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Compliance Rule 2-10: Orders Eligible For Post-Execution Allocation
In August 1998, the CFTC approved certain amendments to Regulation 1.35(a-1) to allow eligible account managers to place orders for a combined group of eligible customers ("block order") on a contract market without specific customer account identification at the time of either order placement or report of execution. These amendments permit orders entered on behalf of these eligible customers to be allocated after execution of the order, in accordance with exchange rules, but no later than the end of the day on which the order is executed. The definitions of eligible customers and eligible account managers are set forth in the rule. NFA Compliance Rule 2-10 adopts by reference CFTC Regulation 1.35, including these recent amendments.
Regulation 1.35(a-1)(5)(iv)(B) requires an eligible account manager prior to placing the initial order eligible for post-execution allocation to notify each FCM carrying any part of the order of the identity of each eligible customer account to which fills may be allocated on a post-allocation basis. Eligible account managers may identify these accounts by several methods, for example by providing a list, a notice at the opening of the account, a letter if the determination that the account is eligible is made after the account is opened or by any similar method.
NFA has issued previous Interpretive Notices addressing an FCM's duty to supervise the handling of customer orders in general and, more specifically, the allocation of block orders. With respect to block orders, NFA has stated that the overriding regulatory objective is that allocations be non-preferential, such that no account or group of accounts receive consistently favorable or unfavorable treatment. That same objective applies to "end of day" allocations as well. To that end, an FCM carrying accounts which receive post execution allocations must have compliance procedures in place reasonably designed to ensure that only eligible accounts have received such allocations.
Please be aware that in certain situations a carrying FCM may need to obtain information from other sources to ensure that only eligible accounts receive such allocations. In such situations, a carrying FCM may choose to test on a regular basis a sample of its accounts receiving post execution allocations to ensure that only eligible accounts are included. For example, in "give-up" situations, the carrying FCM may not know which orders were allocated on a post execution basis. In this circumstance, the carrying FCM would be expected to obtain additional information that may be available to perform such a check. This information, which might be obtained from either the exchange or the executing FCM, would vary depending on the type and form of the information available.
In performing these regular checks, there are two important factors - the frequency and scope. Both of these factors will be influenced by how often an exchange or executing FCM is able to make information readily available to perform the check and the form of such information. For example, if an exchange or executing FCM is able to provide a list of accounts receiving post-execution allocations on a monthly basis to a carrying FCM, then it may be appropriate for the carrying FCM to perform its check on a monthly basis. Additionally, with regard to the scope of the check, the carrying FCM should utilize a sample size reasonably designed to ensure that only eligible accounts have received post-execution allocations. In determining this sample size, a carrying FCM should consider several factors, including the number of its eligible accounts receiving post-trade executions and the frequency of trading in these accounts. Please be advised that if an FCM carries only eligible accounts for a particular trading manager, then the fact that all such accounts receive "end of day" allocations imposes no additional supervisory responsibilities upon the FCM.
Any FCM that has actual or constructive notice that post-execution allocations have been made to accounts that have not been previously identified as eligible must make a reasonable inquiry into the matter and, if appropriate, refer the matter to the proper regulatory authority (e.g., the CFTC, NFA or its DSRO). A carrying FCM's DSRO will review both the frequency and scope of the regular checks performed by the FCM during its annual exam of the FCM's operations. If any Member has questions concerning how this Interpretive Notice would apply to its operations, please contact NFA's Compliance Department.