[Federal Register: January 7, 1998 (Volume 63, Number 4)]

[Proposed Rules]

[Page 695-707]

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

[DOCID:fr07ja98-24]



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Proposed Rules

                                                Federal Register

________________________________________________________________________



This section of the FEDERAL REGISTER contains notices to the public of

the proposed issuance of rules and regulations. The purpose of these

notices is to give interested persons an opportunity to participate in

the rule making prior to the adoption of the final rules.



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[[Page 695]]





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COMMODITY FUTURES TRADING COMMISSION



17 CFR Part 1





Account Identification for Eligible Bunched Orders



AGENCY: Commodity Futures Trading Commission.



ACTION: Proposed rules.



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SUMMARY: The Commodity Futures Trading Commission ("Commission") is

reproposing to amend Commission Regulation 1.35(a-1) to allow eligible

customer orders to be placed on a contract market without specific

customer account identification either at the time of order placement

or at the time of report of execution.<SUP>1</SUP> Specifically, the

amendment would exempt from the customer account identification

requirements of Regulation 1.35(a-1) (1), (2)(i), and (4) bunched

futures and/or futures option orders placed by an eligible account

manager on behalf of consenting eligible customer accounts as part of

its management of a portfolio also containing instruments which are

either exempt from regulation pursuant to the Commission's regulations

or excluded from regulation under the Commodity Exchange Act ("Act").

The proposed rule would permit orders entered on behalf of these

accounts to be allocated no later than the end of the day on which the

order is executed.



    \1\ The Commission published a proposed amendment to Regulation

1.35(a-1) on May 3, 1993. 58 FR 26270 (May 3, 1993).

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DATES: Comments must be received on or before March 9, 1998.



ADDRESSES: Interested persons should submit their views and comments to

Jean A. Webb, Secretary, Commodity Futures Trading Commission, Three

Lafayette Centre, 1155 21st Street, N.W., Washington, D.C. 20581. In

addition, comments may be sent by facsimile transmission to facsimile

number (202) 418-5521, or by electronic mail to [email protected]

Reference should be made to "Eligible orders."



FOR FURTHER INFORMATION CONTACT: Duane C. Andresen, Special Counsel,

Division of Trading and Markets, Commodity Futures Trading Commission,

Three Lafayette Centre, 1155 21st Street, N.W., Washington, D.C. 20581.

Telephone: (202) 418-5490.



SUPPLEMENTARY INFORMATION:



Table of Contents



I. Background

    A. Current Regulatory Requirements

    B. Proposed Amendment to CME Rule 536

    C. Proposed Amendment to Regulation 1.35(a-1)

    1. Predetermined Allocation Formulas

    2. End-of-Day Allocation to Eligible Customers

II. Reproposed Amendment to Commission Regulation 1.35(a-1)

    A. Eligible Orders

    1. Proposed Regulation 1.35(a-1)(6)(i)

    2. Comments Received

    3. Reproposed Regulation 1.35(a-1)(5)(i)

    B. Eligible Account Managers

    1. Proposed Regulation 1.35(a-1)(6)(ii)

    2. Comments Received

    3. Reproposed Regulation 1.35(a-1)(5)(ii)

    C. Eligible Customers

    1. Proposed Regulation 1.35(a-1)(6)(iii)

    (a). 1.35(a-1)(6)(iii)(A)--Types of Customers

    (b). 1.35(a-1)(6)(iii)(B)--Proprietary Interest

    2. Comments Received

    (a). 1.35(a-1)(6)(iii)(A)--Types of Customers

    (b). 1.35(a-1)(6)(iii)(B)--Proprietary Interest

    3. Reproposed Regulation 1.35(a-1)(5)(iii)

    (a). 1.35(a-1)(5)(iii)(A)--Types of Customers

    (b). 1.35(a-1)(5)(iii)(B)--Proprietary Interest

    D. Account Certification

    1. Proposed Regulation 1.35(a-1)(6)(iv)

    2. Comments Received

    3. Reproposed Regulation 1.35(a-1)(5)(iv)

    E. Allocation

    1. Proposed Regulation 1.35(a-1)(6)(v)

    2. Comments Received

    3. Reproposed Regulation 1.35(a-1)(5)(v)

    F. Recordkeeping

    1. Proposed Regulation 1.35(a-1)(6)(vi)

    2. Comments Received

    3. Reproposed Regulation 1.35(a-1)(5)(vi)

    G. Contract Market Rule Enforcement Programs

    1. Proposed Regulation 1.35(a-1)(6)(vii)

    2. Comments Received

    3. Reproposed Regulation 1.35(a-1)(5)(vii)

III. Conclusion

IV. Other Matters

    A. Regulatory Flexibility Act

    B. Paperwork Reduction Act



I. Background



A. Current Regulatory Requirements



    Commission regulations specify that customer orders must be

recorded promptly and include customer account identification at the

time of entry and the time of report of execution. These recordkeeping

requirements, in effect since March 24, 1972, permit a specific

customer's order to be traced at each stage of the order processing

system and help to prevent the improper allocation of trades and other

abuses. Specifically, Commission Regulation 1.35(a-1)(1) requires that

each futures commission merchant ("FCM") and each introducing broker

("IB") receiving a customer's order immediately prepare a written

record of that order, which includes an account identifier for that

customer. Regulation 1.35(a-1)(2)(i) requires that each member of a

contract market who receives a customer's order on the floor of a

contract market that is not in writing immediately prepare a written

record of that order, including the appropriate customer account

identification. Regulation 1.35(a-1)(4) requires, among other things,

that each member of a contract market reporting the time of execution

of a customer's order from the floor of a contract market include the

account identification on a written record of that order.



B. Proposed Amendment to CME Rule 536



    By letters dated February 24, 1992, CME submitted both a proposed

amendment to CME Rule 536 pursuant to Section 5a(12) of the

Act,<SUP>2</SUP> 7 U.S.C. 1 et seq., and a petition for rulemaking to

amend Commission Regulation 1.35(a-1) pursuant to Commission Regulation

13.2.<SUP>3</SUP> As discussed below, the Commission published requests

for comments on both submissions.

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    \2\ Now redesignated as Section 5a(a)(12)(A).

    \3\ The Exchange submitted additional information regarding the

proposed rule amendment in letters dated May 7, 1992, and August 12,

1992. By letter dated August 20, 1992, the Division of Trading and

Markets posed a series of questions to the Exchange. The CME

responded in a letter dated September 25, 1992.

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    The proposed CME rule amendment would have exempted from the

customer account designation requirement certain orders entered by

investment advisers registered with the Securities and Exchange

Commission ("SEC") pursuant to the Investment



[[Page 696]]



Advisers Act of 1940, 15 U.S.C. 80b et seq. [1988], and banks,

insurance companies, trust companies, and savings and loan institutions

subject to federal or state regulation ("account

managers").<SUP>4</SUP> These orders could have been placed only for

certain specified institutional accounts whose owners had been notified

in writing that their orders were being placed without customer account

designations. The orders would have been required to be allocated among

participating accounts prior to the end of the day. Finally, the

individual or firm directing the allocation of the orders could not

have a proprietary interest in any account that received any part of

the order, and no related-party account could receive any part of the

order.

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    \4\ The term account manager hereinafter is used to include

investment advisers and other persons identified in the proposed

regulation, and their principals, if any, who would place orders and

direct the allocation thereof in accordance with the procedures set

forth in the reproposed amendment.

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    On June 8, 1992, the Commission published the proposed amendment to

CME Rule 536 for public comment. <SUP>5</SUP> The Commission received

31 comments in response to the CME's proposal. Twenty-six of the

comments evidenced support for the proposed rule amendment, four were

opposed to the amendment,<SUP>6</SUP> and one recommended

caution.<SUP>7</SUP> Those comments were addressed in the Commission's

subsequent proposed amendment to Regulation 1.35 and are not addressed

herein.

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    \5\ 57 FR 24251.

    \6\ Commenters opposed to approval of the proposed rule

amendment included a Commission Administrative Law Judge; his law

clerk; the Director, Office of Financial Enforcement, Department of

the Treasury; and the Chief, White-Collar Crimes Section, Criminal

Investigative Division, Federal Bureau of Investigation. These

commenters expressed concern that, by weakening the audit trail, the

proposal could facilitate misallocation, money laundering and tax

evasion.

    \7\ The United States Attorney for the Northern District of

Illinois urged that the Commission "exercise great care before

taking any action that could provide any opportunity for fraud,

self-dealing, or other criminal activity."

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C. Proposed Amendment to Regulation 1.35(a-1)



    On May 3, 1993, the Commission published proposed amendments to

Regulation 1.35(a-1) for public comment.<SUP>8</SUP> In addition to

amending Regulations 1.35(a-1)(1), (2), and (4), the Commission

proposed to add paragraphs 1.35(a-1)(5) and (6). Paragraph (5)

addressed the placement and allocation of bunched orders generally and

the use of predetermined allocation formulas. Paragraph (6) was the

Commission's followup to CME's proposal to permit the allocation of

certain bunched orders at the end of the day.

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    \8\ 58 FR 26274 (May 3, 1993).

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1. Predetermined Allocation Formulas

    Proposed Regulation 1.35(a-1)(5) would have permitted the placement

of a bunched order for multiple customer accounts without individual

customer account identification at the time of entry and the time of

report of execution, subject to certain requirements.<SUP>9</SUP>

Proposed Regulation 1.35(a-1)(5) is being withdrawn because it has been

superseded. On May 9, 1997, the Commission published a Notice of

Interpretation and Approval Order approving the National Futures

Association ("NFA") Interpretative Notice to NFA Compliance Rule 2-10

Relating to the Allocation of Block Orders for Multiple Accounts and

providing additional Commission guidance regarding bunched orders and

allocation procedures.<SUP>10</SUP> The guidance provided therein has

been published as Appendix C to Part One of the Commission's

regulations.

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    \9\ Those requirements included providing an allocation formula

for allocating the fills fairly among the participating accounts.

Directing profitable fills to favored accounts and unprofitable

fills to unfavored accounts (preferential allocation) is a violation

of Section 4b of the Act. In the Matter of GNP Commodities, Inc., et

al., [1990-1992 Transfer Binder] Comm. Fut. L. Rep. (CCH) para.

25,360 at 39,214 (CFTC August 11, 1992); In the Matter of

Lincolnwood Commodities, Inc., of California, et al., [1982-1984

Transfer Binder] Comm. Fut. L. Rep. (CCH) para. 21,986 at 28,246

(CFTC January 31, 1984).

    \10\ 62 FR 25470 (May 9, 1997).

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2. End-of-Day Allocation to Eligible Customers

    Under proposed Regulation 1.35(a-1)(6), contract markets could have

submitted rules for Commission approval that would have exempted

certain orders from the requirement that a specific customer account be

identified at the time of entry and the time of report of execution if

specified requirements were met. These orders could have been allocated

at the end of the day. The specific requirements of the proposal

addressed: (a) Eligible orders, (b) eligible account managers, (c)

eligible customers, (d) account certification, (e) allocation

requirements, (f) account manager recordkeeping, and (g) contract

market rule enforcement programs. The Commission stated that the

proposed regulation would encourage and facilitate institutional

participation in the futures markets subject to customer protection

requirements that were consistent with the sophistication of the

institutional customers.

    The Commission received 34 comments in response to the proposed

amendments to Regulation 1.35(a-1).<SUP>11</SUP> Commenters included

eleven FCMs; <SUP>12</SUP> one investment adviser registered with the

SEC; <SUP>13</SUP> seven firms registered with both the Commission and

the SEC; <SUP>14</SUP> four commodity trading advisors ("CTA");

<SUP>15</SUP> three industry associations; <SUP>16</SUP> the CME, the

Chicago Board of Trade ("CBT"), and the NFA.<SUP>17</SUP>

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    \11\ Only those comments addressing proposed paragraph 1.35(a-

1)(6) are addressed herein.

    \12\ BA Futures, Inc. ("BA"); Cargill Investor Services

("Cargill"); Credit Agricole Futures, Inc. ("Credit Agricole"),

which is also registered as a CTA; Dean Witter Reynolds, Inc.,

Futures Division ("Dean Witter"); First Boston Corporation

("First Boston"); Lind-Waldock & Company ("Lind-Waldock");

PaineWebber Incorporated ("PaineWebber"); Refco, Inc. ("Refco");

Rodman & Renshaw, Inc. ("Rodman"); Sanwa-BGK Futures, Inc.

("Sanwa-BGK"); and Saul Stone and Company ("Saul Stone").

    \13\ Pacific Investment Management Company ("Pacific").

    \14\ Bear, Stearns & Co., Inc. ("Bear Stearns"); Flaherty &

Crumrine Inc. ("Flaherty"); Goldman, Sachs & Co. ("Goldman

Sachs"); Indosuez Carr Futures, Inc. ("Carr"); Merrill Lynch;

Morgan Stanley & Co. ("Morgan Stanley"); and TSA Capital

Management ("TSA").

    \15\ Campbell Company ("Campbell"); John W. Henry & Co., Inc.

("John Henry"); Leland O'Brien Rubinstein Associates Inc.

("Leland"); and Sunrise Commodities, Inc. ("Sunrise").

    \16\ Futures Industry Association ("FIA"), Managed Futures

Association ("MFA"), and Investment Company Institute ("ICI").

    \17\ The Commission also received comments from the New York

City Bar Association ("N.Y. Bar") and a law firm, Abramson and

Fox.

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    Most commenters found the proposed rule burdensome and too

restrictive to be of value. In particular, these commenters objected to

the proposed requirement for an intermarket trading strategy involving

securities and to the recordkeeping and certification requirements. Two

comments from the same commenter opposed the proposal,<SUP>18</SUP> and

one raised concerns about money laundering.<SUP>19</SUP> The Commission

has carefully reviewed the comments received and, as a result, has

modified and clarified the proposed amendments to Regulation 1.35(a-1).

Comments addressing specific areas and an explanation of the

Commission's revisions are discussed below.

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    \18\ The commenter, who submitted two comments, was a Commission

Administrative Law Judge. He opposed the proposal because of the

potential for fraud, money laundering and tax evasion. He further

commented that the industry has failed to articulate a compelling

need and that the real reason to do so, the desire to increase

account managers' flexibility and conform commodity regulation to

security regulation, does not justify adoption of a system so open

to abuse.

    \19\ The Chief, Money Laundering Section, Criminal Division,

Department of Justice, asked that the Commission consider the

proposal's impact on future money laundering and other law

enforcement investigations.



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[[Page 697]]



II. Reproposed Amendment to Commission Regulation 1.35(a-1)



    The Commission is reproposing to amend Regulation 1.35(a-1). Under

reproposed Regulation 1.35(a-1)(5) (formerly 1.35(a-1)(6)), a specific

customer's account identifier need not be recorded at the time an

eligible bunched order ("eligible order") is placed or upon report of

execution, and the order may be allocated by the end of the day on

which it is executed, provided that certain requirements are met. In

addition, the order must be handled in accordance with contract market

rules that have been submitted to the Commission and approved or

permitted into effect pursuant to Section 5a(a)(12)(A) of the Act and

Regulation 1.41. The Commission intends that this reproposal include

certain core regulatory protections while providing meaningful

regulatory relief in a manner which is responsive to the comments

previously received. In the discussion below, the Commission sets forth

each of the components of its 1993 proposal, a summary of the comments

then received, and the manner in which the reproposal addresses the

same issue.



A. Eligible Orders



1. Proposed Regulation 1.35(6)(a-1)(i)

    Proposed Regulation 1.35(6)(a-1)(i) would have required that orders

entered and allocated pursuant to the proposed regulation must be

intermarket orders. The term intermarket order was defined as a futures

or futures option order entered on behalf of an eligible customer as

part of a bona fide intermarket trading strategy also involving

securities. The term "securities" was defined to mean equity or debt

securities within the meaning of Section 2(1) of the Securities Act of

1933.

    This requirement was based on the stated rationale for allowing

post-trade allocation, which was to permit account managers to provide

equivalent treatment to customers' accounts traded pursuant to

strategies involving activity in both futures markets and securities

markets. For example, if a securities trade is allocable at the end of

the day and the account manager follows a strategy of buying securities

and selling futures, with the futures order to be executed throughout

the day, the account manager may need to await the results of all

transactions before allocating to the accounts so as to provide

equivalent treatment. Similarly, for strategies such as duration

management, where futures transactions are executed on the basis of a

change in interest rates that affects the price of the bonds in an

underlying portfolio, the procedure could be used to maintain positions

of a specified duration under circumstances when this result could not

be achieved through the use of a predetermined allocation formula.

2. Comments Received

    With regard to the proposal's description of eligible orders, most

commenters focussed on two issues: the definition of "intermarket"

and the definition of "securities." Numerous commenters suggested

that the proposal should not be limited to intermarket strategies based

on a securities requirement and suggested expanding the definition of

"intermarket" to include trading strategies that did not involve

securities directly.\20\ In addition to concerns about the definition

of intermarket, several commenters voiced the opinion that the

definition of "securities" was too restrictive.\21\ Several

commenters indicated that the proposal appeared to require a

transaction test, i.e., that the securities and futures executions

would be required to occur simultaneously.\22\

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    \20\ Bear Stearns, Dean Witter, Goldman Sachs, Carr, Morgan

Stanley, Lind-Waldock, TSA, NFA, ICI, N.Y. Bar, CME and CBT.

    CME stated that many other instruments, such as forex and

commodity and interest rate swaps, are used as part of investment

strategies and should not be excluded from the proposed amendments.

CBT commented that the exemption should cover strategies that

include foreign products and off-exchange products such as swaps.

The ICI stated that the "intermarket" requirement should be

deleted and that all orders entered on behalf of investment

companies that are registered with the SEC under the Investment

Company Act of 1940 should be presumed to be eligible orders.

    \21\ Bear Stearns, Dean Witter, Lind-Waldock, Merrill Lynch, and

Pacific.

    \22\ The CME noted that a requirement that the futures and

securities executions must occur simultaneously would inhibit the

use of duration adjustments, overlay, and other strategies. Goldman

Sachs commented that the Commission should make clear that the

proposed rule did not require that the futures transaction be

related to specific securities transactions, provided that it is

related to the management of a securities portfolio. Morgan Stanley

voiced similar concerns.

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3. Reproposed Regulation 1.35(a-1)(5)(i)

    After consideration of the comments, the Commission believes that

it would be appropriate to delete the term "intermarket" as the

descriptive term used to identify eligible orders. The Commission also

agrees with the commenters in recognizing that appropriate multi-market

investment management strategies can involve futures and/or futures

options and financial instruments other than securities. Thus, the

Commission is proposing to eliminate the requirement that the trading

strategy also involve securities. The Commission also wants to make

clear that eligible orders would be subject to a portfolio test and not

a transaction test.

    As previously noted, the overriding rationale for allowing post-

trade allocation is to permit equivalent treatment of customers'

accounts traded pursuant to strategies involving trading activity or

changes in valuation in more than one market. The Commission believes

that the account manager, in his or her role as a fiduciary, should be

permitted to determine that the portfolio management strategy requires

the placement of this type of order. Generally, this situation exists

when accounts are being traded in more than one market and the account

manager must review the results of trading activity in all markets

prior to directing order allocation in order to assure fairness. Of

course, it would not be permissible for a purported portfolio to be

established solely to obtain the relief being proposed. Rather, the

other financial instruments included in the portfolio must have a

legitimate financial relationship to the futures or futures option

orders for post-trade allocation to be appropriate.

    Where trades are executed only on domestic futures exchanges, the

account manager should be able to achieve equivalent treatment of

customers' accounts while complying with either the existing customer

account identifier requirements of Regulation 1.35(a-1)(1) and (2)(i)

or the predetermined allocation formula exceptions thereto as described

in Appendix C to Part One of the Commission's regulations. In

particular, for futures-only orders executed on one domestic futures

exchange, average pricing would be available to provide fair treatment

among customers. Accordingly, the Commission is proposing that to be

eligible, orders must be placed as part of the management of a

portfolio also containing instruments which are either exempt from

regulation pursuant to the Commission's regulations or excluded from

Commission regulation under the Act.

    The Commission has been advised that there may be instances where a

CTA placing exchange traded futures-only orders on more than one

futures exchange may need post-trade allocation in order to achieve

equivalent treatment of customers' accounts. The Commission requests

comments with regard to whether that relief is necessary. Any comments

should provide specific examples illustrating why the use of

predetermined allocation formulas or average pricing is insufficient to

provide fair treatment.



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B. Eligible Account Managers



1. Proposed Regulation 1.35(a-1)(6)(ii)

    Proposed Regulation 1.35(a-1)(6)(ii) would have required that the

person placing and/or directing the allocation of an eligible order and

its principal, if any, ("account manager") must be one of the

following which had been granted investment discretion with regard to

the eligible customer accounts:

    (i) an investment adviser registered with the SEC pursuant to the

Investment Advisers Act of 1940, or

    (ii) a bank, insurance company, trust company, or savings and loan

association subject to federal or state regulation.

    As proposed, the class of persons eligible to place intermarket

orders and direct the end-of-day allocation thereof would have been

identical to that suggested by CME. The Commission believed that, when

managing multiple accounts, these entities might be better able to

achieve similar results for institutional accounts being traded

pursuant to a program which involved multi-market trading strategies.

Under the proposed regulation, account managers for these types of

accounts would have been able to allocate futures and futures option

trades in the same manner as they allocated trades on securities

exchanges and over-the-counter markets.\23\ Additionally, these

entities' fiduciary activities were subject to oversight by various

state or federal regulatory agencies.

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    \23\ See, e.g., Interpretation 88-3 of New York Stock Exchange

Rule 410(a)(3): "Member organizations may accept block orders and

permit investment advisors to make allocations on such orders to

customers and remain in compliance with Rule 410(a)(3) provided that

the organizations receive specific account designations or customer

names by the end of the business day." See also Securities and

Futures Authority Rule Book. Rule 5-41 allows a firm to aggregate

customers' orders when it is unlikely to disadvantage the customer

and the firm has disclosed that orders may be aggregated. Rule 5-

34(13), averaging of prices, allows a firm to execute a series of

transactions within a 24-hour period to meet orders it has

aggregated. When a firm has aggregated orders, Rule 5-42 specifies

that the firm must not give unfair preference and if all the orders

cannot be satisfied, the firm generally must give priority to

satisfying customer orders.

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2. Comments Received

    Numerous commenters suggested that the list of eligible account

managers be expanded to include other entities. The suggested

additional entities include CTAs,<SUP>24</SUP> foreign investment

advisers subject to regulation in their home jurisdiction,<SUP>25</SUP>

non-U.S. investment advisers registered with the Commission or

otherwise exempt from registration pursuant to Regulation

30.10,<SUP>26</SUP> and investment advisers exempt from SEC

registration under Section 203(b)(3) of the Investment Advisers Act of

1940.<SUP>27</SUP> Finally, CBT proposed that the proposal should be

modified to afford sufficient flexibility to allow exchanges to include

any account manager that is regulated and subject to fiduciary

liability.

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    \24\ Campbell, First Boston, John Henry, Merrill Lynch, Morgan

Stanley, PaineWebber, FIA, and NFA. The N.Y. Bar recommended that

CTAs be considered after the rule had been evaluated.

    \25\ First Boston, Goldman Sachs, Merrill Lynch, and Morgan

Stanley.

    \26\ Carr and N.Y. Bar.

    \27\ First Boston and N.Y. Bar.

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3. Reproposed Regulation 1.35(a-1)(5)(ii)

    After consideration of the comments, the Commission believes that

it is appropriate to expand the list of eligible account managers to

include CTAs registered with the Commission pursuant to the

Act.<SUP>28</SUP> Because CTAs also attempt to achieve equivalent

treatment of customers' accounts traded pursuant to strategies

involving trading activity in more than one market, the Commission

believes that the relief afforded by this provision should be extended

to these account managers. In addition, CTAs are subject to Commission

and NFA regulatory requirements and oversight, including periodic

audits by the NFA.

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    \28\ Where applicable, the employing firm of an account manager

should have appropriate internal controls in place to address the

added discretion that the account manager will be able to exercise

pursuant to this proposal.

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    The Commission is not including as eligible account managers non-

U.S. investment advisers registered with the Commission or otherwise

exempt from registration pursuant to Regulation 30.10 and foreign

investment advisers subject to regulation in their home jurisdiction.

The Commission is concerned about potential difficulty in auditing

these entities and in obtaining documentation required to be made

available pursuant to the recordkeeping requirements discussed below.

The Commission specifically requests comments concerning this

determination. The Commission also requests comments with regard to its

determination not to include, at present, investment advisers exempt

from SEC registration under Section 203(b)(3) of the Investment

Advisers Act of 1940.



C. Eligible Customers



1. Proposed Regulation 1.35(a-1)(6)(iii)

(a). 1.35(a-1)(6)(iii)(A)--Types of Customers

    Proposed Regulation 1.35(a-1)(6)(iii)(A) provided that intermarket

orders could be allocated to accounts maintained by any of the

following institutional customers:

    (i) An Investment Company registered as such under the Investment

Company Act of 1940, 15 U.S.C. 80a et seq. [1988].

    (ii) A bank, trust company, insurance company or savings and loan

association subject to federal or state regulation.

     (iii) An account for which a bank, trust company, insurance

company or savings and loan association subject to federal or state

regulation is a fiduciary vested with investment discretion.

    (iv) A corporate qualified pension, profit sharing, or stock bonus

plan subject to Title 1 of the Employee Retirement Income Security Act

of 1974 ("ERISA"), or any plan defined as a governmental plan in

Section 3(32) of Title 1 of such Act, but not including a self-directed

plan.

    (v) An educational endowment, foundation, charitable institution or

trust which is organized or qualifies under Section 501(c)(3) of the

Internal Revenue Code with net assets of more than $100 million.

    This group of proposed eligible customers was substantially the

same as that included in the proposed amendment to CME Rule 536. The

CME and certain institutional customers represented that professional

managers of multi-market portfolios needed the flexibility afforded by

CME's proposed rule amendment to treat similarly managed accounts

fairly. Further, the Commission believed that those customers were

institutional investors whose accounts were subject to other regulatory

regimes or a portfolio size requirement and who participated in multi-

market investment strategies. Therefore, these customers could benefit

from use of the proposed regulation. The Commission further believed

the proposed eligible customer accounts were owned by entities with the

capacity to review and evaluate the accounts' trading activity and

results.

(b). 1.35(a-1)(6)(iii)(B)--Proprietary Interest

    Proposed Regulation 1.35(a-1)(6)(iii)(B) provided that the

following persons may have no interest in any account that receives any

part of such order or in any related securities account:

    (i) The account manager;

    (ii) The futures commission merchant allocating the order;

    (iii) Any general partner, officer, director, or owner of ten

percent or more of the equity interest in the account manager or the

futures commission merchant allocating the order;



[[Page 699]]



    (iv) Any employee or associated person or limited partner of the

account manager or the futures commission merchant allocating the order

who affects or supervises the handling of the order;

    (v) Any business affiliate that, directly or indirectly, controls,

is controlled by, or is under common control with, the account manager

or the futures commission merchant allocating the order;

    (vi) An employee benefit plan of the account manager, the futures

commission merchant allocating the order, or an affiliate, as defined

in subparagraph (v) above; or

    (vii) Any spouse, parent, sibling, or child of the foregoing

persons.

    The Commission believed, based on its experience with misallocation

of trades, that the ability to allocate fills between customer and

proprietary accounts subsequent to execution would have created an

unacceptably high potential for favoring the proprietary

accounts.<SUP>29</SUP> The Commission further believed that the ability

to allocate fills subsequent to execution while maintaining a

proprietary interest in a related securities account also would have

created an unacceptably high potential for abuse.<SUP>30</SUP> The

Commission, therefore, believed that prohibiting the account manager,

the allocating FCM, and their related or affiliated persons, from

having any interest in either the futures or a related securities

account was a preventive approach that effectively eliminated the

possibility of preferential allocation for personal gain.

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    \29\ See, e.g., In the Matter of GNP Commodities, Inc., et al.,

[1990-1992 Transfer Binder] Comm. Fut. L. Rep. (CCH) para.25,360

(CFTC August 11, 1992); In the Matter of Lincolnwood Commodities,

Inc., of California, et al., [1982-1984 Transfer Binder] Comm. Fut.

L. Rep. (CCH) para.21,986 (CFTC January 31, 1984); Parciasepe v.

Shearson Hayden Stone, Inc., et al., [1980-1982 Transfer Binder]

Comm. Fut. L. Rep. (CCH) para.21,461 (CFTC August 18, 1982); Wilke,

et al., v. Winchester-Hardin Oppenheimer Trading Co., et al., [1977-

1980 Transfer Binder] Comm. Fut. L. Rep. (CCH) para.20,605 (CFTC

December 29, 1977).

    \30\ The CME's proposed rule amendment would have prohibited the

individual or firm directing the allocation of the order from having

a proprietary interest in any account that received any part of such

order. Commission Regulation 1.3(y) defines a proprietary account to

include the ownership of ten percent or more of a futures or option

trading account. Therefore, the proposed CME amendment would have

permitted the person or firm directing the allocation to have an

interest of less than ten percent of one or more of the accounts

receiving part of the allocated order.

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2. Comments Received

(a). 1.35(a-1)(6)(iii)(A)--Types of Customers

    Numerous commenters suggested that the list of eligible customers

be expanded to include other entities. Several commenters suggested

that the list be expanded to include "appropriate persons" as

described in Section 4(c)(3) of the Act <SUP>31</SUP> or eligible swap

participants.<SUP>32</SUP> One commenter suggested expanding the list

to include either "appropriate persons" or "accredited investor" as

set forth in Rule 501 (Regulation D) of the Securities Act of

1993.<SUP>33</SUP> Four commenters stated that domestic and foreign

corporations should be eligible customers.<SUP>34</SUP> Commenters also

suggested including large, sophisticated corporate investors

<SUP>35</SUP> and individuals or entities with assets in excess of $100

million.<SUP>36</SUP> One commenter suggested including a CTA acting

for its proprietary account.<SUP>37</SUP> Finally, one exchange

recommended expanding the list to include "appropriate persons" and

all those who qualify for exemptive relief under Commission Regulation

4.7.<SUP>38</SUP>

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    \31\ Carr, Pacific, FIA, and CME. CME also proposed expanding

the list to include foreign corporations.

    \32\ Dean Witter, First Boston, Lind-Waldock, and Morgan

Stanley. Goldman Sachs suggested that the eligible customer

restriction be eliminated because it would require account managers

to treat their customers in a disparate manner and to disadvantage

those customers who were not permitted to be included in a bunched

order. In the alternative, Goldman Sachs recommended that the list

be expanded to include eligible swap participants.

    \33\ Bear Stearns.

    \34\ Bear Stearns, Dean Witter, Lind-Waldock, and TSA.

    \35\  Flaherty.

    \36\ N.Y. Bar.

    \37\ First Boston. The N.Y. Bar suggested including FCMs, IBs,

CTAs, and CPOs trading for their own accounts as eligible customers.

    \38\ CBT.

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(b). 1.35(a-1)(6)(iii)(B)--Proprietary Interest

    Many commenters believed the provision limiting proprietary

interests was overly restrictive. Commenters stated that it would

inhibit access to U.S. markets <SUP>39</SUP> and would result in unfair

customer treatment.<SUP>40</SUP> Two commenters pointed out that the

provision would exclude certain publicly owned organizations from

becoming eligible customers.<SUP>41</SUP> Most commenters stated that

the limit on proprietary interest should be less than 10 percent, which

is consistent with the definition of proprietary interest contained in

Commission Regulation 1.3(y).<SUP>42</SUP> One commenter, however,

stated that a de minimis provision exempting interests of less than one

percent in participating accounts would be adequate.<SUP>43</SUP>

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    \39\ Credit Agricole and Refco.

    \40\ Bear Stearns asserted that it would be unfair to exclude

otherwise eligible types of funds because the account manager was

required to have a small interest in a partnership or contributed

seed money at the start up of a mutual fund or was paid a management

fee by the fund.

    \41\ Flaherty stated that a registered investment company would

not be an eligible customer, for instance, if the investment adviser

made a seed money investment in the initial shares issued by the

fund or if officers of the account manager served on the Board of

Directors of the fund and, held shares of the fund. In addition, it

would be impossible for the account manager or the FCM allocating

the order to know with certainty that no relative of any of the

listed persons held any shares in a publicly owned corporation for

whose account the transaction was executed.

    The ICI commented that the practical effect of the provision

would be to disqualify most, if not all, investment advisers to

investment companies from relying on the proposal. Additionally, it

would be almost impossible for such investment advisers to assure

compliance on an ongoing basis and it would impede the investment

adviser's ability to act in the best interests of investment

companies that were clients.

    \42\ Dean Witter, First Boston, Lind-Waldock, Pacific, FIA, N.Y.

Bar, CBT, and CME. CME also suggested removing from the list of

entities subject to the no interest provision "[a]ny business

affiliate that, directly or indirectly, controls, is controlled by,

or is under common control with, the account manager or the futures

commission merchant allocating the order." The CME posited that

removing this provision would prevent managed accounts from being

unnecessarily excluded from eligibility.

    \43\ Flaherty stated that while an FCM who is also an

underwriter and a market maker for securities might want a higher

percentage interest, permitting an owner of up to 10 percent of the

interest in the account manager to hold an unlimited interest in a

participating account would seem to invite possible abuse.

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3. Reproposed Regulation 1.35(a-1)(5)(iii)



(a). 1.35(a-1)(5)(iii)(A)--Types of Customers

    After consideration of the comments, the Commission believes that

it is appropriate to expand the list of eligible customers. As

reproposed, the group of eligible customers would be substantially

similar to those entities defined as "eligible participants" for

purposes of Part 36--Exemption of Section 4(c) Contract Market

Transactions, of the Commission's regulations, except that sole

proprietorships, floor brokers, floor traders, and natural persons, as

well as self-directed employee benefit plans, would not be included as

eligible customers.

    As the Commission stated in promulgating the final rules for Part

36, the list of "eligible participants" was modeled on the list of

"appropriate persons" set forth in Section 4(c)(3)(A) through (J) of

the Act and on the definition of "eligible swap participant" under

Part 35 of the Commission's regulations.<SUP>44</SUP> Having previously

considered this group of entities and



[[Page 700]]



determined that they are eligible to participate both in exempt

transactions and in swaps, the Commission believes that they are

sufficiently sophisticated to monitor the results of post-trade

allocations in their accounts. The Commission is incorporating into

this paragraph the requirement that these entities, in order to be

considered eligible customers, must have consented in writing that

eligible orders may be placed, executed, and allocated for their

accounts. The issue of consent is discussed below.

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    \44\ 60 FR 51328 (October 2, 1995).

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    The Commission does not believe, however, that accounts owned by

sole proprietorships, floor brokers, floor traders, natural persons, or

self-directed employee benefit plans should be included as eligible

customers. The Commission believes that the eligible customers should

be institutional or other comparatively large entities whose accounts

are subject to other regulatory or management regimes and who may

participate in multi-market investment strategies. Although the

Commission recognizes that natural persons meeting certain asset or net

worth standards may be sufficiently sophisticated to participate, the

Commission believes that preferential allocations would be more likely

to occur if accounts owned by individuals were included in eligible

orders.<SUP>45</SUP> The Commission requests comments regarding the

proposed exclusion of natural persons as eligible customers.

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    \45\ A review of preferential allocation cases reveals that

misallocations, when they occur, often are made to personal or

proprietary accounts or to accounts owned by family members.

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(b). 1.35(a-1)(5)(iii)(B)--Proprietary Interest

    After consideration of the comments, the Commission has determined

to modify the proposed provisions regarding ownership interest in any

account that receives any part of an eligible order or in any related

securities account. The Commission is deleting from the reproposal the

interest requirement as it applies to any related securities account.

As reproposed, the regulation requires that there be a portfolio

containing instruments which are either exempt from regulation pursuant

to the Commission's regulations or excluded from regulation under the

Act rather than a related securities account.

    The Commission also is proposing to increase the acceptable level

of ownership interest in any account that receives any part of an

eligible order from no interest to an interest of less than ten

percent, which is similar to the Commission's definition of proprietary

interest as set forth in Regulation 1.3(y). The Commission is aware

that the account manager may have "seed" money invested in the

eligible account or, in fact, may invest in the account in order to

attract other investors. In any event, the Commission believes that

application of the less than ten percent restriction to the listed

participants is an appropriate provision that would neither unduly

restrict the placement of eligible orders nor increase the incentive to

misallocate.

    Finally, the Commission is proposing to delete the following as one

of the entities subject to the interest restriction: an employee

benefit plan of the account manager, the futures commission merchant

allocating the order, or an affiliate. These plans are subject to

strict ERISA regulations.



D. Account Certification



1. Proposed Regulation 1.35(a-1)(6)(iv)

    Proposed Regulation 1.35(a-1)(6)(iv)(A) required that the account

manager, before placing the initial order pursuant to this paragraph,

certify the following, in writing, to the FCM allocating the order:

    (i) The account manager had no interest in any account to which any

part of the order may be allocated or in any related securities

account.

    (ii) The account was owned by an eligible customer.

    (iii) The customer had consented in writing that orders may be

executed and allocated in accordance with this regulation.

    (iv) Orders for such account would be intermarket orders for which

it would be impracticable to pre-file a predetermined allocation

formula.

    (v) Records required by paragraph (a-1)(6)(vi)(A) of the regulation

would be made available to the Commission or Department of Justice upon

request of any representative thereof.

    In addition, proposed Regulation 1.35(a-1)(6)(iv)(B) required that

the account manager, before placing the initial order pursuant to this

paragraph, must provide the FCM allocating the order with a list of

eligible accounts and their related securities accounts.

    The Commission believed that these safeguards addressed several

purposes of the proposed regulation and were intended to reduce the

likelihood of misallocation. In order to encourage compliance with the

proposal's requirements, the account manager placing intermarket orders

would have been required to certify to the FCM allocating the order

that he or she had no interest in any account to which any part of an

intermarket order may have been allocated or in any related securities

account. The account manager also would have been required to certify

that the accounts to which intermarket orders would be allocated were

owned by eligible customers. These one-time certification requirements

would have helped to assure that personal or proprietary accounts were

not included among the accounts to which intermarket order allocations

were made.

    With regard to customer consent, the Commission believed that

notification was insufficient and that these institutional accounts

should have the opportunity to consent affirmatively to participate in

the intermarket allocation procedure.\46\ The Commission believed that

customer consent was an important tool in assuring adequate customer

oversight of trading activity. Drawing upon comments that the account

controller had the relevant relationship with the customer for purposes

of obtaining consent, the Commission believed that the account manager

would be the appropriate party to obtain that consent and so certify to

the FCM so that the FCM could assure that intermarket allocations were

made only to the eligible accounts. The consent could have been

contained in account opening documents or obtained separately.

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    \46\ The CME's proposed amendment to Rule 536 would have

required that the FCM notify the identified eligible account owners

that orders for those accounts could be bunched and entered without

individual customer account identification and allocated at the end

of the day.

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    The proposed amendment was designed for the benefit of

institutional accounts that were being traded pursuant to a strategy

that involved related positions in both the futures and securities

markets. The Commission believed that, whenever possible, the account

manager should place and allocate the order by use of a predetermined

allocation formula. The intermarket order allocation procedure was

available where use of the predetermined allocation formula would not

permit the account manager to attain equitable results. Thus, the

Commission believed that a one-time certification that orders placed

would be intermarket orders for which it would be impracticable to pre-

file a predetermined allocation formula was appropriate.

    The use of the post-trade order allocation procedure would have

been limited to eligible accounts participating in regulated multi-

market trading and both the futures and the related securities accounts

would have to have



[[Page 701]]



been identified to the FCM allocating the order.\47\ Additionally, the

proposed regulation contained a requirement that the account manager

agree that the records discussed in paragraph (vi)(A) of the proposed

regulation would be made available to specified government agencies

upon request.\48\

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    \47\ The identification of both the futures and securities

accounts was believed to be necessary to assure that (1) use of the

allocation procedure was restricted to eligible accounts

participating in multi-market trading and (2) the related securities

account was known in the event it became necessary to review the

trading in both markets for possible violative activity.

    \48\ The Commission, although not the primary regulator of the

account manager, recognized that it might require records of

transactions in other markets which would not otherwise have been

readily available in order to review allegations of preferential

allocation.

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2. Comments Received

    Two commenters stated that all five certifications were unnecessary

and duplicative.\49\ Numerous commenters opposed the requirement that

the account manager certify that the customer had consented in writing

that intermarket orders may be executed and allocated, stating that

notification would be sufficient.\50\ Commenters also stated that the

requirement to obtain consent would deter account managers from

utilizing the markets in this manner \51\ and that it is inconsistent

with practices in other markets \52\ and with the ability of account

managers to monitor client activity and to perform in the client's best

interest.\53\ One commenter agreed that customer consent should be in

writing.\54\ Several commenters opposed the requirement that the

account manager certify that the orders would be intermarket orders

\55\ for which it would be impracticable to pre-file a predetermined

allocation formula.\56\

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    \49\ CBT and CME. In addition, Morgan Stanley commented that,

since it was the account manager's obligation to obtain the written

consent, it seemed redundant to require that the FCM obtain such a

certification.

    \50\ Dean Witter, Lind-Waldock, Pacific, PaineWebber, TSA, and

FIA. Bear Stearns stated that the proposal should be clarified so

that customer consent could be given when the customer signs the

investment manager contract with the account manager and further

stated that, for those customers with existing contracts,

notification with the right of the customer to affirmatively opt out

should be sufficient.

    \51\ Credit Agricole and PaineWebber.

    \52\ Credit Agricole, Pacific, and CME.

    \53\ Leland. Carr asserted that requiring the expert (account

manager) to get written permission from the account owner to manage

the assets in the best possible manner seemed a bit pointless.

    \54\ Flaherty.

    \55\ Leland, Lind-Waldock, TSA, and ICI. Carr commented that the

requirement to identify the orders as part of an intermarket

strategy undermined the proprietary nature and confidentiality of a

trader's strategy. Morgan Stanley stated that the FCM would not be

in a position to determine whether orders were in fact intermarket

orders.

    \56\ ICI expressed concern regarding the standards by which

impracticability would be judged. It recommended elimination of this

component of the certification requirement.

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    Numerous commenters stated that the requirement that the account

manager must provide the FCM with a list of eligible accounts and their

related securities accounts should be eliminated. Commenters felt that

this requirement would result in the disclosure of proprietary

information,<SUP>57</SUP> would serve no useful purpose,<SUP>58</SUP>

and would be overly burdensome because of the potentially large number

of accounts at issue.<SUP>59</SUP>

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    \57\ Dean Witter, Lind-Waldock, TSA, FIA, ICI, CBT, and CME.

Bear Sterns also stated that providing such information to the FCM

might be a breach of the account manager's fiduciary duty. Pacific

stated that it would breach customer confidence to share such

information with FCMs. Goldman Sachs stated that, for reasons of

confidentiality, account managers may not be willing to provide FCMs

with the identification of securities accounts under their

management. NFA commented that the burden imposed and the privacy

concerns which may be raised outweighed the minimal benefit to be

derived from requiring the account manager to provide the FCM with a

list of related securities accounts.

    \58\ Credit Agricole, Dean Witter, Refco, and FIA. Goldman Sachs

also stated that, even with the information, the FCM would be unable

to make any meaningful assessment regarding the nature of the order.

In addition, in some instances, such as overlay programs, the

account manager might not have the ability to provide information

because he or she may not control the accounts.

    \59\ Bear Sterns, Merrill Lynch, Pacific, PaineWebber, FIA, CBT,

and CME.

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3. Reproposed Regulation 1.35(a-1)(5)(iv)

    After consideration of the comments received, the Commission has

determined to reduce the required account manager certifications to

one: any account manager placing eligible orders must certify, in

writing, to each FCM executing and/or allocating any part of an

eligible order, that he or she is aware of the provisions of this

paragraph and is, and will remain, in compliance with the requirements

therein. The Commission intends that this certification would encourage

compliance by account managers and need be made only once to each

applicable FCM, not on an order-by-order basis.<SUP>60</SUP>

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    \60\ Where the account manager places orders directly with a

floor broker rather than an executing FCM, the certification need

only be filed with each FCM allocating any part of an eligible order

and not with the floor broker.

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    The Commission believes that the responsibility for compliance with

the eligible order provisions should generally fall on the account

manager and his or her principal, if applicable.<SUP>61</SUP> The

Commission has become convinced that little regulatory benefit or

additional customer protection would accrue from requiring the FCM to

obtain other account manager certifications. The extent of the account

manager's compliance with these requirements would be determined during

audits and on a for-cause basis.

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    \61\ Pursuant to Regulation 166.3, an account manager's

employer, if registered with the Commission, has a duty diligently

to supervise his or her activities. Regardless of registration

status, a principal could be held liable for an account manager's

wrongdoing under Section 2(a)(1)(A) of the Act.

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    On the topic of customer consent, the Commission continues to

believe that notification alone is insufficient and that these eligible

accounts should have to consent affirmatively prior to participating in

the post-trade allocation of eligible orders. This is particularly true

in the context of the reproposal, which has streamlined and deleted

many previously proposed requirements. As the Commission stated in the

proposed rule, the account manager is the appropriate party to obtain

that consent, either in account opening documents or

separately.<SUP>62</SUP>

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    \62\ Where applicable, the account manager's employing firm

should be aware that an account manager has the client's consent to

place eligible orders.

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    The Commission has eliminated the requirement that the account

manager must provide the FCM allocating the order with a list of

related securities accounts. However, the reproposal continues to

require that the account manager must provide a list of eligible

futures accounts to the FCM allocating the order. This requirement

should enable the FCM to assure that allocations are made only to

eligible accounts.



E. Allocation



1. Proposed Regulation 1.35(a-1)(6)(v)

    Proposed Regulation 1.35(a-1)(6)(v) required the following:

    (1) Intermarket orders allocated pursuant to the regulation must be

designated as such on the order at the time of entry.

    (2) Intermarket orders must be identified on contract market trade

registers and other computerized trade practice surveillance records.

    (3) The account manager and the FCM allocating the order must

allocate fills from intermarket orders to eligible participating

customer accounts prior to the deadline for final submission of trade

data to clearing on the day the intermarket order is executed.

    (4) The FCM allocating the order must assure that all intermarket

orders are allocated to eligible customer accounts.



[[Page 702]]



    The Commission believed that these allocation requirements, in

combination with the requirement that the account manager, the FCM, and

their affiliates and related parties not have any interest in any

participating account or related securities account, would limit the

potential for self-dealing by the account manager and the FCM. It would

also provide an audit trail reflecting the ultimate disposition of the

order. Further, these requirements would be consistent with good

business practice.

    When the order was placed, it would have to be identified as an

intermarket order. The exchange would have to assure that the order was

specially identified on the trade register and other computerized trade

practice surveillance records. The account manager would have to

provide allocation instructions for the entire order to the FCM prior

to the deadline for final submission of trade data to clearing on the

day the intermarket order was executed. Finally, the FCM would have to

assure that the entire order was allocated to eligible customer

accounts previously identified by the account manager.

2. Comments Received

    The CME and CBT stated that the proposed requirement that

intermarket orders must be so designated at the time of entry was

inappropriate because it could reveal proprietary information and would

impose a costly regulatory burden.<SUP>63</SUP> One commenter opposed

the proposed requirement that these orders be identified on contract

market trade registers and other records.<SUP>64</SUP> Three

commenters, while agreeing that allocations should occur by the end of

the day, stated that the exchange, and not the Commission, should

decide the trade submission deadlines.<SUP>65</SUP> Finally, several

commenters expressed concern about holding the FCM responsible for

assuring that orders are allocated to eligible customer

accounts.<SUP>66</SUP>

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    \63\ CBT also stated that no such requirement existed for

securities transactions and that the requirement ignored the fact

that the account manager was already under an existing regulatory

scheme that imposed fiduciary duties. As previously noted, Carr

commented that requiring that such orders be designated as part of

an intermarket strategy undermines the proprietary nature and

confidentiality of a trader's strategy.

    \64\ CBT stated that the requirement would lead to a costly

regulatory burden and should be eliminated.

    \65\ FIA, CBT, and CME.

    \66\ Merrill Lynch. First Boston stated that imposing this

requirement on the FCM failed to recognize that the FCM acts for the

account manager and that it should be the account manager's

responsibility to document and to use a fair and equitable

allocation system. CBT stated that the FCM's allocation

responsibilities should be limited to making allocations in

accordance with the account manager's instructions and in a timely

manner. Commenting on the proposed regulation generally, FIA stated

that its focus should be to enable account managers the maximum

latitude in placing trades subject to a fair, equitable and

demonstrable allocation scheme, while recognizing that FCMs have no

practical ability to supervise independent account controllers.

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3. Reproposed Regulation 1.35(a-1)(5)(v)

    After consideration of the comments received, the Commission has

determined to modify certain of the allocation requirements and to add

one requirement. In addition, the Commission has reorganized this

paragraph to include some of the originally proposed allocation

requirements as recordkeeping requirements.

    The requirement that eligible orders must be so identified on the

order at time of entry has been redesignated as a recordkeeping

requirement. The Commission currently is proposing that each eligible

order, as well as the account manager placing that order, be identified

on the office order ticket, if applicable, and on the floor order

ticket at the time of order placement. The Commission believes that the

maintenance of a complete audit trail requires that eligible orders be

properly identified from order placement through order allocation. The

office and/or floor order ticket is the first step in this process.

    Identification of this kind would not appear to reveal any

proprietary or trading strategy information. The executing and/or

allocating FCM would not need to know the specifics of the other

instruments in the portfolio. Moreover, the only accounts identified to

an FCM would be those to which that FCM would be allocating fills

either directly or through give-ups. Rather than identifying a trading

strategy, the designator would only identify an eligible order that

would be allocated pursuant to these procedures. The requirement that

each transaction resulting from the execution of an eligible order be

identified on contract market trade registers and other computerized

trade practice surveillance records remains substantially unchanged. It

is simply redesignated as a recordkeeping requirement.

    The reproposal would require that allocation of an eligible order

must take place prior to the end of the day the order is executed, as

specified by exchange rules for this purpose. Because this paragraph

would also require that the account manager and the FCM allocating the

order allocate fills to eligible participating customer accounts, the

Commission is deleting as redundant the proposed separate paragraph

that required that the FCM do so.<SUP>67</SUP>

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    \67\ When a trade is allocated to a specific eligible account,

it belongs to that account and cannot be reallocated to any other

eligible account. In re Collins, CFTC Docket No. 94-13, Slip op. at

11-15 (CFTC Dec. 10, 1997).

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    The Commission agrees that the account manager has the

responsibility for employing a system that results in fair, equitable,

and non-preferential allocations. As noted below, the account manager

must, upon request, provide to the Commission or the Department of

Justice records that, among other things, identify the trading strategy

and demonstrate the fairness of the allocations. The FCM's allocation

responsibilities generally should be limited to complying with

instructions from the account manager. However, as previously noted,

the account manager is required to provide the FCM allocating the order

with a list of eligible accounts. If the FCM were directed to allocate

eligible orders to accounts not included on the list, or if the FCM

should become aware of what appear to be preferential allocations, the

FCM is required to make a reasonable inquiry and, if appropriate, to

refer the matter to a regulatory authority (i.e., the Commission, the

NFA, or its designated self regulatory organization). In addition, the

FCM must act consistently with its obligations under Regulation 166.3

diligently to supervise the handling of its customer accounts.

    Finally, the Commission is proposing to add a new paragraph to the

allocation requirements. Specifically, the Commission is proposing a

requirement that allocations made pursuant to these procedures must be

fair and non-preferential, taking into account the effect on each

relevant portfolio in the bunched order.



F. Recordkeeping



1. Proposed Regulation 1.35(a-1)(6)(vi)

    Proposed Regulation 1.35(a-1)(6)(vi) required the following:

    (1) Each account manager must make available, upon request of the

Commission or the United States Department of Justice, the records

referred to in paragraph (iv) of the regulation and other records,

including records of securities transactions, reflecting order

placement and allocation to the participating customer accounts. These

records must demonstrate the relationship between the futures and the

other transactions, the allocations made, the basis for allocation, and

the nature of the



[[Page 703]]



intermarket strategy. They should also permit reviewers to compare

results obtained for different customers.

    (2) Each account manager shall make available for review, upon

request of an eligible customer, documentation sufficient for the

customer to compare its results with those of other customers. The

other accounts for which intermarket orders are entered may be

designated by symbols so that the identity of account holders is not

disclosed.

    (3) Upon request, each FCM allocating intermarket orders at the

direction of an account manager will exercise its best efforts to

obtain from the account manager and to provide to the Commission or the

Department of Justice records reflecting the related transactions in

the securities accounts.

    In order that any allegation of misallocation or unfavorable

treatment could be properly investigated, the Commission believed that

the account manager should have been required to retain and to make

available for review, upon request of the Commission or the Department

of Justice, the investment management rationale for intermarket orders

and allocations. In order to enhance customer protection and to

simplify customer account review, the Commission believed that the

account manager should have been required to make available for review,

upon request of a customer, documentation sufficient for that customer

to compare its results with those of other customers. The identity of

other account holders for which intermarket orders were entered need

not, however, have been disclosed to another customer.

    Finally, the Commission believed that the FCM allocating

intermarket orders at the direction of an account manager should have

been required, upon request of certain government agencies, to exercise

its best efforts to obtain records reflecting the related transactions

in the securities accounts. The determination that preferential

allocation occurred could be accomplished only when all related

transactions were examined and allocations in all markets were

compared.\68\

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    \68\ Based upon discussions with participants in the industry,

the Commission believed that the documents, worksheets and computer

programs that determined the allocation formula already were created

and retained by account managers responsible for allocation

decisions.

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2. Comments Received

    Numerous commenters described the proposed recordkeeping

requirements as burdensome,\69\ unnecessary,\70\ or unreasonable.\71\

Commenters addressing the proposed requirement to make documentation

available to the customer to allow that customer to compare its results

with those of other customers focussed both on the possible disclosure

of proprietary or confidential information \72\ and on the limited

value of such information to the customer.\73\ All commenters who

addressed the issue opposed the proposed requirement that the FCM

exercise its best efforts to obtain records reflecting securities

transactions from the account manager.\74\

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    \69\ Credit Agricole, Goldman Sachs, Pacific, Refco, Saul Stone,

and NFA.

    \70\ Goldman Sachs, Morgan Stanley, TSA, MFA, and NFA. CBT

commented that the value of the recordkeeping requirements appeared

to be minimal.

    \71\ Dean Witter and Lind-Waldock. CME commented that it was

overreaching for the Commission to impose recordkeeping requirements

on investment advisers that are otherwise regulated.

    \72\ Flaherty, First Boston, Carr, N.Y. Bar, and CBT. Carr

commented that it doubted customers would authorize their account

manager to release details of their trading activity in order for

another managed account to verify the fairness of its allocations.

The N.Y. Bar stated that it believed that many customers would

object to such disclosure, even in the absence of the customer's

identity. According to the N.Y. Bar, activity in a particular

account could provide information which would serve to identify a

particular customer, and even if the identity were shielded,

customers and advisers may object to the release of information

which would reveal market strategies.

    \73\ Pacific, CBT, and CME. Flaherty commented that the proposed

requirement should be modified to data, rather than documentation,

sufficient for the customer to compare its overall results with

those of other customers. Flaherty also suggested that eligible

customers be required to acknowledge in writing that they have been

informed of their right to request information on comparative

results.

    \74\ First Boston, Goldman Sachs, Carr, Merrill Lynch, Morgan

Stanley, Pacific, FIA, NFA, N.Y. Bar, CBT, and CME. According to

Flaherty, such a requirement would give FCMs substantial leverage

for obtaining proprietary data of the account manager and its

clients, would result in account managers switching to FCMs without

securities operations, and would be unnecessary because the same

data could be obtained directly from the account manager by the

Commission or the Department of Justice.

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3. Reproposed Regulation 1.35 (a-1)(5)(vi)

    After consideration of the comments, the Commission has determined

to modify the recordkeeping requirements originally proposed. As noted

above, two items formerly identified as allocation requirements have

been redesignated as recordkeeping requirements. Additionally, the

Commission is proposing to add the requirement that the FCM carrying an

eligible account to which an eligible order has been allocated must

identify each trade resulting from the execution of an eligible order

on confirmation statements provided to the affected account owner and/

or trustee. The Commission believes that the account owner should be

informed of all aspects of transactions executed for his or her account

in order to make informed decisions about the continued use of the

eligible order procedures. The Commission is deleting the requirement

that, upon request, the FCM allocating eligible orders exercise its

best efforts to obtain documentation from the account manager. This

requirement is unnecessary since the account manager already is

required to provide such documentation directly to the Commission or

the Department of Justice if requested.

    The Commission proposes to streamline the documentation that would

be required to be made available to the Commission or the Department of

Justice by the account manager. In addition to documentation reflecting

customer consent to the placement and allocation of eligible orders,

the account manager would be required to make available records

reflecting (i) futures and option transactions,\75\ (ii) other

transactions executed pursuant to the portfolio management strategy,

and (iii) any other records that identify the strategy and relate to,

or reflect upon, the fairness of the allocations. Thus, the reproposal

does not identify with the same specificity the records required to be

provided. Nonetheless, the account manager would have the

responsibility to demonstrate, when records are requested or during

regulatory authority audits, that allocations were made fairly.

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    \75\ The account manager must create and retain a record

reflecting the participation of all accounts in each eligible order,

including the allocation of all fills.

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    The Commission continues to believe that eligible customers should

be able to compare results to other customers with similar accounts and

investment strategies. Thus, the reproposal would require that the

account manager make available, upon request of an eligible customer,

data sufficient for that customer to compare its results with those of

other relevant customers. In addition, the account manager must

indicate in which of the other relevant customers it or the FCM has an

interest. The Commission believes that describing the requirement in

these terms permits the use of established methods used by

sophisticated institutional investors in securities to measure and to

compare performance. Data enabling the customer to perform such a

comparison may be prepared so



[[Page 704]]



as not to disclose the identity of individual account holders.



G. Contract Market Rule Enforcement Programs



1. Proposed Regulation 1.35(a-1)(6)(vii)

    Proposed Regulation 1.35(a-1)(6)(vii) required that, as part of its

rule enforcement program, each contract market that adopted rules

allowing the placement of intermarket orders would have to assure that

all fills resulting from these orders were identified on contract

market trade registers and other computerized trade practice

surveillance records. Each contract market, or the designated self-

regulatory organization ("DSRO") of a member firm, would have to

adopt an audit procedure to determine compliance with the following

components of the regulation: recordkeeping requirements in paragraph

(iv), account certification in paragraph (v), and allocation

requirements in paragraph (vi).

    The Commission believed that this surveillance was necessary to

deter possible unlawful activity and to ensure that an adequate audit

trail existed for intermarket transactions. As part of its routine

oversight of member firms, the exchange would have been required to

assure that intermarket orders were correctly identified on exchange

trade registers. The exchange or the DSRO would have been required to

audit member firms to assure that (i) the order was allocated prior to

the deadline for final submission of trade data to clearing on the day

the intermarket order was executed; (ii) the order was allocated only

to eligible participating institutional customer accounts whose owners

had consented to the allocation; and (iii) the FCM received and

retained required documents from the account managers.

2. Comments Received

    CME and CBT commented adversely on the audit procedures proposed to

be imposed on exchanges. Both exchanges asserted that costs would be

high and the benefit to market users would be minimal.

3. Reproposed Regulation 1.35(a-1)(5)(vii)

    The requirement that the contract market assure that all fills

resulting from eligible orders are identified on trade registers and

other computerized trade practice surveillance records is being

retained as a proposed recordkeeping requirement. Therefore, it is

being deleted from this paragraph as redundant. The remainder of this

paragraph is substantially consistent with the paragraph originally

proposed. The contract market must adopt audit procedures to determine

compliance with the identified provisions of the reproposed regulation.

Specifically, these provisions would include (i) the certification

requirements; (ii) the requirement that orders must be allocated to

eligible accounts by the end of the day; and (iii) the requirement that

eligible orders must be so identified on trade registers, other

surveillance records, order tickets, and customer confirmation

statements. The Commission continues to believe that these requirements

are necessary to deter possible unlawful activity and to ensure that an

adequate audit trail is created for eligible transactions.



III. Conclusion



    The Commission is proposing, subject to certain core regulatory

protections, to permit a limited number of regulated account managers

to place orders for a defined group of eligible customers without

providing specific customer account identifiers at the time of order

placement.\76\ The Commission previously has identified all of these

customers as eligible to enter swap agreements or execute Section 4(c)

contract market transactions. The account managers would be required to

allocate the order at the end of the day.\77\ As discussed below, in

addition to the customer safeguards being reproposed, significant

existing audit trail and recordkeeping requirements would remain

applicable.

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    \76\ The Commission believes that these core regulatory

protections adequately address the issues raised by those who

submitted comments opposed to either the proposed amendment to CME

Rule 536 or the Commission's proposed amendment to Regulation 1.35.

    The Commission appreciates the views of the law enforcement

authorities which commented on the previous proposed regulation and

shares their desire that Commission-regulated futures and option

markets not be used as a vehicle to commit serious financial crimes.

It is with those concerns in mind that the Commission has crafted

the protections incorporated into the reproposed regulation. These

protections include specific eligibility requirements for account

managers and customers and recordkeeping provisions intended to

document fair and non-preferential treatment of customers. Coupled

with the strong antifraud provisions of the Act and the Commission's

rigorous supervision rule, these protections should insure that the

proposed allocation procedure will not unduly threaten customer

protection or market integrity. Rather, the rule should enable

portfolio managers acting in a fiduciary capacity to handle customer

interests across markets, without undermining any legitimate

customer or law enforcement interests.

    \77\ End-of-day or post-trade allocation of bunched or block

orders is permissible on foreign futures exchanges and in the cash

and securities markets. The New York Stock Exchange ("NYSE"), for

example, has permitted end-of-day allocation of securities block

orders since October 1983. Interpretation 88-3 of NYSE Rule

410(a)(3).

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    Under the reproposal, the customer must consent in advance, in

writing, that orders may be placed, executed, and allocated as eligible

orders. Allocations of eligible orders must be fair and non-

preferential, taking into account the effect on the relevant portfolio

of each customer in the bunched order. The account managers would be

required to maintain records that would, among other things, reflect

the portfolio management strategy and demonstrate the fairness of the

allocations. These records would be available, upon request, to the

Commission or the Department of Justice. The account manager would be

required to provide the customer, upon request, with data sufficient to

compare results with those of other relevant customers.

    The reproposal prohibits an account manager and his or her

partners, officers, employees, and related parties and affiliates from

having an interest of ten percent or more in any account to which he or

she is allocating orders. This prohibition should diminish the

incentive to make preferential allocations for personal gain. Because,

in some instances, the FCM may be able to influence the fairness of the

allocations, the same restriction would apply to the FCM allocating the

order and its partners, officers, employees, and related parties and

affiliates. In addition, the reproposed recordkeeping requirements

would deter and facilitate detection of misallocations which may

indirectly benefit the account manager.\78\ The reproposal would also

require that an exchange that permits the placement, execution, and

allocation of eligible orders must adopt, as part of its rule

enforcement program, audit procedures to determine compliance with

relevant provisions.

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    \78\ As a matter of state law and federal securities,

commodities, or banking law, eligible account managers would have

fiduciary responsibility for their investment management activities.

Additionally, account managers would be subject to Section 4b, the

general antifraud provision of the Act. Account managers who are

also acting as commodity trading advisors or commodity pool

operators, irrespective of registration status, would also be

subject to Section 4o. The securities anti-fraud rules may also

apply.

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    Under the reproposal, an eligible order must be identified at time

of placement on the floor order ticket and, if appropriate, on the

office order ticket. The identity of the account manager must also be

included on the order tickets. All trades resulting from the execution

of an eligible order must be identified on exchange trade registers and

computerized trade practice



[[Page 705]]



surveillance records. Finally, these trades must also be identified on

confirmation statements provided to the customer accounts.

    Those requirements, in conjunction with existing audit trail

requirements, should enable the Commission and self-regulatory

organizations to track any eligible order from time of placement to

allocation of fills. At time of placement, the order would be

identified on order tickets. These order tickets would be timestamped

upon receipt of the order. The order executions would be identified on

exchange trade registers by, among other things, both time and price.

The order tickets would be timestamped again to identify time of report

of execution. The trading cards and/or order tickets would reflect the

terms of the order executions. The subsequent allocation of the fills

would be maintained on FCM and exchange records. Where it is the

exchange's practice to do so, the allocation of the fills to specific

customer accounts would be reflected on the exchange's final trade

register. The order would be identified on confirmation statements sent

to the owner of the account. Thus, an auditor could determine, among

other things, the size and time of initial order placement, the times

and prices of executions, the identities of accounts to which the fills

were allocated, and the prices and quantities of the fills allocated

thereto.

    The Commission encourages commenters to address the appropriateness

of the balance being struck by this reproposal between protection of

sophisticated market participants and regulatory reform. Additionally,

the Commission encourages commenters to address the proposition that

the relief being proposed herein, through an amendment to the

Commission's recordkeeping requirements, might be achievable to some

extent through enhanced customer disclosure and reliance on the account

managers' fiduciary responsibility.



IV. Other Matters



A. Regulatory Flexibility Act



    The Regulatory Flexibility Act ("RFA"), 5 U.S.C. 601 et. seq.,

requires that agencies, in proposing rules, consider the impact of

those rules on small businesses. The Commission has previously

determined that contract markets,\79\ futures commission merchants,\80\

registered commodity pool operators,\81\ and large traders \82\ are not

"small entities" for purposes of the Regulatory Flexibility Act. The

Commission has previously determined to evaluate within the context of

a particular rule proposal whether all or some commodity trading

advisors should be considered "small entities" for purposes of the

Regulatory Flexibility Act and, if so, to analyze the economic impact

on commodity trading advisors of any such rule at that time.\83\

Commodity trading advisors who would place eligible orders pursuant to

these procedures would do so for multiple clients and would be

participating as investment managers in more than one financial market.

Accordingly, the Commission does not believe that commodity trading

advisers should be considered "small entities" for purposes of this

regulation.

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    \79\ 47 FR 18618, 18619 (April 30, 1982).

    \80\ Id.

    \81\ Id. at 18620.

    \82\ Id.

    \83\ Id.

---------------------------------------------------------------------------



    Therefore, the Chairperson, on behalf of the Commission, hereby

certifies, pursuant to 5 U.S.C. 605(b), that the action proposed to be

taken herein will not have a significant economic impact on a

substantial number of small entities.

    Proposed Regulation 1.35(a-1)(5) generally would apply to large

users of the market. It would provide relief from individual account

identification requirements, thereby providing those small entities who

elect to use the relief with a less burdensome method for satisfying

Commission Regulation 1.35 requirements.



B. Paperwork Reduction Act



    When publishing proposed rules, the Paperwork Reduction Act of 1995

(Pub. L. 104-13 (May 13, 1995)) imposes certain requirements on federal

agencies (including the Commission) in connection with their conducting

or sponsoring any collection of information as defined by the Paperwork

Reduction Act. In compliance with the Act, the Commission, through this

rule proposal, solicits comments to:

    (1) evaluate whether the proposed collection of information is

necessary for the proper performance of the functions of the agency,

including the validity of the methodology and assumptions used; (2)

evaluate the accuracy of the agency's estimate of the burden of the

proposed collection of information, including the validity of the

methodology and assumptions used; (3) enhance the quality, utility, and

clarity of the information to be collected; and (4) minimize the burden

of the collection of information on those who are to respond, including

through the use of appropriate automated, electronic, mechanical, or

other technological collection techniques or other forms of information

technology, e.g., permitting electronic submission of responses.

    The Commission has submitted this proposed rule and its associated

information collection requirements to the Office of Management and

Budget. The burden associated with this entire collection (3038-0022),

including this proposed rule, is as follows:

    Average burden hours per response: 3547.01.

    Number of Respondents: 11,011.00.

    Frequency of Response: On Occasion.

    The burden associated with this specific proposed rule is as

follows:

    Average burden hours per response: 0.75.

    Number of Respondents: 400.00.

    Frequency of Response: On Occasion.

    Persons wishing to comment on the information which would be

required by this proposed rule should contact the Desk Officer, CFTC,

Office of Management and Budget, Room 10202, NEOB, Washington, DC

20503, (202) 395-7340. Copies of the information collection submission

to OMB are available from the CFTC Clearance Officer, 1155 21st Street,

NW, Washington, DC 20581, (202) 418-5160.



List of Subjects in 17 CFR Part 1



    Brokers, Commodity futures, Commodity options, Consumer protection,

Contract markets, Customers, Members of contract markets,

Noncompetitive trading, Reporting and recordkeeping requirements, Rule

enforcement programs.

    In consideration of the foregoing, and pursuant to the authority

contained in the Commodity Exchange Act and, in particular, Sections 5,

5a, 5b, 6(a), 6b, 8a(7), 8a(9) and 8c, 7 U.S.C. 7, 7a, 7b, 8(a), 8b,

12a(7), 12a(9), and 12c, the Commission hereby proposes to amend Part 1

of 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 read as follows:



    Authority: 7 U.S.C. 1a, 2, 2a, 4, 4a, 6, 6a, 6b, 6c, 6d, 6e, 6f,

6g, 6h, 6i, 6j, 6k, 6l, 6m, 6n, 6o, 6p, 7, 7a, 7b, 8, 9, 12, 12a,

12c, 13a, 13a-1, 16, 16a, 19, 21, 23 and 24.



    2. Section 1.35 is proposed to be amended by revising paragraphs

(a-1)(1), (2)(i), and (4) and by adding paragraph (a-1)(5) to read as

follows:



[[Page 706]]



Sec. 1.35  Records of Cash Commodity, Futures, and Option Transactions



* * * * *

    (a-1) * * *

    (1) Each futures commission merchant and each introducing broker

receiving a customer's or option customer's order shall immediately

upon receipt thereof prepare a written record of the order including

the account identification, except as provided in paragraph (a-1)(5) of

this section, and order number, and shall record thereon, by timestamp

or other timing device, the date and time, to the nearest minute, the

order is received, and in addition, for option customers' orders, the

time, to the nearest minute, the order is transmitted for execution.

    (2)(i) Each member of a contract market who on the floor of such

contract market receives a customer's or option customer's order which

is not in the form of a written record including the account

identification, order number, and the date and time, to the nearest

minute, the order was transmitted or received on the floor of such

contract market, shall immediately upon receipt thereof prepare a

written record of the order in nonerasable ink, including the account

identification, except as provided in paragraph (a-1)(5) of this

section or appendix C to this part, and order number and shall record

thereon, by timestamp or other timing device, the date and time, to the

nearest minute, the order is received.

* * * * *

    (4) Each member of a contract market reporting the execution from

the floor of the contract market of a customer's or option customer's

order or the order of another member of the contract market received in

accordance with paragraphs (a-1)(2)(i) or (a-1)(2)(ii)(A) of this

section, shall record on a written record of the order, including the

account identification, except as provided in paragraph (a-1)(5) of

this section, and order number, by timestamp or other timing device,

the date and time to the nearest minute such report of execution is

made. Each member of a contract market shall submit the written records

of customer orders or orders from other contract market members to

contract market personnel or to the clearing member responsible for the

collection of orders prepared pursuant to this paragraph as required by

contract market rules adopted in accordance with paragraph (j)(1) of

this section. The execution price and other information reported on

such order tickets must be written in nonerasable ink.

    (5) Bunched orders for eligible accounts. A specific customer's

account identifier need not be recorded at the time a bunched order is

placed on a contract market or upon report of execution, provided that

the following requirements are met and that the order is handled in

accordance with contract market rules that have been submitted to the

Commission and approved or permitted into effect pursuant to Section

5a(a)(12)(A) of the Act and Sec. 1.41. The bunched order must be

allocated to the eligible accounts prior to the end of the day on which

the order is executed.

    (i) Eligible orders. Bunched orders placed, executed, and allocated

pursuant to this paragraph (a-1)(5) must be placed by an eligible

account manager on behalf of consenting eligible customers as part of

its management of a portfolio also containing instruments which are

either exempt from regulation pursuant to the Commission's regulations

or excluded from Commission regulation under the Act.

    (ii) Eligible account managers. The person placing and/or directing

the allocation of an eligible order and its principal, if any,

("account manager") must be one of the following which has been

granted investment discretion with regard to eligible customer

accounts:

    (A) A commodity trading advisor registered with the Commission

pursuant to the Act;

    (B) An investment adviser registered with the Securities and

Exchange Commission pursuant to the Investment Advisers Act of 1940; or

    (C) A bank, insurance company, trust company, or savings and loan

association subject to federal or state regulation.

    (iii)Eligible customers.

    (A) Eligible orders may be allocated to accounts owned by the

following entities which have consented in advance, in writing, to the

account manager that orders may be placed, executed, and allocated in

accordance with this paragraph:

    (1) A bank or trust company;

    (2) A savings association or credit union;

    (3) An insurance company;

    (4) An investment company subject to regulation under the

Investment Company Act of 1940 (15 U.S.C. 80a-1, et seq.) or an

investment company performing a similar role or function subject to

foreign regulation, provided that the investment company or foreign

person is not formed solely for the purpose of constituting an eligible

customer and has total assets exceeding $5,000,000;

    (5) A commodity pool formed and operated by a person subject to

regulation under the Act or a foreign person performing a similar role

or function subject to foreign regulation, provided that the commodity

pool or foreign person is not formed solely for the purpose of

constituting an eligible customer and has total assets exceeding

$5,000,000;

    (6) A corporation, partnership, proprietorship (but not a sole

proprietorship), organization, trust, or other entity comprised of more

than one person, provided that the entity was not formed solely for the

purpose of constituting an eligible customer and has either a net worth

exceeding $1,000,000 or total assets exceeding $10,000,000;

    (7) A corporate qualified pension, profit sharing, or stock bonus

plan subject to Title 1 of the Employee Retirement Income Security Act

of 1974 ("ERISA"), or a foreign person performing a similar role or

function subject to foreign regulation, with total assets exceeding

$5,000,000 or whose investment decisions are made by a bank, trust

company, insurance company, investment adviser subject to regulation

under the Investment Advisers Act of 1940 (15 U.S.C. 80b-1, et seq.),

or a commodity trading advisor subject to regulation under the Act, or

any plan defined as a governmental plan in Section 3(32) of Title 1 of

ERISA, but not including a self-directed plan;

    (8) Any governmental entity (including the United States, any

state, or any foreign government) or political subdivision thereof, or

any multinational or supranational entity or any instrumentality,

agency, or department of any of the foregoing;

    (9) A broker-dealer subject to regulation under the Securities

Exchange Act of 1934 (15 U.S.C. 78a, et seq.) or a foreign person

performing a similar role or function subject to foreign regulation,

acting on its own behalf; provided, however, that the broker-dealer may

not be a natural person or sole proprietorship; or

    (10) A futures commission merchant subject to regulation under the

Act or a foreign person performing a similar role or function subject

to foreign regulation, acting on its own behalf; provided, however,

that the futures commission merchant may not be a natural person or

sole proprietorship.

    (B) The following persons, or any combination thereof, may not have

an interest of ten percent or greater in any account that receives any

part of an eligible order:

    (1) The account manager;

    (2) The futures commission merchant allocating the order;

    (3) Any general partner, officer, director, or owner of ten percent

or more of the equity interest in the



[[Page 707]]



account manager or the futures commission merchant allocating the

order;

    (4) Any employee, associated person, or limited partner of the

account manager or the futures commission merchant allocating the order

who affects or supervises the handling of the order;

    (5) Any business affiliate that, directly or indirectly, controls,

is controlled by, or is under common control with, the account manager

or the futures commission merchant allocating the order; or

    (6) Any spouse, parent, sibling, or child of the foregoing persons.

    (iv) Account certification.

    (A) Before placing the initial eligible order, the account manager

must certify, in writing, to each futures commission merchant executing

and/or allocating any part of the order that the account manager is

aware of the provisions of this paragraph and is, and will remain, in

compliance with the requirements of this paragraph.

    (B) Before placing the initial eligible order, the account manager

must provide each futures commission merchant allocating the order with

a list of eligible futures accounts.

    (v) Allocation.

    (A) The account manager and the futures commission merchant

allocating the order must allocate fills from each eligible order to

eligible participating customer accounts prior to the end of the day

the order is executed, as specified by exchange rules for this purpose.

    (B) Allocations of eligible orders must be fair and non-

preferential, taking into account the effect on each relevant portfolio

in the bunched order.

    (vi) Recordkeeping.

    (A) Each eligible order must be identified on the office and floor

order tickets at the time of placement. These order tickets also must

identify the account manager placing the order.

    (B) Each transaction resulting from an eligible order must be

identified on contract market trade registers and other computerized

trade practice surveillance records.

    (C) The futures commission merchant carrying the account must

identify each trade resulting from the execution of an eligible order

on confirmation statements provided to eligible customer accounts.

    (D) Each account manager must make available, upon request of any

representative of the Commission or the United States Department of

Justice, the following:

    (1) The customer consent documents required pursuant to paragraph

(a-1)(5)(iii)(A) of this section; and

    (2) Records reflecting futures and option transactions, other

transactions executed pursuant to the portfolio management strategy,

and any other records that would identify the management strategy and

relate to, or reflect upon, the fairness of the allocations.

    (E) Each account manager must make available for review, upon

request of an eligible customer, data sufficient for that customer to

compare its results with those of other relevant customers. These data

may be prepared so as not to disclose the identity of individual

account holders.

    (vii) Contract market rule enforcement programs. As part of its

rule enforcement program, each contract market that adopts rules that

allow the placement, execution, and allocation of eligible orders must

adopt audit procedures to determine compliance with the certification,

allocation, and recordkeeping requirements identified in paragraphs (a-

1)(5)(iv), (v)(A), and (vi)(A) through (C) of this section.

* * * * *

    Issued in Washington, DC on December 31, 1997 by the Commission.

Catherine D. Dixon,

Assistant Secretary of the Commission.

[FR Doc. 98-240 Filed 1-6-98; 8:45 am]

BILLING CODE 6351-01-P






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