[Federal Register: April 12, 2004 (Volume 69, Number 70)]
[Page 19166-19168]
From the Federal Register Online via GPO Access [wais.access.gpo.gov]



Futures Market Self-Regulation

AGENCY: Commodity Futures Trading Commission.

ACTION: Request for comment.


SUMMARY: The Commodity Exchange Act (the ``Act''),\1\ through Core
Principles added by the Commodity Futures Modernization Act of 2000
(``CFMA'') \2\ and otherwise, imposes upon trading facilities
(designated contract markets or ''DCMs'' and derivatives transaction
execution facilities or ``DTEFs''), upon registered futures
associations (``RFAs''),\3\ and upon clearinghouses (derivatives
clearing organizations or ``DCOs'') certain self-regulatory obligations
with respect to futures commission merchants (``FCMs'') that are
members of such DCMs, DTEFs, RFAs, and DCOs (together, ``self-
regulatory organizations'' or ``SROs''). In order to avoid duplicative
supervisory burdens upon FCMs that are members of more than one SRO,
the Commodity Futures Trading Commission (the ``Commission'' or
``CFTC'') permits SROs to enter into voluntary, cooperative agreements
to both allocate certain supervisory responsibilities among themselves
so that each FCM has a single designated self-regulatory organization
(``DSRO'') and to share relevant financial and risk information among
themselves. Under such an agreement, each DSRO is primarily responsible
for conducting periodic examinations of firms assigned to it, and the
other SROs rely upon the findings of such examinations, yet under the
Act and Commission regulations each SRO retains ultimate responsibility
for ensuring proper performance of its self-regulatory duties.\4\

    \1\ 7 U.S.C. 1 et seq. (2000).
    \2\ See Pub. L. 106-554, 114 Stat. 2763 (Dec. 21, 2000).
    \3\ CFTC Regulation 170.15 requires each FCM to be a member of
at least one RFA that is registered with the Commission pursuant to
section 17 of the Act. Commission regulations referred to herein may
be found at 17 CFR Ch. I (2003).
    \4\ DSROs also monitor compliance in the areas of sales
practice, recordkeeping, and anti-money laundering protections.

    Any two or more SROs may propose to enter into an agreement to
effectuate a DSRO plan but such a plan may not be implemented unless
and until the Commission, following appropriate notice and opportunity
for public comment, approves the plan (in whole or in part and as
submitted or as modified according to the Commission's direction). \5\
The Commission also may, after appropriate notice and opportunity for
hearing, withdraw its approval of a plan (in whole or in part) that it
has previously approved if, in the Commission's determination, the plan
(or part) no longer adequately effectuates the purposes of the Act or
Commission regulations.\6\

    \5\ Regulation 1.52(g) states:
    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 auditing for compliance with the minimum
financial rules of the [SROs] submitting the plan for any [FCM or IB
that] is a member of more than one [SRO]; (4) Reduces multiple
reporting of the financial information necessitated by such minimum
financial and related reporting requirements by any [FCM or IB that]
is a member of more than one [SRO]; (5) Fosters cooperation and
coordination among the contract markets; and (6) Does not hinder the
development of [an RFA] under [S]ection 17 of the Act.
    \6\ See Regulation 1.52(i).

    In 1984, a number of SROs entered into a Joint Audit Agreement
(``1984 Agreement'') to effectuate a DSRO plan.\7\ Proposed amendments
to the 1984 Agreement were recently submitted for approval (``Proposed
Agreement''). In accordance with Sec.  1.52(g) of its regulations and
in conjunction with its ongoing review of the self-regulatory system
for futures markets, the Commission is publishing this notice to

[[Page 19167]]

request public comment on the Proposed Agreement.

    \7\ See 49 FR 28906 (Jul. 17, 1984) (approved in large part on
Oct. 10, 1984 (``1984 Commission Letter'')).

DATES: Comments must be received on or before May 27, 2004.

ADDRESSES: Interested persons should submit their views and comments to
Jean A. Webb, Secretary, Commodity Futures Trading Commission, Three
Lafayette Centre, 1155 21st Street, NW., Washington, DC 20581. In
addition, comments may be sent by facsimile transmission to (202) 418-
5521, or by electronic mail to [email protected]. Reference should be
made to ``Futures Market Self-Regulation''. This document also will be
available for comment at  href="http://frwebgate.access.gpo.gov/cgi-bin/leaving.cgi?from=leavingFR.html&log=linklog&to=http://www.regulations.gov" shape="rect">http://www.regulations.gov.

FOR FURTHER INFORMATION CONTACT: Thomas J. Smith, Associate Deputy
Director and Chief Accountant, or Natalie A. Markman, Senior Special
Counsel, Division of Clearing and Intermediary Oversight, Commodity
Futures Trading Commission, Three Lafayette Centre, 1155 21st Street,
NW., Washington, DC 20581. Telephone (202) 418-5450.


I. Background

A. The DSRO System

    The Commission promulgated Regulation 1.52 in 1978 to permit
cooperative self-regulatory arrangements such as the DSRO system that
operates today.\8\ Under CFTC regulations, the term ``designated self-
regulatory organization'' means an SRO of which an FCM is a member or,
if the FCM is a member of more than one SRO, the SRO to whom certain
self-regulatory responsibilities are delegated pursuant to a DSRO
agreement.\9\ Notwithstanding the DSRO system, moreover, each SRO must
establish and maintain appropriate procedures for monitoring the
financial integrity of its member firms.\10\ This fundamental
obligation is reflected in the Act.\11\

    \8\ 43 FR 39956, 39981-82 (Sep. 8, 1978). Although the
regulation has been amended over the years, its fundamental
requirements have remained substantially the same.
    \9\ Originally, Regulation 1.3(ff) defined a DSRO to be an SRO:
    \10\ Commission staff has provided detailed guidance on
conducting an effective surveillance program. See Division of
Trading and Markets Financial and Segregation Interpretation No. 4-
1--Advisory Interpretation for Self-Regulatory Organization
Surveillance over Members' Compliance with Minimum Financial,
Segregation, Reporting, and Related Recordkeeping Requirements, 1
Comm. Fut. L. Rep. (CCH) ] 7114A at ] 43 (Jul. 29, 1985).
    \11\ Both trading facilities and clearing organizations have
important self-regulatory obligations under the Act. Core Principle
2 requires each DCM to monitor and enforce compliance with its
rules. Core Principle 11 further requires each DCM to establish and
enforce rules to ensure the financial integrity of FCMs and IBs and
the protection of customer funds. 7 U.S.C. 7(d)(2) and (11). Core
Principle H requires each DCO to monitor and enforce its rules, and
the rules of a clearing organization focus extensively on issues of
financial integrity. Moreover, Core Principle C requires each DCO to
establish appropriate continuing eligibility standards (including
appropriate minimum financial requirements) for its members and
participants, and Core Principle M directs each DCO to enter into
all appropriate and applicable information-sharing agreements and to
use relevant information obtained thereby in carrying out its risk
management program. 7 U.S.C. 7a-1(c)(2)(C), (H), and (M); see also,
DTEF Registration Criterion 4, 7 U.S.C. 7a(c)(4); DTEF Core
Principle 2, 7 U.S.C. 7a(d)(2); and Section 17(b)(4) of the Act
(financial responsibility standards for RFA members), 7 U.S.C.

Of which [an FCM] is a member or, if the [FCM] is a member of more than
one [SRO] and such [FCM] is the subject of an approved plan under Sec.
1.52, then [an SRO] delegated the responsibility by such a plan for
monitoring and auditing such [FCM] for compliance with the minimum
financial and related reporting requirements of the [SROs] of which the
[FCM] is a member, and for receiving the financial reports necessitated
by such minimum financial and related reporting requirements from such

43 FR at 39967. Regulation 1.3(ff) subsequently has been amended to
include introducing brokers (``IBs'') and leverage transaction
    The 1984 Agreement created a Joint Audit Committee (``JAC'' or
``Committee'') made up of one representative appointed by each of the
parties to the agreement.\12\ Currently, if an FCM is a member of a
single DCM among a group of certain DCMs that are long-time JAC
members, then that DCM serves as DSRO for such firm. If an FCM is a
member of more than one DCM within that group, then the Committee
designates one of those DCMs to act as the firm's DSRO. If an FCM is
not a member of one of the DCMs within that group, then NFA acts as the
DSRO for such FCM.

    \12\ The parties to the 1984 Agreement were: the Board of Trade
of the City of Chicago (''CBOT''); Board of Trade of Kansas City
(``KCBOT''); Chicago Mercantile Exchange (``CME''); Chicago Rice and
Cotton Exchange; Coffee, Sugar & Cocoa Exchange, Inc. (``CSCE'');
Commodity Exchange, Inc. (``COMEX''); MidAmerica Commodity Exchange;
Minneapolis Grain Exchange (``MGE''); New York Cotton Exchange
(``NYCE''); New York Futures Exchange, Inc.; New York Mercantile
Exchange (``NYMEX''); and NFA.
    Current JAC members are: the AMEX Commodities Corp.; BrokerTec
Futures Exchange, LLC; CBOE Futures Exchange, LLC; CBOT; CME; CSCE;
COMEX; Island Futures Exchange, LLC; KCBOT; Merchants' Exchange,
LLC; MGE; NQLX, LLC; NFA; NYCE; NYMEX; OneChicago, LLC; Philadelphia
Board of Trade; and U.S. Futures Exchange, LLC. Not all members,
however, have been assigned DSRO responsibilities.

    In addition to allocating DSRO responsibilities among certain SROs,
the Committee also oversees the design and implementation of the
examination program utilized by those DSROs that maintain in-house
examination staffs in their examinations of assigned firms. (The NFA
has a comparable examination program that it utilizes in examining
firms for which it has been assigned as DSRO and firms that it examines
under contractual arrangements with other SROs.) The Committee also
determines the minimum examination practices and procedures to be
followed in the conduct of examinations. Committee members may share
information with each other about the financial condition and risk
exposures of FCMs but are under confidentiality restrictions with
respect to sharing such information with other persons.\13\

    \13\ For example, Paragraph 8(b) of the 1984 Agreement does not
permit a DSRO to share such information with any clearinghouse
except the clearinghouse that clears transactions executed on the
DSRO's trading facility. The proposed amendments, however, would
permit a DSRO to share information about an FCM with any DCO of
which the FCM is a member.

B. Commission Review of the DSRO System

    CFTC Chairman James Newsome announced in May 2003 that the
Commission would review ``the roles, responsibilities, and capabilities
of SROs in the context of market changes,'' such as demutualization and
increasing competition.\14\ Chairman Newsome recognized that self-
regulation ``has been integral to the success of the futures markets''
and stated that it is appropriate for the Commission ``to ensure that
the principles of objectivity, confidentiality, and consistency
continue to be adhered to as well as they have always been in this
business.'' \15\

    \14\ Address by Chairman James E. Newsome at the Futures
Industry Association Law and Compliance Luncheon (May 28, 2003),
available at  href="http://frwebgate.access.gpo.gov/cgi-bin/leaving.cgi?from=leavingFR.html&log=linklog&to=http://www.cftc.gov/opa/speeches03/opanewsm-40.htm" shape="rect">http://www.cftc.gov/opa/speeches03/opanewsm-40.htm.

    \15\ In congressional testimony, Chairman Newsome explained that
he initiated a review of the SRO system ``not because there are any
particular issues that have arisen; but given the number of changes
that have taken place in the industry over the last 2 or 3 years of
both the exchanges and the firms, we think it is prudent and
responsible for the CFTC to take a look at SROs and to make sure
that the same principles that applied when SROs were put into place[
] apply now.'' Commodity Futures Modernization Act: Hearings Before
the Subcomm. on General Farm Commodities and Risk Management of the
House Comm. on Agriculture, 108th Cong., 1st Sess. 6 (2003)
(statement of James E. Newsome, Chairman, CFTC).

    In February 2004, the Commission issued a press release announcing
several initiatives in connection with its

[[Page 19168]]

ongoing review of self-regulation.\16\ One such initiative is the
examination of the DSRO system, including its cooperative agreements
and programs.\17\ The CFTC's Division of Clearing and Intermediary
Oversight has been assessing the impact of changes in the futures
industry, such as new entrants being designated as DCMs \18\ and the
CFMA's creation of a new registration category for DCOs,\19\ upon the
DSRO system and its examination programs. A timely review of the DSRO
system will ensure that DSROs continue to meet the needs of the markets
and their participants. Accordingly, staff is conducting a formal
review of the DSRO system as administered by the JAC through its
examination program, including assessment of: (1) The governance and
operation of the JAC; and (2) the effectiveness of the JAC and NFA
examination programs, and related programs (``Programs'').

    \16\ CFTC Press Release 4890-04 (Feb. 6, 2004), available at
 href="http://frwebgate.access.gpo.gov/cgi-bin/leaving.cgi?from=leavingFR.html&log=linklog&to=http://www.cftc.gov/opa/press04/opa4890-04.htm" shape="rect">http://www.cftc.gov/opa/press04/opa4890-04.htm.

    \17\ In a related initiative, the Commission encouraged each SRO
to reexamine its policies and procedures, training efforts, and day-
to-day practices to confirm that there are adequate safeguards to
prevent the inappropriate use of confidential information obtained
by SROs during audits, investigations, or other self-regulatory
activities. The Commission also encouraged SROs to publicize any
safeguards so market participants would continue to have faith in
the integrity of the self-regulatory process and to participate
enthusiastically in it.
    \18\ The Commission has designated seven new DCMs since passage
of the CFMA.
    \19\ The CFMA changed the manner in which clearing organizations
are recognized and regulated under the Act, and granted the
Commission explicit authority to regulate DCOs. See 7 U.S.C. 7a-1.
Each DCO must comply with certain core principles to maintain its
registration. In particular, Section 5b(c)(2)(H)--Core Principle H
on rule enforcement--requires a DCO to ``maintain adequate
arrangements and resources for the effective monitoring and
enforcement of compliance'' with its rules and for resolving
disputes and to ``have the authority and ability to discipline,
limit, suspend, or terminate a member's or participant's activities
for violations'' of its rules.

    The Commission invites comment on the Proposed Agreement,
particularly with respect to the ability of the DSRO system to serve
the public interest, reduce duplicative reporting and examination
burdens on FCMs, strengthen customer protections, and foster
cooperation and coordination among the markets. Some, but certainly not
all, of the issues that the Commission may consider in its assessment
of the Proposed Agreement include:
    1. Membership criteria;
    2. Decision-making processes and the limitation of voting
eligibility on the bases of longevity and self-performance of
examination services;
    3. The process by which an FCM is assigned to a particular DSRO;
    4. Delegation versus outsourcing of examination services;
    5. Distinctions between RFAs and non-RFAs with respect to
delegation and outsourcing issues;
    6. Distinctions between DSRO responsibilities and SRO
    7. The extent to which the Commission should review the JAC's
governance and operation on a more routine, periodic basis; and
    8. The general transparency of the DSRO system and its

    \20\ Commission staff receives and reviews the Programs on an
annual basis, but has not in the past reviewed the Joint Audit
Agreement except in response to the submission of a new agreement.

In addition to the issues mentioned above, the Commission welcomes
comment on any aspect of the DSRO system.
    The 1984 Agreement, 1984 Commission Letter, and the Proposed
Agreement are available on the Commission's Web site at  href="http://frwebgate.access.gpo.gov/cgi-bin/leaving.cgi?from=leavingFR.html&log=linklog&to=http://www.cftc.gov" shape="rect">http://www.cftc.gov
 upon the issuance of this notice by the Commission. Copies

also may be obtained from the Office of the Secretariat, Commodity
Futures Trading Commission, 1155 21st Street, NW., Washington, DC

    Issued in Washington, DC, on April 7, 2004, by the Commission.
Jean A. Webb,
Secretary of the Commission.
[FR Doc. 04-8235 Filed 4-9-04; 8:45 am]