[Federal Register Volume 77, Number 136 (Monday, July 16, 2012)]
[Rules and Regulations]
[Pages 41671-41678]
From the Federal Register Online via the Government Printing Office [www.gpo.gov]
[FR Doc No: 2012-17261]
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SECURITIES AND EXCHANGE COMMISSION
17 CFR Part 240
[Release No. 34-67405; File No. S7-30-11]
RIN 3235-AL19
Extension of Interim Final Temporary Rule on Retail Foreign
Exchange Transactions
AGENCY: Securities and Exchange Commission.
ACTION: Interim final temporary rule; extension.
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SUMMARY: The Securities and Exchange Commission (``Commission'') is
amending interim final temporary Rule 15b12-1T under the Securities
Exchange Act of 1934 (``Exchange Act'') to extend the date on which the
rule will expire from July 16, 2012 to July 16, 2013.
DATES: Effective Date: July 16, 2012. The expiration date of interim
final temporary Rule 15b12-1T (17 CFR 240.15b12-1T) is extended to July
16, 2013.
FOR FURTHER INFORMATION CONTACT: Joanne Rutkowski, Branch Chief, Bonnie
Gauch, Senior Special Counsel, and Leila Bham, Special Counsel,
Division of Trading and Markets, at (202) 551-5550, Securities and
Exchange Commission, 100 F Street NE., Washington, DC 20549.
SUPPLEMENTARY INFORMATION: The Commission is extending the expiration
date for Rule 15b12-1T under the Exchange Act.
I. Discussion
Section 742 of the Dodd-Frank Wall Street Reform and Consumer
Protection Act (``Dodd-Frank Act'') \1\ amended the Commodity Exchange
Act (``CEA'') to provide that a person for which there is a Federal
regulatory agency,\2\ including a broker or dealer (``broker-dealer'')
registered under section 15(b) (except pursuant to paragraph (11)
thereof) or 15C of the Exchange Act,\3\ shall not enter into, or offer
to enter into, a foreign exchange (``forex'') transaction \4\ with a
person who is not an ``eligible contract participant'' \5\ (``ECP'')
except pursuant to a rule or regulation of a Federal regulatory agency
allowing the transaction under such terms and conditions as the Federal
regulatory agency shall prescribe (``retail forex rule'').\6\ A Federal
regulatory agency's
[[Page 41672]]
retail forex rule must treat all forex agreements, contracts, and
transactions and their functional or economic equivalents,
similarly.\7\ Any retail forex rule also must prescribe appropriate
requirements with respect to disclosure, recordkeeping, capital and
margin, reporting, business conduct, and documentation, and may include
such other standards or requirements as the Federal regulatory agency
determines to be necessary.\8\
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\1\ Public Law 111-203, 124 Stat. 1376 (2010).
\2\ 7 U.S.C. 2(c)(2)(E)(i), as amended by Sec. 742(c) of the
Dodd-Frank Act, defines a ``Federal regulatory agency'' to mean the
Commodity Futures Trading Commission (``CFTC''), the Securities and
Exchange Commission, an appropriate Federal banking agency, the
National Credit Union Association, and the Farm Credit
Administration.
\3\ 7 U.S.C. 2(c)(2)(B)(i)(II).
\4\ 7 U.S.C. 2(c)(2)(B)(i)(I). Transactions described in CEA
section 2(c)(2)(B)(i)(I) include ``an agreement, contract, or
transaction in foreign currency that * * * is a contract of sale of
a commodity for future delivery (or an option on such a contract) or
an option (other than an option executed or traded on a national
securities exchange registered pursuant to section 6(a) of the
Securities Exchange Act of 1934 (15 U.S.C. 78f(a)).''
\5\ Section 1a(18) of the CEA defines ``eligible contract
participant'' generally to mean certain regulated persons; entities
that meet a specified total asset test (e.g., a corporation,
partnership, proprietorship, organization, trust, or other entity
with total assets exceeding $10 million) or an alternative monetary
test coupled with a non-monetary component (e.g., an entity with a
net worth in excess of $1 million and engaging in business-related
hedging; or certain employee benefit plans, the investment decisions
of which are made by one of four enumerated types of regulated
entities); and certain governmental entities and individuals that
meet defined thresholds. 7 U.S.C. 2(c)(2)(E)(i). The CFTC has
adopted rules further clarifying the definition of ``eligible
contract participant'' in the CEA. See 17 CFR 1.3(m). See also
Further Definition of ``Swap Dealer,'' ``Security-Based Swap
Dealer,'' ``Major Swap Participant,'' ``Major Security-Based Swap
Participant'' and ``Eligible Contract Participant,'' Exchange Act
Release No. 66868 (April 27, 2012), 77 FR 30596 (May 23, 2012).
Because transactions that are the subject of this release are
commonly referred to as ``retail forex transactions,'' this release
uses the term ``retail customer'' to describe persons who are not
ECPs.
\6\ See 7 U.S.C. 2(c)(2)(B)(i)(II) and 7 U.S.C.
2(c)(2)(E)(ii)(I). On September 10, 2010, the CFTC adopted a retail
forex rule for persons subject to its jurisdiction. See Regulation
of Off-Exchange Retail Foreign Exchange Transactions and
Intermediaries, 75 FR 55410 (September 10, 2010). The CFTC had
proposed its rules regarding retail forex transactions prior to the
enactment of the Dodd-Frank Act. See Regulation of Off-Exchange
Retail Foreign Exchange Transactions and Intermediaries, 75 FR 3282
(January 20, 2010). The Federal Deposit Insurance Corporation
(``FDIC'') and the Office of the Comptroller of the Currency
(``OCC'') have adopted similar rules. See Retail Foreign Exchange
Transactions, 76 FR 40779 (July 12, 2011); Retail Foreign Exchange
Transactions, 76 FR 41375 (July 14, 2011). The Board of Governors of
the Federal Reserve System (the ``Board'') has proposed rules for
bank holding companies. See Retail Foreign Exchange Transactions, 76
FR 46652 (August 3, 2011).
\7\ 7 U.S.C. 2(c)(2)(E)(iii)(II).
\8\ 7 U.S.C. 2(c)(2)(E)(iii)(I).
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The prohibition in CEA section 2(c)(2)(B) took effect on July 16,
2011. Beginning on that date, broker-dealers, including broker-dealers
also registered with the CFTC as futures commission merchants (``BD-
FCMs''), for which the Commission is the ``Federal regulatory agency,''
were no longer able to engage in off-exchange retail forex futures and
options transactions with a customer except pursuant to a retail forex
rule issued by the Commission.\9\ On July 13, 2011, the Commission
adopted interim final temporary Rule 15b12-1T, which temporarily
permits a broker-dealer to engage in a ``retail forex business,'' as
defined in the rule, in compliance with the Exchange Act, the rules and
regulations thereunder, and the rules of the self-regulatory
organizations of which the broker-dealer is a member, insofar as they
are applicable to retail forex transactions.\10\ We explained at the
time that our action was intended to preserve potentially beneficial
market practices that, for example, may serve to minimize a retail
customer's exposure to the risk of changes in foreign currency rates in
connection with the customer's purchase or sale of a security. We also
discussed in the Interim Release that there may be potentially abusive
practices such as lack of disclosure about fees and forex pricing, and
insufficient capital or margin requirements occurring in the retail
forex market, and sought comment on these practices and steps we should
take to seek to prevent them.\11\ Rule 15b12-1T, by its terms and
without further Commission action, would have expired on July 16, 2012.
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\9\ See 7 U.S.C. 2(c)(2)(B)(i)(II)(cc) (giving the CFTC
jurisdiction over retail forex transactions with FCMs that, among
other things, are not registered broker-dealers) and 7 U.S.C.
2(c)(2)(C)(i)(I)(aa). In addition, a commenter noted that the CFTC
``does not have jurisdiction over retail foreign exchange activities
conducted by broker-dealers, including entities that are dually
registered as broker-dealers with the SEC and as futures commission
merchants (`FCMs') with the CFTC.'' SIFMA/ISDA Letter at 1.
\10\ See Retail Foreign Exchange Transactions, Exchange Act
Release No. 64874 (July 13, 2011), 76 FR 41676 (July 15, 2011)
(adopting 17 CFR 240.15b12-1T) (``Interim Release'').
\11\ Our Office of Investor Education Advocacy has published an
Investor Bulletin providing information about retail forex
investing, including information about the risks involved in that
trading. See Investor Bulletin: Foreign Currency Exchange (Forex)
Trading for Individual Investors (July 2011), available at http://www.sec.gov/investor/alerts/forextrading.pdf. The CFTC and the North
American Securities Administrators Association also have published
an alert regarding risks of fraud in forex markets. See Foreign
Exchange Currency Fraud: CFTC/NASAA Investor Alert, available at
http://www.cftc.gov/ConsumerProtection/FraudAwarenessPrevention/ForeignCurrencyTrading/cftcnasaaforexalert. We recently brought an
enforcement action against the CEO of a purported foreign currency
trading firm alleging fraud by that person. See SEC v. Jeffery A.
Lowrance, et al., Case No. CV-11-3451, press release, complaint and
litigation release, available at http://www.sec.gov/news/press/2011/2011-147.htm.
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The Commission received comments on the Interim Release, which are
summarized below.\12\
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\12\ The comments are available at http://www.sec.gov/comments/s7-30-11/s73011.shtml. In addition to other specific requests for
comment, the Commission requested comment in the Interim Release as
to whether Rule 15b12-1T should be extended, and if so for how long.
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Nine commenters asked the Commission to preserve their
ability to engage in retail forex transactions.\13\
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\13\ See email comments from Raul Gonzalez, dated July 17, 2011,
James Peck, dated July 17, 2011, Bob Flowers, dated July 17, 2011,
James M. Beatty, dated July 17, 2011, Angela Li, dated July 17,
2011, Mark A. McDonnell, dated July 21, 2011, Mark Smith, dated July
23, 2011, John Baur, dated July 27, 2011, and Ronald Covington,
dated October 23, 2011.
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One commenter stated that the Commission should rescind
the rule and allow the ban to take effect or, in the alternative, to
limit the scope of the rule to a narrowly defined class of forex
transactions, specifically hedging and the facilitation of settlement
of foreign securities.\14\ The commenter further stated that in
adopting Rule 15b12-1T, the Commission did not provide notice of and
opportunity for comment on the rule, and did not include a ``concrete
assessment or quantification of the need'' for the relief granted by
this rule.
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\14\ See Letter from Dennis M. Kelleher, President and CEO, and
Stephen W. Hall, Securities Specialist, Better Markets, Inc. to Ms.
Elizabeth Murphy, Secretary, Commission, dated September 12, 2011
(``Better Markets Letter''). We understand the commenter's reference
to transactions entered into to facilitate the settlement of foreign
securities to mean the conversion trades discussed infra, in the
text accompanying notes 19 and 20.
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Another commenter provided data on the returns of retail
forex accounts at futures commission merchants and retail foreign
exchange dealers, and offered recommendations that the commenter
believed would improve retail forex transactions and identified areas
of retail forex that the commenter believed warrants further study.\15\
This commenter also suggested that currency exchange-traded funds
(``currency ETFs'') would provide an alternative means for effectively
hedging against currency risk.\16\
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\15\ Letter from Justin Hughes, CFA and Managing Member,
Philadelphia Financial Management of San Francisco to Ms. Elizabeth
Murphy, Secretary, Commission, dated August 2, 2011 (``Philadelphia
Financial Letter''). See also letter from P. Georgia Bullitt,
Michael A. Piracci and F. Mindy Lo, Morgan Lewis to Joseph Furey,
Bonnie L. Gauch and Adam Yonce, Commission, dated July 28, 2011
(``Morgan Lewis Letter'').
\16\ See Philadelphia Financial Letter. See also Better Markets
Letter. While certain forex transactions, in particular portfolio
hedges or currency transactions that are part of a diversified
investment strategy, may have close substitutes in currency ETFs,
currency conversions that facilitate securities transactions
(discussed in more detail below) may not have such close
substitutes.
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One commenter provided data from five large broker-dealers
showing that the notional amount of foreign exchange conversion trades
at those broker-dealers accounts for approximately 90% of those firms'
foreign exchange transactions. The firms' data further indicated that
99% of customer accounts have entered into a conversion trade, though
not all trades within an account may be conversion trades.\17\
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\17\ See Morgan Lewis Letter.
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One group of commenters urged the Commission to adopt a
final rule based on the approach followed in the interim final
temporary rule, with certain modifications.\18\ These commenters
maintained that it is in the best interests of retail customers to have
the opportunity to conduct forex activity as part of their broader
investing activity, through their broker-dealers, with the assistance
of personnel who have expertise in forex.
More recently, in April 2012, a group of commenters asked the CFTC,
as well as other Federal regulatory agencies (including the
Commission), to take the view that forex transactions that are solely
incidental to, and that are initiated for the sole purpose of,
permitting a customer to complete a transaction in a foreign security,
so-called ``conversion trades,'' are not prohibited retail forex
transactions for purposes of section 2 of the CEA.\19\
[[Page 41673]]
These commenters maintain that Congress did not intend to include
within the scope of the CEA section 2 prohibition currency transactions
effected in connection with securities transactions, stating that
``[s]uch transactions do not involve speculation in the underlying
currencies and, to the contrary, will result in an exchange of
currencies to be used to settle the relevant securities transactions.''
\20\ We anticipate that the interpretation will be addressed in the
context of the CFTC's and SEC's joint rulemaking to further define
terms such as ``swap'' and ``security-based swap'' under Title VII of
the Dodd-Frank Act (``Products Definition Release'').\21\ We further
anticipate that the rulemaking will be finalized in the near future and
the CFTC will provide at that time its views of whether conversion
trades are excluded from the prohibition under CEA section 2.
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\18\ See Letter from Kenneth E. Bentsen, Jr., Executive Vice
President Public Policy and Advocacy, SIFMA and Robert Pickel,
Executive Vice Chairman, ISDA, to Ms. Elizabeth Murphy, Secretary,
Commission, dated October 17, 2011 (``SIFMA/ISDA Letter''). See also
Memorandum from SIFMA and ISDA to Marc Menchel, Gary Goldsholle,
Matthew Vitek, Rudy Verra, Glen Garofalo, FINRA, dated February 23,
2012.
\19\ See Letter from Phoebe A. Papageorgiou, Senior Counsel,
American Bankers Association, and James Kemp, Managing Director,
Global Foreign Exchange Division, to Thomas J. Curry, Comptroller,
OCC, Robert E. Feldman, Executive Secretary, FDIC, Jennifer J.
Johnson, Secretary, the Board, David Stanwick, Secretary, CFTC, and
Elizabeth Murphy, Secretary, Commission, dated April 18, 2012
(``ABA/GFMA Letter'').
\20\ Id. at 2.
\21\ See also Further Definition of ``Swap,'' ``Security-Based
Swap,'' and ``Security-Based Swap Agreement''; Mixed Swaps;
Security-Based Swap Agreement Recordkeeping, Securities Act Release
No. 9204 (April 29, 2011), 76 FR 29818 (May 23, 2011) (proposing
release).
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The ABA/GFMA Letter and the CFTC response affect the scope,
substance, and timing of our consideration of further rulemaking for
retail forex transactions. If the CFTC were to adopt the interpretation
put forth by the ABA/GFMA, conversion trades, which commenters have
asserted comprise the overwhelming majority of retail forex
transactions conducted through broker-dealers,\22\ would not fall
within the scope of the prohibition. The potential for such
interpretation means that further rulemaking could well confront a very
different set of transactions than contemplated in April 2012, one
focused not on conversion trades, but rather on apparently less common
and more diverse retail forex transactions identified by commenters,
such as hedging transactions and direct investments.\23\ It also means
that further rulemaking would need to consider whether there are
classes of conversion trades not excluded under any final
interpretation that may be adopted by the CFTC that must be addressed
separately. We expect to consider these types of transactions and an
appropriate regulatory approach to them in considering whether and what
permanent rules we should adopt in this area.
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\22\ See Morgan Lewis Letter.
\23\ See SIFMA/ISDA Letter (Annex A, Part I).
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Extending the expiration of Rule 15b12-1T to July 16, 2013 will
provide the Commission additional time to consider carefully these
issues. The extension will help to ensure that we have sufficient time
to take such action as we may determine appropriate in this area,
particularly in light of the diverse classes of transactions--beyond
the conversion trades that have been the focus of comments to date--
that any further rulemaking may need to consider.\24\ We recognize that
commenters' views differed as to whether and to what extent we should
permit broker-dealers to continue to engage in some or all retail forex
transactions. As discussed above, some commenters urged us to permit
the statutory prohibition simply to take effect, thereby preventing
potential abuses of retail customers by broker-dealers and BD-FCMs. A
number of retail customers asked us to permit them to have continued
access to retail forex transactions through broker-dealers. Some
commenters stated that we should make certain revisions to Rule 15b12-
1T, while others favored the rule as written, stating that existing
broker-dealer regulations adequately address retail forex activities.
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\24\ If the Commission adopts permanent rules for retail forex
transactions by broker-dealers before July 16, 2013, the Commission
will consider whether it is appropriate to terminate the
effectiveness of Rule 15b12-1T as part of that rulemaking.
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In considering commenters' views, we believe, on balance, that we
should extend the expiration date of the rule to permit further
assessment by the Commission in this area, which would be informed by
any potential CFTC interpretation regarding conversion trades. Our view
is influenced by investors' views that we should permit them to conduct
retail forex transactions with broker-dealers. We also are mindful that
while futures commission merchants that are not also broker-dealers
could continue to engage in retail forex transactions in compliance
with CFTC rules, a futures commission merchant that is also a broker-
dealer would be prohibited from engaging in retail forex transactions
if we do not extend Rule 15b12-1T. For these reasons, we are extending
the expiration date of Rule 15b12-1T to July 16, 2013 to prevent retail
customers who transact retail forex transactions through a broker-
dealer from being potentially disadvantaged by the prohibition for
retail forex transactions taking effect.\25\ Given the limited nature
of this extension, the pending request for a CFTC interpretation
regarding conversion trades, the need to further understand the
implications of the CFTC's interpretation, and the scope of comments we
are seeking before any further action is taken, we are not modifying
the interim final temporary rule other than to extend the expiration
date of Rule 15b12-1T to July 16, 2013. Absent further action by the
Commission, Rule 15b12-1T as amended will expire on July 16, 2013 at
11:59 p.m. Eastern Time.
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\25\ While retail customers could of course open an account with
a futures commission merchant (that is not also registered as a
broker-dealer) to engage in retail forex transactions, as explained
below, this could create certain inefficiencies and additional
costs. See discussion in the Economic Analysis section below.
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II. Request for Comment
The Commission requests comment regarding all aspects of the
interim final temporary rule and the current market practices involving
retail forex transactions, as well as any investor protection or other
concerns that commenters believe should be addressed by Commission
rulemaking. The Commission particularly requests comment from broker-
dealers, including BD-FCMs, that are currently engaged or plan to
engage in a retail forex business, retail customers that engage in
forex transactions, and ECPs. The Commission welcomes information from
all affected parties about the current scope and nature of retail forex
transactions. This information, together with input from market
participants and other regulators, as well as comments received on the
Interim Release, will help inform the Commission's consideration of the
appropriate regulatory framework, if any, for retail forex transactions
before or beyond the expiration of the interim final temporary rule.
The Commission seeks comment on the need for further Commission
rulemaking, should the CFTC determine that certain conversion trades
are not subject to the CEA prohibition with respect to retail forex
transactions.\26\ We specifically seek to better understand the other
types of retail forex transactions in which broker-dealers may engage,
such as forex transactions to hedge portfolio currency risk or to
diversify a portfolio, that would not be excluded from the prohibition
under section 2 of the CEA by the requested interpretation. We also
request information about what mechanisms broker-dealers use currently
to comply with existing disclosure, recordkeeping, capital and margin,
reporting, business conduct and documentation rules with respect to
each type of retail forex transaction in which they engage. What
policies and procedures and supervisory controls, for example, have
broker-
[[Page 41674]]
dealers implemented to address those transactions? We also seek comment
on what mechanisms broker-dealers use currently to comply with other
existing regulatory requirements with respect to retail forex
transactions.
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\26\ See 7 U.S.C. 2(c)(2)(E)(ii)(I).
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If commenters believe further rulemaking is needed, please explain
why, and provide us with a discussion of the types of transactions for
which rules are needed and the circumstances under which such
transactions are entered into. If commenters believe further rulemaking
is not needed, please explain why not. The Commission seeks comment on
the extent to which broker-dealers' retail forex activities may be
affected, and any impact on retail customers of broker-dealers, in the
event the Commission does not adopt any further rules in this area.
The Commission also seeks comment on the retail forex activities of
BD-FCMs, and whether the Commission should adopt tailored rules for
these intermediaries. We seek comment on the nature of BD-FCM retail
forex activities, including the type of transactions in which they
engage, and which part of the dually registered entity may engage in
these activities or transactions. We also request comment on the
mechanisms BD-FCMs use currently to comply with existing disclosure,
recordkeeping, capital and margin, reporting, business conduct and
documentation rules with respect to each type of retail forex
transaction in which they engage. In connection with this specific
request for comment, please identify whether the relevant requirements
are Exchange Act Rules, CEA Rules, or rules of a particular self-
regulatory organization (``SRO'') of which the BD-FCM is a member. The
Commission also seeks comment on the extent to which the retail forex
activities of BD-FCMs may be affected, and any impact on retail
customers of BD-FCMs, in the event the Commission does not adopt any
further rules in this area.
Some commenters have suggested that if broker-dealers were
prohibited from engaging in retail forex activities, currency ETFs
would be a reasonable substitute for broker-dealer customers seeking to
hedge their currency exposures.\27\ The Commission requests comment on
whether and how currency ETFs could meet the needs of retail customers
in this regard. The Commission also requests information about how
currency ETFs (and any other financial product or service that
commenters believe could serve as a substitute for forex) could be used
more generally to meet the risk mitigation and any other needs of
retail customers that currently are addressed using retail forex
transactions. Would currency ETFs (or other financial products) hedge
currency risks in connection with foreign securities transactions in
the same manner or differently than retail forex transactions? How
would the transaction and other costs associated with currency ETFs and
retail forex transactions compare? We further seek comment on what the
associated benefits and costs would be of retail customers using
currency ETFs or some other product or service, as a substitute for
retail forex. We also seek comment on the liquidity of such alternative
products or services, the ease or difficulty of accessing and using
those products or services, and any additional risks involved in using
those products or services.
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\27\ See Philadelphia Financial Letter at 8, and Better Markets
Letter at 3.
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The Commission also seeks comment on whether Rule 15b12-1T should
be extended beyond July 16, 2013, and if so, why and for how long, or
whether it should be adopted as a final rule.
III. Economic Analysis
A. Introduction
Section 3(f) of the Exchange Act requires the Commission, whenever
it engages in rulemaking under the Exchange Act and is required to
consider or determine whether an action is necessary or appropriate in
the public interest, to consider, in addition to the protection of
investors, whether the action would promote efficiency, competition and
capital formation.\28\ In addition, Section 23(a)(2) of the Exchange
Act requires the Commission, when making rules under the Exchange Act,
to consider the impact such rules would have on competition.\29\
Section 23(a)(2) of the Exchange Act 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.\30\
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\28\ See 15 U.S.C. 78c(f).
\29\ See 15 U.S.C. 78w(a)(2).
\30\ See id.
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We understand that under the current regulatory regime, retail
customers typically enter into foreign exchange transactions with
broker-dealers for a number of reasons. Industry participants have told
us that the most common transaction is a foreign exchange conversion
trade, in which a currency trade is made in connection with a foreign
securities transaction.\31\ Commenters have also told us that retail
customers enter into forex transactions with broker-dealers as part of
a hedging strategy. For instance, retail customers may engage in forex
transactions through broker-dealers in order to hedge currency risk in
securities or in a portfolio generally held in the customer's brokerage
account; they may also engage in these transactions in order to obtain
exposure to foreign markets as part of their investment strategy.\32\
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\31\ Morgan Lewis Letter. As explained above, the ABA/GFMA
Letter requests an interpretation that would exclude conversion
trades from the prohibition under CEA section 2.
\32\ SIFMA/ISDA Letter at 4, Annex A at 1-2.
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Congress prohibited the retail forex transactions described in CEA
section 2 except pursuant to rules adopted by the relevant Federal
regulatory agencies allowing the transactions. As we noted in the
Interim Release, some of these transactions, in particular hedging
transactions and securities conversion trades, may be beneficial to
investors.\33\ At the same time, as discussed in the Interim Release,
the Commission is aware of potentially abusive practices that may be
occurring in the retail forex market. Such practices may include, for
example, lack of disclosure about fees and forex pricing, and
insufficient capital or margin requirements.\34\
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\33\ See Interim Release at 41684.
\34\ See id.
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As discussed above, on April 18, 2012, a group of commenters asked
the CFTC, as well as other Federal regulatory agencies (including the
Commission), to take the view that forex transactions that are solely
incidental to, and are initiated for the sole purpose of, permitting a
client to complete a transaction in a foreign security, through
``conversion trades,'' would not be subject to the retail forex
prohibition under section 2 of the CEA.\35\ An interpretation by the
CFTC that conversion trades are not subject to the statutory
prohibition could significantly affect the costs and benefits of any
action by the Commission with regard to retail forex transactions going
forward. Commenters have stated that conversion trades comprise the
vast majority of retail forex transactions engaged in by broker-
dealers,\36\ but also note that there are other types of forex
transactions in which broker-dealers engage with retail customers.\37\
Because the request for the interpretation is still pending, however,
the Commission will continue to consider conversion trades as retail
forex transactions that would be
[[Page 41675]]
prohibited but for Rule 15b12-1T, for purposes of our economic
analysis.
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\35\ See ABA/GFMA Letter.
\36\ See Morgan Lewis Letter.
\37\ See SIFMA/ISDA Letter, Annex A.
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Extending Rule 15b12-1T maintains the regulatory framework that
currently exists for broker-dealers, and does not create any new
regulatory obligations. Furthermore, the rule preserves the ability of
broker-dealers to provide, among other services, hedging and conversion
trades to retail customers while the Commission considers what further
appropriate steps to take, if any.\38\
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\38\ To the extent that conversion trades are not excluded from
the prohibition in CEA section 2, extension of the Rule 15b12-1T
would also have the benefit of allowing customers to continue to
engage in those transactions as part of their brokerage activities
while the Commission considers any further action.
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The Commission has previously considered and discussed in the
Interim Release its economic analysis of Rule 15b12-1T.\39\ The
Commission solicited comment on its economic analysis in the Interim
Release, and received one comment that addressed but did not support
its economic analysis.\40\ As stated in the Interim Release, we adopted
Rule 15b12-1T as an interim final temporary rule to allow the existing
regulatory framework for retail forex transactions to continue for a
defined period, to avoid potentially unintended consequences from
broker-dealers immediately discontinuing their retail forex business,
and to provide the Commission sufficient time to determine the
appropriate regulatory framework regarding retail forex
transactions.\41\ Furthermore, investors who commented on the rule
asked the Commission to preserve their ability to engage in retail
forex transaction through their broker-dealers. In addition, we
included an economic analysis of the rule in the Interim Release.\42\
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\39\ For a detailed description of the costs and benefits of
Rule 15b12-1T, see also Interim Release at 41684.
\40\ Better Markets Letter. But see SIFMA/ISDA Letter.
\41\ See Interim Release at 48683.
\42\ See id. at 41684.
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As mentioned above, based on data a commenter provided of five
broker-dealers, in terms of notional amount, foreign exchange
conversion trades would account for approximately 90% of foreign
exchange transactions done through broker-dealers, and 99% of all
broker-dealer customer accounts are involved in conversion trades,
though not all trades within an account may be conversions.\43\
Commenters have told us that certain forex transactions, particularly
certain portfolio hedges, may have close substitutes in currency
ETFs.\44\ It does not appear that currency ETFs would necessarily
function as effectively in mitigating the currency risk of particular
securities transactions, because the precise timing and amount of a
securities transaction may not be readily matched to a currency ETF, as
conversion trades are customer-specific and typically designed to
facilitate particular securities transactions, whereas currency ETFs
generally are designed to provide broad exposure to exchange rate
movements. The contracts used to complete forex conversions do have
close substitutes in exchange-traded currency futures, as both involve
the exchange of currency at a future date. However, as with currency
ETFs, the precise timing and amount of a securities transaction may not
be easily matched to exchange-traded futures contracts, which have
standardized maturity dates and notional amounts. Off-exchange
forwards, on the other hand, can be easily customized to match a
particular transaction. Additionally, exchange-traded futures are not
as effective at mitigating risks between the trade and settlement
dates, since mark-to-market margin requirements expose the investor to
additional cash flow risk.
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\43\ Morgan Lewis Letter.
\44\ See Philadelphia Financial Letter. See also Better Markets
Letter.
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The Commission understands that conversion trades can be replicated
at futures commission merchants. However, as a practical matter, this
would require the customer to maintain multiple accounts, which could
increase transaction costs and reduce efficiency relative to conversion
trades performed within a broker-dealer.
B. Alternatives Considered
The Commission considered certain alternatives to extending Rule
15b12-1T. One alternative would be to let Rule 15b12-1T expire on its
original expiration date, and so preclude broker-dealers from engaging
in certain types of retail forex business other than, potentially,
conversion trades, at least until such time as the Commission were to
adopt final rules in this area. The benefit of this alternative would
be that the abuses Congress sought to address through Dodd-Frank Act
Section 724 would be addressed through this complete prohibition. The
cost of this alternative would be that an outright prohibition on
retail forex activity would interfere with certain business activities
engaged in by broker-dealers that are potentially beneficial for their
customers, in particular the potential benefit to customers relating to
conversion trades. We note in this alternative approach, retail
customers of broker-dealers would be required to open an account with a
futures commission merchant or other financial service provider merely
to engage in currency transactions intended to mitigate risks in
connection with brokerage transactions in foreign securities. While
this shifting to services to another intermediary would impose
additional costs, retail customers may, however, benefit from the
protection of rules to which those intermediaries are subject.\45\
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\45\ See supra note 6.
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The Commission has not adopted this alternative at this time for
the reasons discussed above, and in particular because of concerns that
we not disrupt potentially beneficial market practices, such as
conversion trades that may serve to minimize a retail customer's
exposure to the risk of changes in foreign currency rates in connection
with the customer's purchase or sale of a security. In addition, we
have not adopted this alternative because the CFTC's interpretation
regarding conversion trades is not yet settled.
The Commission also considered adopting Rule 15b12-1T as a final,
permanent rule. While the direct costs and benefits of this alternative
would be minimal (as it would simply continue the existing regulatory
requirements for broker-dealers engaging in retail forex transactions),
it nevertheless could have broader impacts on the markets given that
other regulators have now adopted or proposed final rules with various
specific requirements relating to retail forex that impose different
requirements on market intermediaries than those the Commission imposes
on broker-dealers under Rule 15b12-1T.\46\ The lack of comparable rules
across the various intermediaries engaging in a retail forex business
could lead to regulatory arbitrage or regulatory gaps. The Commission
is considering alternatives, including proposing rules pertaining to
retail forex that are more tailored than Rule 15b12-1T and that would
be more closely aligned with those of the other regulators but has
deferred a determination pending the resolution by the CFTC of the
pending request in the ABA/GFMA Letter concerning the treatment of
conversion trades.
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\46\ Id.
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C. Benefits
Rule 15b12-1T was designed to preserve retail customers' access to
the forex markets through broker-dealers and so promote efficiency by,
for example, permitting retail customers to continue to enter into
forex transactions in connection with trades in foreign
[[Page 41676]]
securities, as part of their brokerage activities until such time as
the Commission allows Rule 15b12-1T to expire or adopts final,
permanent rules in this area. Without the Commission acting to extend
Rule 15b12-1T, broker-dealers would be required to exit certain types
of retail forex business, which could require retail customers to
engage in forex transactions through a futures commission merchant or
other service provider. This could be economically inefficient. In
particular, to the extent that access to the foreign exchange markets
through broker-dealers provides hedging and conversion opportunities
for foreign investments, economic benefits may accrue to retail
customers.\47\ To the extent that the CFTC takes the view that some or
all conversion trades remain subject to the retail forex prohibition,
and as noted in the Interim Release, the benefits of these trades may
not be as easily or efficiently replicated outside of the broker-
dealer.\48\ Furthermore, by continuing to preserve a channel for
broker-dealers' retail customers to access forex transactions through
broker-dealers, the extension of the interim final temporary rule will
continue to prevent any loss of competition in the retail forex market
that could result if broker-dealers were required to exit the business.
Moreover, extending the term of the rule will likely, for the period of
the extended term, maintain the status quo for broker-dealers with
respect to other regulated intermediaries offering retail forex
services, whose regulators have adopted (or have proposed to adopt)
rules targeted to retail forex with which those intermediaries must
comply.\49\ Extending the term of the rule would not necessarily
promote competition between broker-dealers and the other regulated
intermediaries, as broker-dealers would continue to offer retail forex
services under Rule 15b12-1T which, in general, imposes requirements
that arguably could be viewed as less burdensome than those that have
become (or are proposed to become) applicable to other regulated
intermediaries. Competition among broker-dealers would most likely not
be affected by extending the term of the rule.
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\47\ See Interim Release at 41684.
\48\ See id.
\49\ See supra note 6.
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Because the regulatory requirements for broker-dealers operating in
the retail forex market will remain unchanged, extending the expiration
date of Rule 15b12-1T will impose no new burden on competition.
Similarly, since the rule preserves an existing regulatory structure,
the Commission does not expect that extending the term of the rule
would result in any potential impairment of the capital formation
process.
D. Costs
Because Rule 15b12-1T preserves the regulatory regime that had been
in place prior to the effective date of Section 742(c) of the Dodd-
Frank Act, the extension of the rule imposes no new regulatory burdens
beyond those that already existed for broker-dealers engaged in a
retail forex business. The Commission recognizes that broker-dealers
will face regulatory costs and requirements associated with operating
in the retail forex market, but these costs and requirements are those
they already shouldered from engaging in the business.\50\ As discussed
above and in the Interim Release, the Commission is aware of
potentially abusive practices that may be occurring in the retail forex
market. To the extent that such practices continue, customers may bear
the costs associated with these abuses. We are monitoring potential
fraud involved in forex within our jurisdiction,\52\ and our staff has
also alerted investors to the risks of retail forex trading.\53\ The
Commission believes, on balance, that the cost of market disruption
that may occur if the Commission does not extend Rule 15b12-1T,
particularly with respect to conversion transactions that may not be
easily replicated outside of the broker-dealer,\54\ justifies the cost
of maintaining the current regulatory regime while the Commission
considers proposing rules in light of additional developments,
including the recent request for the CFTC's interpretation regarding
conversion trades.\55\
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\50\ As described in the Interim Release, these costs include
costs related to disclosure, recordkeeping and documentation,
capital and margin, reporting, and business conduct. A broker-dealer
that currently engages in forex transactions with retail customers,
for example, incurs costs associated with establishing, maintaining,
and implementing policies and procedures to comply with regulatory
requirements; preparing disclosure documents; establishing and
maintaining forex-related business records; and preparing filings
with the Commission, which may include legal and accounting fees.
Interim Release at 41684.
\52\ For instance, we recently brought an enforcement action
against the CEO of a purported foreign currency trading firm,
alleging fraud by that person. See SEC v. Jeffery A. Lowrance, et
al., Case No. CV-11-3451, press release, complaint and litigation
release, available at http://www.sec.gov/news/press/2011/2011-147.htm.
\53\ See Investor Bulletin: Foreign Currency Exchange (Forex)
Trading for Individual Investors (July 2011), available at http://www.sec.gov/investor/alerts/forextrading.pdf.
\54\ See Interim Release at 41684.
\55\ Id.
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E. Conclusion
Because the extension of Rule 15b12-1T will not affect the
regulatory requirements for broker-dealers operating in the retail
forex market, this extension will impose no new burden on competition.
Similarly, because the rule's extension does not alter the existing
regulatory structure, the Commission does not expect any potential
impairment of the capital formation process. To the extent that
potentially abusive practices continue in the retail forex market, the
market will continue to bear the costs associated with any such abuses
and the resultant inefficient provision of services across the market.
Because extending Rule 15b12-1T does not alter the existing regulatory
structure or regime, the Commission does not expect any potential
impairment of the capital formation process, especially as the rule's
extension allows retail customers to continue to have access through
broker-dealers to hedging transactions, conversion trades, and other
forex transactions, without the need to shift business and open new
accounts at other market intermediaries.
IV. Paperwork Reduction Act
Rule 15b12-1T does not impose any new ``collection of information''
requirements within the meaning of the Paperwork Reduction Act of 1995
(``PRA''),\56\ or create any new filing, reporting, recordkeeping, or
disclosure reporting requirements for broker-dealers that are or plan
to be engaged in a retail forex business. In the Interim Release, the
Commission requested comment on its conclusion that there are no
collections of information.\57\ The Commission received no comments
relating to the PRA analysis. Accordingly, the Commission maintains its
PRA analysis set forth in the Interim Release for purposes of this
extension.
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\56\ 44 U.S.C. 3501 et seq.
\57\ See Interim Release at 41683-84.
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V. Other Matters
A. Administrative Procedure Act
The Administrative Procedure Act generally requires an agency to
publish notice of a proposed rulemaking in the Federal Register.\58\
This requirement does not apply, however, if the agency ``for good
cause finds * * * that notice and public procedure are impracticable,
unnecessary, or contrary to the public interest.'' \59\ The
Administrative Procedure Act also generally requires that an agency
publish an adopted rule
[[Page 41677]]
in the Federal Register 30 days before it becomes effective.\60\ This
requirement, however, does not apply if the agency finds good cause for
making the rule effective sooner.\61\ The Commission finds that there
is good cause to extend the expiration date of Rule 15b12-1T to July
16, 2013, without notice and comment and not to delay the effective
date of the extension. The Commission further finds that notice and
solicitation of comment on the extension is impracticable, unnecessary,
or contrary to the public interest.\62\
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\58\ See 5 U.S.C. 553(b).
\59\ Id.
\60\ See 5 U.S.C. 553(d).
\61\ Id.
\62\ See 5 U.S.C. 553(b) and (d).
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As discussed above, on April 18, 2012, a group of commenters asked
the CFTC, as well as other Federal regulatory agencies (including the
Commission), to find that forex transactions that are solely incidental
to, and are initiated for the sole purpose of, permitting a client to
complete a transaction in a foreign security, so-called ``conversion
trades,'' would not be subject to the retail forex prohibition under
section 2 of the CEA.\63\ We anticipate that the CFTC will address this
request in the context of the Products Definition Release. An
interpretation by the CFTC that conversion trades are not subject to
the statutory prohibition could affect the need for, or the extent and
reach of, any Commission rulemaking for retail forex transactions
generally. Commenters have stated that conversion trades comprise the
vast majority of retail forex transactions engaged in by broker-
dealers,\64\ and permitting conversion trades by broker-dealers was one
of the reasons we adopted Rule 15b12-1T.\65\ As we previously have
noted, there are other types of forex transactions broker-dealers
engage in which may be potentially beneficial for retail customers,
such as using forex to hedge portfolio currency risk or to provide
portfolio diversification.\66\ The potential CFTC interpretation means
that further rulemaking could well confront a very different set of
transactions than contemplated in April 2012, one focused not on
conversion trades, but rather on these other types of forex
transactions. It also means that further rulemaking would need to
consider whether there are classes of conversion trades not excluded
under any final interpretation that may be adopted by the CFTC that
must be addressed separately. Accordingly, if the CEA is interpreted so
that certain conversion trades would not be prohibited, we would want
to consider what, if anything, we believe is appropriate with respect
to proposing and adopting a permanent rule in this area in light of the
diverse classes of transactions--beyond the conversion trades that have
been the focus of comments to date--that any such rule may need to
consider. Accordingly, in view of these very recent developments, the
Commission has determined that it would be impracticable to publish
notice of the proposed extension.
---------------------------------------------------------------------------
\63\ See ABA/GFMA Letter.
\64\ See Morgan Lewis Letter.
\65\ See Interim Release at 41684.
\66\ See id. See also SIFMA/ISDA Letter (Annex A, Part I).
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In making this finding of good cause,\67\ the Commission has
decided to maintain the current regulatory regime in order to avoid
disruption for investors engaging in retail forex transactions through
broker-delaers, until such time as the Commission makes any final
decision with regard to permanent rulemaking in this area, in light of
any potential interpretation by the CFTC. In particular, the Commission
considered that not extending the expiration date, or allowing the
extension to be delayed, would cause disruption to the markets and
potentially harm investors, as retail forex transactions, including
conversion trades, would, as of July 16, 2012, the original expiration
date of Rule 15b12-1T, be prohibited. For the same reasons, the
Commission finds good cause not to delay the effective date of this
extension for 30 days.
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\67\ This finding also satisfies the requirements of 5 U.S.C.
808(2), allowing the rules to become effective notwithstanding the
requirement of 5 U.S.C. 801 (if a federal agency finds that notice
and public comment are ``impractical, unnecessary or contrary to the
public interest,'' a rule ``shall take effect at such time as the
federal agency promulgating the rule determines'').
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In the event that the Commission determines to propose a permanent
rule to replace Rule 15b12-1T, the Commission will provide notice and
solicit comment on that proposal.
B. Regulatory Flexibility Act Certification
In the Interim Release, the Commission certified that pursuant to 5
U.S.C. 605(b), Rule 15b12-1T would not have a significant economic
impact on a substantial number of small entities. As explained in the
Interim Release, although Rule 15b12-1T applies to broker-dealers that
may engage in retail forex transactions, which may include small
businesses, any costs or regulatory burdens incurred as a result of the
rule are the same as those incurred by small broker-dealers prior to
the effective date of Section 742 of the Dodd-Frank Act.\68\ We also
noted that the rule would impose no new regulatory obligations, costs,
or burdens on such broker-dealers. Thus, there would not be a
significant economic impact on a substantial number of small entities.
In the Interim Release, we requested comment on our conclusion that
Rule 15b12-1T should not have a significant economic impact on a
substantial number of small entities. The Commission received no
comments addressing this issue. In light of this, as well as the fact
that we are making no change to Rule 15b12-1T apart from extending its
expiration date, we hereby certify pursuant to 5 U.S.C. 605(b) that
extending Rule 15b12-1T will not have a significant economic impact on
a substantial number of small entities.
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\68\ See id. at 41684-85.
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VI. Statutory Authority and Text of Rule and Amendment
Pursuant to section 2(c)(2) of the Commodity Exchange Act, as well
as the Exchange Act as amended, the Commission is amending Exchange Act
Rule 15b12-1T.
List of Subjects in 17 CFR Part 240
Brokers, Consumer protection, Currency, Reporting and recordkeeping
requirements.
In accordance with the foregoing, the Securities and Exchange
Commission is amending Title 17, chapter II, of the Code of Federal
Regulations as follows:
Text of the Rule and Amendment
PART 240--GENERAL RULES AND REGULATIONS, SECURITIES EXCHANGE ACT OF
1934
0
1. The general authority citation for Part 240 continues to read 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, 78n-1, 78o, 78o-4, 78p, 78q,
78s, 78u-5, 78w, 78x, 78ll, 78mm, 80a-20, 80a-23, 80a-29, 80a-37,
80b-3, 80b-4, 80b-11, and 7201 et. seq.; 18 U.S.C. 1350; 12 U.S.C.
5221(e)(3); and 7 U.S.C. 2(c)(2)(E), unless otherwise noted.
* * * * *
Sec. 240.15b12-1T [Amended]
0
2. Revise paragraph (d) of Sec. 240.15b12-1T to read as follows:
Sec. 240.15b12-1T Brokers or dealers engaged in a retail forex
business.
* * * * *
(d) This section will expire and no longer be effective on July 16,
2013.
Dated: July 11, 2012.
[[Page 41678]]
By the Commission.
Elizabeth M. Murphy,
Secretary.
[FR Doc. 2012-17261 Filed 7-13-12; 8:45 am]
BILLING CODE 8011-01-P