DIVISION OF TRADING AND MARKETS

FINANCIAL AND SEGREGATION INTERPRETATION NO. 3

Interpretation Relating to Secured Receivables

        The Division of Trading and Markets has recently received an inquiry from a Contract Market in which the Contract Market requested several interpretations of the Commission's minimum financial regulations. The Division believes that the interpretations requested by the Contract Market are applicable to all futures commission merchants ("FCMs"). For that reason, the Division has decided to issue a formal interpretation in response to the inquiry.

        The Contract Market asked the following questions:

1.   Can customers' deficits be considered secured by commissions withheld from those customers' account executives?

        Section 1.17(c)(3) of the Commission's regulations provides that:

A loan or advance or any other form of receivable shall not be considered "secured" for the purposes of paragraph (c)(2) of this section unless the following conditions exist:

(i) The receivable is secured by readily marketable collateral which is otherwise unencumbered and which can be readily converted into cash equal to or in excess of that part of the receivable which is shown in the applicant's or registrant's records as secured; and

(ii)(A) The readily marketable collateral is in the possession or control of the applicant or registrant; or

(B) The applicant or registrant has a legally enforceable, written security agreement, signed by the debtor, and has a perfected security interest in the readily marketable collateral within the meaning of the laws of the State in which the readily marketable collateral is located.

        Customer deficits normally represent debts of the customers to the FCM and are not the debts of those customers' account executives. Unless the account executives agree to allow the FCM to withhold commissions from them to secure their cutomers' deficits, commissions payable to those account executives would not be otherwise encumbered, and therefore would not constitute adequate security in accordance with the above definition. Consequently, commissions owed to account executives cannot be considered adequate security for customer deficits unless there are legally enforceable written agreements between the FCM and the account executives which specifically provide that the FCM can withhold commissions due the account executives to cover customer deficits. These arrangements must also specify the manner in which commissions will be withheld and the extent to which they may be withheld.

        In order to treat commissions payable as security for deficits, the FCM must not only demonstrate its ability to withhold commissions, but must also be able to show that it actually has withheld the applicable commissions. In addition, the FCM must continue to withhold the commissions until the customer has repaid the deficit. Deficits can only be considered secured to the extent that commissions can be and have been withheld. For example, if an FCM has a customer account that is in deficit by $30,000 and has withheld commissions of $10,000 from the customer's account executive, the FCM may treat only $10,000 of the deficit as secured.

        We also want to point out that commissions withheld from account executives to secure deficits must be reflected as liabilities, whenever the FCM prepares a capital computation. These liabilities would also have to be included in aggregate indebtedness because they are not adequately collateralized. In addition, commissions withheld from account executives cannot be used to offset or reduce the applicable safety factor charges for undermargined accounts because those commissions do not represent margin payments made by customers.

2.   Should the following situations be treated as advances on cash commodities1 or as secured receivables?

Situation A. An FCM makes a loan to a customer, the proceeds of which are credited to the customer's commodity futures trading account. The customer in turn deposits commodity warehouse receipts with the FCM to secure the loan.

To the extent of the current market value of the warehouse receipts, this would be treated as a secured receivable. This secured receivable would be a current asset, and there would be no applicable charge against net capital. If the outstanding amount of the loan exceeds the market value of the warehouse receipts, the difference must be classified as a non-current asset.

Situation B. A customer takes delivery on a commodity futures contract, but does not have sufficient equity in his or her account to pay for the delivery. The FCM finances the delivery for the customer, and retains possession of the cash commodities or the warehouse receipts which are the subject of the delivery.

This receivable should be treated in the same manner as the receivable described in Situation A above.

        There seems to be a considerable amount of confusion concerning the term "advances on cash commodities" as it is used in the Commission's minimum financial requirements. We feel, therefore, that we should clarify the meaning of that term. For purposes of clarification, an advance on cash commodities would only arise in a situation where an FCM has entered into a contract to purchase cash commodities for future delivery and in connection with that contract makes an unsecured advance to the seller representing a portion of the purchase price.

        The statements made in this interpretation are not rules or interpretations of the Commodity Futures Trading Commission, nor are they published as bearing the Commission's official approval; they represent interpretations and practices followed by the Division of Trading and Markets in administering the financial and segregation requirements of the Commodity Exchange Act and the regulations thereunder.

FOR FURTHER INFORMATION CONTACT: Paul H. Bjarnason, Jr., Chief Accountant, Division of Trading and Markets, Commodity Futures Trading Commission, (202) 418-5430.

Issued in Washington, D.C., on May 9, 1979, by the Division of Trading and Markets.

ANDREA M. CORCORAN

DIRECTOR


1 Regulation 1.17(c)(2)(ii) provides that the term "current assets" shall exclude unsecured receivables, advances, and loans with certain specified exceptions. One exception is receivables resulting from the marketing of inventories commonly associated with the business activities of the FCM, and advances on fixed price purchase commitments. However, such receivables or advances can be considered current assets only if they have been outstanding no longer than 3 calendar months from the date they are accrued.

        Regulation 1.17(c)(5) provides for certain charges which an FCM must deduct from net capital to arrive at adjusted net capital. One of these charges is the amount by which any advances paid by the FCM on cash commodity contracts and used in computing net capital exceeds 95% of the market value of the commodities covered by such contracts.