, SEC, or securities-industry self-regulatory body, would ensure

that the Commission is aware of any significant developments affecting

the FCM that have been observed or communicated by other regulatory

bodies. Such communications could prompt the Commission to heighten its

monitoring of specific FCMs, or create an opportunity for the

Commission to work collaboratively and proactively with other

regulators to address any concerns about how developments in the FCM's

business could affect customer funds.

The proposed requirement that notifications to the Commission

pursuant to Sec. 1.12 include a discussion of what caused the

reporting event and what has been, or is being done about the event

would provide additional information to Commission staff that help them

quickly gauge the potential severity of related problems that have been

or are developing at the reporting FCM, IB, or SRO. It would also help

Commission staff discern how effectively the reporting entity is

responding to such problems, which could assist the staff in

determining whether the situation is likely to be corrected quickly or

to continue deteriorating.

Costs

As discussed above, the proposed rule requires that FCMs provide

immediate notice to the Commission and its DSRO in five additional

circumstances. These additional requirements create some minimal

reporting costs when such circumstances arise. The Commission estimates

that the total cost of completing and sending the requisite form is

approximately $9,700 and $19,400 per form.\115\

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\115\ This estimates 8-16 hours of time from both the CCO and

the CFO, 10-20 from the General Counsel, 20-40 from a compliance

attorney, and 10-20 from a senior accountant. The average

compensation for a chief compliance officer is $110.97/hour [

$170,727 per year/(2000 hours per year)*1.3 = $110.97/hour];

$110.97*2 = $221.95 and $110.97*4 = $443.89. The average

compensation for a chief financial officer is estimated by the

Commission to be $455.00/hour [$700,000 per year/(2000 hours per

year)*1.3 is $455.00 per hour]; $455.00*2 = $910.00 and $455.00*4 =

$1,820.00. The average compensation for a general counsel is

estimated by the Commission to be $260.00/hour [$400,000 per year/

(2000 hours per year)*1.3 is $260.00 per hour]; $260.00*10 =

$2,600.00 and $260.00*20 = $5,200.00. The average compensation for a

senior accountant is $44.18/hour [$67,971 per year/(2000 hours per

year)*1.3 = $44.18/hour]; $44.18*10 = $441.81 and $44.18*20 =

$883.62. These figures are taken from the 2011 SIFMA Report on

Management and Professional Earnings in the Securities Industry.

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Ongoing monitoring for any of the five additional circumstances

that require reporting to the Commission, relevant SRO, and to the SEC

if the FCM is a broker-dealer will also create some costs. In its

consideration of the proposed rule, the Commission assumes that FCMs

will automate the process for monitoring residual interest for any

shortfall against the firm's target. Furthermore, the Commission

anticipates that FCMs will build on the systems that they already have

in place to calculate residual interest once per day at the close of

business. The incremental cost of modifying such systems to monitor

residual interest compared to the target value on an ongoing basis is

likely to be between $1,800 and $6,300.\116\ Identifying instances

where their FCM has experienced a material adverse impact to its

creditworthiness or ability to fund its obligations, as would be

required by proposed Sec. 1.12(k), would likely require deliberation

among senior leaders at the FCM. Such deliberations, however, would

likely be prompted by observations that such leaders make in the

ordinary course of business, and therefore would not require proactive

monitoring. The Commission estimates that deliberations among senior

leaders to determine whether there is evidence suggesting a material

decrease in the FCM's creditworthiness has occurred would cost at least

$6,600 per year.\117\

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\116\ This estimates 20-90 hours of personnel time from a

programmer and 10-20 hours of personnel time from a senior

programmer. The average compensation for a programmer is $53.64/hour

[$82,518 per year/(2000 hours per year)*1.3 = $53.64/hour];

$53.64*20 = $1,072.73 and $53.64*90 = $4,827.30. The average

compensation for a senior programmer is $74.56/hour [$114,714 per

year/(2000 hours per year)*1.3; $74.56*10 = $745.64 and $74.56*20 =

$1,491.28. All figures are taken from the 2011 SIFMA Report on

Management and Professional Earnings in the Securities Industry.

\117\ This estimates at least 8 hours per year from the CFO, the

CCO, and the General Counsel. The average compensation for a chief

compliance officer is $110.97/hour [ $170,727 per year/(2000 hours

per year)*1.3 = $110.97/hour]; $110.97*8 = $887.78. The average

compensation for a chief financial officer is estimated by the

Commission to be $455.00/hour [$700,000 per year/(2000 hours per

year)*1.3 is $455.00 per hour]; $455.00*8 = $3,640. The average

compensation for a general counsel is estimated by the Commission to

be $260.00/hour $400,000.00 per year/(2000 hours per year)*1.3 is

$260.00 per hour]; $260.00*8 = $2,100.00. The figure for the CCO is

taken from the 2011 SIFMA Report on Management and Professional

Earnings in the Securities Industry; other compensations are

estimates by the Commission.

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Material changes to the FCM's leadership or business would create

some incremental costs. Some of the material changes envisioned, such

as changes in senior leadership, are discrete events that do not

require monitoring in order to identify. On the other hand, events that

constitute a material change in operations, credit arrangements, or

``any change that could adversely impact the firm's liquidity

[[Page 67911]]

resources,'' \118\ would only be reliably recognized as a material

change by someone with a broad knowledge of the firm's operations and

finances, so the Commission assumes that senior management would

fulfill these requirements. However, identifying and addressing

material changes to the business is a function that senior management

already plays, and therefore monitoring for such changes would not

create any incremental costs. The proposed rule would make it necessary

for senior management, in addition to identifying changes to the

business, to make a decision about whether or not those changes are

material and therefore should be reported. The Commission proposes that

the additional time senior management spends making determinations

about the materiality of changes to the business, as defined by the

proposed rule, would require approximately twenty hours of time from

both the CCO and CFO. Therefore, the Commission estimates that the

monitoring costs would be $11,300 and $22,600.\119\

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\118\ Sec. 1.12(l).

\119\ This estimates 20-40 hours of time each from the CCO and

CFO. The average compensation for a chief compliance officer is

$110.97/hour [$170,727 per year/(2000 hours per year)*1.3 = $110.97/

hour]; $110.97*20 = $2,219.45 and $110.97*40 = $4,438.90. The

average compensation for a chief financial officer is estimated by

the Commission to be $455.00/hour [$700,000 per year/(2000 hours per

year)*1.3 is $455.00 per hour]; $455.00*20 = $9,100.00 and

$455.00*40 = $18,200.00. The compensations of an average CFO is an

estimate by the Commission. The figure for a CCO is taken from the

2011 SIFMA Report on Management and Professional Earnings in the

Securities Industry.

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The proposed requirement that notices or reports filed with the

Commission pursuant to Sec. 1.12 include a discussion of how the

reporting event originated and what has been, or is being done to

address the reporting event, will increase the cost of such reports.

The Commission anticipates that this requirement would prompt the CFO,

General Counsel, and CCO of a reporting entity to invest additional

time in developing and reviewing the report. The Commission anticipates

that the incremental cost associated with the additional time spent by

the CFO, General Counsel, and CCO would be between $3,300 and $6,600

per report.\120\

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\120\ This estimates that the CFO, General Counsel, and CCO will

each spend an additional 4-8 hours developing and reviewing the

report. The average compensation for a chief financial officer is

estimated by the Commission to be $455.00/hour [$700,000 per year/

(2000 hours per year)*1.3 is $455.00 per hour]; $455.00*4 =

$1,780.00 and $455.00*8 = $3,640.00. The average compensation for a

general counsel is estimated by the Commission to be $260.00/hour

[$400,000.00 per year/(2000 hours per year)*1.3 is $260.00 per

hour]; $260.00*4 = $1,040.00 and $260.00*8 = $2,100.00. The average

compensation for a chief compliance officer is $110.97/hour [

$170,727 per year/(2000 hours per year)*1.3 = $110.97/hour];

$110.97*4 = $443.88 and $110.97*8 = $887.78. The figure for the CCO

is taken from the 2011 SIFMA Report on Management and Professional

Earnings in the Securities Industry; other compensations are

estimates by the Commission.

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Additional proposed changes would introduce only minimal, if any,

additional costs. For example, all FCMs already use WinJammer to submit

certain reports to DSROs and to the Commission, so there would not be

any additional cost involved with Sec. 1.12(n)(3) requirement that

such notices to be submitted through that platform rather than via

fax.\121\ Nor is there any cost associated with this proposed change to

Sec. 1.12(a)(1). The FCM is still required to disclose its financial

condition to the Commission, DSRO and SEC (if applicable) as soon as it

can be ascertained. The proposed change does not alter the information

that the FCM must gather, calculate, or report. It merely requires that

each of the two pieces of information relevant to the requirements in

Sec. 1.12(a)(1-2) are submitted as soon as they are known.

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\121\ See NFA Interpretive Notice 9028--NFA Financial

Requirements: The Electronic Filing of Financial Reports. Available

at: http://prodwebvip.futures.org/nfamanual/NFAManual.aspx?RuleID=9028&Section=9. See also CME Advisory Notice:

Enhanced Customer Protections & Rule Amendments, June 27, 2012.

Available at: http://www.cmegroup.com/tools-information/lookups/advisories/clearing/AIB12-08.html.

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Request for Comment

Question 5: The Commission requests additional information

regarding the costs of these additional notification requirements.

Specifically, how much time will information technology and compliance

personnel have to invest in order to modify systems to calculate

residual interest on a continual basis? How much time would be

necessary to monitor for material changes in the business and what

level of personnel would have to participate in that in order to draw

reliable conclusions about whether or not a material event had

occurred?

Sec. 1.16 Qualifications and Reports of Accountants

Proposed Changes

As discussed above in II.E, the proposed changes would require that

in order for an accountant to be qualified to conduct an audit of an

FCM, that accountant would have to be registered with the Public

Company Accounting Oversight Board (``PCAOB''),\122\ have undergone at

least one examination by the PCAOB, and have addressed any deficiencies

noted by the PCAOB within three years of the report noting such a

deficiency.

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\122\ ``PCAOB is a nonprofit corporation established by Congress

to oversee the audits of public companies in order to protect the

interests of investors and further the public interest in the

preparation of informative, accurate and independent audit reports.

The PCAOB also oversees the audits of broker-dealers, including

compliance reports filed pursuant to federal securities laws, to

promote investor protection.'' See http://pcaobus.org/Pages/default.aspx.

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Second, the amendments would require that the governing body of the

FCM ensure that the accountant engaged for an audit is duly qualified,

and specifies certain qualifications that must be considered when

evaluating an accountant for such purpose.

Last, the Commission is proposing to require a public accountant to

state in the audit opinion whether the audit was conducted in

accordance with U.S. generally accepted auditing standards after full

consideration of the auditing standards adopted by the PCAOB.

Benefits

By requiring accountants to be registered with PCAOB and to have

undergone at least one examination by the same, the proposed rule would

help to ensure that the accountant is qualified to audit publicly

traded companies, which are often more complex than those that are

privately held. As a consequence, the proposed requirement would

promote selection of accounting firms that are more sophisticated and

experienced than would necessarily be the case in the absence of the

proposed amendment, which would help to ensure that the accountant is

large enough to maintain independence in its examination and has

adequate experience to deal with the unique aspects of an FCM's

business model, operational processes, and financial records.

Requiring the FCM's board to evaluate and approve accountants

conducting audits for the FCM would tend to enhance protection of

customer funds by increasing accountability among the board for any

errors resulting from an accountant's lack of relevant experience.

Consequently, the requirement would incent the board to choose auditors

carefully, or to provide diligent oversight as senior management makes

such selections. This would promote selection of highly qualified

accountants, which would help to ensure that audits are as effective as

possible in identifying problems with operational controls, potential

indications of fraud, or other warning signs that could enable senior

[[Page 67912]]

management and the Commission or DSRO to protect customer funds more

effectively.

Costs

The Commission anticipates that auditors that are registered with

the PCAOB and that have undergone at least one examination by the PCAOB

are likely to charge more for audits, than those that do not have those

qualifications. However, the Commission does not have adequate

information to estimate the difference in costs.

Request for Comment

Question 6: The Commission requests comment regarding the cost of

audits for an FCM. Specifically, what is the range of costs and average

cost of an audit conducted by auditors with the credentials required in

the proposed rule? What is the range of costs and the average cost of

an audit conducted by auditors without such qualifications?

Sec. 1.17 Minimum Financial Requirements for Futures Commission

Merchants And Introducing Brokers \123\

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\123\ CEA 4(d)(2), referenced in Sec. 1.17, states, ``It shall

be unlawful for any person, including but not limited to any

clearing agency of a contract market or derivatives transaction

execution facility and any depository, that has received any money,

securities, or property for deposit in a separate account as

provided in paragraph (2) of this section, to hold, dispose of, or

use any such money, securities, or property as belonging to the

depositing futures commission merchant or any person other than the

customers of such futures commission merchant.''

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Proposed Changes

As described in the section by section discussion at II.F, the

Commission is proposing to amend Sec. 1.17 by adding a new provision

that will authorize the Commission to require an FCM to cease operating

as an FCM and transfer its customer accounts if the FCM is not able to

certify and demonstrate sufficient access to liquidity to continue

operating as a going concern.

In addition, FCMs that are dual registrants (FCM and BD) are

allowed to use the Securities and Exchange Commission's broker-dealer

approach \124\ to evaluating the credit risk of securities that the FCM

invests in and assigning smaller haircuts \125\ to those that are

deemed to be a low credit risk, should the SEC adopt as final its

proposed rule to eliminate references to credit ratings. The proposed

change to Sec. 17(c)(5)(v) would allow FCMs that are not dual

registrants to use the same approach. Reducing the haircut assigned to

low credit risk securities that the FCM invests in (which would

potentially include some investments compliant with the requirements of

Sec. 1.25), reduces the capital charge that the FCM must take for

investing in those securities.

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\124\ As stated above in II.F above, under the SEC proposal, a

BD may impose the default haircuts of 15 percent of the market value

of readily marketable commercial paper, convertible debt, and

nonconvertible debt instruments or 100 percent of the market value

of nonmarketable commercial paper, convertible debt, and

nonconvertible debt instruments. A BD, however, may impose lower

haircut percentages for commercial paper, convertible debt, and

nonconvertible debt instruments that are readily marketable, if the

BD determines that the investments have only a minimal amount of

credit risk pursuant to its written policies and procedures designed

to assess the credit and liquidity risks applicable to a security. A

BD that maintains written policies and procedures and determines

that the credit risk of a security is minimal is permitted under the

SEC proposal to apply the lesser haircut requirement currently

specified in the SEC capital rule for commercial paper (i.e.,

between zero and \1/2\ of 1 percent), nonconvertible debt (i.e.,

between 2 percent and 9 percent), and preferred stock (i.e., 10

percent).

\125\ As stated above in II.F, in computing its adjusted net

capital, an FCM is required to reduce the value of proprietary

futures and securities positions included in its liquid assets by

certain prescribed amounts or percentages of the market value

(otherwise known as ``haircuts'') to discount for potential adverse

market movements in the securities.

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Last, the proposed amendments would change the period of time that

an FCM can wait for margin payments from a customer before taking a

capital charge from three days to one day.

Benefits

As discussed in II.F, an FCM's ability to meet capital requirements

and segregation requirements is not necessarily a sufficient indicator

of the FCM's continued viability as a going concern. If an FCM does not

have access to liquidity to meet identifiable, imminent financial

obligations, the FCM will likely default, regardless of the amount of

capital that is recognized on its balance sheet. In such circumstances,

transferring customer positions to another FCM before the current FCM

enters into bankruptcy provides additional protection to customer

funds. Once the FCM enters into bankruptcy, the transfer of customer

positions may be slowed by the trustee's involvement, which could

interrupt customers' ability to actively manage those positions. In

addition, if the FCM enters into bankruptcy before transferring

customers' positions, customer segregated funds may be subject to

trustee fees. Transferring the positions before the FCM enters into

bankruptcy, therefore, provides additional protection to customers by

preserving their ability to continuously manage their accounts and by

protecting their funds from being subject to trustee fees.

By allowing FCMs that are not dual registrants to follow the same

rules as those that are dual registrants, the change would harmonize

the regulation of FCMs with respect to minimal financial requirements.

This would place FCMs that are not dual registrants on a level playing

field with those that are dual registrants, which contributes to the

competitiveness of the financial markets.

In Sec. 1.17(c)(5)(viii), the Commission proposes to reduce the

period of time an FCM can wait to receive margin call payments from

customers before taking a capital charge, which will incent FCMs to

exercise increased diligence when seeking such payments, and therefore

will likely prompt customers to provide such payments more quickly. As

a consequence, the risk that a debit balance could develop in a

customer's account due to tardy margin call payments would be reduced,

and the amount of residual interest that the FCM would need to maintain

in the segregated accounts in order to protect against the possibility

that such debit balances could cause them to have less that is required

in their segregated accounts would also be reduced. This provides

benefits for the FCM by reducing the amount of capital that it must

contribute to the customer segregated accounts, and for customers, by

promoting more rapid margin call payments from other customers to

support their own positions.

Costs

With respect to costs, the proposed amendment Sec. 1.17(a)(4),

allowing the Commission to require an FCM to transfer its customer

positions if the FCM is not able to immediately certify that its

liquidity is adequate to continue as a going concern, would give the

Commission the authority to force the FCM to transfer its customer

positions to another FCM in such circumstances. This could create

additional costs for the FCM in two different ways. First, it is

possible that while the FCM may not be able to immediately certify that

it has sufficient liquidity to continue as a going concern but may

nevertheless obtain sufficient liquidity before its impending

obligations become due. If the FCM is forced to transfer its positions

before it obtains the liquidity necessary to demonstrate that it may

continue as a going concern, the FCM will have lost its FCM business.

Second, if the FCM is working on obtaining sufficient liquidity to

continue as a going concern, it may be able to obtain such liquidity

under more favorable terms if it has time to consider multiple offers.

However, if the FCM has a

[[Page 67913]]

shortened timeline to consider offers before being forced to transfer

its customer positions to another FCM, it may be forced to accept an

offer that is less attractive than what otherwise would have been the

case.

Regarding the proposed amendment to Sec. 1.17(c)(5)(v) changing

the haircutting procedures for FCMs, lowering the amount of capital

that the FCM must hold reduces the buffer it has to absorb any losses

that result from its own investments. However, the Commission proposes

that even in the absence of the amendment proposed here dual

registrants will be able to use the SEC's haircutting procedure.

Therefore, only FCMs that are not dual registrants would be impacted by

the proposed change to Sec. 1.17. Moreover, the Commission proposes

that FCMs that are not dual registrants do not typically invest in

securities that would be subject to reduced haircuts under the SEC's

proposed rules, and therefore the change would not have a significant

impact on the capital requirements for such FCMs.

Reducing the period of time FCMs can wait for customers' margin

call payments before taking a capital charge may increase the capital

charge that FCMs take due to tardy margin call payments. As a

consequence, proposed Sec. 1.17(c)(5)(viii) would likely force FCMs to

hold more capital, or to more diligently collect margin from customers

on a prompt basis. The Commission does not have adequate information to

estimate the amount of additional capital that FCMs would likely be

required to hold, or the cost of that capital, and therefore is not

able to quantify this cost at this time.

Request for Comment

Question 7: The Commission requests comment regarding whether FCMs

that are not dual registrants typically invest in securities that would

be subject to reduced haircutting procedures under the SEC's proposed

rules. If an FCM would be subject to reduced haircutting, please

quantify the effect that such investments are likely to have on the

capital requirements for such FCM.

Question 8: In addition, the Commission requests information that

would assist it in quantifying the costs and benefits associated with

reducing the number of days an FCM can wait for margin call payments

before taking a capital charge. Specifically, how much margin is

typically owed by those customers?

Question 9: The Commission also requests comment regarding the

amount of additional capital that FCMs would likely be required to hold

and the average cost of capital for an FCM. In addition, please provide

data and calculations that would enable the Commission to replicate and

validate the estimates you provide.

Sec. 1.20 Futures Customer Funds To Be Segregated and Separately

Accounted for

Proposed Changes

As described in the section by section discussion at II.G, the

proposed amendments to Sec. 1.20 reorganize the section, but also

alter the substance of the section's requirements in certain places.

Proposed Sec. 1.20 includes a new Appendix A which is a template

for the acknowledgment letter that FCMs and DCOs must obtain from their

depositories. The proposed changes would require FCMs and DCOs to use

the letter in Appendix A to provide the acknowledgment that they must

obtain, and to clarify that the acknowledgment letter must be obtained

before depositing any funds with a depository. The proposed amendments

to Sec. 1.20 also requires FCMs and DCOs file the acknowledgment

letter with the Commission promptly, and to update the acknowledgment

letter whenever there are changes to the business name, address, or

account numbers referenced in the letter. Last, proposed Sec. 1.20

requires that customer funds deposited at a bank or trust company must

be available for immediate withdrawal upon demand by the FCM or DCO,

which effectively prevents them from placing funds into time-deposit

accounts with depositories.

Benefits

Proposed Sec. 1.20(d)(2) would require that FCMs and DCOs use the

template in Appendix A when obtaining written acknowledgments from

their depositories holding futures customer funds. Through this change

would require depositories accepting customer funds to: (1) Recognize

that the funds are customer segregated funds subject to the Act and

CFTC regulations; (2) agree not to use the funds to secure any

obligation of the FCM to the depository; (3) agree to allow the CFTC

and the FCM's SRO to examine accounts at any reasonable time; (4) agree

to provide CFTC and SRO user login to have read-only access to

segregated accounts 24 hours a day; (5) and agree to release funds in

segregated accounts when instructed to do so by an appropriate officer

of FCM, the Director of DSIO, or the Director of DCR.

These acknowledgments and commitments would result in important

benefits. First, by acknowledging that the funds are subject to the Act

and CFTC regulations, the depository would become accountable for

complying with relevant statutory and regulatory requirements related

to its handling of those funds. Second, the depository would

acknowledge that the FCM is not permitted to use customer funds as

belonging to any person other than the customer which deposited them,

which would also prohibit an FCM from using customer funds to secure

its own obligations. By requiring the FCM or DCO to obtain a statement

from depositories holding customer funds acknowledging these

limitations on use, the proposed rule would ensure that each depository

is aware that the customers' funds cannot be used to secure the FCM's

obligations to the depository. Third, the letter constitutes written

permission by the depository to allow CFTC or DSRO officials to examine

the FCM's customer accounts at any reasonable time, and to view the

those accounts online at any time. As a consequence, the letter would

enable both the Commission and the DSRO to monitor actual balances at

the depository more easily and regularly. This would increase the

probability that any discrepancy between balances reported by the FCM

on its daily customer segregation account reports, and balances

actually held by the depository would be identified quickly by the

Commission or the DSRO. Moreover, with standing authorization from the

depository to examine customer segregated accounts, both the Commission

and DSRO would be better able to move quickly to verify that there is a

problem.

The commitment to distribute funds when directed to do so by the

Director of DSIO, the Director of DCR, or appropriate officials of the

DSRO facilitates the immediate movement of customer funds, and avoids

delay in the release such funds which expedites to the transfer the

customers' positions or to return the customers' funds without delay.

The acknowledgment letter also provides some assurances to the

depository, namely, that it is not liable to the FCM for following

instructions to distribute funds from customer segregated accounts at

the direction of the Director of DSIO or the Director of DCR and that

the depository is not responsible for the FCM's compliance with the Act

or Commission regulations beyond what is expressly stated in this

letter. The letter places depositories holding customer funds on notice

that they must release customer funds without delay when directed to do

so by

[[Page 67914]]

the Director of DSIO or the Director of DCR. The assurance that the FCM

will not hold the depository liable for following instructions from the

Director of DSIO or of DCR should reduce this potential cause for delay

in time-critical situations. Moreover, under the proposed amendments,

depositories must sign the acknowledgment letter in Appendix A in order

to receive funds from an FCM or DCO. If some depositories were not

willing to sign the letter, it would reduce the number of available

depositories for FCMs and DCOs and may force them to move some existing

depository accounts.

The benefit of requiring FCMs and DCOs to obtain an acknowledgment

letter from their depository prior to or contemporaneously with

transferring any customer funds to that depository is that it ensures

that all the protections provided for by the depository's consent to

the terms of the letter are in place for the full time during which a

depository holds customer segregated funds. In other words, it prevents

the possibility of a gap in the protections created by the requirements

of this section.

By requiring FCMs and DCOs to submit the acknowledgment letters,

signed by their depositories, to both the Commission and the relevant

SRO, the proposed rules should make it easier for the Commission or

relevant SRO to act quickly, when necessary, being confident that the

correct legal permissions are in place. Additionally, requiring the

letters to be retained for five years past the time when customer

segregated funds are no longer held by each depository would ensure

that proper documentation of all relevant acknowledgments and

commitments is in the possession of each party that relies upon the

existence of those commitments in order to effectuate the protections

created by this section.

Last, Sec. 1.12(h) requires that funds deposited by an FCM be

available for immediate withdrawal. If an FCM places customer funds in

time-deposit accounts the depository has the contractual right to

require a period of notice from the FCM before distributing funds at

the FCM's request. Under the proposed regulation, a period of notice

would not be acceptable given the obligation that the FCM has to return

customer funds to customers upon request. Moreover, placing funds in a

time-deposit account could prevent the DCO, Commission, or Trustee from

being able to effect the immediate movement of customer funds if

required to do so in the event of a default by the FCM. Requiring that

funds be available for immediate withdrawal at the request of the FCM

ensures prompt access to customer funds by all concerned.

Prohibiting FCMs from placing customer funds in time-deposit

accounts would codify a long-standing staff interpretation that

prohibits FCM's from placing customer funds in such accounts.\126\ The

interpretation and proposed amendment prohibit such deposits because

time-deposit accounts, by law, must retain the right to a certain

number of days advance notice before allowing a customer to withdrawal

funds. This delay could prevent an FCM from returning all customer

funds in a prompt manner if those customers all demanded their funds

and could prevent the DCO from porting open positions to another FCM in

the event that the FCM currently holding those funds defaulted. The

benefits of codifying the current staff interpretation are that it will

provide additional clarity about the legal force of the requirement,

and will put the requirement in a location where relevant market

participants are much more likely to see it, which reduces the

likelihood that FCMs would violate this prohibition unknowingly.

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\126\ See Administrative Determination No. 29 of the Commodity

Exchange Administration dated Sept. 28, 1937 stating, ``the deposit,

by a futures commission merchant, of customers' funds * * * under

conditions whereby such funds would not be subject to withdrawal

upon demand would be repugnant to the spirit and purpose of the

Commodity Exchange Act. All funds deposited in a bank should in all

cases by subject to withdrawal on demand.''

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Costs

FCMs and DCOs are likely to bear some initial and ongoing costs as

a result of the proposed amendment requiring them to use the template

in Appendix A to obtain the acknowledgment letter from their

depositories. Regarding initial costs, the letter includes new

requirements that existing depositories want to discuss with the FCM or

DCO's staff. In addition, some existing depositories may not be willing

to sign the new letter, which would force the FCM or DCO to move any

customer funds held by that depository to a different depository,

creating certain due diligence and operational costs. The Commission

estimates that the cost of obtaining a new acknowledgment letter from

each existing depository is between $1,300 and $4,200.\127\ Based on

conversations with industry participants, the Commission estimates that

FCMs and DCOs would have approximately 1-30 depositories each, from

which they must obtain a new acknowledgment letter. Therefore, the

Commission estimates that the cost of obtaining new acknowledgment

letters from existing depositories is between $2,700 and $82,000 per

FCM or DCO.\128\ In addition, based on conversations with industry

participants, the Commission estimates that identifying new potential

depositories, conducting necessary due diligence, formalizing necessary

agreements, opening accounts, and transferring funds to a new

depository is likely to take between three to six months and is likely

to require support from compliance attorneys, as well as operations,

risk management, and administrative personnel. The Commission estimates

that the cost of moving accounts from an existing depository that is

not willing to sign the letter is between $50,000 and $102,000.\129\

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\127\ This estimate assumes 10-40 hours of time from a

compliance attorney and 10-20 hours from an office services

supervisor. The average compensation for a compliance attorney is

$85.35/hour [$131,303 per year/(2000 hours per year)*1.3 is $85.35

per hour]; $85.35*10 = $853.47 and $85.35*40 = $3,413.88. The

average compensation for an office services supervisor is $40.15/

hour [$61,776.00 per year/(2000 hours per year)*1.3 is $40.15 per

hour]; $40.15*10 = $401.54 and $40.15*20 = $803.09. These figures

are taken from the 2011 SIFMA Report on Management and Professional

Earnings in the Securities Industry.

\128\ Total figures are taken from previous calculation.

($1,255.01+$4,216.97)/2 = $2,735.99; $2,735.99*1 = $2,735.99 and

$2,735.99*30 = $82,079.69.

\129\ This estimate assumes one compliance attorney working

full-time for 3-6 months, 50-200 hours from an office services

supervisor, 80-160 hours of time from a risk management specialist,

and 40-60 hours from an intermediate accountant. The average

compensation for a compliance attorney is $85.35/hour [$131,303 per

year/(2000 hours per year)*1.3 is $85.35 per hour]; $85.35*40 hours/

week*4 weeks/month*3 months = $40,966.54 and $85.35*40 hours/week*4

weeks/month*6 months = $81,933.07. The average compensation for an

office services supervisor is $40.15/hour [$61,776.00 per year/(2000

hours per year)*1.3 is $40.15 per hour]; $40.15*50 = $2,007.72 and

$40.15*200 = $8,030.88. The average compensation for a risk

management specialist is $65.33/hour [$100,500 per year/(2000 hours

per year)*1.3 is $65.33 per hour]; $65.33*80 = $5,226.00 and

$268.84*160 = $10,452.00. The average compensation for an

intermediate accountant is $34.11/hour [$52,484.00 per year/(2000

hours per year)*1.3 is $34.11 per hour]; $34.11*40 = $1,364.58 and

$34.11*60 = $2,046.88. These figures are taken from the 2011 SIFMA

Report on Management and Professional Earnings in the Securities

Industry.

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Ongoing costs include those created by the additional requirements

the FCM or DCO will have to explain to new depositories when obtaining

the required letter. There may be additional operational costs involved

with monitoring depositories for any change that would necessitate

updating the letter. The per-entity cost of obtaining the letter from

new depositories is likely to be the same as it would for obtaining the

letter from existing depositories (i.e.,

[[Page 67915]]

$1,300 and $4,200). The Commission estimates that the ongoing cost

associated with monitoring for changes that would require the

acknowledgement letter to be updated is between $1,100 and $2,800 per

year.\130\

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\130\ This assumes 20-50 hours per year from an office manager

for monitoring costs. The average compensation for an office manager

is $55.82/hour [$85,875 per year/(2000 hours per year)*1.3 = $55.82/

hour]; $55.82*20 = $1,116.38 and $55.82*50 = $2,790.94. This figure

is taken from the 2011 SIFMA Report on Management and Professional

Earnings in the Securities Industry.

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The proposed requirement, embedded in the acknowledgment letter,

that depositories provide to the Commission and DSRO online, read-only

access to accounts where customer segregated funds are held, would

create certain costs for depositories that would likely be passed onto

FCMs. The NFA Board of Directors recently approved rule amendments that

will require FCMs to provide their respective DSROs with on-line view-

only access to customer segregated/secured amount bank account

information. NFA has submitted the rule amendments to the Commission

for approval.\131\ Therefore, the pending NFA rule and the Commission's

proposed requirement would require banks and trust companies to provide

the Commission and the DSROs with the same read-only access to account

information. The Commission estimates that the cost of this additional

access is between $270 and $540 per account.\132\

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\131\ A copy of the NFA rule submission is available on the NFA

Web site, www.nfa.futures.org.

\132\ This assumes 4-8 hours per account from a senior database

administrator. The average compensation for a senior database

administrator is $$68.09/hour [$104,755 per year/(2000 hours per

year)*1.3 = $68.09/hour]; $68.09*4 hour = $272.36 and $68.09/hour *8

hours = $554.73. This figure is taken from the 2011 SIFMA Report on

Management and Professional Earnings in the Securities Industry.

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For all other depositories, the Commission believes that providing

access read-only access to balances and transactions in cash accounts

is possible with existing technology and therefore, for depositories

that already provide such access to their customers, the cost of

providing that access to the Commission and DSRO is likely to be

relatively low. Based on conversations with industry participants, the

Commission estimates that on average an FCM or DCO is likely to have

approximately 5-30 accounts. The Commission estimates that the initial

set-up cost of providing access to each account at depositories that

already provide online access to their customers is approximately $270

and $550 per account.\133\

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\133\ This assumes 4-8 hours per account from a senior database

administrator. The average compensation for a senior database

administrator is $$68.09/hour [ $104,755 per year/(2000 hours per

year)*1.3 = $68.09/hour]; $68.09*4 hour = $272.36 and $68.09/hour *8

hours = $554.73. This figure is taken from the 2011 SIFMA Report on

Management and Professional Earnings in the Securities Industry.

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On the other hand, for depositories that do not currently provide

such access to their customers, setting up the capability to provide it

to the Commission and DSRO will require that the depository implement

additional technology. The Commission does not have adequate data to

estimate the cost for establishing such a system.

The Commission proposes that the requirement embedded in the

acknowledgment letter that depositories consent to release customer

funds whenever requested to do so by the Director of DCR or Director of

DSIO will not create any additional costs for FCMs, depositories, or

market participants.

The Commission does not anticipate any costs associated with

proposed Sec. 1.20(h) prohibiting an FCM from placing customer funds

in time-deposit accounts since it is codifying a current staff

interpretation and FCMs already abide by this standard.

The remaining requirements in proposed Sec. 1.20 are virtually

identical to those in the existing rule, but are reorganized in order

to improve readability. The changes that are merely the result of

reorganizing identical requirements do not result in any costs for

market participants.

Request for Comment

Question 10: The Commission requests data from which to estimate

the initial and ongoing costs for a depository to establish the

capability to provide read-only access to account balances and

transaction history.

Question 11: The Commission requests comment from the public

regarding the initial and ongoing cost of services provided by vendors

that have the ability to provide regular confirmation of balances at

depositories on both a scheduled and unscheduled basis. Also, would

such services be applicable to custodial accounts, and accounts held at

non-bank depositories (e.g. other FCMs or Money Market Mutual Funds)?

Question 12: The Commission requests comment regarding whether

depositories currently have systems that provide their customers with

continuous read-only access to accounts where securities are held that

provide: (1) Real time or end of day balances for each segregated

account; and (2) descriptions of the types of assets contained in each

account with balances associated with each type of asset. How do the

capabilities of systems that provide continuous read-only access to

customers vary across different types of depositories, foreign or

domestic (i.e. banks, FCMs, DCOs, or Money Market Mutual Funds)?

Question 13: If depositories do not currently have the ability to

provide continuous read-only access to accounts holding customer funds

that display transactions and balances for those accounts, what costs

would be required in order to create such a system?

Question 14: The Commission assumes that the costs and benefits

enumerated above capture the range of costs and benefits that would be

experienced by each type of depository. The Commission requests comment

and quantification regarding any additional costs or benefits that

would be experienced by certain types of depositories such FCMs, bank

and trust companies, depositories of an international affiliate.

Sec. 1.22 Use of Customer Funds Restricted

Proposed Changes

As described in the section by section discussion at II.H, the

Commission recently approved amendments to the definition of the term

``commodity and/or options customer.'' \134\ In order to retain the

meaning of the term ``commodity and/or options customer'' as it was

originally defined, the Commission is replacing the term with ``futures

customer.'' As above, the new term has the same meaning as the original

definition of the term that it is replacing, and therefore there are no

costs or benefits associated with this change.

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\134\ The final rulemaking is available on the Commission's Web

site, www.cftc.gov.

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In addition, the proposed amendments to 1.22 clarify that the

prohibition against use of a futures customer's funds to extend credit

to, or to purchase, margin, or settle the contracts of another person

applies at all times. Last, the proposed amendments would clarify that

in order to comply with the prohibition against using one customer's

funds to ``purchase, margin, or settle the trades, contracts, or

commodity options of, or to secure or extend the credit'' \135\ of any

other

[[Page 67916]]

person, the FCM would be required to ensure that its residual interest

in futures customer funds exceeds the sum of all its futures customer

margin deficits.

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\135\ See proposed Sec. 1.22. N.B., the current form of Sec.

1.22 also includes a prohibition against using one customer's funds

to ``to purchase, margin, or settle the trades, contracts, or

commodity options of, or to secure or extend the credit of, any

person other than such customer or commodity option customer.''

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Benefits

The benefit of the proposal is that it protects customer funds by

requiring continual customer segregation balancing thereby avoiding the

potential that an FCM could employ end-of-day balancing to obscure a

shortfall the FCM experienced in the middle of the day.

Under current regulations it is not permitted for an FCM to use one

customer's funds to purchase, margin, secure or settle positions for

another customer. However, the current regulations do not specify how

FCMs must comply with this requirement. The proposed rule would specify

that FCMs must maintain residual interest in customer segregated

accounts that is larger than the sum of all customer margin deficits,

which would ensure that the FCM is not using one customer's funds to

purchase, margin, secure, or settle positions for another customer.

Furthermore, when combined with the reporting requirements in

Sec. Sec. 1.10, 1.32, 22.2, and 30.7, which require the FCM to report

both the sum of their customer margin deficits as well as their

residual interest in customer segregated accounts, the proposed

approach would provide the Commission and the public with sufficient

information to verify that FCMs are not using one customer's funds to

purchase, margin, secure or settle positions for another customer.

Costs

If the sum of an FCM's customer margin deficits is greater than the

residual interest an FCM typically maintains in their customer

accounts, then the FCM would have to increase the amount of residual

interest it maintains in customer segregated accounts, which would

reduce the range of investment options the FCM has for those additional

funds and may prompt the FCM to maintain additional capital to meet

operational needs. On the other hand, if an FCM typically maintains

residual interest in customer segregated accounts that is greater than

the sum of their customer margin deficits, then the proposed rule would

not create any additional costs. In the past, the Commission has not

required FCMs to report the sum of their customers' margin deficits.

Therefore, the Commission does not have adequate information to

determine whether FCMs typically hold residual interest that is greater

than the sum of their customers' margin deficits and cannot estimate

the cost of the proposed rule.

Request for Comment

Question 15: The Commission requests comment regarding whether FCMs

typically maintain residual interest in their customer segregated

accounts that is greater than the sum of their customer margin

deficits, and data from which the Commission may quantify the average

difference between the amount of residual interest an FCM maintains in

customer segregated accounts and the sum of customer margin deficit.

Question 16: How much additional residual interest would FCMs hold

in their customer segregated accounts in order to comply with the

proposed regulation? What is the opportunity cost to FCMs associated

with increasing the amount of capital FCMs place in residual interest,

and data that would allow the Commission to replicate and verify the

calculated estimates provided.

Question 17: The Commission request information regarding the

additional amount of capital that FCMs would likely maintain in their

customer segregated accounts, if any, to comply with the proposed

regulation. What is the average cost of capital for an FCM? Please

provide data and calculations that would allow the Commission to

replicate and verify the cost of capital that you estimate?

Sec. 1.23 Interest of Futures Commission Merchants in Segregated

Funds; Additions and Withdrawals

Proposed Changes

As described in the section by section discussion at II.I, the

proposed text changes the term ``customer funds'' to ``futures customer

funds.'' This is a conforming change in order to retain the same

meaning once the term ``customer'' is redefined in Sec. 1.3.\136\ The

Commission anticipates that there are no costs or benefits associated

with this change.

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\136\ The Commission recently approved final amendments to Sec.

1.3 that revised the definition of the term ``customer'' to include

commodity customers, options customers, and swap customers. A copy

of the Federal Register release is available on the Commission's Web

site, www.cftc.gov.

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The proposed Sec. 1.23 also places new restrictions regarding an

FCM's withdrawal of residual interest funds for proprietary use. Under

the proposed Sec. 1.23, an FCM cannot withdraw funds for proprietary

use unless they have prepared the daily segregation calculation from

the previous business day and must adjust for any activity or events

that may have decreased residual interest since close of business the

previous day. In addition, an FCM is only permitted to withdrawal more

than 25% of its residual interest for proprietary use within one day if

it: (1) Obtains a signature from the CEO, CFO or other senior official

as described in Sec. 1.23(c)(1) confirming approval to make such a

withdrawal; and (2) sends written notice to the CFTC and DSRO

indicating that the requisite approvals from the CEO, CFO or other

senior official has been obtained, providing reasons for the

withdrawal, listing the names and amounts of funds provided to each

recipient, and providing an affirmation from the signatory indicating

that he or she has knowledge and reasonable belief that the FCM is

still in compliance with segregation requirements after the withdrawal.

In addition, if the FCM drops below its target threshold for

residual interest because of a withdrawal of residual interest for

proprietary use, the next day it must either replenish residual

interest enough to surpass its target, or if senior leadership believes

the original target is excessive, the FCM may revise its target in

accordance with its policies and procedures established in proposed

Sec. 1.11.

Benefits

The proposed restrictions on withdrawals of residual interest

provide an additional layer of protection for customer funds contained

in segregated accounts. An FCM may withdraw residual interest as long

as it always maintains sufficient FCM funds in the account to cover any

shortfall that exists in all of its customers' segregated accounts.

However, as a practical matter, the segregation requirements fluctuate

constantly with market movements, and customer surpluses or deficits

also fluctuate depending on the speed with which customers meet margin

calls. As a consequence, an FCM is not expected to have a precise,

real-time knowledge of the amount of residual interest it has in a

segregated account. The Commission recognizes that any precise, real-

time, single calculation would almost immediately become obsolete as

the value of customers' accounts and their obligations to the FCM

continue to fluctuate. Moreover, a sufficient amount of residual

interest to cover deficiencies in customers' accounts at one point in

time may be inadequate to cover such deficiencies an hour later, or

even a few minutes later. Therefore, it is important

[[Page 67917]]

for an FCM to maintain sufficient residual interest to cover both

current deficiencies in customer accounts as well as any additional

deficiencies that could develop over a relatively short period of time.

Restrictions on withdrawals of residual interest help to ensure that

the FCM does not withdraw too much residual interest, either knowingly

or unknowingly, and jeopardize customer funds in the segregated

account.

Prohibiting any withdrawal of residual interest until the customer

segregation account calculations are complete for the previous day and

requiring the FCM take into account any subsequent developments in the

market or the account that could impact the amount of residual interest

before withdrawing funds protects customer funds by reducing the

likelihood that lack of current information could cause the FCM to make

a withdrawal from customer funds that is large enough to cause the

account to fall below its segregated funds requirement.

In addition, the proposed amendment would require several steps in

order for an FCM to remove more than 25% of their residual interest in

a single day. Large, single-day withdrawals of the FCM's residual

interest in the customer segregated account could be an indication of

current or impending capital or liquidity strains at the FCM. The

additional steps ensure that senior management is knowledgeable of and

accountable for such withdrawals, that no shortfall in the customer

segregated accounts is created by the withdrawals and that the CFTC and

DSRO are both alerted and can monitor the FCM and its segregated

accounts closely over subsequent days and weeks. Additional monitoring,

in turn, would help to ensure that the integrity and sufficiency of the

FCM's customer segregated accounts are carefully protected. In

addition, notifying the CFTC and DSRO gives both an opportunity to ask

questions about the FCM's reasonable reliance on its estimations of the

adequacy of its funds necessary to meet segregation requirements. Such

questions may give the Commission and DSRO comfort that the transaction

does not indicate any strain on the FCMs financial position, or

conversely, may raise additional questions and alert the CFTC and DSRO

to the need for heightened monitoring of the FCM or further

investigation of its activities. Also, while the proposed regulations

would reduce the risk that customer funds could be missing in the event

of an FCM's bankruptcy, the proposed rule would establish a second

layer of protection by ensuring that the Commission has records

regarding the name and address of parties receiving funds from the

distribution of residual interest.

In addition, requiring an FCM to replenish its residual funds the

following day any time a withdrawal causes it to drop below the FCM's

target amount helps to ensure that residual interest is not used by the

firm to address liquidity needs in other parts of the firm unless those

needs are very short-term in nature (i.e., less than 24 hours).

Costs

These procedural requirements will create some costs for FCMs.

Restricting an FCMs ability to withdraw residual interest until daily

calculations have been completed may prevent the FCM from withdrawing

funds quickly in order to meet certain operational needs, or to take

advantage of specific investment opportunities. This restriction may

also force the FCM to hold additional capital in order to reduce the

potential that it would need funds from its residual interest in order

to meet any operational needs. The Commission does not have adequate

information to estimate the amount of additional capital that an FCM

might be likely to hold, or the cost of capital for those funds.

Moreover, calculating the opportunity cost for an FCM's potential

missed opportunities is not possible since, by definition, they depend

on the alternative opportunities available to the FCM and the

Commission does not have adequate information to determine what those

opportunities might be.

In addition, abiding by the procedures for withdrawals of residual

interest for proprietary use, whether the withdrawals are less than or

greater than 25% of the FCM's residual interest, would create

operational costs as these percentages must be calculated and requisite

permissions will require time to obtain. The additional cost created by

procedures that are required for additional withdrawals below 25% of

the FCM's residual interest will depend significantly on the procedures

the FCM develops, and the extent to which the FCM has already

implemented similar procedures. The Commission does not have adequate

information to estimate these incremental costs. If an FCM withdraws

more than 25% in a given day they have to get certain signatures and

have to send a notification to the Commission. It is also likely that

the Commission would follow up with questions about the withdrawal. The

Commission proposes that obtaining the necessary signatures, reviewing

the notification sent to the Commission, and conducting any follow-up

conversations would require time from an attorney and office staff

personnel. Therefore, the Commission estimates that the additional cost

to an FCM for complying with procedures to withdraw 25% or more of

their residual interest in a single day is likely to be between $850

and $1,100 each time an FCM needs to make such withdrawals.\137\

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\137\ This assumes 6-8 hours of a compliance attorney's time and

6-8 hours of an office manager's time. The average compensation for

a compliance attorney is $85.35/hour [$131,303 per year/(2000 hours

per year)*1.3 is $85.35 per hour]; $85.35*6 = $512.08 and $85.35*8 =

$682.78. The average compensation for an office manager is $55.82/

hour [$85,875 per year/(2000 hours per year)*1.3 = $55.82/hour];

$55.82*6 = $334.91 and $55.82*8 = $446.55. These figures are taken

from the 2011 SIFMA Report on Management and Professional Earnings

in the Securities Industry.

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Request for Comment

Question 18: The Commission invites comment regarding the amount of

additional capital that FCMs would likely hold because of restrictions

on their ability to withdraw residual interest and the cost of capital

for those funds.

Question 19: In addition, the Commission requests comment regarding

the extent to which FCMs already have procedures in place that would

satisfy the requirements in Sec. Sec. 1.11 and 1.23 regarding

withdrawals of residual interest. For an FCM that do not have such

procedures in place already, please quantify the additional cost that

the FCM will bear as a consequence of complying with any policies and

procedures it may develop and implement in order to satisfy the

requirements of Sec. Sec. 1.11 and 1.23 with respect to withdrawals of

residual interest.

Sec. 1.25 Investment of Customer Funds

Proposed Changes

As described in the section by section discussion at II.J, Sec.

1.25 permits FCMs and DCOs to use customer funds to purchase securities

from a counterparty under an agreement for the resale of the securities

back to the counterparty. This type of transaction is often referred to

as a ``repo,'' and in effect, is a collateralized loan by the FCM to

its counterparty. Currently, Sec. 1.25(b)(3)(v) establishes a

counterparty concentration limit, prohibiting FCMs and DCOs from using

more than 25% of the total funds in the customer segregated account to

conduct reverse repos with a single counterparty. The proposed

amendment would expand the definition of a counterparty to include

additional entities under common ownership or control. The proposed

amendment

[[Page 67918]]

incorporates the Commission's interpretation of the existing rule, and

therefore does not alter its meaning. Therefore, the Commission does

not anticipate that the proposed amendment will create any costs or

benefits.

The additional proposed changes to Sec. 1.25 are conforming

amendments proposed in order to harmonize this section with other

amendments proposed in this release, and therefore do not create any

additional costs or benefits.

Sec. 1.26 Deposit of Instruments Purchased With Customer Funds

Proposed Changes

As described in the section by section discussion at II.K, proposed

Sec. 1.26 would change the term ``commodity or option customers'' to

``futures customers.'' This is a conforming change in order to retain

the same meaning once the term ``customer'' is redefined in Sec. 1.3.

In addition, the other changes proposed for Sec. 1.26(a-b) require

that FCMs and DCOs obtain a written acknowledgment letter from

depositories in accordance with the requirements established in Sec.

1.20. This change introduces significant additional specificity

regarding the timing and content of the letter that FCMs and DCOs must

obtain from their depositories. The specifics of those requirements, as

well as the costs and benefits of them, are detailed in the discussion

of costs and benefits for Sec. 1.20, discussed in the cost benefit

considerations section related to Sec. 1.20.

If, however, an FCM or DCO invests funds with a money market mutual

fund and those funds are held directly by the money market mutual fund

or its affiliate, then the FCM or DCO must use the acknowledgment

letter proposed in Appendix A of Sec. 1.26 rather than the

acknowledgment letters in the appendices of Sec. 1.20. The content of

the letter in Sec. 1.26 is identical to those in Sec. 1.20 except

that it includes three additional provisions related specifically to

funds held by the money market mutual fund or its affiliate (``MMMF'').

Specifically, it requires that: (1) the value of the fund must be

computed and made available to the FCM or DCO by 9:00 a.m. of the

following business day; (2) that the fund must be legally obligated to

redeem shares and make payments to its customers (i.e. the FCM or DCO)

by the following business day; and (3) the money market mutual fund

does not have any agreements in place that would prevent the FCM or DCO

from pledging or transferring fund shares.

Benefits

The benefits are largely the same as for the acknowledgment letters

required in Sec. 1.20, described above in the cost benefit section

related to Sec. 1.20. However, requiring FCMs and DCOs to have Money

Market Mutual Funds (``MMMFs'') sign a different acknowledgment letter

if customer funds are held directly with the money market mutual fund

or its affiliate has some benefits.

First, requiring the MMMF to compute the value of the fund and make

that available to the FCM or DCO by 9:00 a.m. the following business

day ensures that FCMs will have the information they need in order to

produce their daily segregation calculations by 12:00 p.m. the

following business day (i.e., three hours later), which is an existing

requirement for FCMs.\138\ This is important not only because it

enables the FCM to comply with the requirement to produce segregation

calculations by 12:00 p.m. the following day, but because under the

proposed rule, FCMs would not be allowed to withdraw residual interest

until the daily segregation calculations are completed. Second, by

requiring the fund to redeem shares and make payments to their

customers by the following business day, the proposed requirement

prohibits MMMFs from entering into any agreement with an FCM or DCO

that gives the MMMF a contractual right to delay payment, thus

preventing similar risks to what would occur if FCMs were allowed to

place funds in time-deposit accounts. Last, by prohibiting the MMMF

from imposing restrictions that would prevent the FCM or DCO from

pledging or transferring fund shares, the letter would ensure that FCMs

are able to use their shares as collateral at the DCO and that those

shares could be transferred from one FCM to another in the event of the

first FCM's default.

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\138\ See Sec. Sec. 1.32, 22.2, and 30.7.

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Costs

As discussed above in the cost benefit considerations section

related to Sec. 1.20 the NFA already requires electronic read-only

access to customer accounts, so the Commission does not anticipate that

providing the same access to the Commission will create additional

costs.

In addition, if an FCM or DCO currently has an account with a money

market mutual fund that, either directly or through an affiliate, holds

its own funds, and that fund is either not compliant with the

additional provisions of the letter in Appendix A Sec. 1.26 or is

unwilling to sign the proposed acknowledgment letter, the FCM or DCO

would bear some costs related to identifying a compliant money market

mutual fund, conducting due diligence, and moving its accounts to that

fund. This would force the FCM or DCO to identify a new MMMF that is

qualified to accept its customer funds, creating the same costs that

are described above in the cost benefit considerations section related

to Sec. 1.20.

Request for Comment

Question 20: The Commission requests comment regarding the

likelihood that money market mutual funds holding segregated funds from

FCMs or DCOs are not compliant with the additional terms contained in

the proposed acknowledgment letter. In addition, what costs would an

FCM or DCO bear when identifying a compliant money market mutual fund

and transferring their customer funds to that money market?

Question 21: In addition, the Commission requests comment regarding

whether the requirements contained in the acknowledgment letter,

discussed in Sec. 1.20, would impact money market mutual funds

differently from any other depositories.

Sec. 1.29 Gains and Losses Resulting From Investment of Customer Funds

Proposed Changes

As described in the section by section discussion at II.L, under

the Commission's existing regulations, Sec. 1.29(a) states that FCMs

or DCOs investing customer funds in Sec. 1.25 investments are entitled

to the return on those investments. Proposed Sec. 1.29(b) provides

that FCMs or DCOs investing customer segregated funds in instruments

described in Sec. 1.25 also bear sole responsibility for the losses

that result from those investments.

Benefits and Costs of the Proposed Changes

This change was recommended by FIA, which stated its belief that

the FCM or DCO's responsibility for losses in Sec. 1.25 investments

``is clear and is implicit in the Act and the Commission's rules.''

\139\ The Commission believes that market participants already

recognize this and act accordingly. Therefore the Commission does not

believe that

[[Page 67919]]

proposed Sec. 1.29(b) would create any additional costs.

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\139\ FIA, ``Initial Recommendations for Customer Funds

Protection.'' Available at: http://www.futuresindustry.org/downloads/Initial_Recommendations_for_Customer_Funds_Protection.pdf.

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Sec. 1.30 Loans by Futures Commission Merchants; Treatment of Proceeds

Proposed Changes

As described in the section by section discussion at II.M, Sec.

1.30 permits the FCM to lend its own funds to a customer on securities

and property pledged by the customer, effectively performing a

collateral transformation service. The proposed amendment to Sec. 1.30

clarifies that, while an FCM may provide secured loans to a customer,

it may not make loans to a customer on an unsecured basis or use a

customer's futures or options positions as security for a loan from the

FCM to that customer.

Benefits

The proposed prohibition against FCMs providing unsecured loans to

customers reduces counterparty risk borne by the FCM position because

it prevents the FCM from accumulating exposures to customers that have

not margined their positions. In addition, the proposed rule would

prohibit an FCM from using a customer's positions to secure loans made

to customers, which would also reduce the FCM's counterparty risk. If

an FCM used a customer's positions to secure a loan to that customer,

the FCM would be using the same collateral to secure two different

liabilities: the liability associated with the open position; and the

liability associated with the unsecured loan. By prohibiting FCMs from

using a customer's positions to secure a loan to that customer, the

proposed rule would prevent the additional exposure that would

otherwise result from using the same collateral to secure two different

liabilities, which again, reduces the FCM's counterparty risk.

In addition, to the extent that the proposed change would force

customers to obtain such loans from another lender, it diversifies the

counterparty risk across multiple entities. That benefits the FCM that

would otherwise bear more concentrated customer risk, and likely would

be good for the markets more generally because of the additional

protection that it provides to any clearinghouse of which the FCM is a

member.

Costs

Regarding costs associated with the proposed restriction--customers

that need or prefer to use borrowed funds to meet their initial and

maintenance margin requirements for certain positions would be forced

to obtain loans necessary to fund their futures or options positions

from another lender. That would increase the customer's operational

costs since they would have to transfer funds from one institution to

another and would have to administer both accounts. In addition, it is

likely that lenders will conduct more due diligence than would be the

case if the FCM were to loan the requisite funds, which will create

additional costs related to such a loan, both for the customer and for

the party lending the funds.

Request for Comment

Question 22: The Commission requests comment regarding how often

FCMs currently make loans to customers on either a secured or unsecured

basis, and what the processes and terms typify such loans (including

details regarding the process for evaluating credit risk, size of such

loans, payment terms, collateral, and any other details that commenters

believe the Commission should consider).

Question 23: In addition, the Commission requests information

regarding the additional operational costs that customers would bear if

they have to obtain a loan from an entity other than the FCM holding

their funds in a customer segregated account. If possible, please

quantify the additional costs.

Sec. 1.32 Reporting of Segregated Account Computation and Details

Regarding the Holding of Customer Funds

Proposed Changes

As described in the section by section discussion at II.N, The

proposed changes would allow an FCM that is not a dual registrant to

follow the same procedures as dual registrants (FCM/BDs) when assessing

a haircut to securities purchased with customer funds if the FCM

determines that those securities have minimal credit risk. This is the

same change as is proposed in Sec. 1.17 except that in Sec. 1.17 the

proposed change refers to securities purchased by an FCM with its own

capital, whereas the proposed change here would apply to securities

purchased with customer funds. The change proposed here would create

the same costs and benefits as described above in the cost benefit

considerations section related to Sec. 1.17.

In addition, the proposed changes would: (1) Require FCMs to report

daily Segregation Statements to the Commission and their DSRO

electronically by noon the following business day; (2) require that

twice per month, each FCM submit a detailed list of depositories report

listing of all the depositories and custodians where customers

segregated funds are held, including the amount of customer funds held

by each entity and a break-down of the different categories of Sec.

1.25 investments held by each entity; and (3) require that the detailed

list of depositories be submitted to the Commission electronically by

11:59 p.m. the following business day and that both Segregation

Statements and Detailed list of depositories be retained by the FCM in

accordance with Sec. 1.31.

Benefits

Requiring FCMs to submit their daily calculations to the Commission

and DSRO, together with the proposed amendments to Sec. Sec. 1.20 and

1.26 giving the Commission and DSRO electronic access to view the

balances of all depository accounts where customer segregated funds are

held, will enable the Commission and DSRO to better protect customer

funds by more closely monitoring for any discrepancies between the

assets in segregated accounts reported by the FCM and their

depositories. The ability of the Commission and DSRO to check for

discrepancies more regularly, without notice, is likely to provide an

additional disincentive to fraud. Moreover, it will enable both the

Commission and DSROs to monitor for any trends that would indicate

operational or financial problems are developing at the FCM, which

would give the Commission an opportunity to enhance its supervision and

to intervene, if necessary, to protect customer segregated funds.

The detailed list of depositories would provide additional

information to the Commission and DSRO beyond what would be available

to both by virtue of the electronic read-only access that has been

proposed in Sec. Sec. 1.20, 1.26, and 30.7. First, the detailed list

of depositories will provide additional account detail including the

types of securities and investments that constitute each account's

assets rather than existing reports that only include the total value

securities. Second, the reports will account for any pending

transactions that would not necessarily be apparent when viewing a

depository account online. Third, FCMs will, in these reports, provide

to the Commission and DSRO a reconciled balance, which would not be

available to the Commission or DSRO simply by viewing an FCM's

depository accounts online. Each of these additional forms of

information would enable the Commission and DSRO to provide better

oversight and create additional accountability for the FCM.

[[Page 67920]]

Costs

FCMs are already calculating segregated funds information daily and

reporting the results to the NFA via WinJammer by noon the following

day. Similarly, the detailed list of depositories that would be

required to be submitted twice per month is already required by NFA to

be produced and submitted to NFA via WinJammer.\140\ Requiring FCMs to

submit these reports to the Commission via the same platform should not

create any additional costs.

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\140\ See Segregated Investment Detail Report at: http://www.nfa.futures.org/NFA-compliance/NFA-futures-commission-merchants/fcm-reporting.pdf.

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Sec. 1.52 Self-Regulatory Organization Adoption and Surveillance of

Minimum Financial Requirements

Proposed Changes

As described in the section by section discussion at II.O, the

proposed amendments to 1.52 would revise the supervisory program that

SROs are required to create and adopt. In addition, for SROs that

choose to delegate the function to examine FCMs that are members of two

or more SROs to a DSRO, the amended rules would require a plan that

establishes a Joint Audit Committee which, in turn, must propose,

approve, and oversee the implementation of a Joint Audit Program. The

amended rules specify a number of additional requirements for the SRO

supervisory program as well as for the Joint Audit Program.

Benefits

Regarding SROs' supervisory programs, the proposed amendments would

provide significant additional protection to FCMs' counterparties,

investors, and customers by ensuring that SRO audits of member FCMs are

thorough and effective. The proposed amendments would help to ensure

thorough audits by requiring that an SRO's audit program be designed to

address ``all areas of risk to which futures commission merchants can

reasonably be foreseen to be subject,'' that the scope and focus of

such audits would be determined by the risk profile that the SRO

develops for each FCM, and that the audit itself include both controls

testing as well as substantive testing. The last requirement, in

particular, would help to ensure that audits give adequate attention to

testing and review of internal controls, which are critical to help

ensure that each FCM is not only compliant with capital and segregation

requirements at the time of the audit, but that they continue to

operate in such a manner after the audit is completed by preventing

fraud or operational errors that could jeopardize the FCM and its

customers.\141\

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\141\ While many auditors and market participants have noted the

importance of controls testing, the Commission understands that

currently, many audits tend to emphasize substantive testing and

give lesser attention to controls testing. See Public Roundtable to

Discuss Additional Customer Protections, August 9, 2012. A recording

of the roundtable is available at: http://www.cftc.gov/PressRoom/Events/opaevent_cftcstaff080912. See [customer protection

roundtable from 8/9].

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By requiring that the supervisory program for the SRO must be

compliant with U.S. Generally Accepted Auditing Standards and standards

prescribed by the Public Company Accounting Oversight Board, the

proposed rules would ensure that the SROs' supervisory programs draw

from established best practices, and that they address the full range

of issues that would impact the effectiveness of the SRO's audits of

FCMs. This benefit is enhanced by the proposed list of specific issues

that each SRO must address in the standards they develop for their

supervisory program. And by promoting audits that are thorough, the

proposed rules would, again, promote protection of the FCM's

counterparties, investors, and customers.

By requiring that an examinations expert evaluate the SRO's

supervisory program at least once every two years, and that the results

of such examinations include a discussion and recommendation of any new

or best practices, the proposed rules would ensure that the supervisory

program and SRO audits continue to build on best practices, for audits,

which further promotes thorough and effective audits of FCMs.

The proposed rules for the Joint Audit Program would require the

Joint Audit Program to: (1) Establish standards covering all the same

issues; (2) require controls testing as well as substantive testing;

(3) address all areas of risk to which the registered FCM can

reasonably be foreseen to be subject; (4) conform to U.S. generally

accepted auditing standards and as well as those prescribed by the

Public Company Accounting Oversight Board; and (5) have an examinations

expert evaluate the Joint Audit Program at least once every two years.

Therefore, the proposed rules would produce identical benefits related

to audits conducted by a DSRO.

In addition, by requiring that the DSRO audits include examination

of an FCM's compliance with rules and regulations governing minimum net

capital, obligations to segregate customer funds, financial reporting

requirements, etc., the proposed rule would ensure that these critical

elements of the FCM's operations and finances are reviewed during each

audit. Each of these elements safeguard customers. Additionally, by

requiring the Joint Audit Committee to develop procedures to identify

high risk firms and perform enhanced monitoring of such firms, the

proposed rules would help to ensure that any risk to customer funds

that begins to materialize (e.g. the FCM's residual interest begins to

drop) is identified and corrected quickly, thus reducing the risk of a

loss of customer funds.

In addition, commenters at the Commission's August 9th roundtable

on customer protection noted that when audits take several months to

complete, the findings are less relevant when they are delivered to the

business than they would have been if they were communicated more

promptly.\142\ Therefore, by requiring that the Joint Audit Program

maintain adequate levels of staff with adequate training and

experience, the proposed requirements would facilitate timely

completion of audits, which is likely to enhance the protection of

customer funds by promoting more prompt identification and correction

of weaknesses identified in such audits. Moreover, if auditors are not

independent of the FCM they are auditing, their findings may be

compromised by conflicts of interest. By requiring standards related to

independence together with annual ethics training, the proposed rule

would help to ensure that the results of any audit conducted by the

DSRO are not compromised by the influence of any conflict of interests.

Each of these, in turn, facilitate thorough, effective, and timely

audits, which help protect the FCM's customers, counterparties, and

investors by ensuring that the FCM's financial reports are accurate,

and that internal controls are reviewed and tested.

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\142\ See Public Roundtable to Discuss Additional Customer

Protections, August 9, 2012. A recording of the roundtable is

available at: http://www.cftc.gov/PressRoom/Events/opaevent_cftcstaff080912 See [roundtable on Aug 9th].

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Costs

SROs are already required to establish and operate supervisory

programs for auditing FCMs. The proposed amendments require further

detail and documentation with regard to specific elements of such

supervisory programs. The Commission estimates that the cost for

developing these policies and procedures would be between $20,700 and

$31,000 per SRO.\143\

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\143\ This estimate assumes 160-240 hours of time from both a

compliance attorney and a senior accountant. The average

compensation for a compliance attorney is $85.35/hour [$131,303 per

year/(2000 hours per year)*1.3 is $85.35 per hour]; $85.35 *160 =

$13,655.51 and $85.35 *240 = $20,483.27. The average compensation

for a senior accountant is $44.18/hour [$67,971.00 per year/(2000

hours per year)*1.3 is $44.18 per hour]; $44.18*160 = $7,068.98 and

$44.18*240 = $10,603.48. These figures are taken from the 2011 SIFMA

Report on Management and Professional Earnings in the Securities

Industry.

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[[Page 67921]]

The Joint Audit Committee would have to develop policies and

procedures concerning the application of the Joint Audit Program in the

examination of FCMs. The standards would have to, at minimum, conform

to the U.S. GAAS and would also have to address the items in Sec.

1.52(c)(2)(iii). The development of such policies and procedures is

likely to require input from one attorney and one senior accountant at

each SRO, and therefore the Commission estimates that such involvement

will cost each SRO between $2,400 and $6,000.\144\ In addition, the

work required to further develop Joint Audit Program is likely to be

supported by full time staff at the DSRO. The Commission estimates that

such support will cost the DSRO between $18,000 and $26,400.\145\ In

addition the Joint Audit Program would be required to have an

examinations expert review the policies and procedures they develop.

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\144\ This estimate assumes 20-50 hours of time from both a

compliance attorney and an intermediate accountant. The average

compensation for a compliance attorney is $85.35/hour [$131,303 per

year/(2000 hours per year)*1.3 is $85.35 per hour]; $85.35*20 =

$1,706.94 and $85.35*50 = $4,267.35. The average compensation for an

intermediate accountant is $34.11/hour [$52,484.00 per year/(2000

hours per year)*1.3 is $34.11 per hour]; $34.11*20 = $682.29 and

$34.11*50 = $1,705.73. These figures are taken from the 2011 SIFMA

Report on Management and Professional Earnings in the Securities

Industry.

\145\ This estimate assumes 320-400 hours from an office

services supervisor and 40-80 hours from both a compliance attorney

and a senior accountant. The average compensation for an office

services supervisor is $40.15/hour [$61,776.00 per year/(2000 hours

per year)*1.3 is $40.15 per hour]; $40.15*320 = $12,849.41 and

$40.15*400 = $16,061.76. The average compensation for a compliance

attorney is $85.35/hour [$131,303 per year/(2000 hours per year)*1.3

is $85.35 per hour]; $85.35*40 = $3,413.88 and $85.35*80 =

$6,827.76. The average compensation for a senior accountant is

$44.18/hour [$67,971.00 per year/(2000 hours per year)*1.3 is $44.18

per hour]; $44.18*40 = $1,767.25 and $44.18*80 = $3,534.49. These

figures are taken from the 2011 SIFMA Report on Management and

Professional Earnings in the Securities Industry.

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Ongoing costs to the SRO and Joint Audit Program would include fees

charged by the examinations expert for a review every other year, the

incremental cost of more extensive controls testing when auditing each

FCM, and the incremental cost resulting from standards that the SRO

develops to comply with the list of standards that must be addressed in

the supervisory program.\146\ The Commission does not have adequate

information to estimate the ongoing costs for biennial reviews by an

examinations expert, or the incremental costs of additional controls

testing or ongoing compliance with standards that the FCMs develop

pursuant to Sec. 1.52(c)(2)(iii).

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\146\ See Sec. 1.52(c)(2)(iii).

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Request for Comment

Question 24: The Commission requests comment regarding the costs

associated with increased controls testing. To what extent do SROs

currently conduct controls testing when auditing FCMs? What additional

testing would likely be involved in order to comply with the proposed

regulations?

Question 25: In addition, the Commission requests comment regarding

the costs for an expert examiner to conduct a review such as the one

contemplated in the proposed rules.

Question 26: Also, regarding costs associated with the Joint Audit

Committee and Joint Audit Program, which costs are likely to be borne

by the SROs and which are likely to be borne by the DSROs?

Sec. 1.55 Public Disclosures by Futures Commission Merchants

Proposed Changes

As described in the section by section discussion at II.P, the

proposed rules would add new provisions to the disclosure document that

FCMs are required to provide to prospective customers, detailed in

Sec. 1.55(b). The new provisions would require the disclosure document

to contain a statement that: (1) Customer funds are not protected by

insurance in the event of the bankruptcy or insolvency of the FCM, or

if customer funds are misappropriated in the event of fraud; (2)

customer funds are not protected by SIPC, even if the FCM is a BD

registered with the SEC; (3) customer funds are not insured by a DCO in

the event of the bankruptcy or insolvency of the FCM holding the

customer funds; (4) each customer's funds are not held in an individual

segregated account by an FCM, but rather are commingled in one or more

accounts; (5) FCMs may invest funds deposited by customers in

investments listed in Sec. 1.25; and (6) funds deposited by customers

may be deposited with affiliated entities of the FCM, including

affiliated banks and brokers.

In addition, the proposed rule would require each FCM to provide a

Firm Specific Disclosure Document that would address firm specific

information regarding its business, operations, risk profile, and

affiliates that would be material to a customer's decision to entrust

funds to and do business with the FCM.

As stated above, the Firm Specific Disclosure Document would be

made available on the FCM's Web site and would provide material

information about: (1) General firm contact information; (2) the names,

business contacts, and backgrounds for the FCM's senior management and

members of the FCM's board of directors; (3) a discussion of the

significant types of business activities and product lines that the FCM

engages in and the approximate percentage of the FCM's assets and

capital devoted to each line of business; (4) the FCM's business on

behalf of its customers, including types of accounts, markets traded,

international businesses, and clearinghouses and carrying brokers used,

and the futures commission merchant's policies and procedures

concerning the choice of bank depositories, custodians, and other

counterparties; (5) a discussion of the material risks of entrusting

funds to the FCM and an explanation of how such risks may be material

to its customers; \147\ (6) the name and Web site address of the FCM's

DSRO and the location of annual audited financial statements; (7) a

discussion of any material administrative, civil, criminal, or

enforcement actions pending or any enforcement actions taken in the

last three years (8) a basic overview of customer fund segregation, FCM

collateral management and investments, and of FCMs and joint FCM/BDs;

(9) information regarding how customers may file complaints about the

FCM with the Commission or appropriate DSRO; (10) certain financial

data from the most recent month-end when the disclosure document is

prepared; and (11) a summary of the FCMs current risk practices,

controls and procedures.

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\147\ The material risks addressed must include, without

limitation, ``the nature of investments made by the futures

commission merchant (including credit quality, weighted average

maturity, and weighted average coupon); the futures commission

merchant's creditworthiness, leverage, capital, liquidity, principal

liabilities, balance sheet leverage and other lines of business;

risks to the futures commission merchant created by its affiliates

and their activities, including investment of customer funds in an

affiliated entity; and any significant liabilities, contingent or

otherwise, and material commitments.''

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FCMs would be required to update the Firm Specific Disclosure

Document at least annually.

As described in the section by section discussion at II.P, FCMs

would also be

[[Page 67922]]

required to disclose on their Web sites their daily Segregation

Schedule, daily Secured Amount Schedule, and daily Cleared Swaps

Segregation Schedule. Each FCM would be required to maintain 12 months

of the segregation and secured schedules on its Web site. Each FCM

would also be required to disclose on its Web site as well as summary

schedules of its adjusted net capital, net capital, and excess net

capital for the 12 most recent month-end dates as well as the Statement

of Financial Condition, Segregation Schedule, Secured Amount Schedule,

Cleared Swaps Segregation Schedule, and all footnotes related to the

above statements and schedules from its most current year end annual

report that is certified by an independent public accountant.

Benefits

As explained above in the section by section discussion at II.P,

current regulations require FCMs to provide a risk disclosure to

potential customers before accepting customer funds. That risk

disclosure statement is primarily intended to provide a customer with

disclosure of the market risks of engaging in futures trading. The

proposed additions to that disclosure would help to ensure that

customers are aware of certain non-firm-specific risks that have been

relevant in recent FCM bankruptcies and that could be relevant in the

event of future FCM bankruptcies or insolvencies.

The Firm Specific Disclosure Document that would be required by the

proposed rules would address firm-specific risk, which would give

potential customers additional information that they could use when

conducting due diligence and selecting an FCM. By requiring that the

disclosure address several specific topics, the proposed rule would

ensure that certain topics that are relevant are addressed, even if

potential customers might not otherwise think to ask about them when

selecting or conducting due diligence on potential FCMs.

Specifically, by requiring the disclosure to provide information

about the business activities and product lines the FCM engages in, and

the percentage of the FCM's assets and capital that are used in each

type of activity, the proposed rules would assist customers in

acquiring information that may assist them in determining the extent to

which the FCM's business is focused on providing the types of services

that the customer needs, and the extent to which other business

interests could impact either the focus or stability of the FCM.

By requiring that FCMs provide the policies and procedures by which

it selects depositories, the proposed rules would assist potential and

existing customers in evaluating the sufficiency of due diligence

conducted by the FCM when selecting such depositories. This additional

measure of transparency would incent FCMs to be rigorous in conducting

such due diligence because potential or existing customers that are not

satisfied with the FCM's policies and procedures in this respect could

take their business elsewhere.

Requiring FCMs to discuss their business on behalf of customers,

the proposed rules would ensure that customers and potential customers

are able to make a more thorough assessment of risks that the FCM or

customer funds held by the FCM might bear due to the markets or

businesses in which the FCM is active, the clearinghouses and carrying

brokers it uses, or the depositories that hold funds on behalf of the

FCM. Such an assessment could impact customers' decisions as they

select the FCM(s) with which they will conduct business. Moreover,

additional transparency would promote market discipline, which would

provide additional incentive for FCMs to manage such risks diligently.

By requiring FCMs to disclose material risks together with an

explanation of how such risks may be material to its customers, the

proposed rules would ensure that the FCM is responsible to identify and

communicate such risks, which helps to ensure that potential and

existing customers would be aware of those risks when placing or

keeping funds on deposit with the FCM. In the absence of such a

requirement, potential or existing customers may not know the FCM's

business as well as the FCM does, and therefore may not ask about

certain risks that are material to customers, may not have access to

adequate information to determine the magnitude of such risks, or may

not understand how certain risks could impact the FCM's customers.\148\

The proposed amendment would make the FCM responsible both to identify

and provide information regarding all material risks and to provide

explanations that would help educate customers about how such risks

could affect them.

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\148\ In the Public Roundtable to Discuss Additional Customer

Protections on August 9, 2012, participants suggested that FCMs may

not provide all customers and potential customers with equivalent

access to firm-specific data. See http://www.cftc.gov/PressRoom/Events/opaevent_cftcstaff080912.

As a result, larger customers may be able to conduct more

thorough due diligence when selecting an FCM. The proposed

requirements would help ensure that all customers have access to

FCM-specific data that is helpful when evaluating the risks that

would be relevant to customer funds entrusted to an FCM.

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Requiring FCMs to provide information regarding how they may file a

complaint about the FCM with the Commission or the firm's DSRO would

help to ensure that if customers perceive problems at an FCM, those

concerns are communicated to the proper regulatory bodies, giving the

Commission and DSRO an opportunity to investigate further, if

appropriate. As a consequence, the required information would promote

more effective oversight by the Commission and DSRO.

By requiring that FCMs provide an overview of customer fund

segregation and FCM collateral management and investment, the proposed

rules would promote the protection of customer funds by enhancing

market discipline through customer education. The proposed rules would

help customers understand how statutory and regulatory requirements are

designed to provide protections for their funds, and what steps FCMs

must take in order to comply with such regulations. Educated customers,

in turn, provide an additional layer of accountability for the FCM in

complying with such requirements. Moreover, customers will be better

able to understand public disclosures regarding disciplinary actions

against FCMs, updates regarding material risks to customer funds,

financial disclosures made by the FCM, and to make informed decisions

in response.

In particular, the disclosures proposed in Sec. 1.55(k)(10) could

assist customers in evaluating fellow customer risk that they would

bear at each FCM with which they consider doing business. By requiring

FCMs to disclose specific financial data as of the most recent month-

end when the disclosure document is produced, the proposed requirements

would further ensure that all customers have access to data that would

be helpful when considering potential risks associated with entrusting

funds to the FCM.

Requiring FCMs to disclose the dollar value of their proprietary

trading margin requirements as a percentage of margin required for

futures customers, Cleared Swap Customers, and 30.7 Customers would

help customers understand the magnitude of risk created by the FCM's

proprietary positions relative to the magnitude of risk created by

customers' positions. This information could prompt customers to ask

additional questions about the relationship between the risks created

by the firm's

[[Page 67923]]

proprietary trading and trading on behalf of customers. It could also

prompt questions about how the firm's operations related to proprietary

trading may impact their operations related to customer accounts.

By requiring FCMs to disclose the number of customers that

constitute 50% of the FCMs total funds held for futures customers,

Cleared Swaps Customers, and 30.7 Customers, customers would have

additional insight into the potential exposure that the FCM could have

due to a default by one of its largest customers.

The aggregate notional value of non-hedged, principal over-the-

counter transactions into which the FCM has entered, when calculated

and reported for each class of swaps, would give customers some sense

of the potential exposure the FCM has due to potential changes in the

value of its proprietary portfolio.

The aggregate amount of financing FCMs provide for customer

transactions involving illiquid financial products would give customers

additional insight into the potential challenges FCMs would face if a

fellow customer defaulted and the FCM had to liquidate such products in

order to mitigate the losses caused by the customer's default.

Requiring FCMs to disclose the amount, source, and purpose of any

unsecured and uncommitted short term funding the FCM has access to

would help potential and existing customers gain insight into the FCM's

capacity to meet unexpected liquidity needs that might occur due to a

fellow customer's default.

Requiring FCMs to disclose the percentage of customer debts the FCM

experienced during the past 12-month period, as compared to the balance

of funds held for futures customers, Cleared Swaps Customers, and 30.7

Customers would give customers a sense for how effective the firm's

risk management program is, as well as a sense for the quality of the

customer pool that the FCM has accepted.

Requiring FCMs to provide a summary of their current risk

management practices, controls and procedures would give customers

insight into the procedures that FCMs use to manage the risks

associated with fellow customers, which would be valuable to customers

when evaluating potential fellow customer risk at various FCMs.

By requiring each FCM to adopt policies and procedures reasonably

designed to ensure that its advertising and solicitation activities are

not misleading to its FCM customers, the proposed rules would

strengthen accountability for communication related to an FCM's sales

and solicitation activities. Moreover, the Commission and DSROs would

be better equipped to monitor FCMs' internal controls related to sales

and solicitation, and compliance with those controls, if FCMs have

established policies and procedures. In this way, the proposed rules

would promote consistently reliable communication associated with each

FCM's sales and solicitation efforts.

By requiring FCMs to update the disclosure proposed in rule 1.55(i)

annually as well as any time there is a ``material change to its

business operation, financial condition and other factors material to

the customer's decision to entrust the customer's funds and otherwise

do business with the futures commission merchant,'' and requiring the

FCM to provide each updated disclosure to its customers, the rule would

make FCMs responsible to communicate with customers whenever such

events occur. This requirement would help to ensure that the FCM's

financial condition, business operations, or other important factors do

not change in material ways without customers being aware of such

changes, and would likely prompt some customers to conduct additional

due diligence in such situations in order to determine whether their

funds are at risk, which would provide additional accountability for

FCMs.

By requiring FCMs to provide their daily Segregation Schedules,

daily Secured Amount Schedules, and daily Cleared Swaps Segregation

Schedules, as well as additional month end and annual financial data,

the proposed rules would facilitate transparency. All of the

information that firms would be required to post on their Web site is

information that would be public based on the requirements of this rule

even if it were not posted on each FCM's Web site. However, if the

schedules mentioned above were not posted on each FCM's Web site,

market participants would have to submit a request to the Commission in

order to access that information. Requiring each FCM to post the above

schedules and data on its Web site would help to ensure that market

participants are aware that it is available, and would also improve the

speed and efficiency of obtaining it.

Similarly, by requiring FCMs to provide a link to the Web site of

the NFA's Basic System facilitate transparency by promoting awareness

of the additional information that is public regarding each FCM's

investment of customer funds and by minimizing search costs for

obtaining that information.

Costs

FCMs would have to create the Firm Specific Disclosure Document

which would likely require time from compliance, legal, accounting, and

administrative personnel. The Commission estimates that the cost for

producing the content of the initial disclosure would be between $6,000

and $22,200.\149\ In addition, each FCM would have to update the

disclosure annually as well as any time there is a material change to

the business that could affect the customer's willingness to do

business with the FCM. Producing the content of each update is likely

to be less costly than the initial disclosure, since some parts of the

disclosure will likely remain the same from one version to the next.

The Commission estimates that such updates would cost between $6,000

and $12,000.\150\

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\149\ This assumes 40-200 hours from a compliance attorney, 10-

50 hours from a senior accountant, 40-60 hours from an office

services supervisor, and 5 hours from the CCO. The average

compensation for a compliance attorney is $85.35/hour [$131,303 per

year/(2000 hours per year)*1.3 is $85.35 per hour]; $85.35 *40 =

$3,143.88 and $$85.35 *200 = $17,069.39. The average compensation

for a senior accountant is $44.18/hour [$67,971.00 per year/(2000

hours per year)*1.3 is $44.18 per hour]; $44.18*10 = $441.81 and

$44.18*50 = $2,209.06. The average compensation for an office

services supervisor is $40.15/hour [$61,776.00 per year/(2000 hours

per year)*1.3 is $40.15 per hour]; $40.15*40 = $1,606.18 and

$40.15*60 = $2,409.26. The average compensation for a chief

compliance officer is $110.97/hour [ $170,727 per year/(2000 hours

per year)*1.3 = $110.97/hour]; $110.97*5 = $554.86. These figures

are taken from the 2011 SIFMA Report on Management and Professional

Earnings in the Securities Industry.

\150\ This estimate assumes 40-80 hours from a compliance

attorney, 20-40 hours from an intermediate accountant, and 30-60

hours from an office services supervisor. The average compensation

for a compliance attorney is $85.35/hour [$131,303 per year/(2000

hours per year)*1.3 is $85.35 per hour]; $85.35*40 = $3,413.88 and

$85.35*80 = $6,827.768. The average compensation for an intermediate

accountant is $34.11/hour [$52,484.00 per year/(2000 hours per

year)*1.3 is $34.11 per hour]; $34.11*40 = $1364.58 and $34.11*80 =

$2729.17. The average compensation for an office services supervisor

is $40.15/hour [$61,776.00 per year/(2000 hours per year)*1.3 is

$40.15 per hour]; $40.15*20 = $803.09 and $40.15 *60 = $2,409.26.

These figures are taken from the 2011 SIFMA Report on Management and

Professional Earnings in the Securities Industry.

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Posting the Firm Specific Disclosure Document and the schedules and

data that would be required by Sec. 1.55(o) would require firms to

update their Web site on a daily, monthly, and annual basis with the

information that would be required under Sec. 1.55(o). The Commission

estimates that these

[[Page 67924]]

updates would cost between $2,300 and $7,000 per year.\151\

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\151\ This assumes 10-30 minutes of time per day from a

programmer. The average compensation for a programmer is $53.64/hour

[$82,518 per year/(2000 hours per year)*1.3 = $53.64/hour];

$53.64*43 = $2,145.47 and $53.64*130 is $6,972.77.

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Request for Comment

Question 27: What modifications to the requirements of Sec.

1.55(k)(10) should the Commission consider in order to ensure that the

data provided from FCMs' most recent month-end is valuable to customers

evaluating potential fellow customer risk?

In particular, Is there additional information FCMs could

provide related to the value of the FCM's proprietary margin

requirements and customers' margin requirements that would assist

current and potential customers when conducting due diligence on an

FCM?

Is there additional information FCMs could provide that

would give customers a more complete picture of its ability to meet

unexpected liquidity needs that could occur due to the default of one

of its customers?

Question 28: Would the data from an FCM's most recent month-end be

more valuable to customers if it were coupled together with similar

data or the same data from other points in time? If so, what points in

time should the Commission consider?

Sec. 22.2 Futures Commission Merchants: Treatment of Cleared Swaps and

Associated Cleared Swap Customer Collateral

Proposed Changes

As described in the section by section discussion at II.Q, the

proposed amendments to Sec. 22.2 would incorporate changes with

respect to protection of funds for customers trading cleared swaps that

are identical to the changes proposed for protection of futures

customer funds. Those changes include: (1) Incorporating the same

change to haircutting procedures as was proposed above in Sec. 1.17

and Sec. 1.32 but for swaps; (2) requiring the FCM to send daily

Segregation Calculations for cleared swaps to the Commission and DSRO;

and (3) requiring that segregated investment detail report that FCMs

produce twice per month, listing assets on deposit at each depository,

to be sent to CFTC and DSRO electronically by 11:59 p.m. the following

business day. Records of both reports would be required to be

maintained in accordance with Sec. 1.31.

In addition, the proposed rule would specify that FCMs must

maintain residual interest in customer segregated accounts that is

larger than the sum of all customer margin deficits. This proposed

requirement is substantially identical to the proposed requirement in

Sec. Sec. 1.22 and 30.7.

Benefits

As discussed above with reference to Sec. 1.32, requiring FCMs to

submit their daily segregation reports to the Commission and DSRO will

enhance protection of customer funds by giving both of them additional

information that, together with permission to view depository accounts

online at any time, would enable both the Commission and DSRO to

monitor those accounts more closely for any discrepancies that may

result from operational errors or fraud. Moreover, requiring FCMs to

submit their detailed list of depositories to the Commission and DSRO

twice per month would give both organizations additional information

that could help them perform spot checks to ensure that the FCM is

valuing and haircutting securities correctly and, more generally, to

verify that the value of each account that is computed by the FCM is

accurate.

As described in the discussion of cost and benefit considerations

related to Sec. 1.22, by requiring that FCMs maintain residual

interest in their cleared swap customer segregated accounts, the

proposed rule would ensure that the FCM is not using one customer's

funds to purchase, margin, secure, or settle positions for another

customer and when combined with the reporting requirements in Sec.

22.2 would provide the Commission and the public with sufficient

information to verify that FCMs are not using one customer's funds to

purchase, margin, secure or settle positions for another customer.

Costs

With respect to costs, as described above, changes to the reporting

requirements codify requirements that are already established by the

DSROs. Therefore, the additional requirements will not introduce new

costs for market participants. On the other hand, reducing the haircut

increases the likelihood that adverse developments affecting the FCM's

Sec. 1.25 investments could cause financial strain for the FCM, or

could cause losses that the FCM would not be able to cover, either of

which could increase risk to customer funds. However, as described

above in the cost benefit considerations section related to Sec. 1.17,

the Commission proposes that FCMs that are dual registrants will be

able to use the SEC's haircutting procedures, and that FCMs that are

not dual registrants do not typically invest in securities that would

be subject to reduced haircuts under the SEC's proposed rules.

By requiring FCMs to maintain residual interest in the cleared swap

customer segregated accounts that is greater than the sum of their

customers' margin deficits, the proposed rule would create costs and

benefits that are substantially identical to those described in the

cost and benefit considerations related to Sec. 1.22. As discussed in

that section, the Commission does not have information to determine

whether FCMs typically maintain residual interest in their cleared swap

customer segregated accounts that is greater than or less than the sum

of their customers' margin deficits, and requests information

sufficient to make such a determination, and to quantify the associated

costs, if any.

Request for Comment

Question 29: The Commission requests comment regarding whether FCMs

typically maintain residual interest in their customer segregated

accounts that is greater than the sum of their customer margin

deficits, and data from which the Commission may quantify the average

difference between the amount of residual interest an FCM maintains in

customer segregated accounts and the sum of customer margin deficit.

Question 30: How much additional residual interest would FCMs hold

in their customer segregated accounts in order to comply with the

proposed regulation? What is the opportunity cost to FCMs associated

with increasing the amount of capital FCMs place in residual interest,

and data that would allow the Commission to replicate and verify the

calculated estimates provided.

Question 31: The Commission request information regarding the

additional amount of capital that FCMs would likely maintain in their

customer segregated accounts, if any, to comply with the proposed

regulation. What is the average cost of capital for an FCM? Please

provide data and calculations that would allow the Commission to

replicate and verify the cost of capital that you estimate?

Sec. 22.17 Policies and Procedures Governing Disbursements of Cleared

Swaps Customer Collateral From Cleared Swap Customer Accounts

Proposed Changes

As described in the section by section discussion at in II.Q,

proposed Sec. 22.17 would impose restrictions on an FCM's withdrawal

of its residual interest, and

[[Page 67925]]

requires that if a withdrawal of residual interest for proprietary use

causes the FCM to fall below its targeted residual interest that the

funds be replenished the following business day or the residual

interest target be lowered in accordance with its policies and

procedures established under Sec. 1.11.

Benefits and Costs of the Proposed Changes

The costs and benefits are similar to those created by Sec. Sec.

1.23 and 1.11 but apply to customer funds in Cleared Swaps Customer

Accounts rather than customer segregated accounts, and therefore are in

addition to those specified in Sec. Sec. 1.23 and 1.11.

Sec. 30.1 Definitions

Proposed Changes

Proposed Sec. 30.1 establishes definitions for ``30.7 Customer,''

``30.7 Account,'' and ``30.7 Customer Funds.'' The first is defined as

any foreign futures or foreign option customer, together with any

foreign-domiciled person who trades in foreign futures or foreign

options trough an FCM. ``30.7 Account'' and ``30.7 Customer Funds'' are

then defined accordingly. These definitions would replace the terms

``foreign futures or foreign options customer,'' ``foreign futures or

foreign options customer account,'' and ``foreign futures or foreign

options customer funds,'' respectively. The existing term ``foreign

futures or foreign options customer'' only includes U.S.-domiciled

customers that deposit funds with an FCM for use in trading foreign

futures or foreign options. The proposed definitions, on the other

hand, would include both U.S. and foreign customers that deposit funds

with an FCM for use in trading foreign futures or foreign options.

Benefits and Costs of the Proposed Changes

These definitions play a `gatekeeping' function with respect to

other rules by determining what customers are included as ``30.7

Customers.'' However, the costs and benefits of these changes are

attributable to the substantive requirements related to the

definitions, and therefore are discussed in the cost benefit

considerations related to Sec. 30.7.

Sec. 30.7 Treatment of Foreign Futures or Foreign Options Secured

Amount

Proposed Changes

As described in the section by section discussion at II.R, the

proposed amendments would: (1) Incorporate the funds of foreign-

domiciled investors deposited with an FCM for investment in foreign

futures and foreign options within the protections provided in 30.7;

(2) eliminate the Alternative Method and require the Net Equity

Liquidation Method for calculating 30.7 customer segregation

requirements; (3) add specificity to the written acknowledgments that

FCMs and DCOs must obtain from their depositories by providing required

templates; \152\ (4) add restrictions on withdrawing from residual

interest; \153\ (5) require that 30.7 Customer Funds deposited in a

bank must be available for immediate withdrawal at the request of the

FCM; (6) clarify that the FCM is responsible for any losses related to

investing 30.7 Customer Funds in investments that comply with Sec.

1.25; (7) add a prohibition against making unsecured loans to customers

or using the funds in the customer's trading account as security for

the loan; (8) require daily segregation reports and detailed list of

depositories be submitted to the Commission and DSRO, and that targeted

residual interest be included in both of those reports; (9) allow FCMs

that are not dual registrants to use the broker-dealer (``BD'')

procedure for assigning a smaller haircut to instruments with low

default risk; (10) establish a limit on the amount of funds in a 30.7

Account that can be held outside the United States; \154\ and (11)

require FCMs to maintain residual interest in 30.7 Accounts that is

larger than the sum of all 30.7 Customer margin deficits. This proposed

requirement is substantially identical to the proposed requirement in

Sec. Sec. 1.22 and 22.2.

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\152\ The additional specificity incorporates the same

requirements for acknowledgment and agreement that are contained in

the templates in the appendices of Sec. Sec. 1.20 and 1.26.

\153\ The same requirements as are proposed for futures

customers' funds and cleared swaps customers' funds, including a

requirement for the FCM to abide by its policies and procedures

required in Sec. 1.11.

\154\ As a result of the proposed changes, the rules in Sec.

30.7 for the protection of 30.7 Customer Funds would be

substantially the same as the rules for the protection of segregated

customer funds under 4(d) and Sec. Sec. 1.11-1.32, and the rules

for the protection of cleared swaps customer funds in Sec. 22.

However, there are a few proposed changes to Sec. 30.7 that are

dissimilar to current or proposed regulations protecting futures

customer funds and cleared swap customer funds. They are: (1) the

definition of the minimum amount that must be deposited in a 30.7

Account for each 30.7 Customer is different than in the

corresponding requirements in 1.20 and 22.2. The difference is due

to the fact that 30.7 Customers' funds may be deposited overseas

under a different regulatory regime and the proposed rule would

require an FCM to comply with the highest requirement that is

relevant to those funds, whether it is the U.S. or the foreign

regime; (2) the list of acceptable depositories for 30.7 Funds

includes banks or trusts outside of the U.S. with more than $1

billion in regulatory capital, and various other participants of

foreign boards of trade and their depositories; and (3) 30.7 limits

the amount of funds from a 30.7 Account that can be held outside the

U.S.

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A. Compared to Customer Protections Under Sec. Sec. 1.20-1.32 and

Sec. 22

The result of the proposed changes is that the regulatory

requirements established in Sec. 30.7 for the protection of 30.7

Customer Funds would be substantially the same as those established for

segregated customer funds under 4(d) and Sec. Sec. 1.11-1.32, and for

cleared swaps customer funds in Sec. 22. However, the 30.7 regime

would have distinct requirements with respect to: (1) the definition of

the minimum amount that must be deposited in a 30.7 Account for each

30.7 Customer is different than in the corresponding requirements in

Sec. Sec. 1.12 and 22.2.\155\ The difference is due to the fact that

30.7 Customers' funds may be deposited overseas under a different

regulatory regime. The rule requires that FCMs abide by the highest

requirement that is relevant to those funds, whether it is the United

States or the foreign regime; (2) the list of acceptable depositories

for 30.7 Funds includes banks or trusts outside of the United States

with more than $1 billion in regulatory capital, and various other

participants of foreign boards of trade and their depositories; and (3)

30.7 limits the amount of funds from a 30.7 Account that can be held

outside the United States. Of these three differences, the third is the

only one created by the proposed rule, and therefore is the only one

incorporated in the cost benefit considerations discussion.

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\155\ See Sec. 30.7(a).

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Benefits and Costs of the Proposed Changes

The proposed changes would establish regulations for the protection

of customer funds deposited for trading in foreign futures and options

that, with limited exceptions, is substantively identical to the

protections that exist for futures customer funds and cleared swaps

customer funds. Therefore, many of the costs and benefits of the

changes that are proposed are identical to those described above in the

cost benefit considerations related to Sec. Sec. 1.11-1.32 and Sec.

22.

1. Incorporating funds of foreign-domiciled investors deposited

with an FCM for investment in foreign futures and foreign options

within the protections provided in 30.7

[[Page 67926]]

Benefits

Currently, when an FCM receives funds from foreign customers for

use in trading foreign futures and foreign options, the FCM may choose,

but is not required, to keep foreign customer funds in a segregated

account. If the funds are not kept in a segregated account, they are

not subject to the same level of oversight and protection as other

customer funds. For example, those funds are not incorporated in the

daily or bi-monthly calculations that are submitted to the Commission

and DSRO, and the FCM is permitted to use the assets of one foreign

customer to cover the obligations of another foreign customer, may

allow a net deficiency to exist in the funds of foreign customers held

for use in foreign futures or foreign options, and is allowed to

commingle such funds with the FCM's proprietary funds and use them as

part of its business capital.

The benefit or requiring customer funds to be kept in segregated

accounts is that those funds would receive the same protections as

funds deposited by U.S.-domiciled investors. This enhances the safety

of funds deposited by both U.S. and foreign investors by ensuring that

the FCM maintains sufficient funds in segregated accounts to satisfy

its obligations regarding all customer funds that have been deposited

at the FCM.

The proposed change would extend equivalent oversight and

protection to the money, securities and property received by an FCM for

or on behalf of a foreign-domiciled customer for foreign futures or

foreign options trading. Specifically, FCMs would be required to hold

the funds of foreign-domiciled customers in 30.7 secured accounts, to

include such funds in daily and bi-monthly calculations of 30.7

requirements and funds set aside for 30.7 customers, and to abide by

other policies and procedures regarding handling of customer funds.

This is a benefit because FCMs would be required to hold sufficient

funds in 30.7 accounts at all times to cover the obligations they have

to their foreign-domiciled customers as well as their U.S.-domiciled

customers. Various regulations designed to ensure that this requirement

is met at all times would also apply, including the Sec. 30.7(g)

restrictions on an FCM's withdrawal of its residual interest which is

commingled with customer 30.7 funds, and policies and procedures

developed by the FCM pursuant to Sec. 1.11 that are designed to ensure

safe handling of such funds.

Application of the additional protections designed for customer

funds will help to ensure that in the event an FCM has insufficient

regulatory capital, all 30.7 Customer Funds are available to be ported

to another FCM. This benefit is relevant both to foreign-domiciled

customers and to U.S.-domiciled customers holding money at an FCM where

foreign-domiciled customers also hold funds because, as described

above, in the event of a bankruptcy both groups of customers are

entitled to equivalent protections regardless of whether their funds

were held apart in separate accounts. Consequently, under the current

rules, if an FCM keeps foreign-domiciled customer funds out of 30.7

accounts and then defaults, there may not be sufficient funds to cover

the obligations of the FCM to all of their U.S.-domiciled as well as

foreign-domiciled customers. If this occurs, all customers would

receive a pro-rata share of the funds that were kept in 30.7 accounts,

regardless of which customers' funds were kept in the 30.7 account.

U.S.-domiciled customers would possibly suffer a pro rata loss of their

funds in the event of the FCM's bankruptcy because an FCM may not have

included foreign-domiciled customer funds in 30.7 accounts. The

proposed rule would prevent this situation from occurring, thus

providing increased protection not only to the foreign-domiciled

customers that deposited funds, but to the U.S.-domiciled customers as

well.

According to FIA, ``FCMs have generally adopted policies and

procedures designed to provide protections to all customers trading on

foreign boards of trade that are comparable to the protections afforded

customers trading on U.S. futures markets.'' \156\ If true, the

proposed change would not create substantial costs or benefits in

periods of normal activity for the FCM. However, under current

regulations, FCMs still have the ability to diverge from the

aforementioned practices they have generally adopted, and can pull

foreign-domiciled customer funds out of 30.7 accounts and use those

funds as if they were their own. It is precisely in a time of stress

for an FCM that these protections for customer funds are most needed to

prevent the FCM from commingling such funds with its own capital and

using it to meet the general obligations of the firm. It is not

possible to quantify the value of the additional protection that would

be provided to non-U.S.-based customers on the basis of the proposed

change. To do so would require data sufficient to estimate the

probability and expected magnitude of losses due to lesser protections

for funds deposited by foreign-domiciled customers, and the Commission

does not have such data. The Commission, however, requests public

comment regarding these benefits, and specifically requests any data

commenters can provide that would assist the Commission in quantifying

such benefits.

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\156\ FIA ``Initial Recommendations for Customer Funds

Protection,'' p. 10.

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Costs

With respect to costs the Commission understands that in practice,

FCMs have generally adopted practices that provide equivalent

protections to funds deposited by customers domiciled in the U.S. and

those who are not. Therefore, during normal operations the proposed

requirement would not create any additional costs. However, the

proposed amendment will prevent an FCM from using foreign-domiciled

customer funds for trading foreign futures and foreign options as its

own capital, thus reducing the FCM's liquidity which increases risk to

the FCM in times of stress. As a consequence, the FCM will have an

incentive to keep more capital in order to protect itself since it will

no longer be able to use such funds to meet or secure its own

obligations. The Commission does not have adequate data to quantify the

cost of FCMs' decreased liquidity or the cost of the additional capital

they may hold as a result. Doing so would require estimates of

probabilities regarding the likelihood of an FCM's liquidity crisis,

likelihood they hold foreign-domiciled customer funds for use in

foreign futures and foreign options trading, the amount of such funds,

the duration of the liquidity crisis, and a number of other factors

that the Commission does not have adequate information to estimate.

Request for Comment

Question 32: The Commission requests comment from the public

regarding the extent to which FCMs currently provide equivalent

protections to U.S.-domiciled and foreign-domiciled customers for

trading foreign futures and foreign options, as well as the probability

and expected size of losses that foreign-domiciled customers may face

due to lesser regulatory protection. In addition, the Commission

requests comment about any additional impact this change may have on

U.S. domiciled investors, foreign investors, or the public.\157\

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\157\ Questions posed to the public have been numbered for

commenters' convenience. The Commission requests that commenters

identify the number of the question they are addressing when

responding to specific questions posed by the Commission.

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[[Page 67927]]

2. Eliminate the Alternative Method and require the Net Equity

Liquidation Method for calculating 30.7 Customer segregation

requirements

Benefits

Under the current regulations FCMs are allowed to use the

Alternative Method, which only requires the maintenance of sufficient

funds in the foreign futures or foreign options account to satisfy the

margin required on open positions plus or minus any unrealized gains or

losses on such positions, and any funds representing option premiums or

funds necessary to margin or guarantee such options.

By removing the Alternative Method, which the Commission

understands is not in use, and requiring the Net Liquidating Equity

Method, the proposed rules benefit customers by reducing the risk that

a shortfall in customer funds could exist where an FCM operates in

compliance with Commission regulations. More specifically, by requiring

the FCM to segregate in separate accounts sufficient funds to satisfy

the full account equities of all of its customers trading foreign

futures or foreign options, the FCM would have sufficient funds in

segregated accounts to meet all of their obligations to all such

customers at any time, including in the event the FCM defaults.

Further, in the event of default, the proposed regulations would

facilitate the transfer of assets to another FCM by assuring the

receiving FCM that there are sufficient funds to cover the liabilities

that it may be assuming.

Costs

With respect to costs, as described above, the Commission

understands that in practice, all FCMs are currently using the Net

Liquidating Equity Method. However, FCMs currently have the option to

switch to the Alternative Method, which they would have an incentive to

do if the FCM needed additional liquidity. The proposal would prohibit

an FCM switching to the Alternative Method, thereby preventing an FCM

from using some portion of customer funds as if it were its own

operational capital. In doing so, the proposed rule would reduce the

FCM's options for obtaining liquidity.

The Commission does not have adequate data to quantify the cost of

this change. Doing so would require estimates of probabilities

regarding the likelihood of an FCM's liquidity crisis, likelihood they

hold foreign-domiciled customer funds for use in foreign futures and

foreign options trading, the amount of such funds, the amount that are

typically required to margin open positions for 30.7 Customers, and a

number of other factors that the Commission does not have adequate

information to estimate. However, as above, the Commission notes that

it does not believe that FCMs should consider any customer funds a

source of liquidity.

3. Specific requirements contained in the written acknowledgments

that FCMs and DCOs must obtain from their depositories

The costs and benefits resulting from this change are similar to

those discussed the cost benefit considerations sections related to

Sec. Sec. 1.20 and 1.26, but affect 30.7 Customer funds rather than

futures customer funds, and therefore are in addition to the costs and

benefits discussed in the cost benefit considerations sections related

to Sec. 1.20 and Sec. 1.26.

4. Restrictions on withdrawing from residual interest, including a

requirement for the FCM to abide by its policies and procedures

required in Sec. 1.11

The costs and benefits resulting from this change are similar to

those discussed the cost benefit sections related to Sec. Sec. 1.23

and 1.11, but affect 30.7 Customer funds rather than futures customer

funds, and therefore are in addition to the costs and benefits

discussed in cost benefit considerations sections related to Sec. Sec.

1.23 and 1.11.

5. Require that 30.7 Customer Funds deposited in a bank must be

available for immediate withdrawal at the request of the FCM

The costs and benefits resulting from this change are similar to

those discussed cost benefit considerations sections related to

Sec. Sec. 1.20, but affect 30.7 Customer Funds rather than futures

customer funds, and therefore are in addition to the costs and benefits

discussed in the cost benefit considerations section related to Sec.

1.20.

6. Clarification that the FCM is responsible for any losses related

to investing 30.7 Customer Funds in investments that comply with Sec.

1.25

The costs and benefits resulting from this change are similar to

those discussed in the cost benefit considerations section related to

Sec. 1.29, but affect 30.7 Customer Funds rather than futures customer

funds, and therefore are in addition to the costs and benefits

discussed in the cost benefit considerations sections related to

Sec. Sec. 1.20 and 1.29.

7. Prohibition against making unsecured loans to customers and

against using the funds in the customer's trading account as security

for the loan

The costs and benefits resulting from this change are similar to

those discussed the cost benefit considerations section related to

Sec. 1.30, but affect 30.7 Customer funds rather than futures customer

funds, and therefore are in addition to the costs and benefits

discussed in that section.

8. Require daily segregation reports and segregated investment

detail reports be submitted to the Commission and DSRO, and that

targeted residual interest be included in those reports

The costs and benefits resulting from this change are similar to

those discussed the cost benefit considerations sections related to

Sec. 1.32, but affect 30.7 Customer funds rather than futures customer

funds, and therefore are in addition to the costs and benefits

discussed in that section.

9. Allow FCMs that are not dual registrants to abide by the BD

procedure for assigning a smaller haircut to investments purchased with

customer funds that have low default risk

The costs and benefits resulting from this change are similar to

those discussed in the cost benefit sections related to Sec. Sec. 1.32

and 22.2, but affect 30.7 Customer funds rather than futures customer

funds, and therefore are in addition to the costs and benefits

discussed in those sections.

Question

Question 33: However, the Commission requests comment regarding the

extent to which 30.7 Customer funds held outside the United States may

be invested in instruments that are subject to reduced haircuts under

the proposed SEC rules, and the effect that will have on the capital

requirements of U.S. domiciled FCMs.

10. Proposed Sec. 30.7(c) limits the amount of funds from a 30.7

Account that can be held outside the U.S.

Funds held overseas are subject to different regulatory and

bankruptcy regimes that may not offer comparable protections for

customer funds, creating additional repatriation risks to those funds.

For example, if an FCM carrying 30.7 funds, some of which were held in

depositories outside the U.S., were to default, it is possible that the

Trustee would not be able to recover sufficient funds to repay all the

FCM's obligations to 30.7 Customers. As noted above, this is especially

true if the funds are deposited with an overseas affiliate of the FCM,

as the likelihood of coincident bankruptcies of affiliated financial

firms

[[Page 67928]]

is exceedingly high. In such an event, the funds held at the affiliate

would be distributed in accordance with the insolvency rules of the

foreign jurisdiction. In such a case each 30.7 Customer would likely

receive a pro-rata share of the funds that the Trustee is able recover,

when the Trustee is able to recover them. The proposed limit on amount

of funds that can be held outside the U.S. would ensure that as much of

the customers' funds as possible remain subject to the U.S. regulatory

and bankruptcy regimes, eliminating repatriation risk to those funds.

By eliminating this risk for a larger percentage of the 30.7 funds, the

proposed rule promotes higher recovery rates for 30.7 account funds if

the FCM defaults, which helps ensure that 30.7 Customers receive the

largest pro rata distribution possible.

Regarding costs, the proposed change effectively prohibits FCMs

from increasing the amount of 30.7 Customer Funds they hold overseas.

This restriction may reduce the return that FCMs may be able to achieve

through their investment of customer funds.

11. As described in the discussion of cost and benefit

considerations related to Sec. 1.22, by requiring that FCMs maintain

residual interest in segregated accounts, the proposed rule would

ensure that the FCM is not using one customer's funds to purchase,

margin, secure, or settle positions for another customer and when

combined with the reporting requirements in Sec. 30.7 would provide

the Commission and the public with sufficient information to verify

that FCMs are not using one customer's funds to purchase, margin,

secure or settle positions for another customer.

Regarding costs, by requiring FCMs to maintain residual interest in

their 30.7 Accounts that is greater than the sum of their 30.7

Customers' margin deficits, the proposed rule would create costs and

benefits that are substantially identical to those described in the

cost and benefit considerations related to Sec. 1.22. As discussed in

that section, the Commission does not have information to determine

whether FCMs typically maintain residual interest in their 30.7

Accounts that is greater than or less than the sum of their 30.7

Customers' margin deficits, and requests information sufficient to make

such a determination, and to quantify the associated costs, if any.

Additional Requests for Comment Related to the Commission's Proposed

Consideration of Costs and Benefits

Question 34: The Commission requests comment on all aspects of its

proposed consideration of the costs and benefits of the rulemaking.

More specifically, the Commission requests dollar estimates of the

costs and the value of the benefits of the proposed rules described

herein, including supporting data. In addition, the Commission requests

comment on whether there are additional costs or benefits related to

the proposed rules that the Commission should consider, as well as

whether there are alternative approaches that would be more effective

in light of the purpose of the proposal. Commenters should provide

analysis and empirical data to support their views on the costs and

benefits associated with the proposed rule.

Question 35: The Commission requests comment regarding the

different ways in which the proposed rules will impact FCMs that are

different sizes and that are operating with different business models.

In particular, are there any specific proposed requirements that would

be particularly costly for either small or large FCMs to follow? Are

there any specific proposed requirements that would be especially

costly for FCMs with a particular business model to follow? If so,

please explain and where possible please quantify specific costs.

Question 36: The Commission requests comment regarding the effects

of the proposed amendments on the composition of the FCM industry

including bank subsidiaries versus stand-alone FCMs, large versus

small, retail customer oriented versus wholesale, possible

consolidation, etc. Please explain and provide supporting data.

Question 37: The Commission also requests comment regarding the

potential impact of the proposed regulations on specific groups of

customers. Will the proposed rules make it more difficult for certain

groups of customers to obtain FCM services?

IV. Administrative Compliance

A. Regulatory Flexibility Act

The Regulatory Flexibility Act (``RFA'') \158\ requires Federal

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

regulations on small entities. The Commission has previously

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

Commission in evaluating the impact of its rules on small entities in

accordance with the RFA.\159\ The proposed regulations would affect

FCMs and DCOs. The Commission previously has determined that FCMs are

not small entities for purposes of the RFA, and, thus, the requirements

of the RFA do not apply to FCMs.\160\ The Commission's determination

was based, in part, upon the obligation of FCMs to meet the minimum

financial requirements established by the Commission to enhance the

protection of customers' segregated funds and protect the financial

condition of FCMs generally.\161\ The Commission also has previously

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

RFA.\162\ Accordingly, the Chairman, on behalf of the Commission,

hereby certifies pursuant to 5 U.S.C. 605(b) that the proposed

regulations will not have a significant economic impact on a

substantial number of small entities.

---------------------------------------------------------------------------

\158\ 5 U.S.C. 601 et seq.

\159\ 47 FR 18618 (Apr. 30, 1982).

\160\ Id. at 18619.

\161\ Id.

\162\ See 66 FR 45605, 45609, Aug. 29, 2001.

---------------------------------------------------------------------------

The Commission invites comments on the impact of this proposed

regulation on small entities.

B. Paperwork Reduction Act

The Paperwork Reduction Act (``PRA'') provides that a federal

agency may not conduct or sponsor, and a person is not required to

respond to, a collection of information unless it displays a currently

valid control number issued by the Office of Management and Budget

(``OMB''). This proposed rulemaking contains several collections of

information that have not been approved previously by OMB. The

collections contained in this rulemaking are proposed to be mandatory.

To avoid double accounting for the PRA burden hours of collections

that already have been assigned control numbers by OMB, or for burden

hours contained in pending collections of information--in particular

existing collection 3038-0024 and proposed revisions thereto, and

existing collections 3038-0052 and 3038-0091--this PRA analysis

contains only burden estimates for collections of information that have

not previously been submitted to OMB. The Commission seeks comment on

those collections of information contained in this rulemaking that

would increase the burden hours contained in each of the related

currently valid or proposed collections.

In particular, the Commission will submit to OMB information

collection requests (``ICR'') that address the new collection burdens

that would result from the finalization of these proposed rules on or

before the publication of the proposed rules, as required by 44 U.S.C.

3506(c)(2)(B) and 5 CFR 1320.11. All interested parties may submit

comments

[[Page 67929]]

on this analysis and the associated ICR to the Commission and to OMB,

as provided below.

The Commission will protect proprietary information according to

the Freedom of Information Act (``FOIA'') and 17 CFR part 145,

``Commission Records and Information.'' In addition, section 8(a)(1) of

the Act strictly prohibits the Commission, unless specifically

authorized by the Act, from making public ``data and information that

would separately disclose the business transactions or market positions

of any person and trade secrets or names of customers.'' The Commission

is also required to protect certain information contained in a

government system of records according to the Privacy Act of 1974.

1. Collections of Information

The proposed amendments would require FCMs to adopt new policies

and procedures, keep records related to such policies and procedures

and submit reports of such policies and procedures, including certain

management approvals, to the Commission. In addition, the proposals

alter existing FCM reporting requirements in process and substance,

including changes to certain schedules and proposed schedules to the

Form 1-FR-FCM (the Segregation Schedule and Secured Amount Schedule);

changes to the process for filing such schedules and additional

frequency for such filings; and requiring detailed information

supporting such schedules to also be reported to the Commission and the

FCM's designated self-regulatory organization.

Further FCMs and depositories accepting customer funds will be

required to obtain acknowledgment letters in specified formats and file

them directly with the Commission and the FCM's designated self-

regulatory organization. Records will have to be kept of approvals of

certain withdrawals made of an FCM's residual interest in customer

funds and further reported to the Commission. Additional notices will

also be required to be filed with the Commission under the proposed

amendments. The examination process of SROs and DSROs is proposed to be

amended with new recordkeeping and reporting requirements being

imposed, as well as a required report to be obtained from an

examinations expert and filed with the Commission. Lastly, disclosures

made by FCMs to customers will be enhanced and records of such

disclosures will have to be maintained and reported to the Commission.

As noted, some of these proposed amendments will result in the

alteration of existing regulations covered by existing collections

which have already been assigned OMB control numbers. Others will

result in additional or new collection burdens, which will be

incorporated into the most relevant existing collection maintained by

the Commission and previously approved by or submitted for approval to

OMB.

a. Proposed Revision to Collection 3038-0024

Collection 3038-0024 is currently in force, with its control number

having been provided by OMB. In addition, the collection was proposed

to be revised in May 2011, with the approval of and issuance of a

control number by OMB presently pending. Certain collections contained

in this rulemaking would result in further revisions to the collection,

as discussed herein.

First, the Segregation Schedules and the Secured Amount Schedule,

required to be filed under Sec. 1.10, have been proposed to be changed

to reflect the FCM's target for residual amounts and the sum of margin

deficits. The proposed amendments will also increase the frequency of

filing these schedules to daily under Sec. Sec. 1.32 and 30.7.

However, daily computations were previously required with respect to

the subject matter of these schedules and monthly filing procedure for

these schedules is already in place, and these schedules are already

subject to an OMB control number. Thus, the revision of collection

3038-0024 requires only incremental change to capture the new elements

of Sec. 1.10. One time initial system changes, if any, that will need

to be made to effect daily filing of the detail previously required in

the monthly report is anticipated to require between 40 and 80 burden

hours for the approximately 72 firms required to comply with the new

provisions of Sec. 1.10, depending on the size of the firm the

complexity of their systems. The additional filing requirement, which

may be effected electronically by the approximately 72 firms that will

be required to make daily filings, is anticipated to increase the

burdens associated with Sec. 1.10 by an anticipated 10-20 minutes for

each of the approximately 20 days per month that such reports were not

previously required to be filed.

Additionally, the proposed amendments include new requirements for

FCMs to establish comprehensive risk management programs under new

Sec. 1.11, and maintain associated recordkeeping as well as furnish

reports related to such risk management programs to the Commission and

the FCM's DSRO. Included within the risk management programs will be

specific requirements for FCMs to establish and maintain written

policies and procedures regarding the safeguarding of all customer

funds.

Collection burdens associated with the safeguarding of customer

funds under the Commission's regulations prior to the proposed

amendments are already subject to OMB control numbers. Accordingly, the

proposed revisions to collection 3038-0024 require only incremental

change to capture the new elements of Sec. 1.11. The estimated burden

associated with Sec. 1.11 will be divided into two components, a

onetime cost to establish the written policies and procedures and an

annual burden to maintain the such policies and procedures. Currently

there are 72 respondents subject to this change, many of which are

expected simply to establish and maintain policies and procedures

around their existing risk management programs. The estimated number of

hours to create the initial set of policies and procedures by

consolidation of existing risk management practices is anticipated to

average 75 hours across the 72 respondents that will be obligated to

comply. The estimated total annual maintenance burden on each

respondent is anticipated increase by an average 25 hours annually

across the 72 recordkeepers.

The collection is further being revised to reflect additional

proposed requirements for notifications under Sec. 1.12, and the

additional required filings contained in the proposed amendments under

Sec. Sec. 1.20, 1.23, 1.32, and 30.7. Currently there are 72

respondents estimated to be subject to these changes. The total of all

proposed changes to the Schedules of the Form 1-FR, which is already

subject to an OMB control number, is anticipated to be incremental, and

it is estimated that the proposed changes will add 15 minutes to the

preparation and filing of each report.

The proposed revision to Sec. 1.12(i) will require FCMs to report

to the Commission if the FCM discovers or is informed that it has

invested funds held for futures customers in instruments that are not

permitted investments under Sec. 1.25. This new report will be done on

an as required basis. It is estimated that this report will be

completed by two respondents per year with a burden of one hour for

each report.

The proposed revision to Sec. 1.12(j) will require FCMs to

immediately report to the Commission if a withdrawal of funds from

accounts holding futures customers funds causes the amount on

[[Page 67930]]

deposit in such accounts to be less than the FCM's targeted excess or

residual interest in such accounts, or if the residual interest is less

than the sum of all margin deficits. The accounting needed to make

these reports is already conducted under the Commission's regulations

for the purpose of ensuring compliance with the Commission's existing

customer protection regulations. Once an event requiring notice is

identified, it is anticipated that five respondents per year will be

obligated to provide notices to the Commission under Sec. 1.12(j),

with an additional burden of up to two hours for each notice.

The Commission is also proposing to amend paragraphs (k) and (l) of

Sec. 1.12 which will require an FCM to provide notice to the

Commission in the event of a material change in the financial condition

of the firm or the firm's operations. These new reports each will be

prepared and submitted on an as required basis, and are similar to

other notices required to be filed by FCMs in Parts 1 and 190, for

example, of the Commission's regulations. Moreover, FCMs are already

subject to significant regulations in Part 1 that require each FCM to

continuously monitor their financial condition and report shortfalls in

net capital. It is estimated that the notices that would be required

under paragraphs (k) and (l) of Sec. 1.12 will be made by five

respondents per year with a burden of up to three hours for each

notice.

FCMs will be required under Sec. 1.20 to obtain and submit to the

Commission written acknowledgments, in a form and format being proposed

and expected to be required by the Commission, from any depository

institution, including certain DCOs, at which futures customer funds

will be segregated. It is estimated that the execution and filing of

new acknowledgment letters will be completed by five respondents per

year with a burden of up to two hours for completion and filing. It is

estimated that the maintaining of acknowledgment letters prescribed by

the Commission will be conducted by as many as 40 depository

institutions annually with an estimated burden of 45 minutes per

respondent.

FCMs are currently required to obtain and maintain in its files an

acknowledgment letter from depositories for each account holding

customer funds, in the form specified by the Commission. The obtaining

and maintaining of the acknowledgement letters will be done on an as

required basis and are already subject to an OMB control number.

Proposed revisions to Sec. 1.20(d) additionally would require FCMs to

retain and file these acknowledgment letters electronically with the

Commission. This new retention and filing will be done on an as

required basis. It is estimated that the filing of an estimated 1 to 2

new acknowledgment letters will be conducted by 72 respondents per

year, with a burden of 30 minutes associated with the retention and

filing of each of these acknowledgments.

Finally with respect to Sec. 1.20, a derivatives clearing

organization may adopt and submit to the Commission rules providing for

the segregation of customer funds that may be carried by the DCO that

would substitute for the acknowledgment letters completed by other

depositories. It is anticipated that approximately 17 of the DCOs

registered with the Commission will adopt and submit such rules, with

an estimated burden of 45 hours for the adoption and submission of such

rules. The DCO also must obtain acknowledgment letters from any

depository institution at which the DCO places segregated funds, and

these depository institutions must provide the Commission with direct

access to the customer account information at all times. It is

anticipated that as many as 40 depository institutions may complete

such letters, and provide ongoing access to the Commission, with a one-

time burden of 45 minutes per respondent for the completion of such

letters, and an estimated annual burden of 60 hours associated with

providing account access to the Commission.

Similarly, Sec. 30.7(d) is being revised to require FCMs that

maintain 30.7 Customer Accounts to obtain and maintain in its files, an

acknowledgment letter from depositories for each account holding 30.7

Customer Funds, in the form specified by the Commission, and Sec. 1.26

provides for the same from any institution segregating customer funds

in a money market mutual fund account. The proposed revisions to these

regulations require FCMs to file such acknowledgment letters

electronically with the Commission. The obtaining and maintaining of

the acknowledgement letters will be done on an as required basis. It is

estimated that the maintaining of acknowledgment letters will be

completed by 56 respondents with a burden of 45 minutes per respondent.

The completion of the acknowledgment letters by the depositories,

estimated at approximately 90 institutions, is expected to be 45

minutes per letter. Additionally, the requirement that these

acknowledgement letters be electronically filed with the Commission is

anticipated to result in 6 minutes of burden to 56 respondents per year

with respect to the proposed revisions to Sec. 30.7 and the same for

the proposed revisions to Sec. 1.26.

The Commission is also proposing to amend Sec. 1.23(c) to require

an FCM to immediately file written notice with the Commission if the

firm withdraws more than 25 percent of its residual interest in

segregated accounts. This new filing will be done on an as required

basis. It is estimated that the filing of these notices will be

completed by ten respondents per year with a burden of one hour for

each filing.

Pursuant to the proposed revisions of Sec. Sec. 1.32(c) and (d),

the Segregation Statement shall be completed on a daily basis and filed

by noon the following business day. Although the rule proposed herein

now require daily filing of the Segregation Statement, it should be

noted that the Segregation Statement is statement is already required

to be prepared and retained on a daily basis, thus the additional time

electronically filing the statement on a daily basis is minimal.

Currently there are 72 respondents subject to this change. The

estimated total annual burden on each respondent is 2 hours.

Pursuant to the proposed revisions of Sec. 1.32(g) each FCM that

holds customer funds is required to file the segregated investment

detail report twice monthly. Although the rule proposed herein requires

twice monthly filing of the segregated investment detail report, it

should be noted that the segregated investment detail report is already

required to be prepared twice monthly by the FCM's designated self-

regulatory organization. Thus the additional time to electronically

file the statement with the Commission is minimal. Currently there are

72 respondents subject to this change. The estimated total annual

burden on each respondent is 5 minutes per report.

Similar to the proposed revisions of Sec. 1.32 discussed above,

Sec. 30.7(m) requires that the Statement of Secured Amounts shall be

completed on a daily basis and filed electronically by noon the

following business day. Although the rule proposed herein now require

daily filing of the Secured Amounts Statement, it should be noted that

the Secured Amounts is statement is already required to be prepared and

retained on a daily basis, thus the additional time electronically

filing the statement on a daily basis is minimal. Currently there are

56 respondents subject to this change. The estimated total annual

burden on each respondent is 2 hours.

[[Page 67931]]

Revisions to Sec. 30.7(i) will also require that FCMs keep records

of customer funds including a daily valuation of each instrument and

supporting documentation of such daily valuation. Currently there are

56 respondents subject to this change. The estimated total annual

burden on each respondent is 100 hours.

Finally, Sec. 1.55 would require public disclosures to be made by

an FCM to its customers respecting the limitations applicable to and

risks associated with the segregation of funds, among other things. It

is anticipated that 72 FCMs will provide such notices through the

standardization of account opening documents or distribution of the

notices therewith. Each FCM is expected to expend up to 4-20 hours

incorporating the notice, which is prescribed by regulation, into its

account opening process for customers that will establish new accounts,

and up to 10 minutes per customer providing the notices on a one-time

basis to as many as 3,000 customers and accounts opened by existing

customers.

b. Proposed Revision to Collection 3038-0052

The above-referenced collection titled ``Part 38--Designated

Contract Markets'' includes all burden associated with Sec. 1.52,

``Self-regulatory organization adoption and surveillance of minimum

financial requirements''. The proposed amendments include additional

requirements for SROs to adopt for their examination procedures,

including the requirement to have examination programs reviewed by an

examinations expert and having the report of such examinations expert

filed with the Commission at least once every two years. Regulation

1.52 already contains significant requirements with respect to the

examination programs to be established and maintained by SROs, which

are subject already to an OMB control number. The increase in the

burden under this collection for the adoption of enhanced examination

procedures, including the recordkeeping and reporting, to the extent

such may be necessary by any SRO to which Sec. 1.52 is necessary, is

estimated to add up to 50 burden hours to as many as 15 DCMs.

c. Proposed Revision to Collection 3038-0091

Collection 3038-0091was established with the adoption of Part 22 of

the Commissions regulations concerning Cleared Swaps in .February 2012

The proposed amendments would require revisions to this collection with

respect to recordkeeping and reporting associated with additional

filings of the Cleared Swaps Segregation Schedule daily under Sec.

22.2(g), and the associated recordkeeping and reporting with respect to

notices of withdrawals under a newly proposed Sec. 22.17. The

collection burden associated with the proposed amendments is

anticipated to increase by 10 minutes per day and is anticipated to

affect 100 entities.

2. Information Collection Comments

The Commission invites the public and other Federal agencies to

comment on any aspect of the proposed information collection

requirements discussed above. Pursuant to 44 U.S.C. 3506(c)(2)(B), the

Commission will consider public comments on such proposed requirements

in:

[cir] Evaluating whether the proposed collections of information

are necessary for the proper performance of the functions of the

Commission, including whether the information will have a practical

use;

[cir] Evaluating the accuracy of the estimated burden of the

proposed information collection requirements, including the degree to

which the methodology and the assumptions that the Commission employed

were valid;

[cir] Enhancing the quality, utility, and clarity of the

information proposed to be collected; and

[cir] Minimizing the burden of the proposed information collection

requirements on FCMs, SDs, and MSPs, including through the use of

appropriate automated, electronic, mechanical, or other technological

information collection techniques, e.g., permitting electronic

submission of responses.

Copies of the submission from the Commission to OMB are available

from the CFTC Clearance Officer, 1155 21st Street NW., Washington, DC

20581, (202) 418-5160 or from http://RegInfo.gov. Organizations and

individuals desiring to submit comments on the proposed information

collection requirements should send those comments to the OMB Office of

Information and Regulatory Affairs at:

[cir] The Office of Information and Regulatory Affairs, Office of

Management and Budget, Room 10235, New Executive Office Building,

Washington, DC 20503, Attn: Desk Officer of the Commodity Futures

Trading Commission;

[cir] (202) 395-6566 (fax); or

[cir] [email protected] (email).

Please provide the Commission with a copy of submitted comments so

that all comments can be summarized and addressed in the final

rulemaking. Please refer to the ADDRESSES section of this rulemaking

for instructions on submitting comments to the Commission. OMB is

required to make a decision concerning the proposed information

collection requirements between thirty (30) and sixty (60) days after

publication of the NPRM in the Federal Register. Therefore, a comment

to OMB is best assured of receiving full consideration if OMB (as well

as the Commission) receives it within thirty (30) days of publication

of this NPRM. The time frame for commenting on the PRA does not affect

the deadline established by the Commission on the proposed rules,

provided in the DATES section of this rulemaking.

V. Text of Proposed Rules

List of Subjects

17 CFR Part 1

Brokers, Commodity futures, Consumer protection, Reporting and

recordkeeping requirements.

17 CFR Part 3

Associated persons, Brokers, Commodity futures, Customer

protection, Major swap participants, Registration, Swap dealers.

17 CFR Part 22

Brokers, Clearing, Consumer protection, Reporting and recordkeeping

requirements, Swaps.

17 CFR Part 30

Commodity futures, Consumer protection, Currency, Reporting and

recordkeeping requirements.

17 CFR Part 140

Authority delegations (Government agencies), Organization and

functions (Government agencies).

In consideration of the foregoing and pursuant to the authority

contained in the Act, as indicated herein, the Commission hereby

proposes to amend chapter I of title 17 of the Code of Federal

Regulations as follows:

PART 1--GENERAL REGULATIONS UNDER THE COMMODITY EXCHANGE ACT

1. The authority citation for part 1 continues to be read as

follows:

Authority: 7 U.S.C. 1a, 2, 5, 6, 6a, 6b, 6c, 6d, 6e, 6f, 6g,

6h, 6i, 6j, 6k, 6m, 6n, 6o, 6p, 6r, 6s, 7, 7a, 7b, 8, 9, 10a 12,

12a, 12c, 13a, 13a-1, 16, 16a, 19, 21, 23, and 24 as amended by

Title VII of the Dodd-Frank Wall Street Reform and Consumer

Protection Act, Pub. L. 111-203, 124 Stat. 1376 (2010).

2. Amend Sec. 1.3 by revising paragraph (rr) to read as follows:

[[Page 67932]]

Sec. 1.3 Definitions.

* * * * *

(rr) Foreign futures or foreign options secured amount. This term

means all money, securities and property received by a futures

commission merchant from, for, or on behalf of 30.7 Customers as

defined in Sec. 30.1 of this chapter:

(1) To margin, guarantee, or secure foreign futures contracts and

all money accruing to such 30.7 Customers as the result of such

contracts;

(2) In connection with foreign options transactions representing

premiums payable or premiums received, or to guarantee or secure

performance on such transactions; and

(3) All money accruing to such 30.7 Customers as the result of

trading in foreign futures contracts or foreign options.

* * * * *

3. Amend Sec. 1.10 by:

a. Revising paragraph (b)(1)(ii);

b. Adding paragraph (b)(5); and

c. Revising paragraphs (c)(1), (c)(2)(i), (d)(1)(v), (d)(2)(iv),

(d)(2)(vi), and (g)(2)(ii).

The revisions and addition read as follows:

Sec. 1.10 Financial reports of futures commission merchants and

introducing brokers.

* * * * *

(b) * * *

(1) * * *

(ii) In addition to the monthly financial reports required by

paragraph (b)(1)(i) of this section, each person registered as a

futures commission merchant must file a Form 1-FR-FCM as of the close

of its fiscal year, which must be certified by an independent public

accountant in accordance with Sec. 1.16, and must be filed no later

than 60 days after the close of the futures commission merchant's

fiscal year: Provided, however, that a registrant which is registered

with the Securities and Exchange Commission as a securities broker or

dealer must file this report not later than the time permitted for

filing an annual audit report under Sec. 240.17a-5(d)(5) of this

title.

* * * * *

(5) Each futures commission merchant must file with the Commission

the measure of the future commission merchant's leverage (i.e., total

balance sheet assets, less any instruments guaranteed by the U.S.

Government and held as an asset or to collateralize an asset (e.g., a

reverse repo) divided by total capital (the sum of stockholders' equity

and subordinated debt) all computed in accordance with U.S. generally

accepted accounting principles as of the close of business each month.

The filing is required to be made to the Commission within 17 business

days of the close of the futures commission merchant's month end.

(c) Where to file reports. (1) Form 1-FR filed by an introducing

broker pursuant to paragraph (b)(2) of this section need be filed only

with, and will be considered filed when received by, the National

Futures Association. Other reports or information provided for in this

section will be considered filed when received by the Regional office

of the Commission with jurisdiction over the state in which the

registrant's principal place of business is located (as set forth in

Sec. 140.02 of this chapter) and by the designated self-regulatory

organization, if any; and reports or other information required to be

filed by this section by an applicant for registration will be

considered filed when received by the National Futures Association. Any

report or information filed with the National Futures Association

pursuant to this paragraph shall be deemed for all purposes to be filed

with, and to be the official record of, the Commission.

(2)(i) All filings or other notices prepared by a futures

commission merchant pursuant to this section must be submitted to the

Commission in electronic form using a form of user authentication

assigned in accordance with procedures established by or approved by

the Commission, and otherwise in accordance with instructions issued by

or approved by the Commission, if the futures commission merchant or a

designated self-regulatory organization has provided the Commission

with the means necessary to read and to process the information

contained in such report. A Form 1-FR required to be certified by an

independent public accountant in accordance with Sec. 1.16 which is

filed by a futures commission merchant must be filed electronically.

* * * * *

(d) * * *

(1) * * *

(v) For a futures commission merchant only, the statements of

segregation requirements and funds in segregation for customers trading

on U.S. commodity exchanges and for customers' dealer options accounts,

the statement of secured amounts and funds held in separate accounts

for 30.7 Customers (as defined in Sec. 30.1 of this chapter) in

accordance with Sec. 30.7 of this chapter, and the statement of

cleared swaps customer segregation requirements and funds in cleared

swaps customer accounts under section 4d(f) of the Act as of the date

for which the report is made; and

* * * * *

(2) * * *

(iv) For a futures commission merchant only, the statements of

segregation requirements and funds in segregation for customers trading

on U.S. commodity exchanges and for customers' dealer options accounts,

the statement of secured amounts and funds held in separate accounts

for 30.7 Customers (as defined in Sec. 30.1 of this chapter) in

accordance with Sec. 30.7 of the chapter, and the statement of cleared

swaps customers segregation requirements and funds in cleared swaps

customer accounts under section 4d(f) of the Act as of the date for

which the report is made;

* * * * *

(vi) A reconciliation, including appropriate explanations, of the

statement of the computation of the minimum capital requirements

pursuant to Sec. 1.17 of this part and, for a futures commission

merchant only, the statements of segregation requirements and funds in

segregation for customers trading on U.S. commodity exchanges and for

customers' dealer option accounts, the statement of secured amounts and

funds held in separate accounts for 30.7 Customers (as defined in Sec.

30.1 of this chapter) in accordance with Sec. 30.7 of this chapter,

and the statement of cleared swaps customer segregation requirements

and funds in cleared swaps customer accounts under section 4d(f) of the

Act, in the certified Form 1-FR with the applicant's or registrant's

corresponding uncertified most recent Form 1-FR filing when material

differences exist or, if no material differences exist, a statement so

indicating; and

* * * * *

(g) * * *

(2) * * *

(ii) The following statements and footnote disclosures thereof: the

Statement of Financial Condition in the certified annual financial

reports of futures commission merchants and introducing brokers; the

Statements (to be filed by a futures commission merchant only) of

Segregation Requirements and Funds in Segregation for customers trading

on U.S. commodity exchanges and for customers' dealer options accounts,

the Statement (to be filed by a futures commission merchant only) of

Secured Amounts and Funds held in Separate Accounts for 30.7 Customers

(as defined in Sec. 30.1of this chapter) in accordance with Sec. 30.7

of this chapter, and the Statement (to be filed by futures

[[Page 67933]]

commission merchants only) of Cleared Swaps Customer Segregation

Requirements and Funds in Cleared Swaps Customer Accounts under section

4d(f) of the Act.

* * * * *

4. Add Sec. 1.11 to read as follows:

Sec. 1.11 Risk Management Program for Futures Commission Merchants.

(a) Applicability. Nothing in this section shall apply to a futures

commission merchant that does not accept any money, securities, or

property (or extend credit in lieu thereof) to margin, guarantee, or

secure any trades or contracts that result from soliciting or accepting

orders for the purchase or sale of any commodity interest.

(b) Definitions. For purposes of this section:

(1) ``Business Unit'' means any department, division, group, or

personnel of a futures commission merchant or any of its affiliates,

whether or not identified as such that:

(i) Engages in soliciting or in accepting orders for the purchase

or sale of any commodity interest and that, in or in connection with

such solicitation or acceptance of orders, accepts any money,

securities, or property (or extends credit in lieu thereof) to margin,

guarantee, or secure any trades or contracts that result or may result

therefrom; or

(ii) Otherwise handles Segregated Funds, including managing,

investing, and overseeing the custody of Segregated Funds, or any

documentation in connection therewith, other than for risk management

purposes; and

(iii) Any personnel exercising direct supervisory authority of the

performance of the activities described in paragraph (b)(1)(i) or (ii)

of this section.

(2) ``Customer'' means a futures customer as defined at Sec. 1.3

of this part, Cleared Swaps Customer as defined at Sec. 22.1 of this

chapter, and 30.7 Customer as defined at Sec. 30.1 of this chapter.

(3) ``Governing Body'' means the proprietor, if the futures

commission merchant is a sole proprietorship; a general partner, if the

futures commission merchant is a partnership; the board of directors if

the futures commission merchant is a corporation; the chief executive

officer, the chief financial officer, the manager, the managing member,

or those members vested with the management authority if the futures

commission merchant is a limited liability company or limited liability

partnership.

(4) ``Segregated Funds'' means money, securities, or other property

held by a futures commission merchant in separate accounts pursuant to

Sec. 1.20 of this part for futures customers, pursuant to Sec. 22.2

of this chapter for Cleared Swaps Customers, and pursuant to Sec. 30.7

of this chapter for Sec. 30.7 Customers; and

(5) ``Senior Management'' means, any officer or officers

specifically granted the authority and responsibility to fulfill the

requirements of senior management by the Governing Body.

(c) Risk Management Program. (1) Each futures commission merchant

shall establish, maintain, and enforce a system of risk management

policies and procedures designed to monitor and manage the risks

associated with the activities of the futures commission merchant as

such. For purposes of this section, such policies and procedures shall

be referred to collectively as a ``Risk Management Program.''

(2) Each futures commission merchant shall maintain written

policies and procedures that describe the Risk Management Program of

the futures commission merchant.

(3) The Risk Management Program and the written risk management

policies and procedures, and any material changes thereto, shall be

approved in writing by the Governing Body of the futures commission

merchant.

(4) Each futures commission merchant shall furnish a copy of its

written risk management policies and procedures to the Commission and

its designated self-regulatory organization upon application for

registration and thereafter upon request.

(d) Risk management unit. As part of the Risk Management Program,

each futures commission merchant shall establish and maintain a risk

management unit with sufficient authority; qualified personnel; and

financial, operational, and other resources to carry out the risk

management program established pursuant to this section. The risk

management unit shall report directly to Senior Management and shall be

independent from the Business Unit.

(e) Elements of the Risk Management Program. The Risk Management

Program of each futures commission merchant shall include, at a

minimum, the following elements:

(1) Identification of risks and risk tolerance limits. (i) The Risk

Management Program shall take into account market, credit, liquidity,

foreign currency, legal, operational, settlement, segregation,

technological, capital, and any other applicable risks together with a

description of the risk tolerance limits set by the futures commission

merchant and the underlying methodology in the written policies and

procedures. The risk tolerance limits shall be reviewed and approved

quarterly by Senior Management and annually by the Governing Body.

Exceptions to risk tolerance limits shall be subject to written

policies and procedures.

(ii) The Risk Management Program shall take into account risks

posed by affiliates, all lines of business of the futures commission

merchant, and all other trading activity engaged in by the futures

commission merchant. The Risk Management Program shall be integrated

into risk management at the consolidated entity level.

(iii) The Risk Management Program shall include policies and

procedures for detecting breaches of risk tolerance limits set by the

futures commission merchant, and alerting supervisors within the risk

management unit and Senior Management, as appropriate.

(2) Periodic Risk Exposure Reports. (i) The risk management unit of

each futures commission merchant shall provide to Senior Management and

to its Governing Body quarterly written reports setting forth all

applicable risk exposures of the futures commission merchant; any

recommended or completed changes to the Risk Management Program; the

recommended time frame for implementing recommended changes; and the

status of any incomplete implementation of previously recommended

changes to the Risk Management Program. For purposes of this section,

such reports shall be referred to as ``Risk Exposure Reports.'' The

Risk Exposure Reports also shall be provided to the Senior Management

and the Governing Body immediately upon detection of any material

change in the risk exposure of the futures commission merchant.

(ii) Furnishing to the Commission. Each futures commission merchant

shall furnish copies of its Risk Exposure Reports to the Commission

within five (5) business days of providing such reports to its Senior

Management.

(3) Specific risk management considerations. The Risk Management

Program of each futures commission merchant shall include, but not be

limited to, policies and procedures necessary to monitor and manage the

following risks:

(i) Segregation Risk. The written policies and procedures shall be

reasonably designed to ensure that Segregated Funds are separately

accounted for and segregated or secured as belonging to Customers as

required

[[Page 67934]]

by the Act and Commission regulations and must, at a minimum, include

or address the following:

(A) A process for the evaluation of depositories of Segregated

Funds, including, at a minimum, documented criteria that any depository

that will hold Segregated Funds, including an entity affiliated with

the futures commission merchant, must meet, including criteria

addressing the depository's capitalization, creditworthiness,

operational reliability, and access to liquidity. The criteria should

further consider the extent to which Segregated Funds are concentrated

with any depository or group of depositories. The criteria also should

include the availability of deposit insurance and the extent of the

regulation and supervision of the depository;

(B) A program to monitor an approved depository on an ongoing basis

to assess its continued satisfaction of the futures commission

merchant's established criteria, including a thorough due diligence

review of each depository at least annually;

(C) An account opening process for depositories, including

documented authorization requirements, procedures that ensure that

Segregated Funds are not deposited with a depository prior to the

futures commission merchant receiving the acknowledgment letter

required from such depository pursuant to Sec. 1.20 of this part, and

Sec. Sec. 22.2 and 30.7 of this chapter, and procedures that ensure

that such account is properly titled to reflect that it is holding

Segregated Funds pursuant to the Act and Commission regulations;

(D) A process for establishing a targeted amount of residual

interest that the futures commission merchant seeks to maintain as its

residual interest in the Segregated Funds accounts and such process

must be designed to reasonably ensure that the futures commission

merchant maintains the targeted residual amounts and remains in

compliance with the Segregated Funds requirements at all times. The

policies and procedures must require that Senior Management, in

establishing the total amount of the targeted residual interest in the

Segregated Funds accounts, perform appropriate due diligence and

consider various factors, as applicable, relating to the nature of the

futures commission merchant's business including, but not limited to,

the composition of the futures commission merchant's Customer base, the

general creditworthiness of the Customer base, the general trading

activity of the Customers, the types of markets and products traded by

the Customers, the proprietary trading of the futures commission

merchant, the general volatility and liquidity of the markets and

products traded by Customers, the futures commission merchant's own

liquidity and capital needs, and the historical trends in Customer

Segregated Fund balances, including margin debit and net deficit

balances in Customers' accounts. The analysis and calculation of the

targeted amount of the future commission merchant's residual interest

must be described in writing with the specificity necessary to allow

the Commission and the futures commission merchant's designated self-

regulatory organization to duplicate the analysis and calculation and

test the assumptions made by the futures commission merchant. The

adequacy of the targeted residual interest and the process for

establishing the targeted residual interest must be reassessed

periodically by Senior Management and revised as necessary;

(E) A process for the withdrawal of cash, securities, or other

property from accounts holding Segregated Funds, where the withdrawal

is not for the purpose of payments to or on behalf of the futures

commission merchant's Customers. Such policies and procedures must

satisfy the requirements of Sec. 1.23 of this part, Sec. 22.17 of

this chapter, or Sec. 30.7 of this chapter, as applicable;

(F) A process for assessing the appropriateness of specific

investments of Segregated Funds in permitted investments in accordance

with Sec. 1.25 of this part. Such policies and procedures must take

into consideration the market, credit, counterparty, operational, and

liquidity risks associated with such investments, and assess whether

such investments comply with the requirements in Sec. 1.25 of this

part including that the futures commission merchant manage the

permitted investments consistent with the objectives of preserving

principal and maintaining liquidity;

(H) Procedures requiring the appropriate separation of duties among

individuals responsible for compliance with the Act and Commission

regulations relating to the protection and financial reporting of

Segregated Funds, including the separation of duties among personnel

that are responsible for advising customers on trading activities,

approving or overseeing cash receipts and disbursements (including

investment operations), and recording and reporting financial

transactions. The policies and procedures must require that any

movement of funds to affiliated companies and parties are properly

approved and documented;

(I) A process for the timely recording of all transactions,

including transactions impacting Customers' accounts, in the firm's

books of record;

(J) A program for conducting annual training of all finance,

treasury, operations, regulatory, compliance, settlement, and other

relevant officers and employees regarding the segregation requirements

for Segregated Funds required by the Act and regulations, the

requirements for notices under Sec. 1.12 of this part, procedures for

reporting of suspected breaches of the policies and procedures required

by this section to the chief compliance officer, without fear of

retaliation, and the consequences of failing to comply with the

segregation requirements of the Act and regulations; and

(K) Policies and procedures for assessing the liquidity,

marketability and mark-to-market valuation of all securities or other

non-cash assets held as Segregated Funds, including permitted

investments under Sec. 1.25 of this part, to ensure that all non-cash

assets held in the Customer segregated accounts, both customer-owned

securities and investments in accordance with Sec. 1.25 of this part,

are readily marketable and highly liquid. Such policies and procedures

must require daily measurement of liquidity needs with respect to

Customers; assessment of procedures to liquidate all non-cash

collateral in a timely manner and without significant effect on price;

and application of appropriate collateral haircuts that accurately

reflect market and credit risk.

(ii) Operational Risk. The Risk Management Program shall include

automated financial risk management controls reasonably designed to

prevent the placing of erroneous orders, including those that exceed

pre-set capital, credit, or volume thresholds. The Risk Management

Program shall ensure that the use of automated trading programs is

subject to policies and procedures governing the use, supervision,

maintenance, testing, and inspection of such programs.

(iii) Capital Risk. The written policies and procedures shall be

reasonably designed to ensure that the futures commission merchant has

sufficient capital to be in compliance with the Act and the

regulations, and sufficient capital and liquidity to meet the

reasonably foreseeable needs of the futures commission merchant.

(4) Supervision of the Risk Management Program. The Risk Management

Program shall include a supervisory system that is reasonably

[[Page 67935]]

designed to ensure that the policies and procedures required by this

section are diligently followed.

(f) Review and testing. (1) The Risk Management Program of each

futures commission merchant shall be reviewed and tested on at least an

annual basis, or upon any material change in the business of the

futures commission merchant that is reasonably likely to alter the risk

profile of the futures commission merchant.

(2) The annual reviews of the Risk Management Program shall include

an analysis of adherence to, and the effectiveness of, the risk

management policies and procedures, and any recommendations for

modifications to the Risk Management Program. The annual testing shall

be performed by qualified internal audit staff that are independent of

the Business Unit or by a qualified third party audit service reporting

to staff that are independent of the Business Unit. The results of the

annual review of the Risk Management Program shall be promptly reported

to and reviewed by the chief compliance officer, Senior Management, and

Governing Body of the futures commission merchant.

(3) Each futures commission merchant shall document all internal

and external reviews and testing of its Risk Management Program and

written risk management policies and procedures including the date of

the review or test; the results; any deficiencies identified; the

corrective action taken; and the date that corrective action was taken.

Such documentation shall be provided to Commission staff, upon request.

(g) Distribution of risk management policies and procedures. The

Risk Management Program shall include procedures for the timely

distribution of its written risk management policies and procedures to

relevant supervisory personnel. Each futures commission merchant shall

maintain records of the persons to whom the risk management policies

and procedures were distributed and when they were distributed.

(h) Recordkeeping. (1) Each futures commission merchant shall

maintain copies of all written approvals required by this section.

(2) All records or reports, including, but not limited to, the

written policies and procedures and any changes thereto, that a futures

commission merchant is required to maintain pursuant to this regulation

shall be maintained in accordance with Sec. 1.31 and shall be made

available promptly upon request to representatives of the Commission.

5. Amend Sec. 1.12 by revising paragraphs (a)(1) and (2), (b)(1),

(2), and (4), (c), (d), (e), (f)(2) through (4), (f)(5)(i), (g), (h),

and (i), and by adding new paragraphs (j), (k), (l), (m), and (n), to

read as follows:

Sec. 1.12 Maintenance of minimum financial requirements by futures

commission merchants and introducing brokers.

(a) * * *

(1) Give notice, as set forth in paragraph (n) of this section,

that the applicant's or registrant's adjusted net capital is less than

required by Sec. 1.17 of this part or by other capital rule,

identifying the applicable capital rule. The notice must be given

immediately after the applicant or registrant knows or should have

known that its adjusted net capital is less than required by any of the

aforesaid rules to which the applicant or registrant is subject; and

(2) Provide together with such notice documentation, in such form

as necessary, to adequately reflect the applicant's or registrant's

capital condition as of any date on which such person's adjusted net

capital is less than the minimum required; Provided, however, that if

the applicant or registrant cannot calculate or otherwise immediately

determine its financial condition, it must provide the notice required

by paragraph (a)(1) of this section and include in such notice a

statement that the entity cannot presently calculate its financial

condition. The applicant or registrant must provide similar

documentation of its financial condition for other days as the

Commission may request.

(b) * * *

(1) 150 percent of the minimum dollar amount required by Sec.

1.17(a)(1)(i)(A) of this part;

(2) 110 percent of the amount required by Sec. 1.17(a)(1)(i)(B) of

this part;

* * * * *

(4) For securities brokers or dealers, the amount of net capital

specified in Rule 17a-11(c) of the Securities and Exchange Commission

(17 CFR 240.17a-11(c)), must file notice to that effect, as set forth

in paragraph (n) of this section, as soon as possible and no later than

twenty-four (24) hours of such event.

(c) If an applicant or registrant at any time fails to make or keep

current the books and records required by these regulations, such

applicant or registrant must, on the same day such event occurs,

provide notice of such fact as specified in paragraph (n) of this

section, specifying the books and records which have not been made or

which are not current, and as soon as possible, but not later than

forty-eight (48) hours after giving such notice, file a report as

required by paragraph (n) of this section stating what steps have been

and are being taken to correct the situation.

(d) Whenever any applicant or registrant discovers or is notified

by an independent public accountant, pursuant to Sec. 1.16(e)(2) of

this part, of the existence of any material inadequacy, as specified in

Sec. 1.16(d)(2) of this part, such applicant or registrant must give

notice of such material inadequacy, as provided in paragraph (n) of

this section, as soon as possible but not later than twenty-four (24)

hours of discovering or being notified of the material inadequacy. The

applicant or registrant must file, in the manner provided for under

paragraph (n) of this section, a report stating what steps have been

and are being taken to correct the material inadequacy within forty-

eight (48) hours of filing its notice of the material inadequacy.

(e) Whenever any self-regulatory organization learns that a member

registrant has failed to file a notice or report as required by this

section, that self-regulatory organization must immediately report this

failure by notice, as provided in paragraph (n) of this section.

(f) * * *

(2) Whenever a registered futures commission merchant determines

that any position it carries for another registered futures commission

merchant or for a registered leverage transaction merchant must be

liquidated immediately, transferred immediately or that the trading of

any account of such futures commission merchant or leverage transaction

merchant shall be only for purposes of liquidation, because the other

futures commission merchant or the leverage transaction merchant has

failed to meet a call for margin or to make other required deposits,

the carrying futures commission merchant must immediately give notice,

as provided in paragraph (n) of this section, of such a determination.

(3) Whenever a registered futures commission merchant determines

that an account which it is carrying is undermargined by an amount

which exceeds the futures commission merchant's adjusted net capital

determined in accordance with Sec. 1.17 of this part, the futures

commission merchant must immediately provide notice, as provided in

paragraph (n) of this section, of such a determination to the

designated self-regulatory organization and the Commission. This

paragraph (f)(3) shall apply to any account carried by the futures

[[Page 67936]]

commission merchant, whether a customer, noncustomer, omnibus or

proprietary account. For purposes of this paragraph (f)(3), if any

person has an interest of 10 percent or more in ownership or equity in,

or guarantees, more than one account, or has guaranteed an account in

addition to its own account, all such accounts shall be combined.

(4) A futures commission merchant shall provide immediate notice,

as provided in paragraph (n) of this section, whenever any commodity

interest account it carries is subject to a margin call, or call for

other deposits required by the futures commission merchant, that

exceeds the futures commission merchant's excess adjusted net capital,

determined in accordance with Sec. 1.17 of this part, and such call

has not been answered by the close of business on the day following the

issuance of the call. This applies to all accounts carried by the

futures commission merchant, whether customer, noncustomer, or omnibus,

that are subject to margining, including commodity futures, cleared

swaps, and options. In addition to actual margin deposits by an account

owner, a futures commission merchant may also take account of favorable

market moves in determining whether the margin call is required to be

reported under this paragraph.

(5)(i) A futures commission merchant shall provide immediate

notice, as provided in paragraph (n) of this section, whenever its

excess adjusted net capital is less than six percent of the maintenance

margin required by the futures commission merchant on all positions

held in accounts of a noncustomer other than a noncustomer who is

subject to the minimum financial requirements of:

(A) A futures commission merchant, or

(B) The Securities and Exchange Commission for a securities broker

or dealer.

* * * * *

(g) A futures commission merchant shall provide notice, as provided

in paragraph (n) of this section, of a substantial reduction in capital

as compared to that last reported in a financial report filed with the

Commission pursuant to Sec. 1.10 of this part. This notice shall be

provided as follows:

(1) If any event or series of events, including any withdrawal,

advance, loan or loss cause, on a net basis, a reduction in net capital

(or, if the futures commission merchant is qualified to use the filing

option available under Sec. 1.10(h) of this part, tentative net

capital as defined in the rules of the Securities and Exchange

Commission) of 20 percent or more, notice must be provided as provided

in paragraph (n) of this section within two business days of the event

or series of events causing the reduction stating the reason for the

reduction and steps the futures commission merchant will be taking to

ensure an appropriate level of net capital is maintained by the futures

commission merchant; and

(2) If equity capital of the futures commission merchant or a

subsidiary or affiliate of the futures commission merchant consolidated

pursuant to Sec. 1.17(f) of this part (or 17 CFR 240.15c3-1e) would be

withdrawn by action of a stockholder or a partner or a limited

liability company member or by redemption or repurchase of shares of

stock by any of the consolidated entities or through the payment of

dividends or any similar distribution, or an unsecured advance or loan

would be made to a stockholder, partner, sole proprietor, limited

liability company member, employee or affiliate, such that the

withdrawal, advance or loan would cause, on a net basis, a reduction in

excess adjusted net capital (or, if the futures commission merchant is

qualified to use the filing option available under Sec. 1.10(h) of

this part, excess net capital as defined in the rules of the Securities

and Exchange Commission) of 30 percent or more, notice must be provided

as provided in paragraph (n) of this section at least two business days

prior to the withdrawal, advance or loan that would cause the

reduction: Provided, however, That the provisions of paragraphs (g)(1)

and (g)(2) of this section do not apply to any futures or securities

transaction in the ordinary course of business between a futures

commission merchant and any affiliate where the futures commission

merchant makes payment to or on behalf of such affiliate for such

transaction and then receives payment from such affiliate for such

transaction within two business days from the date of the transaction.

(3) Upon receipt of such notice from a futures commission merchant,

or upon a reasonable belief that a substantial reduction in capital has

occurred or will occur, the Director of the Division of Swap Dealer and

Intermediary Oversight or the Director's designee may require that the

futures commission merchant provide or cause a Material Affiliated

Person (as that term is defined in Sec. 1.14(a)(2) of this part) to

provide, within three business days from the date of request or such

shorter period as the Division Director or designee may specify, such

other information as the Division Director or designee determines to be

necessary based upon market conditions, reports provided by the futures

commission merchant, or other available information.

(h) Whenever a person registered as a futures commission merchant

knows or should know that the total amount of its funds on deposit in

segregated accounts on behalf of customers trading on designated

contract markets, or the amount of funds on deposit in segregated

accounts for customers transacting in Cleared Swaps under part 22 of

this chapter, or that the total amount set aside on behalf of customers

trading on non-United States markets under part 30 of this chapter, is

less than the total amount of such funds required by the Act and the

regulations to be on deposit in segregated or secured amount accounts

on behalf of such customers, the registrant must report such deficiency

immediately by notice to the registrant's designated self-regulatory

organization and the Commission, as provided in paragraph (n) of this

section.

(i) A futures commission merchant must provide immediate notice, as

set forth in paragraph (n) of this section, whenever it discovers or is

informed that it has invested funds held for futures customers trading

on designated contract markets pursuant to Sec. 1.20 of this part,

Cleared Swaps Customer Collateral, as defined in Sec. 22.1 of this

chapter, or 30.7 Customer Funds, as defined in Sec. 30.1 of this

chapter, in instruments that are not permitted investments under Sec.

1.25 of this part, or has otherwise violated the requirements governing

the investment of funds belonging to customers under Sec. 1.25 of this

part.

(j) A futures commission merchant must provide immediate notice, as

provided in paragraph (n) of this section, whenever the futures

commission merchant does not hold a sufficient amount of funds in

segregated accounts for futures customers under Sec. 1.20 of this

part, in segregated accounts for Cleared Swaps Customers under part 22

of this chapter, or in secured amount accounts for customers trading on

foreign market under part 30 of this chapter to meet the futures

commission merchant's targeted residual interest in the segregated or

secured amount accounts pursuant to its policies and procedures

required under Sec. 1.11 of this part, or whenever the futures

commission merchant's amount of residual interest in any such accounts

is less than the sum of all margin deficits for such accounts.

[[Page 67937]]

(k) A futures commission merchant must provide immediate notice, as

provided in paragraph (n) of this section, whenever the futures

commission merchant, or the futures commission merchant's parent or

material affiliate, experiences a material adverse impact to its

creditworthiness or ability to fund its obligations.

(l) A futures commission merchant must provide immediate notice, as

provided in paragraph (n) of this section, whenever the futures

commission merchant experiences a material change in its operations or

risk profile, including a change in the senior management of the

futures commission merchant, the establishment or termination of a line

of business, a material adverse change in the futures commission

merchant's clearing arrangements, or a material adverse change to the

futures commission merchant's credit arrangements, including any change

that could adversely impact the firm's liquidity resources.

(m) In the event that a futures commission merchant receives a

notice, examination report, or any other correspondence from a

designated self-regulatory organization, the Securities and Exchange

Commission or a securities industry self-regulatory organization, the

futures commission merchant must immediately file a copy of such

notice, examination report, or any other correspondence, and the

registrant's response, as appropriate, as provided in paragraph (n) of

this section.

(n) Notice. (1) Every notice and report required to be filed by

this section by a futures commission merchant or a self-regulatory

organization must be filed with the Commission, with the designated

self-regulatory organization, if any, and with the Securities and

Exchange Commission, if such registrant is a securities broker or

dealer. Every notice and report required to be filed by this section by

an applicant for registration as a futures commission merchant must be

filed with the National Futures Association (on behalf of the

Commission), with the designated self-regulatory organization, if any,

and with the Securities and Exchange Commission, if such applicant is a

securities broker or dealer. Every notice or report that is required to

be filed by this section by a futures commission merchant or a self-

regulatory organization must include a discussion of how the reporting

event originated and what steps have been, or are being taken, to

address the reporting event.

(2) Every notice and report which an introducing broker or

applicant for registration as an introducing broker is required to file

by paragraphs (a), (c), and (d) of this section must be filed with the

National Futures Association (on behalf of the Commission), with the

designated self-regulatory organization, if any, and with every futures

commission merchant carrying or intending to carry customer accounts

for the introducing broker or applicant for registration as an

introducing broker. Any notice or report filed with the National

Futures Association pursuant to this paragraph shall be deemed for all

purposes to be filed with, and to be the official record of, the

Commission. Every notice or report that is required to be filed by this

section by an introducing broker or applicant for registration as an

introducing broker must include a discussion of how the reporting event

originated and what steps have been, or are being taken, to address the

reporting event.

(3) Every notice or report that is required to be filed by a

futures commission merchant with the Commission or with a designated

self-regulatory organization under this section must be in writing and

must be filed via electronic transmission using a form of user

authentication assigned in accordance with procedures established by or

approved by the Commission, and otherwise in accordance with

instructions issued by or approved by the Commission; Provided,

however, that if the registered futures commission merchant cannot file

the notice or report using the electronic transmission approved by the

Commission due to a transmission or systems failure, the futures

commission merchant must immediately contact the Commission's Regional

office with jurisdiction over the futures commission merchant as

provided in Sec. 140.02 of this chapter, and by email to

[email protected] Any such electronic submission must clearly

indicate the futures commission merchant on whose behalf such filing is

made and the use of such user authentication in submitting such filing

will constitute and become a substitute for the manual signature of the

authorized signer.

6. Amend Sec. 1.15 by revising paragraph (a)(4) to read as

follows:

Sec. 1.15 Risk assessment reporting requirements for futures

commission merchants.

(a) * * *

(4) The reports required to be filed pursuant to paragraphs (a)(1)

and (2) of this section must be filed via electronic transmission using

a form of user authentication assigned in accordance with procedures

established by or approved by the Commission, and otherwise in

accordance with instructions issued by or approved by the Commission.

Any such electronic submission must clearly indicate the registrant on

whose behalf such filing is made and the use of such user

authentication in submitting such filing will constitute and become a

substitute for the manual signature of the authorized signer.

* * * * *

7. Amend Sec. 1.16 by revising paragraphs (a)(4), (b)(1), (c)(1),

(c)(2), and (f)(1)(i)(C), and by adding paragraph (b)(4) to read as

follows:

Sec. 1.16 Qualifications and reports of accountants.

(a) * * *

(4) Customer. The term ``customer'' means customer, as defined in

Sec. 1.3 of this part, and 30.7 Customer, as defined in Sec. 30.1 of

this chapter.

(b) Qualifications of accountants. (1) The Commission will

recognize any person as a certified public accountant who is duly

registered and in good standing as such under the laws of the place of

his residence or principal office; Provided, however, that a certified

public accountant engaged to conduct an examination of a futures

commission merchant must be registered with the Public Company

Accounting Oversight Board, have undergone an examination by the Public

Company Accounting Oversight Board, and any deficiencies noted during

such examination must have been remediated to the satisfaction of the

Public Company Accounting Oversight Board within three years of such

report.

* * * * *

(4) The governing body of each futures commission merchant must

ensure that the certified public accountant engaged is duly qualified

to perform an audit of the futures commission merchant. Such an

evaluation of the qualifications of the certified public accountant

should include, among other issues, the certified public accountant's

experience in auditing futures commission merchants, the depth of the

certified public accountant's staff, the certified public accountant's

knowledge of the Act and Regulations, the size and geographic location

of the futures commission merchant, and the independence of the

certified public accountant.

(c) * * *

(1) Technical requirements. The accountant's report must:

(i) Be dated;

(ii) Indicate the city and State where issued; and

[[Page 67938]]

(iii) Identify without detailed enumeration the financial

statements covered by the report.

(2) Representations as to the audit. The accountant's report must

state whether the audit was made in accordance with U.S. generally

accepted auditing standards after full consideration to the auditing

standards adopted by the Public Company Accounting Oversight Board, and

must designate any auditing procedures deemed necessary by the

accountant under the circumstances of the particular case which have

been omitted and the reasons for their omission. However, nothing in

this paragraph (c)(2) shall be construed to imply authority for the

omission of any procedure which independent accountants would

ordinarily employ in the course of an audit made for the purposes of

expressing the opinion required by paragraph (c)(3) of this section.

* * * * *

(f)(1) * * *

(i) * * *

(C) Any copy that under this paragraph (f)(1)(i) is required to be

filed with the Commission must be filed via electronic transmission

using a form of user authentication assigned in accordance with

procedures established by or approved by the Commission, and otherwise

in accordance with instructions issued by or approved by the

Commission. Any such electronic submission must clearly indicate the

registrant on whose behalf such filing is made and the use of such user

authentication in submitting such filing will constitute and become a

substitute for the manual signature of the authorized signer.

* * * * *

8. Amend Sec. 1.17 by revising paragraphs (a)(4), (b)(2), (b)(7),

(c)(5)(v), (c)(5)(viii), and (c)(5)(ix) to read as follows:

Sec. 1.17 Minimum financial requirements for futures commission

merchants and introducing brokers.

(a) * * *

(4) A futures commission merchant who is not in compliance with

this section, or is unable to demonstrate such compliance as required

by paragraph (a)(3) of this section, or who cannot certify to the

Commission immediately upon request and demonstrate with verifiable

evidence that it has sufficient access to liquidity to continue

operating as a going concern, must transfer all customer accounts and

immediately cease doing business as a futures commission merchant until

such time as the firm is able to demonstrate such compliance; Provided,

however, The registrant may trade for liquidation purposes only unless

otherwise directed by the Commission and/or the designated self-

regulatory organization; And, Provided further, That if such registrant

immediately demonstrates to the satisfaction of the Commission or the

designated self-regulatory organization the ability to achieve

compliance, the Commission or the designated self-regulatory

organization may in its discretion allow such registrant up to a

maximum of 10 business days in which to achieve compliance without

having to transfer accounts and cease doing business as required above.

Nothing in this paragraph (a)(4) shall be construed as preventing the

Commission or the designated self-regulatory organization from taking

action against a registrant for non-compliance with any of the

provisions of this section.

* * * * *

(b) * * *

(2) Customer. This term means a futures customer as defined in

Sec. 1.3 of this chapter, a cleared over the counter customer as

defined in paragraph (b)(10) of this section, and a 30.7 Customer as

defined in Sec. 30.1 of this chapter.

* * * * *

(7) Customer account. This term means an account in which commodity

futures, options or cleared over the counter derivative positions are

carried on the books of the applicant or registrant which is an account

that is included in the definition of customer as defined in Sec.

1.17(b)(2).

* * * * *

(c) * * *

(5) * * *

(v) In the case of securities and obligations used by the applicant

or registrant in computing net capital, and in the case of a futures

commission merchant that invests funds deposited by futures customers

as defined in Sec. 1.3 of this part, Cleared Swaps Customers as

defined in Sec. 22.1 of this chapter, and 30.7 Customers as defined in

Sec. 30.1 of this chapter in securities as permitted investments under

Sec. 1.25 of this part, the deductions specified in Rule 240.15c3-

1(c)(2)(vi) or Rule 240.15c3-1(c)(2)(vii) of the Securities and

Exchange Commission (17 CFR 240.15c3-1(c)(2)(vi) and 17 CFR 240.15c3-

1(c)(2)(vii)) (``securities haircuts''). Futures commission merchants

that establish and enforce written policies and procedures to assess

the credit risk of commercial paper, convertible debt instruments, or

nonconvertible debt instruments in accordance with Rule 240.15c3-

1(c)(2)(vi) of the Securities and Exchange Commission (17 CFR 240.15c3-

1(c)(2)(vi)) may apply the lower haircut percentages specified in Rule

240.15c3-1(c)(2)(vi) for such commercial paper, convertible debt

instruments and nonconvertible debt instruments. Futures commission

merchants must maintain their written policies and procedures in

accordance with Sec. 1.31 of this part;

* * * * *

(viii) In the case of a futures commission merchant, for

undermargined customer commodity futures accounts and commodity option

customer accounts the amount of funds required in each such account to

meet maintenance margin requirements of the applicable board of trade

or if there are no such maintenance margin requirements, clearing

organization margin requirements applicable to such positions, after

application of calls for margin or other required deposits which are

outstanding no more than one business day. If there are no such

maintenance margin requirements or clearing organization margin

requirements, then the amount of funds required to provide margin equal

to the amount necessary, after application of calls for margin or other

required deposits outstanding no more than one business day, to restore

original margin when the original margin has been depleted by 50

percent or more: Provided, To the extent a deficit is excluded from

current assets in accordance with paragraph (c)(2)(i) of this section

such amount shall not also be deducted under this paragraph

(c)(5)(viii). In the event that an owner of a customer account has

deposited an asset other than cash to margin, guarantee or secure his

account, the value attributable to such asset for purposes of this

subparagraph shall be the lesser of (A) the value attributable to the

asset pursuant to the margin rules of the applicable board of trade, or

(B) the market value of the asset after application of the percentage

deductions specified in this paragraph (c)(5);

(ix) In the case of a futures commission merchant, for

undermargined commodity futures and commodity option noncustomer and

omnibus accounts the amount of funds required in each such account to

meet maintenance margin requirements of the applicable board of trade

or if there are no such maintenance margin requirements, clearing

organization margin requirements applicable to such positions, after

application of calls for margin or other required deposits which

[[Page 67939]]

are outstanding no more than one business day. If there are no such

maintenance margin requirements or clearing organization margin

requirements, then the amount of funds required to provide margin equal

to the amount necessary after application of calls for margin or other

required deposits outstanding no more than one business day to restore

original margin when the original margin has been depleted by 50

percent or more: Provided, To the extent a deficit is excluded from

current assets in accordance with paragraph (c)(2)(i) of this section

such amount shall not also be deducted under this paragraph (c)(5)(ix).

In the event that an owner of a noncustomer or omnibus account has

deposited an asset other than cash to margin, guarantee or secure his

account the value attributable to such asset for purposes of this

subparagraph shall be the lesser of the value attributable to such

asset pursuant to the margin rules of the applicable board of trade, or

the market value of such asset after application of the percentage

deductions specified in this paragraph (c)(5);

* * * * *

9. Revise Sec. 1.20 to read as follows:

Sec. 1.20 Futures customer funds to be segregated and separately

accounted for.

(a) General. A futures commission merchant must separately account

for all futures customer funds and segregate such funds as belonging to

its futures customers. A futures commission merchant shall deposit

futures customer funds under an account name which clearly identifies

them as futures customer funds and shows that such funds are segregated

as required by sections 4d(a) and 4d(b) of the Act and this part. A

futures commission merchant must at all times maintain in the separate

account or accounts money, securities and property in an amount at

least sufficient in the aggregate to cover its total obligations to all

futures customers. The futures commission merchant must perform

appropriate due diligence as required by Sec. 1.11 of this part on any

and all locations of futures customer funds, as specified in paragraph

(b) of this section, to ensure that the location in which the futures

commission merchant has deposited such funds is a financially sound

entity.

(b) Location of futures customer funds. A futures commission

merchant may deposit futures customer funds, subject to the risk

management policies and procedures of the futures commission merchant

required by Sec. 1.11 of this part, with the following depositories:

(1) A bank or trust company;

(2) A derivatives clearing organization; or

(3) Another futures commission merchant.

(c) Limitation on the holding of futures customer funds outside of

the United States. A futures commission merchant may hold futures

customer funds with a depository outside of the United States only in

accordance with Sec. 1.49 of this part.

(d) Written acknowledgment from depositories. (1) A futures

commission merchant must obtain a written acknowledgment from each

bank, trust company, derivatives clearing organization, or futures

commission merchant prior to or contemporaneously with the opening of

an account by the futures commission merchant with such depositories;

Provided, however, that a written acknowledgment need not be obtained

from a derivatives clearing organization that has adopted and submitted

to the Commission rules that provide for the segregation of futures

customer funds in accordance with all relevant provisions of the Act

and the rules and orders promulgated thereunder.

(2) The written acknowledgment must be in the form as set out in

Appendix A to this part.

(3) A futures commission merchant may deposit futures customer

funds only with a depository that provides the Commission and the

futures commission merchant's designated self-regulatory organization

with direct, read-only access to account information on 24-hour a day

basis. The Commission and the futures commission merchant's designated

self-regulatory organization must receive the direct access when the

account is opened. The written acknowledgment must contain the futures

commission merchant's authorization to the depository to provide direct

and immediate account access to the Commission and the futures

commission merchant's designated self-regulatory organization without

further notice to or consent from the futures commission merchant.

(4) A futures commission merchant may deposit futures customer

funds only with a depository that agrees to provide the Commission and

the futures commission merchant's designated self-regulatory

organization with a copy of the executed written acknowledgment within

three business days of the opening of the account. The Commission must

receive the written acknowledgment from the depository via electronic

mail at [email protected] The written acknowledgment must

contain the futures commission merchant's authorization to the

depository to provide the written acknowledgment to the Commission and

to the futures commission merchant's designated self-regulatory

organization without further notice to or consent from the futures

commission merchant.

(5) A futures commission merchant may deposit futures customer

funds only with a depository that agrees to reply promptly and directly

to the Commission's or to the futures commission merchant's designated

self-regulatory organization's requests for confirmation of account

balances or other account information without further notice to or

consent from the futures commission merchant. The written

acknowledgment must contain the futures commission merchant's

authorization to the depository to respond directly and immediately to

requests from the Commission or the futures commission merchant's

designated self-regulatory organization for confirmation of account

balances and other account information without further notice to or

consent from the futures commission merchant.

(6) The futures commission merchant shall promptly file a copy of

the written acknowledgment with the Commission in the manner specified

by the Commission and in no event later than the later of:

(i) The effective date of this rule; or

(ii) Three business days after the account is opened.

(7) A futures commission merchant shall amend the written

acknowledgment and promptly file the amended acknowledgment with the

Commission within 120 days of any changes in the following:

(i) The name or business address of the futures commission

merchant;

(ii) The name or business address of the bank, trust company,

derivatives clearing organization or futures commission merchant

receiving futures customer funds; or

(iii) The account number(s) under which futures customer funds are

held.

(8) A futures commission merchant must maintain each written

acknowledgment readily accessible in its files in accordance with Sec.

1.31 of this part, for as long as the account remains open, and

thereafter for the period provided in Sec. 1.31 of this part.

(e) Commingling. (1) A futures commission merchant may for

convenience commingle the futures customer funds that it receives from,

or on behalf of, multiple futures customers in a single account or

multiple accounts with one or more of the depositories listed in

paragraph (b) of this section.

[[Page 67940]]

(2) A futures commission merchant shall not commingle futures

customer funds with the money, securities or property of such futures

commission merchant, or with any proprietary account of such futures

commission merchant, or use such funds to secure or guarantee the

obligation of, or extend credit to, such futures commission merchant or

any proprietary account of such futures commission merchant; Provided,

however, a futures commission merchant may deposit proprietary funds in

segregated accounts as permitted under Sec. 1.23 of this part.

(3) A futures commission merchant may not commingle futures

customer funds with funds deposited by 30.7 Customers as defined in

Sec. 30.1 of this chapter and set aside in separate accounts as

required by part 30 of this chapter, or with funds deposited by Cleared

Swaps Customers as defined in Sec. 22.1 of this chapter and held in

segregated accounts pursuant to Section 4d(f) of the Act; Provided,

however, that a futures commission merchant may commingle futures

customer funds with funds deposited by 30.7 Customers or Cleared Swaps

Customers if expressly permitted by a Commission regulation or order,

or by a derivatives clearing organization rule approved in accordance

with Sec. 39.15(b)(2) of this chapter.

(f) Limitation on use of futures customer funds. (1) A futures

commission merchant shall treat and deal with the funds of a futures

customer as belonging to such futures customer. A futures commission

merchant shall not use the funds of a futures customer to secure or

guarantee the commodity interests, or to secure or extend the credit,

of any person other than the futures customer for whom the funds are

held.

(2) A futures commission merchant shall obligate futures customer

funds to a derivatives clearing organization, a futures commission

merchant, or any depository solely to purchase, margin, guarantee,

secure, transfer, adjust or settle trades, contracts or commodity

option transactions of futures customers; Provided, however, that a

futures commission merchant is permitted to use the funds belonging to

a futures customer that are necessary in the normal course of business

to pay lawfully accruing fees or expenses on behalf of the futures

customer's positions including commissions, brokerage, interest, taxes,

storage and other fees and charges.

(3) No person, including any derivatives clearing organization or

any depository, that has received futures customer funds for deposit in

a segregated account, as provided in this section, may hold, dispose

of, or use any such funds as belonging to any person other than the

futures customers of the futures commission merchant which deposited

such funds.

(g) Derivatives clearing organizations. (1) General. All futures

customer funds received by a derivatives clearing organization from a

member to purchase, margin, guarantee, secure or settle the trades,

contracts or commodity options of the clearing member's futures

customers and all money accruing to such futures customers as the

result of trades, contracts or commodity options so carried shall be

separately accounted for and segregated as belonging to such futures

customers, and a derivatives clearing organization shall not hold, use

or dispose of such futures customer funds except as belonging to such

futures customers. A derivatives clearing organization shall deposit

futures customer funds under an account name that clearly identifies

them as futures customer funds and shows that the futures customer

funds are segregated as required by section 4(d)(a) and 4d(b) of the

Act and this part.

(2) Location of futures customer funds. A derivatives clearing

organization may deposit futures customer funds with a bank or trust

company, which shall include a Federal Reserve Bank with respect to

deposits of a systemically important derivatives clearing organization.

(3) Limitation on the holding of futures customer funds outside of

the United States. A derivatives clearing organization may hold futures

customer funds with a depository outside of the United States only in

accordance with Sec. 1.49 of this part.

(4) Written acknowledgment from depositories. (i) A derivatives

clearing organization must obtain a written acknowledgment from each

depository prior to or contemporaneously with the opening of a futures

customer funds account;

(ii) The written acknowledgment must be in the form as set out in

Appendix A to this part;

(iii) A derivatives clearing organization may deposit futures

customer funds only with a depository that provides the Commission with

direct, read-only access to account information on 24-hour a day basis.

The Commission must receive the direct access when the account is

opened. The written acknowledgment must contain the derivatives

clearing organization's authorization to the depository to provide

direct and immediate account access to the Commission without further

notice to or consent from the derivatives clearing organization;

(iv) A derivatives clearing organization may deposit futures

customer funds only with a depository that agrees to provide the

Commission with a copy of the executed written acknowledgment within

three business days of the opening of the account. The Commission must

receive the written acknowledgment from the depository via electronic

mail at [email protected] The written acknowledgment must

contain the derivatives clearing organization's authorization to the

depository to provide the written acknowledgment to the Commission

without further notice to or consent from the derivatives clearing

organization;

(v) A derivatives clearing organization may deposit futures

customer funds only with a depository that agrees to reply promptly and

directly to the Commission's requests for confirmation of account

balances or other account information without further notice to or

consent from the derivatives clearing organization. The written

acknowledgment must contain the derivatives clearing organization's

authorization to the depository to respond directly and immediately to

requests from the Commission for confirmation of account balances and

other account information without further notice to or consent from the

derivatives clearing organization;

(vi) A derivatives clearing organization shall promptly file a copy

of the written acknowledgment with the Commission in the manner

specified by the Commission and in event later than the later of:

(A) The effective date of this rule; or

(B) Three business days after the account is opened.

(vii) A derivatives clearing organization shall amend the written

acknowledgment and promptly file the amended acknowledgment with the

Commission within 120 days of any changes in the following:

(A)The name or business address of the derivatives clearing

organization;

(B) The name or business address of the depository receiving

futures customer funds; or

(C) The account number(s) under which futures customer funds are

held.

(viii) A derivatives clearing organization must maintain each

written acknowledgment readily accessible in its files in accordance

with Sec. 1.31 of this part, for as long as the account remains open,

and thereafter for the period provided in Sec. 1.31 of this part.

(5) Commingling. (i) A derivatives clearing organization may for

[[Page 67941]]

convenience commingle the futures customer funds that it receives from,

or on behalf of, multiple futures commission merchants in a single

account or multiple accounts with one or more of the depositories

listed in paragraph (g)(2) of this section.

(ii) A derivatives clearing organization shall not commingle

futures customer funds with the money, securities or property of such

derivatives clearing organization or with any proprietary account of

any of its clearing members, or use such funds to secure or guarantee

the obligations of, or extend credit to, such derivatives clearing

organization or any proprietary account of any of its clearing members.

(iii) A derivatives clearing organization may not commingle funds

held for futures customers with funds deposited by clearing members on

behalf of their 30.7 Customers as defined in Sec. 30.1 of this chapter

and set aside in separate accounts as required by part 30 of this

chapter, or with funds deposited by clearing members on behalf of their

Cleared Swaps Customers as defined in Sec. 22.1 of this chapter and

held in segregated accounts pursuant section 4d(f) of the Act;

Provided, however, that a derivatives clearing organization may

commingle futures customer funds with funds deposited by clearing

members on behalf of their 30.7 Customers or Cleared Swaps Customers if

expressly permitted by a Commission regulation or order, or by a

derivatives clearing organization rule approved in accordance with

Sec. 39.15(b)(2) of this chapter.

(h) Immediate availability of bank and trust company deposits. All

futures customer funds deposited by a futures commission merchant or a

derivatives clearing organization with a bank or trust company must be

immediately available for withdrawal upon the demand of the futures

commission merchant or derivatives clearing organization.

(i) Requirements as to Amount. (1) For purposes of this paragraph

(i), the term ``account'' shall mean the entries on the books and

records of a futures commission merchant pertaining to the futures

customer funds of a particular futures customer.

(2) The futures commission merchant must reflect in the account

that it maintains for each futures customer:

(i) The market value of any futures customer funds that it receives

from such customer, as adjusted by:

(A) Any uses permitted under Sec. 1.20(f) of this part;

(B) Any accruals on permitted investments of such collateral under

Sec. 1.25 of this part that, pursuant to the futures commission

merchant's customer agreement with that customer, are creditable to

such customer;

(C) Any gains and losses with respect to contracts for the purchase

or sale of a commodity for future delivery and any options on such

contracts;

(D) Any charges lawfully accruing to the futures customer,

including any commission, brokerage fee, interest, tax, or storage fee;

and

(E) Any appropriately authorized distribution or transfer of such

collateral.

(ii) The amount of collateral required for the futures customer's

contracts for the purchase or sale of a commodity for future delivery

and any options on such contracts at each derivatives clearing

organization on which the futures commission merchant is a member, or

by each other futures commission merchant through which the futures

commission merchant clears futures customer contracts, and the total of

such required collateral amounts.

(3)(i) If the market value of futures customer funds in the account

of a futures customer is positive after adjustments, then that account

has a credit balance. If the market value of futures customer funds in

the account of a futures customer is negative after adjustments, then

that account has a debit balance.

(ii) If the value of the futures customer funds, as calculated in

paragraph (i)(2)(i) of this section, for a futures customer's account

is less than the total amount of collateral required for that account's

contracts for the purchase or sale of a commodity for future delivery

and any options on such contracts at derivatives clearing

organizations, as calculated in paragraph (i)(2)(ii) of this section,

the difference is a margin deficit.

(4) The futures commission merchant must maintain in segregation an

amount equal to the sum of any credit balances that the futures

customers of the futures commission merchant have in their accounts,

excluding from such sum any debit balances that the futures customers

of the futures commission merchant have in their accounts. In addition,

the futures commission merchant must at all times maintain residual

interest in segregated fund sufficient to exceed the sum of all margin

deficits that the futures customers of the futures commission merchant

have in their accounts. Such residual interest may not be withdrawn

pursuant to Sec. 1.23 of this part.

Appendix A to Sec. 1.20--Acknowledgment Letter for CFTC Regulation

1.20 Customer Segregated Account

[Date]

[Name and Address of Bank, Trust Company, Derivatives Clearing

Organization or Futures Commission Merchant]

We refer to the Segregated Account(s) which [Name of Futures

Commission Merchant or Derivatives Clearing Organization] (``we'' or

``our'') have opened or will open with [Name of Bank, Trust Company,

Derivatives Clearing Organization or Futures Commission Merchant]

(``you'' or ``your'') entitled:

[Name of Futures Commission Merchant or Derivatives Clearing

Organization] [if applicable, add ``FCM Customer Omnibus Account'']

CFTC Regulation 1.20 Customer Segregated Account

Account Number(s): [ ]

You acknowledge and agree that we have opened or will open the

above-referenced Account(s) for the purpose of depositing, as

applicable, money, securities and other property (collectively the

``Funds'') of our customers who trade commodities, options, swaps,

other cleared OTC derivatives products and other products, as

required by Commodity Futures Trading Commission (``CFTC'')

Regulations, including Regulation 1.20, as amended; that the Funds

held by you, hereafter deposited in the Account(s) or accruing to

the credit of the Accounts, will be separately accounted for and

segregated on your books from our own funds and all other accounts

maintained by us in accordance with the provisions of the Commodity

Exchange Act, as amended (the ``Act''), and Part 1 of the CFTC's

regulations, as amended; and that the Funds must otherwise be

treated in accordance with the provisions of the Act and CFTC

regulations.

Furthermore, you acknowledge and agree that such Funds may not

be used by you or by us to secure or guarantee any obligations that

we might owe to you, nor may they be used by us to secure credit

from you. You further acknowledge and agree that the Funds in the

Account(s) shall not be subject to any right of offset or lien for

or on account of any indebtedness, obligations or liabilities we may

now or in the future have owing to you. This prohibition does not

affect your right to recover funds advanced in the form of cash

transfers you make in lieu of liquidating non-cash assets held in

the Account(s) for purposes of variation settlement or posting

initial (original) margin.

In addition, you agree that the Account(s) may be examined at

any reasonable time by an appropriate officer, agent or employee of

the CFTC or a self-regulatory organization of which we are a member,

and this letter constitutes the authorization and direction of the

undersigned to permit any such examination or audit to take place.

You agree to respond promptly and directly to requests for

confirmation of account balances and other account information from

an appropriate officer, agent, or employee of the CFTC or a self-

regulatory organization of which we are a member, without further

notice to or consent from the futures

[[Page 67942]]

commission merchant or derivatives clearing organization, as

applicable. You also agree that, immediately upon instruction by the

director of the Division of Swap Dealer and Intermediary Oversight

of the CFTC or the director of the Division of Clearing and Risk of

the CFTC, or any successor divisions, or such directors' designees,

or any appropriate official of a self-regulatory organization of

which we are a member, you will provide any and all information

regarding or related to the Funds or the Accounts as shall be

specified in such instruction and as directed in such instruction.

You further agree that you will provide the CFTC and our designated

self-regulatory organization with the necessary software, a user

log-in, and password that will allow the CFTC and our designated

self-regulatory organization to have read-only access to the

accounts listed above on your Web site or via an alternative

electronic medium on a 24-hour a day basis.

You acknowledge and agree that the Funds in the Account(s) shall

be released immediately, subject to the requirements of U.S. or non-

U.S. law as applicable, upon proper notice and instruction from an

appropriate officer or employee of us or from the director of the

Division of Clearing and Risk of the CFTC, the director of the

Division of Swap Dealer and Intermediary Oversight of the CFTC, or

any successor divisions, or such directors' designees.

We will not hold you responsible for acting pursuant to any

instruction from the CFTC or the self-regulatory organization upon

which you have relied after having taken reasonable measures to

assure that such instruction was provided to you by the director of

the Division of Clearing and Risk of the CFTC, the director of the

Division of Swap Dealer and Intermediary Oversight of the CFTC, or

any successor divisions, or such directors' designees, or any

appropriate official of a self-regulatory organization of which we

are a member.

In the event that we become subject to either a voluntary or

involuntary petition for relief under the U.S. Bankruptcy Code, we

acknowledge that you will have no obligation to release the Funds

held in the Account(s), except upon instruction of the Trustee in

Bankruptcy or pursuant to the Order of the respective U.S.

Bankruptcy Court. Notwithstanding anything in the foregoing to the

contrary, nothing contained herein shall be construed as limiting

your right to assert any right of set off against or lien on assets

other than assets maintained in the Account(s), nor to impose such

charges against us or any proprietary account maintained by us with

you. Further, it is understood that amounts represented by checks,

drafts or other items shall not be considered to be part of the

Account(s) until finally collected. Accordingly, checks, drafts and

other items credited to the Account(s) and subsequently dishonored

or otherwise returned to you, or reversed, for any reason and any

claims relating thereto, including but not limited to claims of

alteration or forgery, may be charged back to the Account(s), and we

shall be responsible to you as a general endorser of all such items

whether or not actually so endorsed. You may conclusively presume

that any withdrawal from the Account(s) and the balances maintained

therein are in conformity with the Act and CFTC regulations without

any further inquiry, provided that you have no notice of or actual

knowledge of, or could not reasonably know of, a violation of the

Act or other provision of law by us; and you shall not in any manner

not expressly agreed to herein be responsible for ensuring

compliance by us with the provisions of the Act and CFTC

regulations. You may, and are hereby authorized to, obey the order,

judgment, decree or levy of any court of competent jurisdiction or

any governmental agency with jurisdiction, which order, judgment,

decree or levy relates in whole or in part to the Account(s). In any

event, you shall not be liable by reason of any such action or

omission to act, to us or to any other person, firm, association or

corporation even if thereafter any such order, decree, judgment or

levy shall be reversed, modified, set aside or vacated.

The terms of this letter agreement shall remain binding upon the

parties, their successors and assigns, including for the avoidance

of doubt, regardless of the change in name of any party. This letter

agreement supersedes and replaces any prior agreement between the

parties in connection with the Account(s), including but not limited

to any prior acknowledgment letter, to the extent that such prior

agreement is inconsistent with the terms hereof. In the event of any

conflict between this letter agreement and any other agreement

between the parties in connection with the Account(s), this letter

agreement shall govern with respect to matters specific to Section

4d of the Act and the CFTC's regulations, as amended.

This letter agreement shall be governed by and construed in

accordance with the laws of [Insert governing law] without regard to

the principles of choice of law.

Please acknowledge that you agree to abide by the requirements

and conditions set forth above by signing and returning the enclosed

copy of this letter. You further acknowledge and agree to provide a

copy of this fully executed letter directly to the CFTC (via

electronic mail to [email protected]) and our

designated self-regulatory organization.

[Name of Futures Commission Merchant or Derivatives Clearing

Organization]

By:

Print Name:

Title:

ACKNOWLEDGED AND AGREED:

[Name of Bank, Trust Company, Derivatives Clearing Organization

or Futures Commission Merchant]

By:

Print Name:

Title:

Contact Information: [Insert phone number and email address]

DATE:

10. Revise Sec. 1.22 to read as follows:

Sec. 1.22 Use of futures customer funds restricted.

(a) No futures commission merchant shall use, or permit the use of,

the futures customer funds of one futures customer to purchase, margin,

or settle the trades, contracts, or commodity options of, or to secure

or extend the credit of, any person other than such futures customer.

The prohibition on the use of one futures customer's funds to extend

credit to, or to purchase, margin, or settle the contracts of another

person applies at all times. For this purpose, a futures commission

merchant which operationally commingles the funds of its futures

customers must ensure that at all times its residual interest in

futures customer funds exceeds the sum of the margin deficits of all of

its futures customers.

(b) Futures customer funds shall not be used to carry trades or

positions of the same futures customer other than in contracts for the

purchase of sale of any commodity for future delivery or for options

thereon traded through the facilities of a designated contract market.

11. Revise Sec. 1.23 to read as follows:

Sec. 1.23 Interest of futures commission merchant in segregated

futures customer funds; additions and withdrawals.

(a)(1) The provision in sections 4d(a)(2) and 4d(b) of the Act and

the provision in Sec. 1.20 of this part that prohibit the commingling

of futures 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 futures

customer funds segregated as required by the Act and the regulations in

this part and set apart for the benefit of futures customers; nor shall

such provisions be construed to prevent a futures commission merchant

from adding to such segregated futures 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 of this part, as

it may deem necessary to ensure any and all futures customers' accounts

from becoming undersegregated at any time.

(2) If a futures commission merchant discovers at any time that it

is holding insufficient funds in segregated accounts to meet its

obligations under Sec. Sec. 1.20 and 1.22 of this part, the futures

commission merchant shall immediately deposit sufficient funds into

segregation to bring the account into compliance.

(b) A futures commission merchant may not withdraw funds on any

business day for its own proprietary use from an account or accounts

holding futures customer funds unless the futures commission merchant

has prepared the daily segregation

[[Page 67943]]

calculation required by Sec. 1.32 of this part as of the close of

business on the previous business day. A futures commission merchant

that has completed its daily segregation calculation may make

withdrawals for its own use, to the extent of its actual residual

financial interest in funds held in segregated futures accounts,

adjusted to reflect market activity and other events that may have

decreased the amount of the firm's residual financial interest since

the close of business on the previous business day, including the

withdrawal of securities held in segregated safekeeping accounts held

by a bank, trust company, derivatives clearing organization or other

futures commission merchant. Such withdrawal(s), however, shall not

result in the funds of one futures customer being used to purchase,

margin or carry the trades, contracts or commodity options, or extend

the credit of any other futures customer or other person.

(c) Notwithstanding paragraphs (a) and (b) of this section, each

futures commission merchant shall establish a targeted residual

interest (i.e., excess funds) that is in an amount that, when

maintained as its residual interest in the segregated funds accounts,

reasonably ensures that the futures commission merchant shall remain in

compliance with the segregated funds requirements at all times. Each

futures commission merchant shall establish policies and procedures

designed to reasonably ensure that the futures commission merchant

maintains the targeted residual amounts in segregated funds at all

times. The futures commission merchant shall maintain sufficient

capital and liquidity, and take such other appropriate steps as are

necessary or appropriate, to reasonably ensure that such amount of

targeted residual interest is maintained as the futures commission

merchant's residual interest in the segregated funds accounts at all

times. In determining the amount of the targeted residual interest, the

futures commission merchant shall analyze all relevant factors

affecting the amounts in segregated funds from time to time, including

without limitation various factors, as applicable, relating to the

nature of the futures commission merchant's business including, but not

limited to, the composition of the futures commission merchant's

customer base, the general creditworthiness of the customer base, the

general trading activity of the customers, the types of markets and

products traded by the customers, the proprietary trading of the

futures commission merchant, the general volatility and liquidity of

the markets and products traded by customers, the futures commission

merchant's own liquidity and capital needs, and the historical trends

in Customer segregated fund balances and debit balances in Customers'

and undermargined accounts. The analysis and calculation of the

targeted amount of the future commission merchant's residual interest

must be described in writing with the specificity necessary to allow

the Commission and the futures commission merchant's designated self-

regulatory organization to duplicate the analysis and calculation and

test the assumptions made by the futures commission merchant. The

adequacy of the targeted residual interest and the process for

establishing the targeted residual interest must be reassessed

periodically by the futures commission merchant and revised as

necessary. Notwithstanding any other provision of this section, a

futures commission merchant must at all times maintain an amount of

residual interest in segregated accounts that exceeds the sum of all

margin deficits of its futures customers under Sec. 1.20 of this part,

and such residual interest may not be withdrawn by the futures

commission merchant.

(d) Notwithstanding any other paragraph of this section, a futures

commission merchant may not withdraw funds for its own proprietary use,

in a single transaction or a series of transactions on a given business

day, from futures accounts if such withdrawal(s) would exceed 25

percent of the futures commission merchant's residual interest in such

accounts as reported on the daily segregation calculation required by

Sec. 1.32 of this part and computed as of the close of business on the

previous business day, unless:

(1) The futures commission merchant's Chief Executive Officer,

Chief Finance Officer or other senior official that is listed as a

principal of the futures commission merchant on its Form 7-R and is

knowledgeable about the futures commission merchant's financial

requirements and financial position pre-approves in writing the

withdrawal, or series of withdrawals;

(2) The futures commission merchant files written notice of the

withdrawal or series of withdrawals, with the Commission and with its

designated self-regulatory organization immediately after the Chief

Executive Officer, Chief Finance Officer or other senior official as

described in paragraph (c)(1) of this section pre-approves the

withdrawal or series of withdrawals. The written notice must:

(i) Be signed by the Chief Executive Officer, Chief Finance Officer

or other senior official as described in paragraph (c)(1) of this

section that pre-approved the withdrawal, and give notice that the

futures commission merchant has withdrawn or intends to withdraw more

than 25 percent of its residual interest in segregated accounts holding

futures customer funds;

(ii) Include a description of the reasons for the withdrawal or

series of withdrawals;

(iii) List the amount of funds provided to each recipient and each

recipient's name;

(iv) Include the current estimate of the amount of the futures

commission merchant's residual interest in the futures accounts after

the withdrawal;

(v) Contain a representation by the Chief Executive Officer, Chief

Finance Officer or other senior official as described in paragraph

(c)(1) of this section that pre-approved the withdrawal, or series of

withdrawals, that, after due diligence, to such person's knowledge and

reasonable belief, the futures commission merchant remains in

compliance with the segregation requirements after the withdrawal. The

Chief Executive Officer, Chief Finance Officer or other senior official

as described in paragraph (c)(1) of this section must consider the

daily segregation calculation as of the close of business on the

previous business day and any other factors that may cause a material

change in the futures commission merchant's residual interest since the

close of business the previous business day, including known unsecured

futures customer debits or deficits, current day market activity and

any other withdrawals made from the futures accounts; and

(vi) Any such written notice filed with the Commission must be

filed via electronic transmission using a form of user authentication

assigned in accordance with procedures established by or approved by

the Commission, and otherwise in accordance with instruction issued by

or approved by the Commission. Any such electronic submission must

clearly indicate the registrant on whose behalf such filing is made and

the use of such user authentication in submitting such filing will

constitute and become a substitute for the manual signature of the

authorized signer. Any written notice filed must be followed up with

direct communication to the Regional office of the Commission that has

supervisory authority over the futures commission merchant whereby the

Commission acknowledges receipt of the notice; and

[[Page 67944]]

(3) After making a withdrawal requiring the approval and notice

required in paragraphs (c)(1) and (2) of this section, and before the

completion of its next daily segregated funds calculation, no futures

commission merchant may make any further withdrawals from accounts

holding futures customer funds, except to or for the benefit of

commodity and option customers, without, for each withdrawal, obtaining

the approval required under paragraph (c)(1) of this section and filing

a written notice in the manner specified under paragraph (c)(2) of this

section with the Commission and its designated self-regulatory

organization signed by the Chief Executive Officer, Chief Finance

Officer, or other senior official. The written notice must:

(i) List the amount of funds provided to each recipient and each

recipient's name;

(ii) Disclose the reason for each withdrawal;

(iii) Confirm that the Chief Executive Officer, Chief Finance

Officer, or other senior official (and identify of the person if

different from the person who signed the notice) pre-approved the

withdrawal in writing;

(iv) Disclose the current estimate of the futures commission

merchant's remaining total residual interest in the segregated accounts

holding futures customer funds after the withdrawal; and

(v) Include a representation that, after due diligence, to the best

of the notice signatory's knowledge and reasonable belief the futures

commission merchant remains in compliance with the segregation

requirements after the withdrawal.

(e) If a futures commission merchant withdraws funds from futures

accounts for its own proprietary use, and the withdrawal causes the

futures commission merchant to not hold sufficient funds in the futures

accounts to meet its targeted residual interest, as required to be

computed under Sec. 1.11 of this part, the futures commission merchant

should deposit its own funds into the futures accounts to restore the

account balance to the targeted residual interest amount by the close

of business on the next business day, or, if appropriate, revise the

futures commission merchant's targeted amount of residual interest

pursuant to the policies and procedures required by Sec. 1.11 of this

part. Notwithstanding the foregoing, if at any time the futures

commission merchant's residual interest in customer accounts is less

than the sum of its futures customers' margin deficits as set forth in

Sec. 1.20(i) of this part, the futures commission merchant must

immediately restore the residual interest to exceed the sum of such

margin deficits. Any proprietary funds deposited in the futures

accounts must be unencumbered and otherwise compliant with Sec. 1.25

of this part, as applicable.

12. Amend Sec. 1.25 by removing paragraph (b)(6) and by revising

paragraphs (b)(3)(v), (c)(3), (d)(7), (d)(11), and (e) to read as

follows:

Sec. 1.25 Investment of customer funds.

* * * * *

(b) * * *

(3) * * *

(v) Counterparty concentration limits. Securities purchased by a

futures commission merchant or derivatives clearing organization from a

single counterparty, or from one or more counterparties under common

ownership or control, subject to an agreement to resell the securities

to the counterparty or counterparties, shall not exceed 25 percent of

total assets held in segregation or under Sec. 30.7 of this chapter by

the futures commission merchant or derivatives clearing organization.

* * * * *

(c) * * *

(3) A futures commission merchant or derivatives clearing

organization shall maintain the confirmation relating to the purchase

in its records in accordance with Sec. 1.31 of this part and note the

ownership of fund shares (by book-entry or otherwise) in a custody

account of the futures commission merchant or derivatives clearing

organization in accordance with Sec. 1.26 of this part. The futures

commission merchant or the derivatives clearing organization shall

obtain the acknowledgment letter required by Sec. 1.26 of this part

from an entity that has substantial control over the fund shares

purchased with customer funds and has the knowledge and authority to

facilitate redemption and payment or transfer of the customer funds.

Such entity may include the fund sponsor or depository acting as

custodian for fund shares.

* * * * *

(d) * * *

(7) Securities transferred to the futures commission merchant or

derivatives clearing organization under the agreement are held in a

safekeeping account with a bank as referred to in paragraph (d)(2) of

this section, a Federal Reserve Bank, a derivatives clearing

organization, or the Depository Trust Company in an account that

complies with the requirements of Sec. 1.26 of this part.

* * * * *

(11) The transactions effecting the agreement are recorded in the

record required to be maintained under Sec. 1.27 of this part of

investments of customer funds, and the securities subject to such

transactions are specifically identified in such record as described in

paragraph (d)(1) of this section and further identified in such record

as being subject to repurchase and reverse repurchase agreements.

* * * * *

(e) Deposit of firm-owned securities into segregation. A futures

commission merchant may deposit unencumbered securities of the type

specified in this section, which it owns for its own account, into a

customer account. A futures commission merchant must include such

securities, transfers of securities, and disposition of proceeds from

the sale or maturity of such securities in the record of investments

required to be maintained by Sec. 1.27 of this part. All such

securities may be segregated in safekeeping only with a bank, trust

company, derivatives clearing organization, or other registered futures

commission merchant in accordance with the provisions of Sec. 1.20 of

this part. For purposes of this section and Sec. Sec. 1.27, 1.28,

1.29, and 1.32 of this part, securities of the type specified by this

section that are owned by the futures commission merchant and deposited

into a customer account shall be considered customer funds until such

investments are withdrawn from segregation in accordance with the

provisions of Sec. 1.23 of this part. Investments permitted by Sec.

1.25 that are owned by the futures commission merchant and deposited

into a futures customer account pursuant to Sec. 1.26 of the part

shall be considered futures customer funds until such investments are

withdrawn from segregation in accordance with Sec. 1.23 of this part.

Investments permitted by Sec. 1.25 that are owned by the futures

commission merchant and deposited into a Cleared Swaps Customer

Account, as defined in Sec. 22.1 of this chapter, shall be considered

Cleared Swaps Customer Collateral, as defined in Sec. 22.1 of this

chapter, until such investments are withdrawn from segregation in

accordance with Sec. 22.17 of this chapter.

* * * * *

13. Revise Sec. 1.26 to read as follows:

Sec. 1.26 Deposit of instruments purchased with futures customer

funds.

(a) Each futures commission merchant who invests futures customer

funds in instruments described in Sec. 1.25 of this part, except for

investments in money market mutual funds, shall separately account for

such instruments as futures

[[Page 67945]]

customer funds and segregate such instruments as funds belonging to

such futures customers in accordance with the requirements of Sec.

1.20 of this part. Each derivatives clearing organization which invests

money belonging or accruing to futures customers of its clearing

members in instruments described in Sec. 1.25 of this part, except for

investments in money market mutual funds, shall separately account for

such instruments as customer funds and segregate such instruments as

customer funds belonging to such futures customers in accordance with

Sec. 1.20 of this part.

(b) Each futures commission merchant or derivatives clearing

organization which invests futures customer funds in money market

mutual funds, as permitted by Sec. 1.25 of this part, shall separately

account for such funds and segregate such funds as belonging to such

futures customers. Such funds shall be deposited under an account name

which clearly shows that they belong to futures customers and are

segregated as required by sections 4d(a) and 4d(b) of the Act and this

part. Each futures commission merchant or derivatives clearing

organization, upon opening such an account, shall obtain and maintain

readily accessible in its files in accordance with Sec. 1.31 of this

part, for as long as the account remains open, and thereafter for the

period provided in Sec. 1.31 of this part, a written acknowledgment

and shall file such acknowledgment in accordance with the requirements

of Sec. 1.20 of this part. In the event such funds are held directly

with the money market mutual fund or its affiliate, the written

acknowledgment letter shall be in the form as set out in Appendix A to

this section. In the event such funds are held with a depository the

written acknowledgment letter shall be in the form as set out in

Appendix A to Sec. 1.20 of this part. In either case, the written

acknowledgment letter shall be obtained, provided to the Commission and

designated self-regulatory organizations, and retained as required

under Sec. 1.20 of this part.

Appendix to Sec. 1.26--Acknowledgment Letter for CFTC Regulation 1.26

Customer Segregated Money Market Mutual Fund Account

[Date]

[Name and Address of Money Market Mutual Fund]

We propose to invest funds held by [Name of Futures Commission

Merchant or Derivatives Clearing Organization] (``we'' or ``our'')

on behalf of our customers in shares of [Name of Money Market Mutual

Fund] (``you'' or ``your'') under account(s) entitled (or shares

issued to):

[Name of Futures Commission Merchant or Derivatives Clearing

Organization] [if applicable, add ``FCM Customer Omnibus Account'']

CFTC Regulation 1.26 Customer Segregated Money Market Mutual Fund

Account

[If applicable, include any abbreviated name of the Account(s)

as reflected in the Depository's electronic systems (provided any

such abbreviated name must reflect that the Account(s) is a CFTC

regulated customer segregated account)]

Account Number(s): [-------- ]

(collectively, the ``Account(s)'').

You acknowledge and agree that we are holding these funds,

including any shares issued and amounts accruing in connection

therewith (collectively, the ``Shares''), for the benefit of our

customers who trade commodities, options, cleared OTC derivatives

products and other products (``Commodity Customers''), as required

by Commodity Futures Trading Commission (``CFTC'') Regulation 1.26,

as amended; that the Shares held by you, hereafter deposited in the

Account(s) or accruing to the credit of the Accounts, will be

separately accounted for and segregated on your books from our own

funds and from any other funds or accounts held by us in accordance

with the provisions of the Commodity Exchange Act, as amended (the

``Act''), and Part 1 of the CFTC's regulations, as amended; and that

the Shares must otherwise be treated in accordance with the

provisions of the Act and CFTC regulations.

Furthermore, you acknowledge and agree that such Shares may not

be used by you or by us to secure or guarantee any obligations that

we might owe to you, nor may they be used by us to secure credit

from you. You further acknowledge and agree that the Shares in the

Account(s) shall not be subject to any right of offset or lien for

or on account of any indebtedness, obligations or liabilities we may

now or in the future have owing to you.

In addition, you agree that the Account(s) may be examined at

any reasonable time by an appropriate officer, agent or employee of

the CFTC or a self-regulatory organization, and this letter

constitutes the authorization and direction of the undersigned to

permit any such examination or audit to take place. You agree to

respond promptly and directly to requests for confirmation of

account balances and other account information from an appropriate

officer, agent, or employee of the CFTC or a self-regulatory

organization of which we are a member, without further notice to or

consent from the futures commission merchant or the derivatives

clearing organization, as applicable. You also agree that,

immediately upon instruction by the director of the Division of Swap

Dealer and Intermediary Oversight of the CFTC or the director of the

Division of Clearing and Risk of the CFTC, or any successor

divisions, or such directors' designees, or any appropriate official

of a self-regulatory organization of which we are a member, you will

provide any and all information regarding or related to the Shares

or the Accounts as shall be specified in such instruction and as

directed in such instruction. You further agree that you will

provide the CFTC and our designated self-regulatory organization

with the necessary software, a user log-in, and password that will

allow the CFTC and our designated self-regulatory organization to

have read-only access to the accounts listed above on your Web site

on a 24-hour a day basis.

You acknowledge and agree that the Shares in the Account(s)

shall be released immediately, subject to the requirements of U.S.

or non-U.S. law as applicable, upon proper notice and instruction

from an appropriate officer or employee of us or from the director

of the Division of Clearing and Risk of the CFTC, or from the

director of the Division of Swap Dealer and Intermediary Oversight,

or any successor divisions, or such directors' designees. We will

not hold you responsible for acting pursuant to any instruction from

the CFTC or from the self-regulatory organization upon which you

have relied after having taken reasonable measures to assure that

such instruction was provided to you by the director of the Division

of Clearing and Risk of the CFTC, or the director of the Division of

Swap Dealer and Intermediary Oversight, or any successor divisions,

or such directors' designees, or any appropriate official of a self-

regulatory organization of which we are a member. You further

acknowledge that we will provide to the CFTC a copy of this

acknowledgment. In the event we become subject to either a voluntary

or involuntary petition for relief under the U.S. Bankruptcy Code,

we acknowledge that you will have no obligation to release the

Shares held in the Account(s), except upon instruction of the

Trustee in Bankruptcy or pursuant to the Order of the respective

U.S. Bankruptcy Court.

Notwithstanding anything in the foregoing to the contrary,

nothing contained herein shall be construed as limiting your right

to assert any right of set off against or lien on assets other than

assets maintained in the Account(s), nor to impose such charges

against us or any proprietary account maintained by us with you.

Further, it is understood that amounts represented by checks, drafts

or other items shall not be considered to be part of the Account(s)

until finally collected. Accordingly, checks, drafts and other items

credited to the Account(s) and subsequently dishonored or otherwise

returned to you, or reversed, for any reason and any claims relating

thereto, including but not limited to claims of alteration or

forgery, may be charged back to the Account(s), and we shall be

responsible to you as a general endorser of all such items whether

or not actually so endorsed. You may conclusively presume that any

withdrawal from the Account(s) and the balances maintained therein

are in conformity with the Act and CFTC regulations without any

further inquiry, provided that you have no notice of or actual

knowledge of, or could not reasonably know of, a violation of the

Act or other provision of law by us; and you shall not in any manner

not expressly agreed to herein be responsible for ensuring

compliance by us with the provisions of the Act and CFTC

regulations.

You may, and are hereby authorized to, obey the order, judgment,

decree or levy of any court of competent jurisdiction or any

[[Page 67946]]

governmental agency with jurisdiction, which order, judgment, decree

or levy relates in whole or in part to the Account(s). In any event,

you shall not be liable by reason of any such action or omission to

act, to us or to any other person, firm, association or corporation

even if thereafter any such order, decree, judgment or levy shall be

reversed, modified, set aside or vacated.

We are permitted to invest our Commodity Customers' funds in

money market mutual funds pursuant to CFTC Regulation 1.25. That

rule sets forth the following conditions, among others, with respect

to any investment in a money market mutual fund:

(1) The net asset value of the fund must be computed by 9:00

a.m. of the business day following each business day and be made

available to us by that time;

(2) The fund must be legally obligated to redeem an interest in

the fund and make payment in satisfaction thereof by the close of

the business day following the day on which we make a redemption

request except as otherwise specified in CFTC Regulation

1.25(c)(5)(ii); and,

(3) The agreement under which we invest our Commodity Customers'

funds must not contain any provision that would prevent us from

pledging or transferring fund shares.

The terms of this letter agreement shall remain binding upon the

parties, their successors and assigns, including for the avoidance

of doubt, regardless of the change in name of any party. This letter

agreement supersedes and replaces any prior agreement between the

parties in connection with the Account(s), including but not limited

to any prior acknowledgment letter, to the extent that such prior

agreement is inconsistent with the terms hereof. In the event of any

conflict between this letter agreement and any other agreement

between the parties in connection with the Account(s), this letter

agreement shall govern with respect to matters specific to Section

4d of the Act and the CFTC's regulations, as amended.

This letter agreement shall be governed by and construed in

accordance with the laws of [Insert governing law] without regard to

the principles of choice of law.

Please acknowledge that you agree to abide by the requirements

and conditions set forth above by signing and returning the enclosed

copy of this letter. You further acknowledge and agree to provide a

copy of this fully executed letter directly to the CFTC (via

electronic mail to [email protected]) and our

designated self-regulatory organization in accordance with CFTC

Regulation 1.20.

[Name of Futures Commission Merchant or Derivatives Clearing

Organization]

By:

Print Name:

Title:

ACKNOWLEDGED AND AGREED:

[Name of Money Market Mutual Fund]

By:

Print Name:

Title:

Contact Information: [Insert phone number and email address]

Date:

14. Revise Sec. 1.29 to read as follows:

Sec. 1.29 Gains and losses resulting from investment of customer

funds.

(a) The investment of customer funds in instruments described in

Sec. 1.25 of this part shall not prevent the futures commission

merchant or derivatives clearing organization so investing such funds

from receiving and retaining as its own any incremental income or

interest income resulting therefrom.

(b) The futures commission merchant or derivatives clearing

organization, as applicable, shall bear sole responsibility for any

losses resulting from the investment of customer funds in instruments

described in Sec. 1.25 of this part. No investment losses shall be

borne or otherwise allocated to the customers of the futures commission

merchant and, if customer funds are invested by a derivatives clearing

organization in its discretion, to the futures commission merchant.

15. Revise Sec. 1.30 to read as follows:

Sec. 1.30 Loans by futures commission merchants; treatment of

proceeds.

Nothing in these regulations shall prevent a futures commission

merchant from lending its own funds to customers on securities and

property pledged by such customers, or from repledging or selling such

securities and property pursuant to specific written agreement with

such customers. The proceeds of such loans used to purchase, margin,

guarantee, or secure the trades, contracts, or commodity options of

customers shall be treated and dealt with by a futures commission

merchant as belonging to such customers, in accordance with and subject

to the provisions of the Act and these regulations. A futures

commission merchant may not loan funds on an unsecured basis to finance

customers' trading, nor may a futures commission merchant loan funds to

customers secured by the customer accounts of such customers.

16. Amend Sec. 1.32 by revising the section heading and paragraphs

(b) and (c) and by adding paragraphs (d), (e), (f), (g), (h), (i), (j),

and (k), to read as follows:

Sec. 1.32 Reporting of segregated account computation and details

regarding the holding of futures customer funds

* * * * *

(b) In computing the amount of futures customer funds required to

be in segregated accounts, a futures commission merchant may offset any

net deficit in a particular futures customer's account against the

current market value of readily marketable securities, less applicable

deductions (i.e., ``securities haircuts'') as set forth in Rule 15c3-

1(c)(2)(vi) of the Securities and Exchange Commission (17 CFR 241.15c3-

1(c)(2)(vi)), held for the same futures customer's account. Futures

commission merchants that establish and enforce written policies and

procedures to assess the credit risk of commercial paper, convertible

debt instruments, or nonconvertible debt instruments in accordance with

Rule 240.15c3-1(c)(2)(vi) of the Securities and Exchange Commission (17

CFR 240.15c3-1(c)(2)(vi)) may apply the lower haircut percentages

specified in Rule 240.15c3-1(c)(2)(vi) for such commercial paper,

convertible debt instruments and nonconvertible debt instruments. The

futures commission merchant must maintain a security interest in the

securities, including a written authorization to liquidate the

securities at the futures commission merchant's discretion, and must

segregate the securities in a safekeeping account with a bank, trust

company, derivatives clearing organization, or another futures

commission merchant. For purposes of this section, a security will be

considered readily marketable if it is traded on a ``ready market'' as

defined in Rule 15c3-1(c)(11)(i) of the Securities and Exchange

Commission (17 CFR 240.15c3-1(c)(11)(i)).

(c) Each futures commission merchant is required to document its

segregation computation required by paragraph (a) of this section by

preparing a Statement of Segregation Requirements and Funds in

Segregation for Customers Trading on U.S. Commodity Exchanges contained

in the Form 1-FR-FCM as of the close of each business day. Nothing in

this paragraph shall affect the requirement that a futures commission

merchant at all times maintain sufficient money, securities and

property to cover its total obligations to all futures customers, in

accordance with Sec. 1.20 of this part.

(d) Each futures commission merchant is required to submit to the

Commission and to the firm's designated self-regulatory organization

the daily Statement of Segregation Requirements and Funds in

Segregation for Customers Trading on U.S. Commodity Exchanges required

by paragraph (c) of this section by noon the following business day.

(e) Each futures commission merchant shall file the Statement of

Segregation Requirements and Funds in Segregation for Customers Trading

on U.S. Commodity Exchanges required by paragraph (c) of this section

in an electronic format using a form of user authentication assigned in

accordance with procedures established or approved by the Commission.

(f) Each futures commission merchant is required to submit to the

Commission

[[Page 67947]]

and to the firm's designated self-regulatory organization a report

listing the names of all banks, trust companies, futures commission

merchants, derivatives clearing organizations, or any other depository

or custodian holding futures customer funds as of the fifteenth day of

the month, or the first business day thereafter, and the last business

day of each month. This report must include:

(1) The name and location of each entity holding futures customer

funds;

(2) The total amount of futures customer funds held by each entity

listed in paragraph (f)(1) of this section; and

(3) The total amount of cash and investments that each entity

listed in paragraph (f)(1) of this section holds for the futures

commission merchant. The futures commission merchant must report the

following investments:

(i) Obligations of the United States and obligations fully

guaranteed as to principal and interest by the United States (U.S.

government securities);

(ii) General obligations of any State or of any political

subdivision of a State (municipal securities);

(iii) General obligation issued by any enterprise sponsored by the

United States (government sponsored enterprise securities);

(iv) Certificates of deposit issued by a bank;

(v) Commercial paper fully guaranteed as to principal and interest

by the United States under the Temporary Liquidity Guarantee Program as

administered by the Federal Deposit Insurance Corporation;

(vi) Corporate notes or bonds fully guaranteed as to principal and

interest by the United States under the Temporary Liquidity Guarantee

Program as administered by the Federal Deposit Insurance Corporation;

and

(vii) Interests in money market mutual funds.

(g) Each futures commission merchant must report the total amount

of futures customer-owned securities held by the futures commission

merchant as margin collateral and must list the names and locations of

the depositories holding such margin collateral.

(h) Each futures commission merchant must report the total amount

of futures customer funds that have been used to purchase securities

under agreements to resell the securities (reverse repurchase

transactions).

(i) Each futures commission merchant must report which, if any, of

the depositories holding futures customer funds under paragraph (f)(1)

of this section are affiliated with the futures commission merchant.

(j) Each futures commission merchant shall file the detailed list

of depositories required by paragraph (f) of this section by 11:59 p.m.

the next business day in an electronic format using a form of user

authentication assigned in accordance with procedures established or

approved by the Commission.

(k) Each futures commission merchant shall retain its daily

segregation computation and the Statement of Segregation Requirements

and Funds in Segregation for Customers Trading on U.S. Commodity

Exchanges required by paragraph (c) of this section, and its detailed

list of depositories required by paragraph (f) of this section,

together with all supporting documentation, in accordance with the

requirements of Sec. 1.31 of this part.

17. Revise Sec. 1.52 to read as follows:

Sec. 1.52 Self-regulatory organization adoption and surveillance of

minimum financial requirements.

(a) For purposes of this section, the following terms are defined

as follows:

(1) ``Examinations expert'' is defined as a Nationally recognized

accounting and auditing firm with substantial expertise in audits of

futures commission merchants, risk assessment and internal control

reviews, and is an accounting and auditing firm that is acceptable to

the Commission;

(2) ``Generally accepted auditing standards'' is defined as U.S.

generally accepted auditing standards, developed by the Auditing

Standards Board of the American Institute of Certified Public

Accountants; and

(3) ``Material weakness'' is defined as a deficiency, or a

combination of deficiencies, in internal control over financial

reporting such that there is a reasonable possibility that a material

misstating of the entities financial statements and regulatory

computations will not be prevented or detected on a timely basis by the

entity's internal controls;

(b)(1) Each self-regulatory organization must adopt rules

prescribing minimum financial and related reporting requirements for

members who are registered futures commission merchants, registered

retail foreign exchange dealers, or registered introducing brokers. The

self-regulatory organization's minimum financial and related reporting

requirements must be the same as, or more stringent than, the

requirements contained in Sec. Sec. 1.10 and 1.17 of this part, for

futures commission merchants and introducing brokers, and Sec. Sec.

5.7 and 5.12 of this chapter for retail foreign exchange dealers;

provided, however, that a self-regulatory organization may permit its

member registrants that are registered with the Securities and Exchange

Commission as securities brokers or dealers to file (in accordance with

Sec. 1.10(h) of this part) a copy of their Financial and Operational

Combined Uniform Single Report under the Securities Exchange Act of

1934 (``FOCUS Report''), Part II, Part IIA, or Part II CSE, as

applicable, in lieu of Form 1-FR; provided, further, that such self-

regulatory organization must require such member registrants to provide

all information in Form 1-FR that is not included in the FOCUS Report

Part provided by such member registrant. The definition of adjusted net

capital must be the same as that prescribed in Sec. 1.17(c) of this

chapter for futures commission merchants and introducing brokers, and

Sec. 5.7(b)(2) of this chapter for futures commission merchants

offering or engaging in retail forex transactions and for retail

foreign exchange dealers.

(2) In addition to the requirements set forth in paragraph (b)(1)

of this section, each self-regulatory organization that has a futures

commission merchant member registrant must adopt rules prescribing risk

management requirements for futures commission merchant member

registrants that shall be the same as, or more stringent than, the

requirements contained in Sec. 1.11 of this part.

(c)(1) Each self-regulatory organization must establish and operate

a supervisory program that includes written policies and procedures

concerning the application of such supervisory program in the

examination of its member registrants for the purpose of assessing

whether each member registrant is in compliance with the applicable

self-regulatory organization and Commission regulations governing

minimum net capital and related financial requirements, the obligation

to segregate customer funds, risk management requirements, financial

reporting requirements, recordkeeping requirements, and sales practice

and other compliance requirements. The supervisory program also must

address the following elements:

(i) Adequate levels and independence of examination staff. A self-

regulatory organization must maintain staff of an adequate size,

training, and experience to effectively implement a supervisory

program. Staff of the self-regulatory organization, including officers,

directors, and supervising committee members, must maintain independent

judgment and its actions must not impair its independence nor appear to

impair its independence in matters related to the supervisory program.

The self-regulatory organization must

[[Page 67948]]

provide annual ethics training to all staff with responsibilities for

the supervisory program.

(ii) Ongoing surveillance. A self-regulatory organization's ongoing

surveillance of member registrants must include the review and analysis

of financial reports and regulatory notices filed by member registrants

with the designated self-regulatory organization.

(iii) High-risk firms. A self-regulatory organization's supervisory

program must include procedures for identifying member registrants that

are determined to pose a high degree of potential financial risk,

including the potential risk of loss of customer funds. High-risk

member registrants must include firms experiencing financial or

operational difficulties, failing to meet segregation or net capital

requirements, failing to maintain current books and records, or

experiencing material inadequacies in internal controls. Enhanced

monitoring for high risk firms should include, as appropriate, daily

review of net capital, segregation, and secured calculations, to assess

compliance with self-regulatory organization and Commission

requirements.

(iv) On-site examinations. (A) A self-regulatory organization must

conduct routine periodic on-site examinations of member registrants.

Member futures commission merchants and retail foreign exchange dealers

must be subject to on-site examinations no less frequently than once

every eighteen months. A self-regulatory organization shall establish a

risk-based method of establishing the scope of each on-site

examination; provided, however, that the scope of each on-site

examination of a futures commission merchant or retail foreign exchange

dealer must include an assessment of whether the registrant is in

compliance with applicable Commission and self-regulatory organization

minimum capital, customer fund protection, recordkeeping, and reporting

requirements.

(B) A self-regulatory organization must establish the frequency of

on-site examinations of member introducing brokers that do not operate

pursuant to guarantee agreements with futures commission merchants or

retail foreign exchange dealers using a risk-based approach; provided,

however, that each introducing broker is subject to an on-site

examination no less frequently than once every three years.

(C) A self-regulatory organization must conduct on-site

examinations of member registrants in accordance with uniform

examination programs and procedures that have been submitted to the

Commission.

(v) Adequate documentation. A self-regulatory organization must

adequately document all aspects of the operation of the supervisory

program, including the conduct of risk-based scope setting and the

risk-based surveillance of high-risk member registrants, and the

imposition of remedial and punitive action(s) for material violations.

(2) In addition to the requirements set forth in paragraph (c)(1)

of this section, the supervisory program of a self-regulatory

organization that has a registered futures commission merchant member

must satisfy the following requirements:

(i) The supervisory program must set forth in writing the

examination standards that the self-regulatory organization must apply

in its examination of its registered futures commission merchant

member. The supervisory program must be based on controls testing as

well as substantive testing and must address all areas of risk to which

futures commission merchants can reasonably be foreseen to be subject.

The determination as to which elements of the supervisory program are

to be performed on any examination must be based on the risk profile of

each registered futures commission merchant member as well as any

additional areas of risk to be addressed in such examination.

(ii) All aspects of the supervisory program, including the

standards pursuant to paragraph (c)(2)(iii) of this section, must, at

minimum, conform to generally accepted auditing standards after giving

full consideration to those auditing standards as prescribed by the

Public Company Accounting Oversight Board.

(iii) The supervisory program must, at a minimum, have standards

addressing the following:

(A) The ethics of an examiner;

(B) The independence of an examiner;

(C) The supervision, review, and quality control of an examiner's

work product;

(D) The evidence and documentation to be reviewed and retained in

connection with an examination;

(E) The sampling size and techniques used in an examination;

(F) The examination risk assessment process;

(G) The examination planning process;

(H) Materiality assessment;

(I) Quality control procedures to ensure that the examinations

maintain the level of quality expected;

(J) Communications between an examiner and the regulatory oversight

committee of the self-regulatory organization of which the registered

futures commission merchant is a member;

(K) Communications between an examiner and a futures commission

merchant's audit committee of the board of directors or other similar

governing body;

(L) Analytical review procedures;

(M) Record retention; and

(N) Required items for inclusion in the examination report, such as

repeat violations, material items, and high risk issues.

(iv) A self-regulatory organization must cause an examinations

expert to evaluate the supervisory program and such self-regulatory

organization's application of the supervisory program at least once

every two years.

(A) The self-regulatory organization must obtain from such

examinations expert a written report that includes the following:

(1) An affirmation that the examinations expert has evaluated the

supervisory program, including the sufficiency of the risk-based

approach and the internal controls testing thereof, and comments and

recommendations in connection with such evaluation from such

examinations expert;

(2) An affirmation that the examinations expert has evaluated the

application of the supervisory program by the self-regulatory

organization, and comments and recommendations in connection with such

evaluation from such examinations expert;

(3) The examinations expert's opinion as to whether the supervisory

program is reasonably likely to identify a material weakness in

internal controls over financial and/or regulatory reporting and in any

of the other items that are the subject of an examination conducted in

accordance with the supervisory program; and

(4) A discussion and recommendation of any new or best practices as

prescribed by industry sources, including, but not limited to, those

from the American Institute of Certified Public Accountants, the

Institute of Internal Auditors, and The Risk Management Association.

(B) The self-regulatory organization must provide the written

report to the Commission no later than fifteen days following the

receipt thereof. Upon resolution of any questions or comments raised by

the Commission, and upon notice from the Commission that it has no

further comments or questions on the supervisory program as amended (by

reason of the examinations expert's proposals, considerations of the

Commission's questions or comments, or otherwise), the self-regulatory

organization shall commence applying

[[Page 67949]]

such supervisory program as the standard for examining its registered

futures commission merchant members.

(v) The supervisory program must require the self-regulatory

organization to report to its risk and/or audit committee of the board

of directors with timely reports of the activities and findings of the

supervisory program to assist the risk and/or audit committee of the

board of directors to fulfill its responsibility of overseeing the

examination function.

(vi) The initial supervisory program shall be established as

follows. Within 120 days following the effective date of this section,

or such other time as the Commission may approve, the self-regulatory

organization shall submit a proposed supervisory program to the

Commission for its review and comment, together with a written report

that includes the elements found in paragraphs (c)(2)(iv)(A)(1) and (3)

of this section from an examinations expert who has evaluated the

supervisory program. Upon resolution of any questions or comments

raised by the Commission, and upon notice from the Commission that it

has no further comments or questions on the proposed supervisory

program as amended (by reason of the considerations of the Commission's

questions or comments or otherwise), the self-regulatory organizations

shall commence applying such supervisory program as the standard for

examining its members that are registered as futures commission

merchants.

(d)(1) Any two or more self-regulatory organizations may file with

the Commission a plan for delegating to a designated self-regulatory

organization, for any registered futures commission merchant, retail

foreign exchange dealer, or introducing broker that is a member of more

than one such self-regulatory organization, the function of:

(i) Monitoring and examining for compliance with the minimum

financial and related reporting requirements and risk management

requirements, including policies and procedures relating to the

receipt, holding, investing and disbursement of customer funds, adopted

by such self-regulatory organizations and the Commission in accordance

with paragraphs (b) and (c) of this section; and

(ii) Receiving the financial reports and notices necessitated by

such minimum financial and related reporting requirements; provided,

however, that the self-regulatory organization that delegates the

functions set forth in this paragraph (d)(1) shall remain responsible

for its member registrants' compliance with the regulatory obligations,

and if such self-regulatory organization becomes aware that a delegated

function is not being performed as required under this section, the

self-regulatory organization shall promptly take any necessary steps to

address any noncompliance.

(2) If a plan established pursuant to paragraph (d)(1) of this

section applies to any registered futures commission merchant, then

such plan must include the following elements:

(i) The Joint Audit Committee. The self-regulatory organizations

that choose to participate in the plan shall form a Joint Audit

Committee, consisting of all self-regulatory organizations in the plan

as members. The members of the Joint Audit Committee shall establish,

operate and maintain a Joint Audit Program in accordance with the

requirements of this section to ensure an effective and a high quality

program for examining futures commission merchants, to designate the

designated self-regulatory organizations that will be responsible for

the examinations of futures commission merchants pursuant to the Joint

Audit Program, and to satisfy such additional obligations set forth in

this section in order to facilitate the examinations of futures

commission merchants by their respective designated self-regulatory

organizations.

(ii) The Joint Audit Program. The Joint Audit Program must, at

minimum, satisfy the following requirements.

(A) The purpose of the Joint Audit Program must be to assess

whether each registered futures commission merchant member of the Joint

Audit Committee members is in compliance with the Joint Audit Program

and Commission regulations governing minimum net capital and related

financial requirements, the obligation to segregate customer funds,

risk management requirements, including policies and procedures

relating to the receipt, holding, investment, and disbursement of

customer funds, financial reporting requirements, recordkeeping

requirements, and sales practice and other compliance requirements.

(B) The Joint Audit Program must include written policies and

procedures concerning the application of the Joint Audit Program in the

examination of the registered futures commission merchant members of

the Joint Audit Committee members.

(C)(1) Adequate levels and independence of examination staff. A

designated self-regulatory organization must maintain staff of an

adequate size, training, and experience to effectively implement the

Joint Audit Program. Staff of the designated self-regulatory

organization, including officers, directors, and supervising committee

members, must maintain independent judgment and its actions must not

impair its independence nor appear to impair its independence in

matters related to the Joint Audit Program. The designated self-

regulatory organization must provide annual ethics training to all

staff with responsibilities for the Joint Audit Program.

(2) Ongoing surveillance. A designated self-regulatory

organization's ongoing surveillance of futures commission merchant

member registrants over which it has oversight responsibilities must

include the review and analysis of financial reports and regulatory

notices filed by such member registrants with the designated self-

regulatory organization.

(3) High-risk firms. The Joint Audit Program must include

procedures for identifying futures commission merchant member

registrants over which it has oversight responsibilities that are

determined to pose a high degree of potential financial risk, including

the potential risk of loss of customer funds. High-risk member

registrants must include firms experiencing financial or operational

difficulties, failing to meet segregation or net capital requirements,

failing to maintain current books and records, or experiencing material

inadequacies in internal controls. Enhanced monitoring for high risk

firms should include, as appropriate, daily review of net capital,

segregation, and secured calculations, to assess compliance with self-

regulatory and Commission requirements.

(4) On-site examinations. A designated self-regulatory organization

must conduct routine periodic on-site examinations of futures

commission merchant member registrants over which it has oversight

responsibilities. Such member registrants must be subject to on-site

examinations no less frequently than once every eighteen months. A

designated self-regulatory organization shall establish a risk-based

method of establishing the scope of each on-site examination, provided,

however, that the scope of each on-site examination of a futures

commission merchant must include an assessment of whether the

registrant is in compliance with applicable Commission and self-

regulatory organization minimum capital, customer fund protection,

recordkeeping, and reporting requirements. A designated self-regulatory

organization must conduct on-site examinations of futures commission

merchant registrants in accordance with the Joint Audit Program.

[[Page 67950]]

(D) The Joint Audit Committee members must adequately document all

aspects of the operation of the Joint Audit Program, including the

conduct of risk-based scope setting and the risk-based surveillance of

high-risk member registrants, and the imposition of remedial and

punitive action(s) for material violations.

(E) The Joint Audit Program must set forth in writing the

examination standards that a designated self-regulatory organization

must apply in its examination of a registered futures commission

merchant. The Joint Audit Program must be based on controls testing as

well as substantive testing and must address all areas of risk to which

registered futures commission merchants can reasonably be foreseen to

be subject. The determination as to which elements of the Joint Audit

Program are to be performed on any examination must be based on the

risk profile of each registered futures commission merchant as well as

any additional areas of risk to be addressed in such examination.

(F) All aspects of the Joint Audit Program, including the standards

required pursuant to paragraph (d)(2)(ii)(G) of this section, must, at

minimum, conform to generally accepted auditing standards after full

consideration to those auditing standards as prescribed by the Public

Company Accounting Oversight Board.

(G) The Joint Audit Program must have standards addressing those

items listed in paragraph (c)(2)(iii) of this section.

(H) The initial Joint Audit Program shall be established as

follows. Within 120 days following the effective date of this section,

or such other time as the Commission may approve, the Joint Audit

Committee members shall submit a proposed initial Joint Audit Program

to the Commission for its review and comment, together with a written

report that includes the elements found in paragraphs (d)(2)(ii)(I)(1)

and (3) of this section from an examinations expert who has evaluated

the Joint Audit Program. Upon resolution of any questions or comments

raised by the Commission, and upon notice from the Commission that it

has no further comments or questions on the proposed Joint Audit

Program as amended (by reason of the considerations of the Commission's

questions or comments or otherwise), the designated self-regulatory

organizations shall commence applying such Joint Audit Program as the

standard for examining their respective registered futures commission

merchants.

(I) Following the establishment of the Joint Audit Program, no less

frequently than once every two years, the Joint Audit Committee members

must cause an examinations expert to evaluate the Joint Audit Program

and each designated self-regulatory organization's application of the

Joint Audit Program. The Joint Audit Committee members must obtain from

such examinations expert a written report, and must provide the written

report to the Commission no later than forty-five days prior to the

annual meeting of the members of the Joint Audit Committee to be held

in that year pursuant to paragraph (d)(2)(iii)(A) of this section. The

written report must include the following:

(1) An affirmation that the examinations expert has evaluated the

Joint Audit Program, including the sufficiency of the risk-based

approach and the internal controls testing thereof, and comments and

recommendations in connection with such evaluation from such

examinations expert;

(2) An affirmation that the examinations expert has evaluated the

application of the Joint Audit Program by each designated self-

regulatory organization, and comments and recommendations in connection

with such evaluation from such examinations expert;

(3) The examinations expert's opinion as to whether the Joint Audit

Program is reasonably likely to identify a material deficiency in

internal controls over financial and/or regulatory reporting and in any

of the other items that are the subject of an examination conducted in

accordance with the Joint Audit Program; and

(4) A discussion and recommendation of any new or best practices as

prescribed by industry sources, including, but not limited to, those

from the American Institute of Certified Public Accountants, the

Internal Audit Association and The Risk Management Association.

(J) The Joint Audit Program must require each Joint Audit Committee

member to report to its risk and/or audit committee of the board of

directors with timely reports of the activities and findings of the

Joint Audit Program to assist the risk and/or audit committee of the

board of directors to fulfill its responsibility of overseeing the

examination function.

(iii) Meetings of the Joint Audit Committee. (A) No less frequently

than once every year, the Joint Audit Committee members must meet to

consider whether changes to the Joint Audit Program are appropriate,

and in considering such, in meetings corresponding to the biennial

written report obtained from an examinations expert pursuant to

paragraph (d)(2)(ii)(I) of this section, the Joint Audit Committee

members must consider such written report, including the results of the

examinations expert's assessment of the Joint Audit Program and any

additional recommendations. The Commission's questions, comments and

proposals must also be considered. Upon notice from the Commission that

it has no further comments or questions on the Joint Audit Program as

amended (by reason of the examinations expert's proposals,

considerations of the Commission's questions, comments and proposals,

or otherwise), the designated self-regulatory organizations shall

commence applying such Joint Audit Program as the standard for

examining their respective registered futures commission merchants.

(B) In addition to the items considered in paragraph (d)(2)(iii)(A)

of this section, the Joint Audit Committee members must consider the

following items during the annual meeting:

(1) The role of the Joint Audit Committee and its members as it

relates to self-regulatory organization responsibilities;

(2) Developing and maintaining the Joint Audit Program for all

designated self-regulatory organizations to follow with no exceptions;

(3) Coordinating self-regulatory organization responsibilities with

those of independent certified public accountants, the Commission and

other regulators and self-regulatory organizations (e.g., the

Securities and Exchange Commission, the Financial Industry Regulatory

Authority, and others, as the case may be for futures commission

merchants subject to regulation by multiple regulators and self-

regulatory organizations);

(4) Coordinating and sharing information between the Joint Audit

Committee members, including issues and industry concerns in connection

with examinations of futures commission merchants;

(5) Identifying industry financial and regulatory reporting issues

and financial and operational internal control issues and modifying the

Joint Audit Program accordingly;

(6) Issuing an annual risk alert for futures commission merchants;

(7) Issuing an annual examination alert for certified public

accountants and designated self-regulatory organization examiners;

(8) Responding to industry issues;

(9) Providing industry feedback to Commission proposals; and

[[Page 67951]]

(10) Developing and maintaining a standard of ethics and

independence with which all examination units of the Joint Audit

Committee members must comply.

(C) Minutes must be taken of all meetings and distributed to all

members on a timely basis.

(D) The Commission must receive timely prior notice of each

meeting, have to right to attend and participate in each meeting and

receive written copies of the reports and minutes required pursuant to

paragraphs (d)(2)(ii)(J) and (d)(2)(iii)(C) of this section,

respectively.

(3) The plan referenced in paragraph (d)(1) of this section shall

not be effective without Commission approval pursuant to paragraph (h)

of this section.

(e) Any plan filed under this section may contain provisions for

the allocation of expenses reasonably incurred by designated self-

regulatory organizations among the self-regulatory organizations

participating in such a plan.

(f) A plan's designated self-regulatory organizations must report

to:

(1) That plan's other self-regulatory organizations any violation

of such other self-regulatory organizations' rules and regulations for

which the responsibility to monitor or examine has been delegated to

such designated self-regulatory organization under this section; and

(2) The Director of the Division of Swap Dealer and Intermediary

Oversight of the Commission any violation of a self-regulatory

organization's rules and regulations or any violation of the

Commission's regulations for which the responsibility to monitor,

audit, or examine has been delegated to such designated self-regulatory

organization under this section.

(g) The Joint Audit Committee members may, among themselves,

establish programs to provide access to any necessary financial or

related information.

(h) After appropriate notice and opportunity for comment, the

Commission may, by written notice, approve such a plan, or any part of

the plan, if it finds that the plan, or any part of it:

(1) Is necessary or appropriate to serve the public interest;

(2) Is for the protection and in the interest of customers;

(3) Reduces multiple monitoring and multiple examining for

compliance with the minimum financial rules of the Commission and of

the self-regulatory organizations submitting the plan of any futures

commission merchant, retail foreign exchange dealer, or introducing

broker that is a member of more than one self-regulatory organization;

(4) Reduces multiple reporting of the financial information

necessitated by such minimum financial and related reporting

requirements by any futures commission merchant, retail foreign

exchange dealer, or introducing broker that is a member of more than

one self-regulatory organization;

(5) Fosters cooperation and coordination among the self-regulatory

organizations; and

(6) Does not hinder the development of a registered futures

association under section 17 of the Act.

(i) After the Commission has approved a plan, or part thereof,

under paragraph (h) of this section, a self-regulatory organization

delegating the functions described in paragraph (d)(1) of this section

must notify each of its members that are subject to such a plan:

(1) Of the limited scope of the delegating self-regulatory

organization's responsibility for such a member's compliance with the

Commission's and self-regulatory organization's minimum financial and

related reporting requirements; and

(2) Of the identity of the designated self-regulatory organization

that has been delegated responsibility for such a member; provided,

however, that the self-regulatory organization that delegates, pursuant

to paragraph (d) of this section, the functions set forth in paragraphs

(b) and (c) of this section shall remain responsible for its member

registrants' compliance with the regulatory obligations, and if such

self-regulatory organization becomes aware that a delegated function is

not being performed as required under this section, the self-regulatory

organization shall promptly take any necessary steps to address any

noncompliance.

(j) The Commission may at any time, after appropriate notice and

opportunity for hearing, withdraw its approval of any plan, or part

thereof, established under this section, if such plan, or part thereof,

ceases to adequately effectuate the purposes of section 4f(b) of the

Act or of this section.

(k) Whenever a registered futures commission merchant, a registered

retail foreign exchange dealer, or a registered introducing broker

holding membership in a self-regulatory organization ceases to be a

member in good standing of that self-regulatory organization, such

self-regulatory organization must, on the same day that event takes

place, give electronic notice of that event to the Commission at its

Washington, DC, headquarters and send a copy of that notification to

such futures commission merchant, retail foreign exchange dealer, or

introducing broker.

(l) Nothing in this section shall preclude the Commission from

examining any futures commission merchant, retail foreign exchange

dealer, or introducing broker for compliance with the minimum financial

and related reporting requirements, and the risk management

requirements, as applicable, to which such futures commission merchant,

retail foreign exchange dealer, or introducing broker is subject.

(m) In the event a plan is not filed and/or approved for each

registered futures commission merchant, retail foreign exchange dealer,

or introducing broker that is a member of more than one self-regulatory

organization, the Commission may design and, after notice and

opportunity for comment, approve a plan for those futures commission

merchants, retail foreign exchange dealers, or introducing brokers that

are not the subject of an approved plan (under paragraph (h) of this

section), delegating to a designated self-regulatory organization the

responsibilities described in paragraph (d) of this section.

18. Amend Sec. 1.55 by revising paragraphs (b)(2) through (8) and

by adding paragraphs (b)(9) through (14), (i), (j), (k), (l), (m), (n),

and (o), to read as follows:

Sec. 1.55 Public disclosures by futures commission merchants

* * * * *

(b) * * *

(2) The funds you deposit with a futures commission merchant for

trading futures positions are not protected by insurance in the event

of the bankruptcy or insolvency of the futures commission merchant, or

in the event your funds are misappropriated due to fraud.

(3) The funds you deposit with a futures commission merchant for

trading futures positions are not protected by the Securities Investor

Protection Corporation even if the futures commission merchant is

registered with the Securities and Exchange Commission as a broker or

dealer.

(4) The funds you deposit with a futures commission merchant are

not guaranteed or insured by a derivatives clearing organization in the

event of the bankruptcy or insolvency of the futures commission

merchant, or if the futures commission merchant is otherwise unable to

refund your funds.

(5) The funds you deposit with a futures commission merchant are

not held by the futures commission

[[Page 67952]]

merchant in a separate account for your individual benefit. Futures

commission merchants commingle the funds received from customers in one

or more accounts and you may be exposed to losses incurred by other

customers if the futures commission merchant does not have sufficient

capital to cover such other customers' trading losses.

(6) The funds you deposit with a futures commission merchant may be

invested by the futures commission merchant in certain types of

financial instruments that have been approved by the Commission for the

purpose of such investments. Permitted investments are listed in

Commission Regulation 1.25 and include: U.S. government securities;

municipal securities; money market mutual funds; and certain corporate

notes and bonds. The futures commission merchant may retain the

interest and other earnings realized from its investment of customer

funds. You should be familiar with the types of financial instruments

that a futures commission merchant may invest customer funds in.

(7) Futures commission merchants are permitted to deposit customer

funds with affiliated entities, such as affiliated banks, securities

brokers or dealers, or foreign brokers. You should inquire as to

whether your futures commission merchant deposits funds with affiliates

and assess whether such deposits by the futures commission merchant

with its affiliates increases the risks to your funds.

(8) You should consult your futures commission merchant concerning

the nature of the protections available to safeguard funds or property

deposited for your account.

(9) Under certain market conditions, you may find it difficult or

impossible to liquidate a position. This can occur, for example, when

the market reaches a daily price fluctuation limit (``limit move'').

(10) All futures positions involve risk, and a ``spread'' position

may not be less risky than an outright ``long'' or ``short'' position.

(11) The high degree of leverage (gearing) that is often obtainable

in futures trading because of the small margin requirements can work

against you as well as for you. Leverage (gearing) can lead to large

losses as well as gains.

(12) In addition to the risks noted in the paragraphs enumerated

above, you should be familiar with the futures commission merchant you

select to entrust your funds for trading futures positions. The

Commodity Futures Trading Commission requires each futures commission

merchant to make publicly available on its Web site firm specific

disclosures and financial information to assist you with your

assessment and selection of a futures commission merchant. Information

regarding this futures commission merchant may be obtained by visiting

our Web site, www.[Web site address].

ALL OF THE POINTS NOTED ABOVE APPLY TO ALL FUTURES TRADING WHETHER

FOREIGN OR DOMESTIC. IN ADDITION, IF YOU ARE CONTEMPLATING TRADING

FOREIGN FUTURES OR OPTIONS CONTRACTS, YOU SHOULD BE AWARE OF THE

FOLLOWING ADDITIONAL RISKS:

(13) Foreign futures transactions involve executing and clearing

trades on a foreign exchange. This is the case even if the foreign

exchange is formally ``linked'' to a domestic exchange, whereby a trade

executed on one exchange liquidates or establishes a position on the

other exchange. No domestic organization regulates the activities of a

foreign exchange, including the execution, delivery, and clearing of

transactions on such an exchange, and no domestic regulator has the

power to compel enforcement of the rules of the foreign exchange or the

laws of the foreign country. Moreover, such laws or regulations will

vary depending on the foreign country in which the transaction occurs.

For these reasons, customers who trade on foreign exchanges may not be

afforded certain of the protections which apply to domestic

transactions, including the right to use domestic alternative dispute

resolution procedures. In particular, funds received from customers to

margin foreign futures transactions may not be provided the same

protections as funds received to margin futures transactions on

domestic exchanges. Before you trade, you should familiarize yourself

with the foreign rules which will apply to your particular transaction.

(14) Finally, you should be aware that the price of any foreign

futures or option contract and, therefore, the potential profit and

loss resulting therefrom, may be affected by any fluctuation in the

foreign exchange rate between the time the order is placed and the

foreign futures contract is liquidated or the foreign option contract

is liquidated or exercised.

THIS BRIEF STATEMENT CANNOT, OF COURSE, DISCLOSE ALL THE RISKS AND

OTHER ASPECTS OF THE COMMODITY MARKETS

I hereby acknowledge that I have received and understood this risk

disclosure statement.

-----------------------------------------------------------------------

Date

-----------------------------------------------------------------------

Signature of Customer

* * * * *

(i) Notwithstanding any other provision of this section, no futures

commission merchant may enter into a customer account agreement or

first accept funds from a customer, unless the futures commission

merchant discloses to the customer all information about the futures

commission merchant, including its business, operations, risk profile,

and affiliates, that would be material to the customer's decision to

entrust such funds to and otherwise do business with the futures

commission merchant and that is otherwise necessary for full and fair

disclosure. In connection with the disclosure of such information, the

futures commission merchant shall provide material information about

the topics described in paragraph (k) of this section, expanding upon

such information as necessary to keep such disclosure from being

misleading, whether through omission or otherwise. The futures

commission merchant shall also disclose the same information required

by this paragraph to all customers existing on the effective date of

this paragraph even if the futures commission merchant and such

existing customers have previously entered into a customer account

agreement or the futures commission merchant has already accepted funds

from such existing customers. The futures commission merchant shall

update the information required by this section as and when necessary,

but at least annually, to keep such information accurate and complete

and shall promptly disclose such updated information to all of its

customers. In connection with such obligation to update information,

the futures commission merchant shall take into account any material

change to its business operation, financial condition and other factors

material to the customer's decision to entrust the customer's funds and

otherwise do business with the futures commission merchant since its

most recent disclosure pursuant to this paragraph, and for this purpose

shall without limitation consider events that require periodic

reporting required to be filed pursuant to Sec. 1.12 of this part. For

purposes of this section, the disclosures required pursuant to this

paragraph (i) will be referred to as the ``Disclosure Documents.'' The

Disclosure Documents shall provide a detailed table of contents

referencing and describing the Disclosure Documents.

[[Page 67953]]

(j)(1) Each futures commission merchant shall make the Disclosure

Documents available to each customer to whom disclosure is required

pursuant to paragraph (i) of this section (for purposes of this

section, its ``FCM Customers'') and to the general public.

(2) A futures commission merchant shall make the Disclosure

Documents available to FCM Customers and to the general public by

posting a copy of the Disclosure Documents on the futures commission

merchant's Web site. A futures commission merchant, however, may use an

electronic means other than its Web site to make the Disclosure

Documents available to its FCM Customers; provided that:

(i) The electronic version of the Disclosure Documents shall be

presented in a format that is readily communicated to the FCM

Customers. Information is readily communicated to the FCM Customers if

it is accessible to the ordinary computer user by means of commonly

available hardware and software and if the electronically delivered

document is organized in substantially the same manner as would be

required for a paper document with respect to the order of presentation

and the relative prominence of information; and

(ii) A complete paper copy of the Disclosure Documents shall be

provided to an FCM Customer upon request.

(k) Specific Topics. The futures commission merchant shall provide

material information about the following specific topics:

(1) The futures commission merchant's name, address of its

principal place of business, phone number, fax number, and email

address;

(2) The names and business addresses of the futures commission

merchant's directors and senior management, including titles, business

background, areas of responsibility, and the nature of duties of each;

(3) The significant types of business activities and product lines

engaged in by the futures commission merchant, and the approximate

percentage of the futures commission merchant's assets and capital that

are used in each type of activity;

(4) The futures commission merchant's business on behalf of its

customers, including types of accounts, markets traded, international

businesses, and clearinghouses and carrying brokers used, and the

futures commission merchant's policies and procedures concerning the

choice of bank depositories, custodians, and other counterparties;

(5) The material risks, accompanied by an explanation of how such

risks may be material to its customers, of entrusting funds to the

futures commission merchant, including, without limitation, the nature

of investments made by the futures commission merchant (including

credit quality, weighted average maturity, and weighted average

coupon); the futures commission merchant's creditworthiness, leverage,

capital, liquidity, principal liabilities, balance sheet leverage and

other lines of business; risks to the futures commission merchant

created by its affiliates and their activities, including investment of

customer funds in an affiliated entity; and any significant

liabilities, contingent or otherwise, and material commitments;

(6) The name of the futures commission merchant's designated self-

regulatory organization and its Web site address and the location where

the annual audited financial statements of the futures commission

merchant is made available;

(7) Any material administrative, civil, enforcement, or criminal

action then pending, and any enforcement actions taken in last three

years;

(8) A basic overview of customer fund segregation, futures

commission merchant collateral management and investments, futures

commission merchants, and joint futures commission merchant/broker

dealers;

(9) Information on how a customer may obtain information regarding

filing a complaint about the futures commission merchant with the

Commission or with the firm's designated self-regulatory organization:

and

(10) The following financial data as of the most recent month-end

when the Disclosure Document is prepared:

(i) The futures commission merchant's total equity, regulatory

capital, and net worth, all computed in accordance with U.S. Generally

Accepted Accounting Principles and Sec. 1.17 of this part, as

applicable;

(ii) The dollar value of the futures commission merchant's

proprietary margin requirements as a percentage of the aggregate margin

requirement for futures customers, Cleared Swaps Customers, and 30.7

Customers;

(iii) The number of futures customers, Cleared Swaps Customers, and

30.7 Customers that comprise 50 percent of the futures commission

merchant's total funds held for futures customers, Cleared Swaps

Customers, and 30.7 Customers, respectively;

(iv) The aggregate notional value, by asset class, of all non-

hedged, principal over-the-counter transactions into which the futures

commission merchant has entered;

(v) The amount, generic source and purpose of any unsecured lines

of credit (or similar short-term funding) the futures commission

merchant has obtained but not yet drawn upon;

(vi) The aggregated amount of financing the futures commission

merchant provides for customer transactions involving illiquid

financial products for which it is difficult to obtain timely and

accurate prices; and

(vii) The percentage of futures customer, Cleared Swaps Customer,

and 30.7 Customer receivable balances that the futures commission

merchant had to write-off as uncollectable during the past 12-month

period, as compared to the current balance of funds held for futures

customers, Cleared Swaps Customers, and 30.7 Customers; and

(11) A summary of the futures commission merchant's current risk

practices, controls and procedures.

(l) In addition to the foregoing, each futures commission merchant

shall adopt policies and procedures reasonably designed to ensure that

advertising and solicitation activities by each such futures commission

merchant and any introducing brokers associated with such futures

commission merchant are not misleading to its FCM Customers in

connection with their decision to entrust funds to and otherwise do

business with such futures commission merchant.

(m) The Disclosure Document required by paragraph (i) of this

section is in addition to the Risk Disclosure Statement required under

paragraph (a) of this section.

(n) All Disclosure Documents, with each Disclosure Document dated

the date of first use, shall be maintained in accordance with Sec.

1.31 and shall be made available promptly upon request to

representatives of its designated self-regulatory organization,

representatives of the Commission, and representatives of applicable

prudential regulators.

(o)(1) Each futures commission merchant shall make the following

financial information publicly available on its Web site:

(i) The daily Statement of Segregation Requirements and Funds in

Segregation for Customers Trading on U.S. Exchanges for the most

current 12-month period;

(ii) The daily Statement of Secured Amounts and Funds Held in

Separate Accounts for 30.7 Customers Pursuant to Commission Regulation

30.7 for the most current 12-month period;

(iii) The daily Statement of Cleared Swaps Customer Segregation

Requirements and Funds in Cleared

[[Page 67954]]

Swaps Customer Accounts Under Section 4d(f) of the Act for the most

current 12-month period;

(iv) A summary schedule of the futures commission merchant's

adjusted net capital, net capital, and excess net capital, all computed

in accordance with Sec. 1.17 of this part and reflecting balances as

of the month-end for the 12 most recent months; and

(v) The Statement of Financial Condition, the Statement of

Segregation Requirements and Funds in Segregation for Customers Trading

on U.S. Exchanges, the Statement of Secured Amounts and Funds Held in

Separate Accounts for 30.7 Customers Pursuant to Commission Regulation

30.7, the Statement of Cleared Swaps Customer Segregation Requirements

and Funds in Cleared Swaps Customer Accounts Under Section 4d(f) of the

Act, an all related footnotes to the above schedules that are part of

the futures commission merchant's most current certified annual report

pursuant to Sec. 1.16 of this part.

(2) Each futures commission merchant must include a statement on

its Web site that is available to the public that financial information

regarding the futures commission merchant, including how the futures

commission merchant invests and holds customer funds, may be obtained

from the National Futures Association and include a link to the Web

site of the National Futures Association's Basic System where

information regarding the futures commission merchant's investment of

customer funds is maintained.

(3) Each futures commission merchant must include a statement on

its Web site that is available to the public that additional financial

information on all futures commission merchants is available from the

Commodity Futures Trading Commission, and include a link to the

Commodity Futures Trading Commission's web page for financial data for

futures commission merchants.

PART 3--REGISTRATION

19. The authority citation for part 3 continues to read as follows:

Authority: 5 U.S.C. 552, 552b; 7 U.S.C. 1a, 2, 6a, 6b, 6b-1, 6c,

6d, 6e, 6f, 6g, 6h, 6i, 6k, 6m, 6n, 6o, 6p, 6s, 8, 9, 9a, 12, 12a,

13b, 13c, 16a, 18, 19, 21, and 23, as amended by Title VII of the

Dodd-Frank Wall Street Reform and Consumer Protection Act, Pub. L.

111-203, 124 Stat. 1376 (Jul. 21, 2010).

20. Amend Sec. 3.3 by revising paragraph (f)(2) to read as

follows:

Sec. 3.3 Chief compliance officer.

* * * * *

(f) * * *

(2) The annual report shall be furnished electronically to the

Commission not more than 60 days after the end of the fiscal year of

the futures commission merchant, swap dealer, or major swap

participant, simultaneously with the submission of Form 1-FR-FCM, as

required under Sec. 1.10(b)(2)(ii) of this chapter, simultaneously

with the Financial and Operational Combined Uniform Single Report, as

required under Sec. 1.10(h) of this chapter, or simultaneously with

the financial condition report, as required under section 4s(f) of the

Act, as applicable.

* * * * *

PART 22--CLEARED SWAPS

21. The authority citation for part 22 continues to read as

follows:

Authority: 7 U.S.C. 1a, 6d, 7a-1 as amended by Title VII of the

Dodd-Frank Wall Street Reform and Consumer Protection Act, Pub. L.

111-203, 124 Stat. 1376 (Jul. 21, 2010).

22. Amend Sec. 22.2 by revising paragraphs (d)(1), (e)(1), (f)(2),

(f)(4), (f)(5)(iii)(B), and (g)(2), and by adding paragraphs (f)(6) and

(g)(3) through (10) to read as follows:

Sec. 22.2 Futures Commission Merchants: Treatment of Cleared Swaps

and Associated Cleared Swap Customer Collateral.

* * * * *

(d) Limitations on use. (1) No futures commission merchant shall

use, or permit the use of, the Cleared Swaps Customer Collateral of one

Cleared Swaps Customer to purchase, margin, or settle the Cleared Swaps

or any other trade or contract of, or to secure or extend the credit

of, any person other than such Cleared Swaps Customer. Cleared Swaps

Customer Collateral shall not be used to margin, guarantee, or secure

trades or contracts of the entity constituting a Cleared Swaps Customer

other than in Cleared Swaps, except to the extent permitted by a

Commission rule, regulation or order. For this purpose, a futures

commission merchant which operationally commingles the funds of its

Cleared Swaps Customers must ensure that at all times its residual

interest in Cleared Swaps Customer Accounts exceeds the sum of the

margin deficits of all of its Cleared Swaps Customers.

* * * * *

(e) * * *

(1) Permitted investments. A futures commission merchant may invest

money, securities, or other property constituting Cleared Swaps

Customer Collateral in accordance with Sec. 1.25 of this chapter,

which shall apply to such money, securities, or other property as if

they comprised customer funds or customer money subject to segregation

pursuant to section 4d(a) of the Act and the regulations thereunder;

Provided, however, that the futures commission merchant shall bear sole

responsibility for any losses resulting from the investment of customer

funds in instruments described in Sec. 1.25 of this chapter. No

investment losses shall be borne or otherwise allocated to Cleared

Swaps Customers of the futures commission merchant.

* * * * *

(f) * * *

(2) The futures commission merchant must reflect in the account

that it maintains for each Cleared Swaps Customer the market value of

any Cleared Swaps Customer Collateral that it receives from such

customer, as adjusted by:

(i) Any uses permitted under Sec. 22.2(d) of this part;

(ii) Any accruals on permitted investments of such collateral under

Sec. 22.2(e) of this part that, pursuant to the futures commission

merchant's customer agreement with that customer, are creditable to

such customer;

(iii) Any gains and losses with respect to Cleared Swaps;

(iv) Any charges lawfully accruing to the Cleared Swaps Customer,

including any commission, brokerage fee, interest, tax, or storage fee;

and

(v) Any appropriately authorized distribution or transfer of such

collateral.

* * * * *

(4) The futures commission merchant must, at all times, maintain in

segregation, in its FCM Physical Locations and/or its Cleared Swaps

Customer Accounts at Permitted Depositories, an amount equal to the sum

of any credit balances that the Cleared Swaps Customers of the futures

commission merchant have in their accounts, excluding from such sum any

debit balances that the Cleared Swaps Customers of the futures

commission merchant have in their accounts.

(5) * * *

(iii) * * *

(B) Reduce such market value by applicable percentage deductions

(i.e., ``securities haircuts'') as set forth in Rule 15c3-1(c)(2)(vi)

of the Securities and Exchange Commission (Sec. 240.15c3-1(c)(2)(vi)

of this title). Futures commission merchants that establish and enforce

written policies and procedures to assess the credit risk of commercial

paper, convertible debt instruments, or nonconvertible debt instruments

in accordance with Rule

[[Page 67955]]

240.15c3-1(c)(2)(vi) of the Securities and Exchange Commission (17 CFR

240.15c3-1(c)(2)(vi)) may apply the lower haircut percentages specified

in Rule 240.15c3-1(c)(2)(vi) for such commercial paper, convertible

debt instruments and nonconvertible debt instruments. The portion of

the debit balance, not exceeding 100 percent, that is secured by the

reduced market value of such readily marketable securities shall be

included in calculating the sum referred to in paragraph (f)(4) of this

section.

(6) The FCM must reflect in the account it maintains for each

Cleared Swaps Customer the amount of collateral required for the

Cleared Swaps Customer's Cleared Swaps at each derivatives clearing

organization on which the futures commission merchant is a member, or

by each other futures commission merchant through which the futures

commission merchant clears Cleared Swaps, and the total of such

required collateral amounts. If the value of the Cleared Swaps Customer

Collateral, as calculated in this section, for a Cleared Swaps Customer

is less than the total amount of collateral required for that Cleared

Swaps Customer's Cleared Swaps at such derivatives clearing

organizations and such other futures commission merchants, the

difference is a margin deficit. The futures commission merchant must at

all times maintain a residual interest in Cleared Swaps Customer

Accounts sufficient to exceed the sum of all margin deficits that

Cleared Swaps Customers of the futures commission merchant have in

their accounts. Such residual interest may not be withdrawn pursuant to

any provision of this chapter.

(g) * * *

(2) Each futures commission merchant is required to document its

segregation computation required by paragraph (g)(1) of this section by

preparing a Statement of Cleared Swaps Customer Segregation

Requirements and Funds in Cleared Swaps Customer Accounts Under 4d(f)

of the CEA contained in the Form 1-FR-FCM as of the close of business

each business day.

(3) Each futures commission merchant is required to submit to the

Commission and to the firm's designated self-regulatory organization

the daily Statement of Cleared Swaps Customer Segregation Requirements

and Funds in Cleared Swaps Customer Accounts Under 4d(f) of the CEA

required by paragraph (g)(2) of this section by noon the following

business day.

(4) Each futures commission merchant shall file the Statement of

Cleared Swaps Customer Segregation Requirements and Funds in Cleared

Swaps Customer Accounts Under 4d(f) of the CEA required by paragraph

(g)(2) of this section in an electronic format using a form of user

authentication assigned in accordance with procedures established or

approved by the Commission.

(5) Each futures commission merchant is required to submit to the

Commission and to the firm's designated self-regulatory organization a

report listing of the names of all banks, trust companies, futures

commission merchants, derivatives clearing organizations, or any other

depository or custodian holding Cleared Swaps Customer Collateral as of

the fifteenth day of the month, or the first business day thereafter,

and the last business day of each month. This report must include:

(i) The name and location of each entity holding Cleared Swaps

Customer Collateral;

(ii) The total amount of Cleared Swaps Customer Collateral held by

each entity listed in this paragraph (g)(5); and

(iii) The total amount of cash and investments that each entity

listed in this paragraph (g)(5) holds for the futures commission

merchant. The futures commission merchant must report the following

investments:

(A) Obligations of the United States and obligations fully

guaranteed as to principal and interest by the United States (U.S.

government securities);

(B) General obligations of any State or of any political

subdivision of a State (municipal securities);

(C) General obligation issued by any enterprise sponsored by the

United States (government sponsored enterprise securities);

(D) Certificates of deposit issued by a bank;

(E) Commercial paper fully guaranteed as to principal and interest

by the United States under the Temporary Liquidity Guarantee Program as

administered by the Federal Deposit Insurance Corporation;

(F) Corporate notes or bonds fully guaranteed as to principal and

interest by the United States under the Temporary Liquidity Guarantee

Program as administered by the Federal Deposit Insurance Corporation;

and

(G) Interests in money market mutual funds.

(6) Each futures commission merchant must report the total amount

of customer owned securities held by the futures commission merchant as

Cleared Swaps Customer Collateral and must list the names and locations

of the depositories holding customer owned securities.

(7) Each futures commission merchant must report the total amount

of Cleared Swaps Customer Collateral that has been used to purchase

securities under agreements to resell the securities (reverse

repurchase transactions).

(8) Each futures commission merchant must report which, if any, of

the depositories holding Cleared Swaps Customer Collateral under

paragraph (g)(5) of this section are affiliated with the futures

commission merchant.

(9) Each futures commission merchant shall file the detailed list

of depositories required by paragraph (g)(5) of this section by 11:59

p.m. the next business day in an electronic format using a form of user

authentication assigned in accordance with procedures established or

approved by the Commission.

(10) Each futures commission merchant shall retain its daily

segregation computation and the Statement of Cleared Swaps Customer

Segregation Requirements and Funds in Cleared Swaps Customer Accounts

under section 4d(f) of the CEA required by paragraph (g)(2) of this

section and the detailed listing of depositories required by paragraph

(g)(5) of this section, together with all supporting documentation, in

accordance with Sec. 1.31 of this chapter.

23. Add Sec. 22.17 to read as follows:

Sec. 22.17 Policies and procedures governing disbursements of Cleared

Swaps Customer Collateral from Cleared Swaps Customer Accounts.

(a) The provision in section 4d(f)(2) of the Act that prohibits the

commingling of Cleared Swaps Customer Collateral 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 funds segregated as required by the Act and the regulations in

this part and set apart for the benefit of Cleared Swaps Customers; nor

shall such provisions be construed to prevent a futures commission

merchant from adding to such segregated 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 of this chapter, as it

may deem necessary to ensure any and all Cleared Swaps Customer

Accounts are not undersegregated at any time.

(b) A futures commission merchant may not withdraw funds on any

business day for its own proprietary use from a Cleared Swaps Customer

Account unless the futures commission merchant has prepared the daily

segregation calculation required by Sec. 22.2 of this part as of the

close of business on the previous business day.

[[Page 67956]]

A futures commission merchant that has completed its daily segregation

calculation may make withdrawals for its own use, to the extent of its

actual residual financial interest in funds held in segregated

accounts, including the withdrawal of securities held in segregated

safekeeping accounts held by a bank, trust company, derivatives

clearing organization or other futures commission merchant. Such

withdrawal(s) shall not result in the funds of one Cleared Swaps

Customer being used to purchase, margin or carry the trades, contracts

or swaps positions, or extend the credit of any other Cleared Swaps

Customer or other person. Notwithstanding any other provision of this

chapter, a futures commission merchant must at all times maintain an

amount of residual interest in Cleared Swaps Customer Accounts for the

benefit of Cleared Swaps Customers that exceeds the sum of all Cleared

Swaps Customers' margin deficits and such residual interest may not be

withdrawn by the futures commission merchant.

(c) A futures commission merchant may not withdraw funds for its

own proprietary use, in a single transaction or a series of

transactions on a given business day, from Cleared Swaps Customer

Accounts if such withdrawal(s) would exceed 25 percent of the futures

commission merchant's residual interest in such accounts as reported on

the daily segregation calculation required by Sec. 22.2 of this part

and computed as of the close of business on the previous business day,

unless:

(1) The futures commission merchant's Chief Executive Officer,

Chief Finance Officer or other senior official that is listed as a

principal of the futures commission merchant on its Form 7-R and is

knowledgeable about the futures commission merchant's financial

requirements and financial position pre-approves in writing the

withdrawal, or series of withdrawals;

(2) The futures commission merchant files written notice of the

withdrawal or series of withdrawals, with the Commission and with its

designated self-regulatory organization immediately after the Chief

Executive Officer, Chief Finance Officer or other senior official pre-

approves the withdrawal or series of withdrawals. The written notice

must:

(i) Be signed by the Chief Executive Officer, Chief Finance Officer

or other senior official that pre-approved the withdrawal, and give

notice that the futures commission merchant has withdrawn or intends to

withdraw more than 25 percent of its residual interest in such accounts

holding Cleared Swaps Customer Accounts funds;

(ii) Include a description of the reasons for the withdrawal or

series of withdrawals;

(iii) List the amount of funds provided to each recipient and the

name of each recipient;

(iv) Include the current estimate of the amount of the futures

commission merchant's residual interest in the swaps customer funds

after the withdrawal;

(v) Contain a representation by the Chief Executive Officer, Chief

Finance Officer or other senior official that pre-approved the

withdrawal, or series of withdrawals, that, after due diligence, to

such person's knowledge and reasonable belief, the futures commission

merchant remains in compliance with the segregation requirements after

the withdrawal. The Chief Executive Officer, Chief Finance Officer or

other senior official must consider the daily segregation calculation

as of the close of business on the previous business day and any other

factors that may cause a material change in the futures commission's

residual interest since the close of business the previous business

day, including known unsecured customer debits or deficits, current day

market activity and any other withdrawals made from the Cleared Swaps

Customer Accounts; and

(vi) Any such written notice filed with the Commission must be

filed via electronic transmission using a form of user authentication

assigned in accordance with procedures established by or approved by

the Commission, and otherwise in accordance with instruction issued by

or approved by the Commission. Any such electronic submission must

clearly indicate the registrant on whose behalf such filing is made and

the use of such user authentication in submitting such filing will

constitute and become a substitute for the manual signature of the

authorized signer. Any written notice filed must be followed up with

direct communication to the Regional office of Commission which has

supervisory authority over the futures commission merchant whereby the

Commission acknowledges receipt of the notice; and

(3) After making a withdrawal requiring the approval and notice

required in paragraphs (c)(1) and (2) of this section, and before the

next daily segregated funds calculation, no futures commission merchant

may make any further withdrawals from accounts holding Cleared Swaps

Customer Account funds, except to or for the benefit of Cleared Swaps

Customers, without complying with paragraph (c)(1) of this section and

filing a written notice with the Commission under (c)(2)(vi) of this

section and its designated self-regulatory organization signed by the

Chief Executive Officer, Chief Finance Officer, or other senior

official. The written notice must:

(i) List the amount of funds provided to each recipient and each

recipient's name;

(ii) Disclose the reason for each withdrawal;

(iii) Confirm that the Chief Executive Officer, Chief Finance

Officer, or other senior official (and identify of the person if

different from the person who signed the notice) pre-approved the

withdrawal in writing;

(iv) Disclose the current estimate of the futures commission

merchant's remaining total residual interest in the segregated accounts

holding Cleared Swaps Customer Account funds after the withdrawal; and

(v) Include a representation that to the best of the notice

signatory's knowledge and reasonable belief the futures commission

merchant remains in compliance with the segregation requirements after

the withdrawal.

(d) If a futures commission merchant withdraws funds from Cleared

Swaps Customer Accounts for its own proprietary use, and the withdrawal

causes the futures commission merchant to not hold sufficient funds in

Cleared Swaps Customer Accounts to meet its targeted residual interest,

as required to be computed under Sec. 1.11 of this chapter, the

futures commission merchant must deposit its own funds into the Cleared

Swaps Customer Accounts to restore the targeted amount of residual

interest on the next business day, or, if appropriate, revise the

futures commission merchant's targeted amount of residual interest

pursuant to the policies and procedures required by Sec. 1.11 of this

chapter. Notwithstanding the foregoing, if at any time the futures

commission merchant's residual interest in Cleared Swaps Customer

Accounts is less than the sum of its Cleared Swaps Customers' margin

deficits, the futures commission merchant must immediately restore the

residual interest to exceed the sum of such margin deficits. Any

proprietary funds deposited in Cleared Swaps Customer Accounts must be

unencumbered and otherwise compliant with Sec. 1.25 of this chapter,

as applicable.

(e) Notwithstanding any other provision of this part, a futures

commission merchant may not withdraw funds for its own proprietary use

from a Cleared Swaps Customer Account unless the futures commission

merchant follows its policies and procedures required by Sec. 1.11 of

this chapter.

[[Page 67957]]

PART 30--FOREIGN FUTURES AND FOREIGN OPTIONS TRANSACTIONS

24. The authority citation for part 30 continues to read as

follows:

Authority: 7 U.S.C. 1a, 2, 4, 6, 6c, and 12a, as amended by

Title VII of the Dodd-Frank Wall Street Reform and Consumer

Protection Act, Pub. L. 111-203, 124 Stat. 1376 (Jul. 21, 2010).

25. Amend Sec. 30.1 by adding paragraphs (f), (g), and (h) to read

as follows:

Sec. 30.1 Definitions.

* * * * *

(f) 30.7 Customer means any foreign futures or foreign options

customer as defined in paragraph (c) of this section as well as any

foreign-domiciled person who trades in foreign futures or foreign

options through a futures commission merchant; Provided, however, that

an owner or holder of a proprietary account as defined in paragraph (y)

of Sec. 1.3 of this chapter shall not be deemed to be a 30.7 customer.

(g) 30.7 Account means any account maintained by a futures

commission merchant for or on behalf of 30.7 Customers to hold money,

securities, or other property to margin, guarantee, or secure foreign

futures or foreign option positions.

(h) 30.7 Customer Funds means any money, securities, or other

property received by a futures commission merchant from, for, or on

behalf of 30.7 Customers to margin, guarantee, or secure foreign

futures or foreign option positions, or money, securities, or other

property accruing to 30.7 Customers as a result of foreign futures and

foreign option positions.

26. Revise Sec. 30.7 to read as follows:

Sec. 30.7 Treatment of foreign futures or foreign options secured

amount.

(a) General. Except as provided in this section, a futures

commission merchant must at all times maintain in a separate account or

accounts money, securities and property in an amount at least

sufficient to cover or satisfy all of its obligations to 30.7 Customers

denominated as the foreign futures or foreign options secured amount.

In computing the foreign futures or foreign options secured amount, a

futures commission merchant may offset any net deficit in a particular

30.7 Customer's Account against the current market value of readily

marketable securities held for the same particular 30.7 Customer's

Account as provided for in paragraph (l) of this section. The amount

that must be deposited in such separate account or accounts for 30.7

Customers must be no less than the amount required to be held in a

separate account or accounts for or on behalf of 30.7 Customers

pursuant to any law, or rule, regulation or order thereunder, or any

rule of any self-regulatory organization authorized thereunder, in the

jurisdiction in which the depository or the 30.7 Customer, as

appropriate, is located. In addition, the futures commission merchant

must at all times maintain residual interest in separate accounts for

30.7 Customers sufficient to exceed the sum of all margin deficits that

the 30.7 Customers of the futures commission merchant have in their

30.7 Accounts. Such residual interest may not be withdrawn pursuant to

any provision of this section. If the value of a 30.7 Customer's Funds

for a 30.7 Account is less than the total amount of collateral required

for that 30.7 Customer's 30.7 Account for foreign futures or foreign

options, the difference is a margin deficit.

(b) Location of 30.7 Customer Funds. A futures commission merchant

shall deposit the foreign futures or foreign options secured amount

under an account name that clearly identifies the funds as belonging to

30.7 Customers and shows that the foreign futures or foreign options

secured amount is set aside as required by this part. A futures

commission merchant may deposit funds set aside as the foreign futures

or foreign options secured amount with the following depositories:

(1) A bank or trust company located in the United States;

(2) A bank or trust company located outside the United States that

has in excess of $1 billion of regulatory capital;

(3) A futures commission merchant registered as such with the

Commission;

(4) A derivatives clearing organization;

(5) The clearing organization of any foreign board of trade;

(6) A member of any foreign board of trade; or

(7) Such member's or clearing organization's designated

depositories.

(c) Limitation on holding foreign futures or foreign options

secured amount outside of the United States. A futures commission

merchant may not deposit or hold the foreign futures or foreign options

secured amount in accounts maintained outside of the United States with

any of the depositories listed in paragraph (b) of this section except

to meet margin requirements, including prefunding margin requirements,

established by rule, regulation, or order of foreign boards of trade or

foreign clearing organizations, or to meet margin calls issued by

foreign brokers carrying the 30.7 Customers' foreign futures and

foreign option positions; Provided, however, that a futures commission

merchant may deposit an additional amount of up to 10 percent of the

total amount of funds necessary to meet margin and prefunding margin

requirements to avoid daily transfers of funds between the futures

commission merchant's 30.7 Accounts maintained in the United States and

those maintained outside of the United States. An FCM must deposit 30.7

Customer Funds under the laws and regulations of the foreign

jurisdiction that provide the greatest degree of protection to such

funds. An FCM may not by contract or otherwise waive any of the

protections afforded customer funds under the laws of the foreign

jurisdiction.

(d) Written acknowledgment from depositories. (1) Each futures

commission merchant must obtain a written acknowledgment from each

depository as set out in Appendix E to this part in accordance with the

requirements of this part; Provided, however, that an acknowledgment

need not be obtained from a derivatives clearing organization that has

adopted and submitted to the Commission rules that provide for the

separate holding of the foreign futures or foreign options secured

amount, in accordance with all relevant provisions of the Act, this

part and the regulations and orders promulgated thereunder, of all

funds held on behalf of 30.7 Customers and all instruments purchased

with funds set aside as the foreign futures or foreign options secured

amount as provided for under paragraph (i) of this section.

(2) The written acknowledgment must be in the form as set out in

Appendix E to this part: Provided, however, that if the futures

commission merchant invests funds set aside as the foreign futures or

foreign options secured amount in money market mutual funds as a

permitted investment under paragraph (i) of this section and in

accordance with the terms and conditions of Sec. 1.25(c) of this

chapter, the written acknowledgment with respect to such investment

must be in the form as set out in Appendix F to this part.

(3) A futures commission merchant may deposit 30.7 Customer Funds

only with a depository that provides the Commission and the futures

commission merchant's designated self-regulatory organization with

direct, read-only access to account information on 24-hour a day basis.

The Commission and the futures commission merchant's designated self-

regulatory organization must receive the direct access when the account

is opened. The written acknowledgment must contain the

[[Page 67958]]

futures commission merchant's authorization to the depository to

provide direct and immediate account access to the Commission and the

futures commission merchant's designated self-regulatory organization.

(4) A futures commission merchant may deposit 30.7 Customer Funds

only with a depository that agrees to provide the Commission and the

futures commission merchant's designated self-regulatory organization

with a copy of the executed written acknowledgment within three

business days of the opening of the account. The Commission must

receive the written acknowledgment from the depository via electronic

mail at [email protected] The written acknowledgment must

contain the futures commission merchant's authorization to the

depository to provide the written acknowledgment to the Commission and

to the futures commission merchant's designated self-regulatory

organization without further notice to or consent from the futures

commission merchant.

(5) A futures commission merchant may deposit 30.7 Customer Funds

only with a depository that agrees to reply promptly and directly to

the Commission's or to the futures commission merchant's designated

self-regulatory organization's requests for confirmation of account

balances or other account information without further notice to or

consent from the futures commission merchant. The written

acknowledgment must contain the futures commission merchant's

authorization to the depository to respond directly and immediately to

requests from the Commission or the futures commission merchant's

designated self-regulatory organization for confirmation of account

balances and other account information without further notice to or

consent from the futures commission merchant.

(6) The futures commission merchant shall promptly file a copy of

the written acknowledgment with the Commission in the manner specified

by the Commission and in no event later than the later of:

(i) The effective date of this rule; or

(ii) Three business days after the account is opened.

(7) The futures commission merchant shall amend the written

acknowledgment and promptly file the amended written acknowledgment

with the Commission within 120 days of any changes in the following:

(i) The name or business address of the futures commission

merchant;

(ii) The name or business address of the depository; or

(iii) The account number(s) under which the foreign futures or

foreign options secured amount are held.

(8) Each futures commission merchant must maintain each written

acknowledgment readily accessible in its files in accordance with Sec.

1.31 of this chapter, for as long as the account remains open, and

thereafter for the period provided in Sec. 1.31 of this chapter.

(e) Commingling. (1) A futures commission merchant may commingle

the funds set aside as the foreign futures or foreign options secured

amount that it receives from, or on behalf of, multiple 30.7 Customers

in a single account or multiple accounts with one or more of the

depositories listed in paragraph (b) of this section.

(2) A futures commission merchant may not commingle the funds set

aside as the foreign futures or foreign options secured amount held for

30.7 Customers with the money, securities or property of such futures

commission merchant, with any proprietary account of such futures

commission merchant, or use such funds to secure or guarantee the

obligations of, or extend credit to, such futures commission merchant

or any proprietary account of such futures commission merchant;

Provided, however, a futures commission merchant may deposit

proprietary funds into 30.7 Customer Accounts as permitted under

paragraph (g) of this section.

(3) A futures commission merchant may not commingle funds held for

30.7 Customers with funds deposited by futures customers as defined in

Sec. 1.3 of this chapter and held in account segregated pursuant to

Section 4d(a) and 4d(b) of the Act or with funds deposited by Cleared

Swap Customers as defined under Sec. 22.1 of this chapter and held in

segregated accounts pursuant to Section 4d(f) of the Act, or with funds

of any account holders of the futures commission merchant unrelated to

trading foreign futures or foreign options; Provided, however, that a

futures commission merchant may commingle 30.7 Customer funds with

funds deposited by futures customers or Cleared Swaps Customers

pursuant to the terms of a Commission regulation or order authorizing

such commingling.

(f) Limitations on use of 30.7 Customer Funds. (1) A futures

commission merchant shall not use, or permit the use of, the funds of

one 30.7 Customer to purchase, margin or settle the trades, contracts,

or commodity options of, or to secure or extend credit to, any person

other than such 30.7 Customer. This prohibition on the use of the funds

of one 30.7 customer to extend credit to, or to purchase, margin or

settle the trades, contracts, or commodity options of another 30.7

Customer applies at all times. For this purpose, a futures commission

merchant which operationally commingles the funds of its 30.7 Customers

must ensure that at all times its residual interest in funds set aside

as the foreign futures or foreign options secured amount exceeds the

sum of all its 30.7 Customers' margin deficits.

(2) A futures commission merchant may not impose or permit the

imposition of a lien on any funds set aside as the foreign futures or

foreign options secured amount, including any residual financial

interest of the futures commission merchant in such funds.

(3) A futures commission merchant may not include in funds set

aside as the foreign futures or foreign options secured amount any

money invested in securities, memberships, or obligations of any

clearing organization or board of trade. A futures commission merchant

may not include in funds set aside as the foreign futures or foreign

options secured amount any other money, securities, or property held by

a member of a foreign board of trade, board of trade, or clearing

organization, except if the funds are deposited to margin, secure, or

guarantee 30.7 Customers' foreign futures or foreign options positions

and the futures commission merchant obtains the written acknowledgment

from the member of the foreign board of trade, board of trade, or

clearing organization as required by paragraph (d) of this section.

(g) Futures commission merchant's residual financial interest and

withdrawal of funds. (1) The provision in paragraph (e) of this

section, which prohibits the commingling of funds set aside as the

foreign futures or foreign options secured amount 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 funds set aside as required by the regulations in this part for

the benefit of 30.7 Customers; nor shall such provisions be construed

to prevent a futures commission merchant from adding to such set aside

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 of this chapter, as it may deem necessary to ensure any

and all 30.7 Accounts from becoming undersecured at any time.

(2) A futures commission merchant may not withdraw funds on any

business day for its own proprietary use

[[Page 67959]]

from an account or accounts holding the foreign futures and foreign

options secured amount unless the futures commission merchant has

prepared the daily 30.7 calculation required by paragraph (l) of this

section as of the close of business on the previous business day. A

futures commission merchant that has completed its daily 30.7

calculation may make withdrawals to its own order, to the extent of its

actual residual financial interest in funds held in 30.7 Accounts,

including the withdrawal of securities held in secured amount

safekeeping accounts held by a bank, trust company, contract market,

clearing organization, member of a foreign board of trade, or other

futures commission merchant. Such withdrawal(s) shall not result in the

funds of one 30.7 Customer being used to purchase, margin or carry the

foreign futures or foreign options positions, or extend the credit of

any other 30.7 Customer or other person. Notwithstanding any other

provision of this section, a futures commission merchant must at all

times maintain an amount of residual interest in separate accounts for

the benefit of 30.7 Customers that exceeds the sum of all 30.7

Customers' margin deficits and such residual interest may not be

withdrawn by the futures commission merchant.

(3) A futures commission merchant may not withdraw funds for its

own proprietary use, in a single transaction or a series of

transactions on a given business day, from an account or accounts

holding 30.7 Customer Funds if such withdrawal(s) would exceed 25

percent of the futures commission merchant's residual interest in such

accounts as reported on the daily secured amount calculation required

by paragraph (l) of this section and computed as of the close of

business on the previous business day, unless the futures commission

merchant's Chief Executive Officer, Chief Finance Officer or other

senior official that is listed as a principal of the futures commission

merchant on its Form 7-R and is knowledgeable about the futures

commission merchant's financial requirements and financial position

pre-approves in writing the withdrawal, or series of withdrawals.

(4) A futures commission merchant must file written notice of the

withdrawal or series of withdrawals that exceed 25 percent of the

futures commission merchant's residual interest in 30.7 Customer Funds

as computed under paragraph (h)(2) of this section with the Commission

and with its designated self-regulatory organization immediately after

the Chief Executive Officer, Chief Finance Officer or other senior

official as described in paragraph (g)(2) of this section pre-approves

the withdrawal or series of withdrawals. The written notice must:

(i) Be signed by the Chief Executive Officer, Chief Finance Officer

or other senior official that pre-approved the withdrawal, and give

notice that the futures commission merchant has withdrawn or intends to

withdraw more than 25 percent of its residual interest in accounts

holding 30.7 Customer Funds;

(ii) Include a description of the reasons for the withdrawal or

series of withdrawals;

(iii) List the amount of funds provided to each recipient and the

name of each recipient;

(iv) Include the current estimate of the amount of the futures

commission merchant's residual interest in the 30.7 Customer Funds

after the withdrawal;

(v) Contain a representation by the Chief Executive Officer, Chief

Finance Officer or other senior official as described in paragraph

(g)(3) of this section that pre-approved the withdrawal, or series of

withdrawals, that to such person's knowledge and reasonable belief, the

futures commission merchant remains in compliance with the secured

amount requirements after the withdrawal. The Chief Executive Officer,

Chief Finance Officer or other appropriate senior official as described

in paragraph (g)(2) of this section must consider the daily 30.7

calculation as of the close of business on the previous business day

and any other factors that may cause a material change in the futures

commission's residual interest since the close of business the previous

business day, including known unsecured customer debits or deficits,

current day market activity and any other withdrawals made from the

30.7 Customer Accounts; and

(vi) Any such written notice filed with the Commission must be

filed via electronic transmission using a form of user authentication

assigned in accordance with procedures established by or approved by

the Commission, and otherwise in accordance with instruction issued by

or approved by the Commission. Any such electronic submission must

clearly indicate the registrant on whose behalf such filing is made and

the use of such user authentication in submitting such filing will

constitute and become a substitute for the manual signature of the

authorized signer. Any written notice filed must be followed up with

direct communication to the Regional office of Commission which has

supervisory authority over the futures commission merchant whereby the

Commission acknowledges receipt of the notice.

(5) After making a withdrawal requiring the approval and notice

required in paragraphs (c)(1) and (2) of this section, and before the

next daily secured amount calculation, no futures commission merchant

may make any further withdrawals from accounts holding 30.7 Customer

Funds, except to or for the benefit of 30.7 Customers, without, for

each withdrawal, obtaining the approval required under paragraph (c)(1)

of this section and filing a written notice with the Commission under

paragraph (g)(4)(vi) of this section and its designated self-regulatory

organization signed by the Chief Executive Officer, Chief Finance

Officer, or other senior official. The written notice must:

(i) List the amount of funds provided to each recipient and each

recipient's name;

(ii) Disclose the reason for each withdrawal;

(iii) Confirm that the Chief Executive Officer, Chief Finance

Officer, or other senior official (and identify of the person if

different from the person who signed the notice) pre-approved the

withdrawal in writing;

(iv) Disclose the current estimate of the futures commission

merchant's remaining total residual interest in the secured accounts

holding 30.7 Customer Funds after the withdrawal; and

(v) Include a representation that to the best of the notice

signatory's knowledge and reasonable belief the futures commission

merchant remains in compliance with the secured amount requirements

after the withdrawal.

(6) If a futures commission merchant withdraws funds from the

separate accounts holding 30.7 Customer Funds for its own proprietary

use, and the withdrawal causes the futures commission merchant to not

hold sufficient funds in the separate accounts for the benefit of the

30.7 Customers to meet its targeted residual interest, as required to

be computed under Sec. 1.11 of this chapter, the futures commission

merchant must deposit its own funds into the separate accounts for the

benefit of 30.7 Customers to restore the account balance to the

targeted residual interest amount on the next business day, or, if

appropriate, revise the futures commission merchant's targeted amount

of residual interest pursuant to the policies and procedures required

by Sec. 1.11 of this chapter. Notwithstanding the foregoing, if at any

time the futures commission merchant's residual interest in separate

accounts for the benefit of 30.7 Customers is less than the sum of

[[Page 67960]]

its 30.7 Customer's margin deficits, the futures commission merchant

must immediately restore the residual interest to exceed the sum of

such margin deficits. Any proprietary funds deposited in the 30.7

Customer Accounts must be unencumbered and otherwise compliant with

Sec. 1.25 of this section, as applicable.

(7) Notwithstanding any other provision of this part, a futures

commission merchant may not withdraw funds for its own proprietary use

from 30.7 Accounts unless the futures commission merchant follows its

policies and procedures required by Sec. 1.11 of this chapter.

(h) Permitted investments and deposits of 30.7 Customer Funds. (1)

A futures commission merchant may invest 30.7 Customer Funds subject

to, and in compliance with, the terms and conditions of Sec. 1.25 of

this chapter. Regulation 1.25 of this chapter shall apply to the

investment of 30.7 Customer Funds as if such funds comprised customer

funds or customer money subject to segregation pursuant to section 4d

of the Act and the regulations thereunder.

(2) Each futures commission merchant that invests money, securities

or property on behalf of 30.7 Customers must keep a record showing the

following:

(i) The date on which such investments were made;

(ii) The name of the person through whom such investments were

made;

(iii) The amount of money or current market value of securities so

invested;

(iv) A description of the obligations in which such investments

were made, including CUSIP or ISIN numbers;

(v) The identity of the depositories or other places where such

investments are maintained;

(vi) The date on which such investments were liquidated or

otherwise disposed of and the amount of money received or current

market value of securities received as a result of such disposition;

(vii) The name of the person to or through whom such investments

were disposed of; and

(viii) A daily valuation for each instrument and readily available

documentation supporting the daily valuation for each instrument. Such

supporting documentation must be sufficient to enable third parties to

verify the valuations and the accuracy of any information from external

sources used in those valuations.

(3) Any 30.7 Customer Funds deposited in a bank or trust company

located in the United States or in a foreign jurisdiction must be

available for immediate withdrawal upon the demand of the futures

commission merchant.

(4) Futures commission merchants that invest 30.7 Customer Funds in

instruments described in Sec. 1.25 of this chapter shall include such

instruments in the computation of its secured amount requirements,

required under paragraph (l) of this section, at values that at no time

exceed current market value, determined as of the close of the market

on the date for which such computation is made.

(i) Responsibility for Sec. 1.25 investment losses. A futures

commission merchant shall bear sole financial responsibility for any

losses resulting from the investment of 30.7 Customer Funds in

instruments described in Sec. 1.25 of this chapter. No investment

losses shall be borne or otherwise allocated to the 30.7 Customers of

the futures commission merchant.

(j) Loans by futures commission merchants; Treatment of proceeds. A

futures commission merchant may lend its own funds to 30.7 Customers on

securities and property pledged, or from repledging or selling such

securities and property pursuant to specific written agreement with

such 30.7 Customers. The proceeds of such loans used to purchase,

margin, guarantee, or secure the trades, contracts, or commodity

options of 30.7 Customers shall be treated and dealt with by a futures

commission merchant as belonging to such 30.7 Customers. A futures

commission merchant may not loan funds on an unsecured basis to finance

a 30.7 Customer's foreign futures and foreign options trading, nor may

a futures commission merchant loan funds to a 30.7 Customer secured by

the 30.7 Customer's trading account.

(k) Permitted withdrawals. A futures commission merchant may

withdraw funds from 30.7 Customer Accounts in an amount necessary in

the normal course of business to margin, guarantee, secure, transfer,

or settle 30.7 Customers' foreign futures or foreign option positions

with a foreign broker or clearing organization. A futures commission

merchant also may withdraw funds from 30.7 Customer Accounts to pay

commissions, brokerage, interest, taxes, storage, and other charges

lawfully accruing in connection with the 30.7 Customers' foreign

futures and foreign options positions.

(l) Daily computation of 30.7 Customer secured amount requirement

and details regarding the holding and investing of 30.7 Customer Funds.

(1) Each futures commission merchant is required to prepare a Statement

of Secured Amounts and Funds Held in Separate Accounts for 30.7

Customers pursuant to Commission Regulation 30.7 contained in the Form

1-FR-FCM as of the close of each business day. Futures commission

merchants that invest funds set aside as the foreign futures or foreign

options secured amount in instruments described in Sec. 1.25 of this

chapter shall include such instruments in the computation of its

secured amount requirements at values that at no time exceed current

market value, determined as of the close of the market on the date for

which such computation is made. Nothing in this paragraph shall affect

the requirement that a futures commission merchant at all times

maintain sufficient money, securities and property to cover its total

obligations to all 30.7 Customers, in accordance with paragraph (a) of

this section.

(2) A futures commission merchant may offset any net deficit in a

particular 30.7 Customer's Account against the current market value of

readily marketable securities, less deductions (i.e. ``securities

haircuts'') as set forth in Rule 15c3-1(c)(2)(vi) of the Securities and

Exchange Commission (17 CFR 240.15c3-1(c)(2)(vi)), held for the same

particular 30.7 Customer's Account in computing the daily Foreign

Futures and Foreign Options Secured Amount. Futures commission

merchants that establish and enforce written policies and procedures to

assess the credit risk of commercial paper, convertible debt

instruments, or nonconvertible debt instruments in accordance with Rule

240.15c3-1(c)(2)(vi) of the Securities and Exchange Commission (17 CFR

240.15c3-1(c)(2)(vi)) may apply the lower haircut percentages specified

in Rule 240.15c3-1(c)(2)(vi) for such commercial paper, convertible

debt instruments and nonconvertible debt instruments. The futures

commission merchant must maintain a security interest in the

securities, including a written authorization to liquidate the

securities at the futures commission merchant's discretion, and must

set aside the securities in a safekeeping account compliant with

paragraph (c) of this section. For purposes of this section, a security

will be considered ``readily marketable'' if it is traded on a ``ready

market'' as defined in Rule 15c3-1(c)(11)(i) of the Securities and

Exchange Commission (17 CFR 240.15c3-1(c)(11)(i)).

(3) Each futures commission merchant is required to submit to the

Commission and to the firm's designated self-regulatory organization

the daily Statement of Secured Amounts and Funds Held in Separate

Accounts for

[[Page 67961]]

30.7 Customers pursuant to Commission Regulation 30.7 required by

paragraph (l)(1) of this section by noon the following business day.

(4) Each futures commission merchant shall file the Statement of

Secured Amounts and Funds Held in Separate Accounts for 30.7 Customers

pursuant to Commission Regulation 30.7 required by paragraph (l)(1) of

this section in an electronic format using a form of user

authentication assigned in accordance with procedures established or

approved by the Commission.

(5) Each futures commission merchant is required to submit to the

Commission and to the firm's designated self-regulatory organization a

report listing of the names of all banks, trust companies, futures

commission merchants, derivatives clearing organizations, foreign

brokers, foreign clearing organizations, or any other depository or

custodian holding 30.7 Customer Funds as of the fifteenth day of the

month, or the first business day thereafter, and the last business day

of each month. This report must include:

(i) The name and location of each depository holding 30.7 Customer

Funds;

(ii) The total amount of 30.7 Customer Funds held by each

depository listed in paragraph (l)(5) of this section; and

(iii) The total amount of cash and investments that each depository

listed in paragraph (l)(5) of this section holds for the futures

commission merchant. The futures commission merchant must report the

following investments:

(A) Obligations of the United States and obligations fully

guaranteed as to principal and interest by the United States (U.S.

government securities);

(B) General obligations of any State or of any political

subdivision of a State (municipal securities);

(C) General obligation issued by any enterprise sponsored by the

United States (government sponsored enterprise securities);

(D) Certificates of deposit issued by a bank;

(E) Commercial paper fully guaranteed as to principal and interest

by the United States under the Temporary Liquidity Guarantee Program as

administered by the Federal Deposit Insurance Corporation;

(F) Corporate notes or bonds fully guaranteed as to principal and

interest by the United States under the Temporary Liquidity Guarantee

Program as administered by the Federal Deposit Insurance Corporation;

and

(G) Interests in money market mutual funds.

(6) Each futures commission merchant must report the total amount

of customer owned securities held by the futures commission merchant as

30.7 Customer Funds and must list the names and locations of the

depositories holding customer owned securities.

(7) Each futures commission merchant must report the total amount

of 30.7 Customer Funds that have been used to purchase securities under

agreements to resell the securities (reverse repurchase transactions).

(8) Each futures commission merchant must report which, if any, of

the depositories holding 30.7 Customer Funds under paragraph (l)(5) of

this section are affiliated with the futures commission merchant.

(9) Each futures commission merchant shall file the detailed list

of depositories required by paragraph (l)(5) of this section by 11:59

p.m. the next business day in an electronic format using a form of user

authentication assigned in accordance with procedures established or

approved by the Commission.

(10) Each futures commission merchant shall retain its daily

secured amount computation, the Statement of Secured Amounts and Funds

Held in Separate Accounts for 30.7 Customers pursuant to Commission

Regulation 30.7 required by paragraph (l)(1) of this section, and the

detailed list of depositories required by paragraph (l)(5) of this

section, together with all supporting documentation, in accordance with

the requirements of Sec. 1.31 of this part.

27. Add Appendix E and Appendix F to part 30 to read as follows:

Appendix E to Part 30--Acknowledgment Letter for CFTC Regulation 30.7

Customer Secured Account

[Date]

[Name and Address of Depository]

We refer to the Secured Amount Account(s) which [Name of Futures

Commission Merchant] (``we'' or ``our'') have opened or will open

with [Name of Depository] (``you'' or ``your'') entitled:

[Name of Futures Commission Merchant] [if applicable, add ``FCM

Customer Omnibus Account''] CFTC Regulation 30.7 Customer Secured

Account [If applicable, include any abbreviated name of the

Account(s) as reflected in the Depository's electronic systems

(provided any such abbreviated name must reflect that the Account(s)

is a CFTC regulated customer secured account)]

Account Number(s):

(collectively, the ``Account(s)'').

You acknowledge and agree that we have opened or will open the

above-referenced Account(s) for the purpose of depositing, as

applicable, money, securities and other property (collectively

``Funds'') for or on behalf of our customers who are entering into

foreign futures and/or foreign options transactions (as such terms

are defined in U.S. Commodity Futures Trading Commission (``CFTC'')

Regulation 30.1, as amended). The Funds deposited in the Account(s)

or accruing to the credit of the Accounts will be kept separate and

apart and separately accounted for on your books from our own funds

and all other accounts maintained by us in accordance with the

provisions of the Commodity Exchange Act, as amended (the ``Act''),

and Part 30 of the CFTC's regulations, as amended, and may not be

commingled with our own funds in any proprietary account we maintain

with you and the Funds must otherwise be treated in accordance with

the provisions of the Act and CFTC Regulations.

Furthermore, you acknowledge and agree that such Funds may not

be used by you or by us to secure or guarantee any obligations that

we might owe to you, nor may they be used by us to secure credit

from you. You further acknowledge and agree that the Funds in the

Account(s) shall not be subject to any right of offset or lien for

or on account of any indebtedness, obligations or liabilities we may

now or in the future have owing to you, and that you understand the

nature of the Funds held or hereafter deposited in the Account(s)

and that you will treat and maintain such Funds in accordance with

the provisions of the Act and CFTC regulations. This prohibition

does not affect your right to recover funds advanced in the form of

cash transfers you make in lieu of liquidating non-cash assets held

in the Account(s) for purposes of variation settlement or posting

initial (original) margin.

In addition, you agree that the Account(s) may be examined at

any reasonable time by an appropriate officer, agent or employee of

the CFTC or a self-regulatory organization, and this letter

constitutes the authorization and direction of the undersigned to

permit any such examination or audit to take place. You agree to

respond promptly and directly to requests for confirmation of

account balances and other account information from an appropriate

officer, agent, or employee of the CFTC or a self-regulatory

organization of which we are a member, without further notice to or

consent from the futures commission merchant. You also agree that,

immediately upon instruction by the director of the Division of Swap

Dealer and Intermediary Oversight of the CFTC or the director of the

Division of Clearing and Risk of the CFTC, or any successor

divisions, or such directors' designees, or any appropriate official

of a self-regulatory organization of which we are a member, you will

provide any and all information regarding or related to the Funds or

the Accounts as shall be specified in such instruction and as

directed in such instruction. You further agree that you will

provide the CFTC and our designated self-regulatory organization

with the necessary software, a user log-in, and password that will

allow the CFTC and our designated self-regulatory organization to

have read-only access to the accounts listed above on your Web site

on a 24-hour a day basis. This letter further constitutes the

consent and authorization of the undersigned for you to respond

immediately to requests from appropriate officers, agents, or

employees of the CFTC or a self-regulatory

[[Page 67962]]

organization for information and/or confirmation of current and

historical account balances of the Account(s).

You acknowledge and agree that you meet the requirements

detailed for depositories in CFTC Regulation 30.7, as amended. You

further acknowledge and agree that the Funds in the Account(s) shall

be released immediately, subject to the requirements of US or non-

U.S. law as applicable, upon proper notice and instruction from an

appropriate officer or employee of us or from the director of the

Division of Clearing and Risk of the CFTC, the director of the

Division of Swap Dealer and Intermediary Oversight, or any successor

divisions, or such directors' designees. We will not hold you

responsible for acting pursuant to any instruction from the CFTC

upon which you have relied after having taken reasonable measures to

assure that such instruction was provided to you by the director of

the Division of Clearing and Risk or the director of the Division of

Swap Dealer and Intermediary Oversight of the CFTC, or any successor

divisions, or such directors' designees.

In the event we become subject to either a voluntary or

involuntary petition for relief under the U.S. Bankruptcy Code, we

acknowledge that you will have no obligation to release the Funds

held in the Account(s), except upon instruction of the Trustee in

Bankruptcy or pursuant to the Order of the respective U.S.

Bankruptcy Court.

Notwithstanding anything in the foregoing to the contrary,

nothing contained herein shall be construed as limiting your right

to assert any right of set off against or lien on assets other than

assets maintained in the Account(s), nor to impose such charges

against us or any proprietary account maintained by us with you.

Further, it is understood that amounts represented by checks, drafts

or other items shall not be considered to be part of the Account(s)

until finally collected. Accordingly, checks, drafts and other items

credited to the Account(s) and subsequently dishonored or otherwise

returned to you, or reversed, for any reason and any claims relating

thereto, including but not limited to claims of alteration or

forgery, may be charged back to the Account(s), and we shall be

responsible to you as a general endorser of all such items whether

or not actually so endorsed.

You may conclusively presume that any withdrawal from the

Account(s) and the balances maintained therein are in conformity

with the Act and CFTC regulations without any further inquiry,

provided that you have no notice of or actual knowledge of, or could

not reasonably know of, a violation of the Act or other provision of

law by us; and you shall not in any manner not expressly agreed to

herein be responsible for ensuring compliance by us with the

provisions of the Act and CFTC regulations.

You may, and are hereby authorized to, obey the order, judgment,

decree or levy of any court of competent jurisdiction or any

governmental agency with jurisdiction, which order, judgment, decree

or levy relates in whole or in part to the Account(s). In any event,

you shall not be liable by reason of any such action or omission to

act, to us or to any other person, firm, association or corporation

even if thereafter any such order, decree, judgment or levy shall be

reversed, modified, set aside or vacated.

The terms of this letter agreement shall remain binding upon the

parties, their successors and assigns, including for the avoidance

of doubt, regardless of the change in name of any party. This letter

agreement supersedes and replaces any prior agreement between the

parties in connection with the Account(s), including but not limited

to any prior acknowledgment letter, to the extent that such prior

agreement is inconsistent with the terms hereof. In the event of any

conflict between this letter agreement and any other agreement

between the parties in connection with the Account(s), this letter

agreement shall govern with respect to matters specific to the Act

and the CFTC's regulations, as amended.

This letter agreement shall be governed by and construed in

accordance with the laws of [Insert governing law] without regard to

the principles of choice of law.

Please acknowledge that you agree to abide by the requirements

and conditions set forth above by signing and returning the enclosed

copy of this letter. You further acknowledge and agree to provide a

copy of this fully executed letter directly to the CFTC (via

electronic mail to [email protected]) and our

designated self-regulatory organization.

[Name of Futures Commission Merchant]

By:

Print Name:

Title:

ACKNOWLEDGED AND AGREED:

[Name of Depository]

By:

Print Name:

Title:

Contact Information: [Insert phone number and email address]

DATE:

Appendix F to Part 30:

CFTC Regulation 30.7--Acknowledgment Letter for CFTC Regulation

30.7 Customer Secured Money Market Mutual Fund Account [All of this

was not proposed]

[Date]

[Name and Address of Money Market Mutual Fund]

We propose to invest funds held by [Name of Futures Commission

Merchant or Derivatives Clearing Organization] (``we'' or ``our'')

on behalf of our customers in shares of [Name of Money Market Mutual

Fund] (``you'' or ``your'') under account(s) entitled (or shares

issued to):

[Name of Futures Commission Merchant or Derivatives Clearing

Organization] [if applicable, add ``FCM Customer Omnibus Account'']

CFTC Regulation 30.7 Customer Secured Money Market Mutual Fund

Account

[If applicable, include any abbreviated name of the Account(s)

as reflected in the Depository's electronic systems (provided any

such abbreviated name must reflect that the Account(s) is a CFTC

regulated customer segregated account)]

Account Number(s): [ ]

(collectively, the ``Account(s)'').

You acknowledge and agree that we are holding these funds,

including any shares issued and amounts accruing in connection

therewith (collectively, the ``Shares''), for the benefit of our

customers who are entering into foreign futures and/or foreign

options transactions (as such terms are defined in U.S. Commodity

Futures Trading Commission (``CFTC'') Regulation 30.1, as amended);

that the Shares held by you, hereafter deposited in the Account(s)

or accruing to the credit of the Accounts, will be kept separate and

apart and separately accounted for on your books from our own funds

and from any other funds or accounts held by us in accordance with

the provisions of the Commodity Exchange Act, as amended (the

``Act''), and Part 30 of the CFTC's regulations, as amended; and

that the Shares must otherwise be treated in accordance with the

provisions of the Act and CFTC regulations.

Furthermore, you acknowledge and agree that such Shares may not

be used by you or by us to secure or guarantee any obligations that

we might owe to you, nor may they be used by us to secure credit

from you. You further acknowledge and agree that the Shares in the

Account(s) shall not be subject to any right of offset or lien for

or on account of any indebtedness, obligations or liabilities we may

now or in the future have owing to you.

In addition, you agree that the Account(s) may be examined at

any reasonable time by an appropriate officer, agent or employee of

the CFTC or a self-regulatory organization, and this letter

constitutes the authorization and direction of the undersigned to

permit any such examination or audit to take place. You agree to

respond promptly and directly to requests for confirmation of

account balances and other account information from an appropriate

officer, agent, or employee of the CFTC or a self-regulatory

organization of which we are a member, without further notice to or

consent from the futures commission merchant. You also agree that,

immediately upon instruction by the director of the Division of Swap

Dealer and Intermediary Oversight of the CFTC or the director of the

Division of Clearing and Risk of the CFTC, or any successor

divisions, or such directors' designees, or any appropriate official

of a self-regulatory organization of which we are a member, you will

provide any and all information regarding or related to the Funds or

the Accounts as shall be specified in such instruction and as

directed in such instruction. You further agree that you will

provide the CFTC and our designated self-regulatory organization

with the necessary software, a user log-in, and password that will

allow the CFTC and our designated self-regulatory organization to

have read-only access to the accounts listed above on your Web site

on a 24-hour a day basis. This letter further constitutes the

consent and authorization of the undersigned for you to respond

immediately to requests from appropriate officers, agents, or

employees of the CFTC or a self-regulatory organization for

information and/or confirmation of current and historical account

balances of the Account(s).

[[Page 67963]]

You acknowledge and agree that the Shares in the Account(s)

shall be released immediately, subject to the requirements of U.S.

or non-U.S. law as applicable, upon proper notice and instruction

from an appropriate officer or employee of us or from the director

of the Division of Clearing and Risk or the director of the Division

of Swap Dealers and Intermediary Oversight of the CFTC, or any

successor divisions, or such directors' designees. We will not hold

you responsible for acting pursuant to any instruction from the CFTC

upon which you have relied after having taken reasonable measures to

assure that such instruction was provided to you by the director of

the Division of Clearing and Risk of the CFTC, or any successor

division, or such director's designee. You further acknowledge that

you will provide to the CFTC a copy of this fully executed

acknowledgment (via electronic mail to

[email protected]).

In the event we become subject to either a voluntary or

involuntary petition for relief under the U.S. Bankruptcy Code, we

acknowledge that you will have no obligation to release the Shares

held in the Account(s), except upon instruction of the Trustee in

Bankruptcy or pursuant to the Order of the respective U.S.

Bankruptcy Court.

Notwithstanding anything in the foregoing to the contrary,

nothing contained herein shall be construed as limiting your right

to assert any right of set off against or lien on assets other than

assets maintained in the Account(s), nor to impose such charges

against us or any proprietary account maintained by us with you.

Further, it is understood that amounts represented by checks, drafts

or other items shall not be considered to be part of the Account(s)

until finally collected. Accordingly, checks, drafts and other items

credited to the Account(s) and subsequently dishonored or otherwise

returned to you, or reversed, for any reason and any claims relating

thereto, including but not limited to claims of alteration or

forgery, may be charged back to the Account(s), and we shall be

responsible to you as a general endorser of all such items whether

or not actually so endorsed.

You may conclusively presume that any withdrawal from the

Account(s) and the balances maintained therein are in conformity

with the Act and CFTC regulations without any further inquiry,

provided that you have no notice of or actual knowledge of, or could

not reasonably know of, a violation of the Act or other provision of

law by us; and you shall not in any manner not expressly agreed to

herein be responsible for ensuring compliance by us with the

provisions of the Act and CFTC regulations.

You may, and are hereby authorized to, obey the order, judgment,

decree or levy of any court of competent jurisdiction or any

governmental agency with jurisdiction, which order, judgment, decree

or levy relates in whole or in part to the Account(s). In any event,

you shall not be liable by reason of any such action or omission to

act, to us or to any other person, firm, association or corporation

even if thereafter any such order, decree, judgment or levy shall be

reversed, modified, set aside or vacated.

We are permitted to invest our Commodity Customers' funds in

money market mutual funds pursuant to CFTC Regulation 1.25. That

rule sets forth the following conditions, among others, with respect

to any investment in a money market mutual fund:

(1) The net asset value of the fund must be computed by 9:00

a.m. of the business day following each business day and be made

available to us by that time;

(2) The fund must be legally obligated to redeem an interest in

the fund and make payment in satisfaction thereof by the close of

the business day following the day on which we make a redemption

request except as otherwise specified in CFTC Regulation

1.25(c)(5)(ii); and

(3) The agreement under which we invest our Commodity Customers'

funds must not contain any provision that would prevent us from

pledging or transferring fund shares. The terms of this letter

agreement shall remain binding upon the parties, their successors

and assigns, including for the avoidance of doubt, regardless of the

change in name of any party. This letter agreement supersedes and

replaces any prior agreement between the parties in connection with

the Account(s), including but not limited to any prior

acknowledgment letter, to the extent that such prior agreement is

inconsistent with the terms hereof. In the event of any conflict

between this letter agreement and any other agreement between the

parties in connection with the Account(s), this letter agreement

shall govern with respect to matters specific to Section 4d of the

Act and the CFTC's regulations, as amended.

This letter agreement shall be governed by and construed in

accordance with the laws of [Insert governing law] without regard to

the principles of choice of law.

Please acknowledge that you agree to abide by the requirements

and conditions set forth above by signing and returning the enclosed

copy of this letter. You further acknowledge and agree to provide a

copy of this fully executed letter directly to the CFTC and our

designated self-regulatory organization.

[Name of Futures Commission Merchant or Derivatives Clearing

Organization]

By:

Print Name:

Title:

ACKNOWLEDGED AND AGREED:

[Name of Money Market Mutual Fund]

By:

Print Name:

Title:

Contact Information: [Insert phone number and email address]

DATE:

PART 140--ORGANIZATION, FUNCTIONS, AND PROCEDURES OF THE COMMISSION

28. The authority citation for part 140 continues to read as

follows:

Authority: 7 U.S.C. 2 and 12a.

29. In Sec. 140.91, redesignate paragraph (a)(8) as paragraph

(a)(12) and paragraph (a)(7) as paragraph (a)(8), add new paragraphs

(a)(7), (a)(9), (a)(10), and (a)(11), and revise paragraph (b) to read

as follows:

Sec. 140.91 Delegation of authority to the Director of the Division

of Clearing and Risk and to the Director of the Division of Swap Dealer

and Intermediary Oversight.

(a) * * *

(7) All functions reserved to the Commission in Sec. 1.20 of this

chapter.

* * * * *

(9) All functions reserved to the Commission in Sec. 1.26 of this

chapter.

(10) All functions reserved to the Commission in Sec. 1.52 of this

chapter.

(11) All functions reserved to the Commission in Sec. 30.7 of this

chapter.

* * * * *

(b) The Director of the Division of Clearing and Risk and the

Director of the Division of Swap Dealer and Intermediary Oversight may

submit any matter which has been delegated to him or her under

paragraph (a) of this section to the Commission for its consideration.

* * * * *

BILLING CODE P

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BILLING CODE C

Issued in Washington, DC, on October 23, 2012 by the Commission.

Stacy Yochum,

Counsel.

Appendices to Enhancing Protections Afforded Customers and Customer

Funds Held by Futures Commission Merchants and Derivatives Clearing

Organizations--Commission Voting Summary and Statements of

Commissioners

Note: The following appendices will not appear in the Code of

Federal Regulations.

Appendix 1--Commission Voting Summary

On this matter, Chairman Gensler and Commissioners Sommers,

Chilton, O'Malia and Wetjen voted in the affirmative; no

Commissioner voted in the negative.

Appendix 2-- Statement of Chairman Gary Gensler

I support the proposed rules to enhance the protections afforded

customers that participate in the futures and swaps markets,

including the protection of customer funds held by futures

commission merchants (FCMs) and derivatives clearing organizations.

The CFTC's mission is to ensure the integrity of the futures and

swaps markets. As part of this, we must do everything within our

authorities and resources to strengthen oversight programs and the

protection of customers and their funds. And that's the goal of this

proposal. It's about ensuring customers have confidence that the

funds they post as margin or collateral are fully segregated and

protected.

CFTC Commissioners and staff have reached out broadly on ways to

enhance customer protections. We hosted two roundtables this year on

issues ranging from the segregation of customer funds to examining

the CFTC's oversight of self-regulatory organizations (SROs).

In July, the CFTC approved a National Futures Association (NFA)

proposal that stemmed from a coordinated effort by the CFTC, the

SROs, other financial regulators, and market participants, including

from the CFTC's roundtable earlier this year.

This customer protection proposal incorporates these NFA rules

into the Commission's regulations so that the CFTC

[[Page 67970]]

can directly enforce these important rules. Under this proposal,

FCMs would be required to:

Hold sufficient funds in Part 30 secured accounts

(funds held for U.S. foreign futures and options customers trading

on foreign contract markets) to meet their total obligations to

customers trading on foreign markets computed under the net

liquidating equity method. FCMs would no longer be allowed to use

the alternative method, which had allowed them to hold a lower

amount of funds representing the margin on their foreign futures;

Maintain written policies and procedures governing the

maintenance of excess funds in customer segregated and Part 30

secured accounts. Withdrawals of 25 percent or more would

necessitate pre-approval in writing by senior management and must be

reported to the designated SRO and the CFTC; and

Make additional reports available to the SRO and the

CFTC, including daily computations of segregated and Part 30 secured

amounts.

Beyond the NFA rules, additional reforms in this proposal

benefited from the CFTC's broad outreach and consultation with the

SROs and market participants, as well as substantial feedback from

CFTC Commissioners. They include:

First, bringing the regulators' view of customer

accounts into the 21st century by giving the SROs and the CFTC

direct electronic access to FCMs' bank and custodial accounts for

customer funds, without asking the FCMs' permission. Further,

acknowledgement letters and confirmation letters must come directly

to regulators from banks and custodians.

Second, increasing disclosures to customers regarding

the risks associated with futures trading and using FCMs to invest

their funds. Futures customers, if they wish, should have access to

information about how their assets are held, similar to that which

is available to mutual fund and securities customers. FCMs would be

required to provide current and potential customers with specific

information about the FCM's risks.

Third, enhancing controls at FCMs regarding how

customer accounts are handled, including policies and procedures on

supervision and risk management of customer funds.

Fourth, setting standards for the SROs' examinations

and the annual certified financial statement audits, including

raising minimum standards for independent public accountants who

audit FCMs.

Fifth, requiring FCMs to ensure they back up segregated

customer accounts with funds to cover potential margin deficits.

Sixth, implementing a more effective early warning

system for the Commission and the SROs that alerts them to certain

problems, including a) when an FCM's funds are insufficient to meet

the targeted residual interest in customer accounts b) when there is

a material adverse impact to the FCM's creditworthiness and c) when

there is a material change to the FCM's clearing or financial

arrangements.

And seventh, instituting a liquidity requirement for

FCMs, in addition to the existing capital requirement, to better

detect FCMs that have become distressed and may put customer funds

at risk.

Prior to this proposal, the Commission already made some

important improvements to protections for customer funds. They

include:

The completed amendments to rule 1.25 regarding the

investment of funds that bring customers back to protections they

had prior to exemptions the Commission granted between 2000 and

2005. Importantly, this prevents use of customer funds for in-house

lending through repurchase agreements;

Clearinghouses will have to collect margin on a gross

basis and FCMs will no longer be able to offset one customer's

collateral against another and then send only the net to the

clearinghouse;

The so-called ``LSOC rule'' (legal segregation with

operational comingling) for swaps ensures customer money is

protected individually all the way to the clearinghouse; and

The Commission included customer protection

enhancements in the final rule for designated contract markets.

These provisions codify into rules staff guidance on minimum

requirements for SROs regarding their financial surveillance of

FCMs.

It is crucial that the CFTC, working with SROs and market

participants, continues its efforts to enhance protections for the

funds of both futures and swaps customers. We look forward to

reviewing the public input on this proposal.

Appendix 3--Statement of Commissioner Jill E. Sommers

Today the Commission has proposed a new set of rules to, among

other things, increase customer protections and disclosures,

strengthen risk management programs, and enhance auditing and

examination procedures for futures commission merchants (FCMs). In

light of the recent events surrounding MF Global and Peregrine, I

am, of course, supportive of such steps to the extent that they lead

to greater customer protection and increased customer awareness of

the risks associated with their futures and swaps accounts.

As always, I am sensitive to the fact that some regulation,

while well intended, may not further its stated goals or may be so

burdensome that the benefits do not justify the costs. I encourage

members of the public to comment, both to support the aspects of

this proposed rule that take appropriate steps towards achieving the

Commission's objectives and to highlight the areas of the proposal

that they believe may be unnecessary or that could be accomplished

through more efficient means. In particular, I welcome comment on

the Commission's proposal requiring an FCM to maintain residual

interest in segregated accounts in an amount that exceeds the sum of

all futures customers' margin deficits. Additionally, it would be

helpful to hear from self-regulatory organizations (SROs) regarding

whether reviews by an examinations expert would assist the SROs in

the application of their respective supervisory programs.

I am hopeful that, with the help of thoughtful recommendations

from market participants, the Commission will finalize an effective

and streamlined rule improving protections for futures and swaps

customers.

Appendix 4--Statement of Commissioner Scott O'Malia

In response to the Peregrine and MF Global failures, the

Commission has proposed a new set of rules to enhance the level of

protection afforded customers of the futures markets. In particular,

the proposal calls for FCMs to maintain adequate capital in their

customer accounts to ensure customers are not bearing the credit

risk of their fellow customers, implement controls around the risks

specific to a particular FCM's business, increase the level of

disclosures provided to customers, and create an independent

segregation account balance verification system. While these

measures are a good start, I believe that it is essential to focus

on a comprehensive technological solution that goes beyond what the

Commission has proposed in this release. Technology can be a cost

effective oversight tool for both customers and the Commission to

enhance transparency and improve risk management. Improving our

capacity to monitor money flows can serve as a significant deterrent

against fraudulent behavior.

I encourage industry participants to voice their opinion as to

how the proposals put forth today can be improved upon.

Specifically, what technological solutions can be employed to

facilitate the dissemination of information about FCMs to their

customers so that they may ``know their FCM''? How can firms

implement the new capital requirements in the most cost effective

manner? What is the best method for an FCM to monitor its level of

risk? I look forward to hearing from market participants on the most

effective ways to implement the customer protection rules proposed

by the Commission today.

I would also like to highlight one of today's proposals that

will require additional development in order to fulfill the goal of

customer protection. Today's proposal calls for the creation of an

electronic balance confirmation process that would allow the

Commission and Self-Regulatory Organizations (``SROs'') to

independently check the balance of each segregated account held on

behalf of customers. While this can be used to aid in the

surveillance of account balances, the Commission proposal only works

on an individual basis and requires significant human involvement to

log in and monitor individual accounts. What the industry needs is a

fully automated system that allows the Commission and SROs to

download the account balances for each segregated account held for a

customer and compare that balance to the figures on record at each

FCM. In response to the Peregrine and MF Global failures, industry

participants discussed the implementation of such a system in July

of this year during the Commission's Technology Advisory Committee

(TAC) meeting. During the meeting, the TAC members present were

virtually unanimous in their belief that an automated customer fund

verification system was needed. Certain TAC members also made

presentations discussing the technological

[[Page 67971]]

hurdles that must be overcome in order to put such a system in

place.

On October 30th we will have another TAC meeting during which

SROs will update us on the status of this system's implementation

and their estimates for when it will be fully operational. Only when

this system is up and running can customers of the futures industry

feel secure that their investments are in safe hands and properly

monitored by both the Commission and SROs. This is an issue of

utmost importance and requires collaboration on the part of the

Commission, SROs and each and every Commission registrant. The end

result of this process will provide customers with the assurance

they need to continue investing in the derivatives markets.

I hope market participants will provide thoughtful

recommendations to improve customer protections and deploy

technology that is cost-effective to create and maintain. I also

encourage market participants to provide specific data that the

Commission can use to develop a robust cost benefit analysis.

[FR Doc. 2012-26435 Filed 11-13-12; 8:45 am]

BILLING CODE P

 

Last Updated: November 14, 2012