Regulation of Off-Exchange Retail Foreign Exchange Transactions and Intermediaries

Federal RegisterJan 20, 2010

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COMMODITY FUTURES TRADING COMMISSION

17 CFR Parts 1, 3, 4, 5, 10, 140, 145, 147, 160, and 166

RIN 3038-AC61

Regulation of Off-Exchange Retail Foreign Exchange Transactions and Intermediaries

AGENCY:

Commodity Futures Trading Commission.

ACTION:

Proposed rules.

SUMMARY:

The Commodity Futures Trading Commission (“Commission” or “CFTC”) is proposing to adopt a comprehensive regulatory scheme (“Proposal”) to implement the CFTC Reauthorization Act of 2008 (“CRA”)

with respect to off-exchange transactions in foreign currency with members of the retail public (

i.e.,

“retail forex transactions”). The Commodity Exchange Act, as amended by the CRA, generally provides that the Commission's jurisdiction extends to contracts of sale of a commodity for future delivery (or an option on such a contract) or an option (other than an option executed or traded on a national securities exchange), and to certain leveraged or margined contracts in foreign currency that are offered to or entered into with retail customers. The Commission is proposing a scheme that would put in place requirements for, among other things, registration, disclosure, recordkeeping, financial reporting, minimum capital, and other operational standards, based on both the CFTC's existing regulations for commodity interest transactions and commodity interest intermediaries, as well as rules of the National Futures Association (“NFA”) that are already existing with respect to retail forex transactions offered by NFA's members. Additionally, the Proposal would amend existing regulations as needed to clarify their application to, and inclusion in, the new regulatory scheme for retail forex.

Food, Conservation, and Energy Act of 2008, Pub. L. 110-246,

122 Stat. 1651, 2189-2204 (2008).

DATES:

Comments must be received on or before March 22, 2010.

ADDRESSES:

You may submit comments, identified by RIN 3038-AC61, by any of the following methods:

•

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

Follow the instructions for submitting comments.

•

E-mail: secretary@cftc.gov.

Include “Regulation of Retail Forex” in the subject line of the message.

•

Fax:

(202) 418-5521.

•

Mail:

Send to David Stawick, Secretary, Commodity Futures Trading Commission, 1155 21st Street, NW., Washington, DC 20581.

•

Courier:

Same as Mail above.

All comments received will be posted without change to

http://www.cftc.gov,

including any personal information provided.

FOR FURTHER INFORMATION CONTACT:

For information regarding financial and related reporting requirements, contact: Thomas Smith, Chief Accountant and Deputy Director, Division of Clearing and Intermediary Oversight, 1155 21st Street, NW., Washington, DC 20581.

Telephone number:

202-418-5495;

facsimile number:

202-418-5547; and

electronic mail: tsmith@cftc.gov

. Jennifer Bauer, Special Counsel, Division of Clearing and Intermediary Oversight, Division of Clearing and Intermediary Oversight, 1155 21st Street, NW., Washington, DC 20581.

Telephone number:

202-418-5472;

facsimile number:

202-418-5547; and

electronic mail: jbauer@cftc.gov

For all other information contact: William Penner, Deputy Director, Division of Clearing and Intermediary Oversight, 1155 21st Street, NW., Washington, DC 20581.

Telephone number:

202-418-5450;

facsimile number:

202-418-5547; and

electronic mail: wpenner@cftc.gov

. Christopher Cummings, Special Counsel, Division of Clearing and Intermediary Oversight, 1155 21st Street, NW., Washington, DC 20581.

Telephone number

(202) 418-5450;

facsimile number:

202-418-5547; and

electronic mail: ccummings@cftc.gov

Peter Sanchez, Special Counsel, Division of Clearing and Intermediary Oversight, 1155 21st Street, NW., Washington, DC 20581.

Telephone number

(202) 418-5450;

facsimile number:

202-418-5547; and

electronic mail: psanchez@cftc.gov

SUPPLEMENTARY INFORMATION:

The CRA provides the Commission with broad authority to “make, promulgate and enforce such rules and regulations as, in the judgment of the Commission, are reasonably necessary to effectuate any of the provisions of [the Commodity Exchange] Act” in connection with off-exchange foreign currency futures, options, and options on futures, as well as leveraged off-exchange contracts offered to or entered into with retail customers.

The Commission is given similarly broad authority to promulgate and enforce rules regarding registration of persons who solicit, exercise discretionary trading authority or operate or solicit funds in connection with any of these types of transactions.

See,

7 U.S.C. 2(c)(2)(B)(v) and 7 U.S.C. 2(c)(2)(C)(ii)(III).

See,

7 U.S.C. 2(c)(2)(B)(iv)(III) and 7 U.S.C. 2(c)(2)(C)(iii)(III).

Pursuant to this authority, the Commission is proposing a scheme that would put in place requirements for, among other things, registration, disclosure, recordkeeping, financial reporting, minimum capital, and other operational standards, based on both the CFTC's existing regulations for commodity interest transactions and commodity interest intermediaries, as well as rules of the National Futures Association (“NFA”) that are already existing with respect to retail forex transactions offered by NFA's members.

Subject to certain exceptions (

e.g.,

for certain regulated financial intermediaries not under the Commission's jurisdiction as established in the CRA), the Proposal would require persons offering to be or acting as counterparties to retail forex transactions but not primarily or substantially engaged in the exchange traded futures business, to register as retail foreign exchange dealers (“RFEDs”) with the CFTC. Registered futures commission merchants (“FCMs”) that are “primarily or substantially” (as defined in the Proposal) engaged in the activities set forth in the Act's definition of an FCM would be permitted to engage in retail forex transactions without also registering as RFEDs.

The Proposal would further require certain entities other than RFEDs and FCMs that intermediate retail forex transactions to register with the Commission as introducing brokers (“IBs”), commodity trading advisors (“CTAs”), commodity pool operators (“CPOs”), or associated persons (“APs”) of such entities, as appropriate, and to be subject to the Act and regulations applicable to that registrant category. In addition, the Proposal would require any IB that introduces retail forex transactions to an RFED or FCM to be guaranteed by that RFED or FCM.

The Proposal would also implement the $20 million minimum net capital standard established in the CRA for registering as an RFED or offering retail forex transactions as an FCM; propose an additional volume-based minimum capital threshold calculated on the amount an FCM or RFED owes as counterparty to retail forex transactions; and require RFEDs or FCMs engaging in retail forex transactions to collect security deposits in a minimum amount in order to prudentially limit the leverage available to their retail

customers on such transactions at 10 to 1.

I. Background

A. The Commodity Futures Trading Commission Act of 1974

Congress created the Commission in 1974 as an independent agency with the mandate to regulate commodity futures and option markets in the United States by the enactment of the Commodity Futures Trading Commission Act of 1974.

While the bill was being considered, the Department of the Treasury (“Treasury”) sent a letter to the Senate Committee with jurisdiction over the bill, expressing concerns that Treasury had regarding the effect that passage would have on the off-exchange foreign currency (“forex”) market that existed at the time between large, institutional customers.

The letter contained proposed language for the bill which would have maintained the

status quo

for institutional off-exchange forex trading, leaving jurisdiction over on-exchange trading in futures and options contracts on forex with the newly-created Commission. The bill was subsequently amended to add the suggested language contained in Treasury's letter, which was intended to give the Commission jurisdiction over retail forex transactions and to exclude from the Commission's jurisdiction the off-exchange, institutional “interbank” market in foreign currencies. This language, which has come to be known as the “Treasury Amendment,” provided that:

Public Law 93-643, 88 Stat. 1389 (1974).

See,

Letter from Donald L.E. Ritger, Acting General Counsel, Department of the Treasury, to the Hon. Herman E. Talmadge (July 30, 1974),

reprinted at

1974 U.S.C.C.A.N. 5843, 5887-89.

Nothing in this Act shall be deemed to govern or in any way be applicable to transactions in foreign currency * * * unless such transactions involve the sale thereof for future delivery conducted on a board of trade.

Id.

at 51.

As is discussed below, over time, and on numerous occasions, the Commission and the courts have opined on the proper boundaries of this exclusion.

The Commission first addressed the possible scope of the Treasury Amendment with regard to off-exchange transactions in securities issued by the Government National Mortgage Association (“GNMA”). In an interpretive letter issued by the Commission's Office of General Counsel, Commission staff stated that the remarks by the Senate Committee were

an expression that regulation by the Commission is unnecessary where there exists an informal market among institutional participants in transactions for future delivery in the specified financial instruments only so long as it is supervised by those agencies having regulatory responsibility over those participants. However, where that market is not supervised and where those transactions are conducted with participation by members of the general public, we do not understand the Committee to have intended that a regulatory gap should exist. In these circumstances, we believe the Commodity Exchange Act should be construed broadly to assure that the public interest will be protected by Commission regulation of those transactions.

Dealers in GNMA Certificates as a Board of Trade

, CFTC Staff Interpretive Letter No. 77-12, [1977-1980 Transfer Binder] Comm. Fut. L. Rep. (CCH) ¶ 20,467 (Aug. 17, 1977).

The scope of the exclusion, again with regard to off-exchange transactions in GNMA securities, was addressed by the U.S. Court of Appeals for the Seventh Circuit (“Seventh Circuit”) when it determined that the Treasury Amendment did not exclude options on government securities from the Commission's authority.

Specifically, the court determined that although trading in GNMA securities was excluded from the Commission's jurisdiction, trading in options on such instruments was within the Commission's authority. As the court stated:

Board of Trade of Chicago

SEC

, 677 F. 2d 1137, 1154 (7th Cir. 1982),

vacated as

moot,

459 U.S. 1026 (1982).

From the legislative history, it is quite clear that the Treasury Amendment was adopted by Congress only to prevent dual regulation by the CFTC and bank regulatory agencies of the banks and other sophisticated institutions that ordinarily trade in financial instruments.

Id.

at 1154.

Following that discussion, in 1985, the Commission issued a Statutory Interpretation concerning the Treasury Amendment that specifically dealt with forex.

Responding to reports that forex futures contracts were being offered to retail customers on an off-exchange basis, under the assumption that such transactions were excluded from the Commission's jurisdiction, the Commission reaffirmed and republished its views, as follows:

Trading in Foreign Currencies for Future Delivery

, 50 FR 42983 (Oct. 23, 1985).

[T]he Commission wishes to make very clear that any marketing to the general public of futures transactions in foreign currencies conducted outside the facilities of a contract market is strictly outside the scope of the [Treasury] Amendment. As a result, such an off-exchange offer or sale of futures contracts involving foreign currencies is unlawful under section 4(a) of the Act,

7 U.S.C. 6(a) (1982).

Id.

at 42985.

The boundaries of the Treasury Amendment were again tested in

Salomon Forex

Tauber

where a sophisticated investor sought to invalidate a multi-million dollar trading debt by claiming that the Treasury Amendment only excluded spot or forward forex transactions from the Commission's jurisdiction, and that trading in off-exchange futures and options were within the Commission's regulatory authority. If such transactions were deemed to be within the Commission's authority, then the transactions could only occur legally on an approved exchange. The Court determined that the Treasury Amendment excluded off-exchange trading in futures and options as well as “spot” and “forward” transactions from the Commission's authority, if it involved “sophisticated, large-scale foreign currency traders.”

Although this holding has sometimes been misinterpreted to imply that off-exchange forex transactions with the general public were outside the Commission's jurisdiction, this holding concerned only large-scale traders and banks that made up the informal network of the foreign currency “interbank” market. Indeed, the Court itself noted that: “[t]his case does not involve mass marketing to small investors, which would appear to require trading through an exchange and our holding in no way implies that such marketing is exempt from the CEA.”

795 F. Supp. 768 (E.D. Va. 1992),

aff'd

, 8 F.3d 966 (4th Cir. 1993).

Id.

at 978.

Id.

B. The Futures Trading Practices Act of 1992

The Futures Trading Practices Act of 1992 reorganized certain sections of the Commodity Exchange Act, 7 U.S.C. 1,

et seq.

(2000) (the “Act”) and gave the Commission significant exemptive authority over the activities of a wide variety of persons, including FCMs, CTAs, and CPOs.

It was pursuant to this exemptive authority that the Commission addressed some aspects of the over-the-counter (“OTC”) markets by adopting Part 35 of its regulations, which provides an exemption from regulation for certain swap agreements.

However, the Commission did not use its newly-

granted exemptive authority in the context of retail forex.

See, Exemption for Certain Swap Agreements

, 58 FR 5587 (Jan. 22, 1993).

See, e.g.,

Sections 4(c) and 4(d) of the Act, 7 U.S.C. 6(c) and 6(d).

Rather, the Commission's efforts were directed to combating forex fraud activities through increased enforcement and public awareness. In response to increased fraud activity in the forex markets, the CFTC issued a fraud advisory to the public on March 30, 1998.

Notwithstanding the Commission's guidance and the legislative history, the ambiguity of the Treasury Amendment continued to present opportunities for defendants to challenge the Commission's jurisdiction in the courts, which consumed much of the Commission staff's time and resources.

Unfortunately, these challenges would persist until the adoption of the Commodity Futures Modernization Act of 2000 (“CFMA”).

Fraud Advisory from the CFTC: Foreign Currency Trading (Forex) Fraud, available at: http://www.cftc.gov/customerprotection/fraudawarenessandprevention/fraudadvisories/fraudadv_forex.html.

The Commission also issued brochures to alert customers to the possible scams involving forex fraud.

See CFTC Brochure on Forex Fraud, available at: http://www.cftc.gov/enf/enf-forex.htm

and

http://www.cftc.gov/stellent/groups/public/@cpfraudawarenessandprotection/documents/file/enfforexbrochure.pdf

(last visited Oct. 15, 2009).

For instance, in

Dunn & Delta Consultants, Inc.

CFTC,

519 U.S. 465, 469 (1997), the U.S. Supreme Court held that foreign currency options were “transactions in foreign currency” within the meaning of the Treasury Amendment.

Consolidated Appropriations Act of 2001, Public Law 106-554, App. E, 114 Stat. 2763 (2000),

available at

Commodity Futures Modernization Act of 2000, [2000-2002 Transfer Binder] Comm. Fut. L. Rep. (CCH) ¶ 28,433 (Dec. 21, 2000).

Under the Treasury Amendment, retail forex transactions were excluded from the Commission's jurisdiction unless they were conducted on a “board of trade.” This broad phrase caused further confusion when courts tried to interpret its meaning in order to delineate where the Commission's jurisdiction ended. The U.S. Court of Appeals for the Ninth Circuit (“Ninth Circuit”) relied on the language in the Senate Committee report to interpret the clause and believed that a proper reading of the Treasury Amendment excluded all off-exchange forex transactions—even with retail customers—from the Commission's jurisdiction and that the Commission only had jurisdiction over forex transactions traded on organized exchanges.

Other courts interpreting the same clause came to the conclusion that retail off-exchange forex transactions were within the Commission's jurisdiction and that the legislative history indicates that only large institutional trades were intended to be excluded from the Commission's oversight.

CFTC

Frankwell Bullion

Ltd.,

99 F. 3d 299 (9th Cir. 1996).

See, CFTC

Baragosh,

278 F.3d 319 (4th Cir. 2002), which relied on the Conference Committee Report, not mentioned in

Frankwell Bullion,

to arrive at the opposite conclusion from the Ninth Circuit;

see also,

Proposed Regulation 5.1(g).

See,

H.R. Rep. No. 110-627, at 980 (2008) (Conf. Rep.).

The enactment of the CFMA permitted registered FCMs and certain of their unregistered affiliates to act as counterparties to retail forex transactions, but it did not specifically require that intermediaries such as introducing brokers, account managers or pool operators be registered in order to engage in forex transactions with retail participants. This created problems when unregistered entities began soliciting retail customers. The lack of vetting by a regulatory agency or an SRO created a situation where members of the general public were being solicited by entities and persons regarding whom they were unable to obtain any background information. In some cases, persons banned from registering in the futures industry as a result of past misconduct were operating as unregistered intermediaries in retail forex transactions because of the lack of minimum requirements to operate in the forex business. Pursuant to the CRA, certain affiliates of FCMs may continue to be proper forex counterparties if the affiliated FCM makes and keeps the risk assessment records required in Section 4f(c)(2)(B) of the Act and the affiliate has at least $20 million in adjusted net capital.

However, under the proposed regulations, the affiliates will have to register in the appropriate capacity in order to serve as a counterparty.

See,

7 U.S.C. 2(c)(2)(B)(i)(II)(cc)(BB).

Proposed Regulation 5.3 imposes the registration requirements called for by the CRA upon specified categories of persons intermediating retail forex transactions. RFEDs are required to register as such.

FCMs not “primarily or substantially” engaged in FCM business are required to register as RFEDs,

and FCM-affiliated persons that serve as retail forex counterparties are also required to register as RFEDs.

Persons introducing forex accounts are required to register as IBs.

Operators

of pooled investment vehicles that engage in retail forex transactions are required to register as CPOs, and persons providing forex trading advice are required to register as CTAs.

Finally, associated persons of all of the foregoing are required to register as APs.

See,

proposed Regulation 5.3(a)(6).

See,

proposed Regulation 5.3(a)(4).

See,

proposed Regulation 5.3(a)(1).

See,

proposed Regulation 5.3(a)(5).

See,

proposed Regulations 5.3(a)(2) and 5.3(a)(3).

The CRA's registration requirements do not apply to certain otherwise regulated entities (

e.g.,

broker-dealers), their associated persons, or persons who would be exempt from registration if they were engaging in such transactions on or subject to the rules of a contract market with regard to forex futures or options

or look-alike contracts.

This is consistent with the original intent of the Treasury Amendment that entities engaging in forex transactions should not be subject to regulation by multiple regulators concerning the same activity. Proposed Regulation 5.3 excludes from the registration requirement the persons specified in the CRA.

See,

7 U.S.C. 2(c)(2)(B)(iv)(II).

See,

7 U.S.C. 2(c)(2)(C)(iii)(II).

4. Proposed Regulation 5.4—Operative Requirements for CPOs and CTAs

Proposed Regulation 5.4 applies all of the disclosure, recordkeeping, reporting and other existing requirements currently applicable to CPOs and CTAs in the context of on-exchange futures and commodity option contracts to persons defined as, and required to register as, CPOs and CTAs because those persons operate pooled investment vehicles that engage in retail forex transactions or because they provide retail forex trading advice.

5. Proposed Regulation 5.5—Risk Disclosure by FCMs, RFEDs and IBs

Proposed Regulation 5.5 requires RFEDs, FCMs and IBs to provide retail forex customers with a risk disclosure statement similar to that currently required by Regulation 1.55, but tailored to address the risks, conflicts of interest and unique characteristics of retail forex trading. For example, the required risk disclosure statement would also be required to disclose the number of non-discretionary retail forex accounts maintained by an RFED or FCM, the percentage of such accounts that were profitable for each of the four most recent quarters, and a statement that past performance is not necessarily indicative of future results.

See,

proposed Regulation 5.5(e).

Under Section 2(c) of the Act, the Commission's jurisdiction with regard to off-exchange forex transactions extends to transactions involving entities that are not eligible contract participants as defined in Section 1a of the Act (i.e., retail customers). These transactions serve no broad price discovery function, and the Commission believes both that the vast majority of retail customers who enter these transactions do so solely for speculative purposes, and that relatively few of these participants trade profitably. Whether or not this is actually the case, the Commission believes that disclosure of the percentage of profitable accounts maintained by RFEDs and FCMs engaging in off-exchange retail forex will provide the retail customer with vital information when deciding whether or not to engage in such transactions.

6. Proposed Regulations 5.6 and 5.7—Minimum Financial Requirements

Under proposed Regulation 5.7, RFEDs and FCMs engaging in retail forex trading are required to meet the minimum net capital requirements prescribed in the CRA.

Proposed Regulation 5.6 sets forth the “early warning” notification requirements pursuant to which RFEDs and FCMs engaging in retail forex trading are required to notify SROs and the Commission if an RFED or an FCM engaging in retail forex trading has experienced declines in capital, has discovered a material inadequacy in internal controls or has become undercapitalized.

Because there is no equivalent to the futures regime of strict segregation of customer funds in off-exchange retail foreign currency dealing, the notice requirement for RFEDs with respect to undersegregation is not included in the proposed regulation. However, a requirement has been proposed that an RFED or FCM engaging in off-exchange retail forex transactions give notice if it is holding liquid assets less than the aggregate retail forex obligation (as defined). The aggregate retail forex obligation is proposed to be the net obligation to all off-exchange retail foreign currency customers at all times (excluding deficit accounts).

Analogous to Regulation 1.17 for FCMs trading only futures and commodity options.

The proposed requirement is analogous to existing Regulation 1.12 for FCMs that trade only on-exchange futures and commodity option contracts.

The minimum net capital regulation for RFEDs and FCMs offering off-exchange retail forex is proposed based on the significantly higher minimum net capital level for RFEDs and FCMs offering retail forex established in the CRA. The Commission believes that the higher level of $20 million reflects Congressional intent to ensure that substantially undercapitalized “shell” FCM off-exchange retail forex dealers and their affiliates, from whom it may be impossible to recover funds in the event of customer claims, do not engage in off-exchange retail forex activity. The existing regulation for the calculation of FCM net capital has been proposed for the calculation of net capital for RFEDs and FCMs offering off-exchange retail forex, with the intent that an FCM offering retail forex should only have one calculation of its adjusted net capital. However, the CRA's higher dollar threshold of minimum capital required, $20 million, will apply, as well as an additional early warning requirement of 110%, resulting in a notice reporting net capital level of $22 million. The proposed early warning level of 110% is lower than the FCM early warning level of 150% due to the substantially higher minimum dollar threshold established in the CRA, which results in an adequate minimum early warning “buffer” of no less than $2 million.

An amount of minimum net capital in addition to the minimum $20 million is proposed to the extent that an FCM or RFED has a total retail forex obligation in excess of $10,000,000. After that threshold, as proposed the FCM or RFED must have net capital of no less than $20,000,000 plus five percent of the total retail forex obligation in excess of $10,000,000. This proposal is intended to address concerns that, although the capital level contained in the CRA is believed to be high at $20,000,000, at particularly high levels of retail customer obligations there should be commensurate increases in an entity's minimum required net capital. The NFA has enacted a similar requirement applicable to all its forex dealer members except those that only provide “straight through processing.” The Commission's proposal has no exceptions for FCMs engaging in off-exchange retail forex or for RFEDs.

Under the existing net capital regulation for FCMs contained in Commission Regulation 1.17, an FCM that becomes undercapitalized must immediately cease business and transfer its customers' positions to another FCM, unless the Commission believes that it will be able to quickly remedy the situation, in which case the Commission may provide up to an additional 10 business days to return to compliance before ceasing business. Because the retail forex contracts at issue are not exchange-traded, and therefore, positions are not fungible among retail forex FCMs and RFEDs, should an RFED become undercapitalized, the

Commission proposes that it either liquidate or transfer all off-exchange retail forex accounts (with a transfer envisioned as a full novation of the retail forex contracts for such accounts by assignment and assumption of the contracts by another RFED or FCM) under the direction and supervision of the Commission or the entity's designated self-regulatory organization (“DSRO”). The same 10 business day period has been proposed for the Commission or DSRO to delay such liquidation or transfer if determined appropriate. The proposal requires the refund or transfer of all funds associated with off-exchange retail forex accounts contemporaneous with the liquidation or transfer. The possibility of an entity needing to refund all customers' accounts and liquidate all positions in such circumstances makes it necessary to include a proposal to require such entity to maintain liquid assets available equal to the amount owed to off-exchange retail forex customers.

Although not permissible to be counted as a liquid asset for fulfilling the requirement of Regulation 5.8, under the proposed net capital regulation, the unsecured receivable resulting from an RFED or FCM offsetting currency exposure with one of several enumerated parties (regulated financial intermediaries or foreign equivalents approved by NFA) will be treated as a current asset. The Commission proposes this, with the counterparty limitation, to balance an RFED's or FCM's need to hedge its net position from offering off-exchange retail forex with the concern that such receivables are collectible for net capital purposes. Without this proposed addition to the net capital calculation, RFEDs and FCMs would have to take a 100% capital charge for such unrealized gains. The Commission understands that NFA, under subparagraph (c) of its Section 11 Financial Requirements for Forex Dealer Members, has been permitting existing forex dealer members to not take such a charge to the extent the counterparty has been considered regulated and approved by NFA, and is not an affiliate of the Forex Dealer Member. Thus, the Commission proposes that a DSRO be afforded the continuing ability to assess the appropriateness of counterparties for this purpose going forward, while making explicit the ability of an entity to cover the net exposure without the burden of a 100% net capital charge being applied. Also, the existing net capital charge with respect to options has been applied to off-exchange retail forex transactions that are options. This net capital charge, with respect to the existing net capital regulation for FCMs, is derived from the SEC's net capital charges for options that are not options on futures. Because these retail forex transactions are, by nature, off-exchange transactions, the resulting charge under the SEC rule would be the charge for “unlisted” options. This charge is based on the notional transactional size of the option which may result in a very significant capital implication for retail forex transactions which are options. However, this result is consistent with the existing requirements for all off-exchange or unlisted foreign exchange options for existing FCMs and broker-dealers.

7. Proposed Regulation 5.8—Aggregate Retail Forex Assets

Proposed Regulation 5.8 requires RFEDs and FCMs engaging in retail forex transactions to compute the net credit balance resulting from combining all money, securities and property deposited by retail forex customers into their accounts, adjusted for realized and unrealized net profit or loss, and not including any accounts that contain net liquidating balances (the “retail forex obligation” of the RFED or FCM).

Under proposed Regulation 5.8(a) each RFED or FCM engaging in retail forex transactions is required to hold assets of the type permitted under Regulation 1.25 equal to the retail forex obligation. Such assets would have to be maintained at one or more qualifying institutions in the U.S., or in money center countries (as defined in Regulation 1.49) where such countries have agreements acceptable to NFA that authorize sharing account information with NFA.

Defined in proposed Regulation 5.1(l).

The requirement to hold assets equal to the retail forex obligation is separate from the adjusted net capital requirement. In computing their adjusted net capital, pursuant to proposed Regulation 5.8(d), RFEDs and FCMs could not include assets held for purposes of complying with proposed Regulation 5.8(a) as current assets, or otherwise recording any property received from retail forex customers as an asset without recording a corresponding liability to such customers.

The requirement to maintain assets equal to or in excess of the retail forex obligation is intended to provide some degree of protection for customers in the absence of the protections afforded by the segregation of customer funds that is required in the context of futures and commodity options trading.

The Commission recognizes that the retail forex obligation is not an equivalent substitute for the segregated funds regime, which cannot be replicated in the context of off-exchange retail forex trading. Unlike segregation of customer funds deposited for futures trading, such amounts would not be provided any preferential treatment to unsecured creditors in a bankruptcy, and would not be held in separately titled accounts under the CEA. Because of the lack of bankruptcy preference with respect to the funds of retail forex customers held at FCMs or RFEDs, the Commission does not intend to propose a separation of funds requirement which may be misconstrued as being similar to the protections that are afforded to customers engaged in exchange-traded futures and options. As previously discussed, Regulation 5.8 has been proposed to ensure that RFEDs and FCMs hold liquid assets in appropriate jurisdictions should they be required to be refunded to customers or seized to compensate customers. NFA first established under Section 14 of its Financial Requirements its version of this requirement, due to its difficulty in ultimately obtaining any funds for restitution with respect to failures of forex dealers and cases of fraud. The proposal follows the NFA's rule in this regard while further requiring that the types of assets held to meet the requirement must also be of the kind and character permitted for the investments of futures customer funds under existing Commission Regulation 1.25. These types of assets are limited to generally liquid financial instruments, which the Commission believes to be an appropriate limitation, should it become necessary to liquidate retail forex accounts, transfer funds, or seize or freeze funds in the event of fraud.

The retail forex obligation is also a factor in one of the options for computation of the RFED's or FCM's net capital requirement.

See,

proposed Regulation 5.7(a)(1)(i)(B).

8. Proposed Regulation 5.9—Security Deposits for Retail Forex Transactions

Proposed Regulation 5.9(a) would require each RFED and each FCM that engages in retail forex transactions, in advance of any such transaction, to collect from the retail forex customer a security deposit (in cash or in financial instruments that meet the requirements of Regulation 1.25) equal to ten percent of the notional value of the retail forex transaction, ten percent of the notional value of short retail forex options in addition to the premium received, or the full premium received for long options,

as the case may be. Pursuant to proposed Regulation 5.9(b), the RFED or FCM would be required to collect additional security deposit or to liquidate the retail forex customer's position if the amount of security deposit collected fails to meet the requirements of paragraph (a).

The extreme volatility of the foreign currency markets exposes retail forex customers to substantial risk. Forex dealers currently extend leverage to their customers at ratios of between 25:1 to 400:1 or higher, which allows customers to control contracts worth significantly more than their cash investment. Given these high leverage ratios, even minor fluctuations in currency rates can exponentially increase a customer's losses and gains. Even a small move against a customer's position can result in a significant loss. Under current practices, customer positions are usually closed out once the losses in an account exceed the initial investment. However, if, for any reason, the positions are not closed out at a zero balance, the customer could be liable for additional losses.

Customers also face counterparty risk, as there is no central counterparty for forex transactions. Customers may not know that customer funds held by a forex counterparty do not receive the bankruptcy protections applicable to funds held by an FCM engaged in on-exchange trading on the customers behalf.

Given the risks that inhere in the trading of off-exchange forex contracts by retail customers, the only funds that should be invested in the off-exchange retail forex market are those that the investor can afford to lose. The Commission's proposed regulation regarding security deposits is intended both to mitigate the risk to which customers are exposed and to provide some capital to cover customer funds held by a failing firm (albeit without the bankruptcy preference applicable to funds held in segregation for exchange-traded contracts). In determining the appropriate leverage or security deposit level to propose, the Commission considered current industry practices, as well as NFA's current leverage restrictions of 100 to 1 on major currencies and 25 to 1 on non-major currencies, and the proposal by the Financial Industry Regulatory Authority (“FINRA”) to limit the maximum leverage on certain retail forex transactions offered by broker-dealers to 4 to 1.

As discussed above, an FCM holding customer funds for trading on-exchange futures contracts is required to have, at all times, in its possession and control, segregated property sufficient to pay all customers with credit balances, without deduction for customer debit balances (which must be made up from the FCM's own capital). In an FCM bankruptcy, customers share the segregated property pro rata in proportion to their claims, without any support from a compensation fund.

See, generally,

Part 190 of the Commission's Regulations, 17 CFR Part 190 (2009).

NFA leverage rules are set forth in Section 12, “Security Deposits for Forex Transactions with FDMs”, of the NFA rules. On June 4, 2009, FINRA submitted to the U.S. Securities and Exchange Commission a proposed rule change to adopt FINRA Rule 2380 to limit the leverage ratio offered by broker-dealers for certain forex transactions to be a maximum of 1.5:1. 74 FR 32022 (July 6, 2009). FINRA subsequently adopted 2 amendments to this proposal, the second of which revised the maximum leverage ratio from 1.5:1 to 4:1.

See

SR-FINRA-2009-40 available on FINRA's website at

http://www.finra.org/Industry/Regulation/RuleFilings/2009/P118864.

9. Proposed Regulations 5.10 and 5.11—Risk Assessment

Proposed Regulation 5.10 imposes risk assessment recordkeeping requirements, and Regulation 5.11 establishes risk assessment reporting requirements, for RFEDs. These sections are patterned on the corresponding existing requirements for FCMs in existing Regulations 1.14 and 1.15, because the same rationale behind risk assessment procedures for FCMs applies equally to RFEDs.

10. Proposed Regulation 5.12—Financial Reporting to Regulators

Proposed Regulation 5.12 requires applicants for registration as RFEDs to submit their applications for registration with a Form 1-FR-FCM, the same financial reporting form that FCMs are required to file, certified by an independent public accountant.

Registered RFEDs would be required to file Form 1-FR-FCM monthly and annually. In addition, RFEDs, like FCMs, when notified in writing by NFA or the Commission, would have to file Form 1-FR-FCM or such other financial information as NFA or the Commission may request at such other times as may be specified in the notice.

The proposed regulation for RFED financial reporting is intended to require the substantial equivalent of independent IB and FCM financial reporting to the Commission and DSROs, with certified financial reports required from independent auditors qualified under existing Commission Regulation 1.16 and similar reports on material inadequacies by such auditors. The existing reporting requirements as separately proposed to be amended for FCMs, including methods of receiving reports, determining fiscal year ends and permitting extensions of time to file, have been proposed for RFEDs.

See,

Regulation 1.10.

See,

Regulation 1.10(b)(4).

11. Proposed Regulation 5.13—Reporting to Customers

RFEDs and FCMs engaging in retail forex transactions are required by proposed Regulation 5.13 to furnish each retail forex customer with monthly statements and confirmation statements in a manner comparable to that required of FCMs under Regulation 1.33. The Commission believes that proposed Regulation 5.13 has been drafted in such a manner as to make the required statements meaningful and useful to customers in light of the distinctive characteristics of retail forex transactions relative to exchange-traded futures and commodity option transactions. FCMs could combine their forex monthly and/or confirmation statements with statements they may otherwise be required by Regulation 1.33 to furnish, so long as the futures and commodity options information and the retail forex information are each properly identified as such. The proposed section also provides that the required statements can be furnished electronically with the customer's (revocable) consent, and RFEDs are required to keep copies of monthly and confirmation statements in accordance with the requirements of Regulation 1.31.

12. Proposed Regulation 5.14—Financial Recordkeeping

Proposed Regulation 5.14(a) requires RFEDs to keep the same ledgers or similar records as FCMs are required to keep under Regulation 1.18, showing transactions affecting assets, liabilities, income, expense and capital accounts, classified in the manner set forth in Form 1-FR-FCM, or in categories consistent with generally accepted accounting principles. Proposed Regulation 5.14(b) requires recordkeeping regarding net capital computations, comparable to existing Regulation 1.18(b) for FCMs.

13. Proposed Regulations 5.15 and 5.16—Unlawful Representations and Prohibitions of Guarantees Against Loss

As with CPOs and CTAs dealing only in futures and commodity options, RFEDs, FCMs, IBs, CPOs and CTAs subject to Part 5, as well as their principals and those who solicit for them, are prohibited by proposed Regulation 5.15 from representing that the Commission or the Federal government has sponsored, recommended or approved them in any

way.

RFEDs, FCMs and IBs are prohibited under proposed Regulation 5.16 from guaranteeing against or limiting customer losses, from failing to collect margin or security deposits, or from representing that they will do any of those things.

This prohibition does not prevent an RFED, FCM or IB from sharing in a loss resulting from error or mishandling of an order, and guarantees entered into prior to effectiveness of the prohibition will only be affected if an attempt is made to extend, modify or renew them.

Similar prohibitions already apply to CPOs and CTAs (section 4o(b) of the Act) and to leverage transaction merchants (Regulation 31.19). See also NFA Compliance Rule 2-22 which speaks to all NFA members. The Commission believes that a broad statement of the prohibition is appropriate here to ensure that customers do not misapprehend the implications of registration as previously unregistered off-exchange retail forex market participants come into compliance with the registration requirements imposed on them by the CRA.

See,

Regulation 1.56 for the existing prohibition affecting FCMs and IBs engaged in futures and commodity option transactions.

14. Proposed Regulation 5.17—Authorization to Trade

Proposed Regulation 5.17 requires RFEDs, FCMs, IBs and their APs to have specific authorization by the customer before effecting a retail forex transaction. For the most part, proposed Regulation 5.17 follows existing Regulation 166.2 for on-exchange futures and commodity option transactions. The Commission believes that registrants acting as off-exchange retail forex counterparties should have to obtain authorization for each transaction like other registrants.

15. Proposed Regulation 5.18—Trading Standards

Proposed Regulation 5.18 contains provisions specific to retail forex transactions that were developed to prevent some of the deceptive or unfair practices identified by the Commission and NFA in recent years. Each retail forex counterparty

would be required to establish and enforce internal rules, procedures and controls: (1) To prevent “front running,” where transactions in accounts of the retail forex counterparty or its related persons

are executed before a like customer order; (2) to establish settlement prices fairly and objectively; and (3) to record and maintain transaction records and make them available to customers (including time and price information, account records, trading platform price changes and volume, and any algorithm used to determine bid and ask prices). Paragraph (c) of the proposed Regulation prohibits a retail forex counterparty from disclosing that it holds another person's order unless disclosure is necessary for execution. Paragraphs (d) and (e) ensure that related persons of retail forex counterparties do not open accounts with other retail forex counterparties without the knowledge and authorization of the account surveillance personnel of the retail forex counterparties with which they are related. Paragraph (f) prohibits retail forex counterparties from: (1) Entering a retail forex transaction to be executed at a price that is not at or near prices at which other retail forex customers have executed transactions with the retail forex counterparty during the same time period unless done pursuant to NFA rules; (2) changing prices after execution unless pursuant to NFA rules; (3) providing a customer a new bid price that is higher (or lower) than previously without providing a new asked price that is higher (or lower) as well; and (4) establishing a new position for a customer (except to offset an existing position) if the retail forex counterparty holds one or more outstanding orders of other retail forex customers for the same currency pair at a comparable price.

“Retail forex counterparty” is defined for purposes of Regulation 5.18 to include RFEDs, FCMs and affiliated persons of FCMs.

“Related person” of a forex counterparty is defined for purposes of Regulation 5.18 as a general partner, officer, director, owner of more than a ten percent interest, associated person, employee, relative or spouse of the foregoing or relative of a spouse who shares the same home.

Additionally, paragraph (g) of proposed Regulation 5.18 would require each retail forex counterparty and each CPO, CTA and IB subject to part 5 to maintain records of all communications they receive concerning possible violations of the Act or Commission regulations involving their retail forex business. The required records would include the complainant's identity (if provided), the date of the transaction or contract at issue, and the name of the person who received the communication. The retail forex counterparty, CPO, CTA or IB would be required to provide copies of such records to the Commission.

The Commission believes that, given the volume of cases it has prosecuted in recent years involving retail forex fraud, requiring the maintenance of detailed records of customer complaints will provide such intermediaries with a comprehensive view of the types and numbers of problems that exist within their operations, and will provide the Commission with ready access to information regarding such problems.

Paragraph (h) of proposed Regulation 5.18 would require each person who applies for registration as an IB in order to solicit or accept off-exchange retail forex orders, and each person who succeeds to the business of an IB that solicits or accepts retail forex orders to enter into a guarantee agreement with an FCM or an RFED. As discussed above in relation to revisions to Commission Regulation 1.10, the Commission believes that the requirement that RFEDs and FCMs enter a guarantee agreement with the IBs that solicit business on their behalf serves the public's interest by discouraging FCMs and RFEDs from associating with IBs without regard to the sales practices they employ.

Paragraph (i) of proposed Regulation 5.18 would require retail forex counterparties to calculate on a quarterly basis the percentage of non-discretionary accounts that were profitable, and to maintain records of those calculations together with supporting data for five years in accordance with Regulation 1.31. As discussed above, Proposed Regulation 5.5 requires that RFEDs, FCMs and IBs provided retail forex customers with a risk disclosure statement that includes the percentage of accounts that were profitable for each of the four most recent quarters. Proposed Regulation 5.8 buttresses this requirement by directing retail forex counterparties to make such calculations on a quarterly basis and maintain records reflecting the calculation.

Finally, paragraph (j) would require each retail forex counterparty to designate at least one principal to serve as its chief compliance officer, who would be required to certify annually to the Commission and to NFA that the retail forex counterparty had in place policies and procedures reasonably designed to achieve compliance with the Act and the Commission's regulations. The Commission intends that retail forex counterparties adhere to the highest professional standards and that they take their compliance responsibilities seriously. With the requirement of a high level compliance officer and annual certification, Commission registrants will be expected to meet these standards and required to identify the person within the entity responsible for meeting them.

16. Proposed Regulation 5.19—Pending Legal Proceedings

Proposed Regulation 5.19 requires RFEDs, FCMs CPOs, CTAs and IBs to disclose pending legal matters and specifies the manner in which such matters are to be reported to the Commission, as well as the criteria for determining which proceedings are

required to be disclosed. As discussed above, given the high incidence of fraud in connection with retail forex transactions, the Commission desires to monitor legal actions taken against registrants. Requiring reporting of such actions is one of the most direct ways of determining where problems exist and what registrants may have failed to deal fairly with customers.

17. Proposed Regulation 5.20—Special Calls for Information

Proposed Regulation 5.20 is patterned on existing Regulations 21.00 through 21.03. The purpose of proposed Regulation 5.20 is to ensure that the Commission has the authority to obtain information regarding retail forex accounts and transactions when such information is necessary to enable the Commission to carry out its responsibilities under the Act, and to set forth the responsibilities and duties of RFEDs, FCMs, and IBs when a special call is issued.

18. Proposed Regulation 5.21—Supervision of Retail Forex Accounts

Proposed Regulation 5.21 imposes the same supervision requirements set forth in existing Regulation 166.3 upon Commission registrants subject to Part 5. A separate provision for retail forex is included in order to avoid any question whether the same duties apply to persons with supervisory responsibilities in the context of retail forex trading activity.

19. Proposed Regulation 5.22—Registered Futures Association Membership

In addition to registering with the Commission, the CRA provides that RFEDs and persons who provide retail forex trading advice, operate retail forex pools or solicit retail forex customers or accounts must also become members of a registered futures association.

Accordingly, proposed Regulation 5.22 requires registered futures association membership for RFEDs, and for each person (1) required to register as an IB because the person accepts orders for retail forex transactions; (2) required to register as a CPO because the person operates, or solicits funds, securities or property for, a pooled investment vehicle that engages in retail forex transactions; or (3) required to register as a CTA because the person exercises discretionary trading authority, or obtains written authority over, an account in connection with retail forex transactions.

See,

7 U.S.C. 2(c)(2)(B)(i)(II)(gg); 2(c)(2)(B)(iv); 2(c)(2)(C)(i)(II)(aa); and 2(c)(2)(C)(iii).

20. Proposed Regulation 5.23—Bulk Transfers and Bulk Liquidations

Proposed Regulation 5.23 is patterned generally upon existing Regulation 1.65, but has been modified to take into account certain rules of the National Futures Association, that have been approved by the Commission, that govern the transfer or liquidation of the accounts of retail forex customers.

Proposed Regulation 5.23 permits transfers that are requested by the retail forex customer or expressly consented to by the retail forex customer's prior, specific consent in writing, or those done in accordance with rules adopted by the DSRO of the RFED, FCM or IB, as the case may be, and approved by the Commission that establish notice and other requirements for such assignments and transfers. The proposed regulation also duplicates, for the most part, the requirements applicable to bulk transfer notices to the Commission under Regulation 1.65. However, the draft regulation requires notice not only of bulk transfers, but also bulk liquidations, and effectively defines the term “bulk” to mean the transfer or liquidation of 50 percent or more of the total retail forex customer accounts carried by the RFED, FCM or IB.

See,

proposed Regulation 5.23(a)(1).

See,

proposed Regulation 5.23(a)(2).

21. Proposed Regulation 5.24—Applicability of Other Parts of the Commission's Regulations

Proposed Regulation 5.24 states that, insofar as consistent with the requirements of part 5, the requirements of other parts of the Commission's regulations that apply to a person shall apply to that person as though those provisions were expressly set forth in part 5. For example, Regulation 1.31 sets forth the Commission's generally applicable recordkeeping requirements and speaks in terms of “persons.” Proposed Regulation 5.24 is intended to incorporate such provisions by reference to the extent that part 5 does not impose contradictory requirements.

22. Proposed Regulation 5.25—Applicability of Act

Proposed Section 5.25 incorporates various provisions of the Act which apply generally to registrants, specifying that the provisions of those sections are to be read to include the categories of forex registrants identified in proposed Section 5.1, and that the provisions of those sections are to be read to include off-exchange retail forex transactions and those that that engage in them. Specifically, the provisions of Sections 4b, 4c(b), 4f, 4g, 4k, 4m, 4n, 4o, 6(c)-(e), 6b, 6c, 8(a)-(e), 8a, and 12(f) apply to off-exchange retail forex transactions just as they do to exchange-traded transactions.

III. Related Matters

A. Regulatory Flexibility Act

FCMs and CPOs:

The Regulatory Flexibility Act (“RFA”)

requires that agencies, in proposing rules, consider the impact of those rules on small businesses.

The Commission has already established certain definitions of “small entities” to be used in evaluating the impact of its rules on such small entities in accordance with the RFA.

In that statement, the Commission concluded that neither FCMs nor registered CPOs should be considered to be small entities for purposes of the RFA. With respect to FCMs, the Commission's determination was based in part upon their obligation to meet the capital requirement established by the Commission and the purposes of protecting financial integrity.

100

5 U.S.C.

et seq.

By its terms, the RFA does not apply to “individuals.”

See

48 FR 14933, n. 115 (April 6, 1983). Because associated persons must be individuals, (see Commission Regulation 1.3(aa) and proposed Regulations 5.1(c), (d)(2), (e)(2), (g)(2) and (i)(2)), the RFA does not apply to APs and no analysis of the economic impact of this rule proposal on such persons is required.

47 FR 18618 (April 30, 1982).

100

Id.

at 18619.

As for CPOs, the Commission determined that registered CPOs are not small entities based upon its existing regulatory standard for exempting certain small CPOs from the requirement to register under the Act.

101

(A CPO need not register with the Commission if the gross capital contributions for all pools under its management do not exceed $400,000 and there are not more than fifteen participants in any one of those pools.

102

)

101

Id.

at 18619-20.

102

17 CFR 4.13(a)(2) (2009).

Thus, with respect to FCMs and registered CPOs, the Commission believes that the Proposal will not have a significant economic impact on a substantial number of small entities.

CTAs:

The Commission has previously decided to evaluate, within the context of a particular rule proposal, whether all or some CTAs should be considered to be small entities, and if so, to then analyze the economic impact on them of any such rule.

103

CTAs

wishing to advise retail forex customers may include both currently registered CTAs and previously unregistered persons who now will be required to register. As to the first group, there should be no significant new economic impact. As to the second group, registration will require the submission of application forms, fingerprinting of principals, and payment of registration fees. To the extent that CTAs can be considered to be small entities, the Commission does not consider either the proposed registration fee or the proposed fingerprinting requirement for newly registered CTAs to have significant economic impact.

104

103

47 FR at 18620.

104

48 FR 35248 at 35276 (August 3, 1983).

IBs:

In its 1982 policy statement, the Commission proposed that for purposes of the RFA and future rulemakings, the Commission would not consider introducing brokers to be “small entities” for essentially the same reasons that FCMs had previously been determined not to be small entities.

105

However, this determination was based, in part, on the fact that IBs, like FCMs, are required to maintain a specified level of adjusted net capital. Under the proposal, retail forex IBs would not be subject to a capital requirement; rather, they would have to operate pursuant to a guarantee agreement. Nevertheless, as discussed above with regard to CTAs, registration of previously unregistered entities will require the submission of application forms, fingerprinting of principals, and payment of registration fees. To the extent that IBs can be considered to be small entities, the Commission does not consider either the proposed registration fee or the proposed fingerprinting requirement for IBs subject to Part 5 to have significant economic impact.

105

47 FR at 18619.

RFEDs:

RFEDs are a new category of registrant. Accordingly, the Commission has not addressed the question of whether such persons are, in fact, small entities for purposes of the RFA. The Commission does not believe that there are regulatory alternatives to those being proposed which would be consistent with the statutory mandate to provide protection to the public against irresponsible or fraudulent business practices. For purposes of the RFA and future rulemakings, the Commission is hereby proposing that RFEDs not be considered to be “small entities” for essentially the same reasons that FCMs have previously been determined not to be small entities.

106

As with FCMs, a requirement to maintain a specified level of adjusted net capital would be imposed upon RFEDs to ensure that they maintain sufficient capital resources to guarantee their financial accountability and to promote responsible and reliable business operations. Moreover, the Commission has sought to fashion its proposed regulatory program for RFEDs in a manner which is responsive to the function, purposes, and size of the entity being regulated consistent with the objective of the RFA. In particular, the minimum capital requirement required by the CRA effectuates the Congressional purpose that RFEDs maintain sufficient reserve of capital to remain economically viable. For the reasons stated above, the Commission hereby proposes not to define RFEDs as small entities for RFA purposes.

106

Id.

B. Paperwork Reduction Act

The Proposal contains information collection requirements. The Paperwork Reduction Act of 1995 (“PRA”)

107

imposes certain requirements of federal agencies (including the Commission) in conducting or sponsoring any collection of information as defined by the PRA. The Commission has submitted to the Director of the Office of Management and Budget (“OMB”), pursuant to the provisions of the PRA, an explanation and details of the information collection and recordkeeping requirements which would be necessary to implement the Proposal.

107

44 U.S.C. 3501,

et seq.

1. Collection of Information

If adopted, the Proposal would require existing and new registrants in the FCM, RFED, CTA, CPO and IB categories to submit certain filings to the Commission which had not been previously required; these collections of information are found primarily in the new part 5 of the proposed regulations. To the extent industry participants are currently registered as CTAs, CPOs, IBs or FCMs, and intend to engage in retail forex transactions, the obligations imposed by the proposed rules would not be significantly altered, but the existing collections will be amended to reflect additional, new registrants within these categories, and the part 5 collection will include any additional information collections not captured in existing collections. The estimated numbers of respondents, annual responses by each, average hours per response and annual reporting burden reflected in section 2 immediately below represent estimates from the last update of the collection plus new respondents, responses and a new calculation of associated burdens. Since several of the proposals contained herein consist of proposed amendments to rules which have already been assigned OMB control numbers, the Commission assumes that the amended rules will be assigned the same OMB control number. Similarly, the Commission is proposing that the new registrants use amendments to existing forms in order to comply with registration and financial reporting requirements, those forms, as amended, will in all likelihood retain the same OMB control number which they have at present. Finally, as to RFEDs, a new category of registrant, new OMB control numbers will be assigned to new collections; to the extent existing regulations have been amended to include RFEDs, the collections associated with those regulations will be amended to reflect the new category of registrant. Each effected collection and the new part 5 collection are discussed separately below.

2. Existing Collections

a. Collection 3038-0024 (Part 1 of the Regulations)

Generally speaking, collections occurring by operation of part 1 regulations affect FCMs and IBs. Those entities that will be required to register as RFEDs are currently registered as FCMs, so existing Collection 3038-0024 has been amended, where appropriate, to reflect fewer FCM respondents. The collection has also been amended, where appropriate, to reflect additional IB registrants, who were not previously required to register to conduct off-exchange retail forex business and now will be.

Estimated number

of respondents:

2,160.

Annual responses

by each

respondent:

38,894.

Estimated average

hours per

response:

1.9.

Annual reporting

burden:

21,229.

b. Collection 3038-0023 (Part 3 of the Regulations)

Part 3 of the Commission's regulations concern registration requirements. Existing Collection 3038-0023 has been amended to reflect the obligations associated with the registration of new entrants, such as CTAs, CPOs, IBs, and APs, that had not previously been required to register in order to conduct off-exchange retail forex transactions. Since the registration requirements are in all respects the same as for current registrants, the collection has been amended only insofar as it concerns the increased estimated number of respondents and the corresponding estimated annual burden.

Estimated number

of respondents:

71,857.

Annual responses

by each

respondent:

73,694.

Estimated average

hours per

response:

0.09.

Annual reporting

burden:

6,632.

c. Collection 3038-0005 (Part 4 of the Commission's Regulations)

Part 4 of the Commission's regulations concerns the operations of CTAs and CPOs, and the circumstances under which they may be exempted from registration. As discussed above, the estimated average time spent per response has not been altered. However, adjustments have been made to the collection to account for additional CPOs and CTAs: filing for exemptions from the Part 4 rules, developing and distributing required disclosure documents; complying with required reporting requirements.

Estimated number

of respondents:

9,486.

Annual responses

by each

respondent:

37,930.

Estimated average

hours per

response:

17.

Annual reporting

burden:

183,700.

108

Due to a mathematical error in the previous Collection 3038-0005, the current estimated numbers reflect a large increase in the burden to respondents. The estimated increase in the annual responses to by each respondent is increased by 721 as a result of this rulemaking. The estimated annual increase in the hours of reporting burden is increased by 4,833 as a result of this rulemaking.

d. Collection 3038-0055 (Part 160 of the Regulations)

Part 160 requires financial institutions to provide notice to customers regarding privacy policies and practices. As discussed above, the estimated average time spent per response has not been amended; rather, the collection has been amended to reflect new registrants that will have to comply with the part 160 requirements.

Estimated number

of respondents:

4,066.

Annual responses

by each

respondent:

96.

Estimated average

hours per

response:

0.24.

Annual reporting

burden:

6,186.

3. New Collection 3038—NEW (Proposed Part 5 of the Regulations)

Part 5 of the proposed regulations requires various information collections by various registrants. The Commission is seeking a new and separate control number for collections occurring pursuant to part 5. Among the sections requiring information collections in the new part 5 is Regulation 5.5, which would require the development and distribution of risk disclosure documents by RFEDs, FCMs and IBs transacting off-exchange retail forex. Regulation 5.6 would require reporting by RFEDs that fail to meet minimum financial requirements or are otherwise required to provide early warning notices. Regulation 5.11 would require annual risk assessment reporting by RFEDs, and Regulation 5.12 would require financial reports of RFEDs applying for registration. Regulation 5.13 concerns reporting to customers by RFEDS and FCMs. Regulation 5.18 generally concerns trading and operational standards for retail forex counterparties and intermediaries. Among the sections within Regulation 5.18 requiring collections of information are 5.18(g), which requires all counterparties and intermediaries to forward to the Commission records of communications received concerning facts giving rise to possible violations of the Act or Regulations, and 5.18(j), which requires forex counterparties to provide the Commission with an annual compliance certification. Regulation 5.19 would require all forex counterparties and intermediaries to provide the Commission with notice of legal proceedings to which they are parties. Finally, Regulation 5.23 concerns the notices that must be given in the event of bulk transfers or liquidations.

OMB Control Number 3038

—NEW.

Estimated number

of respondents:

1,156.

Annual responses

by each

respondent:

4,493.

Estimated average

hours per

response:

1.8.

Annual reporting

burden:

4,202.

Copies of the information collection submission to OMB are available from the CFT Clearance Officer, 1155 21st Street, NW., Washington, DC 20581, (202) 418-5160. The Commission considers comments by the public on this proposed collection of information in—

Evaluating whether the proposed collections of information are necessary for the proper performance of the functions of the Commission, including whether the information will have a practical use;

Evaluating the accuracy of the Commission's estimate of the burden of the proposed collection of information, including the validity of the methodology and assumptions used;

Enhancing the quality, utility and clarity of the information to be collected; and

Minimizing the burden of the collection of information on those who are to respond, including through the use of appropriate automated, electronic, mechanical, or other technological collection techniques or other forms of information technology, e.g., permitting electronic submissions of responses.

Organizations and individuals desiring to submit comments on the information collection should contact the Office of Information and Regulatory Affairs, Office of Management and Budget, Room 10235, New Executive Office Building, Washington, DC 20503, ATTN: Desk Officer of the Commodity Futures Trading Commission. OMB is required to make a decision concerning the collection of information contained in the Proposal between 30 and 60 days after publication of his document in the

Federal Register.

Therefore, a comment to OMB is best assured of having its full effect if OMB receives it within 30 days of publication. This does not affect the deadline for the public comment to the Commission on the proposed rules.

C. Cost-Benefit Analysis

Section 15(a) of the Act

109

requires the Commission to consider the costs and benefits of its action before issuing new regulations under the Act. By its terms, section 15(a) does not require the Commission to quantify the costs and benefits of a new regulation or to determine whether the benefits of the regulation outweigh its costs. Rather, section 15(a) simply requires the Commission to “consider the costs and benefits” of its action.

Section 15(a) further specifies that costs and benefits shall be evaluated in light of five broad areas of market and public concern, enumerated below. Accordingly, the Commission could, in its discretion, give greater weight to any one of the five enumerated areas and could, in its discretion, determine that, notwithstanding its costs, a particular rule was necessary or appropriate to protect the public interest or to effectuate any of the provisions or to accomplish any of the purposes of the Act.

109

7 U.S.C. 19(a).

As discussed in more detail above, the Proposal would create a comprehensive scheme to implement the requirements of the CRA. It would put in place requirements including registration, disclosure, recordkeeping, financial reporting, minimum capital and other operational standards. This would be achieved through both amendments to existing regulations and the creation of a new, free-standing part to the Commission's regulations. The Commission is considering the costs

and benefits of the Proposal in light of the specific provisions of section 15(a) as follows:

1. Protection of market participants and the public. The Proposal should enhance considerably the protection of market participants and the public because it requires, for the first time, the registration of several categories of market participants and requires adherence to operational standards that had not previously applied. The benefits that inhere in the imposition of these requirements to a sector of the off-exchange market that has been largely unregulated to this point, and which is geared towards the retail public, are manifest.

2. Efficiency and competition. In its Conference Report, Congress indicated that the Commission should avoid creating two different regulatory regimes for similar business models with respect to FCMs or RFEDs engaging in off-exchange retail forex transactions.

110

Accordingly, the Commission has endeavored to ensure that these entities be treated in comparable fashion relative to one another. Moreover, the Commission has endeavored, wherever possible, to propose regulations in the proposed part 5 that are analogous to regulations imposed upon intermediaries engaged in on-exchange transactions. Accordingly, the Commission believes that it has provided an evenhanded regulatory scheme that will be familiar to industry participants.

110

As noted in the Conference Report that accompanied the CRA, “To the extent their risk profiles are similar, the managers intend for FCMs and RFEDs to be regulated substantially equivalently in terms of their off-exchange retail foreign currency business.” H.R. Rep. No. 110-627, at 980 (2008) (Conf. Rep.). The Conference Report is available via the Internet on the CFTC's Web site.

3. Financial integrity of futures markets and price discovery. The Proposal's regulations concern retail, off-exchange markets. These markets serve primarily as a vehicle for members of the retail public to engage in speculative transactions. Accordingly, the Commission does not perceive a significant intersection between the operations of these markets and the financial integrity or price discovery functions of the markets generally.

4. Sound risk management practices. The Proposal includes requirements regarding capital, financial reporting, risk assessment recordkeeping, and risk assessment reporting that are comparable to those required of entities engaged in on-exchange trading. The Commission believes that the benefits of these risk management requirements—which strive to ensure the financial soundness of firms—have been borne out on the exchange-traded side and will be of significant benefit with regard to its oversight of retail forex counterparties.

5. Other public interest considerations. The retail, off-exchange forex market has been largely unregulated until now. The Commission believes that the Proposal is beneficial in that will provide needed protections for members of the public engaging in these transactions. The Proposal will also bring much needed oversight to the forex counterparties and intermediaries that interact with the public.

After considering these factors, the Commission has determined to issue the Proposal. The Commission invites public comment on its application of the cost-benefit provision. Commenters also are invited to submit any data that they may have quantifying the costs and benefits of the Proposal with their comment letters.

List of Subjects

17 CFR Part 1

Definitions, Minimum financial and reporting requirements. Recordkeeping requirements, Prohibited transactions in commodity options, Miscellaneous.

17 CFR Part 3

Definitions, Customer protection, Licensing, Registration.

17 CFR Part 4

Advertising, Brokers, Commodity futures, Commodity pool operators, Commodity trading advisors, Consumer protection, Exemption from registration, Reporting and recordkeeping requirements.

17 CFR Part 5

Bulk transfers, Commodity pool operators, Commodity trading advisors, Consumer protection, Customer's money, securities and property, Definitions, Foreign exchange, Minimum financial and reporting requirements, Prohibited transactions in retail foreign exchange, Recordkeeping requirements, Retail foreign exchange dealers, Risk assessment, Special calls, Trading practices.

17 CFR Part 10

Adjudicatory proceedings, Rules of practice.

17 CFR Part 140

Authority delgations (Government agencies, Conflict of interests, Organization and functions (Government agencies).

17 CFR Part 145

Confidential business information, Freedom of information.

17 CFR Part 147

Sunshine Act.

17 CFR Part 160

Consumer financial information, Definitions, Nonpublic personal information, Privacy.

17 CFR Part 166

Arbitration, Authorization to trade, Customer protection, Definitions, Dispute settlement; Litigation; Reparations.

For the reasons presented above, the Commission hereby proposes to amend Chapter I of Title 17 of the Code of Federal Regulations as follows:

PART 1—GENERAL REGULATIONS UNDER THE COMMODITY EXCHANGE ACT

1. The authority citation for part 1 continues to read as follows:

Authority:

7 U.S.C. 1a, 2, 2a, 4, 4a, 6, 6a, 6b, 6c, 6d, 6e, 6f, 6h, 6i, 6j, 6k, 6

6m, 6n, 6

6p, 7, 7a, 7b, 8, 9, 12, 12c, 13a, 13a-1, 16, 16a, 19, 21, 23 and 24.

§ 1.1

[Removed and Reserved]

2. Section 1.1 is removed and reserved.

3. Section 1.3 is amended by revising paragraphs (nn) and (yy) to read as follows:

§ 1.3

Definitions.

(nn)

Guarantee agreement.

This term means an agreement of guaranty in the form set forth in part B or C of Form 1-FR, executed by a registered futures commission merchant or retail foreign exchange dealer, as appropriate, and by an introducing broker or applicant for registration as an introducing broker on behalf of an introducing broker or applicant for registration as an introducing broker in satisfaction of the alternative adjusted net capital requirement set forth in § 1.17(a)(1)(iii).

(yy)

Commodity Interest.

This term means:

(1) Any contract for the purchase or sale of a commodity for future delivery;

(2) Any contract, agreement or transaction subject to Commission regulation under section 4c or 19 of the Act; and

(3) Any contract, agreement or transaction subject to Commission jurisdiction under section 2(c)(2) of the Act.

4. Section 1.4 is revised to read as follows:

§ 1.4

Use of electronic signatures.

For purposes of complying with any provision in the Commodity Exchange Act or the rules or regulations in this Chapter I that requires a document to be signed by a customer of a futures commission merchant or introducing broker, a retail forex customer of a retail foreign exchange dealer or futures commission merchant, a pool participant or a client of a commodity trading advisor, an electronic signature executed by the customer, participant or client will be sufficient, if the futures commission merchant, retail foreign exchange dealer, introducing broker, commodity pool operator or commodity trading advisor elects generally to accept electronic signatures;

Provided, however,

That the electronic signature must comply with applicable Federal laws and other Commission rules; And,

Provided further,

That the futures commission merchant, retail foreign exchange dealer, introducing broker, commodity pool operator or commodity trading advisor must adopt and utilize reasonable safeguards regarding the use of electronic signatures, including at a minimum safeguards employed to prevent alteration of the electronic record with which the electronic signature is associated, after such record has been electronically signed.

5. Section 1.10 is amended by revising paragraph (j) to read as follows:

§ 1.10

Financial reports of futures commission merchants and introducing brokers.

(j)

Requirements for guarantee agreement.

(1) A guarantee agreement filed pursuant to this section must be signed in a manner sufficient to be a binding guarantee under local law by an appropriate person on behalf of the futures commission merchant or retail foreign exchange dealer and the introducing broker, and each signature must be accompanied by evidence that the signatory is authorized to enter the agreement on behalf of the futures commission merchant, retail foreign exchange dealer, or introducing broker and is such an appropriate person. For purposes of this paragraph (j), an appropriate person shall be the proprietor, if the firm is a sole proprietorship; a general partner, if the firm is a partnership; and either the chief executive officer or the chief financial officer, if the firm is a corporation; and, if the firm is a limited liability company or limited liability partnership, either the chief executive officer, the chief financial officer, the manager, the managing member, or those members vested with the management authority for the limited liability company or limited liability partnership.

(2) No futures commission merchant or retail foreign exchange dealer may enter into a guarantee agreement if:

(i) It knows or should have known that its adjusted net capital is less than the amount set forth in § 1.12(b) of this part or § 5.6(b) of this chapter, as applicable; or

(ii) There is filed against the futures commission merchant or retail foreign exchange dealer an adjudicatory proceeding brought by or before the Commission pursuant to the provisions of sections 6(c), 6(d), 6c, 6d, 8a or 9 of the Act or §§ 3.55, 3.56 or 3.60 of this chapter.

(3) A retail foreign exchange dealer may enter into a guarantee agreement only with an introducing broker as defined in § 5.1(f)(1). A retail foreign exchange dealer may not enter into a guarantee agreement with an introducing broker as defined in § 1.3(mm) of this part.

(4) A guarantee agreement filed in connection with an application for initial registration as an introducing broker in accordance with the provisions of § 3.10(a) of this chapter shall become effective upon the granting of registration or, if appropriate, a temporary license, to the introducing broker. A guarantee agreement filed other than in connection with an application for initial registration as an introducing broker shall become effective as of the date agreed to by the parties.

(5)(i) If the registration of the introducing broker is suspended, revoked, or withdrawn in accordance with the provisions of this chapter, the guarantee agreement shall expire as of the date of such suspension, revocation or withdrawal.

(ii) If the registration of the futures commission merchant or retail foreign exchange dealer is suspended or revoked, the guarantee agreement shall expire 30 days after such suspension or revocation, or at such earlier time as may be approved by the Commission, the introducing broker, and the introducing broker's designated self-regulatory organization.

(6) A guarantee agreement may be terminated at any time during the term thereof:

(i) By mutual written consent of the parties, signed by an appropriate person on behalf of each party, with prompt written notice thereof, signed by an appropriate person on behalf of each party, to the Commission and to the designated self-regulatory organizations of the futures commission merchant or retail foreign exchange dealer and the introducing broker;

(ii) For good cause shown, by either party giving written notice of its intention to terminate the agreement, signed by an appropriate person, to the other party to the agreement, to the Commission, and to the designated self-regulatory organizations of the futures commission merchant or retail foreign exchange dealer and the introducing broker; or

(iii) By either party giving written notice of its intention to terminate the agreement, signed by an appropriate person, at least 30 days prior to the proposed termination date, to the other party to the agreement, to the Commission, and to the designated self-regulatory organizations of the futures commission merchant or retail foreign exchange dealer and the introducing broker.

(7) The termination of a guarantee agreement by a futures commission merchant, retail foreign exchange dealer or an introducing broker, or the expiration of such an agreement, shall not relieve any party from any liability or obligation arising from acts or omissions which occurred during the term of the agreement.

(8) An introducing broker may not simultaneously be a party to more than one guarantee agreement:

Provided, however,

That the provisions of this paragraph (j)(8) shall not be deemed to preclude an introducing broker from entering into a guarantee agreement with another futures commission merchant or retail foreign exchange dealer if the introducing broker, futures commission merchant or retail foreign exchange dealer which is a party to the existing agreement has provided notice of termination of the existing agreement in accordance with the provisions of paragraph (j)(6) of this section, and the new guarantee agreement does not become effective until the day following the date of termination of the existing agreement:

And, provided

further,

That the provisions of this paragraph (j)(8) shall not be deemed to preclude an introducing broker from entering into a guarantee agreement with another futures commission merchant or retail foreign exchange dealer if the futures commission merchant or retail foreign exchange dealer which is a party to the existing agreement ceases to remain registered and the existing agreement would therefore expire in accordance with the provisions of paragraph (j)(6)(ii) of this section.

(9)(i)(A) An introducing broker that is a party to a guarantee agreement that has been terminated in accordance with the provisions of paragraph (j)(6) of this

section, or that is due to expire in accordance with the provisions of paragraph (j)(5)(ii) of this section, must cease doing business as an introducing broker on or before the effective date of such termination or expiration unless, on or before 10 days prior to the effective date of such termination or expiration or such other period of time as the Commission or the designated self-regulatory organization may allow for good cause shown, the introducing broker files with its designated self-regulatory organization either a new guarantee agreement effective as of the day following the date of termination of the existing agreement, or, in the case of a guarantee agreement that is due to expire in accordance with the provisions of paragraph (j)(4)(ii) of this section, a new guarantee agreement effective on or before such expiration, or either:

(

) A Form 1-FR-IB certified by an independent public accountant in accordance with § 1.16 as of a date not more than 45 days prior to the date on which the report is filed; or

(

) A Form 1-FR-IB as of a date not more than 17 business days prior to the date on which the report is filed and a Form 1-FR-IB certified by an independent public accountant in accordance with § 1.16 as of a date not more than one year prior to the date on which the report is filed:

Provided, however,

that an introducing broker as defined in § 5.1(f)(1) of this chapter that is party to a guarantee agreement that has been terminated or that has expired must cease doing business as an introducing broker on or before the effective date of such termination or expiration unless, on or before 10 days prior to the effective date of such termination or expiration or such other period of time as the Commission or the designated self-regulatory organization may allow for good cause shown, the introducing broker files with its designated self-regulatory organization a new guarantee agreement effective on or before the termination or expiration date of the terminating or expiring guarantee agreement.

(B) Each person filing a Form 1-FR-IB in accordance with this section must include with the financial report a statement describing the source of his current assets and representing that his capital has been contributed for the purpose of operating his business and will continue to be used for such purpose.

(ii)(A) Notwithstanding the provisions of paragraph (j)(9)(i) of this section or of § 1.17(a), an introducing broker that is a party to a guarantee agreement that has been terminated in accordance with the provisions of paragraph (j)(6)(ii) of this section shall not be deemed to be in violation of the minimum adjusted net capital requirement of § 1.17(a)(1)(iii) or (a)(2) for 30 days following such termination. Such an introducing broker must cease doing business as an introducing broker on or after the effective date of such termination, and may not resume doing business as an introducing broker unless and until it files a new agreement or either:

(

) A Form 1-FR-IB certified by an independent public accountant in accordance with § 1.16 as of a date not more than 45 days prior to the date on which the report is filed; or

(

Provided, however,

that an introducing broker as defined in § 5.1(f)(1) of this chapter that is party to a guarantee agreement that has been terminated must cease doing business as an introducing broker from and after the effective date of such termination, and may not resume doing business as an introducing broker as defined in § 5.1(f)(1) of this chapter unless and until it files a new guarantee agreement.

6. Section 1.35 is amended by revising paragraphs (a), (a-1) and (b) to read as follows:

§ 1.35

Records of cash commodity, futures, and option transactions.

(a)

Futures commission

merchants, retail

foreign exchange

dealers, introducing

brokers, and

members of

contract markets.

Each futures commission merchant, retail foreign exchange dealer, introducing broker, and member of a contract market shall keep full, complete, and systematic records, together with all pertinent data and memoranda, of all transactions relating to its business of dealing in commodity futures, retail forex transactions, commodity options, and cash commodities (including currencies). Each futures commission merchant, retail foreign exchange dealer, introducing broker, and member of a contract market shall retain the required records, data, and memoranda in accordance with the requirements of § 1.31, and produce them for inspection and furnish true and correct information and reports as to the contents or the meaning thereof, when and as requested by an authorized representative of the Commission or the United States Department of Justice. Included among such records shall be all orders (filled, unfilled, or canceled), trading cards, signature cards, street books, journals, ledgers, canceled checks, copies of confirmations, copies of statements of purchase and sale, and all other records, data and memoranda, which have been prepared in the course of its business of dealing in commodity futures, retail forex transactions, commodity options, and cash commodities. Among such records each member of a contract market must retain and produce for inspection are all documents on which trade information is originally recorded, whether or not such documents must be prepared pursuant to the rules or regulations of either the Commission or the contract market. For purposes of this section, such documents are referred to as “original source documents.”

(a-1)

Futures commission

merchants, retail

foreign exchange

dealers, introducing

brokers, and

members of

contract markets:

Recording of

customers' and option

customers' orders.

(1) Each futures commission merchant, each retail foreign exchange dealer and each introducing broker receiving a customer's, retail forex customer's or option customer's order, as applicable, shall immediately upon receipt thereof prepare a written record of the order including the account identification, except as provided in paragraph (a-1)(5) of this section, and order number, and shall record thereon, by timestamp or other timing device, the date and time, to the nearest minute, the order is received, and in addition, for option customers' orders, the time, to the nearest minute, the order is transmitted for execution.

(2)(i) Each member of a contract market who on the floor of such contract market receives a customer's or option customer's order which is not in the form of a written record including the account identification, order number, and the date and time, to the nearest minute, the order was transmitted or received on the floor of such contract market, shall immediately upon receipt thereof prepare a written record of the order in nonerasable ink, including the account identification, except as provided in paragraph (a-1)(5) of this section or appendix C to this part, and order number and shall record thereon,

by timestamp or other timing device, the date and time, to the nearest minute, the order is received.

(ii) Except as provided in paragraph (a-1)(3) of this section:

(A) Each contract market member who on the floor of such contract market receives an order from another member present on the floor which is not in the form of a written record shall, immediately upon receipt of such order, prepare a written record of the order or obtain from the member who placed the order a written record of the order, in non-erasable ink including the account identification and order number and shall record thereon, by time-stamp or other timing device, the date and time, to the nearest minute, the order is received; or

(B) When a contract market member present on the floor places an order, which is not in the form of a written record, for his own account or an account over which he has control, with another member of such contract market for execution:

(1) The member placing such order immediately upon placement of the order shall record the order and time of placement to the nearest minute on a sequentially-numbered trading card maintained in accordance with the requirements of paragraph (d) of this section;

(2) The member receiving and executing such order immediately upon execution of the order shall record the time of execution to the nearest minute on a trading card or other record maintained pursuant to the requirements of paragraph (d) of this section; and

(3) The member receiving and executing the order shall return such trading card or other record to the member placing the order. The member placing the order then must submit together both of the trading cards or other records documenting such trade to contract market personnel or the clearing member, in accordance with contract market rules adopted pursuant to paragraph (j)(1) of this section.

(iii) Each contract market may adopt rules, which must be submitted to the Commission pursuant to section 5a(a)(12)(A) of the Act and Commission Regulation 1.41, that provide alternative requirements to those contained in paragraph (a-1)(2)(ii) of this section. Such rules shall, at a minimum, require that the contemporaneous written records:

(A) Contain the terms of the order;

(B) Include reliable timing data for the initiation and execution of the order which would permit complete and effective reconstruction of the order placement and execution; and

(C) Be submitted to contract market personnel or clearing members in accordance with contract market rules adopted pursuant to paragraph (j)(1) of this section.

(3)(i) The requirements of paragraph (a-1)(2)(ii) of this section will not apply if a contract market maintains in effect rules which have been submitted to the Commission pursuant to section 5a(a)(12)(A) of the Act and Commission Regulation 1.41, which provide for an exemption where:

(A) A contract market member places with another member of such contract market an order that is part of a spread transaction;

(B) The member placing the order personally executes one or more legs of the spread; and

(C) The member receiving and executing such order immediately upon execution of the order records the time of execution to the nearest minute on his trading card or other record maintained in accordance with the requirements of paragraph (d) of this section.

(ii) Each contract market shall, as part of its trade practice surveillance program, conduct surveillance for compliance with the recordkeeping and other requirements under paragraphs (a-1) (2) and (3) of this section, and for trading abuses related to the execution of orders for members present on the floor of the contract market.

(4) Each member of a contract market reporting the execution from the floor of the contract market of a customer's or option customer's order or the order of another member of the contract market received in accordance with paragraphs (a-1)(2)(i) or (a-1)(2)(ii)(A) of this section, shall record on a written record of the order, including the account identification, except as provided in paragraph (a-1)(5) of this section, and order number, by timestamp or other timing device, the date and time to the nearest minute such report of execution is made. Each member of a contract market shall submit the written records of customer orders or orders from other contract market members to contract market personnel or to the clearing member responsible for the collection of orders prepared pursuant to this paragraph as required by contract market rules adopted in accordance with paragraph (j)(1) of this section. The execution price and other information reported on the order tickets must be written in nonerasable ink.

(5)

Post

execution allocation

of bunched

orders.

Specific customer account identifiers for accounts included in bunched orders need not be recorded at time of order placement or upon report of execution if the requirements of paragraphs (a-1)(5)(i)-(iv) of this section are met.

(i)

Eligible account

managers.

The person placing and directing the allocation of an order eligible for post-execution allocation must have been granted written investment discretion with regard to participating customer accounts. The following persons shall qualify as eligible account managers:

(A) A commodity trading advisor registered with the Commission pursuant to the Act or excluded or exempt from registration under the Act or the Commission's rules, except for entities exempt under § 4.14(a)(3) or § 4.14(a)(6) of this chapter;

(B) An investment adviser registered with the Securities and Exchange Commission pursuant to the Investment Advisers Act of 1940 or with a state pursuant to applicable state law or excluded or exempt from registration under such Act or applicable state law or rule;

(D) A foreign adviser that exercises discretionary trading authority solely over the accounts of non-U.S. persons, as defined in § 4.7(a)(1)(iv) of this chapter.

(ii)

Information.

Eligible account managers shall make the following information available to customers upon request:

(A) The general nature of the allocation methodology the account manager will use;

(B) Whether accounts in which the account manager may have any interest may be included with customer accounts in bunched orders eligible for post-execution allocation; and

(C) Summary or composite data sufficient for that customer to compare its results with those of other comparable customers and, if applicable, any account in which the account manager has an interest.

(iii)

Allocation.

Orders eligible for post-execution allocation must be allocated by an eligible account manager in accordance with the following:

(A) Allocations must be made as soon as practicable after the entire transaction is executed, but in any event account managers must provide allocation information to futures commission merchants no later than a time sufficiently before the end of the day the order is executed to ensure that clearing records identify the ultimate customer for each trade.

(B) Allocations must be fair and equitable. No account or group of accounts may receive consistently favorable or unfavorable treatment.

(C) The allocation methodology must be sufficiently objective and specific to permit independent verification of the fairness of the allocations using that methodology by appropriate regulatory and self-regulatory authorities and by outside auditors.

(iv)

Records.

(A) Eligible account managers shall keep and must make available upon request of any representative of the Commission, the United States Department of Justice, or other appropriate regulatory agency, the information specified in paragraph (a-1)(5)(ii) of this section.

(B) Eligible account managers shall keep and must make available upon request of any representative of the Commission, the United States Department of Justice, or other appropriate regulatory agency, records sufficient to demonstrate that all allocations meet the standards of paragraph (a-1)(5)(iii) of this section and to permit the reconstruction of the handling of the order from the time of placement by the account manager to the allocation to individual accounts.

(C) Futures commission merchants that execute orders or that carry accounts eligible for post-execution allocation, and members of contract markets that execute such orders, must maintain records that, as applicable, identify each order subject to post-execution allocation and the accounts to which contracts executed for such order are allocated.

(D) In addition to any other remedies that may be available under the Act or otherwise, if the Commission has reason to believe that an account manager has failed to provide information requested pursuant to paragraph (a-1)(5)(iv)(A) or (a-1)(5)(iv)(B) of this section, the Commission may inform in writing any designated contract market or derivatives transaction execution facility and that designated contract market or derivatives transaction execution facility shall prohibit the account manager from submitting orders for execution except for liquidation of open positions and no futures commission merchants shall accept orders for execution on any designated contract market or derivatives transaction execution facility from the account manager except for liquidation of open positions.

(E) Any account manager that believes he or she is or may be adversely affected or aggrieved by action taken by the Commission under paragraph (a-1)(5)(iv)(D) of this section shall have the opportunity for a prompt hearing in accordance with the provisions of § 21.03(g) of this chapter.

(b)

Futures commission

merchants, retail

foreign exchange

dealers, introducing

brokers, and

clearing members

of contract

markets.

Each futures commission merchant, each retail foreign exchange dealer, and each clearing member of a contract market and, for purposes of paragraph (b)(3) of this section, each introducing broker, shall, as a minimum requirement, prepare regularly and promptly, and keep systematically and in permanent form, the following:

(1) A financial ledger record which will show separately for each customer or retail forex customer or option customer all charges against and credits to such customer's or retail forex customer's or option customer's account, including but not limited to customer or retail forex customer funds deposited, withdrawn, or transferred, and charges or credits resulting from losses or gains on closed transactions;

(2) A record of transactions which will show separately for each account (including proprietary accounts):

(i) All commodity futures transactions executed for such account, including the date, price, quantity, market, commodity and future;

(ii) All retail forex transactions executed for such account, including the date, price, quantity, and currency; and

(iii) All commodity option transactions executed for such account, including the date, whether the transaction involved a put or call, expiration date, quantity, underlying contract for future delivery or underlying physical, strike price, and details of the purchase price of the option, including premium, mark-up, commission and fees; and

(3) A record or journal which will separately show for each business day complete details of:

(i) All commodity futures transactions executed on that day, including the date, price, quantity, market, commodity, future and the person for whom such transaction was made;

(ii) All retail forex transactions executed on that day for such account, including the date, price, quantity, currency and the person for whom such transaction was made; and

(iii) All commodity option transactions executed on that day, including the date, whether the transaction involved a put or call, the expiration date, quantity, underlying contract for future delivery, or underlying physical, strike price, details of the purchase price of the option, including premium, mark-up, commission and fees and the person for whom the transaction was made; and

(iv) In the case of an introducing broker, the record or journal required by this paragraph (b)(3) shall also include the futures commission merchant or retail foreign exchange dealer carrying the account for which each commodity futures, retail forex and commodity option transaction was executed on that day. Provided, however, that where reproductions on microfilm, microfiche or optical disk are substituted for hard copy in accordance with the provisions of § 1.31(b) of this part, the requirements of paragraphs (b)(1) and (b)(2) of this section will be considered met if the person required to keep such records is ready at all times to provide, and immediately provides in the same city as that in which such person's commodity' retail forex or commodity option books and records are maintained, at the expense of such person, reproduced copies which show the records as specified in paragraphs (b)(1) and (b)(2) of this section, on request of any representatives of the Commission or the U.S. Department of Justice.

7. Section 1.36 is amended by revising paragraph (a) to read as follows:

§ 1.36

Record of securities and property received from customers and option customers.

(a) Each futures commission merchant and each retail foreign exchange dealer shall maintain, as provided in § 1.31, a record of all securities and property received from customers, retail forex customers or option customers in lieu of money to margin, purchase, guarantee, or secure the commodity, retail forex or commodity option transactions of such customers, retail forex customers or option customers. Such record shall show separately for each customer, retail forex customer or option customer: a description of the securities or property received; the name and address of such customer, retail forex customer or option customer; the dates when the securities or property were received; the identity of the depositories or other places where such securities or property are segregated or held; the dates of deposits and withdrawals from such depositories; and the dates of return of such securities or property to such customer, retail forex customer or option customer, or other disposition thereof, together with the facts and circumstances of such other disposition. In the event any futures commission

merchant deposits with the clearing organization of a contract market, directly or with a bank or trust company acting as custodian for such clearing organization, securities and/or property which belong to a particular customer or option customer, such futures commission merchant shall obtain written acknowledgment from such clearing organization that it was informed that such securities or property belong to customers or option customers of the futures commission merchant making the deposit. Such acknowledgment shall be retained as provided in § 1.31.

8. Section 1.37 is amended by revising paragraph (a)(1) to read as follows:

§ 1.37

Customer's or option customer's name, address, and occupation recorded; record of guarantor or controller of account.

(a)(1) Each futures commission merchant, retail foreign exchange dealer, introducing broker, and member of a contract market shall keep a record in permanent form which shall show for each commodity futures, retail forex or option account carried or introduced by it the true name and address of the person for whom such account is carried or introduced and the principal occupation or business of such person as well as the name of any other person guaranteeing such account or exercising any trading control with respect to such account. For each such commodity option account, the records kept by such futures commission merchant, introducing broker, and member of a contract market must also show the name of the person who has solicited and is responsible for each option customer's account or assign account numbers in such a manner to identify that person.

9. Section 1.40 is revised to read as follows:

§ 1.40

Crop, market information letters, reports; copies required.

Each futures commission merchant, each retail foreign exchange dealer, each introducing broker and each member of a contract market shall, upon request, furnish or cause to be furnished to the Commission a true copy of any letter, circular, telegram, or report published or given general circulation by such futures commission merchant, retail foreign exchange dealer, introducing broker or member which concerns crop or market information or conditions that affect or tend to affect the price of any commodity or exchange rate, and the true source of or authority for the information contained therein.

10. Section 1.46 is amended by revising paragraphs (a) and (b) to read as follows:

§ 1.46

Application and closing out of offsetting long and short positions.

(a)

Application of

purchases and

sales.

(1) Except with respect to purchases or sales which are for omnibus accounts, or where the customer or account controller has instructed otherwise, any futures commission merchant who, on or subject to the rules of a designated contract market or registered derivatives transaction execution facility:

(i) Purchases any commodity for future delivery for the account of any customer when the account of such customer at the time of such purchase has a short position in the same future of the same commodity on the same market;

(ii) Sells any commodity for future delivery for the account of any customer when the account of such customer at the time of such sale has a long position in the same future of the same commodity on the same market;

(iii) Purchases a put or call option for the account of any option customer when the account of such option customer at the time of such purchase has a short put or call option position with the same underlying futures contract or same underlying physical, strike price, expiration date and contract market as that purchased; or

(iv) Sells a put or call option for the account of any option customer when the account of such option customer at the time of such sale has a long put or call option position with the same underlying futures contract or same underlying physical, strike price, expiration date and contract market as that sold—shall on the same day apply such purchase or sale against such previously held short or long futures or option position, as the case may be, and shall, for futures transactions, promptly furnish such customer a statement showing the financial result of the transactions involved and, if applicable, that the account was introduced to the futures commission merchant by an introducing broker and the names of the futures commission merchant and introducing broker.

(2) Any futures commission merchant or retail foreign exchange dealer who:

(i) Engages in a retail forex transaction involving the purchase of any currency for the account of any retail forex customer when the account of such retail forex customer at the time of such purchase has an open retail forex transaction for the sale of the same currency;

(ii) Engages in a retail forex transaction involving the sale of any currency for the account of any retail forex customer when the account of such retail forex customer at the time of such sale has an open retail forex transaction for the purchase of the same currency;

(iii) Purchases a put or call option involving foreign currency for the account of any option customer when the account of such option customer at the time of such purchase has a short put or call option position with the same underlying currency, strike price, and expiration date as that purchased; or

(iv) Sells a put or call option involving foreign currency for the account of any option customer when the account of such option customer at the time of such sale has a long put or call option position with the same underlying currency, strike price, and expiration date as that sold—shall immediately apply such purchase or sale against such previously held opposite transaction, and shall promptly furnish such retail forex customer a statement showing the financial result of the transactions involved and, if applicable, that the account was introduced to the futures commission merchant or retail foreign exchange dealer by an introducing broker and the names of the futures commission merchant or retail foreign exchange dealer, and the introducing broker.

(b)

Close-out against

oldest open

position.

In all instances wherein the short or long futures, retail forex transaction or option position in such customer's, retail forex customer's or option customer's account immediately prior to such offsetting purchase or sale is greater than the quantity purchased or sold, the futures commission merchant or retail foreign exchange dealer shall apply such offsetting purchase or sale to the oldest portion of the previously held short or long position: Provided, That upon specific instructions from the customer or option customer the offsetting transaction shall be applied as specified by the customer or option customer without regard to the date of acquisition of the previously held position; and Provided, further, that a futures commission merchant or retail foreign exchange dealer, if permitted by the rules of a registered futures association, may offset, at the customer's request, retail forex transactions of the same size, even if the customer holds other transactions of a different size, but in each case must offset the transaction against the oldest

transaction of the same size. Such instructions may also be accepted from any person who, by power of attorney or otherwise, actually directs trading in the customer's, retail forex customer's or option customer's account unless the person directing the trading is the futures commission merchant or retail foreign exchange dealer (including any partner thereof), or is an officer, employee, or agent of the futures commission merchant or retail foreign exchange dealer. With respect to every such offsetting transaction that, in accordance with such specific instructions, is not applied to the oldest portion of the previously held position, the futures commission merchant or retail foreign exchange dealer shall clearly show on the statement issued to the customer, retail forex customer or option customer in connection with the transaction, that because of the specific instructions given by or on behalf of the customer, retail forex customer or option customer the transaction was not applied in the usual manner, i.e., against the oldest portion of the previously held position. However, no such showing need be made if the futures commission merchant or retail foreign exchange dealer has received such specific instructions in writing from the customer, retail forex customer or option customer for whom such account is carried.

11. Section 1.52 is amended by:

a. Revising paragraphs (a) and (c);

b. Revising paragraphs (g)(3) and (g)(4); and

c. Revising paragraphs (h), (j), and (k) to read as follows:

§ 1.52

Self-regulatory organization adoption and surveillance of minimum financial requirements.

(a) Each self-regulatory organization must adopt, and submit for Commission approval, rules prescribing minimum financial and related reporting requirements for all its members who are registered futures commission merchants or registered retail foreign exchange dealers. Each self-regulatory organization other than a contract market must adopt, and submit for Commission approval, rules prescribing minimum financial and related reporting requirements for all its members who are registered introducing brokers. Each contract market which elects to have a category of membership for introducing brokers must adopt, and submit for Commission approval, rules prescribing minimum financial and related reporting requirements for all its members who are registered introducing brokers. Each self-regulatory organization shall submit for Commission approval any modification or other amendments to such rules. Such requirements must be the same as, or more stringent than, those contained in §§ 1.10 and 1.17, for futures commission merchants and introducing brokers, and § 5.7 for retail foreign exchange dealers. The definition of adjusted net capital must be the same as that prescribed in § 1.17(c) for futures commission merchants and introducing brokers, and § 5.7(b)(2) for futures commission merchants offering or engaging in retail forex transactions and for retail foreign exchange dealers: Provided, however, A designated self-regulatory organization may permit its member registrants which are registered with the Securities and Exchange Commission as securities brokers or dealers to file (in accordance with § 1.10(h)) a copy of their Financial and Operational Combined Uniform Single Report under the Securities Exchange Act of 1934, Part II, Part IIA, or Part II CSE, in lieu of Form 1-FR: And, provided further, A designated self-regulatory organization may permit its member introducing brokers to file a Form 1-FR-IB in lieu of a Form 1-FR-FCM.

(c) Any two or more self-regulatory organizations may file with the Commission a plan for delegating to a designated self-regulatory organization, for any registered futures commission merchant, any registered retail foreign exchange dealer, or any registered introducing broker which is a member of more than one such self-regulatory organization, the responsibility of:

(1) Monitoring and auditing for compliance with the minimum financial and related reporting requirements adopted by such self-regulatory organizations in accordance with paragraph (a) of this section; and

(2) Receiving the financial reports necessitated by such minimum financial and related reporting requirements.

(g) * * *

(3) Reduces multiple monitoring and auditing for compliance with the minimum financial rules of the self-regulatory organizations submitting the plan for any futures commission merchant, retail foreign exchange dealer, or introducing broker which is a member of more than one self-regulatory organization;

(4) Reduces multiple reporting of the financial information necessitated by such minimum financial and related reporting requirements by any futures commission merchant, retail foreign exchange dealer, or introducing broker which is a member of more than one self-regulatory organization; * * *

(h) After the Commission has approved a plan or part of one under § 1.52(g), a self-regulatory organization relieved of responsibility must notify each of its members which is subject to such a plan:

(1) Of the limited nature of its responsibility for such a member's compliance with its minimum financial and related reporting requirements; and

(2) Of the identity of the designated self-regulatory organization which has been delegated responsibility for such a member.

(j) Whenever a registered futures commission merchant, a registered retail foreign exchange dealer, or a registered introducing broker holding membership in a self-regulatory organization ceases to be a member in good standing of that self-regulatory organization, such self-regulatory organization must, on the same day that event takes place, give telegraphic notice of that event to the principal office of the Commission in Washington, DC, and send a copy of that notification to such futures commission merchant, retail foreign exchange dealer, or such introducing broker.

(k) Nothing in this section shall preclude the Commission from examining any futures commission merchant, retail foreign exchange dealer, or introducing broker for compliance with the minimum financial and related reporting requirements to which such futures commission merchant, retail foreign exchange dealer, or introducing broker is subject.

PART 3—REGISTRATION

12. The authority citation for part 3 continues to read as follows:

Authority:

7 U.S.C. 1a, 2, 6, 6a, 6b, 6c, 6d, 6e, 6f, 6g, 6h, 6i, 6k, 6m, 6n, 6o, 6p, 8, 9, 9a, 12, 12a, 13b, 13c, 16a, 18, 19, 21 and 23.

13. Section 3.1 is amended by revising paragraph (c) to read as follows:

§ 3.1

Definitions.

(c)

Sponsor.

Sponsor means the futures commission merchant, retail foreign exchange dealer, introducing broker, commodity trading advisor, commodity pool operator or leverage transaction merchant which makes the certification required by § 3.12 of this part for the registration of an associated person of such sponsor.

14. Section 3.4 is amended by revising paragraph (a) to read as follows:

§ 3.4

Registration in one capacity not included in registration in any other capacity.

(a) Except as may be otherwise provided in the Act or in any rule, regulation, or order of the Commission, each futures commission merchant, retail foreign exchange dealer, floor broker, floor trader, associated person, commodity trading advisor, commodity pool operator, introducing broker, and leverage transaction merchant must register as such under the Act. Registration in one capacity under the Act shall not include registration in any other capacity:

Provided, however,

That a registered floor broker need not also register as a floor trader in order to engage in activity as a floor trader.

15. Section 3.10 is amended by:

a. Revising the heading;

b. Revising paragraph (a)(1);

c. Revising paragraph (b); and

d. Revising paragraph (d) to read as follows:

§ 3.10

Registration of futures commission merchants, retail foreign exchange dealers, introducing brokers, commodity trading advisors, commodity pool operators and leverage transaction merchants.

(a)

Application for

registration.

(1)(i) Except as provided in paragraph (a)(3) of this section, application for registration as a futures commission merchant, retail foreign exchange dealers, introducing broker, commodity trading advisor, commodity pool operator or leverage transaction merchant must be on Form 7-R, completed and filed with the National Futures Association in accordance with the instructions thereto.

(ii) Applicants for registration as a futures commission merchant, retail foreign exchange dealer or introducing broker must accompany their Form 7-R with a Form 1-FR-FCM or Form 1-FR-IB, respectively, in accordance with the provisions of § 1.10 of this chapter:

Provided, however,

That an applicant for registration as a

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