Enhancing Protections Afforded Customers and Customer Funds Held by Futures Commission Merchants and Derivatives Clearing Organizations

Federal RegisterNov 14, 2013

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COMMODITY FUTURES TRADING COMMISSION

17 CFR Parts 1, 3, 22, 30, and 140

RIN 3038-AD88

Enhancing Protections Afforded Customers and Customer Funds Held by Futures Commission Merchants and Derivatives Clearing Organizations

AGENCY:

Commodity Futures Trading Commission.

ACTION:

Final rule.

SUMMARY:

The Commodity Futures Trading Commission (“Commission” or “CFTC”) is adopting new regulations and amending existing regulations to require enhanced customer protections, risk management programs, internal monitoring and controls, capital and liquidity standards, customer disclosures, and auditing and examination programs for futures commission merchants (“FCMs”).

The regulations also address certain related issues concerning derivatives clearing organizations (“DCOs”) and chief compliance officers (“CCOs”). The final rules will afford greater assurances to market participants that: Customer segregated funds, secured amount funds, and cleared swaps funds are protected; customers are provided with appropriate notice of the risks of futures trading and of the FCMs with which they may choose to do business; FCMs are monitoring and managing risks in a robust manner; the capital and liquidity of FCMs are strengthened to safeguard their continued operations; and the auditing and examination programs of the Commission and the self-regulatory organizations (“SROs”) are monitoring the activities of FCMs in a prudent and thorough manner.

DATES:

Effective date:

January 13, 2014.

Compliance date:

The applicable compliance dates are discussed in the section of the release titled “III. Compliance Dates.”

FOR FURTHER INFORMATION CONTACT:

Division of Swap Dealer and Intermediary Oversight:

Gary Barnett, Director, 202-418-5977,

gbarnett@cftc.gov

; Thomas Smith, Deputy Director, 202-418-5495,

tsmith@cftc.gov;mailto:

Jennifer Bauer, Special Counsel, 202-418-5472,

jbauer@cftc.gov

; Joshua Beale, Attorney-Advisor, 202-418-5446,

jbeale@cftc.gov

, Three Lafayette Centre, 1155 21st Street NW., Washington, DC 20581; Kevin Piccoli, Deputy Director, 646-746-9834,

kpiccoli@cftc.gov

, 140 Broadway, 19th Floor, New York, NY 10005; or Mark Bretscher, Special Counsel, 312-596-0529,

mbretscher@cftc.gov

, 525 W. Monroe Street, Suite 1100, Chicago, IL. 60661.

Division of Clearing and Risk:

Ananda Radhakrishnan, Director, 202-418-5188,

aradhakrishnan@cftc.gov

; Robert B. Wasserman, Chief Counsel, 202-418-5092,

rwasserman@cftc.gov

; Phyllis P. Dietz, Deputy Director, 202-418-5449,

pdietz@cftc.gov

; M. Laura Astrada, Associate Chief Counsel, 202-418-7622,

lastrada@cftc.gov

, Eileen Donovan, Associate Director, 202-418-5096,

edonovan@cftc.gov

; Kirsten V. K. Robbins, Special Counsel, 202-418-5313,

krobbins@cftc.gov

; or Shawn R. Durrani, Attorney-Advisor, 202-418-5048,

sdurrani@cftc.gov,

Three Lafayette Centre, 1155 21st Street NW., Washington, DC 20581.

Office of the Chief Economist:

Stephen Kane, Research Economist,

skane@cftc.gov

, 202-418-5911, Three Lafayette Centre, 1155 21st Street NW., Washington, DC 20581.

SUPPLEMENTARY INFORMATION:

Table of Contents

I. Background

A. General Statutory and Current Regulatory Structure

B. Self-Regulatory Structure

C. Futures Commission Merchant Insolvencies and Failures of Risk Management

D. Recent Commission Rulemakings and Other Initiatives Relating to Customer Protection

E. The Proposed Amendments

II. Comments on the Notice of Proposed Rulemaking

A. § 1.10: Financial Reports of Futures Commission Merchants and Introducing Brokers

1. Amendments of the Segregation and Secured Amount Schedules With Respect to the Reporting of Residual Interest

2. New Cleared Swaps Segregation Schedules

3. Amendments to Form 1-FR-FCM

4. FCM Certified Annual Report Deadline

5. Leverage Ratio Calculation

6. Procedural Filing Requirements

B. § 1.11: Risk Management Program for Futures Commission Merchants

1. Applicability

2. Definitions

3. Approval of Policies and Procedures and Submission to the Commission

4. Organizational Requirements of the Risk Management Program

a. Separation of Risk Management Unit From Business Unit

5. Components of the Risk Management Program

6. Annual Review, Distribution of Policies and Procedures and Recordkeeping

7. CCO or CEO Certification

C. § 1.12: Maintenance of Minimum Financial Requirements by Futures Commission Merchants and Introducing Brokers

1. Timing of Notices

2. Undercapitalized FCMs and IBs

3. Insufficient Segregation of Funds of Cleared Swaps Customers

4. Investment of Customer Funds in Contravention of Regulation 1.25

5. Notice of Residual Interest Falling Below Targeted Level or Undermargined Amounts

6. Events Causing Material Adverse Financial Impact or Material Change in Operations

7. Notice of Correspondence From Other Regulatory Authorities

8. Filing Process and Content

9. Public Disclosure of Early Warning Notices

D. § 1.15: Risk Assessment Reporting Requirement for Futures Commission Merchants

E. § 1.16: Qualifications and Reports of Accountants

1. Mandatory PCAOB Registration Requirement

2. PCAOB Inspection Requirement

3. Remediation of PCAOB Inspection Findings by the Public Accountant

4. Auditing Standards

5. Review of Public Accountant's Qualifications by the FCM's Governing Body

6. Electronic Filing of Certified Annual Reports

F. § 1.17: Minimum Financial Requirements for Futures Commission Merchants and Introducing Brokers

1. FCM Cessation of Business and Transfer of Customer Accounts if Unable To Demonstrate Adequate Liquidity

2. Reducing Time Period for FCMs To Incur a Capital Charge for Undermargined Accounts to One Day after Margin Calls Are Issued

3. Permit an FCM that is not a BD To Develop Policies and Procedures To Determine Creditworthiness

4. Revisions to Definitions in Regulation 1.17(b)

G. § 1.20: Futures Customer Funds To Be Segregated and Separately Accounted for

1. Identification of Customer Funds and Due Diligence

2. Permitted Depositories

3. Limitation on the Holding of Futures Customer Funds Outside of the United States

4. Acknowledgment Letters

a. Background

b. Technical Changes to the Template Letters

c. Federal Reserve Banks as Depositories

d. Foreign Depositories

e. Release of Funds Upon Commission Instruction

f. Read-Only Access and Information Requests

g. Requirement To File New Acknowledgment Letters

h. Standard of Liability

i. Liens

j. Examination of Accounts

5. Prohibition Against Commingling Customer Funds

6. Limitations on the Use of Customer Funds

7. Segregation Requirements for DCOs

8. Immediate Availability of Bank and Trust Company Deposits

9. Segregated Funds Computation Requirement

10. Segregation Regimes

H. § 1.22: Use of Futures Customer Funds

I. § 1.23: Interest of Futures Commission Merchant in Segregated Futures Customer Funds; Additions and Withdrawals

J. § 1.25: Investment of Customer Funds

1. General Comments Regarding the Investment of Customer Funds

2. Reverse Repurchase Agreement Counterparty Concentration Limits

K. § 1.26: Deposit of Instruments Purchased With Futures Customer Funds

L. § 1.29: Increment or Interest Resulting From Investment of Customer Funds

1. FCM's Responsibility for Losses Incurred on the Investment of Customer Funds

2. FCM's Obligation in Event of Bank Default

M. § 1.30: Loans by Futures Commission Merchants: Treatment of Proceeds

N. § 1.32: (§ 22.2(g) for Cleared Swaps Customers and § 30.7(l) for Foreign Futures and Foreign Options Customers): Segregated Account: Daily Computation and Record

O. § 1.52: Self-Regulatory Organization Adoption and Surveillance of Minimum Financial Requirements

1. Swap Execution Facilities Excluded From the Scope of Regulation 1.52

2. Revisions to the Current SRO Supervisory Program

3. Auditing Standards Utilized in the SRO Supervisory Program

4. “Examinations Expert” Reports

P. § 1.55: Public disclosures by Futures Commission Merchants

1. Amendments to the Risk Disclosure Statement

a. Firm Specific Disclosure Document

i. General Requirements

ii. Specific Disclosure Information Required (by rule paragraph)

2. Public Availability of FCM Financial Information

Q. Part 22—Cleared Swaps

R. Amendments to § 1.3: Definitions; and § 30.7: Treatment of Foreign Futures or Foreign Options Secured Amount

1. Elimination of the “Alternative Method” for Calculating the Secured Amount

2. Funds Held in Non-U.S. Depositories

3. Commingling of Positions in Foreign Futures and Foreign Options Accounts

4. Further Harmonization With Treatment of Customer Segregated Funds

5. Harmonization With Other Commission Proposals

S. § 3.3: Chief Compliance Officer Annual Report

III. Compliance Dates

A. Financial Reports of FCMs: § 1.10

B. Risk Management Program for FCMs: § 1.11

C. Qualifications and Reports of Accountants: § 1.16

D. Minimum Financial Requirements for FCMs

E. Written Acknowledgment Letters: §§ 1.20, 1.26, and 30.7

F. Undermargined Amounts: §§ 1.22(c), 30.7(a)

G. SRO Minimum Financial Surveillance: § 1.52

H. Public Disclosures by FCMs: § 1.55

IV. Cost Benefit Considerations

V. Related Matters

A. Regulatory Flexibility Act

B. Paperwork Reduction Act

Appendix 1—Table of Comment Letters

Appendix 2—CFTC Form 1-FR-FCM

I. Background

A. General Statutory and Current Regulatory Structure

The protection of customers—and the safeguarding of money, securities or other property deposited by customers with an FCM—is a fundamental component of the Commission's disclosure and financial responsibility framework. Section 4d(a)(2)

of the Commodity Exchange Act (“the Act” or “the CEA”)

requires each FCM to segregate from its own assets all money, securities, and other property deposited by futures customers to margin, secure, or guarantee futures contracts and options on futures contracts traded on designated contract markets.

Section 4d(a)(2) further requires an FCM to treat and deal with futures customer funds as belonging to the futures customer, and prohibits an FCM from using the funds deposited by a futures customer to margin or extend credit to any person other than the futures customer that deposited the funds.

7 U.S.C. 6d(a)(2).

7 U.S.C. 1 et seq.

The term “futures customer” is defined in § 1.3(iiii) of the Commission's regulations to include any person who uses an FCM as an agent in connection with trading in any contract for the purchase or sale of a commodity for future delivery or an option on such contract (excluding any proprietary accounts under § 1.3(y)). The Commission adopted the definition of the term “futures customer” on October 16, 2012 as part of the final rulemaking that amended existing Commission regulations to incorporate swaps. The

Federal Register

release adopting the final rules can be accessed at

http://www.cftc.gov/ucm/groups/public/@newsroom/documents/file/federalregister101612.pdf.

Commission regulations can be found at 17 CFR Ch. 1.

Section 4d(f) of the Act, which was added by section 724(a) of the Dodd-Frank Wall Street Reform and Consumer Protection Act (“Dodd-Frank Act”),

requires each FCM to segregate from its own assets all money, securities, and other property deposited by Cleared Swaps Customers to margin Cleared Swaps.

Section 4d(f) also provides that an FCM shall treat and deal with all money, securities, and property of any swaps customer received to margin, guarantee, or secure a swap cleared by or through a DCO (including money, securities, or property accruing to the swaps customer as the result of such a swap) as belonging to the swaps customer. Section 4d(f) further provides that an FCM shall separately account for and not commingle with its own funds any money, securities, and property of a swaps customer, and shall not use such swaps customer's funds to margin, secure, or guarantee any trades or contracts of any swaps customer or person other than the person for whom the same are held.

See Dodd-Frank Act, Public Law 111-203, 124 Stat. 1376 (2010). The text of the Dodd-Frank Act may be accessed at

http://www.cftc.gov/LawRegulation/DoddFrankAct/index.htm.

The term “Cleared Swap” is defined in section 1a(7) of the Act as any swap that is, directly or indirectly, submitted to and cleared by a DCO registered with the Commission. The term “Cleared Swaps Customer” is defined in § 22.1 as any person entering into a Cleared Swap, but excludes: (1) Any owner or holder of a Cleared Swaps Proprietary Account with respect to the Cleared Swaps in such account; and (2) A clearing member of a DCO with respect to Cleared Swaps cleared on that DCO.

The Commission adopted §§ 1.20 through 1.30, and § 1.32, to implement section 4d(a)(2) of the Act, and adopted part 22 to implement section 4d(f) of the Act. The purpose of these regulations is to safeguard funds deposited by futures customers and Cleared Swaps Customers, respectively.

Regulation 1.20 requires each FCM and DCO to separately account for and to segregate from its own proprietary funds all money, securities, or other property deposited by futures customers for trading on designated contract markets. In addition, all futures customer funds must be separately accounted for, and may not be commingled with the money, securities or property of an FCM or of any other person, or be used to secure or guarantee the trades, contracts or commodity options, or to secure or extend the credit, of any person other than the one for whom the same are held. Regulation 1.20 also provides that an FCM or DCO may deposit futures customer funds only with a bank or trust company, and for FCMs only, a DCO or another FCM. The funds must be deposited under an account name that clearly identifies the funds as belonging to the futures customers of the FCM or DCO and further shows that the funds are segregated as required by section 4d(a)(2) of the Act and Commission regulations. FCMs and DCOs also are required to obtain a written acknowledgment from a depository stating that the depository was informed that the funds deposited are customer funds being held in accordance with the Act.

FCMs and DCOs also are restricted in their use of futures customer funds. Regulation 1.22 prohibits an FCM from using, or permitting the use of, the

futures customer funds of one futures customer to purchase, margin, or settle the trades, contracts, or commodity options of, or to secure or extend the credit of, any person other than such futures customer. In addition, § 1.22 provides that futures customer funds may not be used to carry trades or positions of the same futures customer other than in commodities or commodity options traded through the facilities of a contract market. Under § 1.20, an FCM or DCO may, however, for convenience, commingle and hold funds deposited as margin by multiple futures customers in the same account or accounts with one of the recognized depositories. An FCM or DCO also may invest futures customer funds in certain permitted investments under § 1.25.

Part 22 of the Commission's regulations, which governs Cleared Swaps, implements section 4d(f) of the Act and parallels many of the provisions in part 1 that address the manner in which, and the responsibilities imposed upon, an FCM may hold funds for futures customers trading on designated contract markets.

For example, § 22.2 requires an FCM to treat and to deal with funds deposited by Cleared Swaps Customers as belonging to such Cleared Swaps Customers and to hold such funds separately from the FCM's own funds. Regulation 22.4 provides that an FCM may deposit Cleared Swaps Customer Collateral with a bank, trust company, DCO, or another registered FCM.

Regulation 22.6 requires that the account holding the Cleared Swaps Customers Collateral must clearly identify the account as an account for Cleared Swaps Customers of the FCM engaging in Cleared Swaps and that the funds maintained in the account are subject to the segregation provisions of section 4d(f) of the Act and Commission regulations.

The Commission approved the part 22 regulations on January 11, 2012, with an effective date of April 9, 2012. Compliance with the part 22 regulations was required by November 8, 2012.

See Protection of Cleared Swaps Customer Contracts and Collateral; Conforming Amendments to the Commodity Broker Bankruptcy Provisions,

77 FR 6336 (Feb. 7, 2012).

The term “Cleared Swaps Customer Collateral” is defined in § 22.2 to mean all money, securities, or other property (including accruals) received by an FCM or DCO from, for, or on behalf of a Cleared Swaps Customer to margin, guarantee, or secure a Cleared Swap.

Regulation 22.2(d) also prohibits an FCM from using the Cleared Swaps Customer Collateral of one Cleared Swaps Customer to purchase, margin, or settle the Cleared Swaps or any other trade or contract, or to secure or extend credit, of any person other than such Cleared Swaps Customer. Further, § 22.2(c) permits an FCM to commingle the Cleared Swaps Customer Collateral of multiple Cleared Swaps Customers into one or more accounts, and § 22.2(e)(1) permits an FCM to invest Cleared Swaps Customer Collateral in accordance with § 1.25.

In addition to holding funds for futures customers transacting on designated contract markets and for Cleared Swaps Customers engaging in Cleared Swaps, FCMs also hold funds for persons trading futures contracts listed on foreign boards of trade. Section 4(b) of the Act provides that the Commission may adopt rules and regulations proscribing fraud and requiring minimum financial standards, the disclosure of risk, the filing of reports, the keeping of books and records, the safeguarding of the funds deposited by persons for trading on foreign markets, and registration with the Commission by any person located in the United States (“U.S.”) who engages in the offer or sale of any contract of sale of a commodity for future delivery that is made subject to the rules of a board of trade located outside of the U.S. Pursuant to the statutory authority of section 4(b), the Commission adopted part 30 of its regulations to address foreign futures and foreign option transactions.

The segregation provisions for funds deposited by foreign futures or foreign options customers to margin foreign futures or foreign options transactions under part 30, however, are significantly different from the requirements set forth in § 1.20 for futures customers trading on designated contract markets and part 22 for Cleared Swaps Customers engaging in Cleared Swaps.

Regulation 30.7 provides that an FCM may deposit the funds belonging to foreign futures or foreign options customers in an account or accounts maintained at a bank or trust company located in the U.S.; a bank or trust company located outside of the U.S. that has in excess of $1 billion of regulatory capital; an FCM registered with the Commission; a DCO; a member of a foreign board of trade; a foreign clearing organization; or a depository selected by the member of a foreign board of trade or foreign clearing organization. The account with the depository must be titled to clearly specify that the account holds funds belonging to the foreign futures or foreign options customers of the FCM that are trading on foreign futures markets. An FCM also is permitted to invest the funds deposited by foreign futures or foreign option customers in accordance with § 1.25.

The term “foreign futures or foreign options customer” is defined in § 30.1 to mean any person located in the U.S., its territories or possessions who trades in foreign futures or foreign options, with the exception of accounts that are proprietary accounts under § 1.3. The term “foreign futures or foreign option” is defined in § 30.1 to generally mean any futures and/or options transactions executed on a foreign board of trade.

However, unlike § 1.20 and part 22, which require an FCM to hold a sufficient amount of funds in segregation to meet the total account equities of all of the FCM's futures customers and Cleared Swaps Customers “at all times” (

i.e.,

the “Net Liquidating Equity Method”), § 30.7 requires an FCM to maintain in separate accounts an amount of funds only sufficient to cover the margin required on open foreign futures contracts, plus or minus any unrealized gains or losses on such open positions, plus any funds representing premiums payable or received on foreign options (including any additional funds necessary to secure such options, plus or minus any unrealized gains or losses on such options) (

i.e.,

the “Alternative Method”). Thus, under the part 30 Alternative Method an FCM is not required to maintain a sufficient amount of funds in such separate accounts to pay the full account balances of all of its foreign futures or foreign options customers at all times.

In addition to the segregation requirements of sections 4d(a)(2) and 4d(f) of the Act, and the secured amount requirements in part 30 of the Commission's regulations, FCMs also are subject to minimum net capital and financial reporting requirements that are intended to ensure that such firms meet their financial obligations in a regulated marketplace, including their financial obligations to customers and DCOs. Each FCM is required to maintain a minimum level of “adjusted net capital,” which is generally defined under § 1.17 as the firm's net equity as computed under generally accepted accounting principles, less all of the firm's liabilities (except for certain qualifying subordinated debt) and further excluding all assets that are not liquid or readily marketable. Regulation 1.17(c)(5) further requires an FCM to impose capital charges (

i.e.,

deductions) on certain of its liquid assets to protect against possible market risks in such assets.

FCMs also are subject to financial recordkeeping and reporting requirements. FCMs that carry customer accounts are required under § 1.32 to prepare a schedule each business day demonstrating their compliance with the segregation and secured amount requirements. Regulation 1.32 requires the calculation to be performed by noon

each business day, reflecting the account balances and open positions as of the close of business on the previous business day.

Each FCM also is required by § 1.10 to file with the Commission and with its designated self-regulatory organization (“DSRO”) monthly unaudited financial statements and an annual audited financial report.

Regulation 1.12 requires an FCM to file a notice with the Commission and with the firm's DSRO whenever, among other things, the firm: (1) Fails to maintain compliance with the Commission's capital requirements; (2) fails to hold sufficient funds in segregated or secured amount accounts to meet its regulatory requirements; (3) fails to maintain current books and records; or (4) experiences a significant reduction in capital from the previous month-end. The purpose of the regulatory notices is to alert the Commission and the firm's DSRO as early as possible to potential financial issues at the firm that may adversely impact the ability of the FCM to comply with its obligations to safeguard customer funds, or to meet its financial obligations to other FCMs or DCOs.

The term “self-regulatory organization” is defined by § 1.3 to mean a contract market, a swap execution facility, or a registered futures association. A DSRO is the SRO that is appointed to be primarily responsible for conducting ongoing financial surveillance of an FCM that is a member of two or more SROs under a joint audit agreement submitted to and approved by the Commission under § 1.52.

The statutory mandate to segregate customer funds—to treat them as belonging to the customer and not use the funds inappropriately—takes on greater meaning in light of the devastating events experienced over the last two years. Those events, which are discussed in greater detail below, demonstrate that the risks of misfeasance and malfeasance, and the risks of an FCM failing to maintain sufficient excess funds in segregation: (i) Put customer funds at risk; and (ii) are exacerbated by stresses on the business of the FCM. Many of those risks can be mitigated significantly by better risk management systems and controls, along with an increase in risk-oriented oversight and examination of the FCMs.

Determining what is a “sufficient” amount of excess funds in segregation for any particular FCM requires a full understanding of the business of that FCM, including a proper analysis of the factors that affect the actual amount of segregated funds held by the FCM relative to the minimum amount of segregated funds it is required to hold. Further, appropriate care must be taken to avoid withdrawing such excess funds at times of great stress to cover needs unrelated to the purposes for which excess segregated and secured funds are maintained. In times of stress, excess funds may look like an easy liquidity source to help cover other risks of the business; yet withdrawing such excess funds makes the funds unavailable when they may be most needed. The recent market events illustrate both the need to: (i) Require that care be taken about monitoring excess segregated and secured funds, and the conditions under and the extent to which such funds may be withdrawn; and (ii) place appropriate risk management controls around the other risks of the business to help relieve (A) the likelihood of an exigent event or, (B) if such an event occurs, the likelihood of a failure to prepare for such an event, which in either case could create pressures that result in an inappropriate withdrawal of customer funds.

Although the Commission's existing regulations provide an essential foundation to fostering a well-functioning marketplace, wherein customers are protected and institutional risks are minimized, recent events have demonstrated that additional measures are necessary to effectuate the fundamental purposes of the statutory provisions discussed above. Further, concurrently with the enhanced responsibilities for FCMs that were proposed by the Commission, the oversight and examination systems must be enhanced to mitigate risks and effectuate the statutory purposes.

B. Self-Regulatory Structure

The Commission's oversight structure provides that SROs are the frontline regulators of FCMs, introducing brokers (“IBs”), commodity pool operators, and commodity trading advisors. In 2000, Congress affirmed the Commission's reliance on SROs by amending section 3 of the Act to state: “It is the purpose of this Act to serve the public interests through a system of effective self-regulation of trading facilities, clearing systems, market participants and market professionals under the oversight of the Commission.”

As part of its oversight responsibility, an SRO is required to conduct periodic examinations of member FCMs' compliance with Commission and SRO financial and related reporting requirements, including the FCMs' holding of customer funds in segregated and secured accounts. The Commission oversees the SROs by examining them for the performance of their duties. The Commission recently has moved to conducting continuous reviews of the SROs' FCM examination program that includes a process whereby the Commission selects a small sample of the SRO's FCM work papers to review. In addition, the Commission also conducts limited-scope reviews of FCMs in “for cause” situations that are sometimes referred to as “audits,” but they are not full-scale audits as accountants commonly use that term.

In addition, because there are multiple SROs who share the same member FCMs, to avoid subjecting FCMs to duplicative examinations from SROs, the Commission has a permissive system that allows the SROs to agree how to allocate FCMs amongst them. An SRO who is allocated certain FCMs for such examination is referred to as the DSRO of those FCMs.

Under Commission regulations, FCMs must have their annual financial statements audited by an independent certified public accountant following generally accepted auditing standards as adopted in the U.S. (“U.S. GAAS”). As part of this certified annual report, the independent accountant also must conduct appropriate reviews and tests to identify any material inadequacies in systems and controls that could violate the Commission's capital, segregation or secured amount requirements. Any such inadequacies are required to be reported to the FCM's DSRO and to the Commission.

C. Futures Commission Merchant Insolvencies and Failures of Risk Management

The recent insolvencies of two FCMs demonstrate the need for revisions to the Commission's customer protection regime. On October 31, 2011, MF Global, Inc. (“MFGI”), which was dually-registered as an FCM with the Commission and as a securities broker-dealer (“BD”) with the U.S. Securities and Exchange Commission (“SEC”), was placed into a liquidation proceeding under the Securities Investor Protection Act by the Securities Investor Protection Corporation (“SIPC”).

The trustee appointed to oversee the liquidation of MFGI reported a potential $900 million shortfall of funds necessary to repay the account balances due to customers trading futures on designated contract markets, and an approximately $700 million shortfall in funds immediately available to repay the account balances of customers trading on foreign futures markets.

The shortfall in customer segregated accounts was attributed by the MFGI Trustee to significant transfers of funds

out of the customer accounts that were used by MFGI for various purposes other than to meet obligations to or on behalf of customers.

See Report of the Trustee's Investigation and Recommendations, In re MF Global Inc.,

No. 11-2790 (MG) SIPA (Bankr. S.D.N.Y. June 4, 2012).

In addition, the Commission filed a civil injunctive complaint in federal district court on July 10, 2012, against Peregrine Financial Group, Inc. (“PFGI”), a registered FCM and its Chief Executive Officer (“CEO”) and sole owner, Russell R. Wasendorf, Sr., alleging that PFGI and Wasendorf, Sr. committed fraud by misappropriating customer funds, violated customer fund segregation laws, and made false statements regarding the amount of funds in customer segregated accounts in financial statements filed with the Commission. The complaint states that in July 2012 during an NFA examination PFGI falsely represented that it held in excess of $220 million of customer funds when in fact it held approximately $5.1 million.

Complaint,

U.S. Commodity Futures Trading Commission

Peregrine Financial Group, Inc., and Russell R. Wasendorf, Sr.,

No. 12-cv-5383 (N.D. Ill. July 10, 2012). A copy of the Commission's complaint has been posted to the Commission's Web site.

Recent incidents also have demonstrated the value of establishing robust risk management systems within FCMs and enhanced early warning systems to detect and address financial and regulatory issues. In particular, problems that arise through an FCM's non-futures-related business can have a direct and significant impact on the FCM's financial condition, raising questions as to whether the FCM will be able to protect customer funds

and maintain the minimum financial requirements mandated by the Act and Commission regulations.

The Commission notes that the definition of “customer funds” in § 1.3(gg) includes funds held for customers trading on designated contract markets and customers engaging in cleared swap transactions. However, as used in this notice, unless otherwise specified, the term “customer funds” also includes funds held for customers trading on foreign markets pursuant to part 30 of the Commission's regulations.

See, e.g.,

Edward Krudy, Jed Horowitz and John McCrank, “Knight's Future in Balance After Trading Disaster,” Reuters (Aug. 3, 2012), available at

http://in.reuters.com/article/2012/08/03/knightcapital-loss-idINL2E8J27QE20120803

(noting that a software issue caused the firm to incur a $440 million trading loss, which represented much of the firm's capital).

These recent incidents highlighted weaknesses in the customer protection regime prescribed in the Commission's regulations and through the self-regulatory system. In particular, questions have arisen on the requirements surrounding the holding and investment of customer funds, including the ability of FCMs to withdraw funds from futures customer segregated accounts and part 30 secured accounts. Additionally, the incidents have underscored the need for additional safeguards—such as robust risk management systems, strengthened early-warning systems surrounding margin and capital requirements, and enhanced public disclosures—to promote the protection of customer funds and to minimize the systemic risk posed by certain actions of market participants. Further questions have arisen on the system of audits and examinations of FCMs, and whether the system functions adequately to monitor FCMs' activities, verify segregated funds and secured amount balances, and detect fraud.

D. Recent Commission Rulemakings and Other Initiatives Relating to Customer Protection

Since late 2011, the Commission has promulgated rules directly impacting the protection of customer funds. The Commission also has studied the current regulatory framework surrounding customer protection, particularly in light of the recent incidents outlined above, in order to identify potential enhancements to the systems and Commission regulations protecting customer funds. The Commission's efforts have been informed, in part, by efforts undertaken by industry participants. The proposed rule amendments were informed by the efforts detailed below.

In December 2011, the Commission adopted final rule amendments revising the types of investments that an FCM or DCO can make with customer funds under § 1.25, for the purpose of affording greater protection for such funds.

Among other changes to §§ 1.25 and 30.7, the final rule amendments removed from the list of permitted investments: (1) Corporate debt obligations not guaranteed by the U.S. Government; (2) foreign sovereign debt; and (3) in-house and affiliate transactions.

See

Investment of Customer Funds and Funds Held in an Account for Foreign Futures and Foreign Options Transactions, 76 FR 78776 (Dec. 19, 2011).

In adopting the amendments to § 1.25, the Commission was mindful that customer segregated funds must be invested by FCMs and DCOs in a manner that minimizes their exposure to credit, liquidity, and market risks both to preserve their availability to customers and DCOs, and to enable investments to be quickly converted to cash at a predictable value in order to avoid systemic risk. The amendments are consistent with the general prudential standard contained in § 1.25, which provides that all permitted investments must be “consistent with the objectives of preserving principal and maintaining liquidity.”

The Commission also approved final regulations that require DCOs to collect initial customer margin from FCMs on a gross basis.

Under the final regulations, FCMs are no longer permitted to offset one customer's margin requirement against another customer's margin requirements and deposit only the net margin collateral with the DCO. As a result of the rule change, a greater portion of customer initial margin is posted by FCMs to the DCOs.

See

Commission Regulation 39.12(g)(8)(i) and Derivatives Clearing Organization General Provisions and Core Principles, 76 FR 69334 (Nov. 8, 2011).

The Commission also approved regulations that impose requirements on FCMs and DCOs regarding the treatment of Cleared Swaps and Cleared Swaps Customer Collateral.

Under the traditional futures model, DCOs hold an FCM's futures customers' funds on an omnibus basis in a futures customer account. In the event of a double default, which is a situation where a futures customer defaults on its obligation to its clearing FCM and the loss is so great that the clearing FCM defaults on its obligation to the DCO, the DCO is permitted to use the funds held in the futures customers' omnibus account to cover the loss of the defaulting futures customer before applying its own capital or the guaranty fund contributions of non-defaulting FCM members.

See

77 FR 6336 (Feb. 7, 2012).

The Commission approved an alternative model for Cleared Swaps. Under the “LSOC” (legal segregation with operational comingling) model, DCOs may hold Cleared Swaps Customer Collateral on an omnibus basis in a Cleared Swaps Customer Account.

However, unlike with the futures model, following a double default the DCO would only be permitted to access the collateral of the defaulting Cleared Swaps Customers; it would not be permitted to use the collateral of non-defaulting Cleared Swaps Customers to cover a defaulting Cleared Swaps Customer's losses.

The term “Cleared Swaps Customer Account” is defined in § 22.1 and generally refers to an account that an FCM or a DCO maintains at a permitted depository for the Cleared Swaps (and related collateral) of Cleared Swaps Customers.

Pursuant to section 724(c) of the Dodd-Frank Act, the final rule on segregation for uncleared swaps, approved by the Commission on October 30, 2013, implements the

requirements of section 4s(l) of the CEA that Swap Dealers (“SDs”) and Major Swap Participants (“MSPs”) notify their counterparties that such counterparties have a right to require that any initial margin which they post to guarantee uncleared swaps be segregated at an independent custodian. Where the counterparty elects segregation for its initial margin, the account must be held at a custodian that is independent of both the counterparty and the SD or MSP.

The Commission also included customer protection enhancements in a final rulemaking for designated contract markets issued in June 2012. These enhancements codify into regulations staff guidance on minimum requirements for SROs regarding their financial surveillance of FCMs.

The regulations require a DCM to have arrangements and resources for effective rule enforcement and trade and financial surveillance programs, including the authority to collect information and examine books and records of members and market participants. The regulations also establish minimum financial standards for both member FCMs and IBs and non-intermediated market participants. The Commission expressly noted in the preamble of the

Federal Register

release that “a DCM's duty to set financial standards for its FCM members involves setting capital requirements, conducting surveillance of the potential future exposure of each FCM as compared to its capital, and taking appropriate action in light of the results of such surveillance.”

Further, the rules mandate that DCMs adopt rules for the protection of customer funds, including the segregation of customer and proprietary funds, the custody of customer funds, the investment standards for customer funds, intermediary default procedures and related recordkeeping.

See

Core Principles and Other Requirements for Designated Contract Markets, 77 FR 36612 (June 19, 2012).

Id.

at 36646.

In addition to the rulemaking efforts outlined above, the Commission sought additional information through a series of roundtables and other meetings. On February 29 and March 1, 2012, the Commission solicited comments and held public roundtables to solicit input on customer protection issues from a broad cross-section of the futures industry, including market participants, FCMs, DCOs, SROs, securities regulators, foreign clearing organizations, and academics.

The roundtable focused on issues relating to the advisability and practicality of modifying the segregation models for customer funds; alternative models for the custody of customer collateral; enhancing FCM controls over the disbursement of customer funds; increasing transparency surrounding an FCM's holding and investment of customer funds; and lessons learned from recent commodity brokerage bankruptcy proceedings.

Further information on the public roundtable, including video recordings and transcripts of the discussions, have been posted to the Commission's Web site.

See http://www.cftc.gov/PressRoom/Events/opaevent_cftcstaff022912 (relating to Feb. 29, 2012); http://www.cftc.gov/PressRoom/Events/opaevent_cftcstaff030112 (relating to Mar. 1, 2012).

The Commission also hosted a public meeting of the Technology Advisory Committee (“TAC”) on July 26, 2012.

Panelists and TAC members discussed potential technological solutions directed at enhancing the protection of customer funds by identifying and exploring technological issues and possible solutions relating to the ability of the Commission, SROs and customers to verify the location and status of funds held in customer segregated accounts.

Additional information, including documents submitted by meeting participants, has been posted to the Commission's Web site.

See http://www.cftc.gov/PressRoom/Events/opaevent_tac072612

Commission staff hosted an additional roundtable on August 9, 2012, to discuss SRO requirements for examinations of FCMs and Commission oversight of SRO examination programs. The roundtable also focused on the role of the independent public accountant in the FCM examination process, and proposals addressing various alternatives to the current system for segregating customer funds.

The Commission also considered industry initiatives to enhance customer protections. On February 29, 2012, the Futures Industry Association (“FIA”) initiated steps to educate customers on the extent of the protections provided under the current regulatory structure. FIA issued a list of Frequently Asked Questions (“FAQ”) prepared by members of the FIA Law and Compliance Division addressing the basics of segregation, collateral management and investments, capital requirements and other issues for FCMs and joint FCM/BDs, and clearinghouse guaranty funds.

The FAQ is intended to provide existing and potential customers with a better understanding of the risks of engaging in futures trading and a clear explanation of the extent of the protections provided to customers and their funds under the Act and Commission regulations.

The FIA's release addressing FAQs on the protection of customer funds is accessible on the FIA's Web site at

http://www.futuresindustry.org/downloads/PCF-FAQs.PDF

FIA also issued a series of initial recommendations for the protection of customer funds.

The recommendations were prepared by the Financial Management Committee, whose members include representatives of FIA member firms, DCOs and depository institutions. The initial recommendations address enhanced disclosure on the protection of customer funds, reporting on segregated funds balances by FCMs, FCM internal controls surrounding the holding and disbursement of customer funds, and revisions to part 30 regulations to make the protections comparable to those provided for customers trading on designated contract markets.

The FIA's initial recommendations are accessible on the FIA's Web site at

http://www.futuresindustry.org/downloads/Initial_Recommendations_for_Customer_Funds_Protection.pdf

On July 13, 2012, the Commission approved new FCM financial requirements proposed by the National Futures Association (“NFA”).

The NFA Financial Requirements Section 16 and its related Interpretive Notice entitled “NFA Financial Requirements Section 16: FCM Financial Practices and Excess Segregated Funds/Secured Amount Disbursements” (collectively referred to as “the Segregated Funds Provisions”) were developed in consultation with Commission staff.

For more information relating to the new FCM financial requirements, see

http://www.nfa.futures.org/news/newsNotice.asp?ArticleID=4072

NFA's Segregated Funds Provisions require each FCM to: (1) Maintain written policies and procedures governing the deposit of the FCM's proprietary funds (

i.e.,

excess or residual funds) in customer segregated accounts and part 30 secured accounts; (2) maintain a targeted amount of excess funds in segregate accounts and part 30 secured accounts; (3) file on a daily basis the FCM's segregation and part 30 secured amount computations with NFA; (4) obtain the approval of senior management prior to a withdrawal that is not for the benefit of customers whenever the withdrawal equals 25 percent or more of the excess segregated or part 30 secured amount funds; (5) file a notice with NFA of any withdrawal that is not for the benefit of customers whenever the withdrawal equals 25 percent or more of the excess segregated or part 30 secured amount funds; (6) file detailed information regarding the depositories holding customer funds and the investments made with customer funds as of the 15th day (or

the next business day if the 15th is not a business day) and the last business day of each month; and (7) file additional monthly net capital and leverage information with NFA.

Significantly, NFA's Segregated Funds Provisions also require FCMs to compute their part 30 secured amount requirement and compute their targeted excess part 30 secured funds using the same Net Liquidating Equity Method that is required by the Act and Commission regulations for computing the segregation requirements for customers trading on U.S. contract markets under section 4d of the Act. FCMs are not permitted under the NFA rules to use the Alternative Method to compute the part 30 secured amount requirement. The failure of an FCM to maintain its targeted amount of excess part 30 funds computed using the Net Liquidating Equity Method may result in NFA initiating a Membership Responsibility Action against the firm.

In addition, in setting the target amount of excess funds, the FCM's management must perform a due diligence inquiry and consider various factors relating, as applicable, to the nature of the FCM's business, including the type and general creditworthiness of the FCM's customers, the trading activity of the customers, the types and volatility of the markets and products traded by the FCM's customers, and the FCM's own liquidity and capital needs. The FCM's Board of Directors (or similar governing body), CEO or Chief Financial Officer (“CFO”) must approve in writing the FCM's targeted residual amount, any changes thereto, and any material changes in the FCM's written policies and procedures.

The NFA and CME Group Inc. (“CME”) also adopted rules requiring FCMs to instruct each depository holding futures customer funds to report such balances on a daily basis to the NFA or CME, respectively.

Initially, the NFA and CME retained the services of a third-party vendor which received account balance information directly from certain banks, custodians of securities, and money market funds, and passed such information on to the NFA and CME. The CME, however, took over the role of the third-party vendor effective October 29, 2013 and receives account information directly from all depositories holding futures customer funds. The CME also provides NFA with daily account balance information for the FCMs that NFA is the DSRO. The same process applies to the FCM's customer secured account(s) held for customers trading on foreign futures exchanges, and for the FCM's Cleared Swaps Customers engaging in Cleared Swaps.

See

NFA Financial Requirements Rules, Section 4. Financial Requirements and Treatment of Customer Property, and CME Rule 971, Segregation, Secured, and Cleared Swaps Customer Account Requirements.

In addition, NFA and CME expanded their oversight of FCMs under the amended rules, by developing programs that compare the daily balances reported by the depositories with the balances reported by the FCMs in their daily segregation reports. An immediate alert is generated for any material discrepancies.

E. The Proposed Amendments

The incidents outlined above, coupled with the information generated through the recent efforts undertaken by the Commission and industry participants, demonstrate the need for new rules and amendments to existing rules. In particular, an examination of FCM business operations—including the non-futures business of FCMs—and the currently regulatory framework, evince a need for enhanced customer protections, risk management programs, disclosure requirements, and auditing and examination programs. To address these needs, the Commission issued a Notice of Proposed Rulemaking (“NPRM”) on November 14, 2012 (“the Proposal”) containing a series of amendments to enhance customer protections.

77 FR 67866 (Nov. 14, 2012).

The Proposal addressed six main issues. First, recognizing problems surrounding the treatment of customer segregated funds and foreign futures or foreign options secured amounts, the Commission proposed to amend several components of parts 1, 22, and 30 of the Commission's regulations to provide greater certainty to market participants that the customer funds entrusted to FCMs will be protected. Second, to address shortcomings in the risk management of FCMs, the Commission proposed a new § 1.11 that establishes robust risk management programs. Third, the Commission determined that the current regulatory framework should be re-oriented to implement a more risk-based, forward-looking perspective, affording the Commission and SROs with read-only access to accounts holding customer funds and additional information on depositories and the customer assets held in such depositories. Fourth, given the difficulties that can arise in an FCM's business, and the direct and significant impact on the FCM's regulatory capital that can result from such difficulties, the Commission proposed to amend § 1.17(a)(4) to ensure that an FCM's capital and liquidity are sufficient to safeguard the continuation of operations at the FCM. Fifth, to effect the change in orientation needed in FCM examinations programs, as well as to assure quality control over program contents, administration and oversight, the Commission proposed to amend § 1.52, which, among other things, addresses the formation of Joint Audit Committees and the implementation of Joint Audit Programs. And sixth, recognizing the need to increase the information provided to customers concerning the risks of futures trading and the FCMs with which they may choose to conduct business, the Commission proposed amendments to § 1.55 that enhance the disclosures provided by FCMs.

II. Comments on the Notice of Proposed Rulemaking

The Proposal, aimed at: (1) Amending and enhancing its current customer protection regime; (2) imposing risk management requirements on FCMs; (3) requiring additional “early warning” notices from FCMs regarding material changes in their operations or financial condition; (4) imposing additional liquidity requirements for FCMs; (5) revising the examination process of FCMs by both the SROs and public accountants; and (6) requiring additional disclosures to customers concerning the risks of futures trading and the FCMs that hold customer funds. The Commission extended the initial 60-day comment period for approximately 30 additional days at the request of various commenters and in order to provide interested parties with an additional opportunity to comment on the proposal.

The comment period closed on February 15, 2013.

78 FR 4093 (Jan. 18, 2013).

During the comment period the Commission held two public roundtables to solicit input on issues related to the proposal from a cross-section of the futures industry, including market participants, FCMs, DCOs, SROs, securities regulators, foreign clearing organizations, and academics. The Commission received more than 120 written submissions on the proposing release from a range of commenters.

Commission staff also met with representatives from at least eight of the commenters and other

members of the public. Commenters represented a broad spectrum of industry participants, trade organizations, law firms, accounting firms and self-regulatory organizations. The majority of commenters supported the overall principles proposed by the Commission although many raised concerns or offered suggestions regarding certain proposal specifics.

The written submissions from the public are available in the comment file on

www.cftc.gov

. They include, but are not limited to, those listed in the table in Appendix 1 to this release. In citing to the comments received during the discussion of the comments in this Section, the Commission used the abbreviations set forth in the table in Appendix 1.

The Commission also held a meeting of the Agricultural Advisory Committee on July 25, 2013, and included in the agenda a discussion of the Proposal. The transcript of the Agricultural Advisory Committee meeting is included in the comment file to the Proposal, and the Commission has considered those comments in finalizing the regulations.

The Commission has carefully considered the comments received and is adopting the Proposal herein subject to various amendments that address certain concerns raised or suggestions made by commenters. Each section of the final rules, including any relevant revisions to the corresponding section of the Proposal, is discussed in greater detail in the following sections.

A. § 1.10: Financial Reports of Futures Commission Merchants and Introducing Brokers

Regulation 1.10 requires each FCM to file with the Commission and with the firm's DSRO an unaudited financial report each month. The financial report must be prepared using Form 1-FR-FCM. An FCM that is dually-registered as a BD, however, may file a Financial and Operational Combined Uniform Single Report under the Securities Exchange Act of 1934 (“FOCUS Report”) in lieu of the Form 1-FR-FCM. Each FCM also is required to file with the Commission and with its DSRO an annual financial report certified by an independent public accountant.

The unaudited monthly and certified annual financial reports are required to contain basic financial statements, including a statement of financial condition, a statement of income (loss), and a statement of changes in ownership equity. The financial reports also are required to include additional schedules designed to address specific regulatory objectives to demonstrate that the FCM is in compliance with minimum capital and customer funds segregation requirements. These additional schedules include a statement of changes in liabilities subordinated to claims of general creditors, a statement of the computation of the minimum capital requirements (“Capital Computation Schedule”), a statement of segregation requirements and funds in segregation for customers trading on U.S. commodity exchanges (“Segregation Schedule”), and a statement of secured amounts and funds held in separate accounts for foreign futures and foreign options customers (“Secured Amount Schedule”). In addition, the certified annual report must contain a reconciliation of material differences between the Capital Computation Schedule, the Segregation Schedule, and the Secured Amount Schedule contained in the certified annual report and the unaudited monthly report for the FCM's year-end month.

1. Amendments to the Segregation and Secured Amount Schedules With Respect to the Reporting of Residual Interest

The Segregation Schedule and the Secured Amount Schedule generally indicate, respectively, (1) The total amount of funds held by the FCM in segregated or secured accounts; (2) the total amount of funds that the FCM must hold in segregated or secured accounts to meet its regulatory obligations to futures customers and foreign futures or foreign options customers; and (3) whether the firm holds excess segregated or secured funds in the segregated or secured accounts as of the reporting date. FCMs also deposit proprietary funds into customer segregated and secured accounts to protect against becoming undersegregated or undersecured by failing to hold a sufficient amount of funds in such accounts to meet the regulatory requirements. This cushion of proprietary funds is referred to as the FCM's “residual interest” in the customer segregated and secured accounts.

The Commission proposed to amend § 1.10 to require each FCM to also disclose in the Segregation Schedule and in the Secured Amount Schedule its targeted amount of “residual interest” that the FCM seeks to maintain in customer segregated accounts and secured accounts as computed under § 1.11.

As more fully discussed in section II.B. below, new § 1.11(e)(3)(i)(D) requires the senior management of each FCM that carries customer funds to perform appropriate due diligence in setting the amount of the residual interest. Such due diligence must consider the nature of the FCM's business including the type and general creditworthiness of its customer base, the types of markets and products traded by the firm's customers, the proprietary trading activities of the FCM, the volatility and liquidity of the markets and products traded by the customers and by the FCM, the FCM's own liquidity and capital needs, historical trends in customer segregation and secured account funds balances, and historical trends in customer debits and margin deficits (

i.e.,

undermargined amounts).

The FCM also is required to maintain policies and procedures establishing the targeted amount of residual interest that the FCM seeks to maintain as its residual interest in the segregated and secured accounts. The FCM's due diligence and policies and procedures must be designed to reasonably ensure that the FCM maintains the targeted residual interest amount and remains in compliance with its segregation requirements at all times.

The Commission also proposed to revise the title of the “Secured Amount Schedule” by adding the term “30.7 Customer” to specify that the secured amount will include both U.S.-domiciled and foreign-domiciled customers consistent with the proposed amendments to part 30 of the Commission Regulations discussed in Section II.R. below. No comments were received regarding the revisions to the title of the “Secured Amount Schedule,” and the Commission is adopting the revisions as proposed.

The NPRM explained that a margin deficit occurs when the value of the customer funds for a customer's account is less than the total amount of collateral required by DCOs for that account's contracts. As explained further in the discussion in sections II.G.9., II.Q., and II.R., the term “undermargined amount,” as defined in §§ 1.22(c)(1), 22.2(f)(6)(i), and 30.7(f)(1)(ii)(A), is used in place of the term “margin deficit” in the final rule.

The NFA adopted a similar amendment to its rules, mandating that FCMs maintain written policies and procedures identifying a target amount that the FCM will seek to maintain as its residual interest in customer segregated and secured accounts.

See

NFA Notice I-12-14 (July 18, 2012), available at

http://www.nfa.futures.org/news/newsNotice.asp?ArticleID=4072

The disclosure of the targeted amount of the FCM's residual interest in segregated or secured accounts will allow the Commission and the FCM's DSRO to determine whether the FCM actually maintains funds in segregated and secured accounts in amounts sufficient to cover the respective targeted residual interest amounts. If a firm does not maintain sufficient funds to cover the targeted residual interest amounts, the Commission and/or DSRO will take appropriate steps to assess whether the FCM is experiencing financial issues that may indicate potential threats to the overall safety of customer funds. The disclosure of the amounts of the FCM's targeted residual interest also will enhance the Commission's and DSROs' surveillance of FCMs by providing information that will allow for the assessment of the size of the targeted residual interest relative to both the total funds held in segregation or secured accounts and to

the size of the targeted residual interest maintained by other comparable FCMs. This information will assist the Commission and DSROs in the overall risk assessment of the FCMs, including the assessment of the potential risk that a firm may become undersegregated or undersecured. This additional information will further enhance the Commission's and DSROs' overall ability to protect customer funds.

The Commission also proposed to amend the Segregation Schedule and the Secured Amount Schedule to require each FCM filing such schedules to disclose the sum of the outstanding margin deficits (

i.e.,

undermargined amounts) as of the reporting date. The purpose of this disclosure was to demonstrate that the FCM's residual interest in the segregated and secured account exceeded the respective customer margin deficits (

i.e.,

undermargined amounts) as proposed in §§ 1.22 and 1.23.

The Commission has considered the proposal and has determined not to amend the Segregation Schedule and Secured Amount Schedule to require the disclosure of the undermargined amounts. As further discussed in sections II.G.9. and II.R. below, the Commission is revising the proposed amendments to § 1.22 that would have required an FCM to maintain at all times a residual interest in segregated or secured accounts in excess of its undermargined amounts. The final regulations being adopted in § 1.22, § 22.2, and § 30.7 will require computations as of different points in time than that of the computations reflected on the Segregation Schedule and the Secured Amount Schedule, which are prepared as of the close of business each day. The reporting of the undermargined amount information on the Segregation and Secured Amount Schedules would not be accurate as the firm's customers may not be undermargined, or may be less undermargined, at the time the undermargined amount calculations are required to be performed due, for example, to customers meeting margin calls.

The Commission notes, however, that it will receive notice under § 1.12 from an FCM if the firm maintains residual interest in the segregated or secured amount accounts that is less than the sum of the firm's undermargined amount at the point in time the FCM is required to maintain such undermargined amounts under § 1.22, § 22.2, and § 30.7. The notice provision will alert the Commission and the FCM's DSRO to the fact that the undermargined amounts exceed the firm's residual interest in the accounts, and the Commission and DSRO can monitor the firm's actions to restore its residual interest to a level that is above the undermargined amounts, or take other actions as appropriate.

See

section II.C. below.

The Commission has considered the comments and is adopting the amendments to § 1.10 as proposed, with the above revisions to the Segregation Schedule and the Secured Amount Schedule.

2. New Cleared Swaps Segregation Schedules

The Commission proposed to amend § 1.10(d) and to revise the Form 1-FR-FCM to adopt a new “Statement of Cleared Swap Customer Segregation Requirements and Funds in Cleared Swap Customer Accounts Under Section 4d(f) of the Act” (“Cleared Swaps Segregation Schedule”).

The Commission proposed the Cleared Swaps Segregation Schedule to further implement section 724(a) of the Dodd-Frank Act. Section 724(a) of the Dodd-Frank Act amended section 4d of the Act by adding a new paragraph (f) to require an FCM to separately account for and segregate from its own assets Cleared Swaps Customers Collateral deposited by Cleared Swaps Customers. Section 4d(f) of the Act also requires FCMs to treat and deal with all the Cleared Swaps Customer Collateral deposited by a Cleared Swaps Customer as belonging to such customer, and prohibits an FCM from, with certain exceptions, using the Cleared Swaps Customer Collateral to margin, secure or guarantee the Cleared Swaps of any person other than the Cleared Swaps Customer who deposited the Cleared Swaps Customer Collateral. FCMs currently prepare a schedule comparable to the Cleared Swaps Segregation Schedule for Cleared Swaps under applicable contract market or NFA rules, and the Commission's proposal would codify existing practices.

The Commission previously proposed a Cleared Swaps Segregation Schedule as part of its proposed regulations to adopt capital requirements for swap dealers and major swap participants.

See

Capital Requirements of Swap Dealers and Major Swap Participants, 76 FR 27802 (May 12, 2011). The Commission re-proposed the schedule as part of the Proposal in light of the Commission's decision to revise the schedule by requiring FCMs to separately disclose their targeted residual interest in Cleared Swaps Customer Accounts and the sum of margin deficits (

i.e.,

undermargined amounts) for such accounts. The Commission also has adopted new regulations requiring FCMs to hold in segregated accounts funds received from customers engaging in Cleared Swaps to margin, secure or guarantee their Cleared Swaps in accordance with section 4d(f) of the Act.

See

77 FR 6336 (Feb. 7, 2012).

The Commission received one comment on the proposed Cleared Swaps Segregation Schedule. The Students at the SUNY Buffalo Law School supported the development of the Cleared Swaps Segregation Schedule.

The Commission has considered the comment and has determined to adopt the Cleared Swaps Segregation Schedule as proposed.

SUNY Buffalo Comment Letter at 7 (Mar. 19, 2013).

The Commission will revise the Cleared Swaps Segregation Schedule consistent with the revisions to the Segregation Schedule and Secured Amount Schedule discussed in section II.A.1. to remove the requirement for the firm to disclose the amount of the margin deficits as of the close of business on the previous business day. In addition, § 1.10(h) provides that a dually-registered FCM/BD may file a FOCUS Report in lieu of the Form 1-FR-FCM provided that all information that is required to be included in the Form 1-FR-FCM is included in the FOCUS Report. Currently, dual-registrant FCM/BDs include a Segregation Schedule and a Secured Amount Schedule in the FOCUS Report filings as supplemental schedules. Dual-registrant FCM/BDs that have Cleared Swaps Customers will also have to include a Cleared Swaps Segregation Schedule to their Focus Report filings.

In addition, § 1.10 currently provides that the Commission will treat the monthly Form 1-FR-FCM reports, and monthly FOCUS Reports filed in lieu of the Forms 1-FR-FCM, as exempt from mandatory public disclosure for purposes of the Freedom of Information Act and the Government in the Sunshine Act.

Regulation 1.10(g)(2) provides, however, that the following information in Forms 1-FR-FCM, and the same or equivalent information in FOCUS Reports filed in lieu of Forms 1-FR-FCM, are publicly available: The amount of the FCM's adjusted net capital; the amount of the FCM's minimum net capital requirement under § 1.17; and the amount of its adjusted net capital in excess of its minimum net capital requirement. In addition, § 1.10(g)(2) further provides that the FCM's Statement of Financial Condition in the certified annual financial report and the Segregation Schedule and Secured Amount Schedule are public documents.

5 U.S.C. 552.

The Commission proposed to amend § 1.10(g)(2)(ii) to add the Cleared Swaps Segregation Schedule to the list of documents that are publicly available. The only comment that the Commission received regarding making the Cleared Swaps Segregation Schedule public was received from students at the SUNY Buffalo Law School. The students at the SUNY Buffalo Law School supported the development and implementation of the Cleared Swaps Segregation Schedule as a regulatory tool for the Commission to receive additional information and to provide greater protection to customer funds.

The students, however, also stated that the public disclosure of the Cleared Swaps Segregation Schedule and other financial information could

cause public panic in certain situations.

They cited MFGI and Bear Stearns as examples of how public panic can rapidly accelerate a company's collapse by exacerbating the effects of financial injuries that might otherwise be manageable.

SUNY Buffalo Comment Letter at 8 (Mar. 19, 2013).

Id.

at 8-9.

Id.

The Commission notes that the monthly Segregation Schedules and Secured Amount Schedules have been available to the public for many years and provide important information that allows customers to monitor the financial condition of FCMs. As noted in the Proposal, the Commission believes that making the Cleared Swaps Segregation Schedule publicly available will benefit customers and potential customers by providing greater transparency on the status of the Cleared Swaps Customer Collateral held by FCMs. This disclosure allows customers and other members of the public to review an FCM's compliance with its regulatory obligations to safeguard customer funds. The disclosure of the Cleared Swaps Segregation Schedule also will provide a certain amount of detail as to how the FCM holds Cleared Swaps Customer Collateral, which customers and potential customers will be able to assess as part of their risk management process.

The disclosure of the status of an FCM's compliance with its obligation to segregate customer funds, coupled with the additional firm risk disclosures that the Commission proposed in § 1.55 (and is adopting in relevant part herein as discussed in detail in section II.P. below), will provide customers with greater transparency regarding the risks of entrusting their funds and engaging in transactions with particular FCMs. The Commission believes that these benefits to customers outweigh any potential adverse market impact which, in any event, has not been shown to be an issue based on the Commission's experience in making FCMs' Segregation Schedules and Secured Amount Schedules publicly available. The Commission has, therefore, determined to adopt the amendments to § 1.10(g)(2) as proposed.

3. Amendments to Form 1-FR-FCM

The Commission proposed to amend several statements in the Form 1-FR-FCM. The Commission proposed to amend the Statement of Financial Condition by adding a new line item 1.D. Line 1 currently separately details: (1) The amount of funds that the FCM holds in segregated accounts for customers trading on designated contract markets (Line 1.A.); (2) the amount of funds held in segregation for dealer options (Line 1.B.); and (3) the amount of funds held in secured accounts for foreign futures and foreign option customers (Line 1.C.).

Proposed line item 1.D. would set forth the amount of funds held by the FCM in segregated accounts for Cleared Swaps Customers. This amendment is necessary due to the adoption of the part 22 regulations, which requires the segregation of Cleared Swaps Customer Collateral and the proposed adoption of the Cleared Swaps Segregation Schedule as part of the Form 1-FR-FCM.

See

77 FR 6336 (Feb. 7, 2012).

The Commission also proposed to amend the Statement of Financial Condition by adding a new line item 22.F., which would require the separate disclosure of the FCM's liability to Cleared Swaps Customers. The proposed amendments to disclosure the total amount of funds held by the FCM for Cleared Swaps Customers, and the FCM's total obligation to Cleared Swaps Customers, is consistent with the reporting required on the Form 1-FR-FCM for customers trading on designated contract markets.

The Commission also proposed to revise line item 27.J. of the Statement of Financial Condition to require an FCM to disclose separately its obligation to retail forex customers. Currently, an FCM's obligation to retail forex customers is included with other miscellaneous liabilities and reported under current line item 27.J. “Other.” The separate reporting of an FCM's retail forex obligation will provide greater transparency on the Statement of Financial Condition regarding the firm's obligations to its retail counterparties in off-exchange foreign currency transactions, and is appropriate given the Commission's direct jurisdiction over such activities when conducted by an FCM under section 2(c) of the Act.

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

NFA filed the only comment addressing the proposed amendments to the Statement of Financial Condition. NFA noted its full support of the proposed amendments to line item 27.J of the Statement of Financial Condition contained in Form 1-FR-FCM, and further requested that the Commission consider amending the asset section of the Statement of Financial Condition of Form 1-FR-FCM to require an FCM or Retail Foreign Exchange Dealer (“RFED”) to report the total funds on deposit to cover its obligations to retail forex customers as required by Commission Regulation 5.8.

NFA stated that this revision would result in more accurate reporting and is consistent with the reporting for customer segregated funds.

NFA Comment Letter at 9 (Feb. 15, 2013).

Id.

The Commission has considered the comment and has determined to adopt the amendments as proposed. The Commission also is revising the Statement of Financial Condition in the Form 1-FR-FCM in response to the NFA's comment to include a new line item to require FCMs and RFEDs to separately disclose the assets held in qualifying accounts in excess of the firms' obligations to retail forex customers as required by Commission Regulation 5.8.

Regulation 5.8 requires each FCM and RFED offering or engaging in retail forex transactions to hold, at all times, assets of the type permissible in § 1.25 in an amount that exceeds the FCM's or RFED's total obligation to its retail forex customers at qualifying institutions set forth in the Regulation. The requirement of Regulation 5.8 is to ensure the RFED or FCM holds liquid assets in relation to the amount of liability to retail forex customers.

However, such retail forex customer funds are not held in “segregated accounts” in manner comparable to section 4d of the Act, which are provided with explicit protections in the event of the bankruptcy of the FCM. The Commission is revising the Statement of Financial Condition of the Form 1-FR-FCM to require each FCM or RFED to report on line 19.B. the aggregate amount of funds held in qualifying accounts to meet its total obligation to retail forex customers as required by § 5.8. Such disclosure will provide greater transparency as to the firm's compliance with Commission regulations.

See

75 FR 3282, 3290 (Jan. 20, 2010).

4. FCM Certified Annual Report Deadline

The Commission proposed to amend § 1.10(b)(1)(ii) to require an FCM to submit its certified annual report to the Commission and to the firm's DSRO within 60 days of its year-end date. Currently, an FCM is required to submit the annual certified financial statements within 90 days of its year-end date, except for FCMs that also are registered with the SEC as BDs, which are require to submit the certified annual report within 60 days of the year-end date under both Commission and SEC regulations. Therefore, the proposal would impact only FCMs that are not

dually-registered as BDs and would align the filing deadlines for both FCMs and dual registrant FCMs/BDs.

The Commission received one comment on the proposal. NFA supported the proposal noting that the amendment will provide both the Commission and DSROs with more timely information for monitoring the financial condition of an FCM.

The Commission considered the comment received and is adopting the amendments to § 1.10(b)(1)(ii) as proposed. The Commission also is cognizant of the fact that public accountants are currently engaged in the audit of FCMs for the year ending December 31, 2013 and possible for other year-end dates in 2014. Accordingly, in order to ensure that the amendments do not impede examinations that are currently in process, the Commission is establishing a compliance date for FCM annual audits for years ending June 1, 2014 or later. This compliance date also will align the revised reporting deadline with the auditing amendments to the auditing standards that public accountants use in the audit of FCMs and discussed in section II.E. below. Compliance dates are discussed further in section III below.

NFA Comment Letter at 9 (Feb. 15, 2013).

5. Leverage Ratio Calculation

The Commission proposed to add a new requirement in § 1.10(b)(5) to require each FCM to file with the Commission on a monthly basis its balance sheet leverage ratio. Proposed § 1.10(b)(5) defined the term “leverage” as an FCM's total balance sheet assets, less any instruments guaranteed by the U.S. Government and held as an asset or to collateralize an asset

(e.g.,

a reverse repurchase agreement) divided by the FCM's total capital (

i.e.,

the sum of the FCM's stockholders' equity and subordinated debt). FCMs currently file the same leverage information with NFA on a monthly basis using the same definition of the term “leverage.” The leverage ratio would provide information regarding the amount of assets supported by the FCM's capital base, and would allow the Commission to enhance its oversight of FCMs that are highly leveraged relative to their peers or based upon the Commission's understanding of the firm's business model.

The Commission received three comments with respect to this proposal. Commenters were concerned that the leverage metrics proposed might not provide meaningful information and/or that the Commission's leverage definition was not consistent with those of other regulatory authorities. NFA noted that while the leverage definition proposed by the Commission is the same definition as that set forth in NFA Financial Requirement Section 16, it may not be the most appropriate measure.

NFA noted that it has been studying an alternative calculation method and encouraged the Commission to defer codifying a single definition until it has the opportunity to examine NFA's calculation results.

NFA also suggested the Commission consider adopting a requirement that FCMs report a leverage ratio as defined by a registered futures association rather than including a specific definition in the Commission's regulations.

NFA Comment Letter at 7-8 (Feb. 15, 2013).

Id.

at 7.

Id.

at 8.

FIA indicated that it supported the proposed amendment, but stated that it is essential that the definition of the term “leverage” be consistent among regulatory authorities with supervision over FCMs and encouraged the Commission to coordinate with the SEC and the relevant SROs to ensure consistent treatment across the industry.

FIA Comment Letter at 12 (Feb. 15, 2013).

RJ O'Brien objected to the proposal on the grounds that the definition of “leverage” in the proposal “penalizes” FCMs that are not dually-registered as BDs.

RJ O'Brien stated that an FCM-only entity's balance sheet is primarily composed of funds deposited by customers for trading commodity interests, and that the leverage ratio computed under the proposed regulation does not properly reflect the risk of the firm's business.

RJ O'Brien recommended that the Commission work with NFA to develop a more meaningful metric and further recommended that the Commission not permit or require public disclosure of FCM leverage ratios under the current methodology because RJ O'Brien believes it could provide the public with misleading information.

RJ O'Brien Comment Letter at 8-9 (Feb. 15, 2013)

Id.

The Commission has considered the comments and has determined to adopt a final regulation requiring FCMs to submit to the Commission monthly balance sheet leverage information. As noted above, such information will enhance the Commission's ability to conduct financial surveillance of FCMs. The final regulation, however, will define the term “leverage” by referencing to the rules of a registered futures association as suggested by NFA. This revision to the final regulation will align the Commission's definition of leverage with the current NFA definition of leverage.

NFA is currently the only registered futures association.

As stated above, in proposing the requirement for FCMs to report their monthly leverage ratios, the Commission intended for FCMs to file the same leverage information that they currently file with the NFA. In this regard, the Commission proposed a definition of leverage that is identical to the current NFA definition contained in its Financial Requirement Section 16. Such an approach will enhance the consistency in how the Commission and the SROs impose leverage reporting requirements on FCMs and in how leverage is monitored by the regulators. Furthermore, in response to RJ O'Brien's comment, the Commission intends to work with NFA and other regulators going forward on any revisions to the definition of “leverage” to maintain as consistent a definition as practicable.

6. Procedural Filing Requirements

The Commission proposed to amend § 1.10(c)(2)(i) to require FCMs to electronically file with the Commission their monthly unaudited Forms 1-FR-FCM or FOCUS Reports and their certified annual financial reports. FCMs currently file their monthly unaudited financial statements with the Commission electronically using the WinJammer Online Filing System (“WinJammer”) and the proposed amendments merely codify current practices.

WinJammer is a web-based application developed and maintained jointly by the Chicago Mercantile Exchange and the NFA. The WinJammer system is provided at no cost to FCMs. FCMs currently use WinJammer to transmit Forms 1-FR-FCM, FOCUS Reports, and other financial information and regulatory notices to the Commission and to the SROs.

FCM annual financial reports are filed in paper form with the Commission. Under the Commission's proposal, an FCM would use the WinJammer system to electronically file its certified financial report as a “PDF” document.

No comments were received on the proposed amendments to § 1.10(c)(2)(i). The Commission is adopting the amendments as proposed.

The Commission also is adopting a proposed technical amendment to § 1.10(c)(1) on which no comments were received. Regulation 1.10(c)(1) provides that any report or information required to be provided to the Commission by an IB or FCM will be considered filed

when received by the Commission Regional office with jurisdiction over the state in which the FCM has its principal place of business. The amendments to § 1.10(c)(1) sets forth the jurisdiction of each of the Commission's three Regional offices under § 140.02, and is intended to ensure that FCM's financial reports are filed expeditiously with the correct Commission Regional office.

B. § 1.11: Risk Management Program for Futures Commission Merchants

The Commission proposed new § 1.11 to require each FCM that carries customer accounts to establish a “Risk Management Program,” as defined in § 1.11(c), designed to monitor and manage the risks associated with the FCM's activities as an FCM. Under the Commission's proposal, the Risk Management Program must: (1) consist of written policies and procedures that have been approved by the “governing body” (defined below) of the FCM and furnished to the Commission; and (2) establish a risk management unit that is independent from an FCM's “business unit” (defined below) to administer the Risk Management Program.

NFA, FIA, ICI, CFA, Chris Barnard, and Paul/Weiss generally supported proposed § 1.11.

Advantage stated “that most aspects of proposed § 1.11 are appropriate and unlikely to be burdensome as FCMs typically have most (if not all) of these requirements in place.”

Several other commenters raised issues with specific components of the proposed regulation, which are discussed in the sections below. The Commission has considered the comments received and is adopting § 1.11 as proposed, with the following observations and clarifications.

NFA Comment Letter at 10 (Feb. 15, 2013); FIA Comment Letter at 52 (Feb. 15, 2013); ICI Comment Letter at 7 (Jan. 14, 2013); CFA Comment Letter at 4 (Feb. 13, 2013); Chris Barnard Comment Letter at 2 (Dec. 18, 2012); Paul/Weiss Comment Letter at 2 (Feb. 15, 2013).

Advantage Comment Letter at 2 (Feb. 15, 2013).

1. Applicability

Proposed paragraph (a) of § 1.11 provides that the regulation would only apply to FCMs that accept money, securities, or property (or extend credit in lieu thereof) to margin, guarantee, or secure any trades or contracts that result from soliciting or accepting orders for the purchase or sale of any commodity interest. FCMs that do not accept or hold customer funds to margin, guarantee or secure commodity interests are generally not operating as FCMs, and are not subject to § 1.11. To clarify, the Commission notes that it would expect registered FCMs that do not accept customer funds to establish a Risk Management Program that complies with § 1.11 and file such program with the Commission and with the FCMs' DSROs prior to changing their business model to begin accepting customer funds.

The Commission also requested comment on whether different risk management requirements for FCMs should be based upon some measurable criteria, such as size of the firm, and whether different elements of § 1.11 should apply to smaller FCMs versus larger FCMs. Advantage stated that a one-size fits all approach is less than optimal, and that the Commission could establish minimum risk management standards for specific business lines/customer type, and then require that FCMs engaging in those lines of business/clearing that type of customer have those programs in place.

Advantage Comment Letter at 2 (Feb. 15, 2013).

The Commission has considered the comment and has determined that § 1.11 provides sufficient flexibility for FCMs to establish a risk management program that is appropriate to its business operations. To develop specific requirements for different business activities would not be appropriate in that each FCM may operate in a different manner. The Commission believes that each FCM can develop its own program to meet its business activities using the general framework established by § 1.11.

The Commission received no additional comments on proposed § 1.11(a) and is adopting the provision as proposed.

2. Definitions

The Commission proposed definitions of the terms “customer,” “business unit,” “governing body,” “segregated funds,” and “senior management” in paragraph (b) of § 1.11. These definitions are designed to ensure that there is accountability at the highest levels for the FCM's key internal controls and processes regarding the FCM's responsibility to meet its obligations as a futures market participant, including acting as an intermediary for customer transactions, and its obligation to safeguard customer funds.

The term “business unit” was proposed to include generally any department, division, group or personnel of an FCM or any affiliate involved in soliciting orders and handling customer money, including segregation functions, and personnel exercising direct supervisory authority over the performance of such activities. The definition was intended to delineate clearly the separation of the risk management unit required by the regulation from the other personnel of an FCM from whom the risk management must be independent.

The term “customer” was proposed broadly to include futures customers (as defined in § 1.3) trading futures contracts, or options on futures contracts listed on designated contract markets, 30.7 customers (as proposed to be defined in § 30.1) trading futures contracts or options on futures contracts listed on foreign contract markets, and Cleared Swaps Customers (as defined in § 22.1) engaging in Cleared Swaps.

The term “governing body” was proposed to be defined as the sole proprietor, if the FCM is a sole proprietorship; a general partner, if the FCM is a partnership; the board of directors, if the FCM is a corporation; and the chief executive officer, chief financial officer, the manager, the managing member, or those members vested with the management authority if the FCM is a limited liability company or limited liability partnership. The term “senior management” was proposed to mean any officer or officers specifically granted the authority and responsibility to fulfill the requirements of senior management under proposed § 1.11 by the governing body.

The term “segregated funds” was proposed to mean money, securities, or other property held by an FCM in separate accounts pursuant to § 1.20 for futures customers, pursuant to § 22.2 for Cleared Swaps Customers, and pursuant to § 30.7 for 30.7 customers. The proposed definition of “segregated funds” makes clear that the requirements of § 1.11 apply to all customer funds that may be held by an FCM. The Act and Commission regulations currently require FCMs to hold each type of segregated funds in separate accounts and to segregate such segregated funds from the FCM's own funds and to segregate each class of segregated funds from each other type, except if otherwise permitted by Commission rule, regulation or order.

See

7 U.S.C. 6d(a)(2) and 7 U.S.C. 6d(f).

The Commission did not receive any comments regarding the proposed definitions in § 1.11(b) and is adopting the amendments as proposed.

3. Approval of Policies and Procedures and Submission to the Commission

The Commission proposed § 1.11(c) to require each FCM to establish, maintain, and enforce a system of risk management policies and procedures

designed to monitor and manage the risks associated with the activities of the FCM as an FCM.

The policies and procedures are collectively referred to as the FCM's Risk Management Program.

Because § 1.11 applies to all FCMs that accept money, securities, or property (or extend credit in lieu thereof) from customers, it necessarily applies to any risks generated by the FCMs customers' trading activities.

See, e.g., In re FCStone LLC,

CFTC Docket 13-24, (May 29, 2013), where a customer's trading activities and the FCM's inadequate risk management practices caused the firm to lose over $127,000,000.

Under proposed § 1.11, the FCM's governing body is required to approve in writing the FCM's Risk Management Program and any material changes to the Risk Management Program. The FCM also is required to provide a copy of the Risk Management Program to the Commission and to the FCM's DSRO upon application for registration or upon request by the Commission or by the FCM's DSRO. The filing of the Risk Management Program is intended to allow the Commission and the FCM's DSRO to monitor the status of risk management practices among FCMs.

Several commenters expressed general support for the requirement that an FCM implement a risk management program.

The Commission received no other comments on proposed § 1.11(c) and is adopting the amendments as proposed.

See

Franklin Comment Letter at 2 (Feb. 15, 2013); AIMA Comment Letter at 1 and 4 (Feb. 15, 2013); TIAA-CREF Comment Letter at 3 (Feb. 15, 2013).

4. Organizational Requirements of the Risk Management Program

a. Separation of Risk Management Unit from Business Unit

The Commission proposed § 1.11(d), requiring an FCM to establish a risk management unit that is independent from the FCM's business unit to administer the Risk Management Program. As part of the Risk Management Program, each FCM must establish and maintain a risk management unit with sufficient authority, qualified personnel, and financial, operational, and other resources to carry out the Risk Management Program. The risk management unit is required to report directly to senior management.

Several commenters opposed the separation of the risk management unit from the business unit. RCG stated that requiring FCMs to separate the risk management function from the “business unit” is unnecessary, counterproductive, and will likely result in increased risk to the FCM and its customers.

RCG argued that the proposed requirement removes a valuable, mature talent pool from participating in risk management, and the proposal is counterproductive in that it has the potential of blocking the flow of historical and financial information about a customer from the business side of the FCM to the risk management side of the FCM, information that is crucial to evaluating risk.

RCG Comment Letter at 5 (Feb. 12, 2013).

see also

§ 4d(d) of the Act, 7 U.S.C. 6d(d).

The Commission requested comment on whether the standard for the CCO's or CEO's certification in the annual report (

i.e.,

based on the CCO's or CEO's knowledge and reasonable belief) required under § 3.3 is adequate for a certification of the FCM's compliance with policies and procedures for the safeguarding of customer funds. Specifically, the Commission requested comment on whether § 1.11 should contain a separate CCO or CEO certification requirement that would impose a higher duty of strict liability or some other higher obligation on a CCO or CEO.

The Commission received three comments in this regard. NFA and FIA believed that the “knowledge and reasonable belief” standard in § 3.3 remains appropriate for a CCO's/CEO's certification regarding an FCM's customer funds safeguards.

That is, the CCO or CEO should not be liable for matters that are beyond the CCO's/CEO's knowledge and reasonable belief. Further, NFA stated that the Commission should reconsider whether the CCO's/CEO's annual report should contain a separate certification (with the “knowledge and reasonable belief language”) executed by the FCM's CEO or CFO regarding the adequacy of the FCM's customer funds safeguards.

Newedge opposed the imposition of a strict liability standard on a CCO/CEO for the annual certifications because the CCO/CEO is relying on internal representations from other FCM employees that are far more expert regarding these matters.

Newedge stated that such a standard would make it difficult to recruit qualified persons to serve as a CCO/CEO.

FIA Comment Letter at 11 (Feb. 15, 2013); NFA Comment Letter at 10 (Feb. 15, 2013).

NFA Comment Letter at 10 (Feb. 15, 2013).

Newedge Comment Letter at 3 (Feb. 15, 2013).

Id.

In response to these comments, the Commission is not requiring a separate CCO/CEO certification requirement imposing a higher duty of strict liability or other standard for the segregation of customer funds. The Commission also is not imposing a separate certification by the FCM's CEO or CFO at this time. Commission staff will monitor the role of the CCO/CEO as the regulation is implemented and propose to the Commission any amendments to the CCO's/CEO's standard for certifying compliance as deemed appropriate based upon staff's experiences.

C. § 1.12: Maintenance of Minimum Financial Requirements by Futures Commission Merchants and Introducing Brokers

The regulatory notices required under § 1.12 are intended to provide the Commission and SROs with prompt notice of potential adverse conditions at FCMs that may indicate a possible threat to the financial condition of the firm or to the safety of customer funds held by the FCM. Regulation 1.12 currently obligates FCMs to provide notice to the Commission and to the respective DSROs if certain specified reportable events occur. Reportable events include: Failing to maintain the minimum level of required regulatory capital (§ 1.12 (a)); failing to maintain current books and records (§ 1.12(c)); and failing to comply with the requirements to properly segregate customer funds (§ 1.12(h)). As discussed further below, the Commission proposed to amend § 1.12 to include several additional reportable events and to revise the process for submitting reportable events to the Commission and DSROs.

1. Timing of Notices

The proposed new reportable events, discussed individually below, will require immediate notice to the Commission and the firm's DSRO upon the occurrence of the relevant event. FIA commented that while it is not opposed to a requirement for FCMs to provide prompt notice of a reportable event, it questioned the need for “immediate” notice as proposed by the Commission.

FIA recommended that if the Commission determined to adopt the proposed early warning notices that it allow 24 hours if the event is financial in nature and 48 hours for business-related events in order to afford FCMs time to determine the cause of the event and take an appropriate corrective action.

FIA Comment Letter at 37-38 (Feb. 15, 2013).

Id.

The purpose of the “early warning” notice system established under § 1.12 is to provide the Commission and an FCM's DSRO with adequate and prompt notice of a reportable event in order to allow Commission staff to assess the situation and to consult with the registrant and the SROs to determine if further action is necessary in order to protect customer funds or to determine if the FCM can continue to meet its obligations to the marketplace and clearing process. The filing of a notice is often the first step where the Commission staff is alerted to a potential issue at a firm. The Commission also initiates a dialogue with the firm and the firm's DSRO, as necessary, upon receipt of a § 1.12 notice.

Given the critical role that notices play in the Commission's and DSRO's surveillance of FCMs, the Commission believes that immediate notice is necessary when a reportable event is financial in nature (

e.g.,

the FCM is not in compliance with the Commission's capital or segregation requirements). In such situations, the firm should file immediate notice with the Commission. If a firm needs additional time to assess the cause of the reportable event, or if additional time is needed to document what steps the FCM will take to remedy the situation causing the reportable event, it may file an amendment to its initial notice with the Commission. In addition, in a situation where the registrant is reporting that it is undercapitalized or undersegregated, the Commission and DSRO will have initiated an ongoing dialogue whereby the Commission and the DSRO will be in frequent communication with the registrant and will receive updated information as the registrant becomes aware of the facts.

Reportable events that are not related to an FCM's ability to meet its financial obligations or not directly related to the protection of customer funds may not be subject to the same sense of immediacy and the Commission is revising its proposed regulations accordingly. The revisions to the proposed amendments are discussed in the appropriate sections below with the comments received on the proposed new notice provisions.

2. Undercapitalized FCMs and IBs

Regulation 1.12(a) requires an FCM or IB that fails to maintain the minimum level of adjusted net capital required by § 1.17 to provide immediate notice to

the Commission and to the entity's DSRO. The notice must include additional information to adequately reflect the FCM's or IB's current capital condition as of any date that the entity is undercapitalized.

The Commission proposed to amend § 1.12(a) to clarify that if the FCM or IB cannot compute or document its actual capital at the time it knows that it is undercapitalized, it must still provide the written notice required by § 1.12(a) immediately and may not delay filing the notice until it has adequate information to compute its actual level of adjusted net capital.

NFA commented in support of the Commission's proposal noting that in situations where an FCM is in potential distress, it may be even more important for the Commission and the firm's DSRO to become immediately aware of the situation so that the Commission and DSRO staff can assist in determining the firm's current, accurate financial condition.

The Commission agrees that it is imperative that an FCM or IB provide immediate notice if the firm is undercapitalized and, accordingly is adopting the amendment as proposed.

NFA Comment Letter at 10 (Feb. 15, 2013).

3. Insufficient Segregation of Funds of Cleared Swaps Customers

Regulation 1.12(h) currently requires an FCM that fails to hold sufficient funds in segregated accounts to meet its obligations to futures customers, or that fails to hold sufficient funds in separate accounts for foreign futures or foreign options customers, to provide immediate notice to the Commission and to the FCM's DSRO. The Commission proposed to amend paragraph (h) to include an explicit requirement that an FCM provide immediate notice to the Commission and to its DSRO if the FCM fails to hold sufficient funds in segregated accounts for Cleared Swaps Customers to meet its obligation to such customers.

The amendment will ensure immediate notification of a failure to hold sufficient funds in segregation for Cleared Swaps Customers so that the Commission and the firm's DSRO can promptly assess the financial condition of an FCM and determine if there are threats to the safety of the Cleared Swaps Customers Collateral held by the FCM. The amendment also harmonizes the notice requirements whenever an FCM fails to hold in proper segregated or secured accounts sufficient funds to meet its total obligations to futures customers, 30.7 customers, and Cleared Swaps Customers.

Commencing November 13, 2012, the compliance date for certain Commission part 22 regulations, FCMs are required under § 22.2 to hold a sufficient amount of funds in Cleared Swaps Customer Accounts to meet the Net Liquidating Equity of each Cleared Swaps Customer. 77 FR 6336 (Feb. 7, 2012).

The Commission did not receive any comments on proposed § 1.12(h). The Commission is adopting the amendments to paragraph (h) as proposed.

4. Investment of Customer Funds in Contravention of Regulation 1.25

The Commission also proposed to amend § 1.12 by adding new paragraph (i) to require an FCM to provide immediate notice whenever it discovers or is informed that it has invested funds held for customers in investments that are not permitted investments under § 1.25, or if the FCM holds permitted investments in a manner that is not in compliance with the provisions of § 1.25, such as the investment concentration limitations contained in § 1.25(b)(3). The proposal applies to funds held for futures customers, 30.7 customers, and Cleared Swaps Customers.

The Commission received no comments on the proposed amendments to § 1.12(i). The Commission is adopting paragraph (i) as proposed.

5. Notice of Residual Interest Falling Below Targeted Level or Undermargined Amounts

The Commission proposed to amend § 1.12 to provide a new paragraph (j) to require an FCM to provide immediate notice to the Commission and to the firm's DSRO if the FCM does not hold an amount of funds in segregated accounts for futures customers or for Cleared Swaps Customers, or if the FCM does not hold sufficient funds in secured accounts for 30.7 customers, sufficient to meet the firm's targeted residual interest in one or more of these accounts as computed under proposed § 1.11, which is being adopted herein, or if its residual interest in one or more of these accounts is less than the sum of outstanding margin deficits (

i.e.,

undermargined amounts) for such accounts. Regulation 1.11, as adopted herein, also requires each FCM that carries customer funds to calculate an appropriate amount of excess funds (

i.e.,

proprietary funds) to hold in segregated or secured accounts to mitigate the possibility of the FCM being undersegregated or undersecured due to a withdrawal of proprietary funds from a segregated or secured account.

FIA questioned the necessity of the proposed provision noting that under the proposed amendments to § 1.32 each FCM holding customer funds is required to file a report with the Commission on a daily basis that will disclose if the FCM's residual interest has fallen below the FCM's targeted amount or if the residual amount is less than the sum of the customers' margin deficits.

FIA also noted that under current regulations an FCM's residual interest will frequently fall below its targeted amount and that if the Commission adopts its proposed amendments to §§ 1.20, 22.2 and 30.7 to require an FCM to use proprietary funds to cover margin deficits, withdrawals in excess of 25 percent of the firm's residual interest will likely be a daily event requiring daily notices to be filed with the Commission and with the FCM's DSRO.

FIA Comment Letter at 38 (Feb. 15, 2013). The Commission is proposing to require each FCM to file with the Commission and with the firm's DSRO a daily: (1) Segregation Schedule (§ 1.32); (2) Secured Amount Schedule (§ 30.7); and, (3) Cleared Swaps Segregation Schedule (§ 22.2)). The Commission proposed to include information disclosing the FCM's targeted residual interest and whether the amount of the actual residual interest exceeds the targeted residual interest and the total amount of the FCM's margin deficiencies in the Segregation Schedule, Secured Amount Schedule, and the Cleared Swaps Segregation Schedule.

Id.

One of the primary objectives of the proposed amendments to § 1.12 is to ensure that the Commission and DSROs receive notice of potential financial or operational issues at an FCM, or of rule violations by an FCM, in as timely a manner as possible such that the Commission and the FCM's DSRO will be in a position to assess the issues and the potential impact on the FCM's ability to meet its regulatory obligations and its ability to safeguard customer funds. While the proposed amendments to § 1.32 do require each FCM holding customer funds to file on a daily basis a Segregation Schedule, Secured Amount Schedule, and Cleared Swaps Segregation Schedule (as appropriate) that includes information concerning the amount of the firm's actual and targeted residual interests, the notice required by § 1.12(j) requires the firm to include a discussion of the cause of the event, and what steps the firm will take to increase the residual interest. The notice will assist the Commission and the DSROs in determining what, if any, additional steps may be necessary in order to mitigate potential market disruptions if the FCM cannot meet its regulatory obligations, and will enhance the overall safety of customer funds. In addition, the Commission believes that the filing of a notice by an FCM will focus greater attention by management at the firm on the fact that the firm's

actual residual interest is below its targeted residual interest, which should result in further reflection by management on the adequacy of the target amount and/or any changes in operations that may be appropriate, including increasing the firm's residual interest or using other sources of liquidity.

The Commission also notes that an FCM's obligation under § 1.12(j) to file a notice when the firm's residual interest is less than the sum of the undermargined amounts in its customer accounts is determined at the point in time that the firm is required to maintain as residual interest the undermargined amounts under § 1.22, § 22.2, and § 30.7. In addition, the Commission further notes that the obligation to file a notice under § 1.12(j) when the firm's residual interest is less than the sum of the undermargined amounts in its customer accounts commences as of the respective compliance dates for § 1.22, § 22.2, and § 30.7 established by the Commission and discussed further in section III below.

The Commission has considered the comments and has determined to adopt new paragraph 1.12(j) as proposed and as clarified above.

6. Events Causing Material Adverse Financial Impact or Material Change in Operations

The Commission proposed new paragraphs (k) and (l) to § 1.12. Proposed paragraphs (k) and (l) will require an FCM to provide notice to the Commission and to the firm's DSRO in the event of a material adverse impact in the financial condition of the firm or a material change in the firm's operations. Proposed paragraph (k) will require an FCM to provide immediate notice if the FCM, its parent, or a material affiliate, experiences a material adverse impact to its creditworthiness or its ability to fund its obligations. Indications of a material adverse impact of an FCM's creditworthiness may include a bank or other financing entity withdrawing credit facilities, a credit rating downgrade, or the FCM being placed on “credit watch” by a credit rating agency.

Proposed paragraph (l) will require an FCM to provide immediate notice of material changes in the operations of the firm, including: A change in senior management; the establishment or termination of a material line of business; a material change in the FCM's clearing arrangements; or a material change in the FCM's credit arrangements. Paragraph (l) is intended to provide the Commission with notice of material events, such as the departure of the FCM's CCO, CFO, or CEO.

Two comments were received on the proposal. FIA stated that the proposed amendments do not provide an FCM sufficient guidance on the circumstances that would require notice and requested that the Commission define more precisely the events that would require notice.

RJ O'Brien similarly stated its concern that the term “creditworthiness” as used in proposed Regulation 1.12(k) is ambiguous and subjective and requires a clearer definition to afford FCMs the ability to reasonably ascertain their reporting duties and obligations.

Id.

RJ O'Brien Comment Letter at 10 (Feb. 15, 2013).

FIA also recommended that the Commission coordinate with the SEC and the banking regulators to establish a uniform standard identifying “material adverse” changes or impacts.

Finally, FIA noted that it does not believe that a change in senior management at an FCM should require an early warning notice of any kind because such notice is already provided to NFA in the ordinary course.

FIA Comment Letter at 38 (Feb. 15, 2013).

Id.

The Commission has considered the comments and has determined to adopt the amendments to § 1.12(k) and (l) as proposed, with the revision that the notices required by § 1.12(l) must be filed promptly, but not later than 24 hours after the event, instead of immediately. By adopting this revision, the Commission acknowledges that immediate notice is not necessary in all situations.

An FCM should report § 1.12(l) notices in a punctual or prompt manner, but may do so without the expediency required by an immediate notice provision that is required, for example, when a firm is undercapitalized or undersegregated, which may indicate that immediate Commission or DSRO action is required to assess the financial condition of the FCM or the safety of customer funds. This revision provides the appropriate balance between the receipt of timely notices and the ability of the FCM to document an explanation of the events that trigger the notice.

As noted above, the Commission proposed additional notice provisions under § 1.12 in order to ensure that the Commission and DSROs receive timely information regarding certain events that should be assessed by the Commission and the DSROs as part of the overall oversight and risk assessment of FCMs. Regulation 1.12(k) will require an FCM to provide notice if the FCM or its parent or material affiliate experiences a material adverse impact to its creditworthiness or its ability to fund its obligations. Regulation 1.12(l) will require an FCM to provide notice if there is a material change in the firm's operations, senior management, clearing arrangements, or a material line of business.

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The purpose of paragraphs (k) and (l) is to provide the Commission and the relevant DSRO with an opportunity to initiate a dialogue with the firm regarding any potential adverse impact that such a material change may have on the ability of the FCM to meet its obligations as a market intermediary and on the protection of the customer funds held by the FCM.

100

Regulation 1.12(k) and (l) both require an FCM to report a material change in the firm's creditworthiness or its ability to fund its obligations. Accordingly, the Commission is removing the reference to the FCM's credit arrangements in § 1.12(l).

The Commission is cognizant of the commenters' desire for more precise guidance on when notices must be filed under § 1.12(k) and (l). However, FCMs represent a broad range of entities, with diverse business models. In this regard, some FCMs are small operations with a minimum level of capital, and others are highly capitalized entities with more sophisticated operations. Some FCMs focus on retail and/or agricultural clients, and others focus exclusively on institutional clients. Some FCMs are standalone entities that do not engage in proprietary or securities trading, and others are dually-registered with the SEC as BDs and engage in a significant amount of securities transactions for both their proprietary and customer accounts.

With FCMs covering such a broad and diverse spectrum of business organizations and models, the Commission does not believe that it would be appropriate to define by regulation the scenarios that are material to an FCM and would automatically require the filing of a regulatory notice. Instead, the regulation has been developed to allow each FCM to assess whether any particular or unique event is material to the specific firm. In making this determination, each FCM should assess the potential impact that an event may have on the FCM. This would include whether new lines of business would result in a significant increase in the firm's capital requirement or otherwise result in a significant additional financial or operational risk to the FCM's existing business, or whether the change in credit terms will significantly impact

the liquidity resources available to the FCM.

The Commission also considered the comment that FCMs should not be required to report to the Commission changes in senior management as such information is reported to NFA. The Commission does not agree with this comment. As previously noted, the § 1.12 notice provisions are intended to provide the Commission and DSROs with prompt notice of material events at FCMs that will allow the Commission and DSROs to monitor the impact of such material events on FCMs and to factor such events into the risk assessment of the firm as part of their respective surveillance programs. The resignation or appointment of a new chief executive officer or chief risk officer at an FCM is a material change at an FCM and is information that should be reported to enhance the Commission's and DSRO's understanding of the firm's operations and the assessment of risk at the FCM.

7. Notice of Correspondence From Other Regulatory Authorities

The Commission proposed to add a new paragraph (m) to § 1.12 to require an FCM that receives a notice, examination report, or any other correspondence from a DSRO, the SEC, or a securities self-regulatory organization to immediately file a copy of such notice, examination report, or correspondence with the Commission. The Commission stated in proposing § 1.12(m) that the receipt of such notices, examination reports, or correspondence is necessary for the Commission to conduct appropriate oversight of FCMs.

The Commission received several comments that expressed a general concern that the language of the proposal is overbroad.

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FIA noted that FCMs receive regular, and often routine, correspondence from their DSROs and that the amount of correspondence is multiplied for FCMs that are also registered as BDs and receive similar correspondence from their securities SROs and the SEC.

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NFA agreed with the Commission that notices of material regulatory actions would provide the Commission and the DSROs with important information to carry out their oversight responsibilities, but also encouraged the Commission to reconsider the breadth of the proposal.

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NFA noted that with respect to futures examinations reports, it already files such reports with the Commission's Division of Swap Dealer and Intermediary Oversight.

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NFA also requested that the Commission clarify that FCMs would not have to file notices of public regulatory actions taken by futures SROs against an FCM because NFA already provides the complaint associated with these actions to the Commission and makes the action available on NFA's BASIC system.

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TD Ameritrade recommended that the Commission limit notification to items that pertain to financial responsibility rules.

106

101

FIA Comment Letter at 39 (Feb. 15, 2013); TD Ameritrade Comment Letter at 3 (Feb. 15, 2013); RCG Comment Letter at 7 (Feb. 12, 2013); CHS Hedging Comment Letter at 3 (Feb. 15, 2013).

102

FIA Comment Letter at 39 (Feb. 15, 2013).

103

NFA Comment Letter at 10 (Feb. 15, 2013).

104

Id.

at 11.

105

Id.

106

TD Ameritrade Comment Letter at 3 (Feb. 15, 2013).

The Commission notes that it was not its intention to require an FCM to file with the Commission routine or non-material correspondence from regulators or SROs. Regulation 1.12 in general is intended to provide the Commission with information regarding an FCM's interaction with its other regulators regarding the regulators' examinations and other material communications with FCMs. The Commission would use such information to enhance its understanding of the firm and its compliance with regulatory requirements to assess the operations of the firm and learn of events that may present a potential adverse impact on the firm, including its ability to properly operate in a regulated environment or otherwise safeguard customer funds.

The Commission is revising final § 1.12(m) to require an FCM to file notice with the Commission: (1) if the FCM is informed by the SEC or a SRO that it is the subject of a formal investigation; (2) if the FCM is provided with an examination report issued by the SEC or a SRO, and the FCM is required to file a copy of such examination report with the Commission; and (3) if the FCM receives notice of any correspondence from the SEC or a securities SRO that raises issues with the adequacy of the FCM's capital position, liquidity to meet its obligations or otherwise operate its business, or internal controls. The Commission believes that the revised regulation will provide the Commission with information necessary for the effective oversight of FCMs and will minimize the notices that dual-registrant FCMs/BDs will have to file with the Commission.

8. Filing Process and Content

The Commission proposed to amend the process that an FCM uses to file the notices required by § 1.12. Currently, § 1.12 requires an FCM to provide the Commission and DSROs with telephonic and facsimile notice in some situations, and to provide written notice by mail in other situations. An FCM also is permitted, but not required, to file notices and written reports with the Commission and with its DSRO using an electronic filing system in accordance with instructions issued by, or approved by, the Commission.

The Commission proposed to amend § 1.12(n) to require that all notices and reports filed by an FCM with the Commission or with the FCM's DSRO must be in writing and submitted using an electronic filing system.

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Each FCM currently uses WinJammer to file regulatory notices with the Commission and with the firm's DSRO. The proposed regulation further provides that if the FCM cannot file a notice due to the electronic system being inoperable, or for any other reason, it must contact the Commission's Regional office with jurisdiction over the firm and make arrangements for the filing of the regulatory notices with the Commission via electronic mail at a specially designated email address established by the Commission;

fcmnotices@cftc.gov

. The Commission also proposed to amend § 1.12(n) to require that each notice filed by an FCM, IB, or SRO under § 1.12 include a discussion of what caused the reportable event, and what steps have been, or are being taken, to address the reportable event. Additional amendments to § 1.12(b), (d), (e), (f) and (g) were proposed that were necessary and technical in nature, and primarily revise internal cross-references to the filing requirements in § 1.12(n).

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The Commission's proposed amendment to require the electronic filing of reports applies to both registered FCMs and applicants for registration as FCMs. Applicants for FCM registration currently file regulatory notices with NFA using WinJammer.

The Commission received one comment on the proposed amendments to Regulation 1.12(n), specifically with respect to the requirement that notices under the regulation include a discussion of what caused the reportable event and what steps have been or will be taken to address the event.

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CHS Hedging stated its concern that requiring such a discussion in the notice is at odds with the requirement that notices be filed immediately.

109

108

CHS Hedging Comment Letter at 3 (Feb. 15, 2013).

109

Id.

The Commission has determined to adopt the amendments to § 1.12(n) and the technical and related amendments

in § 1.12(b), (d), (e), (f) and (g) as proposed. In the Commission's experience, in many cases an FCM has sufficient information to provide a notice of reportable event and the remedial steps that can be taken to mitigate future issues upon learning of the reportable event or very shortly thereafter. The Commission does not believe that the requirement to provide such information is at odds with the need to provide the information immediately. In the event that an FCM does not possess complete information on what caused the event, or the steps that have been taken or are being taken to address the event, it may revise its notice at a later date when it has more complete or accurate information. It is essential, however, that the Commission receives timely notice of early warning events, and compliance with the relevant notice time period should be an FCM's first priority. Accordingly, as noted in the Proposal, even if such information is not immediately readily available, the reporting entity may not delay the reporting of a reportable event.

9. Public Disclosure of Early Warning Notices

The Commission requested comment as to whether reportable events should be made public by the Commission, SROs, or FCMs and what the benefits and/or negative impact from public disclosure of such events would be. The Commission received several comments regarding the public disclosure of reportable events. Several commenters, including FHLB, the ICI, ACLI, BlackRock, and SIFMA believed that the Commission should mandate public disclosure of such information.

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Two commenters, FIA and NFA, believed that such events should not be made public.

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NFA did not believe any of the filings should be public, but emphasized that those events that are not subject to a formal public action particularly should not be subject to public disclosure.

112

FIA was concerned that without context, public disclosure of the notices would be subject to misinterpretation and could create an adverse market event.

113

110

FHLB Comment Letter at 10 (Feb. 15, 2013); ICI Comment Letter at 7-8 (Jan. 14, 2013); ACLI Comment Letter at 4 (Feb. 15, 2013); BlackRock Letter at 3 (Feb. 15, 2013); and SIFMA Comment Letter at 2 (Feb. 21, 2013).

111

NFA Comment Letter at 11 (Feb. 15, 2013); FIA Comment Letter at 38 (Feb. 15, 2013).

112

NFA Comment Letter at 11 (Feb. 15, 2013).

113

FIA Comment Letter at 38 (Feb. 15, 2013).

The Commission has considered the comments and has determined that regulatory notices filed under § 1.12 should not be made publicly available. The notices required under § 1.12 provide a mechanism whereby Commission and SRO staff are alerted to potential issues at an FCM. In order to fully assess the potential impact of a reportable event, Commission and SRO staff generally must contact the firm to obtain additional information, including up to date information on how the firm is addressing the matter that caused the reportable event to develop. If reportable events were disclosed to the public, they may not provide complete or current information. For example, an FCM may be required to file immediate notice that it was undersegregated at a point in time, but the notice may not contain information that the FCM has taken corrective action and is no longer in violation of the segregation requirements. The Commission also recognizes that many of the § 1.12 notices are required to be filed as a result of one-off processing errors or timing differences that trigger a reportable event but are immediately rectified by the FCM and do not indicate a failure of the FCM's control system nor the firm's ability to effectively operate as an FCM.

In addition, under § 1.12 FCMs that are dually registered BDs with the SEC are required to file with the Commission copies of certain regulatory notices that they are required to file with the SEC. The SEC, however, does not make such notices public. The Commission believes it is important to ensure consistency such that information that a firm must file with the SEC and that is otherwise not publicly disclosed is not made public by the Commission as a result of the firm also being required to file a notice with the Commission under § 1.12.

D. § 1.15: Risk Assessment Reporting Requirement for Futures Commission Merchants

Regulation 1.15 currently requires each FCM subject to the risk assessment reporting requirements to file certain financial reports with the Commission within 120 days of the firm's year end. The risk assessment filings include FCM organizational charts; financial, operational, and risk management policies, procedures, and systems maintained by the FCM; and, fiscal year-end consolidated and consolidating financial information for the FCM and its highest level material affiliate.

The Commission proposed to amend § 1.15 to require the financial information to be filed in electronic format. The Commission received no comments on the proposed amendments to § 1.15. The Commission is adopting the amendments as proposed. The Commission also has revised the final regulation to provide that the risk assessment filings should be filed via transmission using a form of user authentication assigned in accordance with procedures established by or approved by the Commission, and otherwise in accordance with instructions issued by or approved by the Commission. The Commission will provide direction regarding how FCMs should file the risk assessment reports in a secure manner with the Commission prior to the effective date of the regulation.

E. § 1.16: Qualifications and Reports of Accountants

Regulation 1.16 addresses the minimum requirements a public accountant must meet in order to be recognized by the Commission as qualified to conduct an examination for the purpose of expressing an opinion on the financial statements of an FCM. Regulation 1.16(b) currently provides that the Commission will recognize a person as qualified if such person is duly registered and in good standing as a public accountant under the laws of the place of the accountant's principal office or principal residence.

The Commission proposed several amendments to enhance the qualifications that a public accountant must meet in order to conduct an examination of an FCM. Specifically, the Commission proposed to require that the public accountant must: (1) Be registered with the Public Company Accounting Oversight Board (“PCAOB”); (2) have undergone an examination by the PCAOB; and, (3) have remediated to the satisfaction of the PCAOB any deficiencies identified during the examination within three years of the PCAOB issuing its report.

The Commission also sought to enhance the quality of the public accountant's examination of an FCM by proposing to require that the examination be conducted in accordance with U.S. GAAS after full consideration of the auditing standards issued by the PCAOB. The Commission further sought to ensure that the FCM's governing body took an active role in the assessment and appointment of the public accountant by imposing an obligation on the governing body to evaluate, among other things, the accountant's experience auditing FCMs; the adequacy of the accountant's knowledge of the Act and Commission regulations; the depth of the accountant's staff; and, the independence of the accountant.

Additionally, the Commission proposed technical amendments to

§ 1.16. The Commission proposed to amend § 1.16(f)(1)(i)(C) to require each FCM to submit its certified annual report to the Commission in an electronic format. The Commission also proposed to amend § 1.16(c)(2) to remove the requirement that the accountant manually sign the accountant's report, which would facilitate the electronic filing of the FCM's certified annual report with the Commission.

The proposed amendments to § 1.16, including a discussion of the comments received, are discussed below.

1. Mandatory PCAOB Registration Requirement

Regulation 1.16(b)(1) would continue to require a public accountant to be registered and in good standing under the laws of the place of the accountant's principal office or principal residence in order to be qualified to conduct examinations of FCMs. The Commission proposed to enhance the qualifications of public accountants by further requiring the public accountant to be registered with the PCAOB.

The PCAOB is a nonprofit corporation established by Congress under the Sarbanes-Oxley Act of 2002 (“SOX”) to oversee the audits of public companies and BDs of securities registered with the SEC in order to protect investors and the public interest by promoting informative, accurate, and independent audit reports.

114

The SEC has oversight authority over the PCAOB, including the approval of the PCAOB's rules, auditing and other standards, and budget.

115

114

Public Law 107-204, 116 Stat. 745 (July 30, 2002).