Access to Automated Boards of Trade

COMMODITY FUTURES TRADING COMMISSION

17 CFR Parts 1 and 30

Access to Automated Boards of Trade

AGENCY: Commodity Futures Trading Commission.

ACTION: Proposed rules.

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SUMMARY: On July 24, 1998, the Commodity Futures Trading Commission

(``CFTC'' or ``Commission'') published in the Federal Register a

``concept release'' seeking public comment on issues related to

permitting the use in the U.S. of automated trading systems providing

access to electronic boards of trade otherwise primarily operating

outside the U.S. Following its review of the comments received on the

concept release, the Commission has determined to propose new rules

concerning automated access to these boards of trade from within the

U.S. The Commission is proposing herein a new Rule 30.11 that would

establish a procedure for an electronic exchange operating primarily

outside the U.S. to petition the Commission for an order that would

permit use of automated trading systems that provide access to the

board of trade from within the U.S. without requiring the board of

trade to be designated as a U.S. contract market. If appropriate in

light of the information provided in a petition, the Commission would

issue an order under section 4(c) of the Commodity Exchange Act

(``Act'' or ``CEA'') that would allow a member of the petitioner board

of trade or an affiliate thereof to operate automated trading systems

that provide access to the board of trade in the U.S., subject to

specified conditions.

The Commission also is proposing a new Rule 1.71, which would apply

both to domestic and foreign firms. New Rule 1.71 would clarify that

U.S. customers and foreign futures and foreign options customers

wishing to trade on or subject to the rules of the automated trading

system of a U.S. contract market or on or subject to the rules of the

automated trading system of an exchange otherwise operating primarily

outside the U.S. may place orders via automated order routing systems,

provided that such systems meet certain minimum requirements and

provide certain safeguards such as automated checks for customer

trading or position limits and credit limits.

The rules proposed herein are focused on boards of trade with

automated order matching/execution, often referred to as ``electronic

exchanges,'' and do not address the use of order routing systems or

other communication devices that provide access to traditional open

outcry exchanges.

DATES: Comments must be received on or before April 23, 1999.

ADDRESSES: Comments on the proposed rules may be sent to Jean A. Webb,

Secretary of the Commission, Commodity Futures Trading Commission, 1155

21st Street, NW., Washington, DC 20581. In addition, comments may be

sent by facsimile transmission to facsimile number (202) 418-5521 or by

electronic mail to [email protected]. Reference should be made to

``Access to Automated Boards of Trade.''

FOR FURTHER INFORMATION CONTACT: David M. Battan, Chief Counsel,

Lawrence B. Patent, Associate Chief Counsel, or Charles T. O'Brien,

Attorney Advisor, Division of Trading and Markets, Commodity Futures

Trading Commission, 1155 21st Street, NW., Washington, DC 20581.

Telephone (202) 418-5450.

SUPPLEMENTARY INFORMATION:

I. Introduction

Significant developments in technology in recent years have made

automated trading methods a significant addition or alternative to

traditional open outcry for trading commodity futures and option

products on or subject to the rules of foreign and domestic boards of

trade. In February 1996, the Commission's Division of Trading and

Markets (``Division'') issued a no-action letter to the Deutsche

Terminborse (``DTB'' or ``Eurex''), \1\ an automated international

futures and option exchange headquartered in Frankfurt, Germany, in

which the Division agreed, subject to certain conditions, not to

recommend enforcement action to the Commission if Eurex placed computer

terminals in the U.S. offices of its members for principal trading \2\

and, where the Eurex member

[[Page 14160]]

is also an FCM registered under the Act,\3\ for trading on behalf of

U.S. customers as well, without Eurex being designated as a U.S.

contract market (``Letter'').\4\ Since the Division's issuance of the

Letter, several other boards of trade that have heretofore operated

outside the U.S. have requested similar relief.

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\1\ In June 1998, DTB changed its name to Eurex Deutschland

(``Eurex'').

\2\ A ``principal'' trade under Eurex rules is limited to a

trade made by a Eurex member for its own account. Eurex's definition

of ``principal'' is thus narrower than the definition of

``proprietary'' found in Commission Rule 1.3(y). A proprietary trade

under Commission rules includes not only transactions made by

futures commission merchants (``FCMs'') for their own accounts, but

also those made by certain affiliates and insiders of the FCM for

their respective accounts carried by the FCM.

\3\ 7 U.S.C. 1 et seq. (1994).

\4\ See CFTC Interpretative Letter No. 96-28, (1996-1997

Transfer Binder) Comm. Fut. L. Rep. (CCH) para. 26,669 (Feb. 29,

1996). For a thorough discussion of prior Division actions

concerning automated trading system use in the U.S., see the

Commission's concept release, discussed below. 63 FR 39779 (July 24,

1998).

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In light of these requests, the Commission determined that it is

appropriate to address, through the Commission's rulemaking process,

the subject of the use in the U.S. of automated trading systems that

provide access to boards of trade whose primary operations otherwise

take place outside the U.S. The Commission began this process in July

1998 by publishing in the Federal Register a concept release seeking

public comment on a wide variety of questions concerning the use of

automated trading systems in the U.S. and on a possible regulatory

structure to address these questions. After reviewing the comments

received and engaging in discussions with industry participants, the

Commission has decided to propose rules that incorporate many of the

general principles set forth for comment in the concept release.

However, based upon the comments received and the Commission's further

consideration of the issues, the proposal contains a number of

refinements to the model set forth in the concept release.

The Commission's purpose in issuing these proposed rules is to

create a framework for addressing the regulatory issues that arise from

the increasing globalization of futures exchanges. The procedures set

forth herein are intended to provide an exemption from the contract

market designation requirement for boards of trade that are established

in a foreign country and that have historically operated solely within

that countries other than the U.S., but that as a result of a desire to

take advantage of technological advancements, now wish to make their

products accessible from within the U.S. via trading screens, the

Internet, or other automated trading systems. Boards of trade that are

accessible within the U.S. in this manner are not ``located outside the

U.S.'' for purposes of section 4(a) of the Act and might, accordingly,

be required to be designated as contract markets absent an exemption

under Section 4(c) of the Act.\5\ However, the Commission does not

believe that it would be appropriate to require these exchanges to be

designated as contract markets as long as they would be subject to

generally comparable regulation in their home countries. Exemption from

the contract market designation requirement and other related

requirements under the Act and Commission regulations would avoid

duplicative regulation, would encourage other countries to allow access

to the automated trading systems of U.S. exchanges and would encourage

global competition and open markets in the industry. The Commission

believes that the petition approach set forth below would provide the

Commission with the information necessary to identify those boards of

trade that would be ``located in the U.S.'' by virtue of being

accessible from within the U.S. via automated trading systems, but that

otherwise would continue to be primarily operated outside the U.S. The

Commission would exercise its power under section 4(c) of the Act to

exempt such boards of trade from regulation under the Act if the

requirements described below are satisfied. Further, the process

described herein is flexible enough that, if the locus of the board of

trade's activities is such that it should be subject to all

requirements of the Act and the Commission's regulations, if the board

of trade is not subject to a generally comparable regulatory structure,

or if the board of trade has been established and structured

purposefully to evade U.S. regulation, the Commission can require it to

become a designated contract market.

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\5\ Section 4(a) of the Act states in relevant part:

* * *[I]t shall be unlawful for any person to offer to enter

into, to enter into, to execute, to confirm the execution of, or to

conduct any office or business anywhere in the U.S., its territories

or possessions, for the purpose of soliciting, or accepting any

order for, or otherwise dealing in, any transaction in, or in

connection with a contract for the purchase or sale of a commodity

for future delivery (other than a contract which is made on or

subject to the rules of a board of trade, exchange, or market

located outside the U.S., its territories or possessions) unless--

(1) such transaction is conducted on or subject to the rules of

a board of trade which has been designated by the Commission as a

``contract market'' for such commodity;

(2) such contract is executed or consummated by or through a

member of such contract market; and

(3) such contract is evidenced by a record in writing * * *.

Section 4(c) of the Act provides the Commission with authority

``by rule, regulation, or order'' to exempt ``any agreement,

contract or transaction'' from the requirements of Section 4(a) of

the act if the Commission determines that the exemption would be

consistent with the public interest, that the contracts would be

entered into solely by appropriate persons and that the exemption

would not have a material adverse effect on the ability of the

Commission or any contract market to discharge its regulatory or

self-regulatory duties under the Act. 7 U.S.C. 6(a) and 6(c) (1994).

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In determining whether to exercise its section 4(c) exemptive

authority with respect to a particular petitioner, the Commission

believes that it is essential to its customer protection obligations

under the Act to ensure that certain general standards have been met.

Specifically, the Commission intends to ensure that: (1) The petitioner

is an established board of trade that wishes to place within the United

States an automated trading system permitting access to its products

but whose activities are otherwise primarily located in a particular

foreign country that has taken responsibility for regulation of the

petitioner; (2) the petitioner's home country has established a

regulatory scheme that is generally comparable to that in the U.S. and

provides basic protections for customers trading on markets and for the

integrity of the markets themselves; (3) except for certain incidental

contacts with the U.S., the petitioner is present in the U.S. only by

virtue of being accessible from within the U.S. via its automated

trading system; (4) the petitioner is willing to submit itself to the

jurisdiction of the Commission and the U.S. courts in connection with

its activities conducted under an exemptive order; (5) the petitioner's

automated trading system has been approved by the petitioner's home

country regulatory following a review of the system that applied the

standards set forth in the 1990 International Organisation of

Securities Commissions (``IOSCO'') report on screen-based trading

systems (as may be revised and updated from time-to-time) or

substantially similar standards; and (6) satisfactory information

sharing arrangements are in effect between the Commission and the

petitioner and the petitioner's regulatory authority. As discussed

further in the description of the petition procedure below, a

petitioner which satisfies these standards may be issued an order under

section 4(c) of the Act that exempts the petitioner from the contract

market designation requirements of section 4(a) of the Act and related

statutory and regulatory provisions.

II. The Concept Release

The July 1998 concept release raised general questions concerning,

among other things, how to define an

[[Page 14161]]

automated system that would be subject to Commission rules, how to

treat the use of automated order routing systems located in the U.S.

when they are employed to enter orders through a futures commission

merchant (``FCM'') (or through a firm exempt from registration pursuant

to Commission Rule 30.10, also referred to as a ``Rule 30.10 firm'')

\6\ for execution on a board of trade operated primarily outside the

U.S., and how to determine if a board of trade's activities in the U.S.

are such that it should be subject to all of the requirements of the

Act and the Commission's regulations. The concept release also set

forth for comment a possible regulatory approach that was intended to

promote discussion on the appropriate means to resolve these and

related issues.

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\6\ Commission Rule 30.10 provides for a process whereby any

person affected by any requirement in the Commission's part 30 rules

may petition the Commission for an exemption from such requirement.

Appendix A to the part 30 rules provides an interpretative statement

that clarifies that a foreign regulator or self-regulatory

organization (``SRO'') can petition the Commission under Rule 30.10

for an order to permit firms that are members of the SRO and subject

to regulation by the foreign regulator to conduct business from

locations outside the U.S. for U.S. persons on non-U.S. boards of

trade without registering under the Act--based upon substituted

compliance with a foreign regulatory structure found comparable to

that administered by the Commission under the Act. In considering a

request from a foreign regulatory or self-regulatory authority for

Rule 30.10 comparability relief, the Commission considers, among

other things: (1) Registration, authorization or other form of

licensing, fitness review, or qualification of persons through whom

customer orders are solicited and accepted; (2) minimum financial

requirements for those persons that accept customer funds; (3)

minimum sales practice standards, including disclosure of risks and

the risk of transactions undertaken outside of the United States;

(4) procedures for auditing compliance with the requirements of the

regulatory program, including recordkeeping and reporting

requirements; (5) protection of customer funds from misapplication;

and (6) the existence of appropriate information-sharing agreements.

The Commission has issued orders to permit certain foreign firms

that have comparability relief under Rule 30.10 to engage in limited

marketing activities of foreign futures and option products from

locations within the United States. See orders of October 28, 1992,

57 FR 49644 (Nov. 3, 1992), and August 4, 1994, 59 FR 42156 (Aug.

17, 1994).

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The Commission initially provided a 60-day comment period on the

concept release, through September 22, 1998. On September 18, 1998, the

Commission extended the comment period for fifteen days, through

October 7, 1998. The Commission received 31 comments on the release: 19

from futures exchanges, three from FCMs, two from futures trade

associations, two from commodity trading advisors (one of which is also

a registered commodity pool operator), one from a futures self-

regulatory authority, one from an exchange member and three from

foreign securities/futures regulatory authorities. In addition, the

Commission was aided significantly in the development of these proposed

rules by the work of the Commission's Global Markets Advisory Committee

which held two public meetings on these issues, as well as the

Committee's Working Group on Electronic Terminals which prepared a

report for the Commission on these issues. The Commission's Financial

Products Advisory Committee also held a public meeting at which these

issues were discussed.

In general, most commenters supported the Commission's effort to

develop uniform rules concerning the use from within the U.S. of

automated trading systems that provide access to boards of trade

operated primarily outside the U.S. For example, Her Majesty's (``HM'')

Treasury, the regulator that is authorized to grant foreign exchanges

the right to have their automated trading systems placed in the U.K.\7\

indicated in its comment letter that the approach set forth in the

concept release is similar to that applied by HM Treasury when

processing similar requests in the U.K. Other commenters, however, took

issue with various aspects of the possible regulatory approach set

forth in the concept release. Certain specific comments concerning the

approach set forth in the concept release and the issues related

thereto are discussed in the description of the proposed rules which

follows.

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\7\ Specifically, HM Treasury is authorized to grant a foreign

exchange status as a ``recognized overseas investment exchange''

(``ROIE'') and to monitor ROIEs operating in the U.K. through

automated trading systems placed in the U.K. HM Treasury's

responsibilities with respect to ROIEs are to be transferred to the

Financial Services Authority (``FSA'') with the enactment of the

Financial Services and Markets Bill, which is anticipated to take

place some time toward the end of 1999.

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The Commission believes that the rules proposed herein will

establish a regulatory approach that addresses the important issues

presented by the use of automated trading systems in the U.S. by boards

of trade otherwise operated primarily outside the U.S. in a manner that

will foster growth of the global marketplace while fulfilling the

Commission's obligations under the Act to protect U.S. customers and to

maintain the integrity and competitiveness of U.S. markets. The

Commission looks forward to the comments on the proposed rules herein

and will consider such comments carefully in adopting any final rules.

III. The Proposed Rules

A. Definitions

Proposed Rules 30.11(a) (1) and (2) distinguish between two major

types of automated trading systems and establish two mutually exclusive

definitions, ``direct execution system'' (``DES'') and ``automated

order routing system'' (``AORS''). As explained more fully below, DES

is a term that encompasses any system that allows entry of orders from

within the U.S. for an automated board of trade, except those systems

that satisfy the definition of AORS. AORSs generally are systems on

which customers or their representatives would submit orders through an

FMC or rule 30.10 firm for automated execution, although the definition

covers every system on which an order is transmitted to another party

and then transmitted to an automated board of trade. It should be noted

that the definitions of DES and AORS, and these rules generally, only

apply in the context of automated or ``electronic'' boards of trade

where orders are matched and executed at the board of trade without

substantial human intervention. Order routing or other devices that are

used to enter or to communicate trades to be executed on traditional

open outcry exchanges are not within the ambit of these rules.\8\ If

one exchange organization operates both an electronic exchange and an

open outcry exchange, the proposed rules would apply to the former but

not to the latter. The Commission wishes to emphasize that the

definitions of DES and AORS are structured so that every device, system

or software upon which orders for products traded on boards of trade

can be entered from within the U.S. for any electronic exchange would

fall into one or the other category.\9\

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\8\ The definitions of DES and AORS apply to systems that access

boards of trade where trade execution takes place ``without

substantial human intervention.'' See proposed Rules 30.11(a)(1) and

1.3(tt) (emphasis added). The word ``substantial'' is included to

make clear that an automated or electronic exchange cannot evade the

application of these rules by inserting clerical or trivial human

action into the trade matching/execution process. Execution on

traditional open outcry exchanges involves substantial human

intervention and, as noted above, is beyond the scope of these

rules.

\9\ A determination as to whether a system is a DES or an AORS

is not dependent on who designs, maintains or provides the system.

That a particular system implementation uses third-party hardware,

networks or services will not prevent it from being a DES or AORS.

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It should be noted further that, while those rules provide

standards for exemptive relief to certain boards of trade with respect

to their exchange-traded products, these rules do not sanction the

trading of off-exchange products, nor do they alter, restrict or

[[Page 14162]]

expand the coverage of existing Commission exemptions for particular

classes of products. For example, an illegal off-exchange futures

product that is traded in violation of the Act may not lawfully be

traded via an AORS, even if such AORS satisfies the requirements of the

proposed rules. Likewise, a product that has been exempted from

relevant provisions of the Act need not satisfy the requirements of

these rules unless the Commission rule or order exempting the product

so indicates.\10\

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\10\ For example, the Commission could decide in the future that

a particular class of products should be exempt from some Commission

regulations, but that, to the extent such class of products will be

traded through automated trading systems, these proposed rules

should apply.

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Paragraph (a)(1) of proposed Rule 30.11 defines a DES as any system

of computers, software or other devices that allows the entry of orders

for products traded on a board of trade's computer or other automated

device where, without substantial human intervention, trade matching or

execution takes place. One common example of a DES is a board of

trade's proprietary computer terminal (e.g., a dedicated Eurex computer

terminal where members place orders that are then executed in the

exchange's matching system). However, the term DES would also include

any other device that currently is being used or may be used in the

future to provide access to a board of trade's automated matching

engine. Such devices might include, for example, computer software that

facilitates access via a personal computer or other electronic device,

an automated telephonic system that is connected, or can be used to

connect, to the main computer of a board of trade primarily operated

outside the U.S. for order matching and execution, and direct Internet

access to such a board of trade through a personal computer, telephone

or similar device. Thus, for example, if a board of trade that is

otherwise primarily operated outside the U.S. were to provide its

members in the U.S. with personal identification numbers or passwords

that permitted such members to access and to place orders on the board

of trade via an automated telephone system or Internet connection, the

board of trade would be covered by the proposed rules.

Paragraph (a)(2) of proposed Rule 30.11 defines AORS. This term is

defined by reference to a definition that is being proposed herein to

be added as new Rule 1.3(tt).\11\ Proposed rule 1.3(tt) in turn would

define an AORS as any system of computers, software or other devices

that allows entry of orders through another party for transmission to a

board of trade's computer or other automated device where, without

substantial human intervenion, trade matching or execution takes place.

The Commission anticipates that the most common form of an AORS will be

computer software that is provided by an FCM (or Rule 30.10 firm) to

customers, foreign futures and options customers, or their

representatives such as CTAs to enter orders on a board of trade or on

several boards of trade. This rule is intended to cover an AORS used by

any person for trading on a designated contract market's automated

system, whether the person, his or her representative or the AORS is

located in the U.S. or outside of the U.S. The AORS in these

circumstances must provide for trading through an FCM. The rule also is

intended to cover trading by a person located in the U.S. on a board of

trade that otherwise primarily is operated outside the U.S. and that

has received a Commission exemptive order under these rules or whose

products are accessible as part of an automated trading system pursuant

to rules of a designated contract market that have been submitted to

the Commission and are in effect pursuant to section 5a(a)(12)(A) of

the Act and Rule 1.41 (hereinafter referred to as a ``linked

exchange''). The AORS in the latter circumstances must provide for

trading through an FCM or a Rule 30.10 firm.

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\11\ Since this term and the requirements applicable thereto

would, as recommended by some commenters, apply uniformly and not

only to boards of trade primarily operated outside the U.S., the

Commission is proposing to define AORS in a new paragraph (tt) of

Commission Rule 1.3, which contains the Commission's general

definitions.

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Rule 30.10 firms may not solicit or accept orders from U.S. persons

for trading on designated contract markets, and these proposed rules

are not intended to affect that prohibition. Under these rules,

however, Rule 30.10 firms would be authorized to solicit or accept

orders from U.S. customers for products traded on automated boards of

trade that obtain a Commission order under these rules or products

traded on linked exchanges. To this end, the Commission is proposing

Rule 30.11(g), which would deem products traded on a board of trade

that received a Commission order or on a linked exchange to be foreign

futures or foreign options, notwithstanding the board of trade's or

linked exchange's presence in the U.S.\12\ Further, these rules would

not expand the boards of trade for which a Rule 30.10 firm may solicit

or accept orders beyond those provided in the relevant Commission order

issued under rule 30.10 and any confirmation thereof for a particular

firm. Thus, if the Commission's order issued under Rule 30.10 permits a

firm to solicit or accept orders for products traded on boards of trade

in its home country and Countries B and C (but not Country D), the

restriction on soliciting or accepting orders for products traded on a

board of trade in Country D would remain in effect even if the Country

D board of trade were to obtain a section 4(c) exemption order in

accordance with Rule 30.11.

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\12\ Consistent with current regulations regarding linked

exchanges, Rule 30.10 firms could handle U.S. customer orders for

products traded on the linked exchange but not for products traded

on the designated contract market to which that exchange is linked.

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The proposed rules would not permit customer use of DESs; however,

they would allow customers and their representatives to obtain AORSs

and to enter orders via those AORSs. Under the proposal, a customer

order for a contract traded on or subject to the rules of an exempted

board of trade under proposed Rule 30.11 or a linked exchange that is

made via an AORS would be required to be made through a registered FCM

or through a Rule 30.10 firm.

The Commission requested comment as to whether it should consider

imposing any requirements that would enable it to ensure that board of

trade members who would have DESs are bona fide members (i.e. to ensure

that petitioning boards of trade do not create membership categories

that do not meaningfully differentiate between traditional ``members''

and ``customers'').\13\ In response to this request, one commenter

suggested that the Commission should require information concerning a

board of trade's membership standards and closely examine those

standards to ensure that they are meaningful. Another commenter stated,

among other things, that the Commission should not impose formal limits

on exchange membership qualifications and that no limitations should be

imposed as long as a board of trade primarily operated outside the U.S.

does not have special membership categories (i.e., as long as all

members have the same rights and obligations).

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\13\ 63 FR at 39787.

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The Commission has determined to require that petitioners under the

proposed rule provide information concerning their membership rules and

classes. The information should include any financial requirements

(e.g., net worth requirements and fees for

[[Page 14163]]

membership) as well as any experience or professional requirements or

certifications established by the board of trade. The Commission's

proposed rules require that, for customer protection purposes, the

trades of U.S. customers on automated trading systems must be

intermediated by an FCM or by a Rule 30.10 firm. Accordingly, the

Commission wishes to ensure that access to DESs is limited to commodity

professionals and large sophisticated users trading their proprietary

accounts. The Commission would review the information received

concerning a petitioner's membership requirements with a view toward

ensuring that the petitioner's membership criteria did not provide a

means for avoidance of intermediation for U.S. retail investors. In the

event that the commission concluded form the information received that

U.S. retail customers could be ``members'' under a particular

petitioner's rules and could, therefore, have access to DESs if the

Commission were to issue a section 4(c) exemption order to the

petitioner, the Commission could refuse to issue such an order or could

condition its order accordingly. In the latter regard, the Commission

could take into account relevant market structures and financial

protections and controls that potentially could serve the same customer

protection objectives as professional intermediation.

As technology continues to evolve, the available means to provide

direct access from within the U.S. to boards of trade otherwise

primarily operating outside the U.S. undoubtedly will further develop.

By using broad definitions, the Commission hopes to creates a

regulatory approach that provides a flexible means to incorporate the

changing nature of technology. The Commission has no desire to dictate

particular technology choices to market participants, nor does it wish

to restrict innovation, and these rules were crafted accordingly.

B. The Petition Procedure

The Commission's proposal would establish a uniform procedure to

enable a board of trade that primarily is operating outside the U.S. to

request a Commission order that would permit access, via DESs or AORSs,

to the board of trade's products from within the U.S. without requiring

the board of trade to be designated as a U.S. contract market. The

Commission wishes to emphasize that the proposed rules would not alter

a board of trade's obligations to: (a) Receive a no-action position

from the Commission prior to authorizing the offer or sale of any stock

index futures or options contracts in the U.S. or (b) have any foreign

government debt obligation first designated as an ``exempt security''

by the Securities and Exchange Commission (``SEC'') before authorizing

the offer or sale of any futures contract or option thereon in the U.S.

The approach set forth for discussion in the concept release

envisioned a two-step procedure. Under this approach, a board of trade

that primarily is operated outside the U.S. would first petition the

Commission for an order that would permit the use of automated trading

systems in the U.S. to facilitate trading of the board of trade's

products without requiring the board of trade to receive U.S. contract

market designation. Next, if the Commission issued an exemptive order

to a particular board of trade, a member of that board of trade or an

affiliate thereof would be able to make a written request to the

National Futures Association (``NFA'') for confirmation to operate

under the order.\14\

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\14\ 62 FR 47792, 47795 (Sept. 11, 1997)

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The concept of a confirmation process was derived from the

procedure currently required of Eurex members for their compliance with

the Letter. Pursuant to this procedure, if a Eurex member located in

the U.S. wishes to install a Eurex terminal in its office, Eurex must

make a written filing to the NFA on behalf of that member, including

certain information and declarations.

The potential approach set forth in the concept release suggested

the possibility of codifying confirmation process similar to that from

the Eurex Letter. Although the Commission received few comments

regarding the confirmation process, upon reconsideration of this

procedure the Commission has determined that such a process is

unnecessary. A a simpler alter-native to this procedure, the proposed

rules would require only that, as a condition to any section 4(c)

exemption order, a board of trade primarily operating outside the U.S.

must maintain and provide to the Commission's on a quarterly basis, and

at any other time upon request of a Commission representative, a

current list that includes (1) the names and main business addresses in

the U.S. of its members and affiliates thereof that have DESs in the

U.S. indicating which of such persons allow their customers to use

AORSs, and (2) the names and main business addresses of its members and

affiliates thereof that allow their U.S. customers to use AORSs but who

do not have DESs in the U.S.\15\ Thus, under the proposed rules, after

the Commission issues an exemption order,\16\ any member, or affiliate

thereof,\17\ of the petitioner may take advantage of the Commission's

order immediately.\18\ Additionally, as discussed below in Section III.

B. 3. concerning the use of AORSs, after the Commission issues an order

under these rules, any FCM or Rule 30.10 firm may provide U.S.

customers with AORSs that provide access to the products of the board

of trade that received the Commission order provided that the AORS

meets certain minimal requirements and contains certain safeguards.\19\

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\15\ See proposed Rule 30.11(d)(3)(iii).

\16\ Proposed Rule 30.3(c) makes clear that a board of trade

that primarily operates outside the U.S. that is accessible from a

DES in the U.S. must be designated as a U.S. contract market unless

it has received a section 4(c) exemption order under Rule 30.11. The

Commission believes that this rule is necessary to ensure its

ability to enforce proposed Rule 30.11 adequately.

\17\ Proposed Rule 30.11(a)(3) defines an affiliate of a board

of trade member for purposes of the rule as: (1) A person that owns

50% or more of a member (e.g., a board of trade member's parent

company with an ownership interest in the board of trade member of

50% or more); (2) a person owned 50% or more by a member (e.g., a

board of trade member's 50%-or-more-owned subsidiary); or (3) a

person that is owned by a third person that also owns 50% or more of

a member (e.g., a member's sister company where both the member and

the sister company are owned 50% or more by a third person).

\18\ Because any person who solicits or accepts orders and funds

related thereto from U.S. customers for trading pursuant to a

Commission order under Rule 30.11 must be registered as an FCM or

operate pursuant to an order of exemption under Rule 30.10, the

Commission would have appropriate means to discipline such a person

for any violation of the Act or rules thereunder relating to the

operation of board of trade DESs or AORSs in the U.S.

\19\ Proposed Rule 30.3(d) would provide that, except as

provided in Rule 30.11, it shall be unlawful for any person to

solicit or accept orders for, or to accept money, securities or

property in connection with the purchase or sale of, foreign futures

or foreign options by a foreign futures or options customer that are

placed via an AORS (as defined in proposed Rule 30.11(a)(2) by

reference to proposed Rule 1.3(tt)) unless the board of trade

through which the transaction will be executed has been designated

as a contract market under section 5 of the Act. As noted above

proposed Rule 30.11 is not intended to allow Rule 30.10 firms to

solicit or to accept orders from U.S. customers to be placed on a

U.S. contract Market. To obviate any limitations on the use of AORS

by Rule 30.10 firms, Rule 30.11(g) would deem products traded on a

board of trade that received a Commission order under Rule 30.11 to

be foreign futures or foreign options.

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This release is not intended to alter Commission Rule 30.4 that

requires, generally, that a foreign firm be a registered FCM or a Rule

30.10 firm if it solicits or accepts orders for or involving any

foreign futures contract or foreign options transaction and, in

connection therewith, accepts money, securities or property to margin,

guarantee or secure any trades or contracts that result therefrom

[[Page 14164]]

(including where the U.S. person is a nonclearing member of an exempt

board of trade trading solely for its own account).\20\ The Commission

also wishes to make clear that the Commission's issuance of a Rule

30.11 order would not affect the Commission's ability to bring

appropriate actions for fraud or manipulation, nor would it alter the

obligations of the board of trade that received the order, its members,

FCMs or any other persons under applicable provisions of the Act or the

Commission's regulations, except as specifically provided in these

rules or in a section 4(c) exemption order. For example, an FCM who

solicits or accepts orders from U.S. customers for trading on a board

of trade exempted under proposed Rule 30.11 or on a linked exchange

would remain responsible for complying with the risk disclosure

requirements set forth in Rule 30.6 regarding, among other things, the

risks associated with trading foreign futures or foreign options

contracts.\21\

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\20\ Commission staff have interpreted this rule to provide an

exception if (1) the foreign firm is either a member of the relevant

board of trade or is a foreign affiliate of a registered FCM and its

sole contact with a U.S. customer is that it carries the FCM's

customer omnibus account or (2) the foreign firm solely carries

accounts on behalf of U.S. customers that are proprietary accounts

(as defined in Rule 1.3(y)) of the foreign firm. See CFTC

Interpretative Letter No. 87-7, Comm. Fut. L. Rep. (CCH)

para.23,972, (Nov. 17, 1987), and CFTC Interpretative Letter No. 88-

15, Comm. Fut. L. Rep. (CCH) para.24,296 (August 10, 1998).

\21\ Rule 30.6 refers to Rule 1.55 which requires, among other

things, that an FCM provide a risk disclosure statement to each of

its customers that provides certain disclosures regarding the risks

associated with trading in commodity futures contracts. Paragraphs

(b) (7) and (8) of Rule 1.55 contain required language specifically

related to risks concerning trading in foreign futures and foreign

options. In particular, paragraph (b)(7) requires disclosure that,

because ``[n]o domestic organization regulates the activities of a

foreign exchange . . .'', customers who trade on these exchanges may

not be afforded the same protections (e.g., protections regarding

the safety of margin funds) that may apply to domestic transactions.

Rules 4.24 and 4.34 require similar risk disclosure language to be

provided by commodity pool operators and commodity trading advisors

to their customers if the offered pool may trade in foreign futures

or foreign options contracts or the offered trading program permits

the trading of foreign futures or foreign option. See also Rule

30.6, as proposed to be amended by 64 FR 1566 (Jan. 11, 1999).

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1. Application Procedure

Paragraph (b) of proposed Rule 30.11 establishes the petition

procedure discussed above, whereby a board of trade may petition the

Commission for an exemption order under section 4(c) of the Act. Such

an order would enable DESs or AORSs that provide access to the board of

trade's products to be used in the U.S. without requiring the board of

trade to be designated as a contract market.

The approach set forth in the concept release requested comments on

six general categories of information that could be included in a

petition by a board of trade: (1) General information concerning the

petitioner and its products; (2) information concerning the

petitioner's rules and regulations, the laws and regulations in effect

in the petitioner's home country, and the methods for monitoring

compliance therewith; (3) information related to the board of trade's

technological system and standards; (4) financial and accounting

information; (5) information concerning the ability of U.S. contract

markets to operate in the petitioner's home country; and (6)

information concerning the petitioner's U.S. activities and presence.

The concept release suggested that this information would be used to

determine whether a board of trade that is subject to regulation by a

foreign regulator and whose primary locus of operations is aboard

should be exempt from contract market designation requirements if it

places automated trading systems in the U.S. accessing such board of

trade.

Commenters generally agreed that the Commission has a legitimate

regulatory interest in examining automated boards of trade that are

primarily operated abroad, but that nonetheless wish to have a presence

in the U.S. by becoming accessible from within the U.S. via computer

screens or other automated trading systems. However, some commenters

took issue with certain of the specific information included in the

categories above, generally based upon concerns regarding the

information's relevance or based upon concerns that collection of the

information would be unnecessarily duplicative or burdensome. In light

of the comments received and the Commissions's own assessment of the

information that it believes would be necessary in reviewing a board of

trade's petition, the proposed rules provide for a modified set of

information that would be required in a petition. Additionally, the

proposed rules contain certain provisions that are intended to

eliminate the filing of duplicative information.

a. General Approach

At the outset, the Commission wishes to reiterate its general view

that it supports technological innovation and does not wish to make it

unduly burdensome for U.S. customers to access global future and option

markets. The Commission does believe, however, that in order to make

the determinations required before it can issue an order under section

4(c) of the Act concerning the public interest, customer protection and

its ability to discharge its regulatory duties, the Commission has an

obligation to obtain and to review certain basic information. This

basic information relates to, among other things, a board of trade's

regulatory structure, its automated trading systems, and the extent of

its contacts and operations in the U.S. Likewise, in an era where fully

computerized exchanges are becoming common, the Commission has an

interest in ensuring that operators of these exchanges are not using

developments in technology and global communications to evade U.S.

regulatory requirements.

Generally, as noted above, section 4(a) of the Act requires that

futures and option contracts offered or sold in the U.S. be: (1) Traded

on or subject to the rules of a designated contract market; (2)

executed or consummated by or through a member of such contract market;

and (3) evidenced by a written record that includes the date, the

parties and their addresses, the property covered and its price, and

the delivery terms. An exception from these requirements is provided

for contracts that are made on or subject to the rules of a board of

trade located outside of the U.S. or for which the Commission has

granted an exemption from the section 4(a) requirements pursuant to

section 4(c) of the Act. The Commission believes that, if contracts of

a board of trade otherwise primarily operated outside of the U.S. are

accessible from within the U.S. via a DES or an AORS, the board of

trade is no longer ``located outside of the U.S.'' for purposes of

section 4(a) of the Act. The Commission also believes, however, that

regulating boards of trade that satisfy the requirements set forth

below would be largely duplicative of their home country regulations

and unnecessary. Thus, the Commission proposes to establish an

exemption process.

Proposed Rule 30.11 would establish a framework for the

consideration of petitions for exemption pursuant to section 4(c) of

the Act for boards of trade otherwise primarily located outside of the

U.S. section 4(c) of the Act requires the Commission to make certain

determinations prior to granting an exemption thereunder. In the

context of a petition under Rule 30.11, the Commission would be

required to determine that: (1) The requirements of Section 4(a) of the

Act should not apply to the contracts for which the exemption is

requested and the exemption would be consistent with the public

interest and the purposes of the Act; (2) the

[[Page 14165]]

contracts will be entered into solely between appropriate persons; and

(3) the contracts will not have a material adverse effect on the

ability of the Commission or any contract market to discharge its

regulatory or self-regulatory duties under the Act. As noted above, the

standards that will guide the Commission in determining whether a

petitioner meets the requirements under section 4(c) of the Act are

that: (1) The petitioner is an established board of trade that wishes

to place within the United States an automated trading system

permitting access to its products but whose activities are otherwise

primarily located in a particular foreign country that has taken

responsibility for regulation of the petitioner; (2) the petitioner's

home country has established a regulatory scheme that is generally

comparable to that in the U.S. and provides basic protections for

customers trading on markets and for the integrity of the markets

themselves; (3) except for certain incidental contacts with the U.S.

the petitioner is present in the U.S. only by virtue of being

accessible from within the U.S. via its automated trading system; (4)

the petitioner is willing to submit itself to the jurisdiction of the

Commission and the U.S. courts in connection with its activities

conducted under an exemptive order; (5) the petitioner's automated

trading system has been approved by the petitioner's home country

regulator following a review of the system that applied the standards

set forth in the 1990 International Organization of Securities

Commissions (``IOSCO'') report on screen-based trading systems (as may

be revised and updated from time-to-time) or substantially similar

standards; and (6) satisfactory information sharing arrangements are in

effect between the Commission and the petitioner and petitioner's

regulatory authority.

b. Statutory Standards for Exemptive Relief under Section 4(c)

As noted above, section 4(c) of the act provides the Commission

with authority ``by rule, regulation or order'' to exempt ``any

agreement, contract or transaction'' from any of the requirements of

section 4(a) of the Act, if the Commission determines that the

exemption would be consistent with the public interest and that the

contracts would be entered into solely by appropriate persons and would

not have a material adverse effect on the ability of the Commission or

any contract market to discharge its regulatory or self-regulatory

duties under the Act.

As discussed more fully below, the Commission has crafted standards

to apply in evaluating exemptive petitions under the proposed rules

that will enable it to make the requisite findings under section 4(c)

if appropriate. If a petitioner is subject to a regulatory structure in

its home jurisdiction that the Commission finds to be generally

comparable to that in the U.S. in terms of protecting customers and the

integrity of markets, as well as meeting IOSCO standards or similar

standards for screen-based trading, and finds that the regulator in

that other jurisdiction monitors and enforces compliance with that

regulatory structure, the Commission appropriately can determine that

automated trading by U.S. customers pursuant to that foreign regulatory

structure is consistent with the public interest and the purposes of

that Act. the Commission appropriately could permit anyone who can

participate in contract market transactions to be deemed to be an

``appropriate person'' for such automated trading and thus to be

eligible to participate in the petitioner's markets. Further, the

various provisions that the Commission would establish under Rule 30.11

with regard to information sharing arrangements (access to books and

records, notice of enforcement or disciplinary actions and notice of

default, insolvency or bankruptcy), the petitioner's appointment of an

agent for service of process and consent to U.S. jurisdiction, the

Commission's retention of antifraud authority concerning these

transactions, as well as the limitations on the petitioner's U.S.

presence to DESs or AORSs that provide access to its products and

incidental U.S. contacts, would provide a basis for the Commission to

determine that granting the petition would not have a material adverse

effect on the ability of the Commission or any contract market to

discharge its regulatory duties under the Act. A more detailed

description of the requirements for a petition follows.

c. Foreign Regulatory Requirements

The Commission believes that the establishment of automate trading

systems in the U.S. that provide rapid and proximate access to boards

of trade otherwise primarily located outside the U.S. will cause a

fundamental change in the nature of global trading and raise

substantial issues regarding the regulation of increasingly

international or multinational exchanges. Thus, the Commission believes

that one essential factor in determining whether an automated board of

trade that wishes to establish trading systems in the U.S. should be

exempt from contract market designation is whether such board of trade

is subject to a bona fide regulatory system i.e., a structure that is

generally comparable to that in the U.S. in terms of customer

protections and market integrity and that is adequately monitored and

supervised by a foreign futures authority.

To assist the Commission in making the required determinations

under Section 4(c) of the Act and the judgments concerning the general

standards set forth above, the Commission is proposing that a

petitioners submit certain information. With respect to whether the

petitioner is an established board of trade primarily operating outside

the U.S., the petitioners would be required to include the following

basic business information: (1) The address of the petitioner's main

business office and the name, address, telephone number, facsimile

number and electronic mail address of a person to contact for

additional information concerning the petition; (2) the petitioner's

articles of association, constitution, or other similar organizational

documents along with the date and place of its establishment; (3) the

name and address of the petitioner's home country regulatory; and (4) a

complete description of the contracts that initially would be traded

through DESs and/or AORSs located in the U.S.\22\

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\22\ Proposed Rule 30.11(b)(2)(i)-(iii).

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In order for a petitioner to be eligible for an exemption,

petitioner's home country regulatory regime should be generally

comparable to that in the U.S. in providing for: (A) Prohibition of

fraud, abuse and market manipulation relating to trading on the

petitioner's markets; (B) recordkeeping and reporting by the

petitioners and its members; (C) fitness standards for intermediaries

operating on petitioner's markets, members or others; (D) financial

standards for the petitioner's members; (E) protection of customer

funds, including procedures in the event of a clearing member's default

or insolvency; (F) trade practice standards; (G) rule review or general

review of board of trade operations by its regulatory authority; (H)

surveillance, compliance, and enforcement mechanisms employed by the

board of trade and its regulatory authority to ensure compliance with

their rules and regulations; and (I) regulatory oversight of clearing

facilities.\23\ Information concerning the petitioner's rules,

including its membership rules, the laws and regulations of the home

[[Page 14166]]

country applicable to the petitions and its operations, and the

mechanisms available for ensuring compliance with all such rules, laws

and regulations should be provided in the petition. The Commission

would review such information in order to determine whether it is

consistent with the public interest, customer protection and its

ability to discharge its regulatory duties to issue an order under

section 4(c) of the Act to permit U.S. customer access to petitioner's

products from automated systems within the U.S.

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\23\ Proposed Rule 30.11(b)(2)(iv)-(vi).

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In response to the Commission's request for comment concerning ways

to avoid the filing of unnecessarily duplicative information with the

Commission, several commenters argued that, if a petitioner or its

regulator has received an exemption from the Commission pursuant to

Commission Rule 30.10, the petitioner should not be required to submit

duplicative information to the Commission. The Commission agrees that,

if a petitioner or a regulatory authority that governs the petitioner

has received an exemption under Rule 30.30, the Commission may already

have received much of the information referred to above. Accordingly,

the proposed rules provide that, in such a case, a petitioner would not

be required to submit its organizational documents, its current rules,

and the information concerning the regulatory scheme in the

petitioner's home country, if such information was provided to the

Commission as a basis for the Rule 30.10 exemptive order and remains

the same in all material respects and if the petitioner provides a

statement in its petition to this effect that also specifies the

date(s) the information was provided and the name of the petitioner who

received the Rule 30.10 order.\24\ Such a petitioner, however, would be

required to provide all other information set forth in the rules unless

a particular provision of the rules provides to the contrary. It should

be noted that it is only where the information as to a particular board

of trade's regulatory and self-regulatory program has previously been

provided to the Commission under Rule 30.10 that a petitioner under

Rule 30.11 need not provide all required information. Only where

provision of information would, in fact, be duplicative may a

petitioner rely on information provided in a prior Rule 30.10

application.\25\

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\24\ See proviso to proposed Rule 30.11(b)(2)(vi).

\25\ If a petitioner is aware that another board of trade in its

home jurisdiction has recently provided information to the

Commission in a petition that, in fact, duplicates specific

information that would be required in the petitioner's petition, the

petitioner may, in its petition, request that it not be required to

include such duplicative information.

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The Commission wishes to emphasize that it remains very concerned

about, and committed to, the protection of the positions and funds of

U.S. customers who trade on boards of trade whose primary locus of

operations is outside the U.S. Any U.S. customer who trades on such

boards of trade may face additional risks, as various Commission-

mandated risk disclosure statements make clear. There may also be an

impact even on customers who do not themselves trade on such boards of

trade, but have their accounts carried at FCMs that clear trades for

other customers who do. The recent financial failure of Griffin Trading

Company has heightened the Commission's concern in this area. Although

the Commission recognizes that the events leading to Griffin's

insolvency began on automated trading systems outside of the U.S., the

Commission believes that this incident should serve as a reminder of

the importance of establishing and enforcing trading and credit limits,

rules to address the insolvency of intermediaries, and methods to

transfer accounts of non-defaulting customers when there is a customer

default. The protection of customer funds remains one of the

Commission's major goals in its regulatory regime.

In light of the issues raised by the failure of Griffin, the

Commission is considering the appropriateness of adopting a provision,

in connection with its rules concerning automated trading systems, that

would require that the automated order matching/execution system of

contract markets, linked exchanges or boards of trade operating

pursuant to proposed Rule 30.11 exemption orders have the ability to

provide pre-execution credit and trading or position limit screening.

The Commission's intention would be to insure that DESs could not be

used to execute trades in violation of give-up or clearing agreements

with credit and trading or positions limits. (This is to be

distinguished from the trading or credit checks performed by FCMs' or

Rule 30.10 firms' AORSs.) The Commission is not including such a

requirement in these proposed rules, but requests comment on the

appropriateness of such a requirement.

d. Technological Systems and Standards

The Commission's concept release also requested comment concerning

what information should be requested regarding the technological

systems and standards related to a petitioner's automated trading

systems. The concept release suggested that this information could

include a discussion of the petitioner's order processing system and

its system integrity and architecture. Commenters varied in their

suggested approaches to this issue. One commenter stated that

petitioners should be required to provide information concerning their

home country regulator's technological standards and suggested, by

example, that a petitioner be required to specify whether such

regulator has adopted the principles for screen-based trading set forth

by IOSCO.\26\ Another commenter suggested that the Commission's rules

should not require any review or inquiry concerning the technological

features of a petitioner's systems unless special circumstances warrant

such attention. This commenter stated further that, if the home country

regulator has satisfied itself that a trading system meets or surpasses

the standards set forth by IOSCO in its report, no purpose is served by

the Commission requiring any further demonstration of compliance by the

petitioner.

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\26\ These principles address the following topics:

1. Compliance with applicable legal standards, regulatory

policies, and/or market custom or practice where relevant;

2. The equitable availability of accurate and timely trade and

quotation information;

3. The order execution algorithm used by the system;

4. Technical operation of the system that is equitable to all

market participants;

5. Periodic objective risk assessment of the system and system

interfaces;

6. Procedures to ensure the competence, integrity, and authority

of system users and to ensure fair access to the system;

7. Consideration of any additional risk management exposures

pertinent to the system;

8. Mechanisms to ensure that the information necessary to

conduct adequate surveillance of the system for supervisory and

enforcement purposes is available;

9. Adequacy of risk disclosure, including system liability; and

10. Procedures to ensure that the system sponsor, providers, and

users are aware of, and will be responsive to, relevant regulatory

authorities.

See IOSCO report entitled ``Screen-Based Trading Systems for

Derivative Products'' (June 1990).

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The Commission believes it is generally appropriate to respect the

judgment of home country regulators in these matters and does not wish

to conduct a de novo review of the technological decisions made by

petitioning boards of trade. However, the Commission also believes that

it has an obligation to assure that any system that will be accessed

from within the U.S. is sufficiently sound (e.g., its architecture is

sufficient to handle reliably the type and volume of transactions

reasonably anticipated) and secure and provides fair access to U.S.

[[Page 14167]]

customers on a nondiscriminatory basis (i.e., U.S. customers are not

placed at a competitive disadvantage to others trading on the system).

These assurances are necessary in order for the Commission to determine

that issuance of a section 4(c) exemption order would not be contrary

to the public interest, would serve to ensure protection of U.S.

customers and would not adversely affect the Commission's ability to

discharge its regulatory duties.

To address these concerns and the recommendations of commenters,

the proposed rules would require that a petitioner state in detail in

its petition the extent to which a technical review of the system at

issue was performed by its home country regulator and identify the

standards applied in that review. The petitioner would include a copy

of any order or certification received from its home country regulator

as a result of such review. If the home country regulator based its

approval on a review conducted by a third-party, the petitioner should

so indicate and discuss the qualifications of the party that performed

the review and the standards applied.

The petition would also be required to include a general

description of the automated trading system operated by the board of

trade, including at a minimum a general description of the architecture

and security features of the system, information as to the length of

time the particular system has been operating and a history of

significant system failures or interruptions.\27\ Depending upon the

nature of the technical review performed and the information received

concerning the system's operating history, the Commission would

determine what additional inquiry, if any, by the Commission is

necessary and appropriate in reviewing the petitioner's request. The

Commission adopted the IOSCO 1990 Principles on Screen-Based Trading as

a formal Commission statement of regulatory policy and would use the

IOSCO principles as guidelines for its review to determine whether the

petitioner's automated system technology is sufficient to permit the

Commission to issue a section 4(c) exemption order.\28\ In this regard,

the petitioner would be required to describe any differences between

the IOSCO principles and those that were used to perform the technical

review.

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\27\ See proposed rule 30.11(b)(2)(viii).

\28\ 55 FR 48670 (Nov. 21, 1990). IOSCO is currently undertaking

a study to review the principles set forth in its 1990 report in

light of new technological developments.

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To the extent that the information to be provided to the Commission

would be the same for several boards of trade using a shared computer

or for a board of trade that lists its products on another board of

trade's automated trading system, only one of the boards of trade using

the system or making its products available on such system in the U.S.

would be required to provide the information regarding technological

systems and standards. If a petitioner shares a computer system or

platform with another board of trade that has not sought an exemption

order and the petitioner has relied on the system analysis performed by

the other board of trade's home country regulator, it would not be

sufficient for the petitioner simply to state that it relied on such

analysis. Rather, the petitioner would be responsible for obtaining and

providing the Commission with information concerning the analysis

performed by the other board of trade's home country regulator and for

describing whether such analysis was consistent with the IOSCO

principles. Additionally, if a board of trade does not include all or a

portion of the information regarding the type of review that was

performed on its system because the information has been or is being

provided by another board of trade, the petitioner must include a

statement to that effect in its petition and must identify the board of

trade that has provided or is providing the information.

e. U.S. Activities

Another possible information requirement outlined in the concept

release concerned the petitioner's activities in the U.S. The concept

release requested comment on whether to require a petitioner to provide

information concerning its marketing, education, promotional or other

activities in the U.S. including the address of, and number of persons

employed by, any office maintained by the petitioner in the U.S., and

the extent to which the board of trade makes information available on

the Internet that may be relvevant to U.S. customers who wish to trade

its products. Additionally, if the petitioner maintains a warehouse in

the U.S. for any futures contracts that could involve physical delivery

of the underlying commodity, the concept release suggested that the

petitioner should provide the address for such warehouse and the stocks

contain as of the date of the petition.

Commenters generally agreed that the Commission has a legitimate

interest in obtaining information to determine whether a board of

trade's presence in the United States is more than incidental such that

the board of trade should be required to obtain contract market

designation. The Commission has determined to propose generally the

submission of the information discussed in the concept release

concerning a petitioner's U.S. activities.\29\ To qualify for an

exemption order, petitioner's management, back office operations, order

matching/execution facilities and clearing facilities would have to be

located outside the U.S., as would all or the vast majority of its

personnel. The presence of an office or offices in the U.S. might or

might not be deemed to be incidental contact, depending on the size,

purpose, and activities conducted by the office(s). The Commission will

evaluate this issue based on the facts described in the petition.

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\29\ See proposed Rule 30.11(b)(2)(ix)-(xi).

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One commenter questioned the relevance of information concerning

the address of warehouses in the U.S. and the stocks available at such

warehouses. The Commission believes that the location of the underlying

cash market and delivery points with respect to products traded through

U.S.-located automated trading systems is a pertinent factor in

examining the nature and extent of an exchange's activities in the U.S.

Presence in the U.S. of some warehouse facilities would not itself

render a petitioner ineligible for relief under these rules.

Eligibility would depend on the nature of petitioner's U.S. activities

taken as a whole.\30\

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\30\ The proposed rules require petitioners to identify the

addresses of any warehouses maintained in the U.S. for delivery of

underlying commodities, but not to specify the stocks on hand at

such warehouses. If a petition is granted, an exempted exchange must

respond to any Commission requests for information about such

stocks. See proposed Rule 30.11(d)(8).

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f. Rules Concerning Access by U.S. Exchanges to Foreign Markets

The concept release also requested comment on whether the

Commission should require that the petitioner provide a statement from

the regulatory authority in its home country with primary

responsibility for oversight of the petitioner as to whether such

regulator or any other body in that country imposes any restrictions or

regulations regarding: (1) The placement or operation of U.S. exchange

automated trading systems in the country; (2) the types of products

permitted to be traded on such systems; and (3) the sale of U.S.

exchange products, generally. If any such restrictions or regulations

existed, the concept release suggested that the statement include a

description of the restrictions or regulations, copies of any relevant

statutes or other relevant legal

[[Page 14168]]

materials and a description of the application process, if any,

required for a U.S. exchange and its members to place automated trading

systems and/or to sell products in the petitioner's home country.

Commenters generally were in favor of the Commission's collection

of the information described above as a means of ensuring electronic

access to markets globally. Commenters differed, however, regarding the

role such information should have in the Commission's ultimate

determination as to whether it should issue an order. Several

commenters stated that an order should not be issued to a board of

trade primarily located outside the U.S. unless similar electronic

access is made available to U.S. exchanges by the board of trade's home

country regulator. Other commenters warned that the Commission should

not use the request for information concerning the electronic access

rules of the petitioner's home country as a means to require, as a

prerequisite to issuing an order, that a particular regulatory

framework for allowing U.S. exchanges to place automated trading

systems in the foreign jurisdiction be in effect in a foreign

jurisdiction. Two commenters believed that the Commission should

collect information concerning a foreign jurisdiction's rules and

policies vis-a-vis a U.S. contract market's ability to place automated

trading systems in the foreign jurisdiction, but should not deny

electronic access to a board of trade solely on the basis that its home

jurisdiction excludes the systems of U.S. exchanges. Rather, these

commenters believed that the information should be considered as one

element in the Commission's assessment of the entire petition. Another

commenter stated its view that the issue of reciprocity should not be a

significant factor in the Commission's determination as to whether to

issue an exemption order because financial institutions in a country

that does not provide electronic access ultimately will be harmed by

such a policy, thus effectively forcing the country into developing

regulations permitting access. One commenter also noted that any

Commission regulations must be consistent with U.S. obligations under

the General Agreement on Trade in Services (``GATS'') and any

applicable annexes thereto.

With respect to the GATS, Commission staff have held discussions

with staff of the U.S. Department of Treasury (``Treasury'') and the

Office of the U.S. Trade Representative (``USTR'') on this issue.

Treasury and USTR staff have expressed to Commission staff their view

that the Commission may not condition granting an order on reciprocity

by the petitioner's home country without violating U.S. legal

obligations under the GATS and North American Free Trade Agreement

(NAFTA). Indeed, they have expressed concern that even a request for

information such as that set forth in the concept release and described

above might raise questions relating to U.S. obligations under the GATS

and NAFTA.

In light of Treasury's and USTR's view regarding U.S. legal

obligations under the GATS and NAFTA, the Commission is not now

proposing to impose a requirement that a particular partitioner's home

country jurisdiction extend reciprocity to U.S. exchanges' automated

trading systems, even though it had intended to do so. The Commission

would welcome comment on this issue. Even if U.S. international

obligations prevent the Commission from requiring reciprocity, the

Commission strongly supports a policy of open and free access to global

markets and is committed to aiding U.S. exchanges in gaining the right

to place electronic systems in foreign jurisdictions. The Commission

encourages any U.S. exchange that believes that it is being wrongfully

prevented from placing its automated trading systems in foreign

jurisdiction to inform the Commission of this concern. The Commission

will work with the exchange, with the foreign jurisdiction, and with

Treasury and/or USTR as appropriate to open such jurisdiction to U.S.

exchanges and to resolve any dispute over unfair restrictions placed on

U.S. exchanges.

g. Financial Information and Volume Data

The concept release requested comment on a requirement to include

in a petition the petitioner's most recent annual financial statements

and the total trading volume, on a contract-by-contract basis and in

the aggregate, for its most recent year and most recent quarter (or

other period if data is not maintained on an annual and quarterly

basis). Based upon the concerns of commenters regarding the relevance

of the financial statements, the fact that the Commission does not

require similar statements from contract markets and the fact that the

Commission will review the minimum financial standards and clearing

facility oversight in the petitioner's home country, the Commission has

determined not to require financial statements from the petitioner in

the proposed rules. Neither will the Commission require volume figures

in a petition under Proposed Rule 30.11. The proposed rules, however,

would require certain basic U.S. volume data to be reported to the

Commission on a quarterly basis as a condition of a section 4(c)

exemption order.\31\

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\31\ See discussion of conditions of an order in Section

III.B.2., below.

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h. Information Sharing

The prevention of fraud and the protection of U.S. customers,

including customer funds, remain major goals of the Commission's

regulatory scheme. The Commission's ability to access information

regarding trading by persons located in the U.S. that is conducted on a

board of trade exempted under proposed Rule 30.11 is essential to

achieving these goals. The concept release requested comment on a

requirement that a petitioner identify any information sharing

arrangement in effect among the relevant regulatory authorities and the

Commission, including information concerning any blocking statutes or

data protection laws in effect in the petitioner's home country that

might impair the Commission's ability to obtain information under such

arrangements. The commission has determined that the existence of

satisfactory information sharing arrangements between the petitioner

and the petitioner's regulator and the Commission is an essential

prerequisite for an exemptive order under the proposed rules. Under

such arrangements, the Commission and the petitioner and the

petitioner's regulatory authority would agree to cooperate with respect

to inquiries concerning trading on the petitioner's markets that

affects U.S. persons or markets. Relevant information to be provided

under such arrangements may include, without limitation, trade

confirmation data, data necessary to trace funds related to trading

futures and option products subject to regulation in the petitioner's

home country, position data, data on a firm's standing to do business

in the petitioner's home country, and a firm's financial condition.

Mechanisms for cooperating with the Commission and the NFA in

inquiries, compliance matters, investigations and enforcement

proceedings must be established in the information sharing

arrangements. Failure to maintain satisfactory information sharing

arrangements could result in revocation of the Commission's order.

Proposed Rule 30.11(d)(8) also provides that the Commission may seek

information directly from the petitioner to evaluate the petitioner's

continued eligibility for or compliance with the

[[Page 14169]]

conditions of a section 4(c) exemption or for any other reason.

i. Arrangements Among Multiple Exchanges

The Commission envisions that its proposed rules would apply not

only with respect to individual boards of trade that primarily are

operated outside the U.S., but also in circumstances where the products

of multiple boards of trade are traded through a single system. In such

a case, each board of trade whose products would be made available

through U.S.-located automated trading systems generally would be

required to comply with the requirements set forth in the proposed

rules. For example, if two or more boards of trade share the same

system and each wishes to place DESs in the U.S. for its members' (or

members' affiliates') use, each would be required to receive an order

from the Commission prior to such placement. Similarly, if the products

of one or more boards of trade are available through the DES of another

board of trade, each board of trade whose products would be available

in the U.S. through such DES would be required to receive a section

4(c) exemption order. With respect to AORSs that provide U.S. customers

with access to the products of multiple boards of trade, each board of

trade whose products would be available through such device or software

would have to comply with the rules and receive a section 4(c)

exemption order before an FCM or a Rule 30.10 firm could allow its

customers to enter trades on the board of trade via an AORS. In the

examples discussed above, a petition to the Commission under the

proposed rules could be made individually by each board of trade or

jointly, provided that the Commission received all required information

under the proposed rules with respect to each board of trade whose

products would be made available electronically from within the U.S.

In addition to the foregoing, the Commission appreciates that some

boards of trade currently allow automated trading of their products

from within the U.S. through mutual arrangements with designated

contract markets or may in the future do so. In these cases, the

arrangements are submitted to the Commission for its prior review as

rule changes of the contract market. Because the Commission thus has

the opportunity to examine each such arrangement, the proposed rules

carve out an exception that would allow a board of trade primarily

operating outside the U.S. to have its products traded through

automated trading systems located in the U.S. without obtaining

contract market designation and without receiving a section 4(c)

exemption order if (1) the board of trade has entered into an

electronic trading arrangement with a designated contract market which

is submitted to the Commission for review and is in effect as a rule of

the contract market and (2) the products of the board of trade that are

traded in the U.S. through such trading systems are traded in

accordance with such an arrangement. However, a board of trade that has

entered into an electronic trading arrangement with a designated

contract market would be required to receive a Commission order

pursuant to these proposed rules if the board of trade planned to allow

automated access to its products in any manner that would fall outside

the arrangement with a U.S. contract market that has been submitted to

the Commission for review.

The Commission wishes to emphasize that, although a ``linked

exchange'' would not be required to comply with these proposed rules if

access to its products via automated trading systems from within the

U.S. is limited to the terms of an arrangement with a designated

contract market, a designated contract market that enters into such a

linkage arrangement must submit a rule(s) describing the arrangement

and the attendant rights and responsibilities of all parties involved

in the arrangement to the Commission for approval. In reviewing such a

rule submission, the Commission has applied and will continue to apply

substantially the same standards as set forth herein modified as

appropriate based on the exact nature of the linkage arrangement. Among

other things, the Commission seeks assurances from the designated

contract market that the arrangement will conform with the principles

for screen-based trading set forth by IOSCO \32\ and evaluates what

role the U.S. contract market would have in securing its members'

compliance with the rules of the board of trade operating primarily

outside the U.S. Additionally, the Commission will ensure that any

rule(s) it reviews includes language requiring such a board of trade to

subject itself to the jurisdiction of the Commission and U.S. courts

regarding its activities under the linkage arrangement.

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\32\ See supra note 26.

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j. Public Availability of Petitions

The concept release asked for comment on whether petitions received

should routinely be published in the Federal Register for public

comment. After reviewing the comments and in light of the nature of the

petition process that would be established by the proposed rules, the

Commission believes that, as a general matter, it would be beneficial

to provide public notice of petitions. Accordingly, pursuant to section

4(c) of the Act, paragraph (e) of proposed Rule 30.11 provides that the

Commission will publish a ``notice of availability'' in the Federal

Register upon receipt of any petition. The notice of availability would

contain a general description of the information discussed in the

petition and the exemption sought by the petitioner. Interested parties

would thus be aware of each petition and would have the opportunity to

request information concerning the petition from the Secretariat of the

Commission. The proposed rule further provides that the Commission may,

upon the request of a petitioner, limit the public availability of

information included in its petition if the Commission determines that

such information constitutes a trade secret or that public disclosure

would result in material competitive harm to the petitioner.

2. Conditions of an Order

If all standards for exemptive relief are met, exemptive orders

under proposed Rule 30.11 would be issued subject to certain

conditions. The concept release set forth a number of potential

conditions that would be included in each Commission order. The

Commission believes that it generally would be helpful to go further

and provide in its rules a list of conditions that will apply

automatically to each Commission order, unless a particular order

indicates otherwise. In light of the comments received on the concept

release, the Commission is proposing conditions that vary in certain

respects from those discussed in the concept release. These conditions

are intended to aid the Commission to fulfill certain basic goals of

its rulemaking: (1) To ensure protections for U.S. customers and (2) to

ensure that the Commission has ongoing access to data to ensure the

continued appropriateness of the Commission's 4(c) exemption order. The

conditions that are proposed to be included automatically in each

Commission order are as follows:

1. Only memebers of the board of trade that received a

Commission exemptive order and their affiliates may have access to

DESs, and the board of trade will not provide, and will take

reasonable steps to prevent third parties from providing DESs to any

other persons;

[[Page 14170]]

2. Unless otherwise exempt from registration, any member or

affiliate thereof that solicits or accepts orders for, or accepts

money, securities or property in connection with the purchase or

sale of, foreign futures or foreign options by a foreign futures or

foreign options customer via a DES or an AORS must be a registered

FCM or a Rule 30.10 firm;

3. The board of trade that received the exemptive order must

notify the Commission in writing within 30 calendar days of (a) any

material changes in the information provided in its petition to the

Commission and any changes in its rules or in the laws or rules of

its home country that may have a material impact on the order, (b)

any known violation by a member (or its affiliate) of the

Commission's order; and (c) any disciplinary action taken against a

member (or its affiliate that involves any market manipulation,

fraud, deceit or conversion or that results in the member's

suspension or expulsion \33\ and that involves the use of a DES or

an AORS in the U.S., provided, however, that the board of trade must

notify the Commission at least ten business days prior to allowing

any new products (i.e., products other than those discussed in its

petition) to be traded through DESs or AORSs located in the U.S. and

within 24 hours of any significant system failure or interruption or

a member's default, insolvency or bankruptcy; \34\

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\33\ See, e.g., Rule 1.63(a)(6)(ii) (defining disciplinary

offense for purposes of the Commission's rule concerning service on

SRO governing boards by persons with disciplinary histories to

include any violation of SRO rules that involves fraud, deceit or

conversion or results in suspension or expulsion).

\34\ Although the proposed rules would require that the

Commission be notified if a board of trade operating under an

exemption order intends to allow automated access to new products

through DESs or AORSs located in the U.S., the proposed rules

generally would not require any type of pre-approval process.

However, as previously noted, the proposed rules would not alter a

board of trade's obligations: (a) To receive a no-action position

from the Commission prior to engaging in the offer or sale of any

stock index futures or option contracts in the U.S. or (b) to have

any foreign government debt obligation designated as an ``exempt

security'' by the SEC before engaging in the offer or sale of any

futures contract or option thereon in the U.S. section 2(a)(1)(B)(v)

of the Act states generally that no person shall offer or enter into

a contract of sale for future delivery of any security except an

``exempt security'' under Section 3 of the Securities Act of 1933 or

section 3(a)(12) of the Securities Exchange Act of 1934.

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4. Satisfactory information sharing arrangements must remain in

effect between the Commission and the petitioner and the

petitioner's regulatory authority;

5. The board of trade that received the order must provide to

the Comission, on a quarterly basis and at any other time upon the

request of a Commission representative, a current list that (a)

identifies and provides the main business addresses in the United

States for those of its members and affiliates thereof that have

DESs in the United States and indicates which of such members and

affiliates thereof allow the use of AORSs by foreign futures and

foreign options customers and (b) identifies and provides the main

business addresses for those of its members and affiliates thereof

that allow the use of AORSs by foreign futures and foreign options

customers, but who do not have DESs in the U.S.;

6. Prior to operating pursuant to the Commission order, the

board of trade that received the order must file with the

Commission, and maintain thereafter as long as it operates pursuant

to the order, a valid and binding appointment of an agent for

service of process in the United States, pursuant to which such

agent is authorized to accept delivery and service of communications

issued by or on behalf of the Commission, the Department of Justice,

any member of the board of trade or affiliate of such member, or any

foreign futures or foreign options customer. Service or delivery of

any communication issued by or on behalf of any of the foregoing,

pursuant to such appointment, shall constitute valid and effective

service or delivery.

7. Prior to operating pursuant to the Commission order, the

board of trade that received the order must file with the Commission

a written representation, executed by someone with authority to bind

the board of trade, stating that, as long as the board of trade

operates pursuant to the order, the board of trade irrevocably

agrees to and submits to the jurisdiction of the Commission and

state and federal courts in the United States with respect to the

board of trade's activities conducted under the exemption order; and

8. The board of trade that received the order must provide the

Commission with quarterly reports indicating with respect to each

contract available to be traded from within the U.S. via DESs or

AORSs (a) the total volume originating from DESs or AORSs located in

the U.S. and (b) the total worldwide trade volume on the board of

trade. If applicable, the board of trade also must provide reports

upon request indicating the stocks held at any warehouse maintained

by it in the U.S. for products that require physical delivery.

A significant issue raised in the concept release concerned the

extent to which the Commission should look to the volume of a

petitioner's contracts transacted by U.S. persons in determining

whether such petitioner should be issued an exemption order under these

proposed rules. The majority (although not all) of the commenters on

this issue believed that the Commission should not use a volume test as

the sole means to determine whether a board of trade should be eligible

for a Commission order. Commenters varied, however, in their views as

to the extent, if any, to which U.S. volume data should play a role in

this determination. The Commission agrees with those commenters who

suggested that adopting a particular percentage of volume within the

U.S. beyond which a board of trade would be required to receive

contract market designation could serve to inhibit the development of

new products that might appeal to U.S. users and could prove difficult

to manage because volume potentially can vary greatly from one

reporting period to the next. Thus, the Commission is not proposing any

fixed percentage. However, the Commission believes that trade volume

from within the U.S. is relevant in assessing whether a board of

trade's contacts in the U.S. are so extensive that it should be

required to be designated as a contract market and that a quarterely

report that indicates a board of trade's volume of U.S. transactions in

each contract and the total number of transactions worldwide in each

contract would be beneficial to the Commission in obtaining a complete

picture of the board of trade's U.S. activities. Accordingly, the

Commission has determined to include in its proposal a periodic U.S.

volume reporting requirement that would be included as a condition to

each order issued under the proposed rules. The Commission believes

that the volume data that would be required under the proposed rules,

while relevant and helpful to the Commission, should not impose a

significant burden. Specifically, as noted above, the proposed rules

would require that a board of trade that received a Commission order

provide a report to the Commission on a quarterly basis that indicates

the total volume in each of its contracts that originates from

automated trading systems in the U.S. (whether from DESs or AORSs) and

the total volume of transactions in such contracts worldwide (including

the U.S.). This information would be provided for each contract traded

on DESs or AORSs from within the U.S.

Another issue raised in the concept release concerned a potential

requirement for a biennial on-site review of the operations of members

(and their affiliates) operating in the U.S. under a Commission order.

The Commission has determined not to require a separate on-site review.

As one commenter pointed out, any member or affiliate thereof that uses

a DES to trade on behalf of U.S. customers pursuant to a Commission

issued order would have to be registered as an FCM and would be subject

to periodic audits by the Commission and its designated self-regulatory

organization (``DSRO'') (i.e., U.S. contract market or NFA). The

Commission does not believe that it is necessary to require an

additional review under these rules. Rather, it anticipates that the

DSRO's audit procedures would be extended to encompass a review of

compliance with the Commission's new rules, and orders

[[Page 14171]]

issued thereunder, when adopted and issued.

The Commission wishes to make clear that the above list of

conditions that will automatically apply under the proposal would not

necessarily be exhaustive. For clarity's sake, each order likely would

reiterate the conditions that are imposed automatically by the rules.

However, as the rules state, the ``default'' or automatic conditions

would apply even if not contained in an order, unless explicitly

excluded therefrom. Additionally, a petitioner must include in its

petition a written statement in which it consents to or agrees to

comply with each of the conditions should the Commission issue the

petitioner a Rule 30.11 exemption order.\35\ Thus, consent or agreement

to comply with the conditions also would be a prerequisite to the

Commission's issuance of an order under these rules.

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\35\ See proposed rule 30.11(b)(2)(xii).

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The Commission would be free to subject any order to other

conditions that the Commission believes to be necessary or appropriate.

In addition, under paragraph (f) of proposed Rule 30.11, the Commission

would retain the authority to condition further, modify, suspend,

terminate or otherwise restrict the terms of an order as they apply

either to a specific person operating thereunder or to the order in its

entirety. The Commission might determine to take such action, for

example, if the Commission found that the board of trade that received

the order, or an entity operating in the U.S. based on the order,

materially violated a stated condition of the order, that the

activities, operations and trading of the board of trade that received

the order no longer justified the order, or that continuation of the

order otherwise would be contrary to the Act, public policy or the

public interest.

3. Rules Concerning Automated Order Routing Systems

a. AORS Definition

As noted above, the Commission is proposing to adopt a definition

of the term ``automated order routing system'' in a new paragraph (tt)

of Commission Rule 1.3, which contains the Commission's general

definitions and thus would apply to U.S. designated contract markets in

addition to boards of trade granted a Commission order under proposed

Rule 30.11 and linked exchanges. The definition of an AORS is any

system of computers, software or other devices that allows entry of

orders through another party for transmission to a board of trade's

computer or other automated device where, without substantial human

intervention, trade matching or excution takes place. ``Entry of

orders'' for an AORS could be via a screen-based or other automated

system. A customer who telephones an order to an employee of an FCM or

Rule 30.10 firm would not be entering an order for purposes of these

rules, and the AORS definition would not apply. The definition of AORS

and the requirements relating thereto would apply to orders for and

customer or foreign futures or options customer, although order entry

itself could be made by the customer or by a person designated by the

customer to enter orders on its behalf, e.g., a CTA.

As described more fully below, under Proposed Rule 1.71(a), if a

customer or foreign futures or foreign options customer uses an AORS to

transmit an order to an FCM or Rule 30.10 firm, such AORS must be a

``qualified'' AORS and satisfy certain minimum requirements specified

in proposed rule 1.71(b). Further, under proposed rule 30.3 (d), AORSs

can only be used to access designated contract markets, boards of trade

that have received an exemption under Proposed Rule 30.11 or linked

exchanges.

The qualification requirements of Proposed Rule 1.71 do not apply

to orders transmitted via an AORS if such orders are proprietary orders

of the receiving firm, of if they are transmitted by a registered FCM

to another firm for any proprietary account or customer omnibus account

of the FCM. Systems transmitting such orders still fall within the

definition of AORS, however, and therefore Proposed Rule 30.3(d)

requires that such orders be directed to a contract market, a Rule

30.11 exempt board of trade or a linked exchange.

There are a number of possible permutations in how a particular

order may be transmitted from a customer or an FCM for eventual

execution on an automated board of trade, and it is important to

examine each step of a particular transaction to determine what

requirements apply. For example, if a customer telephoned an order to

an employee of a U.S. FCM, who then entered the order into a system

linked directly to an automated board of trade of which it was member,

the second step of the transaction would involve the use of a DES, and

under proposed Rule 30.3(c), the board of trade for which the order was

placed must be a designated contract market, a Rule 30.11 exempt board

of trade, or a linked exchange. If the same customer used a system that

satisfied the definition of an AORS to send an order to an FCM (or Rule

30.10 firm) for transmission to an automated board of trade, such AORS

would have to be a qualified AORS and satisfy the requirements of

Proposed rule 1.71(b). Under proposed Rule 30.3(d), the board of trade

for which the order was placed would have to be a designated contract

market, a Rule 30.11 exempt board of trade, or a linked exchange.

If a foreign futures options customer telephoned an order to an

employee of an FCM and the FCM, using its customer omnibus account,

were to take the order and transmit it electronically to another FCM, a

Rule 30.10 firm or a firm otherwise exempt from registration as an FCM

\36\ for transmission into an automated board of trade, transmission of

the order from the customer's FCM through the other firm for execution

would constitute use of an AORS. Accordingly, under proposed Rule

30.3(d), the board of trade for which the order was placed must be a

Rule 30.11 exempt board of trade or a linked exchange. The AORS used by

the customer's FCM in this example would not have to be a qualified

AORS that meets the credit check and other requirements of proposed

Rule 1.71, however, because its use was by an FCM for a customer

omnibus account.

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\36\ See supra note 20.

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Where a non-clearing member of a board of trade operating under a

Rule 30.11 exemption order or of a linked exchange uses an automated

device directly to access the board of trade's automated order matching

engine and there is a post-trade give-up for clearing to an FCM or a

Rule 30.10 firm, this would be treated as use of a DES rather than an

AORS under the proposed rules. The requirements of proposed Rule 1.71

therefore would not apply.\37\ However, an FCM or Rule 30.10 firm must

bear in mind that, if the non-clearing member used an automated device

to route an order through the FCM or Rule 30.10 firm prior to the

order's transmission to the matching/execution engine of the board of

trade, this would be treated as use of an AORS by the non-clearing

member customer, and the AORS therefore would have to be a qualified

AORS and to satisfy the requirements of proposed Rule 1.71, unless the

non-clearing member is itself an FCM or has a proprietary relationship

to the FCM receiving the order.

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\37\ The firm carrying the account generally would have to be a

registered FCM or Rule 30.10 firm.

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b. Requirements for Qualified AORSs

Proposed Rule 1.71 would set forth very basic standards that must

be met by a qualified AORS. If these minimum requirements are

satisfied, there would

[[Page 14172]]

be no restriction upon the type of customer that could use the AORS,

e.g., no minimum net worth standards, and no restrictions upon the type

of data that may be displayed to the customer. The AORS must be limited

to exchange trading only, either on a designated contract market, an

exchange linked to such a contract market or a board of trade that

receives an exemption order in accordance with proposed Rule 30.11.\38\

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\38\ An AORS could also provide access to trading in cash

markets, securities markets, or CEA-exempt hybrid markets, if such

trading is consistent with all applicable laws and regulations.

Trading of swaps via AORSs would not be permissible under the

current Commission exemption for swaps, which prohibits the use of

multilateral transaction execution facilities for swaps trading,

see, e.g., Rule 35.2(d), and thus would not be permissible under

proposed Rule 1.71.

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A qualified AORS may only provide access for a customer or a

foreign futures or foreign options customer to products that can

lawfully be offered to or entered into by U.S. persons. Thus, for

example, if there were a futures contract traded on a board of trade

with a Rule 30.11 exemption order (or a linked exchange) involving a

foreign stock index or a foreign government's sovereign debt

instruments that had not received the requisite clearances, the futures

contract could not lawfully be offered or sold to U.S. persons. The FCM

(or Rule 30.10 firm, as applicable) should also exercise due diligence

to verify that use of an AORS is permissible under, and undertaken in

accordance with, the rules of the relevant contract market, board of

trade that received a Rule 30.11 exemption order, or linked exchange.

For trading through an FCM, a qualified AORS would be required to

provide all information required by Commission Rule 1.35(a-1)(1)

concerning identification of customer orders, except that order-related

times would have to be captured to the nearest second. The proposed

requirement for timing to the nearest second is consistent with the

Commission's previous advisory concerning recordkeeping requirements

for electronic order-routing systems.\39\

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\39\ 62 FR 7675, at 7677 (Feb. 20, 1997).

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The Commission believes that the use of AORSs may be beneficial for

customers and FCMs in terms of convenience and efficiency. However,

these systems are not infallible or without serious risk. The

Commission is concerned that, due to the speed and the uninterrupted

nature of an automated device, an error, if one should occur, could be

very large in magnitude and impact and thus potentially could pose a

significant risk to customers, to the integrity of the FCM and to the

marketplace in general if the AORS does not contain appropriate

safeguards. Commission Rule 1.16 requires, among other things, that an

FCM have in place appropriate internal accounting controls and

procedures for safeguarding customer and firm assets.\40\ However, that

rule does not prescribe specific controls that must be in place. The

Commission believe that it is appropriate to mandate that certain

specific, minimum controls be present in any qualified AORS. These

minimum safeguards do not supplant or replace an FCM's duties under

Rules 1.16 and 166.3 and other applicable regulations, concerning

proper internal controls and supervision of employees and accounts.

Rather, they are minimum standards that should be implemented in

addition to other appropriate controls employed by FCMs regarding

AORSs.

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\40\ In particular, Rule 1.16(d)(1) requires that the scope of

the FCM's annual audit, review of the accounting system and

procedures for safeguarding customer and firm assets be ``sufficient

to provide reasonable assurance that any material inadequacies

existing at the date of the examination in (i) the accounting

system, (ii) the internal accounting controls, and (iii) the

procedures for safeguarding customer and firm assets . . . will be

discovered.'' A material inadequacy is defined generally in Rule

1.16(d)(2) to include, among others, ``any conditions which

contributed substantially to or, if appropriate corrective action is

not taken, could reasonably be expected to . . . (r)esult in

material financial loss(.)'' See also, Commission Rule 166.3, which

governs an FCM's general supervisory duty with respect to handling

of accounts.

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Proposed Rule 1.71(b)(3) requires generally that an FCM or Rule

30.10 firm take reasonable steps to ensure that its system is and

remains sound and secure and generally fit for its intended purpose.

Proposed Rule 1.71(b)(5) provides that a qualified AORS must contain at

a minimum checks that verify that any credit and trading or position

limits for the account (as established by the FCM or Rule 30.10 firm)

are not exceeded.\41\ Such checking could be performed manually or by

the system itself on an automated basis. If these checks are automated,

the FCM or Rule 30.10 firm must implement proper internal controls to

ensure that limits appropriate to each customer or foreign futures or

foreign options customer, as determined by personnel authorized to set

such limits, are properly input into the AORS and updated as

appropriate. The Commission is also proposing, in proposed Rule

1.71(b)(6) and (b)(7), that a qualified AORS must provide: (1) An FCM

or Rule 30.10 firm, on a unilateral and immediate basis, with the

capability to block use of an AORS if, for example, the firm determines

that its security or the security of any contract market, linked

exchange or board of trade operating pursuant to a Rule 30.11 exemption

order may be adversely affected by use of the AORS and (2) reasonable

precautions to ensure against unauthorized access, unauthorized trading

and unauthorized disclosure of customer or foreign futures or foreign

options customer orders \42\ and to provide overall integrity and

security of the AORS.

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\41\ This proposed rule is consistent with conditions currently

placed on customers of the CME who may transmit Globex orders to

FCMs via the Internet. By letter to the CME dated August 14, 1997,

the Division, under authority delegated by the Commission in Rule

1.41(a)(3), informed the CME that its proposal to permit customers

to transmit Globex orders to FCMs via the Internet did not require

Commission approval under section 5a(a)(12) of the Act. Under CME's

proposal, customers do not have direct access to Globex. Rather, the

proposal permits CME clearing members to accept customer orders via

the Internet. After receipt of a customer order, the order is

transmitted to Globex via the clearing member's order routing system

and CME's computer-to-computer interface (``CTCI''), which enables a

clearing member to upload and download orders between the member's

order routing system and Globex. A CME clearing member may use CME's

CTCI only if (1) the member's order routing system contains

automated credit controls or position limits or (2) customer orders

received by a member through its order routing system are subject to

manual review and processing by a clearing member employee prior to

being entered into a Globex terminal.

\42\ See Commission Rule 155.3(b)(1).

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With respect to recordkeeping, the Commission is proposing that a

qualified AORS must enable an FCM to download trade history on each

order entered through the system on a daily basis and otherwise to

maintain records related to such orders in accordance with Commission

Rule 1.31.\43\ To assure system integrity and appropriate trade data,

any and all modifications to or cancellations of an order must be

recorded. In addition, the Commission is proposing to require an FCM to

maintain a record of accounts for which it will accept or transmit for

execution orders that have been entered through an AORS. This record

shall also include the name of any person designated by a customer or a

foreign futures or foreign options customer to exercise control over

the trading decisions for the account and shall be maintained in

accordance with Commission Rule 1.31.\44\ A Rule 30.10 firm should

maintain records in accordance with the

[[Page 14173]]

requirements of its home country regulator, which would then be

available to Commission or NFA representatives under appropriate

information sharing arrangements.

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\43\ See proposed Rule 1.71(b)(8).

\44\ Proposed Rule 1.71(c). The records of third-party account

controllers, like all books and records required to be kept by the

Act or rules thereunder, must be readily accessible during the first

two years of the required five-year retention period under Rule

1.31. Commission staff have sometimes experienced difficulty in

obtaining this information on existing accounts. Such information is

required by Rule 1.37 and is generally maintained by FCMs, but

sometimes the manner of maintenance improperly makes ready retrieval

difficult.

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As discussed above, proposed Rule 1.71 is intended to establish

minimum requirements with respect to the use and the soundness of an

AORS. The Commission believes that these basic, common sense

requirements likely would be adopted by any responsible FCM or Rule

30.10 firm, even in the absence of Commission action. Indeed, the

Commission anticipates that AORSs may contain protections more

elaborate than those required under the proposed rules. Depending on

the nature of the system, compliance with existing Commission Rules

1.16 and 166.3 may require more stringent internal controls and

protections to be in effect. The Commission requests comments as to

whether any additional specific prudential standards should be included

in the Commission's rules concerning the use of AORSs.

Certain commenters noted that rules pertaining to AORSs should

apply universally. The Commission agrees with that position and is

therefore proposing to add to Commission Rule 30.3 a new paragraph (e)

to provide that, notwithstanding the terms of any prior Rule 30.10

order, it shall be unlawful for a Rule 30.10 firm to accept or transmit

for execution an order from a foreign futures or foreign options

customer through an AORS unless the system satisfies the requirements

of proposed Rule 1.71(a), as appropriate for a Rule 30.10 firm. This

provision would apply to existing Rule 30.10 firms irrespective of what

may have been stated in an earlier Commission order under Rule 30.10.

With respect to the disclosure of risk that an FCM must provide to

a customer or a foreign futures of foreign options customer using an

AORS, the Commission notes that Rule 1.55, certain provisions of which

are referred to above, provides in paragraph (g) thereof that any

specific requirements set forth therein do ``not relieve (an FCM) from

any other disclosure obligation it may have under applicable law.''

Therefore, although the Commission is not proposing any specific risk

disclosure language applicable to an AORS or a DES, just as it has not

done so for contract market automated trading systems, the Commission

believes that FCMs must disclose material risks about these systems.

Designated contract markets have developed risk disclosure statements

for their automated trading systems that FCMs provide to customers

using those systems, and comparable risk disclosures would be necessary

and appropriate as to AORSs and DESs.

The Commission notes that there have been discussions between

Commission staff and a joint industry-NFA committee concerning a

generic electronic trading and order routing systems disclosure

statement, which is proposed to replace the contract market-specific

disclosure statements with the understanding that customers would

always be entitled to further information about a particular system

upon request or about particular material risks not otherwise covered

by the generic disclosure statement. In determining whether a

petitioner's regulatory structure is generally comparable to the U.S.

structure with respect to customer protection and prohibition of fraud

and abuse, the Commission would review the petitioner's risk

disclosures pertaining to its automated trading systems in light of

those prepared by designated contract markets for their systems and any

generic disclosure statement ulitmately developed in discussions

between Commission staff and the industry-NFA committee discussed

above. The Commission requests comment concerning any specific

disclosure provisions that should be set forth in Commission rules.

The Commission also notes that proposed Rule 1.71 would not apply

in a situation where the customer is outside the U.S. and trades on a

Rule 30.11 exempt board of trade or foreign board of trade, but the

trade is given up for clearance after execution to an FCM. The focus of

Rule 1.71 is to assure that there is a sound automated system that will

be secure and provide for credit and trading or position limit checks

prior to execution, and the Commission does not believe that the above

situation would allow pre-screening by the FCM. Of course, the

Commission expects that an FCM will maintain appropriate internal

controls and supervision with respect to any account that it clears in

accordance with existing Rules 1.16 and 166.3.

The Commission is not proposing to apply the AORS definition or

Rule 1.71 to order routing for open outcry execution. The Commission

intends that these proposals would not alter its prior advisory

referred to above or impact on efforts of contract markets using open

outcry execution to enhance the automation of order flow.

4. Interim Procedures

Several commenters have requested that the Commission grant interim

relief to allow automated access from within the U.S. to boards of

trade primarily operated outside the U.S. in anticipation of the

Commission's final rules. The Commission appreciates the importance of

the issues involved in this rulemaking, but does not believe that it is

appropriate to grant interim relief either before the Commission's

adoption of final rules or pending the Commission's review of a board

of trade's petition. Interested boards of trade should feel free,

however, to begin a dialogue now with Commission staff to help expedite

their preparation and submission of a petition following the

Commission's adoption of final rules.

IV. 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 proposed rules discussed herein

would affect boards of trade, their members or members' affiliates and

FCMs. Many board of trade members and affiliates thereof will be FCMs.

The commission previously has determined that, based upon the fiduciary

nature of the FCM/customer relationships, as well as the requirement

that FCMs meet minimum financial requirements, FCMs should be excluded

from the definition of small entity.\45\ With respect to potentially

affected entities that are not FCMs, such entities must be board of

trade members or their affiliates, which generally have financial

requirements comparable to FCMs. On that basis, these entities should

not be considered ``small.'' Boards of trade likely to seek electronic

access to their products from within the U.S. are similar in nature to

designated contract markets, and the Commission has excluded contract

markets from the definition of small entity.\46\ Accordingly, on behalf

of the Commission, the Chairperson certifies that this proposed rule

will not have a significant economic impact on a substantial number of

small entities. Moreover, this proposal provides an alternative to the

contract market designation process and to compliance with the law and

rules related to contract markets and, in that respect, is less

burdensome than that currently in place. Nevertheless, we invite

comments regarding the applicability of the FRA to these proposed

rules.

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\45\ FR 18618-18621 (April 30, 1982).

\46\ Id.

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B. Paperwork Reduction Act

When publishing proposed rules, the Paperwork Reduction Act of 1995

(Pub.

[[Page 14174]]

L. 104-13 (May 13, 1995)) imposes certain requirements on federal

agencies (including the Commission) in connection with their conducting

or sponsoring any collection of information as defined by the Paperwork

Reduction Act. In compliance with the Act, the Commission, through

these rule proposals, solicits comments to:

(1) Evaluate whether the proposed collection of information is

necessary for the proper performance of the functions of the agency,

including the validity of the methodology and assumptions used; (2)

evaluate the accuracy of the agency's estimate of the burden of the

proposed collection of information including the validity of the

methodology and assumptions used; (3) enhance the quality, utility,

and clarity of the information to be collected; and (4) minimize the

burden of the collection of the information on those who are to

respond, including through the use of appropriate automated,

electronic, mechanical, or other technological collection techniques

or other forms of information technology, e.g., permitting

electronic submission of responses.

The Commission has submitted these proposed rules and their

associated information collection requirements to the Office of

Management and Budget. The burden associated with this entire

collection (3038-0023), including these proposed rules, is as follows:

Average Burden Hours Per Response: 39.36003.

Number of Respondents: 73,640.

Frequency of Response: On occasion.

The burden associated with this specific proposed rule, is as

follows:

Average Burden Hours Per Response: 21.25003.

Number of Respondents: 140.

Frequency of Response: On occasion and quarterly.

Persons wishing to comment on the estimated paperwork burden

associated with these proposed rules should contact Desk Officer,

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.

List of Subjects

17 CFR Part 1

Commodity futures; Automated order routing system.

17 CFR Part 30

Commodity futures; Foreign futures and foreign options.

In consideration of the foregoing, and pursuant to the authority

contained in the Commodity Exchange Act, and in particular, sections

2(a)91)(A), 4, 4c and 8a thereof, 7 U.S.C. 2, 6, 6c and 12a, the

Commission hereby proposes to amend parts 1 and 30 of chapter I of

title 17 of the code of Federal Regulations as follows:

PART I--GENERAL REGULATIONS UDNER THE COMMODITY EXCHANGE ACT

1. The authority citation ofr 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, 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 1.3 is proposed to be amended by adding paragraph (tt)

to read as follows:

Sec. 1.3 Definitions.

* * * * *

(tt) Automated order routing system. This term means any system of

computers, software or other devices that allows entry of orders

through another party for transmission to a board of trade's computer

or other automated device where, without substantial human

intervention, trade matching or execution takes place.

3. Section 1.71 is proposed to be added to read as follows:

Sec. 1.71 Automated order routing system.

(a) It shall be unlawful for a firm registered or required to be

registered as a futures commission merchant or a firm exempt from such

registration under Sec. 30.10 of this chapter to accept or transmit for

execution an order from or on behalf of a customer (other than an owner

or holder of a proprietary account as defined in Sec. 1.3(y)) or a

foreign futures or foreign options customer (as defined in Sec. 30.1(c)

of this chapter) that has been entered through an automated order

routing system, whether the system is operated, maintained or provided

to the customer or the foreign futures or foreign options customer by

the futures commission merchant, a firm exempt from such registration

under Sec. 30.10 of this chapter or by another person, unless the

automated order routing system is a qualified automated order routing

system: Provided, however that the requirements of this section shall

not apply to orders received by a firm registered or required to be

registered as a futures commission merchant or a firm exempt from such

registration under Sec. 30.10 of this chapter from a registered futures

commission merchant for that futures commission merchant's customer

omnibus accounts or proprietary accounts.

(b) To be a qualified automated order routing system, such

automated order routing system shall provide that:

(1) Access is limited to:

(i) Trading conducted on or subject to the rules of a designated

contract market, through a registered futures commission merchant;

(ii) Trading conducted on or subject to the rules of a board of

trade to which the Commission has issued an exemption order under

section 4(c) of the Act following the board of trade's submission of a

petition in accordance with Sec. 30.11 of this chapter; or

(iii) Trading conducted on a board of trade the products of which

are accessible as part of an automated trading system operated pursuant

to specific rules regarding the particular linkage arrangement that

have been submitted by a designated contract market to the Commission

and are in effect pursuant to section 5a(a)(12)(A) of the Act and

Sec. 1.41 and which is otherwise primarily operating outside the United

States.

(2) Access is limited to products that can be lawfully offered and

sold in the United States;

(3) The futures commission merchant or firm exempt from such

registration under Sec. 30.10 of this chapter takes reasonable steps to

ensure that the system is and remains sound and secure and fit for the

purpose for which it is intended;

(4) For futures commission merchants, information required by

Sec. 1.35(a-1)(1) is recorded in accordance with that paragraph, except

that order-related times must be captured to the nearest second;

(5) It is designed and operated consistent with the duty of the

futures commission merchant or firm exempt from such registration under

Sec. 30.10 of this chapter to maintain proper internal controls and

supervision over the handling of customer accounts. This must include,

but is not limited to, credit and trading or position limit checks that

are performed, either by a natural person or by the system itself,

prior to the order's execution. If such credit and trading or position

limit checks are automated, the futures commission merchant or firm

exempt from such registration under Sec. 30.10 of this chapter shall

implement proper internal controls to ensure that limits appropriate to

each customer or foreign futures or foreign options customer as

determined by personnel of the futures commission merchant or the firm

exempt from such registration under Sec. 30.10 of this chapter

authorized to set such limits are properly input into the

[[Page 14175]]

automated order routing system and updated as appropriate;

(6) The futures commission merchant or firm exempt from such

registration under Sec. 30.10 of this chapter has the capability on a

unilateral and immediate basis to block any customer's or foreign

futures or foreign options customers' use of an automated order routing

system where necessary or appropriate to safeguard the futures

commission merchant or firm exempt from registration under Sec. 30.10,

customer accounts or the stability or security of any designated

contract market or any board of trade referred to in paragraphs

(b)(1)(ii) and (iii) of this section; or for any other appropriate

reason;

(7) There are reasonable safeguards to ensure against unauthorized

access, unauthorized trading, and unauthorized disclosure of customer

or foreign futures or foreign options customer orders and to provide

overall integrity and security of the automated order routing system;

and

(8) For a futures commission merchant, that the futures commission

merchant has the capability to download trade history on each order

entered through an automated order routing system on a daily basis and

otherwise to maintain records related to such orders in accordance with

Sec. 1.31.

((c)(1) A futures commission merchant shall maintain in accordance

with Sec. 1.31 a record of those accounts of customers or foreign

futures or foreign options customers for which the futures commission

merchant will accept or transmit for execution orders that have been

entered through an automated order routing system. This record shall

also include the name of any person designated by the customer or

foreign futures or foreign options customer to exercise control over

the trading decisions for the account, which shall be readily

accessible during the first two years of the required five-year

retention period under Sec. 1.31.

(2) A firm that is exempt from registration as a futures Medicare

pursuant to an order granted by the Commission under Sec. 30.10 of this

chapter shall maintain in accordance with the recordkeeping

requirements of its home country regulator a record of those accounts

of foreign futures or foreign options customers for which the firm will

accept or transmit for execution orders that have been entered through

an automated order routing system. This record shall also include the

name of any person designated by the foreign futures or foreign options

customer to exercise control over the trading decisions for the account

and shall be made available upon the request of any Commission

representative.

PART 30--FOREIGN OPTIONS AND FOREIGN FUTURES TRANSACTIONS

4. The authority citation for part 30 continues to read as follows:

Authority: 7 U.S.C. 2, 4, 6, 6c, and 12a.

5. Section 30.3 is proposed to be amended by adding paragraphs (c)-

(e) to read as follows:

Sec. 30.3 prohibited transactions.

* * * * *

(c) Except as otherwise provided in Sec. 30.11, it shall be

unlawful to use or to provide to any person in the United States a

direct execution system (as defined in Sec. 30.11(a)(1)) for the

purpose of facilitating the execution of transactions in foreign

futures or foreign options unless the board of trade to which the

direct execution system provides access has been designated as a

contract market under section 5 of the Act.

(d) Except as otherwise provided in Sec. 30.11, it shall be

unlawful for any person to solicit or accept orders for, or to accept

money, securities or property in connection with, the purchase or sale

of foreign futures or foreign options by a foreign futures or options

customer that are entered via an automated order routing system (as

defined in Sec. 30.11(a)(2)) unless the board of trade through which

the transaction is to be executed has been designated as a contract

market under section 5 of the Act.

(e) notwithstanding the terms of any prior Commission order issued

under Sec. 30.10, it shall be unlawful for a firm operating pursuant to

a confirmation of a Commission order issued under Sec. 30.10 to accept

or transmit for execution an order from a foreign futures or foreign

options customer through an automated order routing system unless the

applicable requirements of Sec. 1.71 of this chapter are satisfied.

Sec. 30.11 [Redesignated as Sec. 30.12]

6. Section 30.11 is redesignated as Sec. 30.12 and a new Sec. 30.11

is added to read as follows:

Sec. 30.11 Access from the United States to automated trading systems

of a board of trade whose primary locus of regulation and operations is

otherwise outside the United States.

(a) Definitions: For purposes of this section:

(1) Direct execution system means any system of computers, software

or other devices that allows entry of orders for products traded on a

board of trade's computer or other automated device where, without

substantial human intervention, trade matching or execution takes

place: Provided, however, that this term shall not include an automated

order routing system as that term is defined in Sec. 1.3(tt) of this

chapter.

(2) Automated order routing system means automated order routing

system as defined in Sec. 1.3(tt) of this chapter.

(3) An affiliate of a member of a board of trade for purposes of

this rule means any person that:

(i) Owns 50% or more of a member;

(ii) Is owned 50% or more by the member; or

(iii) Is owned 50% or more by a third person that also owns 50% or

more of the member.

(4) Proprietary account means proprietary account as defined in

Sec. 1.3(y) of this chapter.

(b)(1) Upon the submission of a petition for exemption by a board

of trade in accordance with this section, the Commission may issue an

exemption order to the board of trade if the Commission determines

that:

(i) The petitioner is an established board of trade that wishes to

place within the United States an automated trading system permitting

access to trading its products but whose activities are otherwise

primarily located in a particular foreign country that has taken

responsibility for regulation of the petitioner;

(ii) The petitioner's home country has established a regulatory

scheme that is generally comparable to that in the U.S. and provides

basic protections for customers trading on markets and for the

integrity of the markets themselves;

(iii) Except for certain incidental contacts with the U.S., the

petitioner would be present in the U.S. only by virtue of being

accessible from within the U.S. via its automated trading system;

(iv) The petitioner is willing to submit itself to the jurisdiction

of the Commission and the U.S. courts in connection with its activities

conducted under an exemptive order;

(v) The petitioner's automated trading system has been approved by

the petitioner's home country regulator following a review of the

system that applied the standards set forth in the 1990 International

Organisation of Securities Commissions report on screen-based trading

systems (as may be revised and updated from time-to-time) or

substantially similar standards; and

(vi) Satisfactory information sharing arrangements are in effect

between the Commission and the petitioner and the petitioner's

regulatory authority.

[[Page 14176]]

(2) A petition of a board of trade made pursuant to this section

should be filed with the Secretary of the Commission and must contain

the following information, in English:

(i) The address of the petitioner's main business office and the

name, address, telephone number, facsimile number and electronic mail

address of a person to contact for additional information concerning

the petition;

(ii) The petitioner's articles of association, constitution, or

other similar organizational documents along with the date and place of

its establishment;

(iii) A complete description of the contracts that initially will

be traded through direct execution systems and/or automated order

routing systems located in the United States;

(iv) The petitioner's current rules including all rules for members

and users, which may be attached as an Appendix to the petition, and

shall include a description of membership requirements and classes and

distinctions between customer and proprietary trading;

(v) The address of the office responsible for monitoring compliance

with the petitioner's rules and the supervisory arrangements for

monitoring compliance with the rules insofar as the rules apply to

activities conducted in the United States, as well as the name and

address of the petitioner's home country regulator;

(vi) A description of the regulatory structure established in the

petitioner's home country, including, without limitation, a description

of the regulatory authority to which the petitioner is subject under

the laws of such country, the status of the petitioner under those

laws, and the applicable statutory and regulatory requirements

established by law or by the regulatory authority that govern the

operation of futures and options trading in the petitioner's home

country, including, without limitation, applicable regulations or

requirements concerning:

(A) Prohibition of fraud, abuse and market manipulation relating to

trading on petitioner's markets;

(B) Recordkeeping and reporting by the petitioner or its members;

(C) Fitness standards for intermediaries operating on petitioner's

markets, members, or others;

(D) Financial standards for the petitioner's members;

(E) Protection of customer funds, including procedures in the event

of a clearing member's default, insolvency or bankruptcy;

(F) Trade practice standards;

(G) Rule review or general review of board of trade operations by

its regulatory authority;

(H) Surveillance, compliance, and enforcement mechanisms employed

by the board of trade and its regulatory authority to ensure compliance

with their rules and regulations; and

(I) Regulatory oversight of clearing facilities; Provided, however,

that if the petitioner or the regulatory authority that governs the

petitioner has received an order of exemption, for trading on the

petitioning board of trade, from the Commission under Sec. 30.10 and

the information required by paragraphs (b)(2) (ii), (iv) and (vi) of

this section was provided to the Commission in the petition for such

order and has not changed materially from the date of the Commission's

order, the petitioner may, in lieu of furnishing the information

otherwise required under paragraphs (b)(2) (ii), (iv) and (vi) of this

section, make a statement to such effect which shall specify the

date(s) the information was provided to the Commission and the name of

the petitioner who received an order from the Commission under

Sec. 30.10;

(vii) Information sharing arrangements in effect between the board

of trade and the regulatory authority in the petitioner's home country

and the Commission, including information concerning any blocking

statutes or data protection laws in effect in the petitioner's home

country that might impair the Commission's ability to obtain

information in accordance with such an arrangement;

(viii) A general description of the order matching/execution system

and any direct execution system, software or devices operated by the

board of trade, including, at a minimum, a general description of the

architecture and security features of the systems, a statement as to

the length of time such systems have been operating, a complete history

of any significant system failures or interruptions, and a discussion

of the nature of any technical review of the board of trade's order

matching/execution system or direct execution system performed by the

board of trade's home country regulator, including a copy of any order

or certification received and any discrepancies between the standard of

review and the principles for screen-based trading set forth by the

International Organisation of Securities Commissions: Provided,

however, that if the information required by this paragraph has been

provided to the Commission, or will be provided to the Commission

contemporaneously with the board of trade's petition, by another board

of trade whose products trade through the same direct execution system

or automated order routing system as the petitioner, the petitioner

must so state and must identify the board of trade that has or will

provide the Commission with the required information and need not

itself provide the information required under this paragraph, but will

remain responsible for the provision of such information by the other

board of trade;

(ix) A description of all activities engaged in by the board of

trade or its employees, agents or representatives in the United States,

including, but not limited to, activities in connection with marketing,

education or otherwise promoting the board of trade's business or

products;

(x) The address of, and a description of activities engaged in by,

any office of the board of trade located in the United States and the

number of personnel employed or retained by the board of trade in the

United States, including the number of personnel in each such office;

(xi) If the petitioner lists for trading any futures contracts that

involve physical delivery of the underlying commodity and warehouses in

connection with such delivery are located in the United States, its

territories or possessions, the address of any such warehouses;

(xii) A written statement in which the petitioner consents to or

agrees to comply with each of the conditions listed in paragraph (d) of

this section; and

(xiii) Any further information that the Commission or its

representatives request.

(c) To the extent that the products of multiple boards of trade are

to be traded from the same direct execution system or automated order

routing system, each board of trade whose products will be made

available from such systems located in the United States must, either

individually or jointly, submit a petition in accordance with this

section: Provided, however, that a board of trade's products may be

offered through direct execution systems or automated order routing

systems located in the United States and need not submit a petition to

the Commission under this section or be designated as a contract market

under section 5 of the Act if its products are accessible as part of an

electronic trading system operated pursuant to specific rules regarding

the particular linkage arrangement that have been submitted by a

designated contract market to the Commission for review and are in

effect under section 5a of the Act.

[[Page 14177]]

(d) The Commission may issue an order under section 4(c) of the Act

and the provisions of this section subject to such terms and conditions

as the Commission may find appropriate: Provided, however, that any

order issued to a board of trade under this section will be subject to

the following conditions at a minimum, unless otherwise specified in

the order by the Commission:

(1) Only members of the board of trade and affiliates thereof will

have access to direct execution systems, and the board of trade will

not provide, and will take reasonable steps to prevent third parties

from providing, direct execution systems to persons other than members

and their affiliates;

(2) Unless otherwise exempt from registration, any member or

affiliate thereof that solicits or accepts orders for, or accepts

money, securities or property in connection with the purchase or sale

of foreign futures or foreign options by a foreign futures or foreign

options customer via an automated order routing system, or that

transmits the order of a foreign futures or foreign options customer

via a direct execution system, must be a registered futures commission

merchant or a firm exempt from such registration pursuant to an order

granted under Sec. 30.10;

(3) The board of trade will submit the following information to the

Commission on at least a quarterly basis:

(i) For each contract available to be traded through direct

execution systems and automated order routing systems located in the

United States, the total trade volume originating from such systems

located in the United States; and

(ii) For each contract available to be traded through direct

execution systems and automated order routing systems located in the

United States, the board of trade's total worldwide trade volume, from

any source;

(iii) A current list that:

(A) Identifies and provides the main business addresses in the

United States for those of its members and affiliates thereof that have

direct execution systems in the United States and indicates which of

such members and affiliates thereof allow the use of automated order

routing systems for foreign futures and foreign options customers; and

(B) Identifies and provides the main business addresses for those

of its members and affiliates thereof that allow the use of automated

order routing systems by foreign futures and foreign options customers,

but who do not have direct execution systems in the United States:

Provided, however, that the board of trade will additionally provide a

current list to a Commission representative at any time upon request;

(4) The board of trade will provide the Commission with written

notice within 30 calendar days of:

(i) Any material change to any information provided in its petition

to the commission for a section 4(c) exemption order under this

section: Provided, however, that the board of trade will notify the

Commission in writing:

(A) At least ten business days prior to offering any products not

listed in its initial petition to be traded through direct execution

systems or automated order routing systems located in the United States

and;

(B) Within 24 hours of any significant system failure or

interruption or a member's default, insolvency or bankruptcy;

(ii) A change in any laws or rules in the board of trade's home

country relevant to futures or options, including rules of the board of

trade itself, that may have a material impact on the order;

(iii) Any known violation of any obligations under the order

committed by a member of the board of trade or an affiliate thereof

operating in the United States under the order; and

(iv) Any disciplinary action taken against a member of the board of

trade or an affiliate thereof operating in the United States under the

order that involves any market manipulation, fraud, deceit or

conversion or that results in suspension or expulsion and that involves

the use of a direct execution system or an automated order system in

the United States;

(5) Satisfactory information sharing arrangements must remain in

effect between the board of trade and the board of trade's regulatory

authority and the Commission;

(6) Prior to operating pursuant to the section 4(c) exemption

order, the board of trade must file with the Commission, and maintain

thereafter as long as the board of trade operates pursuant to the

order, a valid and binding appointment of an agent for service of

process in the United States, pursuant to which such agent is

authorized to accept delivery and service of communications issued by

or on behalf of the Commission, the Department of Justice, any board of

trade member or affiliate of such member, or any foreign futures or

foreign options customer. Service or delivery of any communication

issued by or on behalf of any of the foregoing to the appointed agent

shall constitute valid and effective service or delivery; and

(7) Prior to operating pursuant to the section 4(c) exemption

order, the board of trade must file with the Commission a written

representation, executed by someone with authority to bind the board of

trade, that, as long as the board of trade operates pursuant to the

order, the board of trade irrevocably agrees to and submits to the

jurisdiction of the Commission and state and federal courts in the

United States with respect to the board of trade's activities conducted

under the section 4(c) exemption order;

(8) The Commission, in its discretion, may require other

information of the board of trade to evaluate its continued eligibility

for or compliance with conditions of a section 4(c) exemption order, or

for any other reason. The Commission may require the board of trade to

provide information regarding the stocks held at any warehouse

maintained by the board of trade in the U.S. for products that require

physical delivery.

(e) The Commission shall publish in the Federal Register a notice

of availability of each petition received under paragraph (b) of this

section for the purpose of providing notice to the public. Interested

parties may request a copy of the petition or relevant parts thereof

from the Secretary of the Commission: Provided, however, that the

Commission may limit the public availability of any information

received from the petitioner if the petitioner submits a written

request to limit disclosure contemporaneously with the petition and the

Commission determines that the information sought to be restricted

constitutes a trade secret or that public disclosure of the information

would result in material competitive harm to the petitioner.

(f) The Commission may, as it deems appropriate, condition, modify,

suspend, terminate, or otherwise restrict the terms of an order issued

under section 4(c) of the Act in accordance with this section if the

Commission determines that a board of trade that has received a section

4(c) exemption order in accordance with this section is in material

violation of any term or condition of the order, or this section that

the continued effectiveness of the order would be contrary to public

policy or the public interest, or that circumstances otherwise do not

warrant continuation of the order as issued. The Commission may take

such action with respect to the order in its entirety or with respect

to a specific person or persons operating thereunder.

(g) Any trading conducted on or subject to the rules of a board of

trade

[[Page 14178]]

that has received a section 4(c) exemption order in accordance with

this section or a board of trade the products of which are accessible

as part of an automated trading system operated pursuant to specific

rules regarding the particular linkage arrangement that have been

submitted by a designated contract market to the Commission and are in

effect pursuant to section 5a(a)(12)(A) of the Act and Sec. 1.41 of

this chapter and which otherwise operates primarily outside the United

States shall be deemed to involve the trading of foreign futures or

foreign options, as appropriate, under the definitions of Sec. 30.1(a)

and (b) and under any provisions that refer to those definitions. A

person located in the United States, its territories or possessions

engaged in such trading shall be deemed to be a foreign futures or

foreign options customer under Sec. 30.1(c).

Issued in Washington, DC on March 16, 1999 by the Commission.

Jean A. Webb,

Secretary of the Commission.

Commissioner Barbara P. Holum joining in the concurring opinions of

Commissioners Spears and Newsome.

Dated: March 16, 1999.

Commissioner Barbara P. Holum.

Concurring Opinion of Commissioner David D. Spears--Proposed Rules

Concerning Access to Automated Boards of Trade

I have significant reservations about the complexity of the

proposed rules. I believe the elaborate regulatory system this proposal

envisions could impose unnecessary burdens on US FCMs and could be

cited by foreign regulators as justification for imposing unnecessarily

restrictive requirements on US exchanges. However, I also recognize

that the Commission needs to act as quickly as possible to address

issues relating to access to foreign boards of trade from within the

US. Further delay in issuing proposed rules to allow for additional

revisions or refinements in the proposal would be a disservice to those

affected by the proposal. The investing public and the futures industry

have every right to expect this agency to act expeditiously in bringing

legal certainty to this area. Therefore, I have voted to issue the

proposed rules in the form presented. However, I would urge commenters

to review the proposal carefully with an eye toward suggesting

revisions that would make the rules simpler without detracting from

adequate customer protection or the fair and even-handed treatment of

all affected parties.

Concurring Opinion of Commissioner James E. Newsome--Proposed Rules

Concerning Automated Trading System Use in the United States

I respectfully concur in the issuance of the proposed rules

concerning automated trading system use in the United States. I agree

that the proposal should be released for public comment, but I do not

agree with the approach detailed therein, for the reasons stated below.

My concerns are twofold: first, I believe that the proposal is

overly regulatory in approach, and secondly, I believe that there are

troublesome jurisdictional issues inherent in the proposed regulation,

specifically, the use of the Commodity Exchange Act's Sec. 4(c)

exemptive authority and the possible conflict with the Act's Sec. 4(b)

jursidictional limitations. I do not believe that the proposal

appropriately mitigates the competitive concerns of our domestic

exchangers, and, indeed, may well exacerbate the issue of inequitable

regulatory treatment. Moreover, I believe that there are unnecessary

additional burdens included in this proposal that would negatively

affect the futures commission merchant community.

Given the widespread interest in this issue and the unfortunate

delay in its release, I support moving forward expeditiously and giving

the public another opportunity to comment on the proposal. However, I

strongly urge interested parties to comment particularly on the issues

I have mentioned, as well as alternative methods of addressing this

issue, including, for example, the use of no-action procedures or the

CEA's Part 30 Regulations.

Dated: March 15, 1999.

James E. Newsome,

Commissioner.

[FR Doc. 99-6829 Filed 3-23-99; 8:45 am]

BILLING CODE 6351-01-M