02-7345. Request of the National Futures Association for Approval of Interpretive Notice to NFA Compliance Rule 2-9: Supervision of the Use of Automated Order Routing Systems

AGENCY:

Commodity Futures Trading Commission.

ACTION:

Notice and request for comment.

SUMMARY:

The Commodity Futures Trading Commission (the “Commission” or “CFTC”) has determined, pursuant to section 17(j) of the Commodity Exchange Act (the “Act”), to review the National Futures Association's (“NFA's”) proposed Interpretive Notice of (the “Interpretive Notice”) to its Compliance Rule 2-9 regarding supervision of the use of automated order routing systems (“AORSs”) that route orders through futures commission merchants (“FCMs”). The Interpretive Notice would require that NFA members adopt and enforce written procedures in the areas of security, capacity, and credit and risk management controls in connection with AORSs, but it provides flexibility for members to design procedures tailored to their own circumstances. Because NFA's policy is to set standards rather than to require specific technology, other procedures than those described in the Interpretive Notice may comply with the general standards for supervisory responsibilities imposed by NFA Compliance Rule 2-9. The proposed Interpretive Notice would become effective upon approval by the Commission. Therefore, the Commission has determined to provide an opportunity for public comment prior to its consideration of the Interpretive Notice.

DATES:

Comments must be received by April 26, 2002.

ADDRESSES:

Comments on the proposed rules may be sent to Jean A. Webb, Secretary of the Commission, Commodity Futures Trading Commission, Three Lafayette Centre, 1155 21st Street, NW., Washington, DC 20581. In addition, comments may be sent by facsimile transmission to facsimile number [phone], or by electronic mail to [e-mail]. Reference should be made too “NFA Interpretive Notice Regarding Supervision of Automated Order Routing Systems.”

FOR FURTHER INFORMATION CONTACT:

Lawrence B. Patent, Associate Chief Counsel, or Christopher W. Cummings, Special Counsel, Division of Trading and Markets, Commodity Futures Trading Commission, 1155 21st Street, NW., Washington, DC 20581, telephone number: [phone], facsimile number: [phone], electronic mail: [e-mail], or [e-mail].

SUPPLEMENTARY INFORMATION:

I. Introduction

By letter dated March 1, 2002, NFA submitted to the Commission for its approval, pursuant to section 17(j) of the Act, NFA's proposed Interpretive Notice to its Compliance Rule 2-9 regarding supervision of the use of AORSs that route orders through FCMs. NFA's submission indicates that the Interpretive Notice would become effective upon approval by the Commission. NFA Compliance Rule 2-9 requires, in relevant part, that “(e)ach Member shall diligently supervise its employees and agents in the conduct of their commodity futures activities for or on behalf of the Member. Each Associate who has supervisory duties shall diligently exercise such duties in the conduct of that Associate's commodity futures activities on behalf of the Member.” NFA believes that supervisory standards do not change with the medium used, but that the manner in which those standards are applied may be affected by technology. In order to fulfill their supervisory obligations, NFA members using AORSs must adopt and enforce written procedures to examine the security, capacity and credit and risk management controls provided by the firm's AORSs.

NFA notes that the proposed Interpretive Notice applies to AORSs that are within an NFA member's control (including those provided by an application service provider or an independent software vendor). While a member would not be responsible for an AORS chosen by the customer and not under the member's control, the member would be required to adopt procedures that could reasonably be expected to address the trading, clearing and other risks arising from its customer relationship.

II. Description of the Interpretive Release

The proposed Interpretive Notice would require that NFA members adopt and enforce written procedures in three general areas: (1) Security procedures to protect the reliability and confidentiality of customer orders and account information; (2) capacity procedures to maintain adequate personnel and facilities for timely and efficient delivery of orders and reporting of executions, as well as for timely handling of customer complaints; and (3) credit and risk management controls to prevent customers from entering trades that could create undue financial risks for the NFA member or its other customers.

Without specifying the manner in which they are to be implemented, the proposed Interpretive Notice describes a set of essential functions under each general heading and gives non-exclusive examples to illustrate. The essential functions that are listed under security procedures include: (1) Authentication of the user; (2) encryption or equivalent protections; (3) firewalls or equivalent protections; (4) means for customers to give notice that a person is no longer authorized; (5) periodic testing; and (6) administrative oversight and supervision. The essential functions that are listed under capacity procedures include: (1) Regular evaluation of the system's capacity (with increases as needed); (2) monitoring of system capacity and performance; (3) follow-up on customer access complaints; (4) disaster recovery and redundancies; (5) prompt notice to customers of operational difficulties; and (6) advance disclosure of factors that could stress the system. The essential functions that are listed under credit and risk management controls are: (1) Pre-execution controls (to be imposed when appropriate); (2) post-execution controls and trade monitoring; (3) extra precautions for direct-access systems; and (4) review of AORS controls in conjunction with the member's regular credit and risk control procedures.

NFA has also revised the required annual self-examination to include the WebTrust^SM/TM Self-Assessment Questionnaire, which was developed by the American Institute of Certified Public Accountants and the Canadian Institute of Chartered Accountants. WebTrust^SM/TM states that it is “for use by electronic commerce service providers to document their business practices/transaction integrity disclosures, policies, procedures and monitoring.”

As noted earlier, the proposed Interpretive Release would become effective upon approval by the Commission. Accordingly, the Commission seeks comments on the proposed Interpretive Notice to NFA Compliance Rule 2-9 regarding supervision of the use of AORs.

Copies of the proposed Interpretive Notice will be available for inspection at the Office of the Secretariat, Commodity Futures Trading Commission, Three Lafayette Centre, 1155 21st Street, NW., Washington, DC 20581. Copies also may be obtained through the Office of the Secretariat at the above address by telephoning [phone].

Issued in Washington, DC on March 21, 2002, by the Commission.

Jean A. Webb,

Secretary of the Commission.