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December 12, 1997
Via Facsimile and Regular Mail
RE: Agricultural Trade Options 62 Fed. Reg. 59624 (November 4, 1997)
Dear Ms. Webb:
National Futures Association welcomes the opportunity to comment on the Commission's proposal to lift the ban on agricultural trade options through the creation of a three-year pilot program. In doing so, the Commission is attempting to expand the risk management tools available to those in the agricultural industry while imposing a regulatory structure which will prevent the sort of market disruptions occasioned by the Hedge-To-Arrive class of cases. We certainly recognize that the Commission faces a very difficult task in striking this delicate balance. In attempting to do so, the Commission describes a limited role which NFA might play with respect to agricultural trade option merchants ("ATMs"). Specifically, NFA would perform a registration function similar to what it performs for other categories of registration, including proficiency testing, and would serve as a depository for certain periodic reports which ATMs would be required to file. Our comments will focus on the need to clarify the limited extent of NFA's role and how the registration process is intended to operate. We also have some general concerns on the adequacy of the net worth requirement proposed for ATMs.
In our view, the record keeping provisions of proposed Rule 32.13(c) could suggest a wider role for NFA than the Commission actually intends. As mentioned above, it is our understanding that the Commission would be asking NFA to perform a registration function for ATMs and their Associated Persons ("AP") and to administer a proficiency testing program in conjunction with the registration process. In addition, ATMs would file certain periodic reports with NFA, which would, in turn, make those reports available to the Commission. Neither of these tasks calls for NFA to perform ongoing regulatory oversight over the activities of ATMs. The potential ambiguity over NFA's role arises from the requirement in proposed Rule 32.13(c) that ATMs provide access to their books and records to the Commission, the Department of Justice and NFA. NFA does not need such access to perform either of the specific tasks which the Commission identifies in the release. To avoid any false expectation that NFA has assumed any greater responsibility, we would suggest that the reference to NFA in the cited paragraph be deleted.
With respect to registration requirements, we strongly support the Commission's efforts to streamline the registration process but see no reason to limit that effort to one particular category of registrant. As we have stated in previous discussions with the Commission staff, the current registration forms collect certain information which is not remotely related to the central purpose of determining the firm's or individual's fitness for registration. NFA could prepare simplified registration forms which could be used by ATMs and their APs and all other applicants for registration. The Commission should be aware, however, that until our overall redesign of the MRRS system is completed, NFA would not process ATM applications through the MRRS system. As a result, the Commission will not have on-line access to ATM registration information, though we are confident that we will be able to satisfy the Commission's need for prompt access to current information.
In reviewing the proposed rules, we have noted several technical points which would produce what we assume are unintended inconsistencies between ATMs and other categories of registrant:
The Commission should include a definition of principal that is consistent with the provisions of Commission Rule 3.1. The Commission should also include a definition of AP analogous to the definitions of APs found in the Commodity Exchange Act. This would make it clear that a person who supervises others involved in the offering or selling agricultural trade options must be registered as an AP.
The duration of registration rule should provide for notice of termination of the ATM's APs similar to termination of APs of other categories of registrants. These provisions should be consistent with the provisions of Commission Rules 3.12(b) and 3.31(c). An additional rule similar to Commission Rule 3.33 governing the withdrawal of registrations is also needed.
Proposed Rule 3.12(c)(2)(i) requires as a condition for registration that the ATM certify that none of its APs is disqualified from registration under Sections 8a(2) and (3). The effect of this proposed rule is that an ATM would be ineligible for registration if even only one of its APs is subject to a statutory disqualification. Similarly, if after an ATM obtains registration, one of its APs becomes subject to a statutory disqualification, the ATM itself would become disqualified, unless the AP in question was terminated. This is inconsistent with the regulatory scheme for other registration categories, in which such a result is limited to disqualifications involving principals and owners of holding companies. Rather than providing a streamlined registration process, this approach will unduly complicate and actually hinder the registration of ATMs. Instead, the ATM should certify that to the best of its knowledge, information and belief, the APs and natural person principals and owners of holding companies have answered the questions contained in their applications truthfully and completely. This certification would be similar to the sponsor's certification for an AP contained in Commission Rule 3.12(c)(iii).
The proficiency examination requirement should apply only to APs, not natural persons who are only principals or owners of holding companies. This would be consistent with other the registration categories.
There should be separate applications for the ATM, its principals and owners of holding companies, and its APs. NFA will develop applications for ATMs, principals, owners of holding companies and APs that require the applicant to disclose information relevant to the existence of a statutory disqualification under §§8a(2) and (3).
The APs and natural person principals and owners of holding companies should certify that they have answered the questions contained in their applications truthfully and completely and that they will cooperate in any NFA inquiry into their fitness for registration.
The rule should require that the ATM, its principals and owners of holding companies and its APs each must, on a form that NFA requires, update their applications to reflect changes, inaccuracies and deficiencies. This rule should be consistent with the provisions of Commission Rule 3.31. Additionally, ATMs should be required to file annual updates, and to be deemed to have requested withdrawal of registration if no annual filing is made. Commission Rule 3.10(d) contains similar requirements for other registered firms.
The rules regarding termination of temporary licenses ("TL") should include all the bases for termination contained in Commission Rules 3.42 and 3.46. Additionally, the TL rules should clarify that an ATM is eligible for a TL if all of its natural person principals and owners of holding companies would be eligible for TLs if they had applied to be APs. This would be consistent with Commission Rule 3.44 for guaranteed Introducing Brokers.
The Commission needs to adopt rules applicable to ATMs and their APs that are comparable to the provisions of Commission Rules 3.56 through 3.64, which govern denial, suspension and revocation of registrations in other categories. Presumably, provisions permitting conditioned and restricted ATM and AP registrations would be included in these rules. Finally, if the Commission contemplates that APs of ATMs could be dually associated with more than one ATM or with an ATM and a registrant in another category, the Commission needs to adopt a rule similar to Commission Rule 3.12(f).
Our final concern involves the proposed net worth requirement for ATMs. NFA certainly agrees that the pilot program should include minimum financial requirements for ATMs to ensure that the ATMs have the financial ability to meet their obligations to customers. To be effective, such requirements must take into account not only the amount of assets maintained by ATMs but also their liquidity. That is precisely why FCM capital requirements have always been stated in terms of adjusted net capital rather than net worth. The fact is that a net worth requirement of any amount will not ensure that an ATM has readily accessible assets to draw on to meet his obligations to his customers. Even if the rules require ATMs to maintain a certain level of adjusted net capital, rather than net worth, we question whether a flat $50,000 requirement, regardless of the volume of the ATM's business, would provide adequate assurances of financial stability. The Commission explains the $50,000 net worth requirement by citing requirements imposed by the United States Department of Agriculture and various states on federally licensed warehouses and cash market merchants. It is our understanding, however, that most states maintain some form of insurance fund to guard against losses from defaults by such businesses. In the absence of such protection for ATMs, we feel the $50,000 net worth requirement is inadequate.
We recognize the difficulty of creating adequate regulatory protection while avoiding undue regulatory burdens. The Commission, of course, faces this same basic challenge not only with respect to ATMs but for the entire futures industry. We hope our comments assist the Commission in this task and are, as always, available to discuss any of these issues at the Commission's convenience.
Daniel J. Roth