The Commodity Futures Trading Commission (the “CFTC”) is proposing for public comment amendments to its rules regarding the content of the written acknowledgment that a futures commission merchant (“FCM”) or a derivatives clearing organization (“DCO”) obtains from depositories holding its customer funds or secured amount funds, as well as related technical and conforming amendments. If adopted, these amendments would require certain additional representations to be included in these acknowledgments “to reaffirm and clarify the obligations [d]epositories incur when accepting customer funds or secured amount funds.” 47 Fed. Reg. 7838 at 7839. Comments must be submitted on or before March 23, 2009.  

The CFTC believes that these amendments, if adopted, would enhance the risk management practices required of FCMs and DCOs holding customer funds or secured amount funds. These amendments also are designed to reduce the likelihood that a depository will misinterpret its obligations in connection with the safekeeping of customer funds or secured amount funds under the Commodity Exchange Act (the “CEA”) and the rules and regulations thereunder.  

Background  

Rule 1.20 requires, among other things, that FCMs and DCOs obtain from a bank or trust company (or another FCM or DCO) holding customer funds in the capacity of a depository (each, a “Depository”) a written acknowledgment that the Depository was informed that the customer funds deposited therein are those of commodity or option customers and are being held in accordance with the provisions of the CEA and CFTC rules thereunder. Rule 1.26, which requires FCMs and DCOs to separately account for and segregate instruments purchased with customer funds, also provides for an acknowledgment to be obtained from a depository holding such instruments.1

Rule 30.7, which is applicable to the treatment of funds, securities and property held for or on behalf of an FCM’s foreign futures and options customers, includes a requirement that the FCM obtain a similar acknowledgment from the Depositories holding secured amount funds. Under Rule 30.7(c)(1), an eligible depository for secured amount funds is limited to the following categories: (i) a bank or trust company located in the United States; (ii) a bank or trust company located outside the United States that meets certain specified capital or rating requirements; (iii) another registered FCM; (iv) a DCO; (v) a member of a foreign board of trade; or (vi) such member or clearing organization’s designated depositories.  

Summary of Proposed Amendments

Rule 1.20  

The CFTC is proposing to amend Rule 1.20 to include certain additional representations that Depositories would need to make in the written acknowledgment required thereunder. Specifically, a Depository would be required to acknowledge that (i) the FCM or DCO has established the account for the purpose of depositing customer funds; (ii) the customer funds deposited therein are those of commodity or option customers of the FCM or clearing members of the DCO and those funds are to be segregated in accordance with the provisions of the CEA and Part 1 of the CFTC’s rules; (iii) customer funds are not subject to any sight of offset, or lien, for or on account of any indebtedness, obligations or liabilities owed by the FCM or DCO; (iv) it must treat the customer funds in accordance with the CEA and the CFTC’s rules; and (v) it must “immediately” release the customer funds upon “proper notice” and instruction from the FCM or DCO, or from the CFTC2; and (vi) the FCM or DCO has informed it that the FCM or DCO will provide the CFTC with a copy of the written acknowledgment.  

The written acknowledgment would need to include the account number for each account covered by it. This information may be listed in an attachment if multiple accounts are covered by a single written acknowledgment. A copy of the written acknowledgment would be required to be filed with the regional office of the CFTC with jurisdiction over the state in which the FCM’s or DCO’s principal place of business is located.  

Rule 1.26  

The proposed amendments to Rule 1.26 would require the written acknowledgment for instruments in which customer funds are invested to be identical to the written acknowledgment required under Rule 1.20. Thus, the written acknowledgment required by Rule 1.26 would need to meet the requirements set forth in Rule 1.20 as proposed to be amended.  

Rule 30.7  

The CFTC is proposing to amend Rule 30.7 to add specific representations that Depositories holding secured amount funds would need to include in the written acknowledgment required thereunder.3 Pursuant thereto, a Depository would be required to acknowledge that (i) it meets the requirements for a depository for secured amount funds in Rule 30.7(c)(1); (ii) the FCM has established the account for the purpose of depositing money, securities or property on behalf of customers that include foreign futures and options customers; (iii) the money, securities or property deposited therein are held on behalf of the FCM’s foreign futures and options customers and may not be commingled with the FCM’s own funds or any other funds that the Depository may hold in accordance with the provisions of the CEA and the CFTC’s Part 30 rules; (iv) the money, securities, or property is not subject to any right of offset or lien, for or on account of any indebtedness, obligations or liabilities owed by the FCM; (v) it must treat the money, securities, or property in accordance with the provisions of the CEA and the CFTC’s rules; (vi) it must release “immediately, subject to requirements of applicable foreign law,”4 the money, securities, or property upon proper notice and instruction from the FCM or the CFTC; and (vii) the FCM has informed it that the FCM will provide the CFTC with a copy of the written acknowledgment.  

Just as the written acknowledgment under Rule 1.20, the written acknowledgment under Rule 30.7 would need to include the account number for each account covered by it. This information may be listed in an attachment if multiple accounts are covered by a single written acknowledgment. Also, just as the written acknowledgment under Rule 1.20, an FCM would need to file a copy of the written acknowledgment under Rule 30.7 with the regional office of the CFTC with jurisdiction over the state in which the FCM’s principal place of business is located.  

Record Retention Requirements  

The proposed amendments would require that each such written acknowledgment be kept readily accessible for as long as any of the accounts covered by it remain open and that the retention requirements which would otherwise apply under CFTC Rule 1.31 would only take effect once the accounts have been closed. Under Rule 1.31, records must be kept for a five year period and be readily accessible for the first two years of that five year period. For this purpose, as explained in the Federal Register notice, if an account remains open for ten years, the acknowledgment would have to be kept readily accessible for twelve years (the ten years during which the account is open plus the two years required by Rule 1.31) and then for an additional three years, also as required by Rule 1.31.  

Technical, Conforming Amendments  

The CFTC is also proposing to make certain related technical and conforming amendments, including references to the new representations and record retention requirements and replacing the term “clearing organization”, wherever it appears in Rules 1.20 and 1.26 with the term “derivatives clearing organization”, to be consistent with the CEA and other CFTC rules. Similarly, the CFTC is proposing certain conforming amendments to Rule 30.7 to reflect the new representations and record retention requirements. Finally, the CFTC is proposing technical amendments to Rule 140.9 to delegate to the Director of its Division of Clearing and Intermediary Oversight (“DCIO”) the authority to perform certain functions that are reserved to the CFTC under the proposed amendments to Rules 1.20 and 30.7. Thus, the Director of DCIO would have delegated authority to instruct a Depository to release customer funds or secured amount funds.  

Delayed Effective Date  

The CFTC recognizes that it will take time for FCMs and DCOs to obtain new written acknowledgments to comply with the final rules as proposed to be amended. The CFTC is therefore proposing that the effective date of these amendments be 180 days from the date of publication of final rules in the Federal Register.

Discussion  

These amendments, if adopted as proposed, are designed to make clear that the transfer of customer funds from a segregated or a secured account cannot be delayed due to concerns by the Depository about the financial status of the FCM or DCO that deposited the funds, as the case may be. In that respect, these amendments would codify and clarify existing law and should be helpful in avoiding any potential misunderstanding or inadvertent confusion about the applicable requirements of the CEA and the rules and regulations thereunder in the future.  

We cannot be sure whether or to what extent Depositories will object to making these additional representations, particularly Depositories located outside the United States with respect to holding secured amount funds. At least, if these amendments are adopted, an FCM should only need to obtain a new written acknowledgment with respect to the maintenance of accounts containing secured amount funds by an initial depository in the chain of custody, and not with respect to the manner in which any subsequent depository holds or thereafter transmits those funds in accordance with Appendix B to the Part 30 rules.