Trade Options on the Enumerated Agricultural Commodities

COMMODITY FUTURES TRADING COMMISSION

17 CFR Parts 3 and 32

RIN 3038-AB43

Trade Options on the Enumerated Agricultural Commodities

AGENCY: Commodity Futures Trading Commission.

ACTION: Final rulemaking.

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SUMMARY: The Commodity Futures Trading Commission (Commission or CFTC)

in April 1998, removed a long-standing prohibition on the offer and

sale of off-exchange trade options on certain agricultural commodities

subject to a number of regulatory requirements. On August 31, 1999, the

Commission proposed to amend a number of those requirements. 64 FR

47452. The Commission is adopting as final those proposed amendments.

In particular, the Commission is permitting cash settlement and offset

or cancellation of agricultural trade options. It is also eliminating

the transaction-specific disclosure statement, revising the summary

disclosure statement provided to customers when opening an account and

streamlining the registration requirements for Agricultural Trade

Option Merchants (ATOMs) and their sales agents and certain reporting

and recordkeeping requirements. The Commission believes that these

amendments will increase the commercial utility of agricultural trade

options while maintaining basic customer protections.

EFFECTIVE DATE: February 4, 2000.

FOR FURTHER INFORMATION CONTACT: Paul M. Architzel, Chief Counsel,

Division of Economic Analysis, Commodity Futures Trading Commission,

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

(202) 418-5260, or electronically at [P[email protected]].

SUPPLEMENTARY INFORMATION:

I. Background

In April 1998, the Commission promulgated interim final rules to

permit the trading of agricultural trade options subject to various

regulatory requirements.\1\ 63 FR 18821 (April 16, 1998). These

requirements provided a number of customer protections, including

limitations on the types of instruments or strategies permitted to be

traded, registration of ATOMs, disclosure of risks to option buyers,

financial safeguards, and recordkeeping. No one has applied for

registration as an ATOM since the interim rules became effective in

June 1998. Some observers have suggested that certain of the interim

final rules' provisions discourage participation, and agricultural

trade options would be offered more readily if the rules were

modified.\2\

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\1\ Generally, the offer or sale of commodity options is

prohibited except on designated contract markets. 17 CFR 32.11. One

of several specified exceptions to the general prohibition on off-

exchange options is for ``trade options.'' ``Trade options'' are

off-exchange options ``offered by a person having a reasonable basis

to believe that the option is offered to'' a person or entity within

the categories of commercial users specified in the rule, where such

commercial user ``is offered or enters into the commodity option

transaction solely for purposes related to its business as such.''

17 CFR 32.4(a). However, this exception from the general ban on off-

exchange options does not apply to trade options on the agricultural

commodities enumerated in the Commodity Exchange Act (Act). 7 U.S.C.

1a(3). A full statement of the statutory and regulatory history is

provided in the notice of final rulemaking promulgating the interim

final rules. 63 FR 18821 (April 16, 1998).

\2\ The Commission receives the views of a cross-section of the

agricultural sector through its Agricultural Advisory Committee

(AAC). The AAC, at its meeting on April 21, 1999, engaged in a

detailed discussion of various policy issues raised by possible rule

alternatives. Subsequently, nine organizations representing a broad

cross-section of production agriculture submitted to the Commission

their common views on these issues by letter dated April 23, 1999.

The nine producer organizations were: (1) American Farm Bureau

Federation, (2) National Association of Wheat Growers, (3) National

Corn Growers Association, (4) National Farmers Union; (5) National

Pork Producers, (6) American Soybean Association, (7) National

Cattlemen's Beef Association, (8) National Cotton Council of

America, and (9) National Grain Sorghum Producers.

Additional letters were submitted by the Farm Credit Council

(dated April 19, 1999), the Illinois Farm Bureau (dated April 21,

1999), the National Grain and Feed Association (NGFA) (dated June

15, 1999), the Chicago Board of Trade (CBT) (dated June 16, 1999),

the National Grain Sorghum Producers (dated July 9, 1999), and the

American Farm Bureau Federation, the National Association of Wheat

Growers, the American Soybean Association and the National Farmers

Union (joint letter dated August 9, 1999).

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A. Proposed Revisions to the Agricultural Trade Option Rules

Based in part on those views, the Commission published a notice of

proposed rulemaking (proposed rulemaking) reconsidering a number of the

requirements of the agricultural trade option rules ``with a view

toward maintaining their basic customer protection while increasing the

[[Page 68012]]

commercial utility of the instruments or trading strategies permitted

and streamlining regulatory or paperwork burdens.'' 64 FR 47452 (August

31, 1999). In particular, the Commission proposed to streamline the

registration requirements for ATOMs and their sales agents by, among

other things, removing the training requirement for associated persons

and limiting the number of principals that must certify that they are

not subject to statutory disqualification from registration. In

addition, the Commission proposed to permit cash settlement and offset

or cancellation of agricultural trade options by removing the

requirement that such options, if exercised, must result in physical

delivery. The Commission also proposed to eliminate the transaction-

specific disclosure statement and to revise the summary disclosure

statement provided to customers when opening an account. The Commission

also proposed to streamline certain reporting and recordkeeping

requirements. It also considered, but did not propose, permitting

producers to write call options or changing the $10 million exemptive

level.

B. Comments

The Commission received a total of 22 comment letters, including

those recommending that the Commission propose various amendments to

the interim final rules. See note 2 supra. Overall, the comment letters

expressed a wide range of opinions. Five commenters, including one

academic, two introducing brokers (IBs), one commodity trading advisor

(CTA)/IB and the National Introducing Brokers Association (NIBA)

generally opposed the proposed changes. They expressed the view that

the proposed amendments would weaken existing customer protections,

increase the opportunity for fraud and abuse and facilitate poor

business practices on the part of those offering or soliciting

agricultural trade options.

Eight commenters, including four agribusinesses, three trade

associations and one risk management firm, generally supported the

proposed changes. They particularly supported the proposal to permit

cash settlement and offset or cancellation of the option contracts, but

argued that the Commission should go farther in easing the rule's

requirements. They especially objected to the $10 million dollar

exemption level and to the requirement that option vendors and their

sales agents be registered with the Commission. In contrast, the nine

producer organizations strongly supported retaining the registration

requirement, including the associated right of a registrant's customers

to bring grievances arising from a violation of the Act or Commission

rules before the Commission's reparations forum, and opposed lowering

the $10 million exemption level.\3\

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\3\ Additional comments were submitted by the Chicago Board of

Trade (CBT), the Chicago Mercantile Exchange (CME) and a futures

commission merchant (FCM). The CBT concurred with many of the

proposed changes, noting that it was ``pleased that the Commission

has incorporated several of [the CBT's] recommendations into [the

Commission's] proposed rulemaking.'' See the CBT's comment letter at

p. 1. The CME did not address the specific issues raised in the

proposed rulemaking.

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II. The Final Rules

A. Registration

As the Commission noted in its proposed rulemaking, ``[t]he

requirement that all market profession[als] be registered, and the

authority to approve or revoke registrations, is an important means of

policing conduct in a market.'' 64 FR 47453. As the Commission

explained in the proposed rulemaking, with registration customers have

available to them the Commission's reparations forum for dispute

resolution.\4\ Although there is ``substantial support for a

registration requirement, both because of the higher level of customer

protection it provides and a desire to have available the Commission's

reparations forum for dispute resolution,'' potential agricultural

trade option vendors are opposed to the registration requirement. Id.

Accordingly, the Commission specifically invited comments in the

proposed rulemaking on the issue.

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\4\ Specifically:

[S]ection 14 of the Act provides that `any person complaining of

any violation of any provision of this Act or any rule * * * issued

pursuant to this Act by any person who is registered under this Act'

may bring a reparations action [b]efore the Commission. Accordingly,

complaints that do not relate to violations of the Act or Commission

rules are not subject to Commission reparations proceedings.

Id.

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The NGFA's comment letter opposed a registration requirement and

urged the Commission to ``seriously consider notification as an

alternative''.\5\ NGFA's continued opposition to registration flows

from its opposition to the availability of Commission reparations

proceedings to customers to resolve disputes with ATOMs involving trade

options. NGFA voiced particular concern that the availability of

reparations to resolve disputes involving trade options might expose

ATOMs to reparations cases involving cash contracts.\6\

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\5\ See the letter of September 30, 1999 from NGFA to the

Commission.

\6\ Other commenters, including three agribusinesses, concurred

in NGFA's position. They noted that the reparations requirement

might deter them, as well as others, from offering these

instruments. One commenter, Consolidated Grain and Barge, Co.,

expressed particular support for the NGFA arbitration system. The

CBT also supported rules permitting required dispute resolution

under industry arbitration procedures such as the NGFA's trade

rules.

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In contrast, the nine producer organizations expressed strong

support for maintaining the registration requirement. Other commenters,

including NIBA, an academic and other Commission registrants agreed. In

general, these commenters were of the view that registration of those

offering or soliciting agricultural trade options is an essential

customer protection which should be mandatory.

Based upon thorough and careful consideration of the comments, the

Commission has determined to retain the current registration

requirement, which includes the statutory right to seek redress of

violations of the Act or Commission rules through Commission

reparations proceedings. This is particularly appropriate because

although ``some sectors of agriculture may have well-regarded industry

arbitration fora available, many do not. For these sectors, reparations

may be the only readily available non-judicial avenue for dispute

resolution.'' 64 FR 47453.\7\

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\7\ The Commission is also incorporating, as proposed,

streamlined procedures clarifying the use of pre-dispute arbitration

clauses for agricultural trade options and the procedures by which

customers can waive their right to use Commission reparations

procedures to resolve disputes with an ATOM.

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In retaining the registration requirement for ATOMs and their APs,

the Commission notes that reparation proceedings are available only

where a violation of the Act or Commission rules is alleged. Under the

Commission's rules, the Director of the Office of Proceedings forwards

a complaint and answer if the facts alleged so warrant. If no violation

of the Act or Commission rules is alleged, the Director of the Office

of Proceedings may terminate consideration of the filings. See, 17 CFR

12.26, 12.27. A dispute arising solely out of a cash market

transaction, therefore, would be dismissed and not forwarded for

adjudicatory action.

1. Simplification of the Registration Process

The Commission proposed a number of modifications based upon the

acknowledged ``broad agreement that the registration procedures for

ATOMs and their sales agents be streamlined

[[Page 68013]]

and simple.'' Id. at 47454. Specifically, the Commission proposed

removal of the requirement that ATOMs separately certify the truth of

their principals' and APs' applications. The Commission also proposed

to limit the principals required to file as part of an ATOM's

application to those principals who exercise direct control over the

ATOM's business affairs. In addition, the Commission proposed deletion

of the mandatory six-hour training course for ATOMs' sales agents.

NIBA, the academic commenter and the registrants opposed the

proposed amendments, particularly deletion of the mandatory six-hour

training required of APs. NGFA, the agribusinesses, a trade

association, and the CBT supported the proposed changes, although

several opined that the proposed changes did not go far enough. The

three agribusinesses particularly commended the Commission for

proposing to delete the mandatory AP training requirement.

The Commission is adopting the proposed amendments to the

registration procedures as final rules. In doing so, it has modified

the definition of an AP, as provided in Commission Rule 3.13(a)(2)(ii),

to include those who ``supervise directly,'' an ATOMs'' associated

persons. The Commission also is modifying Rule 3.13(b) to state that

those who ``supervise directly'' an ATOMs' associated persons, must

register as an AP. These modifications clarify that only immediate

supervisors of associated persons must register as APs (in addition to

principals of the firm who control or direct the ATOM's activities) and

must certify that they are not disqualified from registration under the

Act. These modifications clarify that second or third tier supervisors

are not covered by the registration and certification requirements.

In addition to the proposed amendments, the Commission requested

comment on the relative burden and benefits of the current requirement

that ATOMs notify the NFA when an associated person leaves its employ

or when a new associated person begins. Generally, commenters did not

respond to the request for comment. However, as some have observed,

ATOMs, particularly those with a decentralized sales force, potentially

will benefit from the requirement, which offers customers a means to

determine whether an individual is duly authorized to offer and sell

trade options on an ATOM's behalf. Accordingly, the Commission is

retaining the requirement.\8\

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\8\ Under prior Commission Rule 3.13(c)(2), when an AP ceased to

be associated with an ATOM, the ATOM was required to notify NFA of

that disassociation within 20 days of the disassociation's

occurrence. The Commission has revised Rule 3.13(c)(2) to extend

this notification time period to 45 days to enable smaller

businesses to perform this notification as part of their routine

month-end accounting.

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2. Commission Processing of Applications

Seven commenters addressed specifically the Commission's request

for comments on the possible benefits to ATOMs, their APs or potential

customers from the Commission's direct processing of registration

applications, and the relative costs of such a proposal. Four

commenters opined that it would be more efficient for NFA to perform

this administrative task on the Commission's behalf as the interim

final rules currently provide.\9\ Two commenters disagreed, raising

concerns regarding the degree of regulatory oversight NFA will have in

performing this function.

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\9\ Under the interim final rules, the Commission delegated to

NFA the authority to directly process applications for registration

as an ATOM or an AP of an ATOM.

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The Commission remains convinced that NFA should perform these

functions on the Commission's behalf. In reaching this conclusion, the

Commission found that the possible benefits to ATOMs and their APs or

potential customers from the Commission's direct processing of

registration applications did not outweigh the relative costs of such a

proposal.\10\ Accordingly, the Commission finds it appropriate that

NFA, which has the capacity to process registration applications with

only minor changes to its existing systems, will perform these

functions.\11\

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\10\ As the Commission explained in the proposed rulemaking,

during the 1980s, it:

[C]ompletely transferred [its registration administrative

functions] to NFA * * * and no longer has systems in place to

process [registration applications such as those filed by ATOMs or

their APs]. Accordingly, the Commission would have to rebuild this

capability from the ground up before it could begin reviewing and

approving registrations once again. Moreover, rebuilding such

administrative systems would, in the short-run, compete for

technical resources that are being devoted to Y2K compliance.

64 FR 47454.

\11\ NGFA expressed that the Commission should clarify what

degree of ``regulatory authority'' NFA will have in processing

applications. In this regard, as explained by the Commission in its

proposed rulemaking, these final rules, like the prior interim final

rules, ``strictly limit NFA's role. NFA does not become a self-

regulatory authority for ATOMs simply by administratively processing

their registration applications on the Commission's behalf. NFA

exercises no regulatory authority over the offer or sale of

agricultural trade options by ATOMs as a consequence of that

administrative function, nor do ATOMs or their APs thereby become

members of NFA.'' Id.

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Finally, one commenter suggested that the Commission permit

potential registrants to begin filing for registration with the NFA as

ATOMs and their APs in reliance upon the amended registration

conditions in advance of the effective date of the rules. The

Commission will take no adverse action in connection with an ATOM and

its APs processing or submitting registration materials with the NFA in

reliance on these amended procedures in advance of the rule's effective

date.\12\ Because currently there are no registered ATOMs, to the

extent that the amended rules increase the likelihood of registration

and competition to be the first registered, an initial surge may cause

administrative delay. This no-action position is in the public interest

because it will enable ATOMs and their APs an initial period during

which to process and submit their registrations with NFA so that all

interested ATOMS may begin offering and selling trade options under the

amended rules as soon as the rules become effective, in time for the

coming crop year. This will provide producers with greater availability

of instruments and choice in vendors in time to meet their hedging

needs for the coming crop year.

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\12\ Although ATOMs and their APs may have their registration

applications processed in reliance upon the amended rules, unless

they are registered in compliance with the current rules, they may

not offer or sell these instruments until the rule amendments are

effective.

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B. Cash Settlement

In proposing to permit cash settlement and offset or cancellation

of agricultural trade options, the Commission noted its widespread

support ``among all sectors of agriculture.'' Id at 47455. In addition,

the Commission proposed to require ATOMs to provide customers with an

account statement following the termination, cancellation, cash

settlement or amendment of an option's expiration date (rolling the

contract). In making this proposal, the Commission explained that:

[C]ustomers could have expected to have their accounts settled

upon physical delivery, and this requirement will ensure that

customers who cash settle their contracts are provided with similar

information. Moreover, by receiving an accounting and knowing with

certainty the outcome of their closed position, customers should

better be able to ascertain the potential outcome of entering into a

subsequent transaction.

Id.\13\

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\13\ The Commission also noted that ``[i]n addition, the

Disclosure Statement continues to advise potential purchasers that

trade options are required to have a business purpose and are not to

be used for speculation.'' Id.

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The majority of commenters strongly approved of the proposed

change,

[[Page 68014]]

noting that it is ``critical'' to increasing the ``effectiveness and

flexibility of these products for both buyers and sellers.'' \14\ A

minority of commenters opposed the proposal, however, voicing concern

that if cash settlement is permitted, agricultural trade options

``could easily develop into an off-exchange traded speculative

marketplace.''

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\14\ See the CBT's letter of September 30, 1999 to the

Commission.

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The Commission is adopting the rule as proposed, including the

requirement that ATOMs provide customers with an account statement

following the termination, cancellation, cash settlement or amendment

of an option's expiration date (rolling the contract). The Commission

is also clarifying that commercial enterprises eligible to be ATOMs

include those selling inputs used in producing the commodity as well as

banks that routinely finance businesses involved in the production,

processing or handling of the commodity. 64 FR 47455.\15\

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\15\ An FCM submitted a comment letter to the Commission

requesting clarification on whether FCMs can register to become

ATOMs. The Commission believes that an FCM may satisfy the

requirements of Rule 32.13(a) and be allowed to become an ATOM.

However, there are issues unique to FCMs, including possible

procedures to address potential conflict of interest by a

fiduciary's becoming the principal of an off-exchange transaction

and the effect of that position on the FCM's required net capital.

The Commission will consider these issues in a separate Federal

Register release.

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C. Risk Disclosure, Customer Account Information and Reports to the

Commission

1. Risk Disclosure

The interim final rules required that customers be provided with

both a general, summary disclosure statement upon opening an account

and transaction-specific disclosures before entering into a specific

transaction.\16\ However, as noted by the Commission in the notice of

proposed rulemaking, representatives of both potential trade option

vendors and customers agreed that many of the transaction-specific

disclosures could be made in the summary disclosure statement and

others readily ascertainable from the face of the option contract

itself, thus permitting the elimination of the transaction-specific

disclosure requirement. Id. Accordingly, the Commission proposed to

streamline risk disclosure by revising the summary disclosure to

include some of the material that formerly was included in the

transaction-specific disclosure. Id.

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\16\ The transaction-specific disclosure included information

relating to the specific terms of a particular transaction. The ATOM

was required to disclose the customer's worst possible financial

outcome when the option premium was not collected up front or when

an option contract was amended.

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Although two commenters supported retention of the current risk

disclosure rules, a number of commenters described the proposed

amendments as ``positive.'' \17\ The Commission is adopting the rules

as proposed.

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\17\ Cargill, in its comment characterized them as

``reasonable'' and ``necessary.'' See the letter of September 30,

1999 from Cargill Grain Division to the Commission.

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2. Customer Account Information

In addition to proposing revisions to streamline the risk

disclosure requirements, the Commission proposed to amend the

requirements relating to reporting of account information to

customers.\18\ As explained in the proposed rulemaking:

\18\ Specifically, under prior Rule 32.13(b), ATOMs were

required to provide customers with written confirmation of contracts

within 24 hours of executions and within 48 hours of a customer

request, a written response regarding the customer's account or

position. In addition, ATOMs were required to notify customers in

writing of an option's expiration within the coming calendar month.

A number of sources, including several state-level

representatives of producers and commodity first handers, suggested

that the requirements that ATOMs provide customers with account-

related information potentially created too great a paperwork burden

for smaller firms. * * * Similarly, some have observed that oral

contracting is still the prevailing means of transacting business in

certain agricultural cash markets, and they suggest that the interim

rules, which require agricultural trade option contracts to be

written, should be amended to reflect that reality. In this regard,

state law has recognized this practice by recognizing the validity

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of such oral contracts when they have been confirmed in writing.

64 FR 47455-47456.

One commenter opined that ``verbal confirmation is not an

acceptable business practice.'' The Commission agrees that best

business practice is for all such communications to be in writing,

including the option contract itself at the time the contract is made.

However, there was consensus among representatives of potential vendors

and purchasers that the Commission's rules should be amended to

correspond more closely to current practice permitted under state law.

Accordingly, the Commission is adopting the rule amendments as

proposed, permitting ATOMs to enter into a contract orally, with

subsequent written confirmation.\19\ The written confirmation, which

must be signed by the ATOM, must include all material terms of the

option contract. The rules further permit use of oral communications

and notice to customers with respect to account information.

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\19\ The Commission notes that a customer retains the right to

have a written agricultural trade option contract and that, unless

the customer chooses to contract orally, the ATOM must provide the

agricultural trade option contract to the customer in writing.

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3. Reports to the Commission

The interim rules required ATOMs to file reports on volume and open

interest four times a year with the NFA. In response to this

requirement, the Commission observed that there was ``widespread

support among agricultural groups for reducing ATOMs required

reports.'' 64 FR 47456. In light of this, the Commission proposed to

reduce periodic reporting to one annual report, filed by the ATOM with

the Commission within 90 days of the end of its fiscal year.

Commenters addressing this specific proposed change offered a

variety of views. One commenter, an agribusiness, disfavored having

this reporting requirement, indicating that while the Commission was

proceeding in the right direction by reducing the number of required

reports, ultimately, it should delete the requirement all together.

However, other commenters, including two agribusinesses and NGFA,

voiced their support for this proposed amendment. In particular, one

agribusiness stated that ``the switch to annual reporting will greatly

reduce the paperwork required to participate in the program.''

Taking these comments into consideration, the Commission believes

it appropriate to reduce the periodic reporting requirement that ATOMs

file reports on volume and open interest four times a year with the

NFA, to one annual report, filed by the ATOM with the Commission within

90 days of the end of its fiscal year, as proposed. Also as proposed,

the Commission is retaining authority to obtain information as needed

for regulatory purposes through inspections of the books and records of

a particular firm and to conduct a market-wide survey, by special call,

in order to evaluate the success of the rules. The information that

would be required in a special call is specified in the rules.

The Commission is also revising, as proposed, the requirement that,

except for funds used to purchase exchange-traded contracts as cover,

ATOMs keep in segregation 100% of customer funds paid up front. In its

rules governing the offer or sale of dealer options, another type of

over-the-counter option, the Commission required the option grantor to

hold not less than 90% of funds paid by a customer in segregation (17

CFR

[[Page 68015]]

32.6(a)). The Commission is applying that 90% requirement to

agricultural trade options, as well. This will provide ATOMs with

greater flexibility in structuring their businesses.

D. Required Contract Terms and Limitations on Certain Strategies

Commission final interim Rule 32.13(a)(6)(i)-(vii) required that

agricultural trade option contracts specify a number of contract

terms.\20\ The Commission proposed to delete these design requirements

on the grounds that the terms would be expected to be found in any

fully-specified physical delivery option contract. Instead, the

Commission proposed to include a statement in the Disclosure Document

that option customers should be sure that the contract includes, and

that the customer understands the operation of, all of the above

contract provisions. The Commission believes that the proposal provides

adequate customer protection while permitting ATOMS greater flexibility

in specifying option contracts and is therefore adopting the change as

final.

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\20\ These terms included the procedure for exercise, the

expiration date and latest time on that date for exercise; the

strike price; the total quantity of the commodity underlying the

option; the quality or grade of commodity to be delivered if the

option is exercised and any adjustments to price for deviations from

stated quality or grade, or the range of, and a statement of the

method for calculating such adjustments; the delivery location; the

elements comprising the purchase price to be charged, including the

premium, mark-ups on the premium, costs, fees and other charges; and

additional costs, if any, which may be incurred if the commodity

option is exercised.

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The Commission did not propose to change the existing requirement

that a producer may write a call only to the extent that it is paired

with a purchased or long put option in a window or fence strategy.\21\

The Commission explained that, although some observers have suggested

that producers, if they desire, should be able to grant or write call

options if the position is covered by expected production, many

producer representatives opposed changing the current requirement. As

the Commission noted, this strategy:

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\21\ See 64 FR 47456.

[I]s not riskless. For example, if the producer suffers a

production shortfall or loss, the producer's liability could be

significant. For this reason, many of the producer representatives

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opposed changing the interim rules in this respect.

Id.

Two commenters in addition to the nine producer organizations

supported continuation of the prohibition against producers writing

covered calls. Others disagreed, suggesting that the prohibition

against producers writing covered call options should be lifted to

allow the greatest flexibility possible in formulating risk management

strategies. As explained by one trade association, ``[w]e believe the

prohibition is an unnecessary restriction and could reduce the profit

potential for an agricultural business and limit the potential for

managing commodity price risk.''\22\

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\22\ See the letter of September 30, 1999 from the National

Grain Trade Council to the CFTC.

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After careful consideration of the comments on this proposal, the

Commission remains convinced that the current prohibition permitting

call writing by producers only to the extent that the written call is

paired with a purchased or long put option in a window or fence

strategy should not be revised at this time. As the Commission stated

in the proposed rulemaking, however, ``[i]n taking this position, the

Commission is not ruling out its reconsideration after producers have

had an opportunity to gain experience generally with the offer and sale

of trade options.'' 64 FR 47456.

E. Exemption Level for Sophisticated Entities

The interim rules exempted transactions in which each party to the

option contract had a net worth of not less than $10 million from

compliance with all of the specific conditions for trading agricultural

trade options. The Commission determined that the exemption should

apply only to those entities with a very high net worth and that a

greater level of regulatory protection was appropriate for transactions

involving less well-financed entities. In implementing the exemption

for sophisticated entities, the Commission observed that there was no

consensus among commenters regarding what the exemption level should

be, or whether there should be an exemption at all.

Several commenters remarked on the current exemption level.

Overall, there continues to be a lack of consensus regarding lowering

the exemption level. Although some commenters advocated lowering the

dollar amount of the exemption level, others, including the producer

organizations opposed any exemption from the amended requirements or

advocated maintaining the exemption at the current level. In light of

the wide diversity of opinion, the untested nature of the rules, and

the very broad changes already being made, the Commission continues to

believe that the current exemption level should not be reduced at this

time.

III. Other Matters

A. Paperwork Reduction Act (PRA)

Rules 3.13(e), 32.6, 32.13(a), 32.13(d), 32.13(e), 32.13(f)(1),

32.13(F)(2)-(5) and 32.13(c) contain information collection

requirements. As required by the PRA of 1995 (Pub. L. 104-13 (May 13,

1996)), the Commission submitted a copy of the proposed rules and the

associated paperwork burden to the Office of Management and Budget

(OMB) for its review (44 U.S.C. 3504(h)) and requested comments on the

paperwork burden from the public. The Commission did not receive

comments addressing this specific associated paperwork burden. The

Commission did receive and address, however, comments concerning the

information that would be collected under the proposed rules.

OMB previously approved the collection of information related to

these rules as information collection 3038-0048, Off-Exchange

Agricultural Options. The final rules adopted by the Commission, which

have been submitted to OMB for approval, have the following paperwork

burden:

Number of respondents: 3,605.

Estimated average hours per response: 5.59.

Frequency of response: On occasion and annually.

Number of responses per year: 4,115.

Annual reporting burden: 23,003.

This represents a reduction of 9,045 burden hours as a result of

the rule changes adopted. Persons wishing to comment on the paperwork

burden contained in the final rules may contact the Desk Officer, CFTC,

Office of Management and Budget, Room 10202, NEOB, Washington, DC

20503, (202) 395-7340. Copies of the information collection submission

to OMB are available from the CFTC Clearance Officer, 1155 21st Street,

NW, Washington, DC 20581, (202) 418-5160.

B. Regulatory Flexibility Act (RFA)

The RFA, 5 U.S.C. 601 et seq., requires that agencies consider the

impact of their rules on small businesses. The Commission has not

previously determined whether all or some agricultural trade option

merchants should be considered ``small entities'' for purposes of the

RFA and, if so, to analyze the economic impact on such entities.

However, the Commission is requiring one of the conditions for

registration as an agricultural trade option merchant to be maintenance

of a minimum level of net worth. The Commission previously found that

other entities which were required to maintain minimum levels of net

capital

[[Page 68016]]

were not small entities for purposes of the RFA. See, 47 FR 18618,

18619 (April 30, 1982). The Commission has also found, however, that

one category of Commission registrant--introducing brokers (IBs)--which

is required to maintain a minimum level of net capital, may include

small entities for purposes of the RFA. Nevertheless, in addition to

the $50,000 minimum net worth required for registration as an

agricultural trade option merchant, such registrants must be in

business in the underlying cash commodity. This will require that they

have additional resources invested in order to qualify as an

agricultural trade option merchant, in contrast to an IB whose

additional investment beyond the minimum net capital may be relatively

small. For this reason, the Commission believes that agricultural trade

option merchants are more appropriately treated as not being small

entities under the RFA. The Chairman, on behalf of the Commission,

hereby certifies, pursuant to 5 U.S.C. 605(b), that the action taken

herein will not have a significant economic impact on a substantial

number of small entities.

List of Subjects

17 CFR Part 3

Administrative practice and procedure, Brokers, Commodity futures.

17 CFR Part 32

Commodity futures, Commodity options, Prohibited transactions,

Trade options.

In consideration of the foregoing, and pursuant to the authority

contained in the Act, and in particular sections 2(a)(1)(A), 4c, and

8a, 7 U.S.C. 2, 6c, and 12A, as amended, the Commission hereby amends

parts 3 and 32 of chapter I of title 17 of the Code of Federal

Regulations as follows:

PART 3--REGISTRATION

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

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

6k, 6m, 6n, 6o, 6p, 8, 9, 9a, 12, 12a, 13b, 13c, 16a, 18, 19, 21,

23; 5 U.S.C. 552, 552b.

2. Section 3.13 is revised to read as follows:

Sec. 3.13 Registration of agricultural trade option merchants and

their associated persons.

(a) Definitions. (1) Agricultural trade option merchant.

``Agricultural trade option merchant'' means any person that is in the

business of soliciting, offering to enter into, entering into,

confirming the execution of, or maintaining a position in, transactions

or agreements in interstate commerce which are not conducted or

executed on or subject to the rules of a contract market, and which are

or are held out to be of the character of, or are commonly known to the

trade as, an ``option,'' ``privilege,'' ``indemnity,'' ``bid,''

``offer,'' ``put,'' ``call,'' ``advance guarantee,'' or ``decline

guarantee,'' involving wheat, cotton, rice, corn, oats, barley, rye,

flaxseed, grain sorghums, mill feeds, butter, eggs, solanum tuberosum

(Irish potatoes), wool, wool tops, fats and oils (including lard,

tallow, cottonseed oil, peanut oil, soybean oil and all other fats and

oils), cottonseed meal, cottonseed, peanuts, soybeans, soybean meal,

livestock, livestock products, and frozen concentrated orange juice.

Provided, however, that any person entering into such transactions

solely for the purpose of managing the risk arising from the conduct of

his or her own commercial enterprise is not considered to be in the

business described in this paragraph.

(2) Associated person of an agricultural trade option merchant.

``Associated person of an agricultural trade option merchant'' means a

partner, employee, or agent (or any person occupying a similar status

or performing similar functions) that:

(i) Solicits or accepts customers' orders (other than in a clerical

capacity) or

(ii) Supervises directly any person or persons so engaged.

(b) Registration required. It shall be unlawful for any person in

the business of soliciting, offering or selling the instruments listed

in Sec. 32.2 of this chapter to solicit, to offer to enter into, or to

enter into, to confirm the execution of, or to maintain transactions in

such instruments or to supervise directly persons so engaged except if

registered as an agricultural trade option merchant or as an associated

person of such a registered agricultural trade option merchant under

this section.

(c) Duration of registration. (1) A person registered in accordance

with the provisions of this section shall continue to be registered

until the revocation or withdrawal of registration.

(2) Agricultural trade option merchants must notify the National

Futures Association within forty five days when an associated person

has ceased to be so associated.

(3) An associated person who ceases to be associated with a

registered agricultural trade option merchant is prohibited from

engaging in activities requiring registration under Sec. 32.13 of this

chapter or representing himself or herself to be a registrant until:

(i) A registered agricultural trade option merchant notifies the

National Futures Association of the person's association; and

(ii) The associated person certifies to the National Futures

Association that he or she is not disqualified from registration for

the reasons listed in section 8a (2) and (3) of the Act; provided,

however, no such certification is required when the associated person

becomes associated with the new agricultural trade option merchant

within ninety days from when the associated person ceased the previous

association.

(d) Conditions for registration. (1) Applicants for registration as

an agricultural trade option merchant must meet the following

conditions:

(i) The agricultural trade option merchant must have and maintain

at all times net worth of at least $50,000 computed in accordance with

generally accepted accounting principles;

(ii) The agricultural trade option merchant must identify each of

the natural persons who controls or directs the offer or sale of trade

options or associated trading activity by the agricultural trade option

merchant and any associated person of the agricultural trade option

merchant and each such natural person must certify that he or she is

not disqualified from registration for the reasons listed in sections

8a(2) and (3) of the Act; and

(iii) The agricultural trade option merchant must provide access to

any representative of the Commission or the United States Department of

Justice for the purpose of inspecting books and records.

(2) Applicants for registration as an associated person of an must

meet the following conditions. Such persons must:

(i) Identify the agricultural trade option merchant with whom the

person is associated or to be associated within thirty days of the

person's registration; and

(ii) Certify that he or she is not disqualified from registration

for the reasons listed in sections 8a(2) and (3) of the Act.

(e) Applications for registration. (1) The agricultural trade

option merchant, including its principals, and associated persons of an

agricultural trade option merchant must apply for registration on the

appropriate forms specified by the National Futures Association and

approved by the Commission, in accordance with the instructions

thereto, including the separate certifications from each natural person

that he or she is not disqualified for any of the reasons listed in

sections 8a(2)

[[Page 68017]]

and (3) of the Act and such other identifying background information as

may be specified.

(2) The agricultural trade option merchant's application must also

include its most recent annual financial statements certified by an

independent certified public accountant in accordance with generally

accepted auditing standards prepared within the prior 12 months.

(3) These applications must be supplemented to include any changes

in the information required to be provided thereon on a form specified

by the National Futures Association and approved by the Commission.

(f) Withdrawal of application for registration; denial, suspension

and revocation of registration. The provisions of Secs. 3.51, 3.55,

3.56 and 3.60 shall apply to applicants for registration and

registrants as agricultural trade options merchants and their

associated persons under this part 3 as though they were an applicant

or registrant in any capacity under the Act.

(g) Withdrawal from registration. An agricultural trade option

merchant that has ceased or has not commenced engaging in activities

requiring registration may withdraw from registration 30 days after

notifying the National Futures Association on the specified form of its

intent to do so, unless otherwise notified by the Commission. Such a

withdrawal notification must include information identifying the

location of, and the custodian authorized to release, the agricultural

trade option merchant's records, a statement of the disposition of

customer positions, cash balances, securities or other property and a

statement that no obligations to customers arising from agricultural

trade options remain outstanding.

(h) Dual registration of associated persons. An associated person

of an agricultural trade option merchant may be associated with other

registrants subject to the provision of Sec. 3.12(f).

3. Section 3.14 is removed and reserved.

PART 32--REGULATION OF COMMODITY OPTION TRANSACTIONS

4. The authority citation for part 32 continues to read as follows:

Authority: 7 U.S.C. 2, 6c and 12a.

5. Section 32.2 is republished for the convenience of the reader:

Sec. 32.2 Prohibited transactions.

Notwithstanding the provisions of Sec. 32.11, no person may offer

to enter into, confirm the execution of, or maintain a position in, any

transaction in interstate commerce involving wheat, cotton, rice, corn,

oats, barley, rye, flaxseed, grain sorghums, mill feeds, butter, eggs,

solanum tuberosum (Irish potatoes), wool, wool tops, fats and oils

(including lard, tallow, cottonseed oil, peanut oil, soybean oil and

all other fats and oils), cottonseed meal, cottonseed, peanuts,

soybeans, soybean meal, livestock, livestock products, and frozen

concentrated orange juice if the transaction is or is held out to be of

the character of, or is commonly known to the trade as an ``option,''

``privilege,'' ``indemnity,'' ``bid,'' ``offer,'' ``put,'' ``call,''

``advance guarantee,'' or ``decline guarantee,'' except as provided

under Sec. 32.13 of this part.

6. Section 32.13 is revised to read as follows:

Sec. 32.13 Exemption from prohibition of commodity option transactions

for trade options on certain agricultural commodities.

(a) The provisions of Sec. 32.11 shall not apply to the

solicitation or acceptance of orders for, or the acceptance of money,

securities or property in connection with, the purchase or sale of any

commodity option on a physical commodity listed in Sec. 32.2 by a

person who is a producer, processor, or commercial user of, or a

merchant handing or selling inputs used in the production of, the

commodity which is the subject of the commodity option transaction, or

the products or byproducts thereof, or a bank routinely engaged in the

financing of such businesses, if all of the following conditions are

met at the time of the solicitation or acceptance:

(1) That person is registered with the Commission as an

agricultural trade option merchant and that person's associated persons

and their supervisors are registered as associated persons of an

agricultural trade option merchant under Sec. 3.13 of this chapter.

(2) The option offered by the agricultural trade option merchant is

offered to a producer, processor, or commercial user of, or a merchant

handling, the commodity which is the subject of the commodity option

transaction, or the products or byproducts thereof, and such producer,

processor, commercial user, or merchant is offered or enters into the

commodity option transaction solely for purposes related to its

business as such.

(3) [Reserved]

(4) To the extent that the customer makes payment of the purchase

price to the agricultural trade option merchant prior to option

expiration or exercise, that amount:

(i) May only be used by the agricultural trade option merchant to

purchase a covering position on a contract market designated under

section 6 of the Act or part 33 of this chapter; and

(ii) Any amount not so used shall be treated as belonging to the

customer until option expiration or exercise as provided under and in

accordance with Sec. 32.6.

(5) Producers may not:

(i) Grant or sell a put option; or

(ii) Grant or sell a call option, except to the extent that such a

call option is purchased or combined with a purchased or long put

option position, and only to the extent that the customer's call option

position does not exceed the customer's put option position in the

amount to be delivered. Provided, however, that the options must be

entered into simultaneously and expire simultaneously or at any time

that one or the other option is exercised.

(6) All option contracts, including all terms and conditions,

offered or sold pursuant to this section shall be in writing, a signed

copy of which shall be provided to the customer, or if the contract is

verbal, it shall be confirmed in a writing which includes all terms and

conditions, signed by the agricultural trade option merchant, and

provided to the customer within 48 hours.

(7) Prior to the entry by a customer into the first option

transaction with an agricultural trade option merchant, the

agricultural trade option merchant shall furnish, through written or

electronic media, a summary disclosure statement to the option

customer. The summary disclosure statement shall include:

(i) The following statements in boldface type on the first page(s)

of the summary disclosure statement:

This brief statement does not disclose all of the risks and

other significant aspects of trading in community trade options. You

are encouraged to seek out as much information as possible from

sources other than the person selling you this option about the use

and risks of option contracts before entering into this contract.

The issuer of your option should be willing and able to answer

clearly any of your questions.

Appropriateness of Option Contracts

Option contracts may result in the total loss of any funds you

pay to the issuer of your option. You should carefully consider

whether trading in such instruments is appropriate for you in light

of your experience, objectives, financial resources and other

relevant circumstances. The issuer of your option contract should be

willing and able to explain the financial outcome of your option

contract under different market conditions. You should also be aware

that

[[Page 68018]]

this option is not issued by, guaranteed by, or traded on or subject

to the rules of a futures exchange. You may be able to obtain a

similar contract or execute a similar risk management strategy using

an instrument traded on a futures exchange which offers greater

regulatory and financial protections.

Costs and Fees Associated With an Option Contract

Before entering into an option contract, you should understand

all of the costs associated with it. These include the option

premium, commissions, fees, costs associated with delivery if the

option requires settlement by delivery upon its exercise and any

other charges which may be incurred. All of these costs and fees

must be specified in the terms of your option contract.

Know and Understand the Terms of the Option Contract

Before entering into an option contract, you should know and

understand all of the option contract's terms. All of the option

contract's terms should be included in the written contract, or for

a verbal agreement, in a written confirmation. You should receive a

signed copy of either the written contract or of the written

confirmation. Your option contract should include contract terms

setting:

(A) The total quantity of commodity underlying the option

contract;

(B) The strike price(s) of the option contract;

(C) The procedure for exercise of the option contract, including

when you can exercise and the latest time and date for exercise;

(D) Whether the option can be offset or canceled prior to

expiration;

(E) Whether settlement of the option is for cash or by delivery

of the commodity;

(F) If settlement is by delivery, the delivery location or

locations, the quality or grade of commodity to be delivered and how

adjustments to price for deviations from stated quality or grade are

determined;

(G) If settlement is by cash, the method for determining the

cash-settlement price; and

(H) The cost and method of payment.

Business Use of Trade Options

In order to comply with the law, you must be buying this option

for business-related purposes. The terms and structure of the

contracts must therefore relate to your activity or commitments in

the underlying cash market. Any amendments allowed to the option

contract or its cancellation or offset prior to its expiration date

must reflect changes in your activity, in your commitments in the

underlying cash market or in the carrying of inventory. Producers

are not permitted to enter into short call options unless the

producer also enters into a long put option contract for the same

amount or more of the commodity, at the same time and with the same

expiration date. Producers are not permitted to sell put options,

whether alone or in combination with a call option.

Dispute Resolution

If a dispute should arise under the terms of this trade option

contract, you have the right to choose to use the reparations

program run by the Commodity Futures Trading Commission or any other

dispute resolution forum provided to you under the terms of your

customer agreement or by law. For more information on the

Commission's Reparations Program contact: Office of Proceedings,

Commodity Futures Trading Commission, Three Lafayette Centre, 1155

21st Street, NW, Washington, DC 20581, (202) 418-5250.

Acknowledgment of Receipt

The Commodity Futures Trading Commission requires that all

customers receive and acknowledge receipt of this disclosure

statement. The Commodity Futures Trading Commission does not intend

this statement as a recommendation or endorsement of agricultural

trade options. These commodity options have not been approved or

disapproved by the Commodity Futures Trading Commission, nor has the

Commission passed upon the accuracy or adequacy of this disclosure

statement. Any representation to the contrary is a violation of the

Commodity Exchange Act and Federal regulations.

(ii) The following acknowledgment section:

I hereby acknowledge that I have received and understood this

summary risk disclosure statement.

----------------------------------------------------------------------

(Date)

----------------------------------------------------------------------

Signature of Customer

(8) An agricultural trade option merchant may not require a

customer to waive the right to seek reparations under section 14 of the

Act and part 12 of this chapter by an agreement or understanding to

submit a claim or grievance to a specified settlement procedure prior

to the time a claim or grievance arises. An agricultural trade option

merchant, when notifying a customer of its intent to submit a claim or

grievance to arbitration under a pre-existing agreement, must advise

the customer in writing that the customer within forty-five days may

elect to seek reparations under Section 14 of the Act and part 12 of

this chapter.

(b) Report of account information. Agricultural trade option

merchants must provide to customers with open positions the following

information:

(1) Within two business days of the offset, cancellation or

settlement of the option for cash, or of the amendment of the

expiration of the option, a statement of profit or loss on the

transaction and on the account;

(2) In response to a customer's request, current commodity price

quotes, all other information relevant to the customer's position or

account, and the amount of any funds owed by, or to, the customer

within one business day if responding orally and within two business

days if responding in writing;

(3) Written, verbal or electronic notice of the expiration date of

each option which will expire within the subsequent calendar month.

(c) Recordkeeping. Agricultural trade option merchants shall keep

full, complete and systematic books and records together with all

pertinent data and memoranda of or relating to agricultural trade

option transactions, covering transactions, and all written or

electronic customer solicitation materials. Agricultural trade option

merchants shall maintain such books and records as specified in

Sec. 1.31 of this chapter, and report to the Commission as provided for

in this paragraph (c) and paragraph (d) of this section and as the

Commission may otherwise require by rule, regulation, or order. Such

books and records shall be open at all times to inspection by any

representative of the Commission and the United States Department of

Justice.

(d) Reports. Agricultural trade option merchants must file annual

reports with the Commission at its Washington, DC, headquarters within

ninety days after the close of the agricultural trade option merchant's

fiscal year, in the form and manner specified by the Commission, which

shall contain the following information:

(1) By commodity and put, call or combined option

(i) Total number of new contracts entered into during the reporting

period;

(ii) Total quantity of commodity underlying new contracts entered

into during the reporting period;

(iii) Total number of contracts outstanding at the end of the

reporting period;

(iv) Total quantity of underlying commodity outstanding under

option contracts at the end of the reporting period;

(v) Total number of options exercised during the reporting period;

and

(vi) Total quantity of commodity underlying the options exercised

during the reporting period.

(2) Total number of customers by commodity with open option

contracts at the end of the reporting period.

(e) Special calls. Upon special call by the Commission for

information relating to agricultural trade options offered or sold on

the dates specified in the call, each agricultural trade option

merchant shall furnish to the Commission within the time specified the

following information as specified in the call:

(1) All positions and transactions in agricultural trade options,

including information on the identity of agricultural trade option

customers and on the value of premiums, fees, commissions, or charges

other than

[[Page 68019]]

option premiums, collected on such transactions.

(2) All related positions and transactions for future delivery or

options on contracts for future delivery or on physicals on all

contract markets.

(3) All related positions and transactions in cash commodities,

their products, and by-products.

(f) Internal controls. (1) Each agricultural trade option merchant

registered with the Commission shall prepare, maintain and preserve

information relating to its written policies, procedures, or systems

concerning the agricultural trade option merchant's internal controls

with respect to market risk, credit risk, and other risks created by

the agricultural trade option merchant's activities, including systems

and policies for supervising, monitoring, reporting and reviewing

trading activities in agricultural trade options; policies for hedging

or managing risk created by trading activities in agricultural trade

options, including a description of the types of reviews conducted to

monitor positions; and policies relating to restrictions or limitations

on trading activities.

(2) The financial statements of the agricultural trade option

merchant must on an annual basis be audited by a certified public

accountant in accordance with generally accepted auditing standards.

(3) The agricultural trade option merchant must file with the

Commission a copy of its certified financial statements within 90 days

after the close of the agricultural trade option merchant's fiscal

year.

(4) The agricultural trade option merchant must perform a

reconciliation of its books at least monthly.

(5) The agricultural trade option merchant:

(i) Must report immediately if its net worth falls below the level

prescribed in Sec. 3.13(d)(1)(i) of this chapter, and must report

within three days discovery of a material inadequacy in its financial

statements by an independent public accountant or any state or federal

agency performing an audit of its financial statements, such report to

be made to the Commission by facsimile, telegraphic or other similar

electronic notice; and

(ii) Within five business days after giving such notice, the

agricultural trade option merchant must file a written report with the

Commission stating what steps have been taken or are being taken to

correct the material inadequacy.

(6) If the agricultural trade option merchant's net worth falls

below the level prescribed in Sec. 3.13(d)(1)(i) of this chapter, it

must immediately cease offering or entering into new option

transactions and must notify customers having premiums which the

agricultural trade option merchant is holding under paragraph (a)(4) of

this section that such customers can obtain an immediate refund of that

premium amount, thereby closing the option position.

(g) Exemption.

(1) The provisions of Secs. 3.13, 32.2, 32.11 of this chapter and

this section shall not apply to a commodity option offered by a person

which has a reasonable basis to believe that:

(i) The option is offered to a producer, processor, or commercial

user of, or a merchant handling, the commodity which is the subject of

the commodity option transaction, or the products or byproducts

thereof;

(ii) Such producer, processor, commercial user or merchant is

offered or enters into the commodity option transaction solely for

purposes related to its business as such; and

(iii) Each party to the option contract has a net worth of not less

than $10 million or the party's obligations on the option are

guaranteed by a person which has a net worth of $10 million and has a

majority ownership interest in, is owned by, or is under common

ownership with, the party to the option.

(2) Provided, however, that Sec. 32.9 continues to apply to such

option transactions.

Issued this 29th day of November, 1999, in Washington, DC, by

the Commodity Futures Trading Commission.

Jean A. Webb,

Secretary of the Commission.

[FR Doc. 99-31453 Filed 12-3-99; 8:45 am]

BILLING CODE 6351-01-P