2010-29003

FR Doc 2010-29003[Federal Register: November 17, 2010 (Volume 75, Number 221)]

[Proposed Rules]

[Page 70152-70159]

From the Federal Register Online via GPO Access [wais.access.gpo.gov]

[DOCID:fr17no10-25]

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COMMODITY FUTURES TRADING COMMISSION

17 CFR Part 1

RIN 3038-AC96

Implementation of Conflicts of Interest Policies and Procedures

by Futures Commission Merchants and Introducing Brokers

AGENCY: Commodity Futures Trading Commission.

ACTION: Notice of proposed rulemaking.

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SUMMARY: The Commodity Futures Trading Commission (Commission or CFTC)

is proposing rules to implement new statutory provisions enacted by

Title VII of the Dodd-Frank Wall Street

[[Page 70153]]

Reform and Consumer Protection Act (Dodd-Frank Act). The proposed

regulations establish conflicts of interest requirements for futures

commission merchants (FCMs) and introducing brokers (IBs) for the

purpose of ensuring that such persons implement adequate policies and

procedures in compliance with the Commodity Exchange Act (CEA), as

amended by the Dodd-Frank Act.

DATES: Comments must be received on or before January 18, 2011.

ADDRESSES: You may submit comments, identified by RIN number 3038-AC96

and FCM-IB Conflicts of Interest, by any of the following methods:

Agency Web site, via its Comments Online process: http://

comments.cftc.gov. Follow the instructions for submitting comments

through the Web site.

Mail: David A. Stawick, Secretary of the Commission,

Commodity Futures Trading Commission, Three Lafayette Centre, 1155 21st

Street, NW., Washington, DC 20581.

Hand Delivery/Courier: Same as mail above.

Federal eRulemaking Portal: http://www.regulations.gov.

Follow the instructions for submitting comments.

Please submit your comments using only one method.

All comments must be submitted in English, or if not, accompanied

by an English translation. Comments will be posted as received to

http://www.cftc.gov. You should submit only information that you wish

to make available publicly. If you wish the Commission to consider

information that you believe is exempt from disclosure under the

Freedom of Information Act, a petition for confidential treatment of

the exempt information may be submitted according to the procedures

established in CFTC Regulation 145.9, 17 CFR 145.9.

The Commission reserves the right, but shall have no obligation, to

review, pre-screen, filter, redact, refuse or remove any or all of your

submission from http://www.cftc.gov that it may deem to be

inappropriate for publication, such as obscene language. All

submissions that have been redacted or removed that contain comments on

the merits of the rulemaking will be retained in the public comment

file and will be considered as required under the Administrative

Procedure Act and other applicable laws, and may be accessible under

the Freedom of Information Act.

FOR FURTHER INFORMATION CONTACT: Sarah E. Josephson, Associate

Director, Division of Clearing and Intermediary Oversight, (202) 418-

5684, sjosephson@cftc.gov, or Ward P. Griffin, Counsel, Office of

General Counsel, (202) 418-5425, wgriffin@cftc.gov, Commodity Futures

Trading Commission, Three Lafayette Centre, 1155 21st Street, NW.,

Washington, DC 20581.

SUPPLEMENTARY INFORMATION:

I. Background

On July 21, 2010, President Obama signed the Dodd-Frank Act.\1\

Title VII of the Dodd-Frank Act \2\ amended the CEA \3\ to establish a

comprehensive regulatory framework to reduce risk, increase

transparency, and promote market integrity within the financial system

by, among other things: (1) Providing for the registration and

comprehensive regulation of swap dealers and major swap participants;

(2) imposing clearing and trade execution requirements on standardized

derivative products; (3) creating rigorous recordkeeping and real-time

reporting regimes; and (4) enhancing the rulemaking and enforcement

authorities of the Commission with respect to all registered entities

and intermediaries subject to the Commission's oversight.

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\1\ See Dodd-Frank Wall Street Reform and Consumer Protection

Act, Public Law 111-203, 124 Stat. 1376 (2010). The text of the

Dodd-Frank Act may be accessed at http://www.cftc.gov.

\2\ Pursuant to section 701 of the Dodd-Frank Act, Title VII may

be cited as the ``Wall Street Transparency and Accountability Act of

2010.''

\3\ 7 U.S.C. 1 et seq.

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This proposed rulemaking relates to the conflicts of interest

provisions set forth in section 732 of the Dodd-Frank Act. In relevant

part, section 732 of the Dodd-Frank Act amends section 4d of the CEA to

direct each FCM and IB to implement conflicts of interest systems and

procedures that establish safeguards within the firm to ensure that any

persons researching or analyzing the price or market for any commodity

are separated by ``appropriate informational partitions'' within the

firm from review, pressure, or oversight of persons whose involvement

in trading or clearing activities might potentially bias the judgment

or supervision of the persons. Section 732 also requires that such

conflicts of interest systems and procedures ``address such other

issues as the Commission determines to be appropriate.''

Section 754 of the Dodd-Frank Act establishes that ``[u]nless

otherwise provided in this title, the provisions of this subtitle shall

take effect on the later of 360 days after the date of the enactment of

this subtitle or, to the extent a provision of this subtitle requires a

rulemaking, not less than 60 days after publication of the final rule

or regulation implementing such provision of this subtitle.''

Consequently, the Commission will seek to promulgate rules--by July 15,

2011--implementing the conflicts of interest provisions of section 732

of the Dodd-Frank Act.

Accordingly, pursuant to authority granted under sections 4d(c) and

8a(5) of the CEA, as amended by the Dodd-Frank Act, the Commission is

proposing to adopt Regulation 1.71 to address potential conflicts of

interest in the preparation and release of research reports by FCMs and

IBs, and the establishment of ``appropriate informational partitions''

within such firms, as required by the Dodd-Frank Act. The proposed rule

also will address other issues, such as enhanced disclosure

requirements, in order to minimize the potential that conflicts of

interest will arise within FCMs and IBs.

The proposed rules reflect consultation with staff of the following

agencies: (i) The Securities and Exchange Commission; (ii) the Board of

Governors of the Federal Reserve System; (iii) the Office of the

Comptroller of the Currency; and (iv) the Federal Deposit Insurance

Corporation. Staff from each of these agencies has had the opportunity

to provide oral and/or written comments to the proposal, and the

proposed rules incorporate elements of the comments provided.

The Commission requests comment on all aspects of the proposed

rules, as well as comment on the specific provisions and issues

highlighted in the discussion below.

II. Proposed Regulations

A. Conflicts of Interest in Research or Analysis

Section 732 of the Dodd-Frank Act requires, in relevant part, that

FCMs and IBs implement conflicts of interest systems and procedures

that ``establish structural and institutional safeguards to ensure that

the activities of any person within the firm relating to research or

analysis of the price or market for any commodity are separated by

appropriate informational partitions within the firm from the review,

pressure, or oversight of persons whose involvement in trading or

clearing activities might potentially bias the judgment or supervision

of the persons.''

The language in section 732 of the Dodd-Frank Act is similar to

certain language contained in section 501(a) of the Sarbanes-Oxley Act

of 2002,\4\ which

[[Page 70154]]

amended the Securities Exchange Act of 1934 by creating a new section

15D. In relevant part, section 15D(a) mandates that the Securities and

Exchange Commission, or a registered securities association or national

securities exchange, adopt ``rules reasonably designed to address

conflicts of interest that can arise when securities analysts recommend

equity securities in research reports and public appearances, in order

to improve the objectivity of research and provide investors with more

useful and reliable information, including rules designed * * * to

establish structural and institutional safeguards within registered

brokers or dealers to assure that securities analysts are separated by

appropriate informational partitions within the firm from the review,

pressure, or oversight of those whose involvement in investment banking

activities might potentially bias their judgment or supervision * *

*.''

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\4\ Public Law 107-204, 116 Stat. 745 (2002) (codified at 15

U.S.C. 78o-6).

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Unlike section 15D of the Securities Exchange Act of 1934, section

732 of the Dodd-Frank Act does not expressly limit the requirement for

informational partitions to only those persons who are responsible for

the preparation of the substance of research reports; rather, section

732 could be read to require informational partitions between persons

involved in trading or clearing activities and any person within a FCM

or IB who engages in ``research or analysis of the price or market for

any commodity,'' whether or not such research or analysis is to be made

part of a research report that may be publicly disseminated.

However, the Commission believes that an untenable outcome could

result from implementing informational partitions between persons

involved in trading or clearing activities and all persons who may be

engaged in ``research or analysis of the price or market for any

commodity,'' given that persons involved in trading or clearing

activities are routinely--or even primarily--engaged in ``research or

analysis of the price or market for'' commodities. Sound trading and/or

clearing activities necessarily require some form of pre-decisional

research or analysis of the facts supporting such trading or clearing

determinations.

Therefore, given the untenable alternative, the proposed rules

reflect the Commission's belief that the Congressional intent

underlying section 732 with respect to ``research and analysis of the

price or market of any commodity'' is primarily intended to prevent

undue influence by persons involved in trading or clearing activities

over the substance of research reports that may be publicly

disseminated, and to prevent pre-public dissemination of any material

information in the possession of a person engaged in research and

analysis, or of the research reports, to traders.

Many elements of the proposed rule, particularly those provisions

relating to potential conflicts of interest surrounding research and

analysis, have been adapted from National Association of Securities

Dealers (NASD) Rule 2711. To construct the ``structural and

institutional safeguards'' mandated by Congress under section 732 of

the Dodd-Frank Act, the proposed rule establishes specific restrictions

on the interaction and communications between persons within a FCM or

IB involved in research or analysis of the price or market for any

derivative \5\ and persons involved in trading or clearing activities.

The proposed rules also impose duties and constraints on persons

involved in the research or analysis of the price or market for any

derivative. For instance, such persons will be required to disclose

conspicuously during public appearances any relevant personal financial

interests relating to any derivative of a type that the person follows.

FCMs and IBs similarly will be obligated to make certain disclosures

clearly and prominently in research reports, including third-party

research reports that are distributed or made available by the FCM or

IB. Further, FCMs and IBs, as well as employees involved in trading or

clearing activities, will be prohibited from retaliating against any

person involved in the research or analysis of the price or market for

any derivative who produces, in good faith, a research report that

adversely impacts the current or prospective trading or clearing

activities of the FCM or IB.

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\5\ Use of the term ``derivative'' is based upon the products

listed in the definitions of futures commission merchant and

introducing broker in sections 1a(28) and 1a(29) of the CEA.

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Although section 732 of the Dodd-Frank Act requires that

appropriate informational partitions be constructed within FCMs and

IBs, the Commission recognizes that the appropriateness of such

partitions may be affected by the size of the FCM or IB and the scope

of its operations. The Commission invites comment on how these rules

should apply to FCMs and IBs, considering the varying size and scope of

the operations of such firms. For instance, NASD Rule 2711(k) provides

an exception from certain requirements for ``small firms,'' defined to

include those firms that over the past three years have participated in

ten or fewer ``investment banking services transactions'' and

``generated $5 million or less in gross investment banking services

revenues from those transactions.'' The Commission solicits comment on

whether a similar approach should be adopted for small FCMs and IBs.

Moreover, the exceptions to the definition of ``research report'' are

designed to address issues typically found in smaller firms where

individuals in the trading unit perform their own research to advise

their clients or potential clients. These exceptions do not in any way

impact or lessen the restrictions placed on firms that prepare research

reports and release them for public consumption. Any attempt by such

firms to move research personnel into a trading unit to attempt to

avail themselves of the exception will result in insufficient

``structural and institutional safeguards'' and will be a violation of

Section 732 of the Dodd-Frank Act and these Regulations.

To address the possibility that the proposed rules could be evaded

by employing research analysts in an affiliate of a FCM or IB, the

proposed rules also will restrict communications with research analysts

employed by an affiliate. An affiliate will be defined as an entity

controlling, controlled by, or under common control with, a FCM or IB.

B. Other Issues

In addition to mandating the establishment of ``appropriate

informational partitions'' within FCMs and IBs that focus on the

activities of persons involved in the ``research or analysis of the

price or market for any commodity,'' section 732 of the Dodd-Frank Act

also requires FCMs and IBs to ``implement conflict-of-interest systems

and procedures that * * * address such other issues as the Commission

determines to be appropriate.'' Having considered the potential

conflicts of interest that may arise in a FCM or IB, the Commission is

proposing rules that will address two general topics: (1) Clearing

activities; and (2) the potential for undue influence on customers. The

intended cumulative effect of the proposed rules is to fulfill

Congress's objective that FCMs and IBs construct ``structural and

institutional safeguards'' to minimize the potential conflicts of

interest that could arise within such firms.

With respect to the proposed language relating to clearing

activities, although the Commission is exercising its statutory

authority under section 4d(c)(2) of the CEA, as amended by the Dodd-

Frank Act, the impetus underlying the proposed language originates in

the Dodd-Frank Act: Section 731. Section 731 creates a new

[[Page 70155]]

section 4s of the CEA, which provides for the registration and

regulation of swap dealers (SDs) and major swap participants (MSPs).

New section 4s contains a conflicts of interest provision that is

similar--though not identical--to the conflicts of interest provision

in section 732 of the Dodd-Frank Act. New section 4s(j)(5) requires the

establishment of ``structural and institutional safeguards''

surrounding the activities of any person ``providing clearing

activities or making determinations as to accepting clearing

customers''--specifically that the activities of such persons be

separated from the review, pressure, or oversight of persons involved

in pricing, trading, or clearing. Although the quoted language is not

contained in section 4d(c) of the CEA, as amended by section 732 of the

Dodd-Frank Act, the Commission believes that to effectuate fully the

intent of section 4s(j)(5) of the CEA, these issues should be addressed

with regard to FCMs.

The Dodd-Frank Act stipulates that only a person registered as a

FCM may accept money, securities or property to clear a swap through a

derivatives clearing organization on behalf of another person, though

the restriction does not prohibit a SD or MSP from clearing its own

swap transaction.\6\ New section 4s(j)(5) of the CEA requires that

certain determinations be made relating to the provision of clearing

activities or the acceptance of clearing customers, such as (1) whether

to enter into a cleared or uncleared trade, (2) whether to refer a

counterparty to a particular FCM for clearing, or (3) whether to send a

cleared trade to a particular derivatives clearing organization.

Although the ultimate determination as to whether to accept a customer

for clearing would be made at a FCM, an affiliated SD or MSP could have

incentives to try to influence that decision improperly. Such influence

may be motivated by conflicts of interest that could have a direct

impact on the clearing treatment of transactions. Moreover, in any

situation where a person is dually registered as a FCM and as a SD or

MSP, the restrictions on clearing activities set forth in the proposed

regulations are intended to apply to the relationship between the

clearing unit of the FCM and the business trading unit of the SD or

MSP, even though the business trading unit and clearing unit reside

within the same entity. The proposed rules, set forth at subsection

(d), have been adapted from NASD Rule 2711(b).

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\6\ See section 4d(f)(1) of the CEA, as amended by section

724(a) of the Dodd-Frank Act.

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The Commission specifically requests comment regarding whether

there are alternative approaches that could be taken to address the

potential conflicts of interest that may arise between a FCM providing

clearing services to customers and the business trading unit personnel

of an affiliated swap dealer or major swap participant. For example,

what approach would address an attempt by a swap dealer's trading desk

personnel to interfere with an affiliated FCM's decision to offer

clearing services to a particular customer because of a perceived

competitive threat?

As an additional safeguard, the Commission is proposing to require

that each affected FCM and IB implement policies and procedures

mandating the disclosure to its customers of any material conflicts of

interest that relate to a customer's decision on the execution or

clearing of a transaction.

III. Related Matters

A. Regulatory Flexibility Act

The Regulatory Flexibility Act (RFA) \7\ requires that agencies, in

proposing rules, consider whether the rules they propose will have a

significant economic impact on a substantial number of small entities

and, if so, provide a regulatory flexibility analysis addressing the

impact. The proposed rules would impact FCMs and IBs, each of which is

addressed separately in the following paragraphs.

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\7\ 5 U.S.C. 601 et seq.

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The Commission previously has established certain definitions of

``small entities'' to be used in evaluating the impact of the

Commission's rules on such small entities in accordance with the RFA.

In the Commission's ``Policy Statement and Establishment of Definitions

of `Small Entities' for Purposes of the Regulatory Flexibility Act,''

\8\ the Commission concluded that registered FCMs should not be

considered to be small entities for purposes of the RFA. The

Commission's determination in this regard was based, in part, upon the

obligation of registered FCMs to meet the capital requirements

established by the Commission. Likewise, the Commission determined

``that, for the basic purpose of protection of the financial integrity

of futures trading, Commission regulations can make no size distinction

among registered FCMs.'' \9\ Thus, with respect to registered FCMs, the

Commission believes that the proposed regulations will not have a

significant economic impact on a substantial number of small entities.

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\8\ 47 FR 18618, Apr. 30, 1982.

\9\ Id. at 18619.

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The Commission previously has determined that, for purposes of the

RFA, the Commission should ``evaluate within the context of a

particular rule proposal whether all or some [IBs] should be considered

to be small entities and, if so, to analyze the economic impact on

[IBs] of any such rule at that time. Specifically, the Commission

recognizes that the [IB] definition, even as narrowed to exclude

certain persons, undoubtedly encompasses many business enterprises of

variable size.'' \10\ At present, IBs are subject to various existing

rules that govern and impose minimum requirements on their internal

compliance operations, based on the nature of their business. The

proposed amendments would merely augment the existing compliance

requirements of such persons to address potential conflicts of interest

within such firms. To the extent that certain IBs may be considered to

be small entities, the Commission believes that the proposed

regulations will not have a significant economic impact.

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\10\ 48 FR 35248, 35276, Aug. 3, 1983.

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Accordingly, pursuant to Section 605(b) of the RFA, 5 U.S.C.

605(b), the Chairman, on behalf of the Commission, certifies that these

proposed rule amendments will not have a significant economic impact on

a substantial number of small entities. However, the Commission invites

the public to comment on this finding.

B. Paperwork Reduction Act

The Paperwork Reduction Act (PRA),\11\ imposes certain requirements

on Federal agencies in connection with their conducting or sponsoring

any collection of information as defined by the PRA. Certain provisions

of this proposed rulemaking would result in new collection of

information within the meaning of the PRA. The Commission therefore is

submitting this proposal to the Office of Management and Budget (OMB)

for review in accordance with 44 U.S.C. 3597(d) and 5 CFR 1320.11. The

title for this collection is ``Conflicts of Interest Policies and

Procedures by Futures Commission Merchants and Introducing Brokers.''

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. OMB has not yet assigned a control number to the

new collection.

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\11\ 44 U.S.C. 3501 et seq.

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[[Page 70156]]

The collection of information under these proposed rules is

necessary to implement certain provisions of the CEA, as amended by the

Dodd-Frank Act. Specifically, it is essential to ensuring that FCMs and

IBs develop and maintain the required conflicts of interest systems and

procedures. The Commission's staff would use the information collected

when conducting examination and oversight to evaluate the completeness

and effectiveness of the conflicts of interest procedures and

disclosures of FCMs and IBs.

If the proposed regulations are adopted, responses to this new

collection of information would be mandatory. The Commission will

protect proprietary information according to the Freedom of Information

Act and 17 CFR part 145, ``Commission Records and Information.'' In

addition, section 8(a)(1) of the CEA strictly prohibits the Commission,

unless specifically authorized by the CEA, from making public ``data

and information that would separately disclose the business

transactions or market positions of any person and trade secrets or

names of customers.'' The Commission also is required to protect

certain information contained in a government system of records

according to the Privacy Act of 1974.\12\

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\12\ 5 U.S.C. 552a.

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1. Information Provided by Reporting Entities/Persons

The proposed rules will require FCMs and IBs to adopt conflicts of

interest policies and procedures that may impose PRA burdens,

particularly through the implementation of certain recordkeeping

requirements. For purposes of the PRA, the term ``burden'' means the

``time, effort, or financial resources expended by persons to generate,

maintain, or provide information to or for a Federal agency.'' \13\

This burden will result from the recordkeeping obligations related to

an FCM and IB's obligations to adopt and implement written policies and

procedures reasonably designed to ensure compliance with the proposed

regulation, document certain communications between non-research

personnel and research department personnel, and provide certain

disclosures. The burden relates solely to recordkeeping requirements;

the proposed regulation does not contain any reporting requirements.

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\13\ 44 U.S.C. 3502(2).

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The burden for compliance per respondent is expected to be 44.5

hours, at a cost annually of $4,450 for each respondent. This estimate

includes the time needed to review applicable laws and regulations;

develop and update conflicts of interest policies and procedures and to

maintain records of certain communications and disclosures periodically

required by the proposed regulation. The Commission does not expect

respondents to incur any start-up costs in connection with this

proposed regulation as it anticipates that respondents already maintain

personnel and systems for regulatory recordkeeping.

There are currently 159 registered FCMs and 1,645 registered IBs

that will be required to comply with the proposed conflicts of interest

provisions (or a total of 1,804 registrants). It is expected that the

compliance officers of those firms will be the employees charged with

fulfilling the regulatory obligations imposed by the proposed

regulations. According to recent Bureau of Labor Statistics, the mean

hourly wage of an employee under occupation code 13-1041, ``Compliance

Officers, Except Agriculture, Construction, Health and Safety, and

Transportation,'' that is employed by the ``Securities and Commodity

Contracts Intermediation and Brokerage'' industry is $38.77.\14\

Because FCMs and IBs include financial institutions whose compliance

employees' salaries may exceed the mean wage, the Commission has taken

a conservative approach and estimated the cost burden of these proposed

regulations based upon an average salary of $100 per hour. Accordingly,

the estimated burden was calculated as follows:

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\14\ http://www.bls.gov/oes/current/oes131041.htm.

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Recordkeeping Related to Maintenance of Conflicts of Interest

Policies and Procedures

Number of registrants: 1,804.

Average number of annual responses by each registrant: 1.

Estimated average hours per response: 2.

Frequency of collection: Annually.

Aggregate annual burden: 1,804 registrants x 1 response x 2 hours =

3,608 burden hours.

Recordkeeping Related to Communications Between Certain Personnel

Number of registrants: 1,804.

Average number of annual responses by each registrant: 20.

Estimated average hours per response: 0.5.

Frequency of collection: As needed.

Aggregate annual burden: 1,804 registrants x 20 responses x 0.5

hours = 18,040 burden hours.

Recordkeeping Related to Disclosure Requirements

Number of registrants: 1,804.

Average number of annual responses by each registrant: 65.

Estimated average hours per response: 0.5.

Frequency of collection: As needed.

Aggregate annual burden: 1,804 registrants x 65 responses x 0.5

hours = 58,630 burden hours.

Based upon the above, the aggregate cost for all registrants is

80,278 burden hours and $8,027,800 [80,278 burden hours x $100 per

hour].

2. Information Collection Comments

The Commission invites the public and other federal agencies to

comment on any aspect of the recordkeeping burdens discussed above.

Pursuant to 44 U.S.C. 3506(c)(2)(B), the Commission solicits comments

in order 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 will have practical

utility; (ii) evaluate the accuracy of the Commission's estimate of the

burden of the proposed collection of information; (iii) determine

whether there are ways to enhance the quality, utility, and clarity of

the information to be collected; and (iv) minimize the burden of the

collection of information on those who are to respond, including

through the use of automated collection techniques or other forms of

information technology.

Comments may be submitted directly to the Office of Information and

Regulatory Affairs, by fax at (202) 395-6566 or by e-mail at

OIRAsubmissions@omb.eop.gov. Please provide the Commission with a copy

of submitted comments so that they can be summarized and addressed in

the final rule. Refer to the Addresses section of this notice of

proposed rulemaking for comment submission instructions to the

Commission. A copy of the supporting statements for the collections of

information discussed above may be obtained by visiting http://

www.RegInfo.gov. OMB is required to make a decision concerning the

collection of information between 30 and 60 days after publication of

this release. Consequently, a comment to OMB is most assured of being

fully effective if received by OMB (and the Commission) within 30 days

after publication of this notice of proposed rulemaking.

C. Cost-Benefit Analysis

Section 15(a) of the CEA \15\ requires the Commission to consider

the costs

[[Page 70157]]

and benefits of its actions before issuing a rulemaking under the Act.

By its terms, section 15(a) does not require the Commission to quantify

the costs and benefits of the rule or to determine whether the benefits

of the rulemaking outweigh its costs; rather, it requires that the

Commission ``consider'' the costs and benefits of its actions.

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\15\ 7 U.S.C. 19(a).

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Section 15(a) further specifies that the costs and benefits of a

proposed rulemaking shall be evaluated in light of five broad areas of

market and public concern: (1) Protection of market participants and

the public; (2) efficiency, competitiveness and financial integrity of

futures markets; (3) price discovery; (4) sound risk management

practices; and (5) other public interest considerations. The Commission

may, in its discretion, give greater weight to any one of the five

enumerated areas and could, in its discretion, determine that,

notwithstanding its costs, a particular rule is necessary or

appropriate to protect the public interest or to effectuate any of the

provisions or accomplish any of the purposes of the Act.

1. Summary of Proposed Requirements

The proposed regulations would implement section 732 of the Act,

which amends section 4d of the CEA \16\ to direct each FCM and IB to

implement conflicts of interest systems and procedures to ensure that

any persons researching or analyzing the price or market for any

commodity are separated by ``appropriate informational partitions''

within the firm from review, pressure, or oversight of persons whose

involvement in trading or clearing activities might potentially bias

the judgment or supervision of the persons. Such conflicts of interest

systems and procedures also must address any other issues that the

Commission determines to be appropriate.

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\16\ 7 U.S.C. 6d.

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2. Costs

With respect to costs, the Commission has determined that costs to

FCMs and IBs would be minimal because the anticipated implementation of

the proposed rules would require little additional resources beyond

internal organizational changes to prevent compliance violations.

3. Benefits

With respect to benefits, the Commission has determined that formal

conflicts of interest rules will enhance transparency, bolster

confidence in markets, reduce risk and allow regulators to better

monitor and manage risks to our financial system.

4. Public Comment

The Commission invites public comment on its cost-benefit

considerations. Commenters also are invited to submit any data or other

information that they may have quantifying or qualifying the costs and

benefits of the proposed regulations with their comment letters.

List of Subjects in 17 CFR Part 1

Brokers, Commodity futures, Conflicts of interest, Reporting and

recordkeeping requirements.

For the reasons stated in this release, the Commission proposes to

amend 17 CFR part 1 as follows:

PART 1--GENERAL REGULATIONS UNDER THE COMMODITY EXCHANGE ACT

1. The authority citation for part 1 is revised to read as follows:

Authority: 7 U.S.C. 1a, 2, 6, 6a, 6b, 6b-1, 6c, 6d, 6e, 6f, 6g,

6h, 6i, 6j, 6k, 6l, 6m, 6n, 6o, 6p, 7, 7a, 7b, 8, 9, 9a, 12, 12a,

16, 18, 19, 21, 23.

2. Section 1.71 is added to read as follows:

Sec. 1.71 Implementation of conflicts of interest policies and

procedures by futures commission merchants and introducing brokers.

(a) Definitions. For purposes of this section, the following terms

shall be defined as provided.

(1) Affiliate. This term means, with respect to any person, a

person controlling, controlled by, or under common control with, such

person.

(2) Business trading unit. This term means any department,

division, group, or personnel of a futures commission merchant or

introducing broker or any of its affiliates, whether or not identified

as such, that performs or is involved in any pricing, trading, sales,

marketing, advertising, solicitation, structuring, or brokerage

activities on behalf of a futures commission merchant or introducing

broker.

(3) Clearing unit. This term means any department, division, group,

or personnel of a futures commission merchant or any of its affiliates,

whether or not identified as such, that performs or is involved in any

proprietary or customer clearing activities on behalf of a futures

commission merchant.

(4) Derivative. This term means (i) a contract for the purchase or

sale of a commodity for future delivery; (ii) a security futures

product; (iii) a swap; (iv) any agreement, contract, or transaction

described in section 2(c)(2)(C)(i) or section 2(c)(2)(D)(i) of the Act;

(v) any commodity option authorized under section 4c of the Act; and

(vi) any leverage transaction authorized under section 19 of the Act.

(5) Non-research personnel. This term means any employee of the

business trading unit or clearing unit, or any other employee of the

futures commission merchant or introducing broker who is not directly

responsible for, or otherwise involved with, research concerning a

derivative, other than legal or compliance personnel.

(6) Public appearance. This term means any participation in a

conference call, seminar, forum (including an interactive electronic

forum) or other public speaking activity before 15 or more persons, or

interview or appearance before one or more representatives of the

media, radio, television or print media, or the writing of a print

media article, in which a research analyst makes a recommendation or

offers an opinion concerning a derivatives transaction. This term does

not include a password-protected Webcast, conference call or similar

event with 15 or more existing customers, provided that all of the

event participants previously received the most current research report

or other documentation that contains the required applicable

disclosures, and that the research analyst appearing at the event

corrects and updates during the public appearance any disclosures in

the research report that are inaccurate, misleading, or no longer

applicable.

(7) Research analyst. This term means the employee of a futures

commission merchant or introducing broker who is primarily responsible

for, and any employee who reports directly or indirectly to such

research analyst in connection with, preparation of the substance of a

research report relating to any derivative, whether or not any such

person has the job title of ``research analyst.''

(8) Research department. This term means any department or division

that is principally responsible for preparing the substance of a

research report relating to any derivative on behalf of a futures

commission merchant or introducing broker, including a department or

division contained in an affiliate of a futures commission merchant or

introducing broker.

(9) Research report. This term means any written communication

(including electronic) that includes an analysis of the price or market

for any derivative, and that provides information reasonably sufficient

upon which to base a decision to enter into a

[[Page 70158]]

derivatives transaction. This term does not include:

(i) Communications distributed to fewer than 15 persons;

(ii) periodic reports or other communications prepared for

investment company shareholders or commodity pool participants that

discuss individual derivatives positions in the context of a fund's

past performance or the basis for previously-made discretionary

decisions;

(iii) any communication generated by an employee of the business

trading unit that is conveyed as a solicitation for entering into a

derivatives transaction, and is conspicuously identified as such; and

(iv) internal communications that are not given to current or

prospective customers.

(b) Policies and Procedures. Each futures commission merchant and

introducing broker subject to this rule must adopt and implement

written policies and procedures reasonably designed to ensure that the

futures commission merchant or introducing broker and its employees

comply with the provisions of this rule.

(c) Research Analysts and Research Reports.

(1) Restrictions on Relationship with Research Department.

(i) Non-research personnel shall not influence the content of a

research report of the futures commission merchant or the introducing

broker.

(ii) No research analyst may be subject to the supervision or

control of any employee of the futures commission merchant's or

introducing broker's business trading unit or clearing unit, and no

personnel engaged in trading or clearing activities may have any

influence or control over the evaluation or compensation of a research

analyst.

(iii) Except as provided in paragraph (c)(1)(iv) of this section,

non-research personnel, other than the board of directors and any

committee thereof, shall not review or approve a research report of the

futures commission merchant or introducing broker before its

publication.

(iv) Non-research personnel may review a research report before its

publication as necessary only to verify the factual accuracy of

information in the research report, to provide for non-substantive

editing, to format the layout or style of the research report, or to

identify any potential conflicts of interest, provided that:

(A) Any written communication between non-research personnel and

research department personnel concerning the content of a research

report must be made either through authorized legal or compliance

personnel of the futures commission merchant or introducing broker or

in a transmission copied to such personnel; and

(B) Any oral communication between non-research personnel and

research department personnel concerning the content of a research

report must be documented and made either through authorized legal or

compliance personnel acting as an intermediary or in a conversation

conducted in the presence of such personnel.

(2) Restrictions on Communications. Any written or oral

communication by a research analyst to a current or prospective

customer, or to any employee of the futures commission merchant or

introducing broker, relating to any derivative must not omit any

material fact or qualification that would cause the communication to be

misleading to a reasonable person.

(3) Restrictions on Research Analyst Compensation. A futures

commission merchant or introducing broker may not consider as a factor

in reviewing or approving a research analyst's compensation his or her

contributions to the futures commission merchant's or introducing

broker's trading or clearing business. No employee of the business

trading unit or clearing unit of the futures commission merchant or

introducing broker may influence the review or approval of a research

analyst's compensation.

(4) Prohibition of Promise of Favorable Research. No futures

commission merchant or introducing broker may directly or indirectly

offer favorable research, or threaten to change research, to an

existing or prospective customer as consideration or inducement for the

receipt of business or compensation.

(5) Disclosure Requirements.

(i) Ownership and Material Conflicts of Interest. A futures

commission merchant or introducing broker must disclose in research

reports and a research analyst must disclose in public appearances

whether the research analyst maintains, from time to time, a financial

interest in any derivative of a type that the research analyst follows,

and the general nature of the financial interest.

(ii) Prominence of Disclosure. Disclosures and references to

disclosures must be clear, comprehensive, and prominent. With respect

to public appearances by research analysts, the disclosures required by

paragraph (c)(5) of this section must be conspicuous.

(iii) Records of Public Appearances. Each futures commission

merchant and introducing broker must maintain records of public

appearances by research analysts sufficient to demonstrate compliance

by those research analysts with the applicable disclosure requirements

under paragraph (c)(5) of this section.

(iv) Third-Party Research Reports.

(A) For the purposes of paragraph (c)(5)(iv) of this section,

``independent third-party research report'' shall mean a research

report, in respect of which the person or entity producing the report:

(1) Has no affiliation or business or contractual relationship with

the distributing futures commission merchant or introducing broker, or

that futures commission merchant's or introducing broker's affiliates,

that is reasonably likely to inform the content of its research

reports; and

(2) makes content determinations without any input from the

distributing futures commission merchant or introducing broker or from

the futures commission merchant's or introducing broker's affiliates.

(B) Subject to paragraph (c)(5)(iv)(C) of this section, if a

futures commission merchant or introducing broker distributes or makes

available any independent third-party research report, the futures

commission merchant or introducing broker must accompany the research

report with, or provide a web address that directs the recipient to,

the current applicable disclosures, as they pertain to the futures

commission merchant or introducing broker, required by this section.

Each futures commission merchant and introducing broker must establish

written policies and procedures reasonably designed to ensure the

completeness and accuracy of all applicable disclosures.

(C) The requirements of paragraph (c)(5)(iv)(B) of this section

shall not apply to independent third-party research reports made

available by a futures commission merchant or introducing broker to its

customers:

(1) Upon request; or

(2) through a website maintained by the futures commission merchant

or introducing broker.

(6) Prohibition of Retaliation Against Research Analysts. No

futures commission merchant or introducing broker, and no employee of a

futures commission merchant or introducing broker who is involved with

the futures commission merchant's or introducing broker's trading or

clearing activities, may, directly or indirectly, retaliate against or

threaten to retaliate against any research analyst employed by the

futures commission merchant or introducing broker or its affiliates as

a

[[Page 70159]]

result of an adverse, negative, or otherwise unfavorable research

report or public appearance written or made, in good faith, by the

research analyst that may adversely affect the futures commission

merchant's or introducing broker's present or prospective trading or

clearing activities.

(d) Clearing activities.

(1) No futures commission merchant shall permit any affiliated swap

dealer or major swap participant to directly or indirectly interfere

with, or attempt to influence, the decision of the clearing unit

personnel of the futures commission merchant with regard to the

provision of clearing services and activities, including but not

limited to:

(i) Whether to offer clearing services and activities to customers;

(ii) Whether to accept a particular customer for the purposes of

clearing derivatives;

(iii) Whether to submit a transaction to a particular derivatives

clearing organization;

(iv) Setting risk tolerance levels for particular customers;

(v) Determining acceptable forms of collateral from particular

customers; or

(vi) Setting fees for clearing services.

(2) Each futures commission merchant shall create and maintain an

appropriate informational partition between business trading units of

an affiliated swap dealer or major swap participant and clearing unit

personnel of the futures commission merchant. At a minimum, such

informational partitions shall require that:

(i) No employee of a business trading unit of an affiliated swap

dealer or major swap participant may review or approve the provision of

clearing services and activities by clearing unit personnel of the

futures commission merchant, make any determination regarding whether

the futures commission merchant accepts clearing customers, or

participate in any way with the provision of clearing services and

activities by the futures commission merchant;

(ii) No employee of a business trading unit of an affiliated swap

dealer or major swap participant shall supervise, control, or influence

any employee of a clearing unit of the futures commission merchant; and

(iii) No employee of the business trading unit of an affiliated

swap dealer or major swap participant shall influence or control

compensation or evaluation of any employee of the clearing unit of the

futures commission merchant.

(e) Undue Influence on Customers. Each futures commission merchant

and introducing broker must adopt and implement written policies and

procedures that mandate the disclosure to its customers of any material

incentives and any material conflicts of interest regarding the

decision of a customer as to the trade execution and/or clearing of the

derivatives transaction.

(f) All records that a futures commission merchant or introducing

broker is required to maintain pursuant to this regulation shall be

maintained in accordance with Commission Regulation Sec. 1.31 and

shall be made available promptly upon request to representatives of the

Commission.

Issued in Washington, DC, on November 10, 2010, by the

Commission.

David A. Stawick,

Secretary of the Commission.

Statement of Chairman Gary Gensler

Implementation of Conflicts of Interest Policies and Procedures by

Futures Commission Merchants and Introducing Brokers

I support the proposed rulemakings that establish firewalls to

ensure a separation between the research arm, the trading arm and the

clearing activities of swap dealers, major swap participants, futures

commission merchants and introducing brokers. This rule proposal

relates to the conflicts-of-interest provisions of the Dodd-Frank Act

that direct swap dealers and major swap participants to have

appropriate informational partitions. The proposal builds upon similar

protections in the securities markets as mandated in the Sarbanes-Oxley

Act. The proposed rules will protect market participants and the public

while also promoting the financial integrity of the marketplace.

[FR Doc. 2010-29003 Filed 11-16-10; 8:45 am]

BILLING CODE 6351-01-P

Last Updated: November 17, 2010