[Federal Register: June 10, 2002 (Volume 67, Number 111)]
[Proposed Rules]
[Page 39647-39658]
From the Federal Register Online via GPO Access [wais.access.gpo.gov]
[DOCID:fr10jn02-17]
[[Page 39647]]
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SECURITIES AND EXCHANGE COMMISSION
17 CFR Part 240
[Release No. 34-46014; File No. S7-19-02]
RIN 3235-AI50
Confirmation Requirements for Transactions of Security Futures
Products Effected in Futures Accounts
AGENCY: Securities and Exchange Commission.
ACTION: Proposed rule.
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SUMMARY: In accordance with the Commodity Futures Modernization Act of
2000 (``CFMA''), the Securities and Exchange Commission (``SEC'' or
``Commission'') is publishing for comment proposed rule amendments and
a new rule under the Securities Exchange Act of 1934 (``Exchange
Act''). The proposed rule amendments and new rule are designed to
clarify the disclosures broker-dealers effecting transactions in
security futures products in customer futures accounts must make in the
confirmations sent to customers regarding those transactions. The
amendments would exclude certain broker-dealers effecting transactions
in security futures products in customer futures accounts from the
SEC's confirmation disclosure rule, provided that the transaction
confirmations for these accounts disclose specific information and
notify customers that certain additional information would be available
upon written request. The new rule would also provide that broker-
dealers effecting transactions for customers in security futures
products in a futures account are exempt from the disclosure
requirements of Exchange Act Section 11(d)(2).
DATES: Comments should be received on or before July 10, 2002.
ADDRESSES: Comments should be submitted in triplicate to Jonathan G.
Katz, Secretary, Securities and Exchange Commission, 450 Fifth Street,
NW., Washington, DC 20549-0609. Comments also may be submitted
electronically at the following e-mail address: rule-comments@sec.gov.
All comment letters should refer to File No. S7-19-02; this file number
should be included on the subject line if e-mail is used. Comment
letters received will be available for public inspection and copying in
the SEC's Public Reference Room, 450 Fifth Street, NW, Washington, DC
20549-0102. Electronically submitted comment letters will be posted on
the SEC's Internet web site (http://www.sec.gov). The SEC does not edit
personal identifying information, such as names or e-mail addresses,
from electronic submissions. Submit only the information you wish to
make publicly available.
FOR FURTHER INFORMATION CONTACT: Catherine McGuire, Chief Counsel,
Patricia Albrecht, Special Counsel, or Norman Reed, Staff Attorney, at
(202) 942-0073, Office of the Chief Counsel, Division of Market
Regulation, Securities and Exchange Commission, 450 5th Street, NW.,
Washington, DC 20549-1001.
SUPPLEMENTARY INFORMATION:
Table of Contents
I. Introduction
II. Proposed Amendments and New Rule
A. Rule 10b-10
B. Rule 10b-10 SIPC Disclosure Requirement
C. Rule 11d2-1
III. General Request for Comments
IV. Paperwork Reduction Act
V. Costs and Benefits of Proposed Amendments
VI. Consideration of Burden on Competition, and Promotion of
Efficiency, Competition, and Capital Formation
VII. Regulatory Flexibility Act Certification
VIII. Statutory Authority
Text of Proposed Rule Amendments and Rule
I. Introduction
The CFMA permits the trading of security futures, i.e., futures
contracts on individual securities and on narrow-based security
indexes.\1\ The CFMA defines security futures both as ``securities''
under the federal securities laws,\2\ and as futures contracts for
purposes of the Commodity Exchange Act (``CEA'').\3\ Accordingly, the
SEC and the Commodity Futures Trading Commission (``CFTC'') have joint
jurisdiction over the intermediaries and markets that trade security
futures products (``SFPs'').
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\1\ Pub. L. 106-554, 114 Stat. 2763. Under Exchange Act Section
3(a)(55)(A), the term ``security future'' is defined as a contract
of sale for future delivery of a single security or of a narrow-
based security index. 15 U.S.C. 78c(a)(55)(A). Under Exchange Act
Section 3(a)(56), the term ``security futures product'' is defined
as a security future or an option on security future. 15 U.S.C.
78C(a)(56).
\2\ See, e.g., Exchange Act Section 3(a)(10) (15 U.S.C.
78c(a)(10)).
\3\ The term ``security future'' is defined in CEA Section
1a(31) (7 U.S.C. 1a(31)) as a contract of sale for future delivery
of a single security or of a narrow-based security index. Under CEA
Section 1a(33) (7 U.S.C. 1a(33)), the term ``security futures
product'' is defined as a security future or an option on a security
future.
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Because they are subject to regulation both as securities and as
futures contracts, SFPs must be traded on trading facilities and
through intermediaries that are registered with both the SEC and the
CFTC. The CFMA amended the CEA and the Exchange Act to provide notice
registration procedures for persons that may be required to register
with the SEC or the CFTC solely because they are effecting SFP
transactions. Under the notice registration procedures, a futures
commission merchant (``FCM'') may register with the SEC pursuant to
Section 15(b)(11) of the Exchange Act and the rules adopted by the SEC
\4\ (``Notice BD'') and a broker-dealer may register with the CFTC
pursuant to Section 4f(a)(2) of the CEA and rules adopted by the CFTC
\5\ (``Notice FCM'').
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\4\ 15 U.S.C. 78o(b)(11)(a)(i) and Exchange Act Release No.
44730 (August 21, 2001), 66 FR 45137 (August 27, 2001).
\5\ 7 U.S.C. 6f(a)(2) and 66 FR 43080 (August 17, 2001).
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Notice BDs are exempt from certain provisions of the Exchange
Act,\6\ and Notice FCMs are exempt from certain provisions of the
CEA.\7\ These statutory provisions were designed to allow persons that
previously had engaged ``solely'' in either the securities or futures
business to participate in SFP business without being subject to
conflicting or duplicative regulation. The CFMA does not exempt firms
that are ``fully-registered'' with both the CFTC and the SEC (``Full
FCM/Full BDs'') from any provisions of the Exchange Act or the CEA.
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\6\ Exchange Act Section 15(b)(11)(B) (15 U.S.C. 78o(b)(11)(B)).
\7\ CEA Section 4f(a)(4)(A) (7 U.S.C. 6f(a)(4)(A)).
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The CFMA requires the SEC, in consultation with the CFTC, to issue
such rules, regulations, or orders as are necessary to avoid
duplicative or conflicting regulations applicable to Full FCM/Full BDs
with respect to the treatment of customer funds, securities, or
property, maintenance of books and records, financial reporting, or
other financial responsibility rules, involving SFPs.\8\ In absence of
this proposed rulemaking, every firm effecting transactions in SFPs
would need to comply with all of the confirmation disclosure
requirements of the Exchange Act and the CEA, which would create the
kind of duplicate regulation for SFPs that the CFMA's direction
attempts to avoid.
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\8\ Exchange Act Section 15(c)(3)(B) (15 U.S.C. 78o(c)(3)(B)).
Cf. CEA Section 4d(c) (7 U.S.C. 6d(c)) (providing the same
requirement for the CFTC).
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II. Proposed Amendments and New Rule
A. Rule 10b-10
Generally, Exchange Act Rule 10b-10 requires broker-dealers that
effect transactions for customers in securities, other than U.S.
savings bonds or
[[Page 39648]]
municipal securities,\9\ to provide a confirmation, at or before the
completion of each transaction, disclosing certain basic terms of the
transaction. The confirmation requires, among other things, the
disclosure of: the date, identity, price, and number of shares bought
or sold; \10\ the capacity of the broker-dealer; \11\ the net dollar
price and yield of a debt security; \12\ and, under specified
circumstances, the amount of compensation paid to the broker-dealer and
whether payment for order flow is received.\13\ The customer
confirmation requirement, portions of which have been in effect for
over 50 years, provides basic investor protections by conveying
information allowing investors to verify the terms of their
transactions; alerting investors to potential conflicts of interest
with their broker-dealers; acting as a safeguard against fraud; and
providing investors a means to evaluate the costs of their transactions
and the quality of their broker-dealer's execution.\14\
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\9\ Municipal securities are covered by a parallel rule MSRB
Rule G-15, which applies to all municipal securities-dealers--both
bank and non-bank dealers.
\10\ 17 CFR 240.10b-10(a)(1).
\11\ 17 CFR 240.10b-10(a)(2) and (8).
\12\ 17 CFR 240.10b-10(a)(5) and (6).
\13\ See, e.g., 17 CFR 240.10b-10(a)(2)(i)(B), (C) and (D); 17
CFR 240.10b-10(a)(8)(i)(A).
\14\ Exchange Act Release. No. 34962 (November 10, 1994), 59 FR
59612 (November 17, 1994).
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Although the CFMA exempted Notice BDs from certain Exchange Act
provisions, including Exchange Act Section 11,\15\ it did not exempt
them from Exchange Act Section 10 and the rules promulgated thereunder,
including Exchange Act Rule 10b-10.\16\ In addition, as stated
previously, the CFMA did not exempt Full FCM/Full BDs from any
provisions of the Exchange Act or the rules promulgated thereunder.
Accordingly, under the CFMA, entities effecting SFP transactions in
futures accounts currently are required to meet the confirmation
disclosure requirements of both the CEA and the Exchange Act and the
rules thereunder.
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\15\ Exchange Act Section 15(b)(11)(B) (15 U.S.C.
78o(b)(11)(B)).
\16\ 17 CFR 240.10b-10.
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CEA Rule 1.33(b)\17\ provides the disclosure requirements FCMs
effecting futures transactions must follow. However, although CEA Rule
1.33(b) requires an FCM to provide a customer with a ``written
confirmation of each commodity futures transaction,'' \18\ it does not
specify what information must be included in the confirmation.\19\ The
rules of certain futures exchanges, such as the Chicago Mercantile
Exchange (``CME'') and the Chicago Board of Trade (``CBOT''),\20\
require an FCM to disclose in writing no later than the following
business day after each transaction specific information regarding that
transaction effected in a futures account. Information that must be
disclosed includes the commodity bought or sold, the quantity, the
price, and the delivery month.\21\ The CBOT also requires disclosure of
the name of the other party to the contract (in other words, the FCM on
the opposite side of the contract) or a notice disclosing that such
information is available upon request.\22\
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\17\ 17 CFR 1.33(b). Specifically, CEA Rule 1.33(b)(1) requires
FCMs that effect futures transactions for customers to provide, no
later than the next business day after the transaction, ``a written
confirmation of each commodity futures transaction caused to be
executed by it * * *.''
\18\ 17 CFR 1.33(b)(1).
\19\ CEA Rule 1.33b(2) (17 CFR 1.33(b)(2)) does specify the
detail required in a confirmation of a commodity option transaction.
In addition, CEA Rule 1.46(a) (17 CFR 1.46(a)) requires an FCM to
furnish a futures or options customer a purchase-and-sale statement
when an offsetting transaction is executed showing the financial
result of the transactions in involved.
\20\ See, e.g., CME Rule 537; CBOT Rules 421.00 and 421.01.
\21\ CME Rule 537; CBOT Rules 421.00.
\22\ See, e.g., CBOT Rules 421.00 and 421.01.
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In a joint release issued by the SEC and the CFTC (``the
Commissions'') proposing customer protection, reccordkeeping,
reporting, and bankruptcy rules for accounts holding SFPs,\23\ the
Commissions requested comment on the application to transactions in
SFPs of their confirmation rules (Rule 10b-10 under the Exchange Act
\24\ and Rule 1.33(b) under the CEA \25\). Of the three comment letters
the Commissions received, two specifically addressed the Commissions'
requests for comments on the subject of confirmations for SFPs.\26\
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\23\ Exchange Act Release. No. 44854 (September 26, 2001), 66 FR
50786 (October 4, 2001).
\24\ 17 CFR 240.10b-10.
\25\ 17 CFR 1.33(b). Specifically, CEA Rule 1.33(b)(1) requires
FCMs that effect futures transactions for customers to provide, no
later than the next business day after the transaction, ``a written
confirmation of each commodity futures transaction caused to be
executed by it * * *.''
\26\ Letter dated December 5, 2001, from Thomas W. Sexton, Vice
President and General Counsel, National Futures Association, to
Jonathan G. Katz, Secretary, U.S. Securities and Exchange
Commission; Letter dated December 5, 2001, from John M. Damgard,
President, Futures Industry Association, and Mark E. Lackritz,
President, Securities Industry Association, to Jonathan G. Katz,
Secretary, U.S. Securities & Exchange Commission. The other letter,
dated December 4, 2001, from James J. McNulty, Chicago Mercantile
Exchange, Inc. and David J. Vitale, Board of Trade of the City of
Chicago, Inc, to Jonathan G. Katz, Secretary, U.S. Securities and
Exchange Commission, did not address the application of the
confirmation requirements of the Commission and the CFTC but did
support account specific recordkeeping requirements.
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As an initial matter, the Commissions asked whether the application
of the confirmation rules to FCMs and broker-dealers should follow from
the type of account in which the SFPs are effected. One commenter
supported having confirmation statements follow the type of the account
and recommended that the SEC adopt a rule that would exempt SFPs
carried in futures accounts from Exchange Act Rule 10b-10.\27\ The
other commenter suggested that the SEC clarify that Exchange Act Rule
10b-10 would not apply to a Notice BD or a Full FCM/Full BD carrying
SFPs in a futures account.\28\
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\27\ Letter dated December 5, 2001, from Thomas W. Sexton, Vice
President and General Counsel, National Futures Association, to
Jonathan G. Katz, Secretary, U.S. Securities and Exchange
Commission.
\28\ Letter dated December 5, 2001, from John M. Damgard,
President, Futures Industry Association, and Mark E. Lackritz,
President, Securities Industry Association, to Jonathan G. Katz,
Secretary, U.S. Securities and Exchange Commission.
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The Commissions also asked whether the information that FCM
customers currently receive on confirmations would fulfill the purposes
of Rule 10b-10 or whether FCMs should provide the particular
information required by Rule 10b-10 to customers in SFP transactions
upon the customers' request, to the extent that information is not
already provided on the confirmations that the FCM prepares. In
addition, the Commissions asked what it would cost FCMs to provide the
information required under Rule 10b-10 on SFP confirmations.
One commenter noted that confirmations of futures transactions
generally provide much of the same information required by Rule 10b-10.
Moreover, this commenter stated that futures customers understand that
they have a right to request information in addition to that
specifically disclosed on the confirmation. Some of this additional
information includes the time of the transaction and the name of the
person on the opposite side of the transaction.\29\ The commenter noted
this is the same information that Rule 10b-10 generally allows broker-
dealers to choose whether to disclose in the confirmation or to make
available upon written request of the customer.\30\ This commenter also
maintained that applying Rule 10b-10(a)(2)--which
[[Page 39649]]
requires a broker-dealer to disclose whether it is acting as a
principal or agent in a transaction--to confirmations of SFP
transactions would create operational and programming burdens for FCMs
without providing corresponding benefits.\31\
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\29\ Letter dated December 5, 2001, from Thomas W. Sexton, Vice
President and General Counsel, National Futures Association, to
Jonathan G. Katz, Secretary, U.S. Securities and Exchange
Commission.
\30\ See Exchange Act Rule 10b-10(a)(1) and (a)(2)(i)(A) (17 CFR
240.10b-10(a)(1) and (a)(2)(i)(A)).
\31\ Letter dated December 5, 2001, from Thomas W. Sexton, Vice
President and General Counsel, National Futures Association, to
Jonathan G. Katz, Secretary, U.S. Securities and Exchange
Commission.
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The Commissions also requested information on whether there would
be any costs to broker-dealers to provide the information required
under CEA Rule 1.33(b) on SFP confirmations and how long it would take
firms to implement systems to provide this information. In addition,
the Commissions asked whether any other considerations relating to
customers should be taken into account. The Commissions did not receive
any comments on these queries.
After carefully considering all of the comments received, the SEC
has decided to avoid duplicate regulation by proposing a new paragraph
(e) to Rule 10b-10. New paragraph (e) would clarify the type and nature
of information a Notice BD and a Full FCM/Full BD must disclose under
Rule 10b-10 in confirmations of SFP transactions effected in futures
accounts. In doing so, we have taken into account the disclosure
requirements of CEA Rule 1.33(b) and the disclosure rules of the CME
and the CBOT.\32\
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\32\ See CME Rule 537; CBOT Rules 421.00 and 421.01.
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Amended Rule 10b-10(e) would require essentially the same type and
nature of information required under CEA Rule 1.33(b) and the above-
described futures exchange rules, as well as additional information
concerning the capacity in which the Notice BD or Full FCM/Full BD is
acting when effecting an SFP transaction and information regarding
payment for order flow. It also would conform to the timing
requirements that are customary for futures confirmations.
Specifically, Rule 10b-10(e)(1) would provide that, as long as
certain conditions are met, the requirements of paragraphs (a) and (b)
of Rule 10b-10 will not apply to a Notice BD or a Full FCM/Full BD that
effects transactions for customers in SFPs in a futures account (as
that term is defined in proposed Exchange Act Rule 15c3-3(a)(15)).\33\
First, under subparagraph (i) of proposed paragraph (e)(1), the Notice
BD or Full FCM/Full BD must give or send to the customer, no later than
the next business day after execution of any SFP transaction, written
notification disclosing: the date the transaction was executed, the
identity of the single security or narrow-based security index
underlying the contract for the SFP, the number of shares or units (or
principal amount) of such SFP purchased or sold, the price, and the
delivery month. Second, under subparagraph (ii) of proposed paragraph
(e)(1), the Notice BD or Full FCM/Full BD must give or send to the
customer no later than the next business day after execution of any SFP
transaction, written notification disclosing the source and amount of
any remuneration received or to be received in connection with the
transaction. This includes, but is not limited to, any markup,
commissions, costs, fees, and other charges incurred in connection with
the transaction.
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\33\ Exchange Act Release No. 44854 (September 25, 2001), 66 FR
50785 (October 4, 2001).
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From discussions with industry participants, our staff understands
that this information is routinely disclosed in confirmations on
futures transactions.\34\ The staff also understands from these
discussions that customers in the futures markets may negotiate to pay
commissions or fees on futures transactions based on the purchase and
subsequent liquidating sale or based on the sale and subsequent
covering purchase rather than paying the commissions or fees at both
the initiating and closing trade.\35\
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\34\ See Memorandum to file number S7-17-01 regarding February
12, 2002 Conference call between Commission staff members and
representatives of Morgan Stanley Dean Witter (March 13, 2002).
\35\ See Memorandum to file number S7-17-01 regarding February
27, 2002 and March 5, 2002 conversations between Securities and
Exchange Commission staff member and representative of Morgan
Stanley Dean Witter (March 12, 2002).
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Regardless, confirmation statements are sent to customers after
both the initiating and closing trades, and the remuneration
information in these confirmation statements reflects how the customers
have chosen to pay commissions and fees. This disclosure system is
designed to ensure that the customer is consistently aware of the
nature and amount of the commissions and fees he is paying for the
transactions effected in his futures account.\36\ Accordingly, we
believe that this same disclosure system for fees and commissions for
SFP transactions effected by Notice BDs and Full FCM/Full BDs in
futures accounts is sufficient for purposes of Rule 10b-10(e)(1)(ii).
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\36\ See Memorandum to file number S7-17-01 regarding February
27, 2002 and March 5, 2002 conversations between Securities and
Exchange Commission staff member and representative of Morgan
Stanley Dean Witter (March 12, 2002).
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Subparagraph (iii) of Rule 10b-10(e)(1) would also require the
Notice BD or Full FCM/Full BD to give or send to the customer no later
than the next business day after execution of any SFP transaction,
written notification disclosing the fact that certain information will
be available upon written request of the customer. This includes
information about the time of the execution of the transaction and the
identity of the other party to the contract. We believe that, while
this information does not necessarily need to appear on the
confirmation statement itself, the customer should have notice that it
is available and will be provided upon written request.
Subparagraph (iii) also would require the Notice BD or Full FCM/
Full BD to disclose that it will provide upon written request of the
customer information regarding whether the broker or dealer is acting
as agent for such customer, as agent for some other person, as agent
for both such customer and some other person, or as principal for its
own account; and, if the broker or dealer is acting as principal,
whether it is engaging in a block transaction or an exchange of SFPs
for physical securities (``EFP''). Although Rule 10b-10(a)(2) requires
this information to appear in a confirmation of a securities
transaction, we note that confirmations of futures transactions do not
generally include this information. A commenter has also noted that
customers would be aware of block trades and exchanges for physicals
because these transactions require customer consent and that it would
be unduly burdensome to require futures confirmations systems to
capture and transmit this information.\37\
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\37\ Letter dated December 5, 2001, from Thomas W. Sexton, Vice
President and General Counsel, National Futures Association, to
Jonathan G. Katz, Secretary, U.S. Securities and Exchange
Commission. See, e.g., CRE Rules 526 and 538, BrokerTec Futures
Exchange (``BTEX'') Rules 406 and 407; see also Chicago Board of
Trade's Proposal to Adopt Block Trading Procedures, 65 FR 58051
(September 27, 2000).
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The nature of the futures markets appears to provide the reasons
for this disparity. First, the CEA and CFTC Regulations require most
futures transactions to be agency transactions.\38\ An FCM conducts
futures transaction in a principal capacity only when conducting a
block trade or an EFP.\39\
[[Page 39650]]
Block trades and EFPs are privately-negotiated transactions that may be
traded apart from the public auction market either on or off the
exchange trading floor.\40\ In addition, a block trade executed on an
exchange generally cannot trigger the execution of conditional orders,
such as stop orders, or otherwise affect orders in the regular
market.\41\ An FCM that effects block trades and EFPs must meet
stringent exchange rules, including keeping and maintaining detailed
records of the transactions, timely reporting the transactions to the
relevant exchange and/or clearing organization, and obtaining customer
consent for the transactions.\42\
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\38\ See CEA Section 4b(a)(iv) (7 U.S.C. 6b(a)(iv)) and CFTC
Regulations 1.38 and 1.55.2(a)-(b) (17 CFR 1.38 and 155.2(a)-(b)).
\39\ See Memorandum to file number S7-17-01 regarding March 11,
2002, and March 12, 2002, conversations between Securities and
Exchange Commission staff member and representative of Credit Suisse
First Boston (March 12, 2002).
\40\ See CME Rules 526, 538; CME Rulebook definitions of
``Exchange-For-Physical'' and ``Block Trade;'' see also (``BTEX'')
Rules 406, 407.
\41\ See CME Rule 526.E.
\42\ See BTEX Rule 406(d) and (f); BTEX Rule 407(h) and (i); CME
Rules 520, 526.A and H, 538.4.
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Nevertheless, an SFP is not only a futures product but a security
product, and, as reflected in Rule 10b-10(a)(2) and Exchange Act
Section 11(d)(2),\43\ we consider that a broker-dealer's capacity when
effecting a securities transaction is important information that should
be available to a customer. We recognize, however, that requiring a
confirmation of an SFP transaction effected in futures accounts to
disclose whether the Notice BD or Full FCM/Full BD effected the
transaction as an agent (and who the entity was an agent for) or a
principal could create operational and programming burdens. Therefore,
Rule 10b-10(e)(1)(iii) would require only that the information be made
available upon written request of the customer.
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\43\ 15 U.S.C. 78k(d)(2).
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Because the futures industry has never previously been required to
provide this type of information on a regular basis, it may need
additional time to adjust its members' operational systems, not only to
capture this information when necessary, but also to disclose on the
confirmation itself that the information is available upon a customer's
written request. Therefore, as explained further below, new Rule 10b-
10(e)(2) would provide that the provisions of Rule 10b-10(e)(1)(iii) do
not become effective for broker-dealers effecting SFP transactions in
futures accounts until June 1, 2003, as long as the broker-dealers meet
certain conditions. This transitional provision should provide the
futures industry with sufficient time to make the necessary adjustments
to their systems to comply with Rule 10b-10(e)(1)(iii).
Finally, subparagraph (iv) of Rule 10b-10(e)(1) would require a
Notice BD or Full FCM/Full BD to give or send to the customer no later
than the next business day after execution of any SFP transaction,
written notification disclosing whether it receives payment for order
flow for effecting SFP transactions. It must also disclose the fact
that the source and nature of any compensation received in connection
with the particular transaction will be furnished upon the customer's
written request. Our staff understands from discussions with industry
representatives that payment for order flow is not currently practiced
in the futures industry.\44\ There is no reliable method to predict
whether the practice of payment for order flow will develop in relation
to SFP transactions. Nevertheless, subparagraph (iv) provides a
foundation to address the disclosure of payment for order flow in the
event it arises in relation to SFP transactions. Because payment for
order flow is not currently a practice in the futures industry, it is
unlikely that the operational systems for futures accounts would
currently capture such information for disclosure purposes. Therefore,
as explained further below, Rule 10b-10(e)(2) would provide the futures
industry additional time to modify their systems to capture payment for
order flow information.
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\44\ See Memorandum to file number S7-17-01 regarding March 11,
2002, and March 12, 2002, conversations between Securities and
Exchange Commission staff member and representative of Credit Suisse
First Boston (March 12, 2002).
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Because the futures industry may need additional time to make the
necessary changes to comply with all of the requirements of Rule 10b-
10(e)(1), the Commission proposes to provide a transitional provision
to allow the futures industry the extra time to make those changes.
Specifically, Rule 10b-10(e)(2)(i) would provide that subparagraph
(iii) of Rule 10b-10(e)(1) does not become effective until June 1,
2003, provided that, if the broker-dealer receives a written request
from a customer for the information Paragraph (e)(1)(iii) requires the
broker-dealer to disclose upon a customer's written request, the
broker-dealer makes the information available to the customer. Rule
10b-10(e)(2)(ii) would provide that Paragraph (e)(1)(iv) shall also
become effective June 1, 2003.
In proposing these amendments to Rule 10b-10, we believe it is
important to remind broker-dealers that they would continue to be
subject to the antifraud provisions of the federal securities laws,
including Exchange Act Rule 10b-5. We note in this regard that the
preliminary note to Rule 10b-10 explains that the disclosure
confirmation requirements of Rule 10b-10 are in addition to ``a broker-
dealer's obligation under the general antifraud provisions of the
federal securities laws to disclose additional information to a
customer at the time of the customer's investment decision.'' In
addition, broker-dealers are still subject to self-regulatory
organization rules that, in their current form, require broker-dealers
to disclose information that would not be required by our proposed
amendments to Rule 10b-10.\45\
We invite comment on all aspects of this amendment to Rule 10b-10.
We especially invite comment on the following subjects: (i) What, if
any, burdens would result from requiring futures confirmation systems
to capture and transmit information regarding capacity and payment for
order flow for SFP transactions effected by Notice BDs or Full FCM/Full
BDs in a futures accounts; (ii) what, if any, competitive burdens would
affect Notice BDs effecting SFP transactions in futures accounts that
similarly situated Full FCM/Full BDs would not be subject to; (iii)
whether the amendments to Rule 10b-10 providing confirmation
requirements for SFP transactions effected in futures accounts could
result in competitive disadvantages for broker-dealers effecting SFP
transactions in securities accounts that must follow all of the
disclosure requirements of Rule 10b-10; (iv) if so, whether the
requirements of paragraph (e) should be applied to all SFP transactions
regardless of whether the transactions are effected in a securities
account or in a futures account; (v) whether there are rules of other
exchanges that provide different disclosure requirements that we should
consider; (vi) whether there is any additional information that should
be disclosed to customers; and (vii) whether the transitional period
provides sufficient time to develop the necessary systems to capture
the information required to be disclosed under proposed Rule 10b-10(e).
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\45\ See, e.g., National Association of Securities Dealers Rule
2230.
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B. Rule 10b-10 SIPC Disclosure Requirement
Exchange Act Rule 10b-10(a)(9) \46\ generally requires that a
broker-dealer effecting securities transactions for a customer, or a
broker-dealer clearing or carrying a customer's account, disclose in
the confirmation if such broker-dealer is not a member of the
Securities Investor Protection Corporation
[[Page 39651]]
(``SIPC'').\47\ This requirement is intended to make clear when
customers are not protected by SIPC.
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\46\ 17 CFR 240.10b-10(a)(9).
\47\ See Exchange Act Release No. 34962 (November 10, 1994), 59
FR 59612 (November 17, 1994).
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Under the Securities Investor Protection Act of 1970 (``SIPA''),
most broker-dealers registered under Exchange Act Section 15(b) must be
members of SIPC.\48\ When a SIPC member is liquidated in a SIPC
proceeding, due to bankruptcy or other financial difficulties, SIPC
will return to customers their cash and securities held by the broker-
dealer. To the extent that the broker-dealer does not have sufficient
resources to return the cash and securities to customers, SIPC will
replace the missing assets, up to $500,000 per customer (including
$100,000 for cash claims).\49\
We required that a broker-dealer disclose in its confirmations when
it is not a SIPC member after we witnessed several incidents involving
the financial failure of registered broker-dealers and their
unregistered affiliates where customers became confused regarding the
application of SIPC coverage to their accounts.\50\ For example, in one
of these cases, the failure of a registered broker-dealer and its
government securities affiliate, which shared personnel and office
facilities and did not distinguish between the two entities in certain
written and oral communications, led to customer confusion concerning
SIPC coverage. Because government securities brokers and dealers
registered under Exchange Act 15C are not members of SIPC, the accounts
of the customers of the government securities affiliates were not
protected by SIPC.\51\
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\48\ 15 U.S.C. 78ccc(a)(2) and 78ddd.
\49\ 15 U.S.C. 78fff-3(a)(1).
\50\ Exchange Act Release No. 33743 (March 9, 1994), 59 FR 12767
(March 17, 1994).
\51\ See id.; see generally, SEC v. Donald Sheldon Group, Inc.
et al., Admin. Pro. File No. 3-6626 (Dec. 2, 1988.)
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The SIPC disclosure requirement is in addition to a separate
regulatory scheme pursuant to Exchange Act Section 15(c)(3) and
Exchange Act Rule 15c3-3 to protect customers. That scheme protects the
assets of broker-dealer customers by requiring a broker-dealer to
follow certain steps to assure that customer assets are not used to
fund the broker-dealer's business.\52\
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\52\ Exchange Act Section 15(c)(3) (15 U.S.C. 78o(c)(3)) and 17
CFR 240.15c3-3.
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The CEA has a different customer protection scheme for customers of
FCMs. Under the CEA, customer funds must be segregated and separately
accounted for by FCMs.\53\
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\53\ CEA Section 4f(a)(4)(A) (7 U.S.C. 6f(a)(4)(A)).
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The CFMA amended the Exchange Act and SIPA to provide that a Notice
BD is not subject to Exchange Act Section 15(c)(3), or the rules
promulgated thereunder, and that a Notice BD may not become a member of
SIPC.\54\ In addition, the CFMA amended the CEA to provide that a
Notice FCM is not subject to the segregation requirements of the
CEA.\55\
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\54\ Exchange Act Section 15(b)(11)(B)(iii) (15 U.S.C.
78o(b)(11)(B)(iii)); SIPA Section 3(a)(2)(A) (15 U.S.C.
78ccc(a)(2)(A)).
\55\ CEA Section 4f(a)(4)(A)(ii) (7 U.S.C. 6f(a)(4)(A)(ii)).
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Full FCM/Full BDs do not have similar exemptions. Accordingly, the
SEC and the CFTC have proposed rules that would permit Full FCM/Full
BDs either to choose, or allow their customers to choose, whether SFP
positions will be held in a futures account subject to CEA segregation
requirements or a securities account subject to Rule 15c3-3 and
SIPA.\56\ These rules would also require that, before a Full FCM/Full
BD accepts an order from a customer for an SFP transaction, the Full
FCM/Full BD must obtain a signed acknowledgement that the customer
understands which protections would apply to the customer's particular
account. The acknowledgment would have to specify which regulatory
regime applies, and the customer would have to sign the acknowledgement
stating that he understands that his particular account will not be
protected under the alternative regulatory scheme. This acknowledgement
is designed to help a customer understand that an SFP held in a futures
account is not covered by SIPA and an SFP held in a securities account
is not protected by segregation. Notice registrants are not required to
obtain this acknowledgment from customers because they are subject only
to one customer protection regulatory scheme.
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\56\ Exchange Act Release No. 44854 (September 26, 2001), 66 FR
50786 (October 4, 2001).
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We are requesting comment on whether certain Notice BDs should be
required, pursuant to Exchange Act Rule 10b-10(a)(9), to inform
customers on a transaction-by-transaction basis that they are not
members of SIPC. Should such a requirement be applicable to all notice
registrants or to a subset that creates the greatest risk of confusion,
such as those notice registrants that are associated persons \57\ of
fully-registered SIPC-member broker-dealers? In addition, we request
comment on whether customers would benefit from being informed on a
transaction-by-transaction basis that the protections provided by
Exchange Act Rule 15c3-3 and SIPA do not apply to SFPs held in futures
accounts by Full FCM/Full BDs. Further, we are interested in receiving
comment on whether the absence of such disclosures in transaction
confirmations could lead to the type of customer confusion the SIPC
disclosure requirement in Exchange Act 10b-10(a)(9) was designed to
address.
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\57\ See Exchange Act Section 3(a)(18) (15 U.S.C. 78c(a)(18))
(``The term ``person associated with a broker or dealer'' or
``associated person of a broker or dealer'' means * * * any person
directly or indirectly controlling, controlled by, or under common
control with such broker or dealer * * *.''); see also Exchange Act
Section 3(a)(9) (15 U.S.C. 78c(a)(9)) (``The term ``person'' means a
natural person, company, government, or political subdivision,
agency, or instrumentality of a government.'').
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In addition, we note that self-regulatory organizations, such as
the National Association of Dealers, Inc. and the National Futures
Association, are working to develop model disclosure documents for
SFPs. If these documents informed customers that the protections
provided by Exchange Act Rule 15c3-3 and SIPA do not apply to SFPs held
in futures accounts, would such disclosures provide them with
sufficient information so that they would not need to be informed on a
transaction-by-transaction basis?
C. Rule 11d2-1
Exchange Act Rule 10b-10(a)(2) \58\ generally requires that a
broker-dealer effecting a transaction for a customer must provide
written notification at or before the completion of a transaction
disclosing the capacity in which the broker-dealer acted when effecting
a securities transaction. Similarly, Exchange Act Section 11(d)(2) \59\
prohibits a broker-dealer from effecting any transaction for a customer
with respect to any security (other than an exempted security) unless
the broker-dealer ``discloses to such customer in writing at or before
the completion of the transaction whether he is acting as a dealer for
his own account, as a broker for such customer, or as a broker for some
other person.''
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\58\ 17 CFR 240.10b-10(a)(2).
\59\ 15 U.S.C. 78k(d)(2).
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As explained above, amended Rule 10b-10 would provide Full FCM/Full
BDs and Notice BDs a conditional exception from the requirement in
Exchange Act Rule 10b-10 to disclose the capacity in which they are
acting when they effect SFP transactions for a customer in a futures
account. Amended Rule 10b-10, however, would not provide an exception
from the disclosure requirement of Exchange Act Section 11(d)(2). Under
the CFMA, Notice BDs are exempt from the
[[Page 39652]]
provisions of Exchange Act Section 11.\60\ This exemption, however,
does not apply to Full FCM/Full BDs.
---------------------------------------------------------------------------
\60\ See Exchange Act Section 15(b)(11)(B)(ii) (15 U.S.C.
78o(b)(11)(B)(ii)).
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We believe that requiring Full FCM/Full BDs to comply with the
disclosure requirement of Exchange Act Section 11(d)(2) would be
inconsistent with the relief provided in the proposed amendments to
Rule 10b-10. Therefore, to provide consistent relief, we are proposing
an exemption from the disclosure requirement of Exchange Act Section
11(d)(2).\61\ This exemption would be available only to Full FCM/Full
BDs that effect SFP transactions in futures accounts and would allow
them to effect SFP transactions in futures accounts without being
required to disclose the capacity in which they are acting when they
effect these transactions.
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\61\ Exchange Act Section 36(a)(1) (15 U.S.C. 78mm(a)(1)); see
also Exchange Act Section 23(a)(1) (15 U.S.C. 78w(a)(1)).
---------------------------------------------------------------------------
We invite comments on all aspects of proposed Rule 11d2-1. We
especially invite comment on whether this exemption for Full FCM/Full
BDs will have any anticompetitive impact on broker-dealers that are not
eligible for this exemption.
III. General Request for Comments
We invite interested persons to submit written comments on all
aspects of the proposed amendments and new rule, in addition to the
specific requests for comments included in the release. Further, we
invite comment on other matters that might have an effect on the
proposals contained in the release, including any competitive impact.
Additionally, we request comment on whether broker-dealers
executing trades in futures accounts for certain customers should be
subject only to the confirmation requirements prescribed by the CFTC
and the futures exchanges. Specifically, should broker-dealers
effecting SFP transactions in customers' futures accounts be exempted
from the disclosure requirements of Rule 10b-10 for their sophisticated
institutional customers who are ``qualified investors,'' as that term
is defined in the Exchange Act Section 3(a)(54),\62\ if: (1) The
institutional customers, after receiving full disclosure, knowingly
agree not to receive information on the capacity in which a broker-
dealer is acting when effecting SFP transactions in a customer's
futures account and any information regarding payment for order flow;
and (2) the disclosure rules of the CFTC and/or the futures exchanges,
at a minimum, require disclosure of basic information, as specified in
proposed paragraph (e)(1)(i) and (ii), the identity of the other party
to the contract, and the time of the execution of the transaction (or
the fact that information regarding the identity of the other party to
the contract and the time of the execution of the transaction will be
available upon request)? Should we use the statutory definition of
``qualified investors'' for purposes of this exemption, or should we
define the category of customers differently?
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\62\ 15 U.S.C. 78c(a)(54).
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More generally, in order to help us determine whether, and to what
extent, direct regulation in this area is necessary, and to minimize
the burdens associated with duplicative regulation while maintaining
investor protection, we request detailed comments from futures
exchanges that plan to trade security futures on their rules that will
apply to the trading of security futures and whether there are any
differences or similarities between those rules and the proposed
amendments to Rule 10b-10 regarding the information required to be
provided to customers effecting security futures transactions in
futures accounts.
IV. Paperwork Reduction Act
Certain provisions of the proposed amendments to Exchange Act Rule
10b-10 contain ``collection of information'' requirements within the
meaning of the Paperwork Reduction Act of 1995.\63\ The Commission has
submitted the proposed amendment to the Office of Management and Budget
(``OMB'') for review in accordance with 44 U.S.C. 3507(d) and 5 CFR
1320.11. The Commission is revising the collection of information
entitled ``Proposed Confirmation of Transactions Amendment,'' OMB
Control Number 3235-0444. 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 control number.
---------------------------------------------------------------------------
\63\ 44 U.S.C. 3501 et seq.
---------------------------------------------------------------------------
A. Rule 10b-10
1. Collection of Information Under the Proposed Confirmation of
Transactions Amendment
As discussed previously in this release, the Proposed Confirmation
of Transactions Amendment would permit alternative information
disclosure requirements in confirmations provided to customers for
transactions in SFPs in a futures account. This alternative information
includes, the date the transaction was executed; the identity and
number of shares or units bought or sold; the price and delivery month;
the source and amount of broker remuneration; whether the broker
received payment for order flow; and, the fact that other specified
information about the execution of the transaction will be available
upon written request. This information would be provided to a customer
in the form of a confirmation.
2. Proposed Use of Information
The purpose of the proposed amendments to Rule 10b-10 is to provide
to investors the information necessary to evaluate their securities
transactions and the broker-dealers effecting those transactions. In
the absence of the Rule's requirements, investors may not be fully
informed of important information relating to their securities
transactions. In addition, the confirmations may be used by the
Commission, self-regulatory organizations, and other securities
regulatory authorities in the course of examinations, investigations,
and enforcement proceedings. No governmental agency regularly would
receive any of the information described above.
3. Respondents
The proposed amendments to Rule 10b-10 potentially apply to all of
the approximately 8,000 fully registered broker-dealers and the
projected 1,399 notice registered broker-dealers registered with the
Securities and Exchange Commission provided they effect transactions
for customers. It is important to note, however, that the provisions of
the Proposed Confirmation of Transactions Amendments would apply only
to the approximately 5,600 fully registered broker-dealers that conduct
business with the general public and the approximately 1,399 of the
projected notice registered broker-dealers that conduct business with
the general public.
4. Total Annual Reporting and Recordkeeping Burden
We estimate that there will be 100 million confirmations during the
first year of trading of security futures products. In our April 29,
2002 order adjusting the fee rates under Section 31 of the Exchange
Act, we estimated that we would collect $450,000 in assessments on
round turn transactions in security futures in fiscal 2003.\64\ This
estimate was based on the Congressional
[[Page 39653]]
Budget Office's August 28, 2001 estimate of collections for that fiscal
year, adjusted to reflect the reduction in the assessment rate included
in the Investor and Capital Markets Fee Relief Act.\65\ Dividing the
estimated $450,000 in collections on round turn transactions in
security futures by the assessment rate of $0.009 per round turn
transaction yields 50 million round turn transactions. Because each of
the estimated 50 million round turn transaction will involve at least
two confirmations, we estimate that there will be approximately 100
million confirmations.
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\64\ See Order Making 2003 Annual Adjustments to the Fee Rates
Applicable Under Section 6(b) of the Securities Act of 1933 and
Sections 13(e), 14(g), 31(b) and 31(c) of the Securities Exchange
Act of 1934, Release Nos. 33-8095 and 34-45842 (April 29, 2002).
\65\ See Pub. L. 107-123, 115 Stat. 2390 (2002). In August 2001,
the Congressional Budget Office estimated that the Commission would
collect $1,000,000 in assessments on round turn transactions in
security futures in fiscal 2003. This estimate was based on an
assessment rate of $0.02 per round turn transaction. The Investor
and Capital Markets Fee Relief Act reduced the assessment rate to
$0.009 per round turn transaction. In our fee adjustment order, we
adjusted the Congressional Budget Office's estimate to reflect the
assessment rate reduction. $1,000,000 x 0.009/0.02 = $450,000.
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Because the process of generating a confirmation is automated, the
Commission staff estimates from information provided by industry
participants that it takes about one minute to generate and send a
confirmation. The Commission staff also estimates from information
provided by industry participants that broker-dealers effecting SFP
transactions will spend 1.7 million hours complying with the proposed
amendments to Rule 10b-10 (100 million confirmations at one minute per
confirmation = 100 million minutes; 100 million minutes/60 minutes per
hour = 1.7 million hours).
Broker-dealers routinely use confirmations for billing purposes. In
addition, broker-dealers would send customers some type of statement
regardless of the requirements of the proposed amendments to Rule 10b-
10. The amount of confirmations sent and the cost of the confirmations
vary from firm to firm. Smaller firms send fewer confirmations than
larger firms because they effect fewer transactions.
As stated earlier, the Commission staff estimates that broker-
dealers effecting SFP transactions will send approximately 100 million
confirmations annually. According to the information provided by
industry participants, the average cost per confirmation is estimated
to be 89 cents, including postage. The annual cost to the industry for
fiscal year 2003 is therefore estimated to be $89 million.
5. Collection of Information is Mandatory
This collection of information is mandatory.
6. Confidentiality
The collection of information pursuant to the proposed amendments
to Rule 10b-10 would be provided by broker-dealers to customers, and
also would be maintained by broker-dealers.
7. Record Retention Period
Exchange Act Rule 17a-4(b)(1) \66\ requires broker-dealers to
preserve confirmations for three years, the first two years in an
accessible place.
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\66\ 17 CFR 240.17a-4(b)(1).
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8. Request for Comment
Pursuant to 44 U.S.C. 3506(c)(2)(B), the Commission solicits
comments to:
(i) Evaluate whether the proposed collection of information is
necessary for the proper performance of the functions of the
Commission, including whether the information would have practical
utility;
(ii) Evaluate the accuracy of the Commission's estimate of the
burden of the proposed collection of information;
(iii) Enhance the quality, utility, and clarity of the information
to be collected; and
(iv) Minimize the burden of the collection of information on those
required to respond, including through the use of automated collection
techniques or other forms of information technology.
Persons desiring to submit comments on the collection of
information requirements should direct them to the Office of Management
and Budget, Attention: Desk Officer for the Securities and Exchange
Commission, Office of Information and Regulatory Affairs, Washington,
DC 20503, and should also send a copy of their comments to Jonathan G.
Katz, Secretary, Securities and Exchange Commission, 450 Fifth Street,
NW, Washington, DC 20549-0609, and refer to File No. S7-19-02. OMB is
required to make a decision concerning the collections of information
between 30 and 60 days after publication of this release in the Federal
Register, therefore, comments to OMB are best assured of having full
effect if OMB receives them within 30 days of this publication. The
Commission has submitted the proposed collections of information to OMB
for approval. Requests for the materials submitted to OMB by the
Commission with regard to these collections of information should be in
writing, refer to File No. S7-19-02, and be submitted to the Securities
and Exchange Commission, Records Management, Office of Filings and
Information Services, 450 Fifth Street, NW., Washington, DC 20549.
B. Rule 11d2-1
For the reasons discussed above, new Exchange Act Rule 11d2-1
provides an exemption from the capacity disclosure requirement in
Exchange Act Section 11(d)(2) for Full FCM/Full BDs that are effecting
transactions for customers in SFPs in futures accounts. This exemption
from a statutory requirement does not impose recordkeeping or
information collection requirements, or other collections of
information that require approval of the Office of Management and
Budget under 44 U.S.C. 3501, et seq. Accordingly, the Paperwork
Reduction Act does not apply.
V. Costs and Benefits of Proposed Amendments
A. Introduction
Passage of the CFMA in December of 2000 permitted the trading of
SFPs and established a framework for joint regulation of SFPs by the
CFTC and the SEC. This framework was necessary because the CFMA defined
an SFP to be, at the same time, both a security and a contract for
future delivery and therefore subject to both the CEA and the Exchange
Act and the rules thereunder. Recognizing that some entities may be
subject to duplicative or conflicting regulations, the CFMA amended the
CEA and the Exchange Act to: (1) Exempt notice-registrants from certain
(but not all) sections of the CEA, Exchange Act, and the rules
thereunder, and (2) direct the CFTC and the SEC to issue rules,
regulations, or orders, as necessary, to avoid certain duplicative or
conflicting regulations relating to Full FCM/Full BDs.\67\ Consistent
with these provisions, the SEC is proposing to amend Exchange Act Rule
10b-10 by adding new paragraph (e) to Rule 10b-10, and proposing
Exchange Act Rule 11d2-1.
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\67\ CEA section 4d(c) (7 U.S.C. 6d(c)) and Exchange Act section
15(c)(3)(B) (15 U.S.C. 78o(c)(3)(B)) respectively.
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B. Rule 10b-10
The proposed amendments to Rule 10b-10 strive to avoid duplicate
regulation by requiring disclosure of essentially the same type and
nature of information currently required to be disclosed in
confirmations of futures transactions at essentially the same time.
Specifically, proposed Rule 10b-10(e) provides that a Full FCM/Full BD
[[Page 39654]]
and a Notice BD that effects transactions for customers in security
futures products in a futures account (as that term is defined in
Exchange Act Rule 15c3-3(a)(15)) does not have to comply with the
disclosure requirements of paragraphs (a) and (b) of Rule 10b-10 if the
Full FCM/Full BD or Notice BD discloses on the SFP transaction
confirmations the date the transaction was executed; the identity and
number of shares or units bought or sold; the price and delivery month;
the source and amount of broker remuneration; and the fact that the
time of the execution of the transaction, the identity of the other
party to the contract, and the capacity in which the broker-dealer was
acting in effecting the transaction will be available upon written
request. The information to be made available upon written request is
the same type of information that futures confirmations currently
disclose is available to the customer upon written request. Proposed
Rule 10b-10(e) also provides that Full FCM/Full BDs and Notice BDs must
disclose whether they receive payment for order flow, and if so, must
provide the source and nature of such remuneration upon request. In
addition, proposed Rule 10b-10(e)(2) provides a phase-in period. Under
that provision, broker-dealers are not required until June 1, 2003, to
disclose in SFP confirmations information on payment for order flow and
the fact that certain information will be provided upon request.
In considering the potential costs and benefits of the proposed
amendments to Rule 10b-10, we have considered the transaction
confirmation practices of both the futures industry and the securities
industry and our duty to protect consumers by requiring adequate
disclosure on securities transactions. In addition, we have considered
how Full FCM/Full BDs and Notice BDs effecting SFP transactions in
futures accounts will have to restructure their confirmation
technology. Finally, we have identified specific costs and benefits,
and requested comment on additional costs or benefits that may stem
from proposed Rule 10b-10(e).
1. Benefits
a. Elimination of Conflicting and Duplicative Regulation
As stated previously, under the CFMA, Notice BDs and Full FCM/Full
BDs effecting SFP transactions in futures accounts currently are
required to meet the disclosure requirements of both the CEA and the
Exchange Act and the rules thereunder. The proposed amendments to Rule
10b-10 are designed to benefit Notice BDs and Full FCM/Full BDs by
avoiding conflicting and duplicative regulation of the disclosure
requirements of SFP transactions effected in futures accounts. The
proposed amendments accomplish this benefit by clarifying the type and
nature of information these entities must disclose under Rule 10b-10 in
confirmations of SFP transactions effected in futures accounts. Without
the proposed amendments to Rule 10b-10, all Notice BDs and Full FCM/
Full BDs would need to change their confirmation systems to comply with
all of the disclosure requirements of Rule 10b-10.
The amendments would require delivery of a confirmation at the same
point in time and containing essentially the same type and nature of
information these registrants currently provide in confirmations of
transactions in futures accounts. In addition, the amendments would
provide a phase-in period that gives the affected entities until June
1, 2003, to disclose in SFP confirmations information on payment for
order flow and the fact that certain information will be provided upon
request. Because such information is not generally provided in
confirmations of futures transactions, the transitional period will
allow these broker-dealers time to make the necessary adjustments to
their confirmation technology, not only to amend their confirmations to
make the required additional disclosures, but also to ensure that their
systems are capturing all of the information that customers are
entitled to receive if they make a written request.
b. Customer Understanding
The confirmations for SFP transactions effected in futures accounts
pursuant to the proposed amendments of Rule 10b-10 should benefit
customers who choose to effect SFP transactions in a futures account
but have not previously traded in a futures account by providing them
with information similar to the type of information they would receive
if they receive confirmations of trades effected in a securities
account. In addition, the confirmations of the SFP transactions
effected in the futures accounts will disclose specific additional
information that the customer may receive if he makes a written
request. The amendments should also benefit customers that already have
experience in the futures markets and decide to effect SFPs in a
futures account by providing them with a confirmation that is similar
in type and information to the kind of confirmations they are used to
receiving on transactions effected in futures accounts. In addition,
customers should also benefit from the proposed Rule 10b-10 requirement
that, if entities begin to receive payment for order flow for SFP
transactions executed in futures accounts, they must disclose that fact
and disclose upon written request the source and nature of the
remuneration.
2. Costs
Pursuant to paragraph (e)(1)(i) of proposed Rule 10b-10, a Full
FCM/Full BD and a Notice BD that effect transactions in SFPs in a
customer's futures account will not be required to meet the disclosure
requirements of Exchange Act Rule 10b-10(a) and (b), which broker-
dealers effecting securities transactions must generally meet. Rather,
the Full FCM/Full BD and Notice BD would be required to disclose
certain information in the confirmation and also disclose in the
confirmation the fact that certain additional information is available
upon a customer's written request.
Subparagraphs (i) and (ii) of proposed Rule 10b-10(e)(1) require
Full FCM/Full BDs and Notice BDs to give or send to the customer no
later than the next business day after execution of any SFP
transaction, written notification disclosing the date the transaction
was executed, the identity of the single security or narrow-based
security index underlying the contract for the security futures
product, the number of shares or units (or principal amount) of such
security futures product purchased or sold, the price, the delivery
month, the source and amount of any remuneration received or to be
received by the broker in connection with the transaction, including,
but limited to, commissions, costs, fees, and other charges incurred in
connection with the transaction. We understand that futures
confirmations already provide this information.\68\ Therefore, the SEC
does not believe that requiring this information on confirmations of
SFP transactions effected in futures accounts generates any additional
costs to the futures industry.
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\68\ See CME Rule 537; CBOT Rules 421.00 and 421.01; see also
Memorandum to file number S7-17-01 regarding February 12, 2002
conference call between Commission staff members and representatives
of Morgan Stanley Dean Witter (March 13, 2002).
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Subparagraph (iii) of Rule 10b-10(e)(1) would require the Notice BD
or Full FCM/Full BD to give or send to the customer no later than the
next business day after execution of any futures securities product
transaction, written notification disclosing the fact that certain
information will be available upon written request of the customer.
[[Page 39655]]
This includes information about the time of the execution of the
transaction, and the identity of the other party to the contract. We
understand from discussions with industry representatives that futures
confirmations generally disclose that this information is available
upon the customer's request.\69\ Therefore, the SEC does not anticipate
that this requirement will impose additional costs on the futures
industry.
---------------------------------------------------------------------------
\69\ See Memorandum to file number S7-17-01 regarding February
12, 2002 conference call between Commission staff members and
representatives of Morgan Stanley Dean Witter (March 13, 2002).
---------------------------------------------------------------------------
Subparagraph (iii) of Rule 10b-10(e)(1) would also require the
Notice BD or Full FCM/Full BD to give or send to the customer no later
than the next business day after execution of any futures securities
product transaction, written notification disclosing that information
regarding whether the broker or dealer is acting as agent for such
customer, as agent for some other person, as agent for both such
customer and some other person, or as principal for its own account;
and if the broker or dealer is acting as principal, whether it is
engaging in a block transaction or an exchange of securities futures
products for physical securities, will be available upon written
request of the customer. From discussions with industry
representatives, the SEC staff understands that Full FCM/Full BDs and
Notice BDs would not incur substantial expense by adding a disclosure
that information regarding the capacity in which the Full FCM/Full BD
or Notice BD acted in effecting the transaction is available upon a
customer's request.\70\ The SEC staff, however, understands from these
discussions that there would be some expense involved in requiring the
collection of information relating to the capacity in which the orders
are executed in the trading systems, although industry representatives
were unable to quantify the potential expenses.\71\ Because the futures
industry has never previously been required to provide this type of
information on a regular basis, it may need additional time to adjust
its members' operational systems, not only to capture this information
when necessary, but also to disclose on the confirmation itself that
the information is available upon a customer's written request. Thus,
the proposed rule contains a transitional provision. Under proposed
Exchange Act Rule 10b-10(e)(2), broker-dealers have until June 1, 2003
to disclose that certain information will be provided upon written
request, as long as that information can be made available if a
customer submits a written request. This transitional provision should
provide the futures industry with sufficient time to make the necessary
adjustments to their systems to comply with this provision of proposed
Exchange Act Rule 10b-10(e)(1)(iv).
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\70\ See Memorandum to file number S7-17-01 regarding February
27, 2002 and March 5, 2002 conversations between Securities and
Exchange Commission staff member and representative of Morgan
Stanley Dean Witter (March 12, 2002).
\71\ See id.
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Subparagraph (iv) of proposed Rule 10b-10(e)(1) also requires that
the Notice BD or Full FCM/Full BD give or send to the customer no later
than the next business day after execution of any futures securities
product transaction, written notification disclosing whether the entity
receives payment for order flow for such transactions and, if it does,
it must disclose the fact that the source and nature of the
compensation will be furnished upon written request of the customer.
The SEC staff understands from discussions with futures industry
participants that payment for order flow is not currently a practice in
the futures industry.\72\ Accordingly, if the practice does not arise
in connection with SFP transactions effected in futures accounts, there
would be no costs associated with the proposed disclosure requirement
of subparagraph (iii) because there would be nothing to report.
---------------------------------------------------------------------------
\72\ See Memorandum to file number S7-17-01 regarding February
12, 2002 conference call between Commission staff members and
representatives of Morgan Stanley Dean Witter (March 13, 2002);
Memorandum to file number S7-17-01 regarding March 11, 2002, and
March 12, 2002, conversations between Securities and Exchange
Commission staff member and representative of Credit Suisse First
Boston (March 12, 2002).
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If, however, Full FCM/Full BDS or Notice BDs begin to receive
payment for order flow for SFP transactions effected in futures
accounts then those entities would need to adjust their operating
systems to capture this information. Based on discussions with industry
representatives, the SEC understands that systems development costs
should be relatively low given the fact that the rule allows for the
use of a generic disclaimer, as opposed to information that would
require a trade-by-trade coding change. The SEC also understands from
these discussions that more extensive costs would be associated with
providing specific disclosures upon request about the nature and source
of any payment for order flow received in connection with a
transaction. Industry representatives, however, could not quantify the
potential costs, in part, perhaps, because the representatives were
uncertain whether payment for order flow will become a practice in
connection with SFP transactions.\73\
---------------------------------------------------------------------------
\73\ See Memorandum to file number S7-17-01 regarding March 11,
2002, and March 12, 2002, conversations between Securities and
Exchange Commission staff member and representative of Credit Suisse
First Boston (March 12, 2002).
---------------------------------------------------------------------------
In considering the costs Notice BDs and Full FCM/Full BDs would
have to make to their confirmation systems in order to comply with the
proposed amendments, we understand from discussions with industry
representatives that these costs are less than the costs these entities
would incur if they would have to adjust their confirmation systems to
meet all of the Rule 10b-10 disclosure requirements.\74\ Accordingly,
the amendments to Rule 10b-10 actually reduce the costs to the affected
entities.
---------------------------------------------------------------------------
\74\ See Memorandum to file number S7-17-01 regarding February
12, 2002 conference call between Commission staff members and
representatives of Morgan Stanley Dean Witter (March 13, 2002);
Memorandum to file number S7-17-01 regarding March 11, 2002, and
March 12, 2002, conversations between Securities and Exchange
Commission staff member and representative of Credit Suisse First
Boston (March 12, 2002).
---------------------------------------------------------------------------
We do not anticipate that the proposed amendments to Rule 10b-10
will provide any benefits or costs to broker-dealers effecting SFP
transactions in securities accounts because they do not apply to SFP
transactions effected in securities accounts. Accordingly, we believe
that broker-dealers effecting SFP transactions in securities accounts
would use existing systems that currently conform to all of the
disclosure requirements of Rule 10b-10 for securities transactions.
However, we have solicited comment on that issue and may apply the
proposed amendments to Rule 10b-10 to such broker-dealers if it would
result in a significant cost savings.
As we noted above, the proposed amendments to Rule 10b-10 would
apply only to the approximately 5,600 fully registered broker-dealers
that conduct business with the general public and the approximately
1,399 of the projected notice registered broker-dealers that conduct
business with the general public. Also, as noted above, we estimate
that there will be 100 million confirmations during the first year of
trading of security futures products. According to the information
provided by industry participants, the average cost per confirmation is
estimated to be 89 cents, including postage. Therefore,
[[Page 39656]]
we estimate that the annual paperwork cost to the industry for fiscal
year 2003 will be $89 million.
We request comments on the costs and benefits of the proposed
amendments to Rule 10b-10. Commenters are strongly encouraged to
identify and supply any relevant data, analysis, and estimates
concerning the costs and/or benefits of the proposed amendments.
Commenters should address in particular whether the proposed amendments
to Rule 10b-10 will generate the anticipated benefits or impose the
anticipated costs. As always, commenters are specifically invited to
share additional quantifiable costs and benefits that they believe may
be imposed or generated by the proposed amendments to Rule 10b-10.
C. Rule 11d2-1
Proposed Exchange Act Rule 11d2-1 would provide to Full FCM/Full
BDs that are effecting SFP transactions for customers futures accounts
an exemption from the requirement in Exchange Act Section 11(d)(2) that
a broker-dealer effecting a transaction for a customer disclose in
writing, at or before the completion of the transaction, the capacity
in which the broker-dealer acted when effecting the transaction. As we
have previously explained, we believe that requiring Full FCM/Full BDs
to comply with the capacity disclosure requirement of Exchange Act
11(d)(2) would be inconsistent with the exemptive relief provided in
proposed amendments to Rule 10b-10 that does not require automatic
disclosure of capacity. Therefore, to provide consistent relief, we are
proposing new Rule 11d2-1.
We do not anticipate that this exemption will generate large
benefits or impose great costs. However, we have identified some
potential benefits and costs that could result from Rule 11d2-1.
1. Benefits
This proposed exemption benefits Full FCM/Full BDs by avoiding any
potential conflicting regulation regarding the disclosure of capacity
when Full FCM/Full BDs effect SFP transactions for customers in futures
accounts. This proposed exemption also is designed so that Notice BDs
and Full FCM/Full BDs effecting SFP transactions in futures accounts
will not have different disclosure requirements. Finally, if the
Commission did not propose an exemption from Exchange Act Section
11(d)(2), certain of the anticipated benefits of the proposed
amendments to Rule 10b-10 would be undermined.
2. Costs
Proposed Rule 11d2-1 would exempt Full FCM/Full BDS that effect SFP
transactions in futures accounts from a statutory requirement to
provide specific information to customers regarding the capacity those
entities acted in when effecting such transactions. The exemption,
therefore, prevents customers from learning this information from the
confirmations they receive about these transactions. This cost,
however, is ameliorated to a large extent by the fact that, pursuant to
proposed amendments to Rule 10b-10, the confirmations of these
transactions would inform the customers that information on capacity is
available upon the customers' written request.
We request comments on the costs and benefits of proposed Rule
11d2-1 and ask commenters to provide supporting empirical data for any
positions advanced. Commenters should address in particular whether
proposed Rule 11d2-1 will generate the anticipated benefits or impose
the anticipated costs. As always, commenters are specifically invited
to share additionally quantifiable costs and benefits that they believe
may be imposed or generated by proposed Rule 11d2-1.
VI. Consideration of Burden on Competition, and Promotion of
Efficiency, Competition, and Capital Formation
Section 3(f) of the Exchange Act\75\ requires the Commission,
whenever it is engaged in rulemaking and is required to consider or
determine whether an action is necessary or appropriate in the public
interest, to consider whether the action will promote efficiency,
competition, and capital formation. The proposed amendments to Rule
10b-10 and proposed Rule 11d2-1 are intended to clarify the disclosures
broker-dealers effecting SFPs in customer futures accounts must make in
the confirmations sent to customers regarding those transactions. We
preliminarily believe that delineating the broker-dealers' disclosure
obligations regarding SFP products effected in futures accounts should
serve as an efficient and cost-effective means for those entities to
reconcile their conflicting confirmation disclosure requirements with
respect to SFPs. The proposed amendments to Rule 10b-10 and proposed
Rule 11d2-1 should promote efficiency because firms may still use their
present confirmation systems, after making the required adjustments,
rather than having to build new confirmation systems.
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\75\ 15 U.S.C. 78c(f).
---------------------------------------------------------------------------
In addition, the proposed amendments to Rule 10b-10 and proposed
new Rule 11d2-1 are designed to give investors the information
necessary to evaluate their securities transactions and the broker-
dealers effecting those transactions. We preliminarily believe that our
proposals would improve investor confidence and will therefore promote
capital formation.
Section 23(a)(2) of the Exchange Act\76\ requires the Commission,
in making rules under the Exchange Act, to consider the impact that any
such rule would have on competition. Exchange Act Section 23(a)(2)
prohibits the Commission from adopting any rule that would impose a
burden on competition not necessary or appropriate in furtherance of
the purposes of the Exchange Act. As stated previously, the proposed
amendments to Rule 10b-10 and new Rule 11d2-1 are designed to clarify
the confirmation disclosure requirements only for broker-dealers
effecting SFP transactions in customers' futures accounts and do not
apply to broker-dealers effecting SFP transactions in customers'
securities accounts. It is possible that the different disclosure
requirements provided by the amendments to Rule 10b-10 and new Rule
11d2-1 may place a competitive burden on broker-dealers who must comply
with all of the disclosure requirements of Rule 10b-10 because they
effect SFP transactions in securities accounts. However, we
preliminarily believe that any competitive burden imposed by these
amendments and new rule are necessary and appropriate in furtherance of
the purposes of the Exchange Act. In addition, we have solicited
comment on whether the amendments and new rule impose any costs on
broker-dealers effecting SFP transactions in securities accounts, and
if so, whether they should also apply to broker-dealers effecting SFP
transactions in securities accounts.
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\76\ 15 U.S.C. 78w(a)(2).
---------------------------------------------------------------------------
The Commission requests comment on whether the proposed amendments
are expected to promote efficiency, competition, and capital formation.
VII. Regulatory Flexibility Act Certification
Section 3(a) of the Regulatory Flexibility Act \77\ requires the
Commission to undertake an initial regulatory flexibility analysis of
the effects of proposed rules and rule amendments on small entities,
unless
[[Page 39657]]
the Chairman certifies that the rules and rule amendments, if adopted,
would not have a significant economic impact on a substantial number of
small entities.\78\
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\77\ 5 U.S.C. 603(a).
\78\ 5 U.S.C. 605(b).
---------------------------------------------------------------------------
The proposed amendments to Rule 10b-10 and proposed Rule 11d2-1
would apply only to broker-dealers that plan to effect security futures
product transactions in futures accounts for the benefit of customers.
The Commission's Office of Economic Analysis has determined that as of
March 31, 2001, 90 broker-dealers were also registered with the CFTC as
FCMs. None of those broker-dealers is a small entity.\79\ There are
also 1,399 entities (which includes FCMs and introducing brokers) that
may be eligible to be registered as Notice BDs.\80\ The CFTC has
determined that FCMs are not small entities for the purposes of the
RFA.\81\ In addition, the CFTC has stated that it would evaluate within
the context of a particular rule proposal whether some or all of
affected introducing brokers would be considered to be small entities
and, if so, what economic impact that rule would have on them.\82\
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\79\ See 17 CFR Sec. 240.0-10.
\80\ See Exchange Act Release No. 44730 (August 21, 2001), 66 FR
45137 (August 27, 2001).
\81\ Policy Statement and Establishment of Definitions of
``Small Entities'' for Purposes of the Regulatory Flexibility Act,
47 FR 18618 (April 30, 1982).
\82\ Id.
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Under the CFMA, all Notice BDs and Full FCM/Full BDs, regardless of
size, that effect SFP transactions in futures accounts must comply with
Rule 10b-10, and all Full FCM/Full BDs effecting SFP transactions in
futures accounts must comply with the disclosure requirements of
Section 11. These disclosure requirements are in addition to the
disclosures required under the CEA. The proposed amendments to Rule
10b-10 would conditionally exclude the affected firms from the general
disclosure requirements of Rule 10b-10. Proposed Rule 11d2-1 would
exempt affected Full FCM/Full BDs from the disclosure requirements of
Section 11. Accordingly, all Notice BDs and Full FCM/Full BDs effecting
SFP transactions in futures accounts would be able to send
confirmations that are substantially similar to those confirmations
they already provide to their customers for other futures transactions.
Thus, the proposed amendments to Rule 10b-10 and proposed Rule 11d2-1,
if adopted, would actually reduce the burden these entities face in
meeting the disclosure requirements of both the Exchange Act and the
CEA. Accordingly, we do not believe that the proposed amendments to
Exchange Act Rule 10b-10 and proposed Rule 11d2-1 would have a
significant economic impact on a substantial number of small entities.
The Chairman has certified that the proposed rules and amendments,
if adopted, would not have a significant economic impact on a
substantial number of small entities. A copy of the certification is
attached as Appendix A.
For purposes of the Small Business Regulatory Enforcement Fairness
Act of 1996, the Commission is also requesting information regarding
the potential impact of the proposed rules and rule amendments on the
economy on an annual basis. Commenters should provide empirical data to
support their views.
VIII. Statutory Authority
The Commission is proposing amendments to Rule 10b-10 and proposing
new Rule 11d2-1 under the Exchange Act pursuant to the authority
conferred by the Exchange Act, including Sections 10, 11, 17, 23(a),
and 36(a)(1). \83\
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\83\ 15 U.S.C. 78j, 78k, 78q, 78w(a), and 78mm(a)(1).
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Text of Proposed Rule Amendments and Rule
List of Subjects in 17 CFR Part 240
Brokers, Reporting and recordkeeping requirements, Securities.
In accordance with the foregoing, the Securities and Exchange
Commission hereby proposes that Title 17, Chapter II, of the Code of
Federal Regulation be amended as follows:
PART 240--GENERAL RULES AND REGULATIONS, SECURITIES EXCHANGE ACT OF
1934
1. The authority citation for Part 240 continues to read, in part,
as follows:
Authority: 15 U.S.C. 77c, 77d, 77g, 77j, 77s, 77z-2, 77z-3,
77eee, 77ggg, 77nnn, 77sss, 77ttt, 78c, 78d, 78e, 78f, 78g, 78i,
78j, 78j-1, 78k, 78k-1, 78l, 78m, 78n, 78o, 78p, 78q, 78s, 78u-5,
78w, 78x, 78ll, 78mm, 79q, 79t, 80a-20, 80a-23, 80a-29, 80a-37, 80b-
3, 80b-4 and 80b-11, unless otherwise noted.
* * * * *
2. Section 240.10b-10 is amended by removing the authority citation
following Sec. 240.10b-10, redesignating paragraph (e) as paragraph
(f), and adding new paragraph (e) to read as follows:
Sec. 240.10b-10 Confirmation of transactions.
* * * * *
(e) Security futures products. The provisions of paragraphs (a) and
(b) of this section shall not apply to a broker or dealer registered
pursuant to section 15(b)(11)(A) of the Act (15 U.S.C. 78o(b)(11)(A))
to the extent that it effects transactions for customers in security
futures products in a futures account (as that term is defined in
Sec. 240.15c3-3(a)(15)) and a broker or dealer registered pursuant to
section 15(b)(1) of the Act (15 U.S.C. 78o(b)(1)) that is also a
futures commission merchant registered pursuant to section 4f(a)(1) of
the Commodity Exchange Act (7 U.S.C. 6f(a)(1)), to the extent that it
effects transactions for customers in security futures products in a
futures account (as that term is defined in Sec. 240.15c3-3(a)(15)),
Provided that:
(1) The broker or dealer that effects any transaction for a
customer in security futures products in a futures account gives or
sends to the customer no later than the next business day after
execution of any futures securities product transaction, written
notification disclosing:
(i) The date the transaction was executed, the identity of the
single security or narrow-based security index underlying the contract
for the security futures product, the number of shares or units (or
principal amount) of such security futures product purchased or sold,
the price, and the delivery month;
(ii) The source and amount of any remuneration received or to be
received by the broker or dealer in connection with the transaction,
including, but not limited to, markups, commissions, costs, fees, and
other charges incurred in connection with the transaction;
(iii) The fact that information about the time of the execution of
the transaction, the identity of the other party to the contract, and
whether the broker or dealer is acting as agent for such customer, as
agent for some other person, as agent for both such customer and some
other person, or as principal for its own account, and if the broker or
dealer is acting as principal, whether it is engaging in a block
transaction or an exchange of security futures products for physical
securities, will be available upon written request of the customer; and
(iv) Whether payment for order flow is received by the broker or
dealer for such transactions and the fact that the source and nature of
the compensation received in connection with the particular transaction
will be furnished upon written request of the customer.
(2) Transitional provision. (i) Broker-dealers are not required to
comply with paragraph (e)(1)(iii) of this section until June 1, 2003,
Provided that, if the broker-dealer receives a written request from a
customer for the information paragraph (e)(1)(iii) of this section
[[Page 39658]]
requires the broker-dealer to disclose upon a customer's written
request, the broker-dealer makes the information available to the
customer; and
(ii) Broker-dealers are not required to comply with paragraph
(e)(1)(iv) of this section until June 1, 2003.
* * * * *
3. Section 240.11d2-1 is added to read as follows:
Sec. 240.11d2-1 Exemption from Section 11(d)(2) for certain broker-
dealers effecting transactions for customers security futures products
in futures accounts.
A broker or dealer registered pursuant to section 15(b)(1) of the
Act (15 U.S.C. 78o(b)(1)) that is also a futures commission merchant
registered pursuant to section 4f(a)(1) of the Commodity Exchange Act
(7 U.S.C. 6f(a)(1)), to the extent that it effects transactions for
customers in security futures products in a futures account (as that
term is defined in Sec. 240.15c3-3(a)(15)), is exempt from section
11(d)(2) of the Act (15 U.S.C. 78k(d)(2)).
By the Commission.
Dated: May 31, 2002.
Jill M. Peterson,
Assistant Secretary.
Appendix A
Note: Appendix A to the Preamble will not appear in the Code of
Federal Regulations.
Regulatory Flexibility Act Certification
I, Harvey L. Pitt, Chairman of the Securities and Exchange
Commission (the ``Commission''), based on the representations of the
Division of Market Regulation provided to me, and the analysis of
the Office of Economic Analysis and the Office of the General
Counsel provided to me, hereby certify, pursuant to 5 U.S.C. 605(b),
that the proposed amendments to Rule 10b-10 and proposed new Rule
11d2-1 would not, if adopted, have a significant economic impact on
a substantial number of small entities.
Dated: May 31, 2002.
Harvey L. Pitt,
Chairman.
[FR Doc. 02-14294 Filed 6-7-02; 8:45 am]
BILLING CODE 8010-01-P