[Federal Register Volume 62, Number 77 (Tuesday, April 22, 1997)]
[Proposed Rules]
[Pages 19530-19534]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 97-10338]
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COMMODITY FUTURES TRADING COMMISSION
17 CFR Part 190
Proposed Amendment to Part 190, Appendix B, to Govern the
Distribution of Customer Property Related to Trading on the Proposed
Chicago Board of Trade--London International Financial Futures and
Options Exchange Trading Link
AGENCY: Commodity Futures Trading Commission.
ACTION: Notice of a proposed amendment to Part 190, Appendix B, to
govern the distribution of customer property related to trading on the
proposed Chicago Board of Trade--London International Financial Futures
and Options Exchange Trading Link.
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SUMMARY: In connection with the proposal of the Board of Trade of the
City of Chicago (``CBT'') to establish a link (``Link'') with the
London International Financial Futures and Options Exchange
(``LIFFE''),\1\ the Commodity Futures Trading Commission
(``Commission'') is proposing to amend an Appendix to its bankruptcy
rules to govern the distribution of property where the debtor is a
futures commission merchant (``FCM'') that maintains customer accounts
that carry or trade positions in Designated CBT Contracts at LIFFE or
Designated LIFFE Contracts at CBT (``Link Accounts'') as well as non-
Link accounts. This new distributional framework is intended to assure
that non-Link customers of such an FCM would not be affected adversely
by a shortfall in Section 4d(2) segregated funds caused by the
operation of the Link. The new distributional framework would become
effective upon the effective date of the Link.
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\1\ The proposal to establish a Link arrangement between CBT and
LIFFE was previously published for comment. 61 FR 16899. (April 18,
1996).
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DATES: Comments must be received on or before May 7, 1997.
FOR FURTHER INFORMATION CONTACT: Lois J. Gregory, Attorney, Division of
Trading and Markets, Commodity Futures Trading Commission, Three
Lafayette Centre, 1155 21st Street, N.W., Washington, D.C. 20581.
Telephone: (202) 418-5483.
SUPPLEMENTARY INFORMATION:
I. Trading in Link Contracts
The CBT, LIFFE and their respective clearing houses have entered
into a Link Agreement, and CBT has sought Commission approval of rules
which would permit the establishment of trading and clearing
arrangements for Designated CBT Contracts \2\ to be traded on LIFFE,
initially cleared by the London Clearing House Limited (``LCH''), and
transferred to the Board of Trade Clearing Corporation (``BOTCC''), and
Designated LIFFE Contracts \3\ to be traded on the CBT, initially
cleared by BOTCC, and transferred to LCH.
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\2\ Designated CBT Contracts would consist of U.S. Treasury Bond
futures and futures options. At a later date, it is anticipated that
10 Year U.S. Treasury Note futures and futures options and 5 Year
U.S. Treasury Note futures and futures options would be added.
\3\ Designated LIFFE Contracts would consist of German
Government Bond futures and futures options. At a later date,
British Gilt futures and futures options and futures and futures
options on the Italian Government Bond would be added.
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In the case of Designated CBT Contracts traded on LIFFE, the U.S.
FCM would likely maintain a customer omnibus account with a LIFFE
clearing member. Each day, LCH would mark futures positions to a
closing price, pay to and collect from the LIFFE clearing member the
difference between trade price and mark price, pay and collect option
premiums and, at the request of the LIFFE clearing member, net
positions prior to their transfer to BOTCC at approximately 10:00 a.m.
Chicago time. Bank settlement commitments would be required in response
to instructions for Link variation obligations on trade date (``T''),
with payment expected to be made to LCH on the next day (``T+1'').
Also, if the CBT were closed for a holiday, LCH would hold positions in
Designated CBT Contracts overnight and could call for margin. Property
of the customers of the U.S. FCM that accrued to such customers as the
result of such trades or contracts prior to their transfer to BOTCC or
which was deposited to margin, guarantee or secure trades or contracts
in Designated CBT Contracts at LIFFE would be deemed to be ``Link
property''. During the interval before transfer back from LCH to BOTCC,
Link property at LCH could for operational purposes be held in a
foreign depository as provided in CFTC Advisory 87-5.\4\
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\4\ Comm. Fut. L. Rep., para. 23,997 (December 3, 1987).
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In the case of Designated LIFFE Contracts traded on CBT, property
received by the U.S. FCM to margin,
[[Page 19531]]
secure or guarantee trades would be included in the foreign futures and
foreign options secured amount, pursuant to Commission Regulation 30.7.
The BOTCC has requested a no action position to permit certain excess
property contained in such secured amount and separately accounted for
to be used to meet original margin requirements for U.S. contracts
under Section 4d(2) of the Act. Such excess property held in a combined
BOTCC account but applied to margin requirements for U.S. contracts as
Section 4d(2) property would also be ``Link property'' under this
Framework.
To the extent that positions in Designated CBT Contracts executed
on LIFFE and property supporting or accruing from those positions are
deemed to be customer property under Section 4d(2) of the Act, or
certain foreign currency margin deposited in respect of Designated
LIFFE Contracts is held in a Section 4d(2) clearing account, any
customer net equity claim in respect of such Link property held by an
FCM in a Link account would be treated as a customer net equity claim
under Part 190 of the Commission's rules \5\ and subchapter IV of
chapter 7 of the Bankruptcy Code (the commodity broker liquidation
provisions).\6\ In the case of an FCM bankruptcy, the commodity broker
liquidation provisions of the Bankruptcy Code and Part 190 of the
Commission's rules provide for a pro rata distribution of assets in
proportion to net equity claims among the Section 4d(2) customers whose
accounts were carried by such FCM. Thus, absent some provision to the
contrary, if a participating FCM defaulted due to losses in its Link-
related account(s), non-Link customers could be forced to share in
losses generated by a shortfall in Link property. To avoid that result,
the new framework would provide a rule of distribution that would
operate to subordinate claims for Link property to Section 4d(2) claims
overall as reflected in Appendix B.
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\5\ 17 CFR part 190.
\6\ 11 U.S.C. Secs. 761-766.
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II. New Bankruptcy Distribution in the Context of the CBT-LIFFE
Link
When the Commission adopted its Part 190 bankruptcy regulations,\7\
it included an Appendix intended to facilitate the execution of a
trustee's duties, forms concerning customer instructions for return of
non-cash property and transfer of hedge positions, and a proof of claim
form. The Commission later adopted Appendix B to provide guidance to a
trustee on the appropriate distribution of property where an FCM's
customers cross-margined non-proprietary futures positions with certain
securities positions.\8\
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\7\ 48 FR 8716 (March 1, 1983).
\8\ 59 FR 17468 (April 13, 1994).
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The proposed extension of Appendix B would have the effect of
subordinating claims for Link property to claims for non-Link property
when a shortfall in Link property was greater than the shortfall, if
any, of non-Link property. The proposed amendment follows the guiding
principles of Appendix B to Part 190: To assure that generally there is
pro rata distribution to customers of the customer property in the
bankrupt FCM's commodity interest estate and that the satisfaction of
non-Link customer claims are not adversely affected by a shortfall in
the pool of Link property. The proposed amendment is intended to assure
that non-Link claims would never receive less than they would have
received in the absence of the Link, but the distributional rule would
not require Link-related claims to be subordinated in every instance.
Under the proposal, a bankruptcy trustee handling the commodity
interest estate of a bankrupt FCM with Link property first would have
to determine the respective shortfalls, if any, in the pools of Link
customer and non-Link customer segregated funds. The trustee would then
calculate the shortfall in each pool as a percentage of the segregation
requirement for the pool. In making this determination, any shortfall
in Link property held overseas could be offset in whole or in part by
any excess funds held by the FCM in segregation in the United States.
If there were: (1) No shortfall in either of the two pools; (2) an
equal percentage shortfall in the two pools; (3) a shortfall in the
non-Link pool only; or (4) a greater percentage of shortfall in the
non-Link pool than in the Link pool, then the two pools of segregated
funds would be combined and Link customers and non-Link customers would
share pro rata in the combined pool.\9\
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\9\ See examples 1, 2, 5 and 6 of proposed Appendix B to part
190, Framework 2.
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However, if there were: (1) A shortfall in the Link pool only, or
(2) a greater percentage of shortfall in the Link pool than in the non-
Link pool, then the two pools of segregated funds would not be
combined.\10\ Rather, Link customers would share pro rata in the pool
of Link segregated funds (including any excess funds held by the FCM in
segregation in the U.S.), while non-Link customers would share pro rata
in the pool of non-Link segregated funds. Further, if a pool of
property initially would be treated as if it had a shortfall because
frozen or otherwise unavailable as the result of government action, and
later the freeze were lifted or funds became available, subsequent
distribution would not be permitted to result in customers for whom
funds were frozen receiving any greater distribution than a pro rata
distribution for Section 4d (segregated funds) customers as a whole. To
facilitate this distributional framework, subclasses of customer
accounts, a Link account and a non-Link account would be recognized.
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\10\ See examples 3 and 4 of proposed Appendix B to part 190,
Framework 2.
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Like the existing distribution system for a bankrupt FCM with
customer claims related to cross-margining, the proposed Appendix would
assure that non-Link customers would never receive less than they would
have received in the absence of the Link. The proposed Framework to the
Appendix is intended to eliminate the need for each customer who seeks
to trade pursuant to the Link to execute a separate subordination
agreement.
III. Request for Comments
The Commission requests comments from interested persons concerning
any aspect of the proposed amendment to Part 190, Appendix B, to govern
the distribution of customer property related to trading on the
proposed CBT-LIFFE Link.
Any person interested in submitting written data, views, or
arguments on the proposal should send such comments to Jean A. Webb,
Secretary, Commodity Futures Trading Commission, Three Lafayette
Centre, 1155 21st Street, N.W., Washington, D.C. 20581 by the specified
date. In addition, comments may be sent by facsimile transmission to
facsimile number (202) 418-5521, or by electronic mail to
secretary@cftc.gov. Reference should be made to the proposed amendment
to Part 190, Appendix B.
IV. Related Matters
A. Regulatory Flexibility Act
The Regulatory Flexibility Act (RFA), 5 U.S.C. sections 601-611
(1988), requires that agencies, in proposing rules, consider the impact
of those rules on small businesses. These rules would affect
distributees of a bankrupt FCM's estate where the FCM had entered into
a Link Clearing Agreement with a clearing member of LIFFE to transfer
or accept the transfer of positions in Designated Link Contracts. The
proposed appendix would eliminate the need for customers of FCMs who
wish
[[Page 19532]]
to participate in the Link to execute a subordination agreement.
Further, the distributional framework is intended to assure that non-
Link customers of such FCM would not be disadvantaged by a shortfall in
the pool of Link funds. Persons participating in the Link will be
provided with special risk disclosure related to such participants.
Thus the adoption of this bankruptcy distributional rule should not in
itself have a significant economic impact on such customers electing to
participate but rather should operate to facilitate the Link
arrangement. Therefore, the Chairperson, on behalf of the Commission,
hereby certifies pursuant to 5 U.S.C. 605(b), that the action taken
herein would not have a significant economic impact on a substantial
number of small entities. The Commission nonetheless invites comments
from any person or entity which believes that the proposal would have a
significant impact on its operations.
B. Paperwork Reduction Act
The Paperwork Reduction Act of 1995 (Pub. L. 104-13 (May 13, 1996))
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.
This rule would eliminate the need to execute a document and therefore
would reduce rather than increase paperwork. While this rule has no
burden, the group of rules (3038-0021) of which this is a part has the
following burden:
Average burden hours per response: 0.35.
Number of Respondents: 802.
Frequency of response: On occasion.
Copies of the OMB approved information collection package
associated with this rule may be obtained from Desk Officer, CFTC,
Office of Management and Budget, Room 10202, NEOB Washington, D.C.
20503, (202) 395-7340.
List of Subjects in 17 CFR Part 190
Bankruptcy.
Accordingly, the Commission pursuant to the authority contained in
the Commodity Exchange Act and, in particular, Sections 1a, 2(a), 4c,
4d, 4g, 5, 5a, 8a, 15, 19 and 20 thereof, 7 U.S.C. 1a, 2 and 4a, 6c,
6d, 6g, 7, 7a, 12a, 19, 23 and 24 (1994), and in the Bankruptcy Code
and, in particular, Sections 362, 546, 548, 556 and 761-766 thereof, 11
U.S.C. 362, 546, 548, 556 and 761-766 (1994), hereby proposes to amend
Part 190 of Chapter I of title 17 of the Code of Federal Regulations as
follows:
PART 190--BANKRUPTCY
1. The authority citation for Part 190 continues to read as
follows:
Authority: 7 U.S.C. 1a, 2, 4a, 6c, 6d, 6g, 7, 7a, 12, 19, 23 and
24 and 11 U.S.C. 362, 546, 548, 566 and 761-766.
2. Part 190 is proposed to be amended by adding to Appendix B
thereof the following:
Appendix B to Part 190--Special Bankruptcy Distributions
* * * * *
Framework 2--Special Distribution of Customer Funds When FCM
Participated in the Trading of Designated Link Contracts Pursuant to
the CBT-LIFFE Link
The Commission has established the following distributional
convention with respect to Section 4d customer funds held by a
futures commission merchant (``FCM'') that participates in the
trading of Chicago Board of Trade (``CBT'')--designated contracts
executed on the London International Financial Futures and Options
Exchange (``LIFFE'') or LIFFE-designated contracts executed on CBT
(``Designated Link Contracts'') pursuant to the CBT-LIFFE Link
(``Link'') which shall apply if customers of the FCM have been
provided with a notice which makes reference to this distributional
rule and the form of such notice has been approved by the Commission
by rule, regulation or order. The maintenance of property in a Link
account would result in subordination of the claim for such property
to certain non-Link customer claims in certain circumstances. This
creates subclasses of customer accounts required to be segregated
for purposes of Section 4d(2) of the Commodity Exchange Act: a Link
account and a non-Link account (a person could hold each type of
account), and results in two pools of customer segregated funds: a
Link pool and a non-Link pool.
In the event that there is a shortfall in the non-Link pool of
customer segregated funds, and there is no shortfall in the Link
pool of customer segregated funds, customer net equity claims,
whether or not they arise out of the Link subclass of accounts, will
be combined and will be paid pro rata out of the total pool of
available Link and non-Link customer funds. In the event that there
is a shortfall in the Link pool of customer segregated funds, and
there is no shortfall in the non-Link pool of customer segregated
funds, customer net equity claims arising from the non-Link subclass
of accounts shall be satisfied from the non-Link customer segregated
funds, and customer net equity claims arising from the Link subclass
of accounts shall be paid from the Link customer segregated funds
(and, if applicable, any excess funds held by the FCM in segregation
in the U.S.). Furthermore, in the event that there is a shortfall in
both the non-Link and Link pools of customer segregated funds: (1)
If the non-Link shortfall as a percentage of the segregation
requirement in the non-Link pool is greater than or equal to the
Link shortfall as a percentage of the segregation requirement in the
Link pool, customer net equity claims will be paid pro rata; and (2)
if the Link shortfall as a percentage of the segregation requirement
in the Link pool is greater than the non-Link shortfall as a
percentage of the segregation requirement of the non-Link pool, non-
Link customer net equity claims would be paid pro rata out of the
available non-Link segregated funds, and Link customer net equity
claims would be paid pro rata out of the available Link segregated
funds. In this way, non-Link customers will never be disadvantaged
by a Link shortfall.\11\
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\11\ Because Link property will be located offshore, it is
possible that such property could be frozen by governmental action
or become unavailable as the result of sovereign events. In that
situation, should such property subsequently become available, the
Link property account may acquire no greater distributional share
than Section 4d(2) (segregated funds) customers generally.
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The following examples illustrate the operation of this
convention. The examples assume that the FCM has two customers, one
with exclusively Link accounts and one with exclusively non-Link
accounts. In practice, the FCM would have a customer omnibus account
with a LIFFE clearing member or would itself be a LIFFE clearing
member with its own customer omnibus account. Positions in
Designated CBT Contracts traded at LIFFE and initially cleared by
LCH would be allocated to this customer omnibus account; following
the transfer of the positions via the Link, the FCM would allocate
the positions and any gains or losses to its customers' accounts.
Accordingly, a customer who trades Designated CBT Contracts at LIFFE
may have the portion of his account which reflects his activity in
the customer omnibus account at LIFFE deemed a Link account and the
remainder of the account a non-Link account. Effectively this will
result in the customer having two claims--one against Link property
and one against non-Link property.\12\
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\12\ Certain other property of the customers of the U.S. FCM
also will be treated as ``Link property'' and part of the Link
account for purposes of this Framework 2. In the case of Designated
LIFFE Contracts traded on CBT, property received by the U.S. FCM to
margin, guarantee or secure trades is included in the foreign
futures and foreign options secured amount, pursuant to Commission
Regulation 30.7. The BOTCC has requested a no action position to
allow certain property in excess of the required secured amount to
be used to meet original margin requirements for U.S. contracts
under Section 4d(2) of the Act. Such excess property held in a
``combined'' account but applied to margin requirements for U.S.
contracts as Section 4d(2) property would also be ``Link property''
under this Framework.
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Non-link Link Total
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1. Sufficient Funds to Meet Non-Link and Link Customer Claims:
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Funds in segregation................................ 150 150 300
Segregation Requirement............................. 150 150 300
Shortfall (dollars)................................. 0 0 ..................
Shortfall (percent)................................. 0 0 ..................
Distribution........................................ 150 150 300
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There are adequate funds available, and both the non-Link and Link customer claims will be paid in full.
2. Shortfall in Non-Link Only:
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Funds in segregation................................ 100 150 250
Segregation Requirement............................. 150 150 300
Shortfall (dollars)................................. 50 0 ..................
Shortfall (percent)................................. 50/150=33.3 0 ..................
Pro Rata (percent).................................. 150/300=50 150/300=50 ..................
Pro Rata (dollars).................................. 125 125 ..................
Distribution........................................ 125 125 250
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Due to the non-Link account, there are insufficient funds available to meet both the non-Link and the Link
customer claims in full. Each customer will receive his or her pro rata share of the funds available, or 50% of
the $250 available, or $125.
3. Shortfall in Link Only:
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Funds in segregation................................ 150 100 250
Segregation Requirement............................. 150 150 300
Shortfall (dollars)................................. 0 50 ..................
Shortfall (percent)................................. 0 50/150=33.3 ..................
Pro Rata (percent).................................. 150/300=50 150/300=50 ..................
Pro Rata (dollars).................................. 125 125 ..................
Distribution........................................ 150 100 250
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Due to the Link account, there are insufficient funds available to meet both the non-Link and Link customer
claims in full. Accordingly, the Link funds and non-Link funds are treated as separate pools, and the non-Link
customer will be paid in full, receiving $150, while the Link customer would receive the remaining $100.
4. Shortfall in Both, Link Shortfall Exceeding Non-Link Shortfall:
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Funds in segregation................................ 125 100 225
Segregation Requirement............................. 150 150 300
Shortfall (dollars)................................. 25 50 ..................
Shortfall (percent)................................. 25/150=16.7 50/150=33.3 ..................
Pro Rata (percent).................................. 150/300=50 150/300=50 ..................
Pro Rata (dollars).................................. 112.50 112.50 ..................
Distribution........................................ 125 100 225
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There are insufficient funds available to meet both the non-Link and Link customer claims in full, and the
Link shortfall exceeds the non-Link shortfall. The non-Link customer will receive $125 available with respect to
non-Link claims while the Link customer will receive the $100 available with respect to the Link claims.
5. Shortfall in Both, With Non-Link Shortfall Exceeding Link Shortfall:
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Funds in segregation................................ 100 125 225
Segregation Requirement............................. 150 150 300
Shortfall (dollars)................................. 50 25 ..................
Shortfall (percent)................................. 50/150=33.3 25/150=16.7 ..................
Pro Rata (percent).................................. 150/300=50 150/300=50 ..................
Pro Rata (dollars).................................. 112.50 112.50 ..................
Distribution........................................ 112.50 112.50 225
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There are insufficient funds available to meet both the non-Link and Link customer claims in full, and the
non-Link shortfall exceeds the Link shortfall. Each customer will receive 50% of the $225 available, or $112.50.
6. Shortfall in Both, Non-Link Shortfall = Link Shortfall:
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Funds in segregation................................ 100 100 200
Segregation Requirement............................. 150 150 300
Shortfall (dollars)................................. 50 50 ..................
Shortfall (percent)................................. 50/150=33.3 50/150=33.3 ..................
Pro Rata (percent).................................. 150/300=50 150/300=50 ..................
Pro Rata (dollars).................................. 100 100 ..................
Distribution........................................ 100 100 200
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[[Page 19534]]
There are insufficient funds available to meet both the non-Link and the Link customer claims in full, and the
non-Link shortfall equals the Link shortfall. Each customer will receive 50% of the $200 available, or $100.
7. Shortfall in Link Account Caused by Freeze That Is Subsequently Lifted, Where Non-Link Account Had Actual
Shortfall But Link Account Did Not Sub -sequent to Lifting of Freeze Order:
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Funds in segregation................................ 100 Frozen 100
Segregation Requirement............................. 150 150 300
Shortfall (dollars)................................. 50 150 ..................
Shortfall (percent)................................. 50/150=33.3 150/150=100 ..................
Pro Rata (percent).................................. 150/300=50 150/300=50 ..................
Pro Rata (dollars).................................. 50 50 ..................
Initial Distribution................................ 100 0 100
Freeze Lifted: Funds Previously Frozen.............. 0 150 150
Subsequent Distribution............................. 25 125 ..................
Total Distribution.................................. 125 125 250
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Through the time of the initial distribution, this situation would follow the pattern of Example 4 because
the shortfall in the Link account was larger. After the freeze was lifted, it would follow the pattern of
Example 2 because the shortfall in the non-Link account was larger.
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These examples illustrate the principle that pro rata distribution across both accounts is the preferable
approach except when a shortfall in the Link account could harm non-Link customers. Thus, pro rata
distribution occurs in Examples 1, 2, 5 and 6. Separate treatment of the Link and non-Link accounts occurs in
Examples 3 and 4. In Example 7, separate treatment occurs where the funds are frozen. It is adjusted to become
pro rata treatment after the freeze is lifted.
Issued in Washington, D.C. on April 16, 1997 by the Commission.
Jean A. Webb,
Secretary of the Commission.
[FR Doc. 97-10338 Filed 4-21-97; 8:45 am]
BILLING CODE 6351-01-P
