2019-06443
Federal Register, Volume 84 Issue 64 (Wednesday, April 3, 2019)
[Federal Register Volume 84, Number 64 (Wednesday, April 3, 2019)]
[Rules and Regulations]
[Pages 12882-12894]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 2019-06443]
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COMMODITY FUTURES TRADING COMMISSION
17 CFR Part 1
RIN 3038-AE73
Financial Surveillance Examination Program Requirements for Self-
Regulatory Organizations
AGENCY: Commodity Futures Trading Commission.
ACTION: Final rule.
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SUMMARY: The Commodity Futures Trading Commission (``Commission'' or
``CFTC'') is amending its regulations governing the minimum standards
for a self-regulatory organization's (``SRO'') financial surveillance
examination program of futures commission merchants (``FCMs''). The
amendments revise the scope of a third-party expert's evaluation of the
SRO's financial surveillance program to cover only the examination
standards used by SRO staff in conducting FCM examinations. The
amendments also extend the minimum timeframes from three years to five
years between when an SRO must engage a third-party expert to evaluate
its FCM examination standards for consistency with applicable auditing
standards. The amendments should reduce the costs associated with the
operation of a financial surveillance program, while also providing
effective third-party evaluation of the FCM examination standards.
DATES: This rule is effective May 3, 2019.
FOR FURTHER INFORMATION CONTACT: Matthew B. Kulkin, Director, 202-418-
5213, [email protected]; Thomas Smith, Deputy Director, 202-418-5495,
[email protected]; Joshua Beale, Associate Director, 202-418-5446,
[email protected]; Jennifer Bauer, Special Counsel, 202-418-5472,
[email protected]; or, Mark Bretscher, Special Counsel, 312-596-0592,
[email protected], Division of Swap Dealer and Intermediary
Oversight, Commodity Futures Trading Commission, Three Lafayette
Centre, 1155 21st Street NW, Washington, DC 20581.
SUPPLEMENTARY INFORMATION:
I. Background
A. Statutory and Regulatory Background of SRO Oversight of FCMs
FCMs perform critical functions to facilitate the efficient
operation of Commission-regulated exchange-traded derivatives
markets.\1\ In addition to
[[Page 12883]]
trading for their own accounts and carrying the accounts of their
affiliates, FCMs are market intermediaries, standing between customers
trading futures and swaps transactions on one side and designated
contract markets (``DCMs''), swap execution facilities, and derivatives
clearing organizations (``DCOs'') on the other side. As market
intermediaries, FCMs carry customer accounts and hold customer funds to
margin futures and cleared swap transactions. Additionally, FCMs
fulfill daily settlement obligations on behalf of customers by posting
sufficient funds to DCOs to support their customers' futures and swap
positions, including paying mark-to-market losses associated with such
positions. FCMs also are essential to the efficient operation of
Commission-regulated markets in that they guarantee each customer's
financial performance for futures and swap positions to DCOs by
agreeing to use their own financial resources to cover any shortfall
resulting from a customer default.\2\
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\1\ An FCM is generally defined in CFTC Regulation 1.3 as (1) an
entity that is engaged in soliciting or accepting orders for the
purchase or sale of any commodity for future delivery or a swap and,
in connection with the solicitation and acceptance of such orders,
accepts money, securities or property (or extends credit in lieu
thereof) to margin, guarantee or secure futures or swaps
transactions, or (2) an entity registered as an FCM.
Commission regulations referred to herein are found at 17 CFR
chapter I, and are accessible on the Commission's website, http://www.cftc.gov.
\2\ Regulation 39.16(c)(2)(vi).
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The Commodity Exchange Act (``Act'') \3\ recognizes the functions
performed by FCMs and authorizes the Commission to adopt regulations to
help ensure that they maintain the necessary financial resources to
properly perform such functions.\4\ Consistent with this statutory
objective, the Commission has adopted regulations requiring FCMs to
maintain a minimum level of regulatory capital,\5\ to segregate
customer funds from their own funds in specially designated customer
accounts,\6\ and to maintain appropriate risk management programs to
monitor and manage the risks associated with their activities as
FCMs.\7\ The Commission also has imposed periodic financial reporting
requirements on FCMs, which allows Commission staff to monitor their
financial condition and compliance with regulatory obligations. The
financial reporting requirements include daily statements demonstrating
compliance with the segregation of customer funds requirements,\8\
monthly unaudited and annual audited financial statements,\9\ and
regulatory notices upon the occurrence of specified events including
failing to meet minimum capital requirements, failing to comply with
segregation requirements, and failing to maintain current books and
records.\10\
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\3\ 7 U.S.C. 1 et seq.
\4\ Section 4f(b) of the Act authorizes the Commission to adopt
regulations imposing minimum capital and financial reporting
requirements on FCMs to help ensure that they maintain adequate
financial resources to meet their obligations.
\5\ Regulation 1.17.
\6\ Regulations 1.20, 22.2, and 30.7 impose segregation
requirements for customer accounts containing futures positions,
swap positions, and foreign futures positions, respectively.
\7\ Regulation 1.11.
\8\ Regulations 1.32, 22.2 and 30.7 require FCMs to prepare and
submit to the Commission daily segregation computations and
schedules for customer futures, cleared swaps and foreign futures
accounts, respectively.
\9\ Regulation 1.10.
\10\ Regulation 1.12.
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The Act also establishes a regulatory oversight structure that
imposes an obligation on DCMs and registered futures associations
(``RFAs''),\11\ as SROs,\12\ to perform frontline regulatory oversight
of market intermediaries, including FCMs.\13\ To further the objective
of effective self-regulation of market participants and market
professionals, the Act and Commission regulations require RFAs and DCMs
to adopt financial and related reporting requirements for member FCMs,
and to periodically examine FCMs for compliance with such requirements.
In this regard, section 17(p) of the Act requires an RFA to establish
and submit for Commission approval rules imposing minimum capital,
segregation and other financial requirements applicable to its members
for which such requirements are imposed by the Commission.\14\ Section
17(p) further provides that the RFA must implement a program to audit
and enforce compliance by its members with the RFA's minimum financial
requirements.\15\
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\11\ The National Futures Association (``NFA'') is the only
registered RFA. NFA's financial requirements for FCMs are available
at its website, http://www.nfa.futures.org.
\12\ An SRO is defined in Regulation 1.52 to include a contract
market (as defined in Regulation 1.3) or an RFA under section 17 of
the Act. The term ``SRO'' as defined in Regulation 1.52(a)(2),
however, does not include a swap execution facility (as defined in
Regulation 1.3).
\13\ Section 3(b) of the Act provides in relevant part that it
is the purpose of the Act to serve the public interest through a
system of effective self-regulation of market participants and
market professionals under the oversight of the Commission.
\14\ Section 17(p)(2) of the Act.
\15\ Id.
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With respect to DCMs, section 5(d)(11)(B) of the Act and Regulation
38.600 require, in relevant part, each DCM to implement rules to ensure
the financial integrity of any member FCM and the protection of
customer funds.\16\ DCMs also are required to monitor an FCM member's
compliance with the DCM's minimum financial requirements by reviewing
financial information filed with the DCM and by conducting periodic
examinations of the FCM.\17\
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\16\ See also, Regulation 38.602 which provides that a DCM must
provide for the financial integrity of its transactions by
establishing and maintaining appropriate minimum financial standards
for its members and non-intermediated market participants, and
Regulation 38.603 which requires a DCM to have rules concerning the
protection of customer funds.
\17\ See Regulations 38.600 through 38.605.
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In recognition of SROs as frontline regulators and the importance
of FCM oversight, the Commission adopted Regulation 1.52 which
establishes minimum standards that all SRO programs must satisfy in
conducting FCM financial oversight. Regulation 1.52 requires each SRO
(including NFA) to adopt rules prescribing minimum financial and
related reporting requirements for member FCMs that are the same as, or
more stringent than, the requirements imposed by the Commission.\18\
Regulation 1.52 also requires each SRO to maintain a financial
surveillance oversight program that includes detailed examinations of
member FCMs' books and records to assess their compliance with SRO and
Commission minimum financial and related reporting and recordkeeping
requirements.\19\
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\18\ Regulation 1.52(b)(1).
\19\ Regulation 1.52(c)(1)(iv).
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Regulation 1.52 also permits two or more SROs to file a plan with
the Commission to delegate primary, but not exclusive, responsibility
to monitor and to examine the financial condition of an FCM that is a
member of two or more SROs to a designated self-regulatory organization
(``DSRO'').\20\ The participating SROs form a Joint Audit Committee
(``JAC'') and submit a Joint Audit Program to the Commission, which may
approve such plan after providing an opportunity for public notice and
comment.\21\
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\20\ Regulation 1.52(d)(1).
\21\ Regulation 1.52(j).
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The delegation of an FCM that is a member of two or more SROs to a
DSRO under a Joint Audit Program allows for a more efficient use of SRO
resources, while also reducing burdens that otherwise would be imposed
on an FCM from duplicative supervision, including periodic on-site
examinations from multiple SROs. All SROs currently are members of a
single JAC and operate
[[Page 12884]]
pursuant to one Joint Audit Program approved by the Commission.\22\
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\22\ The current JAC Joint Audit Program assigns each FCM to
either the CME Group (``CME'') or NFA as the FCM's DSRO.
Accordingly, only the CME and NFA currently engage in routine,
periodic on-site examinations of FCMs pursuant to the JAC agreement.
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B. Current Requirements of Commission Regulation 1.52
Regulation 1.52 requires each SRO or JAC to establish and operate a
supervisory program that includes written policies and procedures
concerning the examination of its member registrants (including FCMs).
The purpose of the supervisory program is to assess whether each member
registrant is in compliance with applicable SRO and Commission
regulations governing net capital and related financial requirements,
the obligations to segregate customer funds, risk management
requirements, financial reporting requirements, recordkeeping
requirements, and sales practices and other compliance
requirements.\23\ The supervisory program is required to address an
SRO's or JAC's staffing levels and independence, ongoing surveillance
of member registrants, procedures for identifying and monitoring high-
risk firms, on-site examinations of registrants, and documentation of
surveillance activities.\24\
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\23\ Regulation 1.52(c)(1) for an SRO and Regulation
1.52(d)(2)(ii)(A)-(B) for a JAC.
\24\ Regulation 1.52(c)(1) for an SRO and Regulation
1.52(d)(2)(ii)(A)-(B) for a JAC.
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The supervisory program as it relates to FCMs also is required to,
at a minimum, incorporate FCM examination standards addressing: (1) The
ethics of an examiner; (2) The independence of an examiner; (3) The
supervision, review, and quality control of an examiner's work product;
(4) The evidence and documentation to be reviewed and retained in
connection with an examination; (5) The examination planning process;
(6) Materiality assessment; (7) Quality control procedures to ensure
that the examinations maintain the level of quality expected; (8)
Communications between an examiner and the regulatory oversight
committee, or the functional equivalent of the regulatory oversight
committee, of the SRO of which the FCM is a member; (9) Communications
between an examiner and an FCM's audit committee of the board of
directors or similar governing body; (10) Analytical review procedures;
(11) Record retention; and (12) Required items for inclusion in the
examination report, such as repeat violations, material items, and high
risk issues.\25\ All aspects of an SRO's supervisory program, including
the FCM examination standards, must conform to auditing standards
issued by the Public Company Accounting Oversight Board (``PCAOB'') as
such standards would apply in the conduct of a non-financial statement
audit.\26\
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\25\ Regulation 1.52(c)(2)(iii) for an SRO and Regulation
1.52(d)(2)(ii)(G) for a JAC.
\26\ Regulation 1.52(c)(2)(ii) for an SRO and Regulation
1.52(d)(2)(ii)(F) for a JAC. The PCAOB is a nonprofit corporation
established by Congress to oversee the audits of public companies in
order to protect investors and the public interest by promoting
informative, accurate, and independent audit reports. The PCAOB also
oversees the audits of brokers and dealers registered with the
Securities and Exchange Commission (``SEC''). The PCAOB, however, is
not vested with the authority to oversee the audits of FCMs.
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Regulation 1.52 also requires an SRO or JAC to engage an
``examinations expert'' to evaluate its supervisory program prior to
its initial use, and to evaluate the SRO's or JAC's application of the
supervisory program at least once every three years after its initial
use.\27\ For each evaluation, the SRO or JAC is required to obtain a
written report from the examinations expert on its findings and
recommendations. The written report is required to be issued under the
consulting services standards of the American Institute of Certified
Public Accountants (``AICPA''). The written report must include: (1) A
statement that the examinations expert has evaluated the supervisory
program (including its design to detect material weaknesses in an FCM's
system of internal controls), including any comments and
recommendations regarding such evaluation; (2) A statement that the
examinations expert has evaluated the application of the supervisory
program by the SRO, including any comments and recommendations in
connection with such evaluation; and (3) A discussion containing
recommendations of any new or best practices as prescribed by industry
sources, including the AICPA and PCAOB.\28\
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\27\ Regulation 1.52(c)(2)(iv) for an SRO and Regulation
1.52(d)(2)(ii)(I) for a JAC. An ``examinations expert'' is defined
in Regulation 1.52(a) as a nationally recognized accounting and
auditing firm with substantial expertise in the audits of futures
commission merchants, risk assessment and internal control reviews,
and is an accounting and auditing firm that is acceptable to the
Commission.
\28\ Regulation 1.52(c)(2)(iv)(A) for an SRO and Regulation
1.52(d)(2)(ii)(I)(1)-(4) for a JAC.
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An SRO or JAC is required to provide the written report, including
responses to any findings, comments, or recommendations made by the
examinations expert, to the Commission within 30 days of receipt of the
report. The SRO or JAC must commence applying the revised supervisory
program, incorporating the examinations expert's findings, comments,
and recommendations, once the Commission has advised the SRO or JAC, by
written notice, that the Commission has no questions or comments on the
written report.
C. Commission Initiative To Simplify and Modernize Regulations
Commission staff initiated an agency-wide internal review of CFTC
regulations and practices in March 2017 to identify areas that could be
simplified, to make them less burdensome and costly for market
participants.\29\ The Commission subsequently published in the Federal
Register on May 9, 2017, a Request for Information soliciting
suggestions from the public regarding how the Commission's existing
rules, regulations, or practices could be applied in a simpler, less
burdensome, and costly manner (i.e., ``Project KISS'').\30\
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\29\ See Remarks of Acting Chairman J. Christopher Giancarlo
before the 42nd Annual International Futures Industry Conference in
Boca Raton, FL, dated March 15, 2017. The remarks are available at
the Commission's website: https://www.cftc.gov/PressRoom/SpeechesTestimony/opagiancarlo-20.
\30\ Project KISS, 82 FR 21494 (May 9, 2017); amended on May 24,
2017, 82 FR 23765 (May 24, 2017). The Federal Register Request for
Information and the suggestion letters filed by the public are
available at the Commission's website: https://comments.cftc.gov/KISS/KissInitiative.aspx.
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The CME submitted suggestions on a variety of rules, regulations,
and practices, including Regulation 1.52, in response to the
Commission's Request for Information.\31\ The CME expressed its view
that the requirement in Regulation 1.52 for an SRO or JAC to engage an
examinations expert at least once every three years does not provide
any meaningful regulatory benefit.\32\ The CME noted that under the
current regulatory framework, Commission staff provides effective
oversight of SRO and JAC FCM examination programs through the conduct
of its rule enforcement reviews.\33\ The CME further noted that it
revises its FCM examination programs to incorporate any regulatory
changes adopted by the Commission or SROs, and provides the actual FCM
examination programs, with the revisions, to Commission staff for
[[Page 12885]]
review at least once each year.\34\ Accordingly, the CME suggested that
the Commission eliminate the requirement for an SRO or JAC to engage an
examinations expert once every three years to evaluate the SRO's or
JAC's supervisory program.\35\
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\31\ Letter from Kathleen Cronin, Senior Managing Director,
General Counsel and Corporate Secretary, CME Group, dated September
29, 2017 (``CME Project KISS Letter''), pp. 13-14. The CME Project
KISS Letter is available at the Commission's website: https://comments.cftc.gov/PublicComments/ViewComment.aspx?id=61395.
\32\ Id.
\33\ Id.
\34\ Id.
\35\ Id.
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II. Proposed Amendments and Comments
A. The Proposal
On July 3, 2018, the Commission published for public comment a
Notice of Proposed Rulemaking (``Proposal'') \36\ to amend Regulation
1.52 to revise the scope and frequency of an examinations expert's
evaluation of an SRO's or JAC's supervisory program, and to address
certain non-substantive revisions to provide greater clarity and
organization to the Regulation. The Proposal was initiated in response
to both comments received from the Project Kiss initiative and
knowledge gained through Commission staff's firsthand experience with
the JAC's implementation of its initial FCM supervisory program
pursuant to Regulation 1.52.\37\
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\36\ Financial Surveillance Examination Program Requirements for
Self-Regulatory Organizations, 83 FR 31078 (July 3, 2018).
\37\ Commission staff gained first-hand experience with the
supervisory programs as staff participated in several meetings with
the JAC (via the CME and NFA as the JAC's representatives) and its
examinations expert to address issues and questions arising during
the drafting of the initial FCM examination standards and
examination programs. This interaction culminated with Commission
staff approving the initial FCM examination standards and programs
pursuant to delegated authority from the Commission in 2015. The
examination standards and programs are now fully implemented and are
used in each JAC examination of an FCM.
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In addition to requesting comment on proposed amendments to
Regulation 1.52, the Commission also solicited comments on the impact
of the Proposal on small entities, the Commission's cost-benefit
considerations, and any anticompetitive effects of the Proposal. The
comment period closed on September 4, 2018.
The Commission received comment letters from the JAC, NFA and CME
concerning the Proposal.\38\ The JAC, NFA and CME were supportive of
the Commission's proposed amendments to revise the scope of the
examinations expert's evaluation of the SRO or JAC supervisory program
and to revise the minimum timeframes between when an SRO or JAC must
engage an examinations expert to evaluate the SRO's or JAC's FCM
examination standards for consistency with auditing standards issued by
the PCAOB. The comments are discussed below.
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\38\ The JAC comment letter was submitted by Debra K. Kokal,
Executive Director, Financial and Regulatory Surveillance, CME
Group, and Chairman of the Joint Audit Committee (``JAC Comment
Letter''). The NFA comment letter was submitted by Carol A. Wooding,
Vice President and General Counsel, National Futures Association
(``NFA Comment Letter''). The CME comment letter was submitted by
Sunil Cutinho, President, CME Clearing (``CME Comment Letter''). The
comment file also includes submissions from United States Sharable
and from Eric Alan Dela Pena, both of which did not include any
discussion of the Proposal. All five submissions are available in
the comment file on the Commission's website: http://comments.cftc.gov/PublicComments/CommentList.aspx?id=2891.
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1. Scope of the Examinations Expert's Evaluation of a Supervisory
Program
Regulation 1.52 requires an SRO or JAC to engage an examinations
expert to evaluate its supervisory program prior to its initial use and
at least once every three years thereafter.\39\ The examinations
expert's evaluation is required to address the SRO's or JAC's
application of its supervisory program, including the sufficiency of
the supervisory program's risk-based approach and internal controls
testing (including its design to detect material weaknesses in an FCM's
internal control environment). The examinations expert is further
required to evaluate whether the SRO's or JAC's FCM examination
standards are consistent with auditing standards issued by the PCAOB as
such standards would be applicable to a non-financial statement audit.
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\39\ Paragraphs (c)(2)(vi) and (c)(2)(iv) of Regulation 1.52,
respectively, contain the requirement for an SRO to engage an
examinations expert prior to the initial implementation of its
supervisory program and at least once every three years thereafter.
Paragraphs (d)(2)(ii)(H) and (I) of Regulation 1.52, respectively,
contain the requirement for a JAC to engage an examinations expert
prior to the initial implementation of its supervisory program and
at least once every three years thereafter.
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Regulation 1.52 also requires an SRO or JAC to obtain from the
examinations expert for each evaluation a written report on findings
and recommendations issued under AICPA consulting services standards.
The report is required to include a statement that the examinations
expert has evaluated the supervisory program, including the sufficiency
of its risk-based approach and internal controls testing. The report
also is required to include a statement that the examinations expert
has evaluated the SRO's or JAC's application of the supervisory
program.
The Commission proposed to amend Regulations 1.52(c)(2)(iv) and
(d)(2)(ii)(I) to remove from the scope of the examinations expert's
evaluation the SRO's or JAC's application of its respective supervisory
program during periodic reviews and the analysis of the sufficiency of
the supervisory program's risk-based approach, internal controls
testing, and design to detect material weaknesses in internal controls
during both the initial assessment of the SRO's or JAC's supervisory
program and during subsequent periodic evaluations. Therefore, the
Proposal limits the scope of the examinations expert's evaluation
during both initial and subsequent periodic evaluations to an
assessment of whether the SRO's and JAC's FCM examination standards are
consistent with PCAOB audit standards as such standards would be
applicable to a non-financial statement audit.
The CME, NFA and JAC each expressed strong support to revise the
scope of the examinations expert's evaluation and written report during
both the initial review and subsequent periodic reviews, to encompass
only whether the FCM examination standards are consistent with
applicable PCAOB auditing standards as such standards would be applied
in a non-financial statement audit.\40\ The CME and JAC each stated
that with respect to the periodic evaluations, requiring the
examinations expert to focus on any new or amended PCAOB auditing
standards issued since the examinations expert's prior evaluation may
enhance an SRO's or JAC's supervisory program.\41\ NFA also stated that
an examinations expert has expertise with respect to reviewing PCAOB
auditing standards and can provide meaningful input to an SRO or JAC
supervisory program regarding the consistency of the FCM examination
standards with the PCAOB audit standards.\42\
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\40\ CME Comment Letter, p. 1; NFA Comment Letter, p. 2; JAC
Comment Letter, p. 1.
\41\ CME Comment Letter, p. 1; JAC Comment Letter, p. 1.
\42\ NFA Comment Letter, p. 2.
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Each of the commenters also stated, however, that an evaluation of
the application of an SRO's or JAC's supervisory program was best
performed by Commission staff. The JAC stated its belief that
Commission staff has subject matter expertise and is best suited to
evaluate, comment upon, and make recommendations regarding enhancements
to the JAC's supervisory program and to assess its application against
the Commission's own regulatory requirements.\43\ NFA also stated that
it agreed with the Commission's statement in the Proposal that
Commission staff has the expertise in the application of CFTC
regulations to operations of FCMs, and that Commission staff is
appropriately situated to assess whether an SRO or
[[Page 12886]]
JAC is accurately and properly applying Commission requirements to FCMs
in the execution of the examination programs.\44\ NFA further stated
that it believes that the rule enforcement reviews currently performed
by Commission staff of the NFA's financial surveillance program are
similar in nature to the examinations expert's review required by
Regulation 1.52 and provide effective and meaningful oversight of the
NFA's application of its FCM supervisory program.\45\ The CME stated
that it agreed with the reasoning set forth in the Proposal revising
the scope of the examinations expert's evaluation, and noted that the
proposed amendment strikes the proper balance between reliance on the
Commission's expertise in its oversight of an SRO's examination program
and the expertise of an examinations expert in evaluating the
consistency of the FCM examination standards with PCAOB audit
standards.\46\
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\43\ JAC Comment Letter, p. 1.
\44\ NFA Comment Letter, p. 2.
\45\ Id.
\46\ CME Comment Letter, p. 1.
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2. Frequency of the Examinations Expert's Evaluation of an SRO's or
JAC's Supervisory Program
Regulation 1.52 currently requires an SRO or JAC to engage an
examinations expert to evaluate its respective supervisory program
prior to the initial implementation of the program, and at least once
every three years thereafter.\47\ The Commission proposed to amend the
timeframes for an SRO or JAC to engage an examinations expert to
conduct periodic evaluations subsequent to the initial
implementation.\48\ Specifically, the Commission proposed to amend
Regulation 1.52 to require an SRO or JAC to review any new or amended
auditing standards as such standards are issued by the PCAOB, and to
revise its FCM examination standards promptly to reflect any changes
that are applicable in the context of the SRO's or JAC's examination of
FCMs.\49\ The Proposal also requires the SRO or JAC to engage an
examinations expert to evaluate any material revisions that the SRO or
JAC makes to the examination standards to conform such standards with
the new or amended PCAOB auditing standards. In addition, the Proposal
requires the SRO or JAC to engage an examinations expert to evaluate
the FCM examination standards in light of new or amended PCAOB auditing
standards if such engagement is directed by the CFTC Director of the
Division of Swap Dealer and Intermediary Oversight (``DSIO'').\50\ The
Commission further proposed to limit the maximum amount of time between
an examinations expert's evaluation of an SRO's or JAC's FCM
examination standards to no more than five years.\51\
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\47\ Regulations 1.52(c)(2)(iv) and (d)(2)(ii)(I) for an SRO and
JAC, respectively.
\48\ The Commission did not propose to amend the requirement
that an SRO or JAC engage an examinations expert to evaluate its FCM
examination standards at the initial implementation of its
supervisory program.
\49\ Proposed Regulation 1.52(c)(2)(iii)(B) for SROs and
Regulation 1.52(d)(2)(ii)(G)(2) for JACs.
\50\ Proposed Regulation 1.52(c)(2)(iii)(B) for SROs and
Regulation 1.52(d)(2)(ii)(G)(2) for JACs.
\51\ Proposed Regulation 1.52(c)(2)(iii)(A) for SROs and
Proposed Regulation 1.52(d)(2)(ii)(G)(1) for JACs.
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At the conclusion of each review, the Proposal requires an SRO or
JAC to obtain from the examinations expert a written report on findings
and recommendations issued under the AICPA consulting services
standards.\52\ The SRO or JAC must provide a copy of the report to the
DSIO Director, along with any written responses to any of the findings
and recommendations in the report, within 30 days of the SRO's or JAC's
receipt of the report. The SRO or JAC must commence applying the
revised FCM examination standards upon receipt of a written notice from
DSIO staff that it has no questions or comments on the revised FCM
examination standards or the written report.
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\52\ Proposed Regulation 1.52(c)(2)(iii)(C) for SROs and
Proposed Regulation 1.52(d)(2)(ii)(G)(3) for JACs.
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The CME, NFA, and JAC supported the proposed amendments to extend
the maximum timeframe for an SRO or JAC to engage an examinations
expert from three to five years.\53\ The JAC and CME, however,
requested that the Commission consider a maximum ten-year timeframe
between examinations expert's reviews given the infrequency with which
the PCAOB issues new or revised auditing standards, particularly
auditing standards that apply in the context of a non-financial
statement audit.\54\ In support of their respective requests, the JAC
and CME represented that the SEC has only approved two amendments to
PCAOB auditing standards since the Commission adopted the FCM
examination standards requirement in 2015, and neither of the two
amendments have an impact on FCM examination standards for non-
financial statement audits.\55\
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\53\ CME Comment Letter, pp. 1-2; NFA Comment Letter, p. 3; JAC
Comment Letter, p. 1.
\54\ JAC Comment Letter, p. 1; CME Comment Letter, p. 2.
\55\ JAC Comment Letter, p. 1; CME Comment Letter, p. 2. NFA
also stated that the SEC has approved only two amendments to PCAOB
audit standards since 2015 and both of the amendments do not apply
to FCM examination standards. NFA Comment Letter, p. 3. Section
107(b) of the Sarbanes Oxley Act of 2002 generally requires the SEC
to approve PCAOB rules prior to their implementation.
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The JAC, CME and NFA further expressed views that a longer maximum
timeframe between required evaluations by an examinations expert was
warranted given that the Proposal requires an SRO or JAC to review any
new or amended audit standards issued by the PCAOB, to promptly make
any necessary revisions to the FCM examinations standards resulting
from such new or amended auditing standards, and to engage an
examinations expert to evaluate material revisions made to the FCM
examination standards.\56\ The JAC, CME and NFA further stated that a
regulatory provision providing for a maximum five-year timeframe
between reviews by an examinations expert is not necessary as the
Proposal authorizes the DSIO Director to require an SRO or JAC to
engage an examinations expert at any time.\57\ The JAC, CME and NFA
also requested that if the Commission were to adopt a final rule that
includes a requirement for an SRO or JAC to engage an examinations
expert no less frequently than once every five years that the
Commission also consider amending the Regulation to authorize the
Director of DSIO to grant a waiver or otherwise provide relief from the
requirement under appropriate circumstances, including situations where
there are no new or revised auditing standards issued by the PCAOB
during the five-year period since the prior examinations expert's
review.\58\
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\56\ JAC Comment Letter, p. 2; CME Comment Letter, p. 2.; NFA
Comment Letter, p. 3. NFA further stated that it envisions that the
only situation in which it would have to engage an examinations
expert once every five years is if there are no changes to the PCAOB
standards during the previous five years that impact the FCM
examination standards. The NFA believes that such a requirement is
unduly burdensome and costly. NFA Comment Letter, pp. 3-4.
\57\ JAC Comment Letter, p. 2; CME Comment Letter, p. 2; NFA
Comment Letter, pp. 3-4.
\58\ JAC Comment Letter, p. 2; CME Comment Letter, p. 2; NFA
Comment Letter, pp. 3-4. The JAC and CME also requested that the
Commission continue to monitor the adoption of auditing standards by
the PCAOB and consider eliminating the requirement for an
examinations expert to perform evaluations in a future rulemaking.
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Commenters also requested that the Commission confirm or clarify
several aspects of the Proposal or existing Regulation 1.52. The JAC
and CME requested that the Commission confirm that the proposed maximum
five-year timeframe between an examinations expert's evaluation of the
FCM examination standards is reset whenever an SRO or JAC engages an
[[Page 12887]]
examinations expert.\59\ The JAC and CME also noted that the regulation
requires that all aspects of the supervisory program must conform to
auditing standards issued by the PCAOB as such standards would be
applicable to a non-financial audit. The JAC and CME requested
confirmation that when auditing standards of the PCAOB are referenced
in Regulation 1.52, it is the standards that would be applicable to a
non-financial statement audit.\60\
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\59\ JAC Comment Letter, p. 2; CME Comment Letter, p. 3.
\60\ JAC Comment Letter, p. 2; CME Comment Letter, p. 3.
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3. Technical Amendments to Regulation 1.52
The Proposal includes several technical amendments to Regulation
1.52 to eliminate redundancies and to simplify the intent of the
Regulation. Specifically, the Commission proposed to consolidate the
examination standards required to be included in an SRO supervisory
program that are currently listed in paragraphs (c)(2)(ii) and (iii)
into a single revised paragraph (c)(2)(ii) of Regulation 1.52. The
Commission further proposed to amend paragraphs (d)(2)(ii)(F) and
(d)(2)(ii)(G) of Regulation 1.52, which sets forth the examination
standards required of a JAC supervisory program, to be consistent with,
and to incorporate by cross-reference, the SRO examination standards
contained in revised paragraph (c)(2)(ii) of Regulation 1.52. The
Commission did not receive any comments on the proposed amendments to
paragraphs (c)(2)(ii), (d)(2)(ii)(F)-(G) of Regulation 1.52.
III. Final Rules
The Commission has considered the comments received and is adopting
the amendments to Regulation 1.52 as proposed, with minor changes
discussed below.
A. Scope of the Examinations Expert's Evaluation of a Supervisory
Program
Amended Regulation 1.52 revises the scope of the examinations
expert's initial and ongoing evaluations of an SRO's or JAC's
supervisory program to encompass only an evaluation of whether the
supervisory program's FCM examination standards are consistent with
auditing standards issued by the PCAOB as such auditing standards would
be applied to a non-financial statement audit. Accordingly, amended
Regulation 1.52 will not require an SRO or JAC to engage an
examinations expert to evaluate the sufficiency of the supervisory
program's risk-based approach or internal controls testing, including
the program's design to detect material weaknesses in an FCM's internal
control environment. Amended Regulation 1.52 also will not require an
SRO or JAC to engage an examinations expert to evaluate the SRO's or
JAC's application of the supervisory program.
Amended Regulation 1.52 continues to require an SRO or JAC to
obtain from the examinations expert a written report on findings and
recommendations issued under AICPA consulting services standards as
part of both the initial and periodic, ongoing evaluations of the SRO's
or JAC's supervisory program. Consistent with the amendments to the
scope of the examinations expert's evaluation, the written report is
required to address the consistency of the supervisory program's FCM
examination standards with auditing standards issued by the PCAOB, as
such standards would be applied in a non-financial statement audit. The
written report is no longer required to include statements regarding
the examinations expert's evaluation of the sufficiency of the
supervisory program's risk-based approach and internal control testing.
The written report also is no longer required to include an analysis of
the supervisory program's design to detect material weaknesses in an
FCM's internal control environment. The written report also is required
to be provided to the Director of DSIO.\61\
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\61\ As stated in the Proposal, DSIO will provide the written
report to the Commission on an informational basis.
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As noted in the Proposal, the Commission initially adopted the
requirement for an examinations expert to evaluate an SRO's or JAC's
application of its supervisory program, including ongoing assessments
of the sufficiency of the SRO's or JAC's internal controls testing, to
address concerns that a third-party assessment was necessary due to
limited Commission resources and expertise to perform a comparable
periodic evaluation. Commission staff subsequently worked closely with
both the CME and NFA in the development of their initial supervisory
programs and has determined that it has sufficient resources and
expertise to effectively oversee the application of SRO and JAC
supervisory programs. In this regard, Commission staff ultimately
approved the JAC's initial supervisory program in 2015, including the
supervisory program's FCM examination standards and detailed
examination programs. Commission staff also has performed routine
scheduled oversight reviews of both the CME's and NFA's application of
their respective supervisory programs since their initial approvals in
2015, including their internal controls testing at member FCMs.
Commission staff also routinely reviews the JAC examination programs to
assess their sufficiency in examining FCMs' compliance with Commission
and SRO financial, reporting, and general operational requirements, as
well as their sufficiency in assessing the effectiveness of the
internal controls at an FCM. Therefore, although the size of the
relevant staff has remained relatively constant since 2015, the
Commission believes that it has the appropriate expertise to provide
the level of supervision necessary to assess an SRO's or JAC's
application of its respective supervisory program.
B. Frequency of the Examinations Expert's Evaluation of an SRO's or
JAC's Supervisory Program
The Commission is amending Regulation 1.52 to adopt a risk-based
approach to determine the required frequency of an examinations
expert's evaluation of an SRO's or JAC's supervisory program. Amended
Regulation 1.52 requires an SRO or JAC to review new or amended
auditing standards as such standards are issued by the PCAOB, and to
revise its FCM examination standards promptly to reflect any changes
that are applicable in the context of the SRO's or JAC's examination of
FCMs. The final amendments also require the SRO or JAC to engage an
examinations expert to evaluate any material revisions that the SRO or
JAC makes to the examination standards to conform such standards with
the new or amended PCAOB auditing standards. In addition, the final
amendments require the SRO or JAC to engage an examinations expert to
evaluate the FCM examination standards in light of new or amended PCAOB
auditing standards whenever such engagement is directed by the Director
of DSIO. The Commission also is amending Regulation 1.52 to revise from
three to five years the maximum period of time that an SRO or JAC may
operate its supervisory program without engaging an examinations expert
to evaluate its FCM examination standards for consistency with PCAOB
auditing standards as such standards would apply to a non-financial
statement audit.
As noted in the Proposal, the Commission believes that the
examinations expert's evaluation provides an important oversight
mechanism whereby an independent third-party that has expertise in the
application of PCAOB auditing standards can assess an SRO's or JAC's
FCM examination standards for
[[Page 12888]]
consistency with such PCAOB auditing standards. The Commission further
believes that the FCM examination standards should be reviewed and
revised promptly whenever the PCAOB issues new or amended auditing
standards, and an SRO or JAC should engage an examinations expert to
review any material revisions made to the FCM examination standards
instead of waiting for the next scheduled review under a three-year
cycle. The provision providing the Director of DSIO with the authority
to direct an SRO or JAC to engage an examinations expert to evaluate
its FCM examination standards for consistency with PCAOB audit
standards is intended to ensure that an independent third-party
assessment is performed whenever material revisions are made to the FCM
examination standards. Accordingly, the third-party assessment may be
initiated either by the SRO/JAC or by the DSIO Director, if necessary.
Lastly, the amended regulation provides that an SRO or JAC must engage
an examinations expert to evaluate its FCM examination standards if it
has not engaged an examinations expert to perform such an evaluation
within the last five years.
The Commission considered the comments received in adopting the
final amendments. The Commission does not believe that it is
appropriate at this time to extend the maximum timeframe between
examinations expert's evaluations to once every 10 years as suggested
by the JAC and CME. Nor does the Commission believe that the provision
granting the Director of DSIO the authority to direct an SRO or JAC to
engage an examinations expert supports the elimination of a maximum
five-year timeframe from the regulation as suggested by the JAC, CME
and NFA.
The requirement that an SRO or JAC engage an examinations expert is
a new requirement that was adopted in 2013. While the NFA and CME have
engaged an examinations expert to assist them with the development of
their initial supervisory programs, including assisting them with
developing FCM examinations standards that are consistent with
applicable PCAOB auditing standards, neither the NFA nor CME has gone
through the process of engaging an examinations expert to perform an
evaluation subsequent to the initial approval. As noted above, both the
Commission and commenters recognize the benefits that an examinations
expert may provide by evaluating the FCM examination standards. The
Commission believes that a maximum five-year period of time between
evaluations provides a more appropriate balance between the costs of
engaging the examinations expert and the benefit provided by the
independent evaluation of the FCM examination standards than a 10-year
timeframe.
The Commission also acknowledges the infrequent nature by which the
PCAOB issues new or amended auditing standards, and the Commission
recognizes that the PCAOB has not issued new or amended auditing
standards that are applicable to an SRO or JAC examination of an FCM
since the NFA and CME supervisory programs were initially adopted. The
Commission believes, however, that existing regulations provide an
appropriate mechanism for an SRO or JAC to seek regulatory relief from
the requirement to engage an examinations expert in situations where
the PCAOB has been relatively inactive in issuing new or amended
auditing standards during the previous five-year period. In such
situations, an SRO or JAC may seek regulatory relief, including
requesting a no-action position from Commission staff pursuant to
Regulation 140.99.\62\
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\62\ The availability of regulatory relief under Regulation
140.99 also negates the need for Regulation 1.52 to include a
provision providing the Director of DSIO the authority to issue
waivers from requirement for an SRO or JAC to engage an examinations
expert.
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As noted above, the Commission is adopting the amendments to
Regulations 1.52(c)(2)(iii) and 1.52(d)(2)(G) setting forth a
requirement that an SRO and JAC, respectively, engage an examinations
expert at least once every five years as proposed. The Commission also
is setting the starting date of the five-year period to coincide with
the effective date of the final amendments to Regulation 1.52. In
addition, the Commission confirms that the five-year timeframe is
restarted whenever an SRO or JAC engages an examinations expert to
evaluate its FCM examination standards.\63\ The restart date for the
running of the five-year period shall be the date on which DSIO staff
provides written notice to an SRO pursuant to Regulation
1.52(c)(2)(iii)(C) or a JAC pursuant to Regulation 1.52(d)(2)(ii)(G)(3)
that DSIO staff has no further comments or questions on the revised
examination standards.
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\63\ The scope of the examinations expert's review shall ensure
that each FCM examination standards is assessed for consistency with
new or revised PCAOB auditing standards issued since the most recent
review.
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C. Technical Amendments to Regulation 1.52
The proposed technical amendments consolidate in Regulation
1.52(c)(2)(ii) the FCM examination standards required to be included in
an SRO supervisory program that are currently listed in paragraphs
(c)(2)(ii) and (iii) of Regulation 1.52. The technical amendments also
revise paragraphs (d)(2)(ii)(F) and (d)(2)(ii)(G) of Regulation 1.52,
which sets forth the FCM examination standards required of a JAC
supervisory program, to be consistent with, and to incorporate by
cross-reference, the SRO examination standards contained in amended
paragraph (c)(2)(ii) of Regulation 1.52.
The Commission did not receive any comments regarding the proposed
technical amendments. The Commission is adopting the technical
amendments as proposed.
D. Additional Comments
The Commission also received several comments that addressed issues
in addition to the scope and frequency of the examinations expert's
evaluation of FCM examination standards. The CME and JAC noted in their
respective comment letters that current Regulation
1.52(d)(2)(iii)(B)(6) provides that JAC members must consider issuing
``risk alerts'' to both FCMs and DSRO examiners on an as needed basis
as issues arise.\64\ The CME and JAC stated that the requirement to
consider issuing risk alerts to DSRO staff examiners is not necessary
and requested that the requirement be eliminated.\65\
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\64\ CME Comment Letter, p. 2; JAC Comment Letter, p. 3.
\65\ CME Comment Letter, p. 3; JAC Comment Letter, p. 2.
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The CME and JAC also commented that Regulation 1.52(d)(2)(ii)(E)
requires a JAC supervisory program to, among other requirements,
``address all areas of risk to which an FCM can reasonably be foreseen
to be subject to.'' \66\ The CME and JAC stated that this provision is
vague and overly broad, and further noted that such requirements are
addressed in Regulation 1.11, which imposes an enterprise risk
management requirement on FCMs. The CME and JAC requested that
Regulation 1.52 be amended to remove the requirement.
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\66\ CME Comment Letter, p. 3; JAC Comment Letter, pp. 2-3.
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In addition, the CME noted that Regulation 1.52(k) requires an SRO
to provide the Commission with notice when an FCM, a registered retail
foreign exchange dealer, or a registered introducing broker ceases to
be a member in good standing of the SRO.\67\ The CME stated that CME
members include both clearing members, which are subject to the
supervisory procedures specified in Regulation 1.52, and ``corporate
members'', which may include FCMs, retail foreign exchange dealers, and
introducing brokers that are
[[Page 12889]]
not clearing members and are subject to NFA as their DSRO. The CME
requested that Regulation 1.52(k) be amended to clarify that NFA is
responsible for providing the notice on the status of such corporate
members not being in good standing of the SRO.
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\67\ CME Comment Letter, p. 3.
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Each of the comments above are beyond the scope of the Commission's
Proposal and the Commission has determined not to amend Regulation 1.52
to address these issues at this time. The Commission, however,
understands that with respect to Regulation 1.52(k), that DSRO
responsibilities are allocated amongst SROs pursuant to the Joint Audit
Plan, and Regulation 1.52 does not prohibit NFA from being the DSRO of
FCMs, retail foreign exchange dealers, or introducing brokers that are
corporate members of an SRO that may be a designated contract market.
Accordingly, the CME is not obligated to file a notice with the
Commission under Regulation 1.52(k) if an FCM, retail foreign exchange
dealer, or introducing broker solely terminated its corporate
membership in the CME. The Commission would expect, however, that if an
SRO is aware of a regulatory issue with a corporate member that may
indicate that the corporate member is not complying with Commission or
SRO regulations, that the SRO would communicate such concerns to the
appropriate DSRO for further review consistent with the terms and
intent of the Joint Audit Plan and Regulation 1.52.
IV. Related Matters
A. Regulatory Flexibility Act
The Regulatory Flexibility Act (``RFA'') \68\ requires Federal
agencies, in promulgating regulations, to consider the impact of those
regulations on small entities. The Commission has previously
established certain definitions of ``small entities'' to be used by the
Commission in evaluating the impact of its rules on small entities in
accordance with the RFA.\69\ The proposed regulations would affect
designated contract markets.
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\68\ 5 U.S.C. 601 et seq.
\69\ 47 FR 18618 (Apr. 30, 1982).
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The Commission has previously determined that designated contract
markets are not small entities for purposes of the RFA, and, thus, the
requirements of the RFA do not apply to designated contract
markets.\70\ Accordingly, the Chairman, on behalf of the Commission,
certifies pursuant to 5 U.S.C. 605(b) that the proposed regulations
would not have a significant economic impact on a substantial number of
small entities.
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\70\ Id. at 18619.
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B. Paperwork Reduction Act
As the Commission stated in the Proposal, this rulemaking does not
impose any new recordkeeping or information collection requirements, or
other collections of information that require approval of the Office of
Management and Budget under the Paperwork Reduction Act (``PRA''). All
recordkeeping or information collection requirements relevant to the
subject of this rulemaking, or discussed herein, already exist under
current law. The title for this collection of information is Core
Principles & Other Requirements for DCMs, OMB control number 3038-0052.
The Commission invited public comment on the accuracy of its estimate
that no additional recordkeeping or information collection requirements
or changes to existing collection requirements would result from the
Proposed Amendment. The Commission did not receive any comments that
addressed whether additional recordkeeping or information collection
requirements or changes to existing collection requirements would
result from the adoption of the Proposal. Nevertheless, the Commission
notes that the final rule will reduce the current burden estimate of
OMB control number 3038-0052. Accordingly, the Commission will, by
separate action, publish in the Federal Register a notice and request
for comment on the amended PRA burden associated with the final rule,
and submit to OMB an information collection request to amend the
information collection, in accordance with 44 U.S.C. 3506(c)(2)(A) and
5 CFR 1320.8(d).
The collections contained in this rulemaking are mandatory
collections. In formulating burden estimates for the collections in
this rulemaking, to avoid double accounting of information collections
that already have been assigned control numbers by OMB, or are covered
as burden hours in collections of information pending before OMB, the
PRA analysis provided in the rulemaking, along with the information
collection request (``ICR'') with burden estimates that were
incorporated into the rulemaking by reference and submitted to OMB,
accounted only burden estimates for collections of information that
have not previously been submitted to OMB. As such, the final rules do
not impose any new burden or any new information collection
requirements in addition to those that already exist.
C. Cost Benefit Considerations
1. Introduction
Section 15(a) of the Act requires the CFTC to consider the costs
and benefits of its actions before promulgating a regulation under the
Act or issuing certain orders.\71\ Section 15(a) of the Act further
specifies that the costs and benefits shall be evaluated in light of
five broad areas of market and public concern: (1) Protection of market
participants and the public; (2) efficiency, competitiveness, and
financial integrity of futures markets; (3) price discovery; (4) sound
risk management practices; and (5) other public interest
considerations. The CFTC considers the costs and benefits resulting
from its discretionary determinations with respect to the section 15(a)
factors below.
Where reasonably feasible, the CFTC endeavors to estimate
quantifiable costs and benefits. Where quantification is not feasible,
the CFTC identifies and describes costs and benefits qualitatively.
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\71\ 7 U.S.C. 19(a).
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The commentators to the CFTC's Proposal gave no negative comments
on the costs and benefits associated with the rule amendments. Indeed,
commentators were supportive of the CFTC's Proposal, in part due to
reduced costs and reduced complexity that the rule changes would
introduce.
2. Economic Baseline
The CFTC's economic baseline for the rule amendment analysis is the
requirements of Regulation 1.52 that currently exist prior to taking
into account the final amendments. Specifically, current Regulation
1.52 requires an SRO or a JAC to engage an examinations expert to
evaluate its supervisory program prior to its initial use, and to
evaluate the SRO's application of the supervisory program at least once
every three years after its initial use.
The Commission's rulemaking will not alter the requirement for an
SRO or JAC to engage an examinations expert to evaluate its supervisory
program prior to the initial use of the supervisory program. The
Commission, however, is eliminating the requirement that the
examinations expert must review the SRO's or JAC's ongoing application
of its supervisory program during periodic reviews and the analysis of
the supervisory program's design to detect material weaknesses in
internal controls during both periodic reviews and the initial review
prior to the program's initial use as such requirement is not
[[Page 12890]]
necessary due to Commission staff performing comparable reviews on a
routine, periodic basis as discussed below. The Commission also is
revising the frequency of when an SRO or a JAC must engage an
examinations expert, as discussed below.
The Commission's elimination of the requirement that an
examinations expert evaluate an SRO's or a JAC's application of its
supervisory program and the program's design to detect material
weaknesses in internal controls will reduce costs related to conducting
such review. However, the rulemaking will not substantially reduce the
benefits obtained from an evaluation of the SRO's and JAC's supervisory
program, including internal controls, as such reviews are performed by
Commission staff on a routine basis. Commission staff evaluates the
SRO's or JAC's execution of its supervisory program, including
performing detailed reviews of SRO and JAC examination work papers, to
assess the adequacy of the scope of the work performed by SRO and JAC
staff members and to determine whether the conclusions reached by SRO
and JAC staff members are supported by the work performed. Commission
staff also reviews at least annually all SRO and JAC examination
programs for conducting examinations of FCMs to assess the completeness
of such programs and to determine that such programs properly reflect
any regulatory updates, including rule amendments, adopted since the
Commission staff's previous review of the examination programs. Reviews
of execution and completeness of supervisory programs for FCMs occur no
less frequently than annually. Furthermore, Commission staff has a
particular expertise in assessing and reviewing whether registrants are
in compliance with Commission regulatory requirements that makes a
third-party review redundant.
The final amendments will continue to require that an examinations
expert review the FCM examination standards contained in the
supervisory program for consistency with PCAOB auditing standards as
such standards apply to a non-financial statement audit. The Commission
recognizes that examinations experts have a particular expertise in the
application of PCAOB auditing standards and can effectively evaluate
whether SRO and JAC FCM examination standards are consistent with such
auditing standards. The Commission, however, is revising the timeframe
for such reviews. Currently, Regulation 1.52 requires an SRO or JAC to
engage an examinations expert at least once every three years to
perform such a review. The Commission is amending Regulation 1.52 to
require an SRO or JAC to engage an examinations expert whenever the
PCAOB issues new or revised auditing standards that are material to the
SRO's or JAC's examination of member FCMs.
The examinations expert's review, however, is limited to only the
new or revised PCAOB auditing standards that have been issued since the
most recent prior review that are applicable to the SRO's or JAC's
examination of FCMs. Accordingly, the examinations expert will not have
to review all of the SRO's or JAC's FCM examination standards for
consistency with PCAOB audit standards. The amendments further require
an SRO or JAC to engage an examinations expert at least once every five
years even if the SRO or JAC determines that the PCAOB did not issue
new or revised auditing standards during the previous five-year period
that are material to its examinations of member FCMs. Based on past
experience, the Commission anticipates that the adoption of new or
revised auditing standards that are material to examination standards
applicable to FCMs will be infrequent and, therefore, the triggering of
an examinations expert review will also likely be an infrequent
event.\72\ Finally, the amendments provide that an SRO or JAC must
engage an examinations expert if directed to by the Director of the
Division of Swap Dealer and Intermediary Oversight.\73\
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\72\ Since 2016 PCAOB has adopted and the SEC has approved
approximately two new standards, neither of which had a significant
impact on the examination standards applicable to FCMs. See PCAOB
website available at: https://pcaobus.org/Standards/Pages/Current_Activities_Related_to_Standards.aspx.
\73\ For example, in circumstances where an SRO or JAC has not
engaged an examinations expert yet DSIO staff believes a material
change to PCAOB auditing standards warrants such engagement.
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The amendments to Regulation 1.52 are intended to streamline the
process under which examinations experts conduct their reviews and the
time period between those reviews. The Commission believes that these
amendments will make conducting the reviews more efficient and less
costly, while also continuing to provide the benefit the Commission and
public obtain from an independent assessment that SROs and JACs use
appropriate FCM examinations standard in the conduct of the oversight
of their member FCMs, which perform critical functions in both the
operation of the futures markets and in the protection of customer
funds.
The Commission does not anticipate that there will be any
significant increase in costs associated with the amendments. By
narrowing the intended scope of examination reviews from an evaluation
of the supervisory program to an assessment of the examinations
standards for conformity with auditing standards established by the
PCAOB as they apply to FCM examinations, the Commission is purposely
limiting the scope of the examinations expert's review. The Commission
anticipates that this limitation, coupled with extending the time
period between examinations experts' reviews, will reduce costs
associated with engaging and hiring an examinations expert.\74\
Nonetheless, the Commission believes that these amendments are
appropriately calibrated to ensure the integrity of the SRO and JAC
supervisory programs and continued oversight over the minimum financial
requirements at FCMs. As noted, Commission staff reviews no less
frequently than annually all SRO and JAC examination programs and
reviews on a routine and periodic basis the SRO' and JAC's application
of their supervisory programs. The Commission anticipates that its
staff will continue to perform such reviews as part of its routine
oversight of SROs and JACs. These Commission staff reviews will
continue to provide the benefits that have been associated with the
examinations experts' reviews.
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\74\ In 2013, the Commission found that it was not feasible to
quantify any costs associated with utilizing an examinations expert,
largely because several nationally recognized accounting firms
expressed their reluctance to provide such information. See,
Enhancing Protections Afforded Customers and Customer Funds Held by
Futures Commission Merchants and Derivatives Clearing Organizations,
78 FR, 68506, 68605 (Nov. 14, 2013). While it is also not feasible
to quantify such costs for the use of an examinations expert under
the final amendments, such costs are likely much less than the costs
under the existing rule.
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3. CEA Section 15(a) Factors
a. Protection of Market Participants and the Public
The Commission believes that these amendments maintain the current
level of protections of market participants and the public provided by
the current regulation. The amendments continue to protect market
participants and the public by ensuring that there is sufficient
oversight over the minimum financial requirements at FCMs. As noted,
the Commission believes that Commission staff is well-equipped to
provide reviews that will no longer be provided by outside examinations
experts and Commission staff intends to continue to conduct such
reviews.
[[Page 12891]]
b. Efficiency, Competitiveness, and Financial Integrity of Markets
The Commission believes that Regulation 1.52 as amended will
continue to help ensure that FCMs can meet their financial and
operational obligations to both customers and DCOs, which, along with
the Commission's ongoing reviews, will continue to foster the
efficiency and financial integrity of markets. The Commission has not
identified any effect of Regulation 1.52 on the competitiveness of
derivatives markets.
c. Price Discovery
The Commission has not identified any material effect of the
amendments on the price discovery process in futures and swap markets.
d. Sound Risk Management Practices
The Commission believes that Regulation 1.52 as amended, along with
the Commission's ongoing reviews, will continue to help ensure that
FCMs can meet their financial and operational obligations to both
customers and DCOs, which should continue to foster sound risk
management practices.
e. Other Public Interest Considerations
The Commission has not identified any additional public interest
considerations associated with the amendments.
f. Consideration of Alternatives
The Commission considered several alternative approaches that were
specified in the comments. In this regard, the Commission considered
the CME's suggestion to fully eliminate the requirement that a third-
party examinations expert perform periodic evaluations and assessments
of an SRO's program to oversee its member FCMs' compliance with
financial and related reporting requirements.\75\ The Commission has
elected to maintain the requirement for a third-party examinations
expert. The Commission, however, has further decided to eliminate the
requirement that the examinations expert periodically review the SRO's
or JAC's ongoing application of its supervisory program as Commission
staff routinely perform such reviews. The Commission further elected to
maintain the examinations expert's required reviews of an FCM's
examinations standards at a modified interval. As noted previously,
FCMs perform significant market functions, including holding customer
funds and guaranteeing customers' financial performance to DCOs. The
effective operation of these functions is necessary for the efficient
operation of the futures markets. The Commission believes that the SRO
or JAC examination program is a critical component of the overall
process for determining an FCM's compliance with regulatory
requirements and the FCM's ability to fulfill its financial
obligations. The Commission further believes that examinations experts
have a particular expertise in PCAOB auditing standards and can
effectively and efficiently evaluate whether SRO or JAC FCM examination
standards are consistent with such PCAOB auditing standards, which will
help ensure that the SRO and JAC examinations satisfy industry
standards for effective FCM audits.
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\75\ CME Comment Letter, p. 2.
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The Commission also considered the CME's and JAC's suggestion that
an SRO or JAC should be required to engage an examinations expert at
least once every ten years as opposed to the Commission's proposal of
once every five years.\76\ The Commission further considered the NFA's
request that the Commission consider whether a set time period between
reviews is even necessary given that the Director of DSIO is authorized
to direct an SRO or JAC to engage an examinations expert at any
time.\77\
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\76\ CME Comment Letter, p. 2; JAC Comment Letter, p. 1.
\77\ NFA Comment Letter, p. 3.
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As noted immediately above, the Commission believes that there are
significant benefits to customers, market participants, clearing
organizations, and the futures industry in general from SRO or JAC
supervisory programs that assess FCMs' compliance with SRO and CFTC
regulatory requirements. Such SRO and JAC reviews help ensure that FCMs
have the operational and financial capacity to meet their obligations
as market intermediaries, which is necessary for efficient markets. The
Commission further believes that such reviews should be performed at
least once every five years (and also when there are material and
relevant changes in PCAOB auditing standards) as required by the
amendments. While, as noted, Commission staff is well-equipped to
review the ongoing application of SRO and JAC supervisory programs and
intends to continue to do so at least annually, the Commission believes
that examinations experts are best equipped to perform evaluations of
examination standards for conformity with auditing standards
established by the PCAOB as they apply to non-financial statement
audits.
The Commission believes that a ten-year time period between
examinations experts' reviews is not appropriate at the current time
given that an SRO or JAC has not gone through an examinations expert's
review since the adoption of the initial requirements in 2013. While
the Commission recognizes that the final rule authorizes the director
of DSIO to instruct an SRO or JAC to engage an examinations expert any
time the PCAOB issues new or amended auditing standards, the Commission
believes that it should gain further experience with the operation of
the rule and develop a more thorough understanding of both the costs
and benefits associated with the examinations experts review before
considering amending the rule to expand the maximum period of time
between such reviews from five to ten years. The Commission further
notes that in the event that there are no changes in PCAOB auditing
standards that would materially impact FCM examination standards, SROs
and JACs may use existing processes for seeking regulatory relief under
Regulation 140.99 if they believe such relief is warranted based upon
the facts and circumstances.
The Commission also considered maintaining the current rule, but
the Commission anticipates that the amendments will significantly
reduce costs to SROs and JACs without materially impacting benefits.
D. Anti-Trust Considerations
Section 15(b) of the CEA requires the Commission to take into
consideration the public interest to be protected by the antitrust laws
and endeavor to take the least anticompetitive means of achieving the
purposes of the CEA, in issuing any order or adopting any Commission
rule or regulation.\78\
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\78\ 7 U.S.C. 19(b).
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The Commission believes that the public interest to be protected by
the antitrust laws is generally to protect competition. The Commission
has considered the amendments to Regulation 1.52 and comments received
to determine whether it is anticompetitive and has identified no
anticompetitive effects.
Because the Commission has determined that the amendments to
Regulation 1.52 are not anticompetitive and have no anticompetitive
effects, the Commission has not identified any less anticompetitive
means of achieving the purposes of the CEA.
List of Subjects in 17 CFR Part 1
Brokers, Commodity futures, Consumer protection, Reporting and
recordkeeping requirements.
[[Page 12892]]
For the reasons stated in the preamble, the Commodity Futures
Trading Commission amends 17 CFR part 1 as follows:
PART 1--GENERAL REGULATIONS UNDER THE COMMODITY EXCHANGE ACT
0
1. The authority citation for part 1 continues to read as follows:
Authority: 7 U.S.C. 1a, 2, 5, 6, 6a, 6b, 6c, 6d, 6e, 6f, 6g, 6h,
6i, 6k, 6l, 6m, 6n, 6o, 6p, 6r, 6s, 7, 7a-1, 7a-2, 7b, 7b-3, 8, 9,
10a, 12, 12a, 12c, 13a, 13a-1, 16, 16a, 19, 21, 23, and 24 (2012).
0
2. Amend Sec. 1.52 as follows:
0
a. Revise paragraphs (c)(2)(ii) through (v);
0
b. Remove paragraphs (c)(2)(vi) and (vii);
0
c. Revise paragraphs (d)(2)(ii)(F) through (I);
0
d. Remove paragraphs (d)(2)(ii)(J) and (K); and
0
e. Revise paragraph (d)(2)(iii).
The revisions read as follows:
Sec. 1.52 Self-regulatory organization adoption and surveillance of
minimum financial requirements.
* * * * *
(c) * * *
(2) * * *
(ii) The supervisory program must, at a minimum, have examination
standards addressing the following:
(A) The ethics of an examiner;
(B) The independence of an examiner;
(C) The supervision, review, and quality control of an examiner's
work product;
(D) The evidence and documentation to be reviewed and retained in
connection with an examination;
(E) The sampling size and techniques used in an examination;
(F) The examination risk assessment process;
(G) The examination planning process;
(H) Materiality assessment;
(I) Quality control procedures to ensure that the examinations
maintain the level of quality expected;
(J) Communications between an examiner and the regulatory oversight
committee, or the functional equivalent of the regulatory oversight
committee, of the self-regulatory organization of which the futures
commission merchant is a member;
(K) Communications between an examiner and a futures commission
merchant's audit committee of the board of directors or other similar
governing body;
(L) Analytical review procedures;
(M) Record retention; and
(N) Required items for inclusion in the examination report, such as
repeat violations, material items, and high risk issues. The
examination report is intended solely for the information and use of
the self-regulatory organizations and the Commission, and is not
intended to be and should not be used by any other person or entity.
(iii)(A) Prior to the initial implementation of the supervisory
program, a self-regulatory organization must engage an examinations
expert to evaluate the examination standards for consistency with
auditing standards issued by the Public Company Accounting Oversight
Board as such auditing standards are applicable in the context of the
self-regulatory organization's examination of its futures commission
merchant members. At least once every five years after the initial
implementation of the supervisory program, a self-regulatory
organization must engage an examinations expert to evaluate the
examination standards for consistency with any new or amended auditing
standards issued by the Public Company Accounting Oversight Board since
the previous review performed by the examinations expert. At the
conclusion of each evaluation, a self-regulatory organization must
obtain a written report from the examinations expert in accordance with
paragraph (c)(2)(iii)(C) of this section.
(B) Notwithstanding paragraph (c)(2)(iii)(A) of this section, a
self-regulatory organization must review any new or amended auditing
standards issued by the Public Company Accounting Oversight Board, and
must revise its examination standards promptly to reflect any changes
in such auditing standards that are applicable in the context of the
self-regulatory organization's examination of its futures commission
merchant members. A self-regulatory organization must engage an
examinations expert to evaluate any material revisions that the self-
regulatory organization makes to the examination standards to conform
such standards with the Public Company Accounting Oversight Board's
auditing standards, or if directed to engage an examinations expert by
the Director of the Division of Swap Dealer and Intermediary Oversight.
At the conclusion of each review, a self-regulatory organization must
obtain a written report from the examinations expert in accordance with
paragraph (c)(2)(iii)(C) of this section.
(C) At the conclusion of the examinations expert's engagement
pursuant to paragraph (c)(2)(iii)(A) or (B) of this section, the self-
regulatory organization must obtain from the examinations expert a
written report on findings and recommendations issued under the
consulting services standards of the American Institute of Certified
Public Accountants. The self-regulatory organization must provide the
Director of the Division of Swap Dealer and Intermediary Oversight with
a copy of the examinations expert's written report, and the self-
regulatory organization's written responses to any of the examinations
expert's findings and recommendations, within thirty days of the
receipt thereof. Upon resolution of any questions or comments raised by
the Division of Swap Dealer and Intermediary Oversight, and upon
written notice from the Division of Swap Dealer and Intermediary
Oversight that it has no further comments or questions on the
examinations standards as amended (by reason of the examinations
expert's proposals, consideration of the Division of Swap Dealer and
Intermediary Oversight's questions or comments, or otherwise), the
self-regulatory organization shall commence applying such examinations
standards for examining its registered futures commission merchant
members for all examinations conducted with an ``as of'' date later
than the date of the Division of Swap Dealer and Intermediary's written
notification.
(iv) The supervisory program must require the self-regulatory
organization to report to its risk and/or audit committee of the board
of directors, or a functional equivalent committee, with timely reports
of the activities and findings of the supervisory program to assist the
risk and/or audit committee of the board of directors, or a functional
equivalent committee, to fulfill its responsibility of overseeing the
examination function.
(v) The examinations expert's written report, the self-regulatory
organization's response, if any, as well as any information concerning
the supervisory program is confidential.
(d) * * *
(2) * * *
(ii) * * *
(F) The Joint Audit Program must include examination standards
addressing the items listed in paragraph (c)(2)(ii) of this section.
(G)(1) Prior to the initial implementation of the Joint Audit
Program, the Joint Audit Committee must engage an examinations expert
to evaluate the examination standards for consistency with auditing
standards issued by the Public Company Accounting Oversight Board as
such auditing standards are applicable in the context of the Joint
Audit Committee's
[[Page 12893]]
examination of its futures commission merchant members. At least once
every five years after the initial implementation of the Joint Audit
Program, the Joint Audit Committee must engage an examinations expert
to evaluate the examination standards for consistency with any new or
amended auditing standards issued by the Public Company Accounting
Oversight Board since the previous review performed by the examinations
expert. At the conclusion of each review, the Joint Audit Committee
must obtain a written report from the examinations expert in accordance
with paragraph (d)(2)(ii)(G)(3) of this section.
(2) Notwithstanding paragraph (d)(2)(ii)(G)(1) of this section, the
Joint Audit Committee must review any new or amended auditing standards
issued by the Public Company Accounting Oversight Board, and must
revise its examination standards promptly to reflect any changes in
such auditing standards that are applicable in the context of the Joint
Audit Committee's examination of its futures commission merchant
members. The Joint Audit Committee must engage an examinations expert
to evaluate any material revisions that the Joint Audit Committee makes
to the examination standards to conform such standards with the Public
Company Accounting Oversight Board's auditing standards, or if directed
to engage an examinations expert by the Director of the Division of
Swap Dealer and Intermediary Oversight. The Joint Audit Committee must
obtain a written report from the examinations expert in accordance with
paragraph (d)(2)(ii)(G)(3) of this section.
(3) At the conclusion of the examinations expert's engagement
pursuant to paragraph (d)(2)(ii)(G)(1) or (2) of this section, the
Joint Audit Committee must obtain from the examinations expert a
written report on findings and recommendations issued under the
consulting services standards of the American Institute of Certified
Public Accountants. The Joint Audit Committee must provide the Director
of the Division of Swap Dealer and Intermediary Oversight with a copy
of the examinations expert's written report, and the Joint Audit
Committee's written responses to any of the examinations expert's
findings and recommendations, within thirty days of the receipt
thereof. Upon resolution of any questions or comments raised by the
Division of Swap Dealer and Intermediary Oversight, and upon written
notice from the Division of Swap Dealer and Intermediary Oversight that
it has no further comments or questions on the examinations standards
as amended (by reason of the examinations expert's proposals,
consideration of the Division of Swap Dealer and Intermediary
Oversight's questions or comments, or otherwise), the Joint Audit
Committee shall commence applying such examinations standards for
examining its registered futures commission merchant members for all
examinations conducted with an ``as of'' date later than the date of
the Division of Swap Dealer and Intermediary's written notification.
(H) The Joint Audit Program must require the Joint Audit Committee
members to report to their respective risk and/or audit committee of
their respective board of directors, or a functional equivalent
committee, with timely reports of the activities and findings of the
Joint Audit Program to assist the risk and/or audit committee of the
board of directors, or a functional equivalent committee, to fulfill
its responsibility of overseeing the examination function.
(I) The examinations expert's written report, the Joint Audit
Committee's response, if any, as well as any information concerning the
supervisory program is confidential.
(iii) Meetings of the Joint Audit Committee. (A) The Joint Audit
Committee members must meet at least once each year. During such
meetings, the Joint Audit Committee members shall consider revisions to
the Joint Audit Program as a result of regulatory changes, revisions to
the examination standards resulting from new or amended auditing
standards issued by the Public Company Accounting Oversight Board, or
the results of an examinations expert's review.
(B) In addition to the items considered in paragraph (d)(2)(iii)(A)
of this section, the Joint Audit Committee members must consider the
following items during the meetings:
(1) Coordinating and sharing information between the Joint Audit
Committee members, including issues and industry concerns in connection
with examinations of futures commission merchants;
(2) Identifying industry regulatory reporting issues and financial
and operational internal control issues and modifying the Joint Audit
Program accordingly;
(3) Issuing risk alerts for futures commission merchants and/or
designated self-regulatory organization examiners on an as-needed
basis;
(4) Responding to industry issues; and
(5) Providing industry feedback to Commission proposals.
(C) Minutes must be taken of all meetings and distributed to all
members on a timely basis.
(D) The Director of the Division of Swap Dealer and Intermediary
Oversight must receive timely prior notice of each meeting, have the
right to attend and participate in each meeting and receive written
copies of the minutes required pursuant to paragraph (d)(2)(iii)(C) of
this section, respectively.
* * * * *
Issued in Washington, DC, on March 29, 2019, by the Commission.
Robert Sidman,
Deputy Secretary of the Commission.
Note: The following appendices will not appear in the Code of
Federal Regulations.
Appendices to Financial Surveillance Examination Program Requirements
for Self-Regulatory Organizations
Appendix 1--Commission Voting Summary
On this matter, Chairman Giancarlo and Commissioners Quintenz,
Behnam, Stump, and Berkovitz voted in the affirmative. No
Commissioner voted in the negative.
Appendix 2--Statement of Chairman J. Christopher Giancarlo
This Project KISS final rule regarding financial surveillance
examination program requirements for self-regulatory organizations
(SROs) will revise and appropriately limit the scope of a third-
party expert's evaluation of a SRO's financial surveillance program,
and extend the minimum timeframes from three to five years from when
a SRO must engage a third-party expert to evaluate its FCM standards
for consistency with certain auditing standards. All of the comments
received were in support of this proposal. I also support it because
it will reduce the burdens and costs for SRO examinations, without
reducing their effectiveness. It also more appropriately balances
and recognizes the role and capabilities of the Commission's
oversight expertise.
Appendix 3--Statement of Commissioner Dan. M. Berkovitz
I support the targeted amendments to Commission Regulation 1.52
made in today's final rules regarding third-party expert
examinations of self-regulatory organization (``SRO'') financial
surveillance programs. The amendments adopted in these final rules
are an outgrowth of the Commission's experience with Regulation 1.52
since 2013, and they maintain the Commission's strong commitment to
customer protection while modifying certain requirements found to
provide no incremental regulatory benefit. The Commission's customer
protection rules are fundamental to safeguarding customer assets,
promoting the safety and soundness of U.S. derivatives markets, and
maintaining public confidence in our markets. I strongly support
these customer protection rules.
[[Page 12894]]
Regulation 1.52 is part of the Commission's comprehensive
framework for the protection of customers and customer funds. The
rules require that SROs, including contract markets and registered
futures associations, monitor member FCMs' compliance with financial
and related reporting rules.\1\ In 2013, the Commission
significantly enhanced its customer protection rules to provide
customers with greater confidence that their funds are secure and
that SROs have effective programs for the oversight of member FCMs.
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\1\ Regulation 1.52 also permits two or more SROs to file a plan
with the Commission for delegating to another SRO certain
responsibilities related to monitoring and examining FCMs'
compliance with financial and related reporting requirements. SROs
participating in such a plan form a Joint Audit Committee (``JAC''),
and prepare a Joint Audit Plan in accordance with the requirements
of Regulation 1.52. The amendments to Regulation 1.52 adopted in
today's final rules also address the JAC's engagement of third-party
experts, as applicable.
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The narrow amendments we are adopting address an SRO's
engagement of a third-party expert to evaluate its financial
surveillance program. With experience, the Commission has determined
that third-party experts are appropriate to assess an SRO's
implementation of examination standards issued by the Public Company
Accounting Oversight Board (``PCAOB''). Commission staff is better
positioned and has the expertise to evaluate an SRO's oversight
program as measured against the Commission's rules. Commission staff
routinely conducts such evaluations and provides feedback to SROs.
The final rules also make additional amendments to Regulation
1.52 regarding, for example, the frequency with which SROs must
engage a third-party expert. Changes to relevant PCAOB standards are
infrequent, and the final rules require an SRO to engage a third-
party expert at least once every five years. As a further safeguard,
Commission staff retains the authority to direct an SRO to engage a
third-party expert when relevant changes in PCAOB standards occur.
I thank the CFTC staff for their work on these final rules and
for their responsiveness to questions and comments.
[FR Doc. 2019-06443 Filed 4-2-19; 8:45 am]
BILLING CODE 6351-01-P