[Federal Register Volume 63, Number 166 (Thursday, August 27, 1998)]
[Rules and Regulations]
[Pages 45699-45711]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 98-22933]
=======================================================================
-----------------------------------------------------------------------
COMMODITY FUTURES TRADING COMMISSION
17 CFR Part 1
Orders Eligible for Post-execution Allocation
AGENCY: Commodity Futures Trading Commission.
ACTION: Final rule.
-----------------------------------------------------------------------
SUMMARY: The Commodity Futures Trading Commission (``Commission'') has
amended Commission Regulation 1.35(a-1) to allow bunched orders for
eligible customers to be placed on a contract market without specific
customer account identification either at the time of order placement
or at the time of report of execution. Specifically, the amendment
exempts from the customer account identification requirements of
Regulation 1.35(a-1)(1), (2)(i), and (4) bunched futures and/or option
orders placed by eligible account managers on behalf of eligible
customer accounts. The amendment permits bunched orders entered on
behalf of these accounts to be allocated no later than the end of the
day on which the order is executed.
EFFECTIVE DATE: October 26, 1998.
FOR FURTHER INFORMATION CONTACT: I. Michael Greenberger, Director; Alan
L. Seifert, Deputy Director; John C. Lawton, Associate Director; Duane
C. Andersen, Special Counsel, Division of Trading and Markets,
Commodity Futures Trading Commission, Three Lafayette Centre, 1155 21st
Street, N.W., Washington, D.C. 20581. Telephone: (202) 418-5430.
SUPPLEMENTARY INFORMATION:
Table of Contents
I. Background
A. Current Regulatory Requirements
B. Prior Regulatory Action
C. Proposed Amendment to Regulation 1.35(a-1)
II. Amendment to Commission Regulation 1.35(a-1)
A. Eligible Orders
1. Proposed Regulation 1.35(a-1)
2. Comments Received
3. Final Regulation 1.35(a-1)(5)
B. Eligible Account Managers
1. Proposed Regulation 1.35(a-1)(5)(ii)
2. Comments Received
3. Final Regulation 1.35(a-1)(5)(i)
C. Eligible Customers
1. Proposed Regulation 1.35(a-1)(5)(iii)
(a). 1.35(a-1)(iii)(A)--Types of Customers
(b). 1.35(a-1)(5)(iii)(B)--Proprietary Interest
2. Comments Received
(a). 1.35(a-1)(5)(iii)(A)--Types of Customers
(b). 1.35(a-1)(iii)(B)--Proprietary Interest
3. Final Regulation 1.35(a-1)(5)(iii)
D. Disclosure--Final Regulation 1.35(a-1)(5)(iii)
E. Account Certification
1. Proposed Regulation 1.35(a-1)(5)(iv)
2. Comments Received
3. Final Regulation 1.35(a-1)(5)(iv)
F. Allocation
1. Proposed Regulation 1.35(a-1)(5)(v)
2. Comments Received
3. Final Regulation 1.35(a-1)(5)(v)
G. Recordkeeping
1. Proposed Regulation 1.35(a-1)(5)(vi)
2. Comments Received
3. Final Regulation 1.35(a-1)(5)(vi)
H. Contract Market Rule Enforcement Programs
1. Proposed Regulation 1.35(a-1)(5)(vii)
2. Comments Received
3. Final Regulation 1.35(a-1)(5)(vii)
III. Conclusion
IV. Other Matters
A. Regulatory Flexibility Act
B. Paperwork Reduction Act
I. Background
A. Current Regulatory Requirements
The Commission's Regulations 1.35(a-1) recordkeeping requirements,
in effect since March 24, 1972, specify that customer orders must be
recorded promptly and include customer account identification at the
time of order entry and the time of report of execution. Specifically,
Commission Regulation 1.35(a-1)(1) requires that each futures
commission merchant (``FCM'') and each introducing broker (``IB'')
receiving a customer's order immediately prepare a written record of
that order, which includes an account identifier for that customer.
Regulation 1.35(a-1)(2)(i) requires that each member of a contract
market who receives a customer's order on the floor of a contract
market that is not in writing immediately prepare a written record of
that order, including the appropriate customer account identification.
Regulation 1.35(a-1)(4) requires, among other things, that each member
of a contract market reporting the execution of a customer's order from
the floor of a contract market include the account identification on a
written record of that order.
B. Prior Regulatory Action
On June 8, 1992, the Commission published for public comment a
proposed amendment to Chicago Mercantile Exchange (``CME'') Rule 536
(``1992 proposal'').\1\ The amendment would have exempted from CME
customer account designation requirements certain orders placed by a
limited group of investment managers on behalf of specified
institutional accounts. The orders would have been required to be
allocated prior to the end of the day. The Commission received 31
comments, which were addressed in the Commission's subsequent proposed
amendment to Regulation 1.35, discussed below.\2\
---------------------------------------------------------------------------
\1\ 57 FR 24251 (June 8, 1992).
\2\ Twenty-six of the comments evidenced support for the
proposed rule amendment, four were opposed to the amendment, and one
recommended caution.
---------------------------------------------------------------------------
On May 3, 1993, the Commission published for public comment
proposed amendments to Regulation 1.35(a-1) designed to accommodate the
CME proposal (``1993 proposal'') \3\ and the related comments thereon.
In addition to amending Regulations 1.35(a-1)(1), (2), and (4), the
Commission proposed to add paragraphs 1.35(a-1) (5) and (6). Paragraph
(5), which addressed the placement of bunched orders and the use of
predetermined allocation formulas, was superseded by the Commission's
Notice of Interpretation and Approval Order, published May 9, 1997.\4\
This Order approved the National Futures Association (``NFA'')
Interpretative Notice to NFA Compliance Rule 2-10 Relating to the
Allocation of Block Orders for Multiple Accounts which established
standards and procedures for allocating orders pursuant to
predetermined allocation schemes.\5\
---------------------------------------------------------------------------
\3\ ``Account Identification for Orders Submitted on Behalf of
Multiple Customer Accounts,'' 58 FR 26274 (May 3, 1993).
\4\ 62 FR 25470 (May 9, 1997).
\5\ The Order also provided additional Commission guidance
regarding bunched orders and allocation procedures. The guidance
provided therein has since been published as Appendix C to Part One
of the Commission's regulations.
---------------------------------------------------------------------------
Paragraph (6) was the Commission's followup to CME's 1992 proposal.
Paragraph (6) proposed allowing the placement of certain bunched
``intermarket'' orders without customer account identification and
permitting the allocation of those orders at the end of the day. The
Commission stated that the proposed regulation would encourage and
facilitate institutional participation in the futures markets subject
to customer protection requirements that were consistent with the
sophistication of the institutional
[[Page 45700]]
customers. The Commission received 34 comments. Most commenters found
the proposed rule burdensome and too restrictive to be of value. In
particular, many commenters objected (1) to the proposed requirement
for an intermarket trading strategy involving securities and (2) to the
detail of recordkeeping and certification requirements.
Following review of the comments on the 1993 proposal, the
Commission staff continued to consider alternative means to provide
relief from the account identification requirements without increasing
the potential for preferential allocation.
C. Proposed Amendment to Regulation 1.35(a-1)
On January 7, 1998, the Commission published the reproposed
amendments to Regulation 1.35(a-1) for public comment (``1998
proposal'') as a response to the concerns raised in the 1993
proposal.\6\ In addition to amending Regulation 1.35(a-1)(1), (2), and
(4), the Commission proposed to add paragraph 1.35(a-1)(5). Under the
1998 proposal, a specific customer's account identifier need not be
recorded at the time an eligible bunched order (``eligible order'') is
placed or upon report of execution, and the order could be allocated by
the end of the day on which it was executed, provided that certain
requirements were met. The order must be handled in accordance with
contract market rules submitted to the Commission pursuant to Section
5a(a)(12)(A) of the Act and Regulation 1.41.
---------------------------------------------------------------------------
\6\ ``Account Identification for Eligible Bunched Orders,'' 63
FR 695 (January 7, 1998).
---------------------------------------------------------------------------
The Commission received 13 comments in response to the 1998
proposal. Commenters included four associations,\7\ six exchanges,\8\
and four firms registered with the Commission as FCMs.\9\ Although most
comments found that the 1998 proposal eliminated many of the practical
difficulties of the 1993 proposal, they also contended that unnecessary
restrictions remained. Among the 1998 proposal's provisions found to be
overly restrictive were the portfolio requirement,\10\ the customer
consent requirement, the limitation on proprietary interest, the
exclusion of foreign advisers as eligible account managers, and the
exclusion of natural persons as eligible customers.
---------------------------------------------------------------------------
\7\ NFA, Managed Funds Association (``MFA''), Investment Company
Institute (``ICI''), and the Association of the Bar of the City of
New York (``NY Bar''). The NFA comment was derived after discussions
among members of a subcommittee of NFA's Special Committee for the
Review of a Multi-Tiered Regulatory Approach.
\8\ Chicago Mercantile Exchange, Chicago Board of Trade
(``CBT''), New York Mercantile Exchange (including Commodity
Exchange, Inc.) (``NYMEX''), Coffee, Sugar & Cocoa Exchange, Inc.
(``CSCE''), and New York Cotton Exchange (``NYCE'').
\9\ Goldman, Sachs & Co. (``Goldman''), E D & F Man
International (``Man'') FIMAT Futures USA, and Lehman Brothers, Inc.
The latter two firms are not individually further referenced because
their comment letters were written to support the NFA comment.
\10\ The proposal required that eligible orders must be placed
as part of the account manager's management of a portfolio also
containing instruments which are either exempt from regulation
pursuant to the Commission's regulations or excluded from Commission
regulation under the Act. This was intended to permit account
managers handling portfolios involving futures and other instruments
to allocate as to all components of the portfolio at the end of the
day.
---------------------------------------------------------------------------
The Commission has carefully reviewed the comments received and
agrees with the commenters that these restrictions can be eliminated
and that certain other provisions can be modified. With regard to the
proposed customer consent requirement and the limitation on proprietary
interest, the Commission has adopted the suggestion of many commenters
that, as detailed below, disclosure to the customer concerning
allocation standards and procedures is an appropriate and less
burdensome substitute that provides the same kind of customer
protection. Based on its review of the comments, the Commission has
modified and clarified the final rule as appropriate.
II. Amendments to Commission Regulation 1.35(a-1)
The Commission is amending Regulation 1.35(a-1). Under Regulation
1.35(a-1)(5), Orders eligible for post-execution allocation, specific
customer account identifiers for accounts included in bunched orders
need not be recorded at time of order placement or upon report of
execution if certain requirements are met. The bunched order must be
placed by an eligible account manager \11\ on behalf of eligible
customer accounts and must be handled in accordance with contract
market rules that have been submitted to the Commission pursuant to
Section 5a(a)(12)(A) of the Act and Regulation 1.41. In the discussion
below, the Commission sets forth each of the components of its 1998
proposal, as summary of any pertinent comments received, and the manner
in which the final rule addresses the issue.
---------------------------------------------------------------------------
\11\ The term ``account manager'' hereinafter is used to include
investment advisers, commodity trading advisors (``CTA''), and other
persons identified in paragraph 1.35(a-1)(5)(i) of the final
regulation who would place orders eligible for post-execution
allocation in accordance with the procedures set forth in the
amendment.
---------------------------------------------------------------------------
A. Eligible Orders
1. Proposed Regulation 1.35(a-1)(5)(i).
The 1998 proposal required that bunched orders placed, executed,
and allocated pursuant to the proposed regulation must be placed by an
eligible account manager on behalf of consenting eligible customers as
part of its management of a portfolio also containing instruments
either exempt from regulation pursuant to the Commission's regulations
or excluded from Commission regulation under the Act.
The consent requirement was based upon the belief that the eligible
account owners should have the opportunity to consent affirmatively to
participate in the post-execution allocation procedure. Further, the
account manager should be the appropriate party to obtain that consent
and to advise the FCM allocating the order so that the FCM could assure
that allocations ere made only to the eligible accounts.
The portfolio requirement was based on the originally stated
rationale for proposing that post-execution allocation be permitted,
i.e., to permit account managers to provide equivalent treatment to
customers' accounts traded pursuant to strategies involving activity in
both futures markets and non-futures markets. Where trades were
executed only on domestic futures exchanges, the Commission stated that
the account manager should be able to achieve equivalent treatment of
customers' accounts while complying with either the existing customer
account identifier requirements \12\ or exchange average pricing rules.
Nonetheless, the Commission requested comments concerning the placement
of futures-only orders where the use of predetermined allocation
formulas or average pricing would be insufficient to provide equivalent
treatment to customers' accounts.
---------------------------------------------------------------------------
\12\ Regulation 1.35(a-1)(1) and (2)(i) or the predetermined
allocation formula exceptions thereto as described in Appendix C to
Part One of the Commission's regulations.
---------------------------------------------------------------------------
2. Comments Received
All commenters who addressed the issue of consent suggested that
disclosure to the customer that orders would be allocated on a post-
execution basis, rather than written consent, would be appropriate.\13\
NFA and MFA
[[Page 45701]]
recommended that required disclosure should include specific customer
protection information including, among other things, a description of
any allocation methodology.\14\
---------------------------------------------------------------------------
\13\ NFA, ICI, and CBT. CME and NYMEX commented that the
Commission should defer regulation of the relationship between the
account manager and the account manager's customer to the account
manager's primary regulator, but that, if the Commission does act in
this area, it should require only disclosure. MFA commented that all
customers, not just the most sophisticated, should be able to
participate in bunched orders being allocated on a post-execution
basis. Under these circumstances, disclosure would be adequate for
the sophisticated customers but signed acknowledgements evidencing
customer consent should be required from unsophisticated customers.
\14\ These recommendations are discussed in detail below in
paragraph 1.35(a-1)(5)(iii) of the final rule.
---------------------------------------------------------------------------
All commenters addressing the portfolio requirement suggested that
it be eliminated and that futures-only orders be permitted to be
allocated on a post-execution basis.\15\ Commenters represented that
there are situations in which futures-only orders need to be allocated
on a post-execution basis in order to attain fairness across accounts,
thus satisfying the original rationale for the proposal. Included among
the instances described by commenters where relief may be necessary
were trading advisors who trade esoteric volatility spreads, who
arbitrage, or who otherwise trade combinations of different futures and
option contracts.\16\ MFA and NYCE commented that relief may be
necessary with regard to orders for which the account manager seeks to
average price where the trading strategies are such that trading
decisions made intraday are dependent upon prior trades or allocations.
MFA and NYMEX stated that relief would be necessary in the case of
orders for multiple accounts at multiple FCMs that are placed on more
than one futures exchange. MFA identified a need for relief for orders
for which a partial fill received at one exchange must be rounded out
by an order in a related instrument at another exchange. Finally, NFA
and MFA stated that relief was necessary when large orders are placed
through a series of smaller orders in order to disguise the size of the
order or to alleviate the impact of one order upon market prices.\17\
Commenters also noted that average pricing is not a viable alternative
in that it is not available at all exchanges and is not structured to
handle partial fills.\18\ Similarly, NFA and NY Bar noted that the use
of predetermined allocation instructions may not be practicable given
the complex and dynamic trading programs used by large, sophisticated
advisors.
---------------------------------------------------------------------------
\15\ NFA, MFA, CBT, NYMEX, CSCE, NYCE, and Goldman. NY Bar
commented that futures-only orders placed on more than one futures
exchange should be eligible for post-execution allocation.
\16\ NFA, CBT, NYMEX, and CSCE.
\17\ Additionally, Goldman commented that account managers
executing futures-only orders have the same need to respond rapidly
to market movements and to use trading models and systems that are
complex and may involve numerous adjustments throughout the course
of a single trading day. As a result, it may often be necessary for
an account manager, particularly in fast moving markets, to be able
to execute orders instantly and to allocate the fills after
completion of the transaction.
\18\ NFA, NY Bar, NYMEX, CSCE, NYCE, and Goldman.
---------------------------------------------------------------------------
3. Final Regulation 1.35(a-1)(5)
After consideration of the comments, the Commission has concluded
that it would be appropriate to delete the requirement for eligible
account owners to consent to orders being allocated on a post-execution
basis. First, the customers for whom orders could be placed and
allocated pursuant to these procedures have previously been identified
by the Commission as sufficiently sophisticated to monitor the results
of post-execution allocations in their accounts.\19\ Second, based in
large part upon comments submitted by NFA and MFA, the Commission has
included in the final regulation a requirement that the account manager
disclose detailed information to its eligible customers. This
information, discussed in detail in final rule paragraph 1.35(a-
1)(5)(iii) below, is designed to apprise the account owner of
allocation methodologies, fairness standards, availability of data for
comparing returns on investment, and any proprietary accounts that may
be included in the bunched order. These disclosures serve as an
appropriate substitute for formal customer consent.
---------------------------------------------------------------------------
\19\ 63 FR 695, 700. The eligible customers are identified and
discussed below in paragraph 1.35(a-1)(5)(ii) of the final rule.
---------------------------------------------------------------------------
The Commission has also determined that it would be appropriate to
delete the portfolio requirement. As previously stated, the overriding
rationale for allowing post-execution allocation is to permit
equivalent treatment of customers' accounts. The Commission believes
that the commenters have sufficiently demonstrated that there are
situations in which account managers placing futures-only bunched
orders for eligible customers may need the relief afforded by post-
execution allocation in order to achieve equivalent treatment of
costumers' accounts. Further, the commenters have sufficiently
demonstrated that there are also situations in which the use of either
predetermined allocation instructions or average pricing may not be
adequate to assure equitable treatment of customer accounts included in
a bunched order.
B. Eligible Account Managers
1. Proposed Regulation 1.35(a-1)(5)(ii)
The 1998 proposal required that the account manager placing and/or
directing the allocation of an eligible order must be one of the
following which has been granted investment discretion with regard to
eligible customer accounts: a CTA registered with the Commission
pursuant to the Act; an investment adviser registered with the
Securities and Exchange Commission (``SEC''), pursuant to the
Investment Advisers Act of 1940; or a bank, insurance company, trust
company, or savings and loan association subject to federal or state
regulation.\20\
---------------------------------------------------------------------------
\20\ On the basis of comments to the 1993 proposal, the 1998
proposal included CTAs as eligible account managers. Otherwise, the
group of entities proposed to be eligible account managers was
identical to that originally found in the 1993 proposal.
---------------------------------------------------------------------------
The Commission stated that these entities might be able to use the
relief afforded by the eligible order procedures to achieve equivalent
results for eligible customer accounts being traded pursuant to
strategies involving trading activity in more that one market. Eligible
account managers would be able to allocate futures and option trades in
the same manner as they allocated trades on securities exchanges and
over-the-counter markets.\21\ Additionally, these entities' fiduciary
activities were subject to oversight by various state or federal
regulatory agencies.
---------------------------------------------------------------------------
\21\ See, e.g., Interpretation 88-3 of New York Stock Exchange
(``NYSE'') Rule 410(a)(3): ``Member organizations may accept block
orders and permit investment advisors to make allocations on such
orders to customers and remain in compliance with Rule 410(a)(3)
provided that the organizations receive specific account
designations or customer names by the end of the business day.''
---------------------------------------------------------------------------
2. Comments Received
Numerous commenters stated that foreign advisers play a significant
role in U.S. financial markets \22\ and suggested that the list of
eligible account managers should be expanded to include foreign
advisers.\23\ MFA suggested including investment advisers exempt from
SEC registration under Section 203(b)(3) of the Investment Advisers Act
of 1940. Finally, CBT proposed that exchanges should be
[[Page 45702]]
afforded the flexibility to expand the relief, on a case-by-case basis,
to other account mangers who are adequately regulated and subject to
fiduciary liability.
---------------------------------------------------------------------------
\22\ NFA, CBT, CSCE, NYCE, and Goldman.
\23\ NFA, MFA, NYCE, Man and CSCE (foreign advisors registered
with, or exempt from, Commission registration, regulated in the
advisor's home jurisdiction, and providing advice to non-U.S.
persons), CBT (registered with the Commission), and Goldman
(operating pursuant to Regulation 30.10 exemptions, located in
countries that have received Regulation 30.10 exemptions, or
otherwise).
---------------------------------------------------------------------------
3. Final Regulation 1.35(a-1)(5)(i)
After consideration of the comments, the Commission believes that
it is appropriate to expand the list of eligible account managers to
include foreign advisers who provide advice solely to foreign
persons.\24\ However, the Commission remains concerned that foreign
advisers are not subject to U.S. regulation and could use the ability
to allocate orders among customers after execution as a vehicle to
engage in fraud, money laundering or other abusive financial schemes.
Thus, the Commission has determined to include only those foreign
advisers who are subject to regulation by a foreign regulator or self-
regulatory organization (``SRO'') that either (1) operates under a
regulatory framework that has been found by the Commission to be
comparable to that in the United States and has been issued a
Commission Order under Regulation 30.10 or (2) has entered into a
Memorandum of Understanding (``MOU'') or other arrangement for
cooperative enforcement and information sharing with the Commission
(hereafter referred to as a ``foreign authority'').
---------------------------------------------------------------------------
\24\ A foreign advisor who places orders on U.S. futures
exchanges for U.S. persons would be required to register as a CTA
and, thus, would be included as an eligible account manager when
placing bunched orders for eligible customers.
---------------------------------------------------------------------------
In addition, as discussed below in final rule paragraph 1.35(a-
1)(5)(iv), the Commission is adding a certification requirement that
must be met in order for a foreign adviser to be an eligible account
manager. The foreign authority must certify that (1) the foreign
adviser's activities are subject to regulation by that foreign
authority and (2) the foreign authority will provide, upon request of
the Commission or Department of Justice, information that relates to
the foreign adviser's compliance with this rule. The Commission
believes that restricting foreign advisers who may be eligible account
managers in this manner, in combination with the certification
requirement, will help facilitate the detection and deterrence of
fraud, money laundering or other abusive financial schemes.
The Commission is not including as eligible account managers
investment advisers exempt from SEC registration under Section
203(b)(3) of the Investment Advisers Act of 1940 or CTAs exempt from
Commission registration under Section 4m(1) of the Act. These entities
are not examined in the ordinary course of audits conducted by the SEC
or NFA, respectively.
C. Eligible Customers
1. Proposed Regulation 1.35(a-1)(5)(iii)
(a). 1.35(a-1)(5)(iii)(A)--Types of Customers. The 1998 proposal
provided that eligible orders could be placed on behalf of, and
allocated to, accounts owned by an identified group of entities
(``eligible customers'') which has consented in advance and in writing
to the account manager that orders could be placed, executed, and
allocated in accordance with the eligible order
procedures.25 Except for the exclusion of sole
proprietorships, natural persons, floor brokers, floor traders, and
self-directed employee benefit plans, the group of eligible customers
was substantially similar to those entities defined as ``eligible
participants'' for purposes of Part 36--Exemption of section 4(c)
Contract Market Transactions, of the Commission's
regulations.26 Having previously considered this group of
entities and determined that they are eligible to participate both in
exempt transactions and in swaps, the Commission determined that they
are sufficiently sophisticated to monitor the results of any post-
execution allocations in their accounts.
---------------------------------------------------------------------------
\25\ The issue of customer consent was discussed above. As
noted, the Commission is eliminating the consent requirement, but
including disclosure requirements to assure the customer is apprised
of, among other things, allocation methodology and fairness
standards.
\26\ As the Commission stated in promulgating the final rules
for Part 36, the list of ``eligible participants'' was modeled on
the list of ``appropriate persons'' set forth in Section 4(c)(3)(A)
through (J) of the Act and on the definition of ``eligible swap
participant'' under Part 35 of the Commission's regulations. 60 FR
51328 (October 2, 1995).
---------------------------------------------------------------------------
Accounts owned by sole proprietorships, floor brokers, floor
traders, natural persons, and self-directed employee benefit plans were
not included as eligible customers.
(b). 1.35(a-1)(5)(iii)(B)--Proprietary Interest. The 1998 proposal
provided that the following persons, or any combination thereof, could
not have an interest of ten percent or greater in any account that
received any part of an eligible order:
(i) the account manager,
(ii) the futures commission merchant allocating the order;
(iii) Any general partner, officer, director, or owner of ten
percent or more of the equity interest in the account manager or the
futures commission merchant allocating the order;
(iv) Any employee, associated person, or limited partner of the
account manager or the futures commission merchant allocating the order
who affects or supervises the handling of the order;
(v) Any business affiliate that, directly or indirectly, controls,
is controlled by, or is under common control with, the account manager
or the futures commission merchant allocating the order, or
(vi) Any spouse, parent, sibling, or child of the foregoing person.
The limitation to less than ten percent ownership interests in any
account that received any part of an eligible order was intended to
balance the potential for misallocation with the recognition that there
are situations where proprietary accounts should be permitted in a
bounded order. For example, the Commission was aware that proprietary
accounts might properly be included with customer accounts in a bunched
order where the account manager had ``seed'' money invested in an
account or where the account manager invested in an account in order to
attract other investors. In addition, a complete prohibition on any
interest in an included account would exclude certain publicly owned
organizations from becoming eligible customers and thus would result in
unfair customer treatment.
2. Comments Received
(a) 1.35(a-1)(5)(iii)(A)--Types of Customers. All commenters
addressing eligible customers suggested that the list be expanded to
include natural persons.27 CBT and CSCE commented that the
list should be expanded to include floor brokers and traders. MFA
suggested that all eligibility restrictions should be eliminated.
---------------------------------------------------------------------------
\27\ NYCE and Man. NFA, CME, CBT, NYMEX, and CSCE commented that
natural person as defined in Parts 35 and 36 should be included. MFA
stated that natural persons as defined in Part 35 and Regulation 4.7
should be included. NY Bar commented that natural persons meeting
the ``qualified eligible client'' criteria defined in Regulation
4.7(b)(1)(ii)(B) should be included. Goldman commented that natural
persons meeting the ``qualified eligible participant'' criteria
defined in Regulation 4.7 should be included.
---------------------------------------------------------------------------
Several commenters also suggested that the Commission should not
create yet another definition of ``sophisticated customer.''\28\ Thus,
CME and CBT proposed that the list of eligible customers should be
consistent with the list of ``eligible participants'' in Part 36; CME,
CBT, and MFA proposed that it should be consistent with the list of
``eligible swap participants'' in Part 35; and MFA proposed that it
should be
[[Page 45703]]
consistent with ``qualified eligible client'' under Regulation 4.7.\29\
---------------------------------------------------------------------------
\28\ NFA, MFA, NY Bar, CME, NYMEX, and CSCE.
\29\ NY Bar recommended that the Commission eliminate the fixed
total asset requirement applied to commodity pools in order for the
pools to meet the eligible customer criteria. The fixed asset level
would not address situations where the pool initially met the
requirement but subsequently fell to a lower asset level because of
investor redemption or trading losses. In the alternative, NY Bar
commented that the fixed asset level requirement should be applied
only at the inception of trading.
---------------------------------------------------------------------------
(b) 1.35(a-1)(5)(iii)(B)--Propriety Interest. Most commenters
believed the provision limiting proprietary interest to an interest of
less than ten percent was overly restrictive and should be
eliminated.\30\ NFA and MFA stated that many institutional customers
desire that their account managers trade their own funds just like the
customers' funds and may, according to MFA, require that the account
manger have a significant proprietary interest. It was noted that
applying a percentage test to determine eligibility to bunch and
allocate orders could prove administratively burdensome.\31\ MFA and
Goldman stated that the account manager could be subject to potential
liability because his or her interest may fluctuate in size over time.
ICI commented that it would be very difficult, and in some cases
impossible, for an account manager to determine ownership interest and
monitor compliance with the ten-percent limitation.\32\
---------------------------------------------------------------------------
\30\ NFA, MFA, NYCE, and Goldman, NY Bar commented that
proprietary interest in excess of ten percent should be permitted so
long as it is disclosed. CBT commented that the limitation should be
clarified to state that an account would not be disqualified from
eligibility if from time to time the ten-percent interest test were
exceeded on a temporary or marginal basis. This would permit some
limited flexibility as the limitation is applied to commodity pool
operators or CTAs setting up new pools or liquidating old pools.
\31\ NFA, MFA and Goldman.
\32\ ICI recommended that interests in registered investment
companies be excluded from the limitation or, in the alternative,
that it be acceptable for the account manager to certify that it
reasonably believes it is in compliance with the requirements of the
regulation.
---------------------------------------------------------------------------
NFA commented that, if the allocation procedures satisfy certain
core fairness principles, then it should not matter that proprietary
accounts are included in the bunched order. MFA commented that, if the
allocation methodology were fundamentally fair, non-preferential, and
verifiable, it would be fair for all orders allocated by that
methodology. MFA further stated that requiring the account manager to
trade a proprietary account outside the bunched order would greatly
diminish the effectiveness of the audit process and create complexity
and opportunities for misallocations in monitoring, auditing and
implementing the separate allocation procedures.\33\
---------------------------------------------------------------------------
\33\ MFA stated that requiring the limitation on proprietary
interest could provide an opportunity for dishonest account managers
to allocate fraudulently by altering the extent of their proprietary
investment or otherwise changing the group of accounts that trade
within, rather than outside, the bunched order. Goldman commented
that preferential allocations to accounts in which the account
manager has a proprietary interest would be more readily apparent
and therefore more easily detected if the proprietary accounts were
included in the bunched order.
---------------------------------------------------------------------------
3. Final Regulation 1.35(a-1)(5)(ii)
After consideration of the comments, the Commission has determined
to modify the 1998 proposal's list of eligible customers to make it
completely consistent with the Part 36 list of ``eligible
participants.''\34\ Thus, the Commission is including as eligible
customers natural persons, subject to the Part 36 total asset
requirement, and floor brokers and traders.\35\ Likewise, the
Commission is removing the 1998 proposal's restriction of self-directed
corporate qualified pension, profit sharing, or stock bonus plans
subject to Title 1 of ERISA for those plans that satisfy the ``eligible
participant'' criteria of Part 36. The Commission believes that these
entities are generally capable of understanding bunched order and post-
execution allocation procedures and risks. Further, in order to assist
the eligible customers in this understanding, the Commission is
requiring that the account manager disclose certain specific
information to them. These disclosure requirements, discussed in detail
in final rule paragraph 1.35(a-1)(5)(iii) below, are designed to
apprise the account owner of allocation methodologies, fairness
standards, availability of data for comparing returns on investment,
and any proprietary accounts that may be included in the bunched order.
---------------------------------------------------------------------------
\34\ As previously noted, the Commission has considered this
group of entities and determined that they are eligible to
participate both in transaction under the Part 36 pilot program and
in swaps and believes that they are sufficiently sophisticated to
monitor the results of any post-execution allocations in their
accounts.
\35\ With regard to allocations to accounts owned by natural
persons, the Commission believes that the various increased
standards applicable to the manner in which account managers will be
required to handle these accounts should mitigate the Commission's
previously stated concerns.
---------------------------------------------------------------------------
The Commission has also determined that it is appropriate to
eliminate the less than ten percent restriction on proprietary interest
that would have been imposed upon the account manager, the FCM
allocating the order, and other listed entities. The Commission is
aware that the proposed limitation does not exist in other markets and
agrees with the commenters that it would be administratively burdensome
and difficult to manage and to enforce. Among other things, the account
manager would have a difficult time determining the level of interest
held by the total group of possible participants who would be subject
to the limitation. That level of interest also would be subject to
fluctuation, would require constant monitoring, and could result in
inadvertent violations, e.g., when redemption in a fund occurred. The
Commission also is aware that the eligible customers may prefer to
invest with an account manager who has a significant proprietary
interest in the trading activity, i.e., an account manager who puts his
or her money at risk along with that of the customer. Finally, the
Commission agrees with the commenters who stated that, if the
allocation procedures are fair, they remain so even if the account
manager has an interest in an included account.
Therefore, the proposed interest limitations have been deleted. In
addition, eligible account managers have been included in the list of
eligible customers for whom orders may be placed and allocated on a
post-execution basis. In order to assure that an eligible customer is
aware that an account in which the account manager has an interest may
be included with the customer's account in the bunched order, the
Commission is requiring, as discussed below, that the account manager
disclose his or her policies with regard to this issue.
D. Disclosure--Final Regulation 1.35(a-1)(5)(iii)
As previously noted, the 1998 proposal required that the customer
consent, in writing to the use of eligible order procedures, and the
proposal placed a less than ten percent interest limitation on
proprietary orders that could be included in the bunched order. Because
the Commission has concluded that the customer protection intended to
be provided by these proposed requirements can be provided as
effectively through detailed disclosure, the Commission has determined
to substitute disclosure requirements for the proposal's consent
requirement and proprietary interest limitation.
These disclosure requirements are based upon comments submitted by
NFA and MFA both of which stated that strengthened customer protection
could be attained by expanding disclosure requirements. Among other
things, NFA proposed that the regulation should require that eligible
account managers describe to their customers, in general
[[Page 45704]]
terms, their basic approach to allocating trades among participants in
a particular trading program. NFA stated that the account manager
should be required to represent to eligible customers that it regularly
reviews each account to assure that the allocation methodology has been
fair and equitable and that it will document the internal procedures
and results of its regular analysis and maintain these procedures and
results as firm records.\30\
---------------------------------------------------------------------------
\30\ As discussed below, NFA strongly supported the proposed
requirement that each account manager make available data sufficient
for customers to compare their results with those of other relevant
customers.
---------------------------------------------------------------------------
MFA commented that the account manager should be required to
disclose to the customer the nature of its allocation methodology and
the fairness standard required of the methodology, the ability of the
customer to request confirmation regarding the operation of the
methodology, and the extent to which the account manager includes
accounts in which it has an interest in the bunched order. According to
MFA, requiring that disclosure to the customer include this information
would assure that the customer would be able to provide informed
consent to participation in the bunched order and fair allocation
procedures.
The Commission has drawn upon these NFA and MFA comments to craft
the disclosure requirements found in the final regulation and described
below. The Commission believes that compliance with these requirements
will assure that the customer is armed with adequate knowledge of the
bunched order and post-execution allocation procedures as they apply to
his or her account and thus will have an enhanced ability effectively
to monitor account activity. Thus, these disclosure requirements are an
appropriate substitute for the written customer consent requirement and
less than ten-percent proprietary interest limitation.
Before placing the initial order eligible for post-execution
allocation, the account manager must disclose the following to each of
its customers to be subject to post-execution allocation:
(i) The general nature of the allocation methodology the account
manager will use;
(ii) The standard by which the account manager will judge the
fairness of allocations;
(iii) The ability of the customer to review summary or composite
data sufficient for that customer to compare its results with those of
other relevant customers;\37\ and
---------------------------------------------------------------------------
\37\ Of course, the account manager would be expected to
disclose the customer's ability to compare its results with those of
similarly traded accounts in which the account manager has an
interest, if such accounts are included. In those circumstances, the
accounts in which the account manager has an interest would be
accounts ``of other relevant customers.''
---------------------------------------------------------------------------
(iv) Whether accounts in which the account manager may have any
interest may be included with customer orders in orders eligible for
post-execution allocation.
E. Account Certification
1. Proposed Regulation 1.35(a-1)(5)(iv)
In 1998 proposal required that, before placing the initial eligible
order, the account manager certify in writing to each FCM executing
and/or allocating any part of the order that the account manager was
aware of the eligible order provisions and would comply with those
provisions. Further, the account manager was required to provide each
FCM allocating the order with a list of eligible futures accounts.
The certification requirement was designed to assure that the
account manager, who has overall responsibility for compliance with the
eligible order provisions, was cognizant of, and would comply with, the
provisions. The certification requirement would need to be made only
once to each applicable FCM, and not on an order-by-order basis.\38\
The extent of the account manager's compliance with these requirements
would be determined during audits and on a for-cause basis.
---------------------------------------------------------------------------
\38\ Where the account manager places orders directly with a
floor broker rather than an executing FCM, the certification would
have to be filed only with each FCM allocating any part of an
eligible order and not with the floor broker.
---------------------------------------------------------------------------
2. Comments Received
Commenters addressing the certification issue generally made two
suggestions. First, the certification should be made only to the
clearing FCM;\39\ and second, the certification should remain in effect
unless revoked.\40\ With regard to the requirement that the account
manager provided a list of eligible futures accounts, ICI commented
that, rather than requiring a cumulative list, the Commission should
permit an account manager to provide the FCM with eligibility
information on an account either when it is opened or once a
determination is made that it is an eligible account for purposes of
the regulation.\41\
---------------------------------------------------------------------------
\39\ NFA, NYMEX, and Goldman, MFA suggested that the
certification be made either to the clearing FCM or to the NFA. NFA
also commented that the term ``represent'' should be used in place
of ``certify.''
\40\ NFA, CBT, and NYMEX.
\41\ Man commented that the failure of an account manager to
inform the FCM of any deviations or changes to the list of eligible
accounts, as well as the potentially large number of accounts which
may be on the list, could result in potential errors and delays in
trade processing. The responsibility for fair, non-preferential
allocation of orders among accounts is that of the account manager
and not the FCM. Obviously, whether or not a list was provided to
the FCM, an FCM has an ongoing obligation to inquire if there are
appearances of preferential allocations. Thus, Man proposed that the
requirement to provide a list of eligible futures accounts to the
FCM not be required since it serves no meaningful purpose.
---------------------------------------------------------------------------
3. Final Regulation 1.35(a-1)(5)(iv)
After consideration of the comments received, the Commission has
determined that the account manager certification need be provided only
to the FCM clearing any part of an order eligible for post-execution
allocation to the ultimate customers. Further, this certification, once
made, will continue in effect until the account manager revokes it or
the FCM is otherwise notified of a change.
With regard to the identification of the eligible customer
accounts, the Commission agrees that a list of the accounts need not be
required. Rather, the Commission has determined to require only that
the account manager must identify these accounts to the FCM clearing
any part of an order eligible for post-execution allocation.
Identification may be accomplished by list; by notice at the opening of
the account; by letter if the determination is made after the account
is open; or by other, similar method. The Commission continues to
believe that the requirement that the account manager identify the
eligible customer accounts to the FCM should enable the FCM to insure
that allocations are made only to those eligible customer accounts.\42\
---------------------------------------------------------------------------
\42\ The account manager must notify the clearing FCM when the
account manager has notice that a previously identified eligible
account is no longer eligible to be included in bunched orders
allocated on a post-execution basis. However, if the account manager
has a reasonable basis to believe that the account will regain its
eligibility status within 10 business days, the account manager need
not notify the FCM and may continue to treat that account as an
eligible account. This timeframe is consistent with the maximum of
10 business days which may be granted by the Commission, in its
discretion, to allow an FCM or IB to achieve compliance with the
Sec. 1.17 net capital requirements without having to transfer
accounts and cease doing business. Thus, although a commodity pool
would no longer be an eligible account if its total assets fell
below the $5,000,000 threshold because of investor redemptions or
trading losses, the account manager may continue to treat that
commodity pool as an eligible customer account if the account
manager has a reasonable basis to believe that the reduction in
assets is temporary and that the commodity pool's total assets will
be increased to the $5,000,000 within 10 business days.
---------------------------------------------------------------------------
Finally, in order to facilitate compliance with the requirements of
this rule, as well as to facilitate the detection and deterrence of
fraud, money laundering and other abusive
[[Page 45705]]
financial schemes, the Commission has determined that an additional
certification requirement is appropriate. Foreign advisers must also
provide to each FCM clearing any part of an order eligible for post-
execution allocation a written certification from a foreign authority
that (1) the foreign adviser's activities are subject to regulation by
that foreign authority and (2) the foreign authority will provide, upon
request of the Commission or Department of Justice, information that
relates to the foreign adviser's compliance with this rule.
F. Allocation
1. Proposed Regulation 1.35(a-1)(5)(v)
The 1998 proposal required that the account manager and the
clearing FCM allocate the order to eligible participating customer
accounts prior to the end of the day the order is executed. Further,
the proposal required that allocations be fair and nonpreferential,
taking into account the effect on each relevant portfolio in the
bunched order. These allocation requirements were designed to assure
that allocations were made fairly, in a timely manner, and only to
eligible customer accounts.
As stated in the 1998 proposal, although the account manager has
the responsibility for employing a system that results in fair,
equitable, and non-preferential allocations, the FCM does assume some
responsibility with regard to the fairness of the allocations.\43\ If
the FCM were directed to allocate eligible orders to previously
unidentified accounts or became aware of what appeared to be
preferential allocations, the FCM would be required to make a
reasonable inquiry and, if appropriate, to refer the matter to the
appropriate regulatory authority.
---------------------------------------------------------------------------
\43\ As discussed herein, FCM responsibilities regarding the
fairness of allocations are those of the clearing FCM.
---------------------------------------------------------------------------
2. Comments Received
Among the comments received that addressed the allocation
requirements, NFA stated that it would be helpful to indicate that
account managers should provide allocation information as soon as
practicable after the entire transaction is executed but no later than
the end of the day. Further, NFA suggested that the Commission clarify
that ``end of the day'' might be defined by certain contract market or
FCM operational timetables.\44\ MFA commented that order allocation
should be required no later than the deadline for the submission of
trade data established by the exchange on which the trade is made.
---------------------------------------------------------------------------
\44\ NFA encouraged the Commission to require that eligible
account managers disclose to their customers that they will provide
allocation information as soon as practicable after an entire
transaction is executed, but no later than as required by certain
exchange or FCM operational timetables.
---------------------------------------------------------------------------
Two commenters expressed concerns regarding allocation
responsibilities proposed to be imposed on the FCMs. NY Bar commented
that the requirement that the FCM conduct reasonable inquiry and refer
to regulatory authorities any situations in which an order allocation
formula appears to be abandoned or significantly departed from poses an
unreasonable burden upon the FCM. In a similar vein, CBT commented that
it is unnecessary to require the FCMs to have responsibilities above
and beyond those already placed on them to ensure fair and equitable
treatment of their customers by Regulation 166.3, which requires that
FCMs diligently supervise the handling of customer accounts.
Finally, NFA suggested that among the representations that the
eligible account manager should be required to make to his or her
customers is that the allocation methodology will be: (1) Non-
preferential, so that no account or group of accounts receive
consistently favorable or unfavorable treatment; (2) sufficiently
objective and specific that the appropriate allocation for a given
trade can be verified in an independent audit; and (3) consistently
applied.
3. Final Regulation 1.35(a-1)(5)(v)
After consideration of the comments received, the Commission has
determined to modify the timeliness and fairness standards and to add
as allocation requirements the NFA's proposed representations regarding
the allocation methodology. The requirement that allocations must be
made only to the accounts of eligible customers is being retained.
With regard to the timeliness of the allocations, the Commission is
revising the standard to require that allocations must be made as soon
as practicable after the entire transaction is executed, but no later
than the end of the day the order is executed.\45\ The Commission is
aware of no reason to postpone the allocations until the end of the day
in situations where the results of the entire transaction are already
known and fairness to the included accounts can thus be attained
without further delay. Although it is no longer separately stated in
this paragraph, the Commission continues to believe that the definition
of ``end of the day'' for purposes of post-execution allocation may be
specified by exchange rule. That provision was removed as an allocation
requirement because it was redundant. Paragraph 1.35(a-1)(5) of the
final rule already provides that orders eligible for post-execution
allocation must be handled in accordance with exchange rules submitted
to the Commission pursuant to Section 5a(a)(12)(A) and Regulation 1.41.
---------------------------------------------------------------------------
\45\ As used herein, the term ``entire transaction'' includes
the bunched futures and/or option order(s) and all related
transactions executed in all markets for the included accounts.
---------------------------------------------------------------------------
The Commission has modified the basic fairness standard of the
allocation requirements in two areas. First, the standard in the final
rule requires that the allocations must be fair and equitable and that
no account or group of accounts may receive consistently favorable or
unfavorable treatment.\46\ The Commission is aware that the existence
of preferential allocations is best determined over a period of time
and not on the basis of individual allocations.\47\
---------------------------------------------------------------------------
\46\ This requirement is consistent with allocation
responsibilities imposed upon banks. Banking regulators require that
banks effecting securities transactions for customers establish
written policies and procedures for the fair and equitable
allocation of securities and prices to the accounts when orders are
placed for the same security. See 12 C.F.R. Sec. 208.24(g)(2) (1998)
(requiring such procedures for state member banks); 12 C.F.R.
Sec. 12.7(a)(2) (1998) (requiring such procedures for national
banks).
\47\ The Commission is also aware that an account in which the
account manager has an interest could, on a given day, even using
random allocation methodology, receive better allocations than one
or more of the included customer accounts. The Commission would not,
absent evidence to the contrary, find that this allocation violated
the fairness standard so long as the account manager could
demonstrate that the results were consistent with the allocation
methodology disclosed by the account manager and so long as the
favorable allocation is not representative of a pattern of
preferential allocation.
---------------------------------------------------------------------------
Second, since the requirement that there must be a portfolio
containing instruments which are either exempt from regulation pursuant
to the Commission's regulations or excluded from Commission regulation
under the Act has been deleted, the fairness standard no longer refers
to ``taking into the account the effect on each relevant portfolio in
the bunched order.'' Nonetheless, even without a portfolio requirement,
the Commission expects that audits determining the fairness of
allocations among accounts will consider all instruments and all
transactions relevant to the accounts being audited.
With respect to the account manager's allocation methodology, the
Commission has determined to include as an allocation requirement NFA's
proposed required representations regarding that methodology. That is,
the
[[Page 45706]]
allocation standard in the final rule will include a requirement that
the account manager's allocation methodology must be (1) sufficiently
objective and specific that the allocation for a given trade can be
verified in an independent audit and (2) consistently applied.
Finally, the requirement that allocations must be made only to the
accounts of eligible customers and must be made in a fair and equitable
manner remains as stated in the proposal. The account manager has the
responsibility for employing a system that results in fair, equitable,
and non-preferential allocations. The FCM generally has the
responsibility for complying with instructions from the account
manager. The FCM also has additional responsibilities with regard to
the allocations. If the account manager were to direct the allocation
of fills into an account that has not been identified as an eligible
account or if the FCM becomes aware of what appear to be preferential
allocations, the FCM is required to make a reasonable inquiry and, if
appropriate, to refer the matter to the appropriate regulatory
authority, i.e., the Commission, NFA, or the FCM's designated self
regulatory organization (``DSRO''). In addition, the FCM must act
consistently with its obligations under Regulation 166.3 to supervise
diligently the handling of its customer accounts.
G. Recordkeeping
1. Proposed Regulation 1.35(a-1)(5)(vi)
The 1998 proposal required that each eligible order and the account
manager placing the order be identified on the order tickets at the
time of placement. Each transaction resulting from an eligible order
was required to be identified on contract market trade registers, other
computerized trade practice surveillance records, and confirmation
statements provided to eligible customer accounts. These requirements
were designed to assure the existence of a complete audit trail from
order placement through order allocation.
The 1998 proposal required that each account manager must make
available, upon request of a representative of the Commission or the
United States Department of Justice, customer consent documents and
records reflecting futures and option transactions, other transactions
executed pursuant to the portfolio management strategy, and any other
records that would identify the management strategy and relate to, or
reflect upon, the fairness of the allocations. Finally, it required
that each account manager must make available for review, upon request
of an eligible customer, data sufficient for that customer to compare
its results with those of other relevant customers, prepared so as not
to disclose the identity of individual account holders. The description
of the requirement in terms of data was intended to permit the use of
established methods used by sophisticated institutional investors in
securities to measure and to compare performance. The comparison data
could be prepared without requiring the disclosure of the identity of
individual account holders.
2. Comments Received
With respect to the requirement that the eligible order and the
account manager placing the order must be identified on the office and
floor order tickets, NFA suggested that the account manager be
identified by code or other appropriate identifier, and CBT questioned
the necessity of designating the account manager on the original order
tickets. MFA and CBT suggested that the rule should permit the use of a
group identifier with respect to the group of accounts to be allocated
in the bunched order.\48\ MFA and CBT were opposed to the requirement
that eligible order transactions be identified on trade registers and
other computerized trade practice surveillance records.\49\ Several
commenters suggested that the requirement that trades be identified on
confirmation statements provided to the customer accounts should be
deleted.\50\ Most of those commenters stated that such a requirement
was redundant and unnecessary once the customer has been informed that
orders for his or her account would be placed and allocated pursuant to
the eligible order procedures.
---------------------------------------------------------------------------
\48\ In its comment objecting to the proposal's requirement that
an eligible order must be identified throughout the execution,
clearing, and confirmation procedures, MFA stated that the account
manager should be required to identify the orders as eligible orders
at the time of entry and on its trade blotter and allocation sheets.
\49\ MFA stated that the cost of requiring compliance would be
large without achieving any identifiable separate regulatory
objective. CBT stated that the requirement would result in excessive
cost to the industry and that the benefit of this type of
information is questionable.
\50\ NFA, MFA, CBT, Goldman, and Man.
---------------------------------------------------------------------------
MFA addressed the requirement that the account manager make certain
information available, upon request, to the Commission or the
Department of Justice. MFA objected to the requirement that the account
manager maintain records demonstrating the relationship between the
futures and other transactions. It contended that the eligible order
relief should be available without regard to whether there were any
other transactions and that the records demonstrating any trading
strategy could cause unnecessary disclosure of proprietary trading
strategies and procedures. MFA further commented that the rule should
be narrowed to require retention only of information essential to the
determination of the appropriateness of the allocations made.
Numerous commenters addressed the requirement that comparative data
be made available to the customer so that he or she could compare
results with those of other relevant customers. NYCE supported the
requirement as stated.\51\ NFA supported it as modified to define the
data required to be made available as ``performance'' data. ICI
supported it as modified to define the data as ``aggregated'' or
``composite'' information. MFA recommended that the rule not require
disclosure of comparative account information of other customers, but
rather disclosure of summary information for the accounts for which
such orders are made. NY Bar and CME recommended that the requirement
be deleted.\52\
---------------------------------------------------------------------------
\51\ NYCE further commented that the data should also be
required to be made available to regulatory authorities.
\52\ NY Bar recommended, as an alternative, requiring the
availability of comparable trading data for audit by the NFA. CME
commented that the account manager's primary regulator should impose
such a requirement if it determines that such a requirement is
necessary.
---------------------------------------------------------------------------
3. Final Regulation 1.35(a-1)(5)(vi)
The Commission has determined to make several revisions to the
proposed recordkeeping requirements. In order to provide for a more
complete audit trail and consistent with SEC recordkeeping requirements
applicable to investment advisers, the Commission is adding a
requirement that the account manager, prior to placing the order,
create and timestamp a document reflecting the terms of the order and
the expected allocation thereof (``order origination document'').\53\
Any subsequent decision
[[Page 45707]]
to alter the included accounts, proposed allocation, or other terms of
the order would likewise be required to be documented and timestamped.
The Commission is specifying the information that must be retained, not
the type or format of the document on which such information must be
recorded. For instance, if an order and its allocation methodology were
generated based upon a computer program, a copy of the computer-timed
output document might be adequate. If an order were to be allocated
according to a standardized methodology described in a pre-existing
document, the timestamped order origination document need only reflect
the terms of the order and a reference to the allocation methodology in
that document, or to the document, as appropriate. The basic
requirement is that the order origination document, which must be
retained pursuant to Regulation 1.31, must assist an auditor in tracing
the allocations attributable to a specific transaction by documenting
the origin of that transaction.\54\
---------------------------------------------------------------------------
\53\ Among the books and records to be maintained by investment
advisers registered or required to be registered under section 204
of the Investment Advisers Act of 1940 are the following:
A memorandum of each order given by the investment adviser for
the purchase or sale of any security, of any instruction received by
the investment adviser from the client concerning the purchase,
sale, receipt or delivery of a particular security, and or any
modification or cancellation of any such order or instruction. Such
memoranda shall show the terms and conditions of the order,
instruction, modification or cancellation; shall identify the person
connected with the investment adviser who recommended the
transaction to the client and the person who placed such order; and
shall show the account for which entered, the date of entry, and the
bank, broker or dealer by or through whom executed where
appropriate. Orders entered pursuant to the exercise of
discretionary power shall be so designated. 17 C.F.R. Sec. 275.204-
2(a)(3) (1997).
Registered investment companies are also required to maintain
records. Section 31(a) of the Investment Company Act of 1940 and
Rule 31a-1(b)(5) thereunder require that registered investment
companies maintain a current record of each brokerage order for
securities, whether executed or unexecuted, showing, among other
things, the terms and conditions of the order, the time of order
entry or cancellation and the time of receipt of report of
execution. 17 C.F.R. Sec. 270.31a-1(b)(5) (1997). Rule 31a-1(b)(6)
applies the Rule 31a-1(b)(5) recordkeeping requirements to all other
portfolio purchases or sales, such as futures transactions. 17
C.F.R. Sec. 270.31a-1(b)(6) (1997).
With regard to permissible procedures for bunching orders and
allocating trades in securities, including the preparation of
allocation documentation prior to order placement, see SMC Capital,
Inc. SEC no-action letter (available September 5, 1995) and Pretzel
& Stouffer SEC no-action letter (available December 1, 1995).
Finally, as previously noted, MFA commented that the account manager
should be required to identify orders eligible for post-execution as
such at the time of entry and on its trade blotter and allocation
sheets. See n. 48.
\54\ Of course, the account manager must create and retain a
record reflecting the participation of all accounts in each order
eligible for post-execution allocation, including the allocations.
---------------------------------------------------------------------------
With regard to the information required to be identified on the
office and/or floor order tickets, the Commission agrees with the
commenters that a group identifier or other code would be adequate, so
long as the order is identified as an order eligible for post-
execution. Thus, the Commission has deleted the requirement that the
account manager placing the order must be identified on the order
tickets. However, in keeping with the Commission's intention to enhance
the ability of an auditor to trace the allocations attributable to a
specific transaction, the Commission is also requiring that the group
identifier or other code on each order ticket relate back to the
specific order origination document described above.\55\
---------------------------------------------------------------------------
\55\ If the account manager places multiple orders to satisfy
the investment criteria documented on the order origination
document, each of the order tickets must contain the group
identifier or other code that relates back to that specific order
origination document.
---------------------------------------------------------------------------
The Commission is retaining the proposed requirement that each
transaction executed based upon an order eligible for post-execution
allocation be identified on contract market trade registers and other
computerized trade practice surveillance records. The Commission
continues to believe that this is an important enhancement to the audit
trail in that it would permit an order to be tracked throughout its
processing.\56\ However, the Commission agrees with the commenters that
the proposed requirement that the transactions must also be identified
on confirmation statements provided to eligible customer accounts is
unnecessary. Once the eligible customers have been informed that orders
for their accounts will be placed and allocated as orders eligible for
post-execution allocation, the trades need not be identified separately
on confirmation statements.
---------------------------------------------------------------------------
\56\ Because of the potential for misallocation, each exchange
should routinely monitor the placement, execution, and allocation of
orders eligible for post-execution allocation as part of its trade
practice surveillance program.
---------------------------------------------------------------------------
The proposed requirement that records be made available, upon
request, to the Commission and Department of Justice has been retained,
but modified to comport with other revisions to the 1998 proposal. The
reference to consent documents has been revised to refer to disclosure
documents, and the reference to the portfolio management strategy has
been deleted. The requirement that records be made available to a
customer for that customer to compare its results with those of other
relevant customers has also been retained, but modified. As suggested
by commenters, the provision specifies ``summary'' or ``composite''
data. The Commission believes that this revision should allay concerns
that the disclosure of comparative account information might lead to
the identification of a particular customer.\57\
---------------------------------------------------------------------------
\57\ Additionally, as previously stated, the account manager
would be required to disclose to a customer that customer's ability
to review composite or summary data sufficient for that customer to
compare its results with those of similarly traded customers,
including similarly traded accounts in which the account manager has
an interest. Thus, the specific amount and extent of information to
be provided could be determined by agreement between the account
manager and his or her customer.
---------------------------------------------------------------------------
H. Contract Market Rule Enforcement Programs
1. Proposed Regulation 1.35(a-1)(5)(vii)
The 1998 proposal required that, as part of its rule enforcement
program, each contract market that adopted rules allowing the placement
of eligible orders must adopt audit procedures to determine compliance
with certain account certification, allocation, and recordkeeping
requirements.
This surveillance requirement, to be met by the exchange as part of
its routine oversight of member firms, was deemed necessary to deter
possible unlawful activity and to ensure that an adequate audit trail
existed for eligible orders. Under the proposal, the contract market
was required to adopt audit procedures to determine compliance with (1)
the certification requirements; (2) the requirement that orders must be
allocated to eligible accounts by the end of the day; and (3) the
requirement that eligible orders must be identified on order tickets,
trade registers, other surveillance records, and customer confirmation
statements.
2. Comments Received
CBT and CSCE commented adversely on the audit procedures proposed
to be required by exchanges. CBT commented that the responsibility for
the surveillance of account managers seems to be appropriately placed
on the NFA rather than on the exchange on which the trades are
transacted. Thus, CBT argued that it would be duplicative and unduly
burdensome to require exchanges to conduct specific regulatory reviews
of these types of accounts as part of the regulations. CSCE commented
that many of the areas required to be reviewed pertained to back-office
FCM activities, which would fall within the scope of the review
conducted by the FCM's DSRO and which would not be part of each
exchange's rule enforcement program. Thus, according to CSCE, the only
areas that would be subject to audit under an exchange rule enforcement
program would be the requirement that eligible order transactions be
identified on floor orders, exchange trade registers and other trade
practice surveillance records.
3. Final Regulation 1.35(a-1)(5)(vii)
The Commission continues to believe that oversight of these areas
should be required. However, in response to the comments, the
Commission has
[[Page 45708]]
modified the responsibilities identified by the 1998 proposal as part
of an exchange's rule enforcement program. Audit of the recordkeeping
requirements pertaining to data on exchange computerized records and
entry data required on order tickets will remain as a responsibility of
an exchange's rule enforcement program.\58\ Audit of certain of the
certification, allocation, and recordkeeping requirements that pertain
to the FCM will be a responsibility of the DSRO of the member firm.
Thus, during its audit of a member firm, the DSRO will be required to
determine that (1) the account manager's certification document is on
file; (2) eligible customer accounts are identified; (3) allocations
are made to eligible customer accounts; and (4) allocations are made by
the end of the day the order is executed. Routine audit of the
requirements that pertain to the account manager, such as fairness and
adequacy of disclosure, remains the responsibility of the regulatory
entity required to perform oversight of the account manager. The NFA,
for instance, has the responsibility to perform routine oversight over
member CTAs. Of course, the Commission has the authority to determine
compliance with all of the rule's requirements and to conduct
investigations as appropriate.
---------------------------------------------------------------------------
\58\ The exchange, as part of its rule enforcement program,
would be expected to examine the order tickets for the presence of
identifiers that would (1) indicate that the order was eligible for
post-execution allocation and (2) relate back to the order
origination document. The exchange would not be required to
determine the validity of the identifier that related back to the
order origination document.
---------------------------------------------------------------------------
III. Conclusion
Subject to certain core regulatory protections, the Commission's
final regulation permits certain regulated account managers to place
orders for a defined group of eligible customers without providing
specific customer account identifiers at the time of order placement or
upon report of execution.\59\ The commission previously has identified
the listed customers as eligible to enter Part 35 swap agreements or to
execute Part 36 contract market transactions. The account managers
would be required to allocate the order as soon as practicable after
the entire transaction is executed, but no later than the end of the
day.\60\ As discussed below, in addition to the customer safeguards
being imposed, significant existing and new audit trail and
recordkeeping requirements would remain applicable.\61\
---------------------------------------------------------------------------
\59\ The Commission appreciates the views of the law enforcement
authorities that commented on the previous proposals and shared
their desire that Commission-regulated futures and option markets
not be used as a vehicle to commit serious financial crimes. It is
with those concerns in mind that the Commission has crafted the
protections incorporated into the final regulation. These
protections include specific eligibility requirements for account
managers and customers, as well as disclosure, allocation and
recordkeeping provisions intended to document fair and non-
preferential treatment of customers. Coupled with the strong
antifraud provisions of the Act and the Commission's rigorous
supervision rule, these protections should insure that the proposed
allocation procedure would not unduly threaten customer protection
or market integrity. Rather, the rule should enable account managers
acting in a fiduciary capacity to handle customer interest without
undermining any legitimate customer or law enforcement interests.
\60\As previously noted, end-of-day or post-execution allocation
of bunched or block orders is permissible on foreign futures
exchanges and in the cash and securities markets. The NYSE has
permitted end-of-day allocation of securities block orders since
October 1983. Interpretation 88-3 of NYSE Rule 410(a)(3).
\61\ NFA commented that the Commission should adopt the rule for
a one-year pilot program and then reevaluate its usage with an eye
toward expanding its application to other types of customers and
making other adjustments deemed appropriate based upon experience.
The Commission is satisfied that, based upon its experience with
this issue, a pilot program is not necessary. Of course, the
Commission retains the right to amend this regulation if actual
experience with the rule indicates that modification would be
appropriate.
---------------------------------------------------------------------------
Under the regulation, the account manager must disclose to the
customer that orders may be placed, executed, and allocated as orders
eligible for post-execution allocation. The account manager also must
disclose the general nature of the allocation methodology that will be
used and the standard by which the account manager will judge the
fairness of the allocations. Allocations must be fair and equitable, so
that no account or group of accounts may receive consistently favorable
or unfavorable treatment.\62\ The allocation methodology must be
consistently applied and must be sufficiently objective and specific so
that the appropriate allocation for a given trade can be verified in an
independent audit.\63\
---------------------------------------------------------------------------
\62\ Where applicable, the employing firm of an account manager
should have appropriate internal controls in place to address the
added discretion that the account manager will be able to exercise
pursuant to this regulation.
\63\ Pursuant to Regulation 166.3, an account manager's
employer, if registered with the Commission, has a duty diligently
to supervise his or her activities. Regardless of registration
status, a principal could be held liable for an account manager's
wrongdoing under Section 2(a)(1)(A) of the Act.
---------------------------------------------------------------------------
The account manager would be required to maintain records that
would, among other things, reflect futures and option transactions and
that would relate to, or reflect upon, the fairness of the allocations.
These records would be available, upon request, to the Commission or
the Department of Justice. The account manager also would be required
to provide the customer, upon request, with summary or composite data
sufficient for that customer to compare results with those of other
similarly traded customers. The account manager would be required to
disclose to the customer that customer's ability to obtain and review
the comparative data.
The rule requires that an account manager disclose to customers
whether accounts in which the account manager has any interest may be
included with customer accounts in bunched orders eligible for post-
execution allocation. In addition, the recordkeeping requirements would
deter and facilitate detection of misallocations, which may indirectly
benefit the account manager.\64\ The regulation also requires that an
exchange that permits the placement, execution, and allocation of
orders eligible for post-execution allocation must adopt, as part of
its rule enforcement program, audit procedures to determine compliance
with relevant recordkeeping provisions. The exchange, or the DSRO of a
member firm clearing orders eligible for post-execution allocation,
must adopt audit procedures to determine compliance with relevant
certification, allocation, and recordkeeping requirements.
---------------------------------------------------------------------------
\64\ As a matter of state law or federal securities,
commodities, and banking law, eligible account managers would have
fiduciary responsibility for their investment management activities.
Account managers would be subject to Section 4b, the general
antifraud provision of the Act. Account managers who are also acting
as CTAs or commodity pool operators (``CPO''), irrespective of
registration status, would also be subject to Section 4o. Account
managers who place orders for option contracts would also be subject
to Commission Regulations 32.9 and 33.10, that prohibit fraud in
connection with commodity option transactions.
---------------------------------------------------------------------------
Under the regulation, the account manager must, prior to order
placement, create and timestamp an order origination document
reflecting the terms of the order and the expected allocation of fills
received. Any subsequent change to the terms or allocation must
likewise be documented and timestamped. These documents must be
retained under the Commission's record retention regulation. The order
must be identified as an order eligible for post-execution allocation
by group identifier or other code at the time of placement on the floor
order ticket and, if appropriate, on the office order ticket. The group
identifier or other code on the order tickets must relate back to the
order origination document. All trades resulting from the execution of
an order must be identified on exchange trade
[[Page 45709]]
registers and computerized trade practice surveillance records.
Those requirements, in conjunction with existing audit trail
requirements, should enable the Commission, other regulatory agencies,
and self-regulatory organizations to track any eligible order from time
of placement to allocation of fills. At the time of placement, the
order would be identified on the order origination document and on
order tickets. These order tickets would be timestamped upon receipt of
the order. The order executions would be identified on trading cards
and/or order tickets and on exchange trade registers by, among other
things, both time and price. The order tickets would be timestamped
again to identify time of report of execution. The subsequent
allocation of the fills would be maintained on FCM and exchange
records. Thus, an auditor could determine, among other things, the size
and time of initial order placement, the times and prices of
executions, the identities of accounts to which the fills were
allocated, and the prices and quantities of the fills allocated
thereto.
Based on the foregoing, the Commission believes that this rule
strikes an appropriate balance between regulatory protection and
regulatory relief.
IV. Other Matters
A. Regulatory Flexibility Act
The Regulatory Flexibility Act (``RFA''), 5 U.S.C. 601 et seq.,
requires that agencies consider the impact of rules on small
businesses. The Commission has previously determined that contract
markets,\65\ FCMs,\66\ registered CPOs,\67\ and large traders \68\ are
not ``small entities'' for purposes of the RFA. The Commission has
previously determined to evaluate within the context of a particular
rule proposal whether all or some CTAs should be considered ``small
entities'' for purposes of the RFA and, if so, to analyze the economic
impact on CTAs of any such rule at that time.\69\ CTAs who would place
orders eligible for post-execution allocation pursuant to these
procedures would do so for multiple clients and would be participating
as investment managers for a sophisticated group of eligible customers.
Accordingly, the Commission does not believe that CTAs should be
considered ``small entities'' for purposes of this regulation.
Similarly, the Commission does not believe that foreign advisers
placing orders pursuant to these procedures on behalf of sophisticated
foreign investors should be considered ``small entities'' for purposes
of this regulation.
---------------------------------------------------------------------------
\65\ 47 FR 18618, 18619 (April 30, 1982).
\66\ Id.
\67\ Id. at 18620.
\68\ Id.
\69\ Id.
---------------------------------------------------------------------------
Therefore, the Chairperson, on behalf of the Commission, hereby
certifies, pursuant to 5 U.S.C. 605(b), that the action taken herein
will not have a significant economic impact on a substantial number of
small entities.
Regulation 1.35(a-would provide relief from individual account
identification requirements, thereby providing those small entities who
qualify and elect to use the relief with a less burdensome method for
satisfying Commission Regulation 1.35 requirements.\70\
---------------------------------------------------------------------------
\70\ The Commission received no comments addressing its
conclusions with regard to the RFA.
---------------------------------------------------------------------------
B. Paperwork Reduction Act
When publishing final rules, the Paperwork Reduction Act of 1995
(Pub. 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, this final rule informs the
public of:
(1) The reasons the information is planned to be and/or has been
collected; (2) the way such information is planned to be and/or has
been used to further the proper performance of the functions of the
agency; (3) an estimate, to the extent practicable, of the average
burden of the collection (together with a request that the public
direct to the agency any comments concerning the accuracy of this
burden estimate and any suggestions for reducing this burden); (4)
whether responses to the collection of information are voluntary,
required to obtain or retain a benefit, or mandatory; (5) the nature
and extent of confidentiality to be provided, if any; and (6) the
fact that an agency may not conduct or sponsor, and a person is not
required to respond to, a collection of information unless it
displays a currently valid OMB control number.
The Commission has previously submitted this rule in proposed form
and its associated information collection requirements to the Office of
Management and Budget. The Office of Management and Budget approved the
collection of information associated with this rule on March 14, 1998,
and assigned OMB control number 3038-0022 to the rule. The burden
associated with this entire collection, including this final rule, is
as follows:
Average burden hours per response--3609.26
Number of Respondents--15,691.00
Frequency of Response--On Occasion
The burden associated with this specific proposed rule is as
follows:
Average burden hours per response--0.5
Number of Respondents--400.00
Frequency of Response--On Occasion
Persons wishing to comment on the information required by this
final rule should contact the Desk Officer, CFTC, Office of Management
and Budget, Room 10202, NEOB, Washington, DC 20503, (202) 395-7340.
Copies of the information collection submission to OMB are available
from the CFTC Clearance Officer, 1155 21st Street, NW, Washington, DC
20581, and (202) 418-5160.
List of Subjects in 17 CFR Part 1
Brokers, Commodity futures, Commodity options, Commodity trading
advisors, Commodity pools, Consumer protection, Contract markets,
Customers, Designated self-regulatory organizations, Futures commission
merchants, Members of contract markets, Noncompetitive trading,
Reporting and recordkeeping requirements, Rule enforcement programs.
In consideration of the foregoing, and pursuant to the authority
contained in the Commodity Exchange Act and, in particular, Sections 5,
5a, 5b, 6(a), 6b, 8a(7), 8a(9) and 8c, 7 U.S.C. 7, 7a, 7b, 8(a), 8b,
12a(7), 12a(9), and 12c, the Commission hereby amends Part 1 of Chapter
I of Title 17 of the Code of Federal Regulations as follows:
PART 1--GENERAL REGULATIONS UNDER THE COMMODITY EXCHANGE ACT
1. The authority citation for Part 1 continues to read as follows:
Authority: 7 U.S.C. 1a, 2, 2a, 4, 4a, 6, 6a, 6b, 6c, 6d, 6e, 6f,
6g, 6h, 6i, 6j, 6k, 6l, 6m, 6n, 6o, 6p, 7, 7a, 7b, 8, 9, 12, 12a,
12c, 13a, 13a-1, 16, 16a, 19, 21, 23 and 24.
2. Section 1.35 is amended by revising paragraphs (a-1)(1), (a-
1)(2)(i), and (a-1)(4) and by adding paragraph (a-1)(5) to read as
follows:
Sec. 1.35 Records of cash commodity, futures, and option transactions.
* * * * *
(a-1) * * *
(1) Each futures commission merchant and each introducing broker
receiving a customer's or option customer's order shall immediately
upon receipt thereof prepare a written record of the order including
the account identification, except as provided in paragraph (a-1)(5) of
this section, and order number, and shall record thereon, by timestamp
or
[[Page 45710]]
other timing device, the date and time, to the nearest minute, the
order is received, and in addition, for option customers' orders, the
time, to the nearest minute, the order is transmitted for execution.
(2)(i) Each member of a contract market who on the floor of such
contract market receives a customer's or option customer's order which
is not in the form of a written record including the account
identification, order number, and the date and time, to the nearest
minute, the order was transmitted or received on the floor of such
contract market, shall immediately upon receipt thereof prepare a
written record of the order in nonerasable ink, including the account
identification, except as provided in paragraph (a-1)(5) of this
section or appendix C to this part, and order number and shall record
thereon, by timestamp or other timing device, the date and time, to the
nearest minute, the order is received.
* * * * *
(4) Each member of a contract market reporting the execution from
the floor of the contract market of a customer's or option customer's
order or the order of another member of the contract market received in
accordance with paragraphs (a-1)(2)(i) or (a-1)(2)(ii)(A) of this
section, shall record on a written record of the order, including the
account identification, except as provided in paragraph (a-1)(5) of
this section, and order number, by timestamp or other timing device,
the date and time to the nearest minute such report of execution is
made. Each member of a contract market shall submit the written records
of customer orders or orders from other contract market members to
contract market personnel or to the clearing member responsible for the
collection of orders prepared pursuant to this paragraph as required by
contract market rules adopted in accordance with paragraph (j)(1) of
this section. The execution price and other information reported on the
order tickets must be written in nonerasable ink.
(5) Orders eligible for post-execution allocation. Specific
customer account identifiers for accounts included in bunched orders
need not be recorded at time of order placement or upon report of
execution if the requirements of this paragraph are met. The bunched
order must be placed by an eligible account manager on behalf of
eligible customer accounts and must be handled in accordance with
contract market rules that have been submitted to the Commission
pursuant to Section 5a(a)(12)(A) of the Act and Sec. 1.41.
(i) Eligible account managers. The person placing and directing the
allocation of an order eligible for post-execution allocation must be
one of the following who has been granted investment discretion with
regard to eligible customer accounts:
(A) A commodity trading advisor registered with the Commission
pursuant to the Act;
(B) An investment adviser registered with the Securities and
Exchange Commission pursuant to the Investment Advisers Act of 1940;
(C) A bank, insurance company, trust company, or savings and loan
association subject to federal or state regulation; or
(D) A foreign adviser who provides advice solely to foreign persons
and who is subject to regulation by a foreign regulator or self-
regulatory organization that has been granted an exemption pursuant to
Sec. 30.10 of this chapter or has entered into a Memorandum of
Understanding or other arrangement for cooperative enforcement and
information sharing with the Commission (for the purposes of this
section, referred to as a ``foreign authority''), provided that the
certification required by paragraph (a-1)(5)(iv)(C) of this section is
made.
(ii) Eligible customers. The accounts for which orders eligible for
post-execution allocation may be placed and to which fills may be
allocated must be owned by the following entities:
(A) A bank or trust company;
(B) A savings and loan association or credit union;
(C) An insurance company;
(D) An investment company subject to regulation under the
Investment Company Act of 1940 (15 U.S.C. 80a-1, et seq.) or a foreign
investment company performing a similar role or function subject to
foreign regulation, provided that the investment company has total
assets exceeding $5,000,000;
(E) A commodity pool formed and operated by a person subject to
regulation under the Act or a foreign entity performing a similar role
or function subject to foreign regulation, provided that the commodity
pool or foreign entity has total assets exceeding $5,000,000;
(F) A corporation, partnership, proprietorship, organization,
trust, or other entity, provided that the entity has either a net worth
exceeding $1,000,000 or total assets exceeding $10,000,000;
(G) An employee benefit plan subject to the Employee Retirement
Income Security Act of 1974 or a foreign entity performing a similar
role or function subject to foreign regulation, with total assets
exceeding $5,000,000 or whose investment decisions are made by a bank,
trust company, insurance company, investment adviser subject to
regulation under the Investment Advisers Act of 1940 (15 U.S.C. 80b-1,
et seq.) or a commodity trading advisor subject to regulation under the
Act;
(H) Any government entity (including the United States, any state,
or any foreign government) or political subdivision thereof, or any
multinational or suparnational entity or any instrumentality, agency,
or department of any of the foregoing;
(I) A broker-dealer subject to regulation under the Securities
Exchange Act of 1934 (15 U.S.C. 78a, et seq.) or a foreign person
performing a similar role or function subject to foreign regulation,
acting on its own behalf:
(J) A futures commission merchant, floor broker, or floor trader
subject to regulation under the Act or a foreign person performing a
similar role or function subject to foreign regulation, acting on its
own behalf;
(K) An eligible account manager, as defined in paragraph (a-
1)(5)(i) of this section; or
(L) Any natural person with total assets exceeding $10,000,000.
(iii) Disclosure. Before placing the initial order eligible for
post-execution allocation, the account manager must disclose the
following to each of its customers to be subject to post-execution
allocation:
(A) The general nature of the allocation methodology the account
manager will use;
(B) The standard by which the account manager will judge the
fairness of allocations;
(C) The ability of the customer to review summary or composite data
sufficient for that customer to compare its results with those of other
relevant customers; and
(D) Whether accounts in which the account manager may have any
interest may be included with customer accounts in bunched orders
eligible for post-execution allocation.
(iv) Account certification. Before placing an order eligible for
post-execution allocation, the account manager must provide the
following to each futures commission merchant clearing any part of the
order:
(A) If not previously provided, certification, in writing, that the
account manager is aware of, and will remain in compliance with, the
requirements of this paragraph. This certification shall remain in
effect until revoked by the account manager; and
[[Page 45711]]
(B) If not previously identified, the identity of each eligible
customer account to which fills will be allocated.
(C) Foreign advisers must also provide a written certification from
a foreign authority stating that the foreign adviser's activities are
subject to regulation by that foreign authority and the foreign
authority will provide, upon request of the Commission or Department of
Justice, information that relates to the foreign adviser's compliance
with the requirements of this paragraph.
(v) Allocation. Orders eligible for post-execution allocation must
be allocated in accordance with the following:
(A) Allocations must be made only to the accounts of eligible
customers.
(B) Allocations must be made as soon as practicable after the
entire transaction is executed, but no later than the end of the day
the order is executed.
(C) Allocations must be fair and equitable. No account or group of
accounts may receive consistently favorable or unfavorable treatment.
(D) The allocation methodology must be sufficiently objective and
specific so that the appropriate allocation for a given trade can be
verified in an independent audit.
(E) The allocation methodology must be consistently applied.
(vi) Recordkeeping. The following recordkeeping requirements apply
to orders eligible for post-execution allocation:
(A) Prior to order placement, each account manager must create and
timestamp an order origination document reflecting the terms of the
order and expected allocation thereof. Any subsequent determination to
alter any terms or allocation of the order should likewise be
documented.
(B) Each order must be identified by group identifier or other code
on the office and/or floor order tickets at the time of placement. The
group identifier or other code on each order ticket must relate back to
the specific order origination document required by paragraph (a-
1)(5)(vi)(A) of this section.
(C) Each transaction must be identified as part of an order
eligible for post-execution allocation on contract market trade
registers and other computerized trade practice surveillance records.
(D) Each account manager must make available, upon request of any
representative of the Commission or the United States Department of
Justice, the following records:
(1) The disclosure documents required pursuant to paragraph (a-
1)(5)(iii) of this section; and
(2) Records reflecting futures and option transactions and other
transactions and any other records, including the order origination
document, that would identify the management strategy or the allocation
methodology or would relate to, or reflect upon, the fairness of the
allocations.
(E) Each account manager must make available for review, upon
request of an eligible customer, summary or composite data sufficient
for that customer to compare its results with those of other relevant
customers. These summary data may be prepared so as not to disclose the
identity of individual account holders.
(vii) Self regulatory organization rule enforcement and audit
procedures. As part of its rule enforcement program, each contract
market that adopts rules that allow the placement of orders eligible
for post-execution allocation must adopt audit procedures to determine
compliance with the recordkeeping requirements identified in paragraph
(a-1)(5)(vi) (B) and (C) of this section. Each contract market, or the
designated self-regulatory organization of a member firm, must adopt
audit procedures to determine compliance with the certification and
allocation requirements identified in paragraphs (a-1)(5)(iv) and (a-
1)(5)(v) (A) and (B) of this section.
* * * * *
Issued in Washington, DC on August 21, 1998 by the Commission.
Catherine D. Dixon,
Assistant Secretary of the Commission.
[FR Doc. 98-22933 Filed 8-26-98; 8:45 am]
BILLING CODE 6351-01-M
