Early Warning Reporting Requirements, Minimum Financial Requirements, Prepayment of Subordinated Debt, Gross Collection of Exchange-Set Margin for Omnibus Accounts and Capital Charge on Receivables From Foreign Brokers

COMMODITY FUTURES TRADING COMMISSION

17 CFR Part 1

Early Warning Reporting Requirements, Minimum Financial

Requirements, Prepayment of Subordinated Debt, Gross Collection of

Exchange-Set Margin for Omnibus Accounts and Capital Charge on

Receivables From Foreign Brokers

AGENCY: Commodity Futures Trading Commission.

ACTION: Final rules.

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SUMMARY: Rule 1.12 of the Commodity Futures Trading Commission

(Commission or CFTC) sets forth the financial early warning reporting

requirements for futures commission merchants (FCMs) and introducing

brokers (IBs), which are designed to afford the Commission and industry

self-regulatory organizations (SROs) sufficient advance notice of a

firm's financial or operational problems to take such protective or

remedial action as may be needed to assure the safety of customer funds

and the integrity of the marketplace. The Commission has determined to

adopt amendments to Commission Rule 1.12, applicable to FCMs only, that

will: amend paragraph (g) to require the reporting of a reduction in

net capital of 20 percent or more within two business days and a

planned reduction in excess adjusted net capital of 30 percent or more

two business days prior thereto, and to make that paragraph applicable

to all FCMs, rather than just those FCMs subject to the risk assessment

reporting requirements of Commission Rule 1.15; require reporting of a

margin call that exceeds an FCM's excess adjusted net capital which

remains unanswered by the close of business on the day following the

issuance of the call; and require reporting by an FCM when-ever its

excess adjusted net capital is less than six percent of the maintenance

margin required to support positions of noncustomers carried by the

FCM, unless the noncustomer is itself subject to the Commission's

minimum financial requirements for an FCM or the Securities and

Exchange Commission's (SEC's) minimum financial requirements for a

securities broker-dealer (BD).

The Commission has also determined to adopt amendments to: Rules

1.17(a)(1)(i) and (ii) to (a) increase the minimum required dollar

amount of adjusted net capital for FCMs from $50,000 to $250,000, (b)

increase the minimum required dollar amount of adjusted net capital for

IBs from $20,000 to $30,000, and (c) make the amount of adjusted net

capital required by a registered futures association for its member

FCMs and IBs an element of the Commission's minimum financial

requirements for FCMs and IBs; Rule 1.17(h)(2)(vii) with respect to the

procedure to obtain approval for prepayment of subordinated debt; and

Rule 1.58, which governs gross collection of exchange-set margins for

omnibus accounts, to make it applicable to omnibus accounts carried by

FCMs for foreign brokers. The Commission believes that these amendments

will conform the Commission's rules with those of SROs and therefore

should not require changes in the operations of most firms. In

addition, the Commission has determined that the five percent capital

charge for unsecured receivables from a foreign broker will not apply

where the receivables represent deposits required to maintain futures

or options positions, the foreign broker has been granted comparability

relief under Commission Rule 30.10, and the asset is held in accordance

with the relevant grant of relief under Rule 30.10 at the foreign

broker, with another foreign broker that has been granted comparability

relief under Commission Rule 30.10, or at a depository in the same

jurisdiction as either foreign broker in accordance with Commission

Rule 30.7.

EFFECTIVE DATE: May 31, 1996.

FOR FURTHER INFORMATION CONTACT: Paul H. Bjarnason, Jr., Chief

Accountant, or Lawrence B. Patent, Associate Chief Counsel, Division of

Trading and Markets, Commodity Futures Trading Commission, 1155 21st

Street, N.W., Washington, D.C. 20581; telephone (202) 418-5459 or 418-

5439.

[[Page 19178]]

SUPPLEMENTARY INFORMATION:

I. Early Warning Rules

A. Reportable Events in General

The Commission has required each FCM 1 to report to the

Commission and to the FCM's designated self-regulatory organization

(DSRO) certain events pertaining to the FCM's financial condition, the

FCM's procedures for safeguarding customer and firm assets, and its

ability to monitor its financial condition through an appropriate

system of records and reports. The purpose of such reporting is to make

the Commission and the FCM's DSRO aware of circumstances that have or

potentially could have a negative impact on the FCM's ability to carry

on normal business operations consistent with the Commission's

prudential requirements and pose a potential threat to customer funds

or the FCM's financial integrity. Receipt of such notices results in a

heightened degree of surveillance over the FCM by the Commission and

the DSRO. The events to be reported include undercapitalization, the

FCM's adjusted net capital being below its early warning level (i.e.,

150 percent of the minimum required), failure to maintain current books

and records, the existence of material inadequacies in the FCM's

accounting systems or internal controls, and the issuance of a margin

call exceeding the FCM's adjusted net capital. Collectively, these are

known as the Commission's early warning reporting requirements and are

set forth in Rule 1.12. With respect to notices relative to reductions

in capital, one purpose of this rulemaking has been to harmonize

required notices to the SEC and relevant futures and securities SROs.

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\1\ Rule 1.12 also requires certain reports from FCMs, IBs, and

exchange clearing organizations. The rule amendments that have been

adopted relate only to reporting by FCMs. No changes have been made

with respect to reporting requirements imposed on FCM applicants,

IBs or IB applicants, or clearing organizations.

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B. Background of This Rulemaking

On March 1, 1994, the Commission published proposed Risk Assessment

Rules for Holding Company Systems, 59 FR 9689. Certain portions of

these proposals were adopted as final rules by the Commission. 59 FR

66674 (Dec. 28, 1994). The proposed risk assessment rules generally

would have required, inter alia, an FCM to notify the Commission of

certain events or transactions that would reduce or potentially reduce

the FCM's net capital. These ``triggering'' events were originally

proposed to be included in a new Rule 1.15 as part of the risk

assessment reporting rules. However, several of the commenters on the

risk assessment proposals suggested that the reporting of certain of

these triggering events should more appropriately be part of the

Commission's early warning reporting system set forth in Rule 1.12, and

the Commission agreed. Therefore, when the Commission adopted as part

of the risk assessment rulemaking one of the triggering provisions

relating to declines in an FCM's adjusted net capital, that provision

was adopted as Rule 1.12(g) instead of as a provision of Rule 1.15, and

was made applicable only to those FCMs which are required to file

reports under Rule 1.15.2

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\2\ The balance of the proposed trigger event provisions remains

under consideration by the Commission.

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Certain commenters on the risk assessment proposals had suggested

that the notice provision relating to declines in capital should be

applicable to all FCMs, not just those subject to the risk assessment

rules. The Commission agreed, but was concerned that FCMs which

believed that they were not subject to the risk assessment rules may

not have availed themselves of the opportunity to comment upon the

Commission's March 1994 risk assessment proposals, including the

provision adopted as Rule 1.12(g). Therefore, the Commission adopted

Rule 1.12(g) in December 1994 as applicable only to those FCMs subject

to the risk assessment rules and at the same time proposed to amend

Rule 1.12(g) to make the reporting of capital declines applicable to

all FCMs. 59 FR 66822 (Dec. 28, 1994). In the same Federal Register

release which announced the proposed amendment to Rule 1.12(g), the

Commission also proposed to make certain other changes to the early

warning system as an adjunct to its risk assessment initiative and in

response to comments received on the March 1994 risk assessment rule

proposals which would: (1) require an FCM to report a margin call that

exceeds its excess adjusted net capital and remains unanswered by the

close of business on the day following the issuance of the call

(proposed Rule 1.12(f)(4)); and (2) require an FCM to report whenever

its excess adjusted net capital is less than six percent of the

maintenance margin required to support proprietary and noncustomer

positions carried by the FCM (proposed Rule 1.12(f)(5)).

The Commission originally permitted 30 days for public comment on

the proposed amendments to Rule 1.12 and it extended the comment period

for an additional 30 days in response to a request from the Securities

Industry Association (SIA). 60 FR 7925 (Feb. 10, 1995). The Commission

received six written comments on these proposals, including two from

contract markets (Chicago Board of Trade (CBT) and Chicago Mercantile

Exchange (CME)), two from trade associations (Futures Industry

Association (FIA) and SIA), one from an FCM, Bielfeldt & Company

(Bielfeldt), and one from an associated person, Alvin L. Goldberg. The

Commission's Division of Trading and Markets (Division) also received

two letters from the Intermarket Financial Surveillance Group

(IFSG),3 dated February 22 and April 8, 1996, respectively, which

bear directly upon one of these proposals and have been considered

along with the other comment letters.

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\3\ The IFSG was formed in 1988 to provide a coordinating body

to address financial surveillance issues relevant to both futures

and securities markets. It includes representatives of most of the

principal commodity and securities exchanges as well as the National

Futures Association (NFA) and the National Association of Securities

Dealers, Inc. Staff members of the CFTC and of the SEC frequently

attend IFSG meetings as observers.

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The Commission has carefully considered the comments received. The

Commission has determined to adopt the proposed amendment concerning

unanswered margin calls as proposed. The Commission has also

determined, based upon a review of the comments and its own

reconsideration of the proposal, that the provision of the early

warning system for FCMs requiring a comparison of excess adjusted net

capital to six percent of the maintenance margin level will only apply

to those positions carried by an FCM on behalf of a noncustomer that is

not itself subject to the Commission's minimum financial requirements

for an FCM or the minimum financial requirements of the SEC for a BD.

The Commission is therefore not adopting Rule 1.12(f)(5) as proposed,

which would have applied six percent of the maintenance margin level to

all positions held in noncustomer and proprietary accounts. The

Commission has further determined to modify slightly the standards in

Rule 1.12(g) concerning notice of substantial declines in capital in

light of the comments received, particularly the IFSG letters, and its

own reconsideration of the issue. The Commission has also clarified

certain matters in response to issues raised in the comment letters, as

discussed more fully below.

C. Reductions in Capital

As noted above, the Commission in December 1994 added to the list

of

[[Page 19179]]

reportable events under Rule 1.12 a new paragraph (g), requiring that

certain FCMs (i.e., those FCMs required to file risk assessment

reports) report capital declines which may not necessarily result in

the FCM being undercapitalized or its capital declining below early

warning levels, but which are sufficiently material to the FCM's

regulatory capital to warrant enhanced monitoring by the Commission and

the FCM's DSRO.4

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\4\ There are approximately 190 FCMs required to file risk

assessment reports, and the extension of Rule 1.12(g) would cover

the remaining FCMs, approximately 70 firms.

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The event currently required to be reported under Rule 1.12(g) is

the occurrence of any transaction or condition that results in a

reduction of more than 20 percent in the adjusted net capital of an FCM

from that reported in the most recent financial report filed with the

Commission pursuant to Commission Rule 1.10.5 The rule draws a

distinction, with respect to when the event must be reported, between

those events occurring in the normal course of business and those which

are extraordinary. If the decline in adjusted net capital is due to

activities in the normal course of an FCM's business, the reduction is

to be reported within two business days following the event. These

events are not normally planned for in advance, such as operating

losses, proprietary trading losses or increased charges against net

capital. However, where a transaction or series of transactions is

planned to be taken which will reduce adjusted net capital by more than

20 percent, the notice must be filed at least two business days in

advance of the transaction or series of transactions.6 This would

permit Commission or DSRO staff to make further inquiries concerning

the transaction before the transaction is effected to assure that the

FCM has adequately considered the effect of the transaction on its

overall liquidity. Ideally, an explanation would be included to

facilitate this process. The rule does not provide for Commission

approval or disapproval of the transaction prior to the FCM effecting

the transaction, nor does it provide a means for the Commission to

delay or prevent the FCM from carrying out the transaction.7

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\5\ Certain exchanges have a similar requirement. The rule

amendment whose adoption is announced herein is intended to induce

all SROs to conform their similar rules to the Commission

requirement. See CME Rule 972A; CBT Rule 285.03; New York Mercantile

Exchange Rule 2.14(d) and Clearing Rule 9.22(c)(i) and (ii);

Commodity Exchange, Inc. Rule 7.08(a); Coffee, Sugar and Cocoa

Exchange, Inc. Clearing Rule 302(c)(i); Kansas City Board of Trade

Rule 1311.00; Kansas City Board of Trade Clearing Corporation Rule

8.01(c); and Minneapolis Grain Exchange Rule 2088.00.

\6\ The SEC also has a similar rule, Rule 240.15c3-1(e)(1), 17

CFR 240.15c3-1(e)(1)(1995), which requires a BD to provide notice

two business days prior to withdrawals of equity capital that on a

net basis exceed in the aggregate in any 30 calendar day period, 30

percent of the firm's excess net capital, or two business days after

such withdrawals during any 30 calendar day period exceed 20 percent

of the firm's excess net capital.

\7\ As more fully discussed below, the Commission requested

comment as to whether Rule 1.12(g) should establish a mechanism by

which the Commission could delay or prevent an FCM from carrying out

the transaction. The SEC has authority to restrict capital

withdrawals for up to twenty business days under certain conditions.

17 CFR 240.15c3-1(e)(3)(1995).

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The filing under Rule 1.12(g) is to be made, in accordance with

Rule 1.12(h), with the regional office of the Commission with which the

FCM normally files its financial reports under Rule 1.10, with the

principal office of the Commission in Washington, D.C., with the FCM's

DSRO and with the SEC if the FCM is also registered as a BD. Rule

1.12(g) also provides that, following receipt of a notice from an FCM,

the Director of the Division, or the Director's designee, may request

additional information concerning the effect of the reported event on

the FCM's financial or operational condition. The FCM is required to

provide such additional information within three business days, or

sooner if the Division believes prompter filing is needed to address

the condition causing the filing of the early warning notice and so

requests.

As adopted in December 1994, Rule 1.12(g) applies only to those

FCMs which are required to file reports with the Commission under the

risk assessment rules. Several commenters on the Commission's March

1994 risk assessment proposals, including FIA and NFA, suggested that

the reporting requirement now in paragraph (g) be made applicable to

all FCMs, not just those required to report under Rule 1.15. The

Commission agreed that this reporting requirement serves to alert the

Commission and DSRO to potential problems resulting from transactions

that affect an FCM directly and therefore should not be limited to

those FCMs subject to the risk assessment rules. Since FCMs that

believed they were not subject to the risk assessment rules may not

have taken the opportunity to comment on the Commission's March 1994

risk assessment rule proposals, the Commission determined to publish

these proposed changes to Rule 1.12(g) for comment.

All of the commenters on the Commission's December 1994 proposals

addressed the Commission's proposal concerning Rule 1.12(g). Two

commenters expressed support for the extension of Rule 1.12(g) to all

FCMs. Three commenters noted that several regulators and SROs had

similar, but slightly different, requirements in this area. They

further pointed out that the IFSG was attempting to develop a consensus

on how to harmonize the various requirements directed at the same types

of reporting and requested that the Commission not adopt its proposals

until the IFSG completed its study. One of these commenters, FIA,

suggested in the alternative that the Commission adopt a ``no-action''

position to permit an FCM to follow a related rule of its DSRO or the

New York Stock Exchange, Inc. (NYSE), as elected by the FCM. The IFSG

reported on its harmonization efforts in its letters to the Division

dated February 22 and April 8, 1996 and stated that the Commission and

SEC should adopt similar rules which would require two business days

prior notice when excess adjusted net capital is to be reduced 30

percent or more and notice within two business when net capital has

been reduced by 20 percent or more.8

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\8\ IFSG's first letter dated February 22, 1996, which was

superseded by its April 8, 1996 letter, recommended that the notices

be made 48 hours, rather than two business days, prior to or

following the event, and that such notices be based upon net capital

declines in either situation, rather than upon a decline in excess

adjusted net capital with respect to prior notice. The prior notice

rule adopted herein is the same as that of the SEC adjusted to apply

to FCMs and the subsequent notice in the same as that required by

the NYSE so adjusted. FCMs that are BDs will continue to have to

file any additional notices required by the SEC which in the case of

post-reduction notices may include some notices triggered by

haircuts.

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As noted above, the Commission requested comment as to whether Rule

1.12(g) should establish a mechanism by which the Commission could

delay or prevent an FCM from carrying out planned transactions that

would reduce adjusted net capital by more than 20 percent. Three

commenters stated that the Commission should not be able to delay or

prevent capital reductions. A fourth commenter, SIA, stated that for

firms dually registered as FCMs and BDs, only the SEC should have such

authority, but it supported CFTC authority to delay or prevent capital

reductions for other FCMs (i.e., those not also registered as BDs).

Although it did not directly address the question posed by the

Commission, the FCM commenter, Bielfeldt, stated that no notice under

Rule 1.12(g) should be required with respect to capital reductions

resulting from planned transactions. Another commenter, Mr. Goldberg,

expressed his belief that the capital rules as written do not require

[[Page 19180]]

firms to establish systems to monitor capital on a day-to-day basis; in

his view, it is sufficient if a firm can, at a later date, demonstrate

that it was in compliance on any date. Therefore, Mr. Goldberg believes

that the effect of planned transactions on a firm's capital would not

be readily determinable, rendering a firm incapable of providing early

warning with respect to such transactions.

There were two other comments related to the proposed amendment of

Rule 1.12(g). Two commenters requested clarification that notice under

the rule would not be required with respect to repayment or prepayment

of subordinated debt, since separate notice of such events and DSRO

approval is already required. Another commenter stated that the

calculation used in Rule 1.12(g) should be based upon net capital, as

modified by the dollar amount of deficit and undermargined accounts,

rather than adjusted net capital.

The Commission has carefully considered these comments and has

determined to amend Rule 1.12(g) consistent with the suggestions of the

IFSG.9 The Commission believes that this action will make its rule

concerning capital reductions consistent with the SEC's rule and the

rules of futures and securities industry SROs in this area. The IFSG's

letters were jointly addressed to the Division and to the SEC's

Division of Market Regulation (DMR) and the Division's staff has been

in contact with DMR staff to assure similarity of treatment regarding

early warning notices related to capital reductions. The Commission's

December 1995 proposals, which are discussed more fully below, as well

as the Commission's February 1996 proposals,10 were intended to

conform Commission minimum financial and related reporting requirements

with those of the SROs and SEC in various areas, as recommended by

several participants in the Commission's roundtable on capital issues

held on September 18, 1995. A uniform approach among the Commission,

SEC and the SROs with respect to notices of major capital reductions

should simplify the reporting requirements for FCMs that are also BDs

and/or members of more than one futures or securities SRO, eliminating

needless inconsistencies among required notices relating to the same

types of circumstances, and provide consistent and sufficient

information to financial regulators and SROs to permit them to monitor

effectively the financial condition of firms under their jurisdiction.

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\9\ The IFSG's April 8, 1996 letter made two other suggestions

in addition to those referred to above which were that: (1) notice

not be triggered by a futures or securities transaction in the

ordinary course of business between an FCM and an affiliate where

the FCM makes payment to or on behalf of such affiliate for such

transaction and then receives payment from such affiliate for such

transaction within two business days from the date of the

transaction; and (2) an FCM's DSRO have discretion to exempt the FCM

from filing notice under Rule 1.12(g) where withdrawals, advances or

loans in the aggregate, on a net basis, equal $500,000 or less. The

Commission is adopting the former suggestion as a proviso to Rule

1.12(g). As to the second suggestion, Commission staff discussed the

issue with an IFSG representative, who stated that it was included

in the letter since the SEC rule provides for such exemptions. The

IFSG representative further indicated that such a provision was not

an issue of concern to the futures industry members of IFSG so the

Commission is not including it in Rule 1.12(g).

\10\ 61 FR 7080 (Feb. 26, 1996). These proposals concerned the

financial reporting cycle and the debt-equity ratio requirements for

FCMs and IBs.

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The Commission notes that basing the event requiring notice within

two business days upon a decline in net capital rather than adjusted

net capital as currently in the rule will require larger reductions to

trigger the notice since net capital will normally exceed adjusted net

capital. Conversely, since the prior notice requirement will be based

upon a decline in excess adjusted net capital rather than adjusted net

capital as currently in the rule, smaller reductions could trigger the

notice since adjusted net capital will necessarily exceed excess

adjusted net capital, despite the fact that the percentage decline

required to trigger prior notice has been increased from 20 to 30

percent. The Commission believes that it has now achieved a balanced

approach in this area that implements its ongoing resolve to streamline

its rules and avoid unnecessary duplication or redundant or

inconsistent requirements to the extent consistent with customer

protection. It also further harmonizes the Commission's rules with SEC

rules and takes account of the ongoing harmonization project of the

IFSG.11

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\11\ For an FCM dually registered as a BD and taking advantage

of the option available under Commission Rule 1.10(h) to file a copy

of its Financial and Operational Combined Uniform Single (FOCUS)

Report in lieu of Form 1-FR-FCM (which includes about one-half of

all FCMs), the calculation for subsequent notice would be based upon

``tentative net capital'' as set forth in SEC Rule 240.15c3-1, i.e.,

net capital before securities haircuts, and the calculation for

prior notice would be based upon ``excess net capital.'' The

Commission's definition of net capital and the SEC's definition of

tentative net capital, as well as the Commission's definition of

excess adjusted net capital and the SEC's definition of excess net

capital, are for practical purposes the same.

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The Commission has also determined not to establish a mechanism

whereby it could delay or prevent an FCM from carrying out planned

transactions that would reduce excess adjusted net capital by 30

percent or more. The Commission continues to view the early warning

requirements under Rule 1.12 as essentially a mechanism for

notification of situations that have or potentially could have a

negative impact on a firm's ability to carry on normal business

operations consistent with the Commission's prudential requirements and

that pose a potential threat to customer funds or a firm's financial

integrity. In the case of a planned reduction, the Commission believes

that an explanation should accompany the notice. Although the

Commission's staff may wish to discuss reported events with the

FCM,12 the Commission does not believe that a formal mechanism to

delay or prevent events giving rise to a notice under Rule 1.12(g) is

warranted at this time. The Commission currently has the authority to

require specific reports from custodians upon the transfer of

segregated funds in certain circumstances and also requires 100 percent

segregation of customer obligations unlike the SEC that has a more

limited requirement. These two authorities make it less likely that

there could be a ``run'' on a futures firm or a misappropriation of

segregated funds without additional authority to preclude reductions of

capital. Moreover, the Commission is aware of the need for regulators

to be sensitive to the liquidity needs of a holding company system as a

whole consistent with its responsibilities to the regulated entity.

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\12\ The Commission notes that Rule 1.12(g)(3) provides that the

Director of the Division or the Director's designee may require an

FCM filing a notice under Rule 1.12(g) to furnish additional

information. The Commission believes that it is important to

maintain this flexibility and this is another reason why early

warning notices should be filed with the Commission as well as the

DSRO and not only with the latter as Bielfeldt suggested.

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The Commission also wishes to respond to the comments of Bielfeldt

and Mr. Goldberg that no notice should be required or can be prepared

with respect to capital reductions resulting from planned transactions.

As the Commission stated when it published the proposals:

The Commission's early warning rules relating to an FCM's level

of capital contemplate that the FCM will have systems in place to

monitor its capital levels and its compliance with the Commission's

net capital rules on a day-to-day basis. The Commission requires

each FCM to be able to demonstrate its capital compliance at any

time and not just on a required formal computation or filing

date.13 Consequently,

[[Page 19181]]

the effect of planned transactions on net capital should be readily

determinable.

\13\ See Commission Rules 1.17(a)(3)-(5) and 1.18(b), 17 CFR

1.17(a)(3)-(5) and 1.18(b) (1995).

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The Commission further notes that since it issued these proposals,

the failure of Barings PLC has occurred. That failure only reinforces

the need for FCMs to have robust internal controls and capital

monitoring systems that permit a firm to assess its financial position

on a day-to-day, if not more frequent, basis.

In response to the request of two of the commenters noted above,

the Commission wishes to make clear that Rule 1.12(g) does not require

separate notice with respect to repayment or prepayment of subordinated

debt since an FCM must always get approval for prepayment of

subordinated debt from its DSRO as discussed more fully below.14

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\14\ See Commission Rules 1.17(h)(2)(vii) and (viii), 17 CFR

1.17(h)(2)(vii) and (viii) (1995); CFTC Interpretative Letter No.

85-17, [1984-1986 Transfer Binder] Comm. Fut. L. Rep. (CCH)

para.22,738 (Sept. 10, 1985).

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D. Unanswered Margin Calls

As part of the March 1994 risk assessment rule proposals, the

Commission had proposed Rule 1.15(b)(2)(iii), which would have required

an FCM to notify the Division whenever aggregate cumulative losses in

all noncustomer accounts exceeded the greater of: (A) in any 30-day

period, 10 percent of the last reported consolidated stockholders'

equity of the FCM's parent or $50 million, or (B) in any 12-month

period, 20 percent of the last reported consolidated stockholders'

equity of the FCM's parent or $100 million.15 This proposal was

opposed by several commenters. Some of the commenters suggested that,

as an alternative, an FCM be required to notify the Commission within

two business days after a margin call to a noncustomer remains

outstanding for two business days, if the margin call exceeds 20

percent of the FCM's adjusted net capital.

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\15\ 59 FR 9689, 9706 (March 1, 1994).

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In response to these comments, the Commission determined in

December 1994 to propose Rule 1.12(f)(4) which would require an FCM to

file an early warning notice when a margin call on a customer,

noncustomer or omnibus account that exceeds the firm's excess adjusted

net capital is not answered by the close of business on the day

following the day the call is made. The Commission's proposal would

permit FCMs to take into account favorable market moves in determining

whether the margin call would be required to be reported under this

rule.16

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\16\ 59 FR 66822, 66823-24.

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For purposes of proposed Rule 1.12(f)(4), a margin call would mean

any deposit of funds required by the FCM to margin, guarantee or secure

a futures or commodity option position. Thus, if, with respect to an

exchange-traded contract, the FCM requires a deposit in excess of the

minimum required pursuant to exchange rules, that greater amount would

be the amount used in determining whether a call has been collected

from an account holder. Although exchanges may exempt firms from the

requirements of Commission Rule 1.12(f)(3), which requires notice of

issuance of a margin call in excess of a firm's entire adjusted net

capital, the Commission proposed not to permit the granting of such

waivers from the Rule 1.12(f)(4) notice requirement. The Commission

also requested additional comment, however, on the originally proposed

trigger event for which Rule 1.12(f)(4) was proposed as an

alternative.17

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\17\ See proposed Rule 1.15(b)(2)(iii) in the March 1994 risk

assessment proposals, 59 FR 9689, 9706.

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The contract market and trade association commenters addressed

proposed Rule 1.12(f)(4). CBT supported the proposal. CME, FIA and SIA

stated that the rule should be based upon the exchange minimum

maintenance margin level only, since such a rule could otherwise be a

disincentive for FCMs to establish higher internal margin requirements.

FIA and SIA also requested that the Commission allow more time to meet

a margin call before notice is required if foreign customers are

involved. CBT and CME urged the Commission to repeal Rule 1.12(f)(3),

which requires an FCM to file a notice when an account is undermargined

by an amount in excess of the FCM's adjusted net capital, since it is

little used and similar to the proposal. FIA suggested two

clarifications: (1) That the Commission state that a margin call is

usually issued on the day following the day the account becomes

undermargined; and (2) that the provision be applied to all commodity

interest accounts subject to margining. FIA and SIA also requested that

the Commission define ``excess adjusted net capital.''

The Commission has carefully considered these comments and has

determined to adopt Rule 1.12(f)(4) as proposed. As to whether the

minimum margin standard in the rule should be the exchange minimum

level or any higher amount set by the FCM, the Commission believes that

FCMs establish margin requirements for accounts based upon an

assessment of the creditworthiness of the account owner and that a Rule

1.12(f)(4) notice requirement should have negligible impact in the

context of margin requirements intended to safeguard a firm's financial

position. Further, if the Commission adopted the view of certain

commenters that the exchange minimum maintenance margin level is the

appropriate level for purposes of Rule 1.12(f)(4) and an FCM set an

account's maintenance margin level higher than the minimum requirement

of an exchange, the FCM would be required to monitor the impact of the

lower exchange minimum requirement for purposes of Rule 1.12(f)(4). The

Commission believes that such a requirement could be more costly and

confusing to keep track of than simply requiring an FCM to treat a

margin call for the account as a margin call under Rule 1.12(f)(4).

Concerning the comment that more time be allowed to meet a margin

call if foreign customers are involved, the Commission is not persuaded

that this would be appropriate. As far back as the October 1987 market

break, the Division noticed a disproportionate incidence of customer

defaults and liquidations attributable to foreign traders. FCMs were

urged to establish procedures to assure that they obtain adequate

security from foreign customers to protect against the potential for

price fluctuations to result in aberrant margin calls that could not be

readily satisfied by such customers and that, for the FCM, could be

unduly costly or impossible to recover were legal action against the

customer ultimately required.18 The Commission believes that the

events that have occurred since 1987, including the growing

internationalization of the futures markets, and the Commission's

determination, as discussed below, to require gross collection of

exchange-set margin for all omnibus accounts, including those

originated by foreign brokers, lead to the conclusion that margin calls

attributable to foreign traders should not be given preferential

treatment in the context of the early warning notice requirement of

Rule 1.12(f)(4).

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\18\ Follow-up Report on Financial Oversight of Stock Index

Futures Markets During October 1987, CFTC Division of Trading and

Markets, at 84 (Jan. 6, 1988).

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In response to FIA's suggestions, the Commission wishes to make

clear that a margin call is usually issued on the business day

following the business day the account becomes undermargined and that

Rule 1.12(f)(4) as proposed and adopted ``applies to all accounts

carried by the futures commission merchant

[[Page 19182]]

* * * that are subject to margining * * *.'' As to the term ``excess

adjusted net capital,'' this means an FCM's adjusted net capital less

its required minimum adjusted net capital computed in accordance with

Commission Rule 1.17.19 The Commission further wishes to make

clear that the notice required by Rule 1.12(f)(4) must include account

name, date of margin call, amount of margin call and the FCM's excess

adjusted net capital. The Commission also believes that Rule 1.12(f)(3)

referred to above, although somewhat similar to Rule 1.12(f)(4), should

continue as a separate early warning notice requirement.

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\19\ See also 17 CFR 1.17(d)(3) (1995); Form 1-FR-FCM, page 8,

line 24.

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E. Maintenance Margin Factor

Some commenters on the Commission's March 1994 risk assessment

proposals also suggested that, in lieu of adopting the proposal

referred to above concerning the reporting of losses in noncustomer

accounts, the Commission amend Rule 1.12 to add an early warning

reporting requirement to require an FCM to report to the Commission

whenever its excess adjusted net capital is less than six percent of

the maintenance margin requirement applicable to positions in

proprietary and noncustomers' accounts. These commenters noted that the

CME imposes a capital requirement on an informal basis on its clearing

members that factors in a percentage of proprietary and noncustomers

margin requirements. The Commission determined to propose an amendment

to Rule 1.12 in December 1994 in line with the commenters' suggestions.

All of the commenters on the December 1994 proposals addressed this

provision and stated that proprietary positions are subject to haircuts

and thus should not be included in the calculation for an early warning

notice requirement.20 The trade association commenters also stated

that positions held by noncustomers who are subject to capital

requirements of the Commission, or of another regulator or an SRO,

either domestic or foreign, should not be included in the calculation

required by Rule 1.12(f)(5).

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\20\ Bielfeldt further commented that haircuts on proprietary

positions should be eliminated and all accounts should be treated

similarly for capital purposes. This comment addresses issues

outside of the scope of this rulemaking proceeding.

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The Commission has reconsidered its proposal in light of these

comments. As noted above, the proposal responded to comments on the

March 1994 risk assessment proposals which apparently misread the CME's

requirements, since the CME rule only adds a percentage of noncustomer

margin. The Commission recognizes that proprietary positions are

already accounted for in the minimum financial rule through haircuts;

however, noncustomer positions are not and neither are they factored

into the minimum financial requirement based upon four percent of

customer funds. Based upon the comments and its reconsideration of the

issue, the Commission has determined not to include proprietary

accounts as a factor in determining whether notice is required under

Rule 1.12(f)(5).21 However, noncustomer accounts will be included

in the calculation under Rule 1.12(f)(5), unless the noncustomer is

itself subject to the Commission's minimum financial requirements for

an FCM or the SEC's minimum financial requirements for a BD. This is

intended to reflect the fact that affiliates rarely retain excess funds

at the clearing firm. The Commission will reassess whether this

exclusion is appropriate in connection with its further review of the

capital rule as a whole.

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\21\ Because of this determination, the Commission's proposal

that maintenance margin with respect to an FCM's proprietary account

shall mean the amount of funds the FCM is required to maintain at

the clearing organization with its clearing broker, or five percent

of the value of the contract, whichever is greater, is moot. The

Commission requested comment on that point and CME and Bielfeldt

objected to the five percent provision, while CBT thought such a

provision should be used only in the absence of margin being set by

the exchange or clearing organization.

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II. Minimum Financial Requirements for FCMs and IBs

On December 7, 1995, the Commission voted to propose amendments to

Rule 1.17 to: (a) Increase the required minimum dollar amount of

adjusted net capital for FCMs from $50,000 to $250,000; 22 (b)

increase the required minimum dollar amount of adjusted net capital for

``independent'' IBs from $20,000 to $30,000; 23 and (c) make the

amount of adjusted net capital required by a registered futures

association for its member FCMs and IBs an element of the Commission's

minimum financial requirements for FCMs and IBs.24

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\22\ This proposal would also have the effect of increasing an

FCM's ``early warning'' level of adjusted net capital from $75,000

to $375,000 despite the fact that Rule 1.12(b)(1) itself would not

be amended.

\23\ More than two-thirds of IBs enter into a guarantee

agreement with an FCM in accordance with Commission Rules

1.17(a)(2)(ii) and 1.10(j) in lieu of raising their own capital, and

thus would be unaffected by the proposed amendment.

\24\ These proposals and others discussed below were published

at 60 FR 63995 (Dec. 13, 1995).

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These amendments were proposed in order to permit the Commission to

use its authority under Section 6c of the Commodity Exchange Act (Act)

25 to enforce compliance with what are effectively, for the

reasons discussed when the proposals were published,26 the current

minimum adjusted net capital requirements applicable to FCMs and

independent IBs with the benefit of all of the remedies available to

the Commission under the Act for the enforcement of compliance with any

provision of the Act and any rule promulgated thereunder.27 In

addition, these amendments would harmonize the Commission's minimum

financial requirements for FCMs and independent IBs with the prevailing

standards established by NFA rules.28 The amendments would also

support the objective of assuring that FCMs have a substantial

commitment to meeting their regulatory obligations to customers, an

objective for which an increased requirement appears appropriate given

the increase in the amount of funds held by FCMs and the change in the

value of the dollar since 1978, the last time the Commission increased

the required minimum dollar amount of capital for FCMs.29 The

Commission also believed that the proposed amendments to Rule 1.17 were

necessary to clarify its authority to require the transfer of positions

at such time as a firm is no longer in compliance with the NFA rule,

and to eliminate any confusion that may have existed as to whether the

Commission could take action where an FCM's adjusted net capital is

below $250,000 yet still at least $50,000,30 or

[[Page 19183]]

an independent IB's adjusted net capital is below $30,000 yet still

$20,000 or more.31

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\25\ 7 U.S.C. 13a-1 (1994).

\26\ See 60 FR 63995, 63996.

\27\ Section 6c of the Act authorizes the Commission, whenever

it appears that a person has engaged, is engaging, or is about to

engage in any act or practice constituting a violation of any

provision of the Act or any rule or regulation thereunder, to bring

an action to enjoin such act or practice, or to enforce compliance

with the Act or any rule or regulation thereunder. However, the

Commission does not have the authority to discipline an exchange

member for violation of an exchange rule in the absence of the

exchange's failure to act, or to enforce compliance with a

registered futures association's own rule upon a member thereof. See

Sections 8c(a)(1) and 17(l)(1) of the Act, 7 U.S.C. 12c(a)(1) and

21(l)(1) (1994).

\28\ Commission Rule 170.15, 17 CFR 170.15 (1995), mandates that

each person required to register as an FCM become and remain a

member of a futures association which provides for the membership

therein of such FCM unless there is no registered futures

association. NFA is the only registered futures association.

\29\ 43 FR 39956, 39972 (Sept. 8, 1978).

\30\ On November 24, 1992, the SEC adopted rule amendments to

raise its minimum net capital requirements for BDs holding customer

funds, which had been $25,000, to $250,000 in stages. The

requirement increased to $100,000 effective July 1, 1993, $175,000

effective January 1, 1994 and to the current level of $250,000

effective July 1, 1994. See 57 FR 56973, 56990 (Dec. 2, 1992); 17

CFR 240.15c3-1e(a) (1995).

\31\ The Commission's minimum dollar amount of adjusted net

capital for independent IBs has remained unchanged at $20,000 since

1983, when rules governing IBs were first adopted, so the change in

the dollar's value since that time justifies an increase to $30,000

for the minimum amount. 48 FR 35248 (Aug. 3, 1983).

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Four comment letters were received on the December 1995 proposals,

submitted by FIA, NFA, CBT and CME. FIA and NFA supported the proposed

amendments to the Commission's minimum financial requirements for FCMs

and independent IBs. CBT and CME supported raising the minimum dollar

amounts of the Commission's financial requirements to those of the NFA

for FCMs and independent IBs, but objected to incorporating all aspects

of NFA's minimum financial requirements (i.e., the standards based on

number of branches and associated persons (APs)) into the Commission's

rules.32 CBT stated that:

\32\ NFA minimum financial requirements for FCMs and independent

IBs based upon the number of branches and APs are discussed in the

proposing release, 60 FR 63995, 63997.

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Many SROs have their own internal rules to determine capital

that have been developed to address a specific need identified by

that SRO. It can be anticipated that the NFA may develop further

capital standards to address the capital needs of the firms for

which it is primarily responsible and although all FCMs doing

customer business are subject to these requirements, by virtue of

being members of the NFA, if such requirements become Commission

mandates, there would be a greater responsibility placed on the

other DSROs to monitor compliance with what are in essence another

organization's internal capital requirements.

The Commission disagrees with this comment. A registered futures

association cannot impose a minimum financial requirement for its

member FCMs and IBs unless such a rule is approved by the Commission.

When the Commission approves such a rule of the registered futures

association, the proposed amendment would make that standard an element

of the Commission's minimum requirements. Therefore, SROs effectively

will be monitoring compliance with the minimum financial requirements

for doing Commission-regulated FCM business, not another organization's

internal capital requirements.33

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\33\ All SROs are required to have in effect and enforce rules

approved by the Commission prescribing minimum financial and related

reporting requirements for member FCMs and IBs. Such requirements

must be the same as, or more stringent than, those contained in

Commission Rules 1.10 and 1.17. See Commission Rule 1.52, 17 CFR

1.52 (1995).

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Based upon a review of the comments and its own consideration of

these issues, the Commission has determined to adopt the amendments to

Rule 1.17(a) as proposed. The Commission is also adopting conforming

amendments to the early warning level of adjusted net capital for FCMs

(new paragraph (b)(3) of Rule 1.12), the restrictions on withdrawals of

equity capital (new paragraph (e)(1)(iii) of Rule 1.17), and various

provisions of Rule 1.17(h) concerning subordinated debt.34 The

Commission further notes that several provisions of Rule 1.17 contain

cross-references to Rule 1.17(a)(1)(i)(A) and 1.17(a)(1)(ii)(A), the

minimum dollar amount of adjusted net capital for FCMs and independent

IBs, respectively. These other provisions of Rule 1.17 restrict or

require certain actions if specified levels of adjusted net capital,

which in all cases exceed 100 percent of the minimum dollar amount, are

breached. Thus, the amendments to Rule 1.17(a)(1)(i)(A) and

(a)(1)(ii)(A) will have a corresponding impact on various FCM and

independent IB activities or obligations referred to elsewhere in Rule

1.17.35

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\34\ See 60 FR 63995, 63997.

\35\ The other provisions of Rule 1.17 referred to herein are

discussed at 60 FR 63995, 63996.

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III. Approval of Prepayment of Subordinated Debt

The Commission also proposed in December 1995 to codify a Division

``no-action'' letter 36 by amending Commission Rule

1.17(h)(2)(vii)(C) generally to require submission by an FCM or

independent IB of a request for approval of prepayment of subordinated

debt only to its DSRO.37 However, the Commission also proposed

that dual approval by the DSRO and the Commission would be required if

the requested prepayment would result in a reduction of 20 percent or

more of the firm's adjusted net capital.38

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\36\ CFTC Interpretative Letter No. 85-17, [1984-1986 Transfer

Binder] Comm. Fut. L. Rep. (CCH) para. 22,738 (Sept. 10, 1985).

\37\ In those rare instances where the registrant is not a

member of any SRO (which would mean that it could not handle

customer business), such a request would be submitted to the

Commission.

\38\ The Commission made clear when it proposed this amendment

that if a firm's subordinated debt amounts to 25 percent of its

adjusted net capital and the firm wishes to prepay all outstanding

subordinated debt and simultaneously enter into new subordinated

debt arrangements for the same amount, but with a different maturity

date or interest rate, dual approval would not be required since

there would be no net effect on the firm's adjusted net capital.

Similarly, if a firm wanted to convert subordinated debt to paid-in

capital, dual approval would not be required so long as such

conversion did not result in a reduction of 20 percent or more of

the firm's adjusted net capital. 60 FR 63995, 63997-98.

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FIA supported the amendment as proposed, but NFA, CBT and CME each

raised objections to a requirement for dual approval by the DSRO and

the Commission where prepayments of subordinated debt would reduce a

firm's adjusted net capital by at least 20 percent. The commenters

stated that DSROs have demonstrated the capability to competently

handle prepayment of subordinated debt during the past ten years of the

no-action period. CME stated that a firm will be required to provide

notice of a decrease of 20 percent or more in adjusted net capital

pursuant to Rule 1.12(g), as discussed above. CBT recommended that the

Commission make clear that a prepayment of subordinated debt that

results in a decrease of 20 percent or more in adjusted net capital

constitutes a reporting event to the Commission.39 NFA recommended

that approval of such prepayment should only be required by the DSRO,

which in turn should be required to provide the Commission with notice

of any such approvals.

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\39\ The comment letters referred to the adjusted net capital

standard in the proposal. As noted above, the amendments to Rule

1.12(g) as adopted are based upon a reduction in a firm's net

capital or excess adjusted net capital.

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The Commission has considered this issue in light of the comments

received and the other rule amendments it is announcing herein,

particularly Rule 1.12(g) discussed above. The Commission believes that

dual approval by the DSRO and the Commission need not be required for

prepayment of subordinated debt, even if such prepayment would reduce

an FCM's or independent IB's net capital by 20 percent or more or its

excess adjusted net capital by 30 percent or more. In such cases,

however, the DSRO must immediately provide the Commission with a copy

of any notice of approval of prepayment of subordinated debt issued to

an FCM or an independent IB.40

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\40\ This requirement is in addition to the current requirement

that each DSRO report monthly to the regional office of the

Commission nearest to it all actions taken with respect to

subordinated loan agreements. Division of Trading and Markets

Financial and Segregation Interpretation No. 4-1, para. 25, 1 Comm.

Fut. L. Rep. (CCH) para. 7114A, at 7102 (July 29, 1985).

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IV. Gross Collection of Exchange-Set Margins

The Commission also proposed in December 1995 to amend Rule 1.58,

which governs gross collection of exchange-set margin for omnibus

accounts, to make it applicable to omnibus accounts carried by FCMs for

foreign brokers. The Commission made this proposal because, in view of

the

[[Page 19184]]

increasing internationalization of the financial markets, and in

particular the increasing use of foreign omnibus accounts, the

Commission believed that foreign broker omnibus accounts should be

treated in the same manner as omnibus accounts carried for domestic

FCMs. The Commission also noted that the proposals would conform Rule

1.58 to the industry practice since, as a result of staff

recommendations in rule enforcement reviews and SRO rule changes, all

active U.S. contract markets other than the New York Cotton Exchange

and the Philadelphia Board of Trade require that FCMs collect margin

for omnibus accounts of foreign brokers as well as other domestic FCMs

on a gross basis.

FIA, CBT and CME supported the proposed amendment to Rule 1.58 and

the Commission has determined to adopt this amendment as

proposed.41 The Commission believes that gross collection of

exchange-set margin at the clearing firm materially improves financial

control over the positions carried through omnibus accounts.

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\41\ A fuller discussion of this issue is set forth in the

proposing release. 60 FR 63995, 63998.

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V. Receivables From Foreign Brokers

Commission Rule 1.17(c)(5)(xiii) requires that an FCM or

independent IB, when computing its adjusted net capital, take a charge

against its net capital based upon:

Five percent of all unsecured receivables includable under

paragraph (c)(2)(ii)(D) of this section used by the applicant or

registrant in computing `net capital' and which are not receivable

from (A) a registered futures commission merchant, or (B) a broker

or dealer which is registered as such with the Securities and

Exchange Commission.42

\42\ This charge relates to funds deposited by an FCM with a

foreign broker for clearing transactions on non-U.S. markets, as

distinct from the exclusion from current assets for debit/deficit

accounts under Rule 1.17(c)(2)(i), where a customer of the FCM has a

debt to the FCM.

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This provision has been unchanged since it was adopted by the

Commission as part of the major overhaul of the minimum financial and

related reporting requirements in 1978.43 In 1978, foreign futures

business was totally unregulated and foreign options were banned.

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\43\ 43 FR 39956, 39975 (Sept. 8, 1978).

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By letter dated January 12, 1996 to the Division, the Joint Audit

Committee 44 requested that the Commission exempt from the five

percent capital charge set forth in Rule 1.17(c)(5)(xiii) those

unsecured receivables from a foreign broker that has been granted

``comparability relief'' under Commission Rule 30.10.45

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\44\ The Joint Audit Committee (JAC) is composed of

representatives of all U.S. futures SROs. It was established to

coordinate audit and financial surveillance, plans, policies and

procedures, particularly with respect to FCMs that are members of

more than one SRO. Responsibility for monitoring firms that are

members of more than one SRO is allocated among the SROs under a

Joint Audit Plan in which all of the exchanges and NFA participate.

\45\ 17 CFR 30.10 (1995). Part 30 of the Commission's rules

governs foreign futures and options transactions (i.e., commodity

interest transactions entered into by a person located in the U.S.

on or subject to the rules of a foreign board of trade) and

generally requires, among other things, that persons engaged in such

transactions for or on behalf of customers located in the U.S.

register under the Act. However, the Part 30 rules contain an

exemptive provision pursuant to which the Commission may exempt a

firm located outside the U.S. from the application of certain of the

Commission's rules based upon substituted compliance by the firm

with corresponding regulatory requirements of the foreign

jurisdiction in areas such as registration, minimum financial

requirements, safeguarding of customer funds, record-keeping and

reporting requirements, and sales practice standards, and subject to

certain conditions primarily related to the protection of customer

funds.

The relief is granted to firms designated by a foreign entity

such as the United Kingdom Securities and Investments Board or the

Association of Futures Brokers and Dealers (U.K.). A listing of

these entities is set forth in Appendix C to the Commission's Part

30 rules.

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When the Commission adopted Rule 1.17(c)(5)(xiii) in 1978, there

were no Part 30 rules and the Commission had little interaction with

foreign regulators compared to what it has in that regard today.

Indeed, many foreign jurisdictions had no developed regulatory

structure for the futures industry at that time. The Commission was

therefore concerned that unsecured receivables from foreign brokers

represented greater risk to a firm's financial condition than those

from a registered FCM or BD, and should be subject to an additional

capital charge. The increased cooperation among regulators globally and

enhancement of capital standards monitoring today as compared to 1978

justifies a reconsideration of the appropriateness of Commission Rule

1.17(c)(5)(xiii). The Commission also notes that registered FCMs and

BDs today may have large exposures in a jurisdiction such as the U.K.

and an unsecured receivable from such an FCM or BD would not be subject

to a haircut whereas the same receivable from a U.K. affiliate of a

U.S. firm would be subject to the five percent charge so the five

percent charge is a regulatory rather than a location charge.

Based upon its consideration of this issue, the Commission has

determined to add a proviso to Rule 1.17(c)(5)(xiii) such that the

haircut will not apply to an unsecured receivable due from a foreign

broker if the receivable represents deposits required to maintain

futures and commodity option positions (i.e., ``excess'' deposits by an

FCM with a foreign broker are still subject to the five percent

charge), the foreign broker has been granted comparability relief

pursuant to Commission Rule 30.10 and the receivable is held in

compliance with the customer funds protection requirements of the

relevant Commission order made under Rule 30.10 by the foreign broker

itself, with another foreign broker that has been granted comparability

relief under Commission Rule 30.10, or at a depository in the same

jurisdiction as either foreign broker that would qualify as a

depository for funds in accordance with Commission Rule 30.7.

Essentially, the Commission is interpreting the existing rule to treat

``Rule 30.10 firms'' akin to a registered FCM, provided the conditions

about the nature and location of the receivable are also met. As this

relieves a burden on FCMs and independent IBs in computing their

adjusted net capital, and follows a request for such relief by the JAC

on behalf of the member firms of the SROs, the Commission finds good

cause that it is unnecessary to publish this rule amendment for public

comment.46 However, although the Commission is publishing this

amendment as a final rule, it would encourage any interested parties to

submit comments on this amendment.

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\46\ See 5 U.S.C. 553(b) (1994). Preliminary review of data

related to this charge by the Commission's staff indicates that

these receivables are not a substantial asset for most firms. The

Commission also notes that its staff will review firms' financial

statements to determine if unsecured receivables from foreign

brokers are a substantial portion, such as 25 percent, of a firm's

assets and, if so, may undertake discussions with the firms

concerning the circumstances involved.

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VI. Related Matters

A. Regulatory Flexibility Act

The Regulatory Flexibility Act (RFA), 5 U.S.C. 601-611 (1994),

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

those rules on small businesses. The rule amendment discussed herein

would affect FCMs and independent IBs. The Commission has previously

determined that, based upon the fiduciary nature of FCM/customer

relationships, as well as the requirement that FCMs meet minimum

financial requirements, FCMs should be excluded from the definition of

small entity.47

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\47\ See 47 FR 18618, 18619 (Apr. 30, 1982).

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With respect to IBs, the Commission stated that it is appropriate

to evaluate within the context of a particular rule whether some or all

IBs should be considered to be small entities and, if

[[Page 19185]]

so, to analyze the economic impact on such entities at that

time.48 The amendments to Rules 1.17(c)(5)(xiii) and (h)(2)(vii)

eliminate the capital charge for unsecured receivables from certain

foreign brokers and reduce the burden associated with the procedure to

obtain approval for prepayment of subordinated debt, respectively.

Accordingly, these amendments impose no additional requirements on an

independent IB. In addition, the amendment to the minimum adjusted net

capital requirement for an IB conforms the Commission's requirement to

that of the NFA and therefore there should be no impact on an IB's

financial operations. Therefore, these rule amendments will not have a

significant economic impact on a substantial number of small entities.

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\48\ See 48 FR 35248, 35275-78 (Aug. 3, 1983).

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B. Paperwork Reduction Act

The Paperwork Reduction Act of 1980 (PRA), 44 U.S.C. 3501 et seq.

(1994), imposes certain requirements on federal agencies (including the

Commission) in connection with their conducting or sponsoring any

collection of information as defined by the PRA. In compliance with the

PRA, the Commission submitted the December 1994 proposed rule

amendments and their associated information collection requirements to

the Office of Management and Budget. The burden associated with that

entire collection (3038-0024) including the December 1994 proposed rule

amendments, is as follows:

Average Burden Hours Per Response: 18.00.

Number of Respondents: 1,782.

Frequency of Response: annually, quarterly and on occasion.

The burden associated with the December 1994 proposed rule

amendments was as follows:

Average Burden Hours Per Response: 1.00.

Number of Respondents: 12.

Frequency of Response: on occasion.

The Office of Management and Budget approved the December 1994

submission concerning collection 3038-0024 on February 1, 1995.

When the Commission proposed rule amendments in December 1995, it

noted that the proposed rule amendments had no burden,49 although

Rules 1.12, 1.17 and 1.58 are part of groups of rules with the

following burdens.

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\49\ The proposed increase in the dollar amount of minimum

adjusted net capital for an FCM and IB would necessitate only a

change in line item 23E of the Statement of the Computation of

Minimum Capital Requirements on Form 1-FR-FCM and in line item 15 of

that Statement on Form 1-FR-IB, as well as a calculation of the

minimum adjusted net capital requirement based upon a firm's branch

offices and APs.

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The burden associated with the collection required by Rules 1.12

and 1.17 (3038-0024), including the rule amendments proposed in

December 1995, is as noted above. The burden associated with the

collection required by Rule 1.58 (3038-0026), including the rule

amendments proposed in December 1995, is as follows:

A. Reporting

Average Burden Hours Per Response: 0.04.

Number of Respondents: 100.00.

Frequency of Response: daily.

B. Recordkeeping

Average Burden Hours Per Response: 1.00.

Number of Respondents: 300.00

Frequency of Response: annually.

Persons wishing to comment on the estimated paperwork burden

associated with these rule amendments should contact Jeff Hill, Office

of Management and Budget, room 3228, NEOB, Washington, DC 20503 (202)

395-7340. Copies of the information collection submissions to OMB are

available from Joe F. Mink, CFTC Clearance Officer, 1155 21st Street,

NW., Washington, DC 20581, (202) 418-5170.

List of Subjects in 17 CFR Part 1

Commodity futures, Minimum financial requirements.

In consideration of the foregoing, and pursuant to the authority

contained in the Commodity Exchange Act, and in particular Sections

4f(b), 4f(c), 4g and 8a, 7 U.S.C. 6f(b), 6f(c), 6g, and 12a, the

Commission hereby amends Part 1 of Chapter I of Title 17 of the Code of

Federal Regulations as follows:

PART 1--GENERAL REGULATIONS UNDER THE COMMODITY EXCHANGE ACT

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

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

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

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

2. Section 1.12 is amended by removing the word ``or'' at the end

of paragraph (b)(2), by redesignating paragraph (b)(3) as paragraph

(b)(4), by adding a new paragraph (b)(3), by adding paragraphs (f)(4)

and (f)(5) and by revising the introductory text of paragraph (g),

paragraph (g)(1) and paragraph (g)(2) to read as follows:

Sec. 1.12 Maintenance of minimum financial requirements by futures

commission merchants and introducing brokers.

* * * * *

(b) * * *

(3) 150 percent of the amount of adjusted net capital required by a

registered futures association of which it is a member; or

* * * * *

(f) * * *

(4) A futures commission merchant shall report immediately whenever

any commodity interest account it carries is subject to a margin call,

or call for other deposits required by the futures commission merchant,

that exceeds the futures commission merchant's excess adjusted net

capital, determined in accordance with Sec. 1.17, and such call has not

been answered by the close of business on the day following the

issuance of the call. This applies to all accounts carried by the

futures commission merchant, whether customer, noncustomer, or omnibus,

that are subject to margining, including commodity futures and options.

In addition to actual margin deposits by an account owner, a futures

commission merchant may also take account of favorable market moves in

determining whether the margin call is required to be reported under

this paragraph.

(f)(5)(i) A futures commission merchant shall report immediately

whenever its excess adjusted net capital is less than six percent of

the maintenance margin required by the futures commission merchant on

all positions held in accounts of a noncustomer other than a

noncustomer who is subject to the minimum financial requirements of:

(A) A futures commission merchant, or

(B) The Securities and Exchange Commission for a securities broker

and dealer.

(ii) For purposes of paragraph (f)(5)(i), maintenance margin shall

include all deposits which the futures commission merchant requires the

noncustomer to maintain in order to carry its positions at the futures

commission merchant.

(g) A futures commission merchant shall provide written notice of a

substantial reduction in capital as compared to that last reported in a

financial report filed with the Commission pursuant to Sec. 1.10. This

notice shall be provided as follows:

(1) If any event or series of events, including any withdrawal,

advance, loan or loss cause, on a net basis, a reduction in net capital

(or, if the futures commission merchant is qualified to use the filing

option available under Sec. 1.10(h), tentative net capital as defined

in the rules of the Securities and Exchange Commission) of 20 percent

or more, notice must be provided within two business days of

[[Page 19186]]

the event or series of events causing the reduction; and

(2) If equity capital of the futures commission merchant or a

subsidiary or affiliate of the futures commission merchant consolidated

pursuant to Sec. 1.10(f) (or 17 CFR 240.15c3-1e) would be withdrawn by

action of a stockholder or a partner or by redemption or repurchase of

shares of stock by any of the consolidated entities or through the

payment of dividends or any similar distribution, or an unsecured

advance or loan would be made to a stockholder, partner, sole

proprietor, employee or affiliate, such that the withdrawal, advance or

loan would cause, on a net basis, a reduction in excess adjusted net

capital (or, if the futures commission merchant is qualified to use the

filing option available under Sec. 1.10(h), excess net capital as

defined in the rules of the Securities and Exchange Commission) of 30

percent or more, notice must be provided at least two business days

prior to the withdrawal, advance or loan that would cause the

reduction: Provided, however, That the provisions of paragraphs (g)(1)

and (g)(2) of this section do not apply to any futures or securities

transaction in the ordinary course of business between a futures

commission merchant and any affiliate where the futures commission

merchant makes payment to or on behalf of such affiliate for such

transaction and then receives payment from such affiliate for such

transaction within two business days from the date of the transaction.

* * * * *

3. Section 1.17 is amended as follows:

3.1. By revising paragraph (a)(1);

3.2. By revising paragraph (c)(5)(xiii);

3.3. By removing the word ``or'' at the end of paragraph

(e)(1)(ii), by redesignating paragraph (e)(1)(iii) as (e)(1)(iv), and

by adding a new paragraph (e)(1)(iii);

3.4. By removing the word ``or'' at the end of paragraph

(h)(2)(vi)(C)(2), by redesignating paragraph (h)(2)(vi)(C)(3) as

paragraph (h)(2)(vi)(C)(4), and by adding a new paragraph

(h)(2)(vi)(C)(3);

3.5. By removing the word ``or'' at the end of paragraph

(h)(2)(vii)(A)(2), by redesignating paragraph (h)(2)(vii)(A)(3) as

paragraph (h)(2)(vii)(A)(4) and, as redesignated, revising it, and by

adding a new paragraph (h)(2)(vii)(A)(3);

3.6. By removing the word ``or'' at the end of paragraph

(h)(2)(vii)(B)(2), by redesignating paragraph (h)(2)(vii)(B)(3) as

paragraph (h)(2)(vii)(B)(4) and, as redesignated, revising it, and by

adding new paragraphs (h)(2)(vii)(B)(3) and (h)(2)(vii)(C);

3.7. By removing the word ``or'' at the end of paragraph

(h)(2)(viii)(A)(2), by redesignating paragraph (h)(2)(viii)(A)(3) as

paragraph (h)(2)(viii)(A)(4), and by adding a new paragraph

(h)(2)(viii)(A)(3);

3.8. By removing the word ``or'' at the end of paragraph

(h)(3)(ii)(B), by redesignating paragraph (h)(3)(ii)(C) as paragraph

(h)(3)(ii)(D), and by adding a new paragraph (h)(3)(ii)(C); and

3.9. By redesignating paragraphs (h)(3)(v)(C) and (D) as paragraphs

(h)(3)(v)(D) and (E) and by adding a new paragraph (h)(3)(v)(C). The

revised and added paragraphs read as follows:

Sec. 1.17 Minimum financial requirements for futures commission

merchants and introducing brokers.

(a)(1)(i) Except as provided in paragraph (a)(2)(i) of this

section, each person registered as a futures commission merchant must

maintain adjusted net capital equal to or in excess of the greatest of:

(A) $250,000;

(B) Four percent of the following amount: The customer funds

required to be segregated pursuant to the Act and these regulations and

the foreign futures or foreign options secured amount, less the market

value of commodity options purchased by customers on or subject to the

rules of a contract market or a foreign board of trade: Provided,

however, That the deduction for each customer shall be limited to the

amount of customer funds in such customer's account(s) and foreign

futures and foreign options secured amounts;

(C) The amount of adjusted net capital required by a registered

futures association of which it is a member; or

(D) For securities brokers and dealers, the amount of net capital

required by Rule 15c3-1(a) of the Securities and Exchange Commission

(17 CFR 240.15c3-1(a)).

(ii) Except as provided in paragraph (a)(2) of this section, each

person registered as an introducing broker must maintain adjusted net

capital equal to or in excess of the greatest of:

(A) $30,000;

(B) The amount of adjusted net capital required by a registered

futures association of which it is a member; or

(C) For securities brokers and dealers, the amount of net capital

required by Rule 15c3-1(a) of the Securities and Exchange Commission

(17 CFR 240.15c3-1(a)).

* * * * *

(c) * * *

(5) * * *

(xiii) Five percent of all unsecured receivables includable under

paragraph (c)(2)(ii)(D) of this section used by the applicant or

registrant in computing ``net capital'' and which are not receivable

from

(A) A registered futures commission merchant, or

(B) A broker or dealer which is registered as such with the

Securities and Exchange Commission: Provided, however, That if the

unsecured receivable represents deposits required to maintain futures

and commodity option positions, is receivable from a broker which has

been granted comparability relief pursuant to Sec. 30.10 of this

chapter, and is held by the broker itself, with another foreign broker

that has been granted comparability relief under Sec. 30.10 of this

chapter, or at a depository in the same jurisdiction as either foreign

broker that would qualify as a depository for funds in accordance with

Sec. 30.7 of this chapter, and, in the case of customer funds, is held

in accordance with the special requirements of the applicable

Commission order issued under Sec. 30.10 of this chapter, there will be

no charge.

* * * * *

(e) * * *

(1) * * *

(iii) 120 percent of the amount of adjusted net capital required by

a registered futures association of which it is a member; or

* * * * *

(h) * * *

(2) * * *

(vi) * * *

(C) * * *

(3) 120 percent of the amount of adjusted net capital required by a

registered futures association of which it is a member; or

* * * * *

(vii) * * *

(A) * * *

(3) 120 percent of the amount of adjusted net capital required by a

registered futures association of which it is a member; or

(4) For an applicant or registrant which is also a securities

broker or dealer, the amount of net capital specified in Rule 15c3-

1d(b)(7) of the Securities and Exchange Commission (17 CFR 240.15c3-

1d(b)(7)).

(B) * * *

(3) 120 percent of the amount of adjusted net capital required by a

registered futures association of which it is a member; or

(4) For an applicant or registrant which is also a securities

broker or dealer, the amount of net capital specified in Rule 15c3-

1d(c)(5)(ii) of the Securities and Exchange Commission (17 CFR

240.15c3-1d(c)(5)(ii)): Provided, however, That no special prepayment

shall be made if pre-tax losses during the latest three-month period

were greater than 15 percent of current excess adjusted net capital.

[[Page 19187]]

(C) Notwithstanding the provisions of paragraphs (h)(2)(vii)(A) and

(h)(2)(vii)(B) of this section, in the case of an applicant, no

prepayment or special prepayment shall occur without the prior written

approval of the National Futures Association; in the case of a

registrant, no prepayment or special prepayment shall occur without the

prior written approval of the designated self-regulatory organization,

if any, or of the Commission if the registrant is not a member of a

self-regulatory organization. The designated self-regulatory

organization shall immediately provide the Commission with a copy of

any notice of approval issued where the requested prepayment or special

prepayment will result in the reduction of the registrant's net capital

by 20 percent or more or the registrant's excess adjusted net capital

by 30 percent or more.

(viii) * * *

(A) * * *

(3) 120 percent of the amount of adjusted net capital required by a

registered futures association of which it is a member; or

* * * * *

(3) * * *

(ii) * * *

(C) 120 percent of the amount of adjusted net capital required by a

registered futures association of which it is a member; or

* * * * *

(v) * * *

(C) 120 percent of the amount of adjusted net capital required by a

registered futures association of which it is a member;

* * * * *

4. Section 1.58 is revised to read as follows:

Sec. 1.58 Gross collection of exchange-set margins.

(a) Each futures commission merchant which carries a commodity

futures or commodity option position for another futures commission

merchant or for a foreign broker on an omnibus basis must collect, and

each futures commission merchant and foreign broker for which an

omnibus account is being carried must deposit, initial and maintenance

margin on each position reported in accordance with Sec. 17.04 of this

chapter at a level no less than that established for customer accounts

by the rules of the applicable contract market.

(b) If the futures commission merchant which carries a commodity

futures or commodity option position for another futures commission

merchant or for a foreign broker on an omnibus basis allows a position

to be margined as a spread position or as a hedged position in

accordance with the rules of the applicable contract market, the

carrying futures commission merchant must obtain and retain a written

representation from the futures commission merchant or from the foreign

broker for which the omnibus account is being carried that each such

position is entitled to be so margined.

Issued in Washington, D.C. on April 25, 1996, by the Commission.

Jean A. Webb,

Secretary of the Commission.

[FR Doc. 96-10714 Filed 4-30-96; 8:45 am]

BILLING CODE 6351-01-P