INTRODUCTION

The Commodity Futures Trading Commission (the “Commission” or “CFTC”) has adopted certain amendments to Rule 18.05 which (i) require that a person holding or controlling a reportable futures or option position retain books and records and make available to the Commission upon request any pertinent information with respect to all other positions and transactions in the commodity in which the trader has a reportable position, including positions held or controlled or transactions executed over-the-counter, on exempt trading platforms, or on foreign exchanges and (ii) make the rule more explicit and more complete with respect to hedging activity. 72 Fed. Reg. 60767 (October 26, 2007). The amendments become effective thirty days after publication in the Federal Register. According to the CFTC, these amendments will enhance its ability to deter and prevent price manipulation or other disruptions to the integrity of the regulated futures markets, help to assure the avoidance of systemic risk, and clarify the meaning of Rule 18.05.

As we noted in our memorandum to Friends and Clients dated June 28, 2007 on the proposal1, the underlying rationale for these amendments is that there is a close relationship between transactions conducted on reporting markets and non-reporting transactions and that it is sometimes necessary to determine all transactions and positions in the commodity in which a trader is reportable to detect and prevent manipulation of regulated markets and products and to assure the avoidance of systemic risk. Thus, according to the CFTC, it is important that its staff be able to assess a reportable trader’s overall position in the same commodity in view of such factors as the growing volume of trading on non-reporting markets and the close relationship among various products and markets involving the same or related commodities.

Under the CFTC’s large trader reporting system, clearing members, futures commission merchants (each, an “FCM”), and foreign brokers file with the Commission daily reports with respect to accounts having reportable positions, i.e., a number of contracts in excess of a specified amount set forth in Rule 15.03 in an exchange-traded futures contract or option. Also, the regulated exchanges which are referred to as “designated contract markets” (each, a “DCM”) report to the CFTC each business day, by proprietary and customer account, on the positions that each clearing member is carrying. These reports are designed to enable the Commission to assess a trader’s activities and potential market power, as well as to monitor compliance with applicable speculative position limits and determine which FCMs may have significant exposure in particular markets.

In addition, once a trader holds or controls a reportable position in an exchange-traded futures contract or option, the trader is subject to Rule 18.05, which requires that the trader keep books and records showing all details concerning (1) all positions and transactions for future delivery in the commodity on all reporting markets; (2) all positions and transactions in the commodity option; (3) all positions and transactions in the cash commodity, its products and byproducts; and (4) commercial activities that the trader hedges in the commodity underlying the futures contract in which the trader is reportable. A reportable trader also must furnish the Commission upon request any pertinent information concerning such positions, transactions or activities. A trader who does not hold or control a reportable position in an exchangetraded futures contract or option does not have any obligations under Rule 18.05.

II. DISCUSSION

Certain commenters requested that the Commission clarify the recordkeeping and reporting aspects of the proposed amendments. In response to these comments, the Commission stated that accurate records of positions and actual transaction documentation created in the ordinary course of business must be retained under Rule 18.05. The Commission also stated that books and records which currently should be maintained by traders in the normal course of business and in the format created in the normal course of business would comply with Rule 18.05’s recordkeeping requirements. Such records are subject to the retention requirements in Rule 1.31. Under Rule 1.31, required records must be retained for five years and be readily accessible during the first two years. The Commission also clarified that Rule 18.05 does not affect or add to the recordkeeping and reporting requirements in Rule 1.35, which are applicable to FCMs, introducing brokers, and members of contract markets.

Although commenters generally did not address issues relating to the scope of CFTC jurisdiction in this area under the Commodity Exchange Act (the “Act”), 7 U.S.C. § 1 et seq., the Commission reiterated that it has ample authority under the Act to require book and recordkeeping and the provision of information with respect to transactions conducted by reportable traders on non-regulated markets. In this regard, the Commission noted that its staff has interpreted Rule 18.05 in its current form to include position and transaction data for transactions on non-regulated markets and has received information in response to these requests. On this basis the Commission stated that the proposal to amend Rule 18.05 merely makes explicit what has been implicit.

These amendments also make the rule more explicit and more complete with respect to what information must be reported in connection with hedging activity. Specifically, the amendments clarify that a trader must maintain records of all commercial activities which are hedged in the commodity underlying any reportable futures or option contract, in addition to records of all positions and transactions in the cash commodity, including its products and byproducts.

III. ANALYSIS

The Commission’s action in amending Rule 18.05 is designed to enhance its market surveillance authority over transactions in non-regulated markets that may affect the regulated futures markets. As noted, the Commission has stated that these amendments merely make explicit what has been implicit, but this action may reflect an intent to use Rule 18.05 to obtain books and records, including with respect to non-regulated transactions, in connection with its market surveillance activities on a more frequent basis in the future. It is helpful, however, that the Commission has clarified the recordkeeping and reporting aspects of the amendments.

Notably, the adoption of these amendments has occurred at the same time as the release of a CFTC report to Congress recommending an increase in the oversight of trading activity on certain electronic trading platforms known as exempt commercial markets (each an “ECM”) which would require various amendments to the Act.2 Among other things, these amendments would authorize the Commission to subject contracts listed on an ECM that are determined to serve a significant price discovery function to large trader position reporting requirements comparable to those that currently are applicable to all DCM contracts.