Amendments to Rule 15c3-1 and Rule 17a-11 Applicable to Broker-Dealers Also Registered as Futures Commission Merchants, 60636-60644 [E6-16956]

Download as PDF 60636 Federal Register / Vol. 71, No. 198 / Friday, October 13, 2006 / Proposed Rules SECURITIES AND EXCHANGE COMMISSION 17 CFR Part 240 [Release No. 34–54575; File No. S7–16–06] RIN 3235–AJ72 Amendments to Rule 15c3–1 and Rule 17a–11 Applicable to Broker-Dealers Also Registered as Futures Commission Merchants Securities and Exchange Commission. ACTION: Proposed rule. AGENCY: SUMMARY: The Securities and Exchange Commission is proposing for comment amendments to conform provisions of its net capital rule to changes to the net capital rule of the Commodity Futures Trading Commission. The proposed amendments would apply to brokerdealers also registered as futures commission merchants with the Commodity Futures Trading Commission. The Securities and Exchange Commission also is proposing to amend certain rules related to subordinated debt agreements to conform those rules to the Commodity Futures Trading Commission’s amended net capital rules. Finally, the Securities and Exchange Commission is proposing to amend its early warning provisions to require that it be notified if a brokerdealer also registered as a futures commission merchant must warn the Commodity Futures Trading Commission or a designated selfregulatory organization that its adjusted net capital has fallen below specified levels. Comments should be received on or before November 13, 2006. ADDRESSES: Comments may be submitted by any of the following methods: DATES: Electronic Comments ycherry on PROD1PC64 with PROPOSALS2 • Use the Commission’s Internet comment form (http://www.sec.gov/ rules/proposed.shtml); or • Send an e-mail to rulecomments@sec.gov. Please include File Number S7–16–06 on the subject line; or • Use the Federal eRulemaking Portal (http://www.regulations.gov). Follow the instructions for submitting comments. Paper Comments • Send paper comments in triplicate to Nancy M. Morris, Secretary, Securities and Exchange Commission, 100 F Street, NE., Washington, DC 20549–1090. VerDate Aug<31>2005 15:27 Oct 12, 2006 Jkt 211001 All submissions should refer to File Number S7–16–06. This file number should be included on the subject line if e-mail is used. To help us process and review your comments more efficiently, please use only one method. The Commission will post all comments on the Commission’s Internet Web site (http://www.sec.gov/rules/ proposed.shtml). Comments also are available for public inspection and copying in the Commission’s Public Reference Room, 100 F Street, NE., Washington, DC 20549. All comments received will be posted without change; we do not edit personal identifying information from submissions. You should submit only information that you wish to make available publicly. FOR FURTHER INFORMATION CONTACT: Michael A. Macchiaroli, Associate Director, at (202) 551–5525; Thomas K. McGowan, Assistant Director, at (202) 551–5521; or Bonnie L. Gauch, Special Counsel, at (202) 551–5524, Division of Market Regulation, Securities and Exchange Commission, 100 F Street, NE., Washington, DC 20549–6628. I. Introduction The Securities and Exchange Commission (‘‘Commission’’) is proposing to amend its financial responsibility rules for broker-dealers registered with the Commodity Futures Trading Commission (‘‘CFTC’’) under the Commodity Exchange Act (‘‘CEA’’) as futures commission merchants (‘‘FCMs’’). The Commission’s net capital rule, Rule 15c3–1,1 imposes minimum financial (net capital) requirements on broker-dealers. The CFTC’s adjusted net capital rule, Rule 1.17,2 similarly imposes minimum financial requirements on FCMs. Under Rule 15c3–1(a)(1)(iii), a broker-dealer/FCM must maintain net capital of no less than the greater of its requirements under the applicable provisions of Rule 15c3–1 or four percent of the funds that must be segregated under the CEA and its rules. The requirement to maintain at least four percent of segregated funds was intended to conform Rule 15c3–1 to the CFTC’s Rule 1.17.3 In 2004, the CFTC amended Rule 1.17 and adopted certain new net capital requirements applicable to FCMs.4 Before adoption of the amended capital 1 17 CFR 240.15c3–1. Section 15(c)(3) of the Securities Exchange Act of 1934 (the ‘‘Exchange Act’’) authorizes the Commission to impose, by regulation, minimum financial requirements on broker-dealers (15 U.S.C. 78o(c)(3)). 2 17 CFR 1.17. 3 See Exchange Act Release No. 15898 (Jun. 5, 1979), 44 FR 24884 (Jun. 15, 1979). 4 The new rules became effective on September 30, 2004. See 69 FR 49784 (Aug. 12, 2004). PO 00000 Frm 00002 Fmt 4701 Sfmt 4702 requirements, Rule 1.17(a)(1)(i)(A)–(D) required an FCM to maintain minimum adjusted net capital equal to, or in excess of, the greatest of the following: (1) $250,000; (2) four percent of an amount that equals the total of funds required to be segregated for customer trading on U.S. commodity markets under section 4d(a)(2) of the CEA and the funds required to be secured for customer trading on foreign commodity markets under Rule 30.7 to the CEA, less the market value of options purchased by customers for which the full premiums have been paid (‘‘segregated funds’’); (3) the amount of adjusted net capital required by a registered futures association; or (4) for broker-dealer/FCMs, the amount of net capital required under Rule 15c3–1(a). CFTC Rule 1.17(a)(1)(i)(B), as amended, eliminates the four percent of segregated funds provision. Instead, the amended rule requires an FCM to maintain adjusted net capital equal to a specified percentage of the margin required to be collected under exchange or clearing organization rules. Under amended CFTC Rule 1.17(a)(1)(i)(B), an FCM must maintain adjusted net capital equal to the following: (1) Eight percent of the total risk margin requirement 5 for positions carried by the FCM in customer accounts; 6 plus (2) four percent of the total risk margin requirement for positions carried by the FCM in noncustomer accounts.7 The CFTC intended changes to Rule 1.17 to address material limitations on the segregated funds method of computing net capital.8 For example, the segregated funds method did not reflect fully the extent to which an FCM was exposed to commodity positions carried for both customers and noncustomers. The segregated funds method did not include ‘‘funds held by an FCM on behalf of foreign-domiciled customers trading on foreign commodity markets, nor [did] it include funds held by an FCM on behalf of noncustomers trading on either U.S. or foreign futures and options markets.’’ 9 This method also did not include ‘‘letters of credit deposited as margin or reflect the additional risks posed by open positions in customer accounts that liquidate to a deficit.’’ 10 Finally, the segregated funds method of calculating net capital ‘‘subjects an FCM to a higher 5 CFTC Rule 1.17(b)(8) defines ‘‘risk margin’’ (17 CFR 1.17(b)(8)). 6 CFTC Rule 1.17(b)(7) defines ‘‘customer account’’ (17 CFR 1.17(b)(7)). 7 CFTC Rule 1.17(b)(4) defines ‘‘noncustomer account’’ (17 CFR 1.17(b)(4)). 8 See 68 FR 40835, 40837 (July 9, 2003). 9 Id. 10 Id. E:\FR\FM\13OCP2.SGM 13OCP2 Federal Register / Vol. 71, No. 198 / Friday, October 13, 2006 / Proposed Rules requirement in situations where the FCM requires additional margin from customers or carries free credit balances for its customers, despite the risk reducing effect of holding higher levels of customer funds.’’ 11 The CFTC amended Rule 1.17 to address these concerns and conform its net capital requirement to the net capital requirements implemented by the National Futures Association (‘‘NFA’’), two exchanges, and a clearing organization. The Commission is proposing to amend Rule 15c3–1 to reflect the amendments to CFTC Rule 1.17, and is also proposing to amend paragraph (c) of Rule 17a–11,12 which generally requires a broker-dealer to notify the Commission and its designated examining authority (‘‘DEA’’) if it fails to maintain certain levels of net capital. II. Proposed Amendments A. Amendments to Rule 15c3–1 1. Amendments to Rule 15c3–1(a)(1)(iii) The Commission is proposing to amend Rule 15c3–1(a)(1)(iii) to conform to amended CFTC Rule 1.17. The proposed amendments to Rule 15c3– 1(a)(1)(iii) would require a brokerdealer/FCM to maintain net capital of not less than the greater of the following: (1) Its requirement under paragraph (a)(1)(i) or (ii) of Rule 15c3– 1; or (2) eight percent of the total risk margin requirement for positions carried by the FCM in customer accounts plus four percent of the total risk margin requirement for positions carried by the FCM in noncustomer accounts (‘‘risk margin-based capital requirement’’). ycherry on PROD1PC64 with PROPOSALS2 2. Amendments to Rule 15c3–1(e)(2)(ii) The Commission also is proposing to amend Rule 15c3–1(e)(2)(ii) to conform it to CFTC Rule 1.17(e)(1)(ii). Rule 15c3–1(e)(2)(ii) prohibits a brokerdealer/FCM from withdrawing equity capital if the withdrawal would cause the broker-dealer/FCM’s net capital to fall below, among other standards, a specified percentage of its minimum net capital dollar amount or a specified level of aggregate indebtedness, or its ‘‘net capital would be less than 7 percent of the funds required to be segregated pursuant to the Commodity Exchange Act and the regulations thereunder’’ after the withdrawal. The Commission is proposing to replace the seven percent of segregated funds requirement with the amended CFTC Rule 1.17(e)(1)(ii) requirement of 120 percent of the risk margin-based capital requirement. B. Amendments to Appendix D to Rule 15c3–1 The Commission also is proposing to amend certain provisions of Appendix D to Rule 15c3–1 (‘‘Rule 15c3–1d’’),13 which contains minimum and nonexclusive requirements for satisfactory broker-dealer subordination agreements. Specifically, the Commission is proposing to amend paragraphs (b)(6)(iii), (b)(7), (b)(8)(i)(A), (b)(10)(ii)(B), (c)(2), (c)(5)(i)(B), (c)(5)(ii)(A), and (c)(7) of Rule 15c3–1d, which relate to repayment and prepayment of subordinated debt. Both Rule 15c3–1 and CFTC Rule 1.17 prohibit a broker-dealer or an FCM, respectively, from repaying or prepaying subordinated debt if the payments would cause the broker-dealer’s or FCM’s net capital to fall below certain thresholds. 1. Amendments to Rule 15c3– 1d(b)(6)(iii) The Commission is proposing to replace the segregated funds requirement of Rule 15c3–1d(b)(6)(iii) with a risk margin-based capital requirement to conform it to the CFTC’s amended Rule 1.17(h)(2)(vi)(C)(2). Rule 15c3–1d(b)(6)(iii) permits a subordinated lender to reduce the unpaid principal amount of a secured demand note pledged to a broker-dealer with the consent of the broker-dealer and its DEA. The reduction, however, may not cause the broker-dealer’s aggregate indebtedness to exceed a specified level of net capital or its net capital to fall below a specified level of aggregate debit items or, if the brokerdealer also is registered as an FCM, its net capital to fall below seven percent of the funds that must be segregated under the CEA and its rules, if that segregated amount is greater. The proposed amendment to Rule 15c3– 1d(b)(6)(iii) would conform to amended CFTC Rule 1.17(h)(2)(vi)(C)(2) and replace the seven percent of segregated funds requirement with 120 percent of the risk margin-based capital requirement. 2. Amendments to Rule 15c3–1d(b)(7) The Commission is proposing to replace the segregated funds requirement of Rule 15c3–1d(b)(7) with a risk margin-based capital requirement to conform it to the CFTC’s amended Rule 1.17(h)(2)(vii)(A)(2). Rule 15c3– 1d(b)(7) permits a broker-dealer to prepay subordinated debt if the 11 Id. 12 17 CFR 240.17a–11(c). VerDate Aug<31>2005 15:27 Oct 12, 2006 13 17CFR Jkt 211001 PO 00000 240.15c3–1d. Frm 00003 Fmt 4701 Sfmt 4702 60637 prepayment occurs at least one year after the effective date of the subordination agreement and the broker-dealer meets certain other requirements. A broker-dealer/FCM may not prepay subordinated debt, however, if the prepayment would cause its aggregated indebtedness to exceed a specified level of net capital or its net capital to fall below a specified percentage of the minimum net capital dollar amount, fall below a specified level of aggregate debit items or, if the broker-dealer also is registered as an FCM, its net capital to fall below seven percent of the funds that must be segregated under the CEA and its rules, if that amount is greater. The proposed amendment to Rule 15c3–1d(b)(7) would conform to amended CFTC Rule 1.17(h)(2)(vii)(A)(2) and replace the seven percent of segregated funds requirement with 120 percent of the risk margin-based capital requirement. 3. Amendments to Rule 15c3– 1d(b)(8)(i)(A) The Commission is proposing to replace the segregated funds requirement of Rule 15c3–1d(b)(8)(i)(A) with a risk margin-based capital requirement to conform it to the CFTC’s amended Rule 1.17(h)(2)(viii)(A)(2). Rule 15c3–1d(b)(8)(i)(A) requires a broker-dealer/FCM to suspend repayment of subordinated debt if the repayment would cause its aggregated indebtedness to exceed a specified level of net capital or its net capital to fall below a specified level of aggregate debit items or, if the broker-dealer also is registered as an FCM, its net capital to fall below six percent of the funds required to be segregated under the CEA and its rules, if that amount is greater. The proposed amendment to Rule 15c3– 1d(b)(8)(i)(A) would conform to amended CFTC Rule 1.17(h)(2)(viii)(A)(2) and replace the six percent of segregated funds requirement with 120 percent of the risk marginbased capital requirement. 4. Amendments to Rule 15c3– 1d(b)(10)(ii)(B) The Commission also is proposing to replace the segregated funds requirement of Rule 15c3– 1d(b)(10)(ii)(B) to reflect the CFTC’s risk margin-based capital requirements. Rule 15c3–1d(b)(10)(ii)(B) limits the events of default that may accelerate a brokerdealer/FCM’s obligation to repay subordinated debt. Those events of default occur if a broker-dealer/FCM’s aggregate indebtedness exceeds 1500 percent of its net capital, its net capital computed under Rule 15c3–1(a)(1)(ii) is less than two percent of aggregate debit E:\FR\FM\13OCP2.SGM 13OCP2 60638 Federal Register / Vol. 71, No. 198 / Friday, October 13, 2006 / Proposed Rules items as computed under Rule 15c3–3a, or its net capital is less than four percent of the funds required to be segregated under the CEA and its rules, if that amount is greater. The proposed amendment to Rule 15c3–1(b)(10)(ii)(B) would replace the four percent of segregated funds requirement with the risk margin-based capital requirements of proposed Rule 15c3–1(a)(1)(iii). ycherry on PROD1PC64 with PROPOSALS2 5. Amendments to Rule 15c3–1d(c)(2) Furthermore, the Commission is proposing to replace the segregated funds requirement of Rule 15c3–1d(c)(2) with a risk margin-based capital requirement to conform it to the CFTC’s amended Rule 1.17(h)(3)(ii)(B). Rule 15c3–1d(c)(2) requires a broker-dealer/ FCM to notify its DEA if repayment of its subordinated debt would cause its aggregate indebtedness to exceed 1200 percent of its net capital; its net capital to be less than 120 percent of the minimum dollar amount required by Rule 15c3–1; less than five percent of aggregate debit items computed in accordance with Rule 15c3–3a; or its net capital to be less than six percent of the funds required to be segregated under the CEA and its rules, if that amount is greater. The proposed amendment to Rule 15c3–1d(c)(2) would conform to amended CFTC Rule 1.17(h)(3)(ii)(B) and replace the six percent of segregated funds requirement with 120 percent of the risk margin-based capital requirement. 6. Amendments to Rule 15c3– 1d(c)(5)(i)(B) The Commission also is proposing to replace the segregated funds requirement of Rule 15c3–1d(c)(5)(i)(B) with a risk margin-based capital requirement to conform it to the CFTC’s amended Rule 1.17(h)(3)(v)(B). Rule 15c3–1d(5)(i)(B) permits a broker-dealer to enter into temporary subordination agreements (terms of no more than 45 days), subject to specified conditions, so that the broker-dealer may engage in securities underwriting and other extraordinary activities. A brokerdealer/FCM operating under Rule 15c3– 1(a)(1)(ii) may not enter into a temporary subordination agreement, however, if its net capital is less than five percent of its aggregate debit items computed under Rule 15c3–3a or seven percent of the funds required to be segregated under the CEA or its rules, if that amount is greater. The proposed amendment to Rule 15c3–1d(c)(5)(i)(B) would conform to amended CFTC Rule 1.17(h)(3)(v)(B) and replace the seven percent of segregated funds requirement with 120 percent of the risk marginbased capital requirement. VerDate Aug<31>2005 15:27 Oct 12, 2006 Jkt 211001 7. Amendments to Rule 15c3– 1d(c)(5)(ii)(A) Finally, the Commission is proposing to replace the segregated funds requirement of Rule 15c3–1d(c)(5)(ii)(A) with a risk margin-based capital requirement to conform it to the CFTC’s amended Rule 1.17(h)(2)(vii)(B)(2). Rule 15c3–1d(c)(5)(ii)(A) permits a brokerdealer to enter into a revolving subordinated loan agreement that provides for prepayment within less than one year. A broker-dealer/FCM may not prepay subordinated debt, however, if, as a result of the prepayment, its aggregate indebtedness would exceed 900 percent of its net capital; its net capital would be less than 200 percent of the minimum dollar amount required under Rule 15c3–1; its net capital would be less than six percent of aggregate debit items computed under Rule 15c3–3a (for broker-dealer operating under Rule 15c3–1(a)(1)(ii)); or its net capital would be less than ten percent of the funds required to be segregated under the CEA or its rules, if that amount is greater. The proposed amendment to Rule 15c3– 1d(c)(5)(ii)(A) would conform to amended CFTC Rule 1.17(h)(2)(vii)(B)(2) and replace the ten percent of segregated funds requirement with 125 percent of the risk margin-based capital requirement. 8. Applicability of Amendments to Rule 15c3–1d to Existing Subordination Agreements Under the proposed amendments to Rule 15c3–1d(c)(7), satisfactory subordination agreements that comply with Rule 15c3–1d, as in effect before adoption of these proposed amendments to that rule, would continue to be deemed satisfactory until their maturity date, if the agreements are not amended or renewed. However, all subordination agreements would be required to meet the requirements of amended Rule 15c3–1d within five years of adoption of these proposed amendments to that rule. Amendments to, or renewals of, subordination agreements would be required to comply with the proposed amendments to Rule 15c3–1d, as would any new subordination agreements. This proposed ‘‘grandfathering’’ provision is intended to allow broker-dealer/FCMs sufficient time to comply with the proposed amendments to subordinated debt rules in a manner that is not unduly burdensome on either the broker-dealer/FCMs or their DEAs, which must approve subordinated debt agreements under Appendix D. PO 00000 Frm 00004 Fmt 4701 Sfmt 4702 C. Rationale for the Amendments to Rules 15c3–1 and 15c3–1d The Commission believes that the proposed amendments to Rules 15c3–1 and 15c3–1d are necessary and appropriate. First, compliance with both the current Commission and the amended CFTC rules could impose duplicative or conflicting obligations on a broker-dealer/FCM because the rules may apply different standards. Under current Rule 15c3–1(a)(1)(iii) and amended CFTC Rule 1.17, a brokerdealer/FCM must maintain net capital equal to at least the greatest of its requirements under Rule 15c3–1(a)(1)(i) or (ii), four percent of the funds required to be segregated under the CEA and its applicable rules, or the risk marginbased capital requirement under amended CFTC Rule 1.17. That is, a broker-dealer/FCM must maintain net capital equal to at least the Commission minimum applicable to broker-dealers, the now-eliminated CFTC segregated funds minimum, or the new CFTC minimum applicable to FCMs. Section 15 of the Exchange Act requires the Commission to issue those rules, in consultation with the CFTC, that are necessary to avoid imposing duplicative or conflicting financial responsibility regulations on broker-dealer/FCMs.14 The proposed amendments to Rules 15c3–1 and 15c3–1d are intended to avoid imposing potentially duplicative or conflicting regulations on brokerdealer/FCMs by eliminating the four percent of segregated funds requirement and replacing it with a risk marginbased capital requirement identical to that contained in amended CFTC Rule 1.17. Second, the risk margin-based capital requirement applicable to FCMs should be an adequate substitute for the previous segregated funds standard. The risk margin-based requirement has been in place at futures exchanges for a number of years without significant problems. Third, the proposed amendments to Rule 15c3–1 also are necessary to avoid potentially placing a broker-dealer/FCM at a competitive disadvantage with respect to entities registered solely as broker-dealers or FCMs. Sole registrants might be subject to lower regulatory 14 Section 15 of the Exchange Act requires the Commission, in consultation with the CFTC, to: issue such rules, regulations, or orders as are necessary to avoid duplicative or conflicting regulations applicable to any broker or dealer registered with the Commission pursuant to section 15(b) (except paragraph (11) thereof), that is also registered with the Commodity Futures Trading Commission pursuant to section 4f(a) of the Commodity Exchange Act * * * with respect to application of * * * financial responsibility rules. 15 U.S.C. 78o(c)(3)(B). E:\FR\FM\13OCP2.SGM 13OCP2 Federal Register / Vol. 71, No. 198 / Friday, October 13, 2006 / Proposed Rules ycherry on PROD1PC64 with PROPOSALS2 costs than a combined broker-dealer/ FCM, which could be required to maintain higher capital than either the broker-dealer or FCM net capital rules would require a sole registrant to maintain. Fourth, the proposed amendments should provide the Commission with enhanced ability to monitor the financial position of broker-dealer/ FCMs. The proposed amendments to Rule 15c3–1 would permit the Commission to oversee a broker-dealer/ FCM for capital problems arising from the firm’s futures business. A brokerdealer/FCM might be in a financial position in which its net capital otherwise is sufficient for the securities aspect of Rule 15c3–1, but is insufficient for purposes of the risk margin-based capital requirement for its futures business. Under the proposed amendments to Rule 15c3–1, a brokerdealer’s failure to maintain sufficient risk margin-based capital, which is a violation of CFTC Rule 1.17, also would be a violation of the Commission’s net capital rule. The Commission, therefore, could force the broker-dealer/FCM to take corrective action (or require it to cease conducting business), an ability the Commission would not have without the proposed amendments. D. Amendments to Rule 17a–11, Notification Provisions for Brokers and Dealers We are proposing to amend paragraph (c) of Rule 17a–11,15 which generally requires a broker-dealer to notify the Commission and its DEA if it fails to maintain certain levels of net capital. Specifically, the Commission is proposing to amend paragraph (c) of Rule 17a–11 to redesignate existing paragraph (c)(4) as paragraph (c)(5); and add a new paragraph (c)(4). Proposed new paragraph (c)(4) would require a broker-dealer/FCM to notify the Commission and its DEA under circumstances in which the CFTC’s rules would require an FCM to provide notification to the CFTC that its adjusted net capital had fallen below a particular threshold. We are proposing these amendments to help protect customers from broker-dealer failures. Current Rule 17a–11 does not require a broker-dealer/FCM to notify the Commission if its adjusted net capital under the CFTC’s net capital rule falls below specified requirements. The proposed notification requirement should provide an early warning to the Commission that a broker-dealer/FCM may be experiencing financial difficulties whatever the source and 15 17 CFR 240.17a–11(c). VerDate Aug<31>2005 15:27 Oct 12, 2006 Jkt 211001 60639 allow the Commission to take corrective action with respect to the firm, if necessary. The proposed amendments to Rule 17a–11 also are consistent with amended CFTC Rule 1.12(b)(2),16 which requires an FCM to notify the CFTC and its designated self-regulatory organization if its adjusted net capital falls below 110% of its risk marginbased requirements under 1.17(a)(1)(i)(B). B. Proposed Use of Information The Commission would use the information collected under the proposed amendments to Rule 17a–11 to determine if a broker-dealer is in compliance with financial responsibility rules. Specifically, the Commission would use the information to monitor whether broker-dealer/FCMs are complying with the net capital rule and relevant notification requirements. III. Request for Comments C. Respondents The proposed amendments to Rule 17a–11 would apply only to brokerdealer/FCMs. As of July 31, 2006, there were approximately 67 broker-dealer/ FCMs.19 A broker-dealer/FCM would be required to notify the Commission and its DEA under circumstances in which the CFTC’s rules would require an FCM to provide notification that its adjusted net capital had fallen below a particular threshold. We invite interested persons to submit written comments on all aspects of the proposed amendments. Further, we invite comment on other matters that might have an effect on the proposals contained in the release. IV. Paperwork Reduction Act Certain provisions of the proposed amendments to Rule 17a–11 17 contain ‘‘collection of information requirements’’ within the meaning of the Paperwork Reduction Act of 1995.18 The Commission has submitted the proposed amendments to the Office of Management and Budget (‘‘OMB’’) for review in accordance with 44 U.S.C. 3507(d) and 5 CFR 1320.11. The Commission is revising the collection of information entitled, ‘‘Rule 17a–11 (17 CFR 240.17a–11) Notification Provision for Brokers and Dealers,’’ OMB Control Number 3235–0085. 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. A. Collection of Information under these Amendments As discussed, the Commission is proposing to amend Rule 17a–11 to provide the Commission with an early warning of a broker-dealer/FCM’s low capital level, which should help protect customers from broker-dealer failures. The proposed amendments to paragraph 17a–11(c)(4) would require a brokerdealer/FCM to notify the Commission and its DEA under circumstances in which the CFTC’s rules would require an FCM to provide notification that its adjusted net capital had fallen below a particular threshold. 16 17 CFR 1.12(b)(2). is no new collection of information imposed on broker-dealer/FCMs under the amendments to Rules 15c3–1 and 15c3–1d. The Commission’s and CFTC’s rules, both in previous form and as amended, require broker-dealer/FCMs to comply with the net capital rules of both agencies. Accordingly, the proposed amendments to Rules 15c3–1 and 15c3–1d do not impose any new requirements on broker-dealer/FCMs. 18 44 U.S.C. 3501 et seq. 17 There PO 00000 Frm 00005 Fmt 4701 Sfmt 4702 D. Total Annual Reporting and Recordkeeping Burden Under the proposed amendment to Rule 17a–11(c)(4), a broker-dealer/FCM would be required to notify the Commission and its DEA under circumstances in which the CFTC’s rules would require an FCM to provide notification that its adjusted net capital had fallen below a particular threshold. The Commission staff estimates that 5 out of 67 broker-dealer/FCMs will file Rule 17a–11 notifications annually.20 The staff further estimates that these broker-dealer/FCMs would spend annually approximately 1.25 hours (or .25 hours each × 5 broker-dealer/FCMs) to send the notifications.21 E. Collection of Information Is Mandatory The collection of information under the proposed amendments to Rule 17a– 11 is mandatory if a broker-dealer/ FCM’s net capital falls below the Commission’s or the CFTC’s early warning thresholds. 19 Selected FCM Financial Data as of July 31, 2006, CFTC Division of Clearing and Intermediary Oversight. 20 There were approximately 5,980 registered broker-dealers as of December 31, 2005. Approximately 450, or 7.5% (450/5,980), of those firms filed early warning notices under Rule 17a– 11. The Commission, therefore, expects that 5 broker-dealer/FCMs (approximately 7.5% of 67 broker-dealer/FCMs) would file early warning notices annually under Rule 17a–11. 21 A broker-dealer/FCM is already required to draft and send these notifications to the CFTC or DSROs pursuant to CFTC Rules. Consequently, the only additional cost relates to the additional time it would take the broker-dealer/FCM’s staff to send the notification to the Commission and its DEA. The Staff estimates, based on its experience, that it would take an individual 15 minutes to send these additional notifications. E:\FR\FM\13OCP2.SGM 13OCP2 60640 Federal Register / Vol. 71, No. 198 / Friday, October 13, 2006 / Proposed Rules F. Confidentiality The collection of information under the proposed amendments to Rule 17a– 11(c)(4) would be provided to the Commission and to a broker-dealer/ FCM’s DEA, but would not be subject to public availability. ycherry on PROD1PC64 with PROPOSALS2 G. Record Retention Period Rule 17a–4(b)(4) requires a brokerdealer to preserve copies of all communications sent relating to its business as such for no less than three years, the first two years in an accessible place. H. Request for Comment Under 44 U.S.C. 3506(c)(2)(B), the Commission solicits comments to: (i) Evaluate whether the proposed collection of information is necessary for the proper performance of the functions of the Commission, including whether the information would have practical utility; (ii) Evaluate the accuracy of the Commission’s estimate of the burden of the proposed collection of information; (iii) Enhance the quality, utility, and clarity of the information to be collected; and (iv) Minimize the burden of the collection of information on those required to respond, including through the use of automated collection techniques or other forms of information technology. Persons who desire to submit comments on the collection of information requirements should direct them to OMB, Attention: Desk Officer for the Securities and Exchange Commission, Office of Information and Regulatory Affairs, Washington, DC 20503, and should also send a copy of their comments to Nancy M. Morris, Secretary, Securities and Exchange Commission, 100 F Street, NE., Washington, DC 20549–1090, and refer to File No. S7–16–06. OMB is required to make a decision concerning the collections of information between 30 and 60 days after publication of this document in the Federal Register; therefore, comments to OMB are best assured of having full effect if OMB receives them within 30 days of this publication. The Commission has submitted the proposed collections of information to OMB for approval. Requests for the materials submitted to OMB by the Commission with regard to these collections of information should be in writing, refer to File No. S7–16– 06, and be submitted to the Securities and Exchange Commission, Records Management, Office of Filings and Information Services, 100 F Street, NE., Washington, DC 20549. VerDate Aug<31>2005 15:27 Oct 12, 2006 Jkt 211001 V. Costs and Benefits of the Proposed Amendments A. Introduction As discussed, the Commission is proposing to amend Exchange Act Rules 15c3–1(a)(1)(iii) and (e)(2)(ii); 15c3– 1d(b)(6)(iii), (b)(7), (b)(8)(i)(A), (b)(10)(ii)(B), (c)(2), (c)(5)(i)(B), (c)(5)(ii)(A), and (c)(7); and 17a–11(c)(3), (c)(4), and (c)(5). The CFTC amended Rules 1.17 and 1.12 to adopt certain new net capital requirements applicable to FCMs.22 Broker-dealer/FCMs must comply with both the CFTC’s and the Commission’s net capital rules under Rule 15c3–1(a)(1)(iii). Accordingly, the Commission is amending Rules 15c3–1 and 15c3–1d to conform those rules to the CFTC’s amendments. Finally, the Commission is amending Rule 17a–11 to provide itself with an early warning that a broker-dealer/FCM may be experiencing financial difficulties. The Commission has identified below certain costs and benefits associated with its proposed amendments. We encourage commenters to discuss, analyze, and supply relevant data regarding any additional costs or benefits. B. Benefits We believe that the proposed amendments to Rules 15c3–1 and 15c3– 1d will benefit both broker-dealer/FCMs and investors. As discussed, the Commission is proposing to amend Rule 15c3–1(a)(1)(iii) by eliminating the rule’s segregated funds requirement and replacing it with the risk margin-based capital requirement. Rule 15c3– 1(a)(1)(iii) requires a broker-dealer/FCM to maintain net capital of not less than the greater of its requirement under Rule 15c3–1 or four percent of the funds required to be segregated under the CEA and its rules. The four percent of segregated funds requirement was intended to conform Rule 15c3– 1(a)(1)(iii) to Rule 1.17, the CFTC’s adjusted net capital rule, and ensure that a broker-dealer/FCM complied with the net capital rules of both the CFTC and the Commission. Rule 1.17, as amended, eliminates the four percent of segregated funds requirement and replaces it with a new risk margin-based capital requirement. Proposed Rule 15c3–1(a)(1)(iii) would require a brokerdealer/FCM to maintain net capital of not less than the greater of its requirement under Rule 15c3–1 or a risk margin-based capital requirement identical to the one contained in CFTC Rule 1.17, as amended. 22 See PO 00000 supra, note 4. Frm 00006 Fmt 4701 Sfmt 4702 We also are proposing to amend Rule 15c3–1(e)(2)(ii) to conform it to the CFTC’s new risk margin-based capital requirement. Rule 15c3–1(e)(2)(ii) prohibits a broker-dealer/FCM from withdrawing equity capital if the withdrawal would cause the brokerdealer/FCM’s net capital to fall below, among other standards, a specified percentage of its minimum net capital dollar amount, a specified level of aggregate indebtedness, or a specified percentage of the funds required to be segregated under the CEA. CFTC Rule 1.17(e)(1)(ii), as amended, prohibits an FCM from withdrawing equity capital if the withdrawal would cause the FCM’s adjusted net capital to fall below a specified percentage of risk marginbased capital, rather than a specified percentage of segregated funds. The proposed amendments would substitute the segregated funds requirement in Rule 15c3–1(e)(2)(ii) with a risk marginbased requirement calculated under Rule 15c3–1(a)(1)(iii). Furthermore, the Commission is proposing amendments to various provisions of Rule 15c3–1d, which contains minimum and non-exclusive requirements for satisfactory subordination agreement involving broker-dealers. Repayment and prepayment of subordinated debt under Rule 15c3–1d generally is permissible only if the broker-dealer/FCM maintains net capital equal to at least a specified percentage of net capital calculated under Rule 15c3–1 and a specified percentage of segregated funds. Rather than permitting repayment or prepayment of subordinated debt if an FCM maintains a specified percentage of segregated funds, the CFTC’s Rule 1.17, as amended, permits repayment or prepayment if the FCM maintains net capital equal to at least a specified percentage of its risk margin-based capital requirement. Accordingly, the Commission is proposing to amend Rule 15c3–1d by substituting the risk marginbased capital requirement for the segregated funds requirement to avoid subjecting broker-dealer/FCMs to conflicting or duplicative regulation. The Commission believes that the risk margin-based capital requirement is appropriate. Each of the amendments to Rules 15c3–1 and 15c3–1d substitutes the risk margin-based capital requirement for the segregated funds standard. The risk margin-based capital requirement should be an adequate substitute for the segregated funds standard based on its implementation and use by the futures exchanges and FCMs’ comfort level with the requirement. E:\FR\FM\13OCP2.SGM 13OCP2 ycherry on PROD1PC64 with PROPOSALS2 Federal Register / Vol. 71, No. 198 / Friday, October 13, 2006 / Proposed Rules As noted, the Commission also believes that the amendments to Rules 15c3–1 and 15c3–1d would benefit both broker-dealer/FCMs and investors. First, the proposed amendments would prevent the imposition of potentially conflicting or duplicative regulation on a broker-dealer/FCM. Current Rule 15c3–1(a)(1)(iii) requires a brokerdealer/FCM to maintain net capital equal to the greater of its net capital requirement under Rule 15c3–1 or four percent of the funds required to be segregated under the CEA and its rules. The four percent of segregated funds requirement reflects the previous version of CFTC Rule 1.17 and has been substituted in current CFTC Rule 1.17 with the risk margin-based capital requirement. The proposed amendments would substitute the risk margin-based capital requirement for the segregated funds requirement in Rules 15c3–1 and 15c3–1d and, therefore, free a brokerdealer/FCM from complying with a capital requirement no longer applicable to FCMs that are sole registrants. Second, the proposed amendments would help to avoid potentially placing a broker-dealer/FCM at a competitive disadvantage with respect to an entity registered solely as a broker-dealer or FCM. Neither a broker-dealer nor an FCM is subject to the four percent of segregated funds requirement; a brokerdealer/FCM is subject to such a requirement unless the proposed amendments are adopted. Accordingly, the proposed amendments could free a broker-dealer/FCM from making three separate capital computations (one based on Rule 15c3–1(a)(1)(i) or (ii), one based on CFTC Rule 1.17, and one based on the four percent of segregated requirement under current Rule 15c3– 1(a)(1)(iii)) and holding unnecessarily more net capital than its sole registrant competitors. Third, the proposed amendments would enhance the Commission’s ability to monitor the financial condition of a broker-dealer/FCM. Under the proposed amendments to Rule 15c3–1, a broker-dealer’s failure to maintain sufficient risk margin-based capital, which is a violation of CFTC Rule 1.17, also would be a violation of the Commission’s net capital rule. The Commission, therefore, could force the broker-dealer/FCM to take corrective action (or require it to cease conducting business), an ability the Commission would not have without the proposed amendments. Finally, the proposed amendments to Rule 17a–11 would help protect customers from broker-dealer failures. Current Rule 17a–11 does not require a broker-dealer/FCM to notify the VerDate Aug<31>2005 15:27 Oct 12, 2006 Jkt 211001 Commission if its adjusted net capital falls below specified requirements. The proposed amendments to Rule 17a–11 would require a broker-dealer/FCM to notify the Commission if its net capital falls below certain thresholds determined in accordance with Rule 15c3–1 or if the CFTC’s rules would require it to notify the CFTC or a DSRO that its adjusted net capital had breached certain thresholds. This notification requirement should provide an early warning to the Commission that a broker-dealer/FCM may be experiencing financial difficulties. C. Costs There would be no costs associated with the proposed amendments to Rules 15c3–1 and 15c3–1d. A broker-dealer/ FCM already must comply with the net capital rules of both the Commission and the CFTC. Likewise, a brokerdealer/FCM already must comply with Rule 15c3–1d and comparable CFTC subordinated debt rules. The proposed amendments would help ensure that broker-dealer/FCMs are not subject to inconsistent or duplicative regulation under Rules 15c3–1 and 15c3–1d by eliminating the four percent of segregated funds standard in those rules and replacing it with the risk margin-based capital requirement. With respect to 15c3–1d, the applicable thresholds no longer will be calculated based upon a segregated funds, but upon risk margin-based, capital, which the broker-dealer/FCM already calculates under CFTC Rule 1.17. As discussed, proposed Rule 17a– 11(c)(4) would require a broker-dealer/ FCM to notify the Commission and its DEA under circumstances in which the CFTC’s rules would require an FCM to notify the CFTC or a DRSO that its adjusted net capital had fallen below a particular threshold. The cost of notification in these circumstances should be minimal because the brokerdealer/FCM already must notify the CFTC.23 We estimate the annual cost of notification under Rule 17a–11(c)(4) would be $331 (.25 hours × $265 per hour for a financial reporting manager 24 × 5 broker-dealer/FCMs).25 23 See supra, note 21. financial reporting manager is a person at a broker-dealer with responsibility for helping to ensure that the broker-dealer complies with its financial reporting requirements with respect to the Commission, other federal or state agencies and SROs. 25 Security Industry Association’s (‘‘SIA’’) Report on Management & Professional Earnings in the Securities Industry 2005, modified to account for an 1800-hour work-year and multiplied by 5.35 to account for bonuses, firm size, employee benefits and overhead. The amount also reflects the average 24 A PO 00000 Frm 00007 Fmt 4701 Sfmt 4702 60641 VI. Consideration of Burden on Competition, and Promotion of Efficiency, Competition, and Capital Formation Section 3(f) of the Exchange Act 26 requires the Commission, whenever it engages in rulemaking and must consider or determine if an action is necessary or appropriate in the public interest, to consider if the action will promote efficiency, competition, and capital formation. Under section 23(a)(2) of the Exchange Act,27 the Commission must consider the impact of its rulemaking on competition. It also 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. We preliminarily believe that the amendments to Rules 15c3–1, 15c3–1d, and 17a–11 would promote efficiency, competition, and capital formation. The amendments to Rules 15c3–1 and 15c3– 1d should promote efficiency because they would help to ensure that brokerdealer/FCMs are not subject to net capital requirements beyond those that the Commission already imposes on broker-dealers and those that the CFTC already imposes on FCMs. That is, the amendments would not subject brokerdealer/FCMs to any new requirements and, consequently, would not impose any new costs. Furthermore, the proposed amendments to Rule 17a– 11(c)(4) should promote efficiency because they would require a brokerdealer/FCM to notify the Commission that it has fallen below a specified percentage of its adjusted net capital requirement under CFTC rules, a notification that it already must provide to the CFTC. This notification should help the Commission address potential financial difficulties at a broker-dealer/ FCM before a liquidation becomes necessary and, therefore, should help protect customers. Each of these provisions also should help foster competition because they would allow firms to function jointly as brokerdealer/FCMs without imposing regulatory requirements beyond those already applicable to broker-dealers and FCMs individually. We preliminarily believe that the proposed amendments to Rules 15c3–1, 15c3–1d and 17a–11would promote capital formation. By eliminating potentially duplicative or conflicting regulation, the proposed amendments to between New York City salaries and Non-New York City salaries. This is the latest report on financial industry salaries that is available from the SIA. 26 15 U.S.C. 78c(f). 27 15 U.S.C. 78w(a)(2). E:\FR\FM\13OCP2.SGM 13OCP2 60642 Federal Register / Vol. 71, No. 198 / Friday, October 13, 2006 / Proposed Rules ycherry on PROD1PC64 with PROPOSALS2 Rules 15c3–1 and 15c3–1d should help to ensure that a broker-dealer/FCM does not unnecessarily use its assets to meet regulatory capital requirements, freeing those assets for business uses. Similarly, the proposed amendments to Rule 17a– 11 should help the Commission to identify a broker-dealer/FCM that faces potential financial difficulties and allow the Commission to take corrective action to help that broker-dealer/FCM preserve its capital which, in turn, should help protect the broker-dealer/ FCM’s customers. Finally, we preliminarily believe that the proposed amendments do not impose any competitive burden that is not necessary and appropriate in furtherance of the purposes of the Exchange Act. As discussed, the Commission is proposing amendments to Rules 15c3–1 and 15c3–1d to conform those rules to the CFTC’s amended net capital rule. The proposed rules are intended to eliminate inconsistent and duplicative regulation on broker-dealer/FCMs. Furthermore, we preliminarily believe that the proposed amendments to Rule 17a–11 are necessary to provide the Commission with an early warning of potential capital insufficiencies at broker-dealer/FCMs. This early warning should help the Commission to protect customers and the integrity of the markets. The amendments to Rule 17a– 11(c)(4), moreover, would require only that a broker-dealer/FCM forward to the Commission a notice that it already must provide to the CFTC. provide empirical data to support the extent of the impact. VIII. Consideration of Impact on The Economy For purposes of the Small Business Regulatory Enforcement Fairness Act of 1996, or ‘‘SBREFA,’’ 30 we must advise OMB as to whether the proposed regulation constitutes a ‘‘major’’ rule. Under SBREFA, a rule is considered ‘‘major’’ if, upon adoption, it results or is likely to result in: • An annual effect on the economy of $100 million or more (either in the form of an increase or a decrease); • A major increase in costs or prices for consumers or individual industries; or • Significant adverse effect on competition, investment or innovation. If a rule is ‘‘major,’’ its effectiveness will generally be delayed for 60 days pending Congressional review. We request comment on the potential impact of the proposed regulation on the economy on an annual basis. Commenters are requested to provide empirical data and other factual support for their view to the extent possible. IX. Statutory Authority The Commission is proposing amendments to Rule 15c3–1, Rule 15c3– 1d, and Rule 17a–11 under the Exchange Act pursuant to the authority conferred by the Exchange Act, including Sections 15, 17 and 23(a).31 Text of Proposed Rule Amendments VII. Regulatory Flexibility Act Certification The Commission hereby certifies, pursuant to 5 U.S.C. 605(b), that the proposed amendments to Rule 15c3–1, Rule 15c3–1d, and Rule 17a–11, if adopted, would not have a significant economic impact on a substantial number of small entities. The proposed amendments would apply only to broker-dealers also registered as FCMs. As of July 31, 2006, there were approximately 67 broker-dealer/FCMs.28 Only one of those broker-dealers would qualify as a small entity.29 Accordingly, we do not believe that the proposed amendments would have a significant economic impact on a substantial number of small entities. We encourage written comments regarding this certification. We request that commenters describe the nature of any impact on small entities and List of Subjects in 17 CFR Part 240 28 Selected FCM Financial Data as of July 31, 2006, CFTC Division of Clearing and Intermediary Oversight. 29 See 17 CFR 240.0–10. 30 Pub. L. No. 104–121, Title II, 110 Stat. 857 (1996) (codified in various sections of 5 U.S.C., 15 U.S.C. and as a note to 5 U.S.C. 601). 31 15 U.S.C. 78o, 78q and 78w(a). VerDate Aug<31>2005 15:27 Oct 12, 2006 Jkt 211001 Brokers, Reporting and recordkeeping requirements, Securities. In accordance with the foregoing, the Commission hereby proposes that Title 17, Chapter II of the Code of Federal Regulation be amended as follows. PART 240—GENERAL RULES AND REGULATIONS, SECURITIES EXCHANGE ACT OF 1934 1. The authority citation for part 240 continues to read, in part, as follows: Authority: 15 U.S.C. 77c, 77d, 77g, 77j, 77s, 77z–2, 77z–3, 77eee, 77ggg, 77nnn, 77sss, 77ttt, 78c, 78d, 78e, 78f, 78g, 78i, 78j, 78j–l, 78k, 78k–1, 78l, 78m, 78n, 78o, 78p, 78q, 78s, 78u–5, 78w, 78x, 78ll, 78mm, 79q, 79t, 80a–20, 80a–23, 80a–29, 80a–37, 80b–3, 80b–4, 80b–11, and 7201 et seq.; and 18 U.S.C. 1350, unless otherwise noted. * PO 00000 * * Frm 00008 * Fmt 4701 * Sfmt 4702 2. Section 240.15c3–1 is amended by revising paragraphs (a)(1)(iii) and (e)(2)(ii) to read as follows: § 240.15c3–1 Net capital requirements for brokers or dealers. (a) * * * (1) * * * (iii) No broker or dealer registered as a futures commission merchant shall permit its net capital to be less than the greater of its requirement under paragraph (a)(1)(i) or (ii) of this section, or eight percent of the total risk margin requirement for positions carried by the futures commission merchant in customer accounts plus four percent of the total risk margin requirement for positions carried by the futures commission merchant in noncustomer accounts, as defined in the Commodity Exchange Act (7 U.S.C. 1 et seq.) and the rules thereunder. * * * * * (e) * * * (2) * * * (ii) The broker-dealer is registered as a futures commission merchant, its net capital would be less than 120 percent of the aggregate amount of its total risk margin requirements for positions carried in customer and noncustomer accounts under paragraph (a)(1)(iii) of this section; * * * * * 3. Section 240.15c3–1d is amended by removing the authority citation at the end of the section and revising paragraphs (b)(6)(iii), (b)(7), (b)(8)(i)(A), (b)(10)(ii)(B), (c)(2), (c)(5)(i)(B), (c)(5)(ii)(A), and (c)(7) to read as follows: § 240.15c3–1d Satisfactory Subordination Agreements (Appendix D to 17 CFR 240.15c3–1). * * * * * (b) * * * (6) * * * (iii) The secured demand note agreement also may provide that, in lieu of the procedures specified in the provisions required by paragraph (b)(6)(ii) of this section, the lender, with the prior written consent of the broker or dealer and the Examining Authority for the broker or dealer, may reduce the unpaid principal amount of the secured demand note. After giving effect to such reduction, the aggregate indebtedness of the broker or dealer may not exceed 1000 percent of its net capital or, in the case of a broker or dealer operating pursuant to paragraph (a)(1)(ii) of § 240.15c3–1, net capital may not be less than 5 percent of aggregate debit items computed in accordance with § 240.15c3–3a, or, if registered as a futures commission merchant, 120 E:\FR\FM\13OCP2.SGM 13OCP2 Federal Register / Vol. 71, No. 198 / Friday, October 13, 2006 / Proposed Rules ycherry on PROD1PC64 with PROPOSALS2 percent of the aggregate amount of its total risk margin requirements for positions carried in customer and noncustomer accounts under paragraph (a)(1)(iii) of § 240.15c3–1, if greater. No single secured demand note shall be permitted to be reduced by more than 15 percent of its original principal amount and after such reduction no excess collateral may be withdrawn. No Examining Authority shall consent to a reduction of the principal amount of a secured demand note if, after giving effect to such reduction, net capital would be less than 120 percent of the minimum dollar amount required by § 240.15c3–1. Permissive Prepayments (7) A broker or dealer at its option, but not at the option of the lender may, if the subordination agreement so provides, make a Payment of all or any portion of the Payment Obligation thereunder prior to the scheduled maturity date of such Payment Obligation (hereinafter referred to as a ‘‘Prepayment’’), but in no event may any Prepayment be made before the expiration of one year from the date such subordination agreement became effective. This restriction shall not apply to temporary subordination agreements that comply with the provisions of paragraph (c)(5) of this Appendix D. No Prepayment shall be made, if, after giving effect thereto (and to all Payments of Payment Obligations under any other subordinated agreements then outstanding the maturity or accelerated maturities of which are scheduled to fall due within six months after the date such Prepayment is to occur pursuant to this provision or on or prior to the date on which the Payment Obligation in respect of such Prepayment is scheduled to mature disregarding this provision, whichever date is earlier) without reference to any projected profit or loss of the broker or dealer, either aggregate indebtedness of the broker or dealer would exceed 1000 percent of its net capital or its net capital would be less than 120 percent of the minimum dollar amount required by § 240.15c3–1 or, in the case of a broker or dealer operating pursuant to paragraph (a)(1)(ii) of § 240.15c3–1, its net capital would be less than 5 percent of its aggregate debit items computed in accordance with § 240.15c3–3a, or if registered as a futures commission merchant, 120 percent of the aggregate amount of its total risk margin requirements for positions carried in customer and noncustomer accounts under paragraph (a)(1)(iii) of § 240.15c3–1, if greater, or its net capital would be less than 120 percent of the VerDate Aug<31>2005 15:27 Oct 12, 2006 Jkt 211001 minimum dollar amount required by paragraph (a)(1)(ii) of § 240.15c3–1. Notwithstanding the provisions of this paragraph, no Prepayment shall occur without the prior written approval of the Examining Authority for such broker or dealer. Suspended Repayment (8)(i) * * * (A) The aggregate indebtedness of the broker or dealer would exceed 1200 percent of its net capital, or in the case of a broker or dealer operating pursuant to paragraph (a)(1)(ii) of § 240.15c3–1, its net capital would be less than 5 percent of aggregate debit items computed in accordance with § 240.15c3–3a or, if registered as a futures commission merchant, 120 percent of the aggregate amount of its total risk margin requirements for positions carried in customer and noncustomer accounts under paragraph (a)(1)(iii) of § 240.15c3–1, if greater, or * * * * * (10) * * * (ii) * * * (B) The aggregate indebtedness of the broker or dealer exceeding 1500 percent of its net capital or, in the case of a broker or dealer that has elected to operate under paragraph (a)(1)(ii) of § 240.15c3–1, its net capital is less than 2 percent of its aggregate debit items computed in accordance with § 240.15c3–3a or, if registered as a futures commission merchant, the aggregate amount of its total risk margin requirements for positions carried in customer and noncustomer accounts under paragraph (a)(1)(iii) of § 240.15c3–1, if greater, throughout a period of 15 consecutive business days, commencing on the day the broker or dealer first determines and notifies the Examining Authority for the broker or dealer, or the Examining Authority or the Commission first determines and notifies the broker or dealer of such fact; * * * * * (c) * * * (2) Every broker or dealer shall immediately notify the Examining Authority for such broker or dealer if, after giving effect to all Payments of Payment Obligations under subordination agreements then outstanding that are then due or mature within the following six months without reference to any projected profit or loss of the broker or dealer either the aggregate indebtedness of the broker or dealer would exceed 1200 percent of its net capital or its net capital would be less than 120 percent of the minimum dollar amount required by § 240.15c3–1, or, in the case of a broker or dealer PO 00000 Frm 00009 Fmt 4701 Sfmt 4702 60643 operating pursuant to paragraph (a)(1)(ii) of § 240.15c3–1, its net capital would be less than 5 percent of aggregate debit items computed in accordance with § 240.15c3–3a, or, if registered as a futures commission merchant, 120 percent of the aggregate amount of its total risk margin requirements for positions carried in customer and noncustomer accounts under paragraph (a)(1)(iii) of § 240.15c3–1, if greater, or less than 120 percent of the minimum dollar amount required by paragraph (a)(1)(ii) of § 240.15c3–1. * * * * * (5) * * * (i) * * * (B) In the case of a broker or dealer operating pursuant to paragraph (a)(1)(ii) of § 240.15c3–1, its net capital is less than 5 percent of aggregate debits computed in accordance with § 240.15c3–3a, or, if registered as a futures commission merchant, less than 120 percent of the aggregate amount of its total risk margin requirements for positions carried in customer and noncustomer accounts under paragraph (a)(1)(iii) of § 240.15c3–1, if greater, or less than 120 percent of the minimum dollar amount required by paragraph (a)(1)(ii) of this section, or * * * * * (ii) * * * (A) After giving effect thereto (and to all Payments of Payment Obligations under any other subordinated agreements then outstanding, the maturity or accelerated maturities of which are scheduled to fall due within six months after the date such prepayment is to occur pursuant to this provision or on or prior to the date on which the Payment Obligation in respect of such prepayment is scheduled to mature disregarding this provision, whichever date is earlier) without reference to any projected profit or loss of the broker or dealer, either aggregate indebtedness of the broker or dealer would exceed 900 percent of its net capital or its net capital would be less than 200 percent of the minimum dollar amount required by § 240.15c3–1 or, in the case of a broker or dealer operating pursuant to paragraph (a)(1)(ii) of § 240.15c3–1, its net capital would be less than 6 percent of aggregate debit items computed in accordance with § 240.15c3–3a, or, if registered as a futures commission merchant, 125 percent of the aggregate amount of its total risk margin requirements for positions carried in customer and noncustomer accounts under paragraph (a)(1)(iii) of § 240.15c3–1, if greater, or its net capital E:\FR\FM\13OCP2.SGM 13OCP2 60644 Federal Register / Vol. 71, No. 198 / Friday, October 13, 2006 / Proposed Rules ycherry on PROD1PC64 with PROPOSALS2 would be less than 200 percent of the minimum dollar amount required by paragraph (a)(1)(ii) of this section or * * * * * (7) Subordination agreements in effect before adoption. Any subordination agreement that incorporates the net capital requirements in paragraphs (b)(6)(iii), (b)(7), (b)(8)(i), (b)(10)(ii)(B), (c)(2), (c)(5)(i)(B), and (c)(5)(ii)(A) of this section, as in effect before adoption of the amendments incorporating the risk margin-based capital requirement in those paragraphs, and that has been deemed to be satisfactorily subordinated pursuant to § 240.15c3–1 as in effect before adoption of those amendments, shall continue to be deemed a satisfactory subordination agreement until the maturity of the agreement. Provided, That if the agreement is amended or renewed for any reason, then the agreement shall not be deemed a satisfactory subordination agreement unless the amended or renewed VerDate Aug<31>2005 15:27 Oct 12, 2006 Jkt 211001 agreement meets the requirements of this Appendix D. Provided, further, That all subordination agreements must meet the requirements of this Appendix D within 5 years of the adoption of the amendments incorporating the risk margin-based capital requirements. 4. Section 240.17a–11 is amended by: a. Revising the introductory text of paragraph (c); b. In paragraph (c)(3) remove the period at the end of the paragraph and in its place add ‘‘; or’’; c. Redesignating paragraph (c)(4) as paragraph (c)(5); and d. Adding new paragraph (c)(4) to read as follows: (c)(3), (c)(4) or (c)(5) of this section in accordance with paragraph (g) of this section: * * * * * (4) For a broker or dealer registered as a futures commission merchant, if the Commodity Exchange Act (7 U.S.C. 1 et seq.) and the rules promulgated under the Commodity Exchange Act would require a futures commission merchant to provide notification to the Commodity Futures Trading Commission or a designated selfregulatory organization that its adjusted net capital has fallen below a specified threshold; or * * * * * § 240.17a–11 Notification provisions for brokers and dealers. Dated: October 5, 2006. By the Commission. J. Lynn Taylor, Assistant Secretary. [FR Doc. E6–16956 Filed 10–12–06; 8:45 am] * * * * * (c) Every broker or dealer shall send notice promptly (but within 24 hours) after the occurrence of the events specified in paragraph (c)(1), (c)(2), PO 00000 Frm 00010 Fmt 4701 Sfmt 4702 BILLING CODE 8011–01–P E:\FR\FM\13OCP2.SGM 13OCP2

Agencies

[Federal Register Volume 71, Number 198 (Friday, October 13, 2006)]
[Proposed Rules]
[Pages 60636-60644]
From the Federal Register Online via the Government Printing Office [www.gpo.gov]
[FR Doc No: E6-16956]



[[Page 60635]]

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Part III





 Securities and Exchange Commission





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 17 CFR Part 240



 Amendments to Rule 15c3-1 and Rule 17a-11 Applicable to Broker-Dealers 
Also Registered as Futures Commission Merchants; Proposed Rule

Federal Register / Vol. 71, No. 198 / Friday, October 13, 2006 / 
Proposed Rules

[[Page 60636]]


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SECURITIES AND EXCHANGE COMMISSION

17 CFR Part 240

[Release No. 34-54575; File No. S7-16-06]
RIN 3235-AJ72


Amendments to Rule 15c3-1 and Rule 17a-11 Applicable to Broker-
Dealers Also Registered as Futures Commission Merchants

AGENCY: Securities and Exchange Commission.

ACTION: Proposed rule.

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SUMMARY: The Securities and Exchange Commission is proposing for 
comment amendments to conform provisions of its net capital rule to 
changes to the net capital rule of the Commodity Futures Trading 
Commission. The proposed amendments would apply to broker-dealers also 
registered as futures commission merchants with the Commodity Futures 
Trading Commission. The Securities and Exchange Commission also is 
proposing to amend certain rules related to subordinated debt 
agreements to conform those rules to the Commodity Futures Trading 
Commission's amended net capital rules. Finally, the Securities and 
Exchange Commission is proposing to amend its early warning provisions 
to require that it be notified if a broker-dealer also registered as a 
futures commission merchant must warn the Commodity Futures Trading 
Commission or a designated self-regulatory organization that its 
adjusted net capital has fallen below specified levels.

DATES: Comments should be received on or before November 13, 2006.

ADDRESSES: Comments may be submitted by any of the following methods:

Electronic Comments

     Use the Commission's Internet comment form (http://
www.sec.gov/rules/proposed.shtml); or
     Send an e-mail to rule-comments@sec.gov. Please include 
File Number S7-16-06 on the subject line; or
     Use the Federal eRulemaking Portal (http://
www.regulations.gov). Follow the instructions for submitting comments.

Paper Comments

     Send paper comments in triplicate to Nancy M. Morris, 
Secretary, Securities and Exchange Commission, 100 F Street, NE., 
Washington, DC 20549-1090.

All submissions should refer to File Number S7-16-06. This file number 
should be included on the subject line if e-mail is used. To help us 
process and review your comments more efficiently, please use only one 
method. The Commission will post all comments on the Commission's 
Internet Web site (http://www.sec.gov/rules/proposed.shtml). Comments 
also are available for public inspection and copying in the 
Commission's Public Reference Room, 100 F Street, NE., Washington, DC 
20549. All comments received will be posted without change; we do not 
edit personal identifying information from submissions. You should 
submit only information that you wish to make available publicly.

FOR FURTHER INFORMATION CONTACT: Michael A. Macchiaroli, Associate 
Director, at (202) 551-5525; Thomas K. McGowan, Assistant Director, at 
(202) 551-5521; or Bonnie L. Gauch, Special Counsel, at (202) 551-5524, 
Division of Market Regulation, Securities and Exchange Commission, 100 
F Street, NE., Washington, DC 20549-6628.

I. Introduction

    The Securities and Exchange Commission (``Commission'') is 
proposing to amend its financial responsibility rules for broker-
dealers registered with the Commodity Futures Trading Commission 
(``CFTC'') under the Commodity Exchange Act (``CEA'') as futures 
commission merchants (``FCMs''). The Commission's net capital rule, 
Rule 15c3-1,\1\ imposes minimum financial (net capital) requirements on 
broker-dealers. The CFTC's adjusted net capital rule, Rule 1.17,\2\ 
similarly imposes minimum financial requirements on FCMs. Under Rule 
15c3-1(a)(1)(iii), a broker-dealer/FCM must maintain net capital of no 
less than the greater of its requirements under the applicable 
provisions of Rule 15c3-1 or four percent of the funds that must be 
segregated under the CEA and its rules. The requirement to maintain at 
least four percent of segregated funds was intended to conform Rule 
15c3-1 to the CFTC's Rule 1.17.\3\
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    \1\ 17 CFR 240.15c3-1. Section 15(c)(3) of the Securities 
Exchange Act of 1934 (the ``Exchange Act'') authorizes the 
Commission to impose, by regulation, minimum financial requirements 
on broker-dealers (15 U.S.C. 78o(c)(3)).
    \2\ 17 CFR 1.17.
    \3\ See Exchange Act Release No. 15898 (Jun. 5, 1979), 44 FR 
24884 (Jun. 15, 1979).
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    In 2004, the CFTC amended Rule 1.17 and adopted certain new net 
capital requirements applicable to FCMs.\4\ Before adoption of the 
amended capital requirements, Rule 1.17(a)(1)(i)(A)-(D) required an FCM 
to maintain minimum adjusted net capital equal to, or in excess of, the 
greatest of the following: (1) $250,000; (2) four percent of an amount 
that equals the total of funds required to be segregated for customer 
trading on U.S. commodity markets under section 4d(a)(2) of the CEA and 
the funds required to be secured for customer trading on foreign 
commodity markets under Rule 30.7 to the CEA, less the market value of 
options purchased by customers for which the full premiums have been 
paid (``segregated funds''); (3) the amount of adjusted net capital 
required by a registered futures association; or (4) for broker-dealer/
FCMs, the amount of net capital required under Rule 15c3-1(a).
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    \4\ The new rules became effective on September 30, 2004. See 69 
FR 49784 (Aug. 12, 2004).
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    CFTC Rule 1.17(a)(1)(i)(B), as amended, eliminates the four percent 
of segregated funds provision. Instead, the amended rule requires an 
FCM to maintain adjusted net capital equal to a specified percentage of 
the margin required to be collected under exchange or clearing 
organization rules. Under amended CFTC Rule 1.17(a)(1)(i)(B), an FCM 
must maintain adjusted net capital equal to the following: (1) Eight 
percent of the total risk margin requirement \5\ for positions carried 
by the FCM in customer accounts; \6\ plus (2) four percent of the total 
risk margin requirement for positions carried by the FCM in noncustomer 
accounts.\7\
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    \5\ CFTC Rule 1.17(b)(8) defines ``risk margin'' (17 CFR 
1.17(b)(8)).
    \6\ CFTC Rule 1.17(b)(7) defines ``customer account'' (17 CFR 
1.17(b)(7)).
    \7\ CFTC Rule 1.17(b)(4) defines ``noncustomer account'' (17 CFR 
1.17(b)(4)).
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    The CFTC intended changes to Rule 1.17 to address material 
limitations on the segregated funds method of computing net capital.\8\ 
For example, the segregated funds method did not reflect fully the 
extent to which an FCM was exposed to commodity positions carried for 
both customers and noncustomers. The segregated funds method did not 
include ``funds held by an FCM on behalf of foreign-domiciled customers 
trading on foreign commodity markets, nor [did] it include funds held 
by an FCM on behalf of noncustomers trading on either U.S. or foreign 
futures and options markets.'' \9\ This method also did not include 
``letters of credit deposited as margin or reflect the additional risks 
posed by open positions in customer accounts that liquidate to a 
deficit.'' \10\ Finally, the segregated funds method of calculating net 
capital ``subjects an FCM to a higher

[[Page 60637]]

requirement in situations where the FCM requires additional margin from 
customers or carries free credit balances for its customers, despite 
the risk reducing effect of holding higher levels of customer funds.'' 
\11\ The CFTC amended Rule 1.17 to address these concerns and conform 
its net capital requirement to the net capital requirements implemented 
by the National Futures Association (``NFA''), two exchanges, and a 
clearing organization.
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    \8\ See 68 FR 40835, 40837 (July 9, 2003).
    \9\ Id.
    \10\ Id.
    \11\ Id.
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    The Commission is proposing to amend Rule 15c3-1 to reflect the 
amendments to CFTC Rule 1.17, and is also proposing to amend paragraph 
(c) of Rule 17a-11,\12\ which generally requires a broker-dealer to 
notify the Commission and its designated examining authority (``DEA'') 
if it fails to maintain certain levels of net capital.
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    \12\ 17 CFR 240.17a-11(c).
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II. Proposed Amendments

A. Amendments to Rule 15c3-1

1. Amendments to Rule 15c3-1(a)(1)(iii)
    The Commission is proposing to amend Rule 15c3-1(a)(1)(iii) to 
conform to amended CFTC Rule 1.17. The proposed amendments to Rule 
15c3-1(a)(1)(iii) would require a broker-dealer/FCM to maintain net 
capital of not less than the greater of the following: (1) Its 
requirement under paragraph (a)(1)(i) or (ii) of Rule 15c3-1; or (2) 
eight percent of the total risk margin requirement for positions 
carried by the FCM in customer accounts plus four percent of the total 
risk margin requirement for positions carried by the FCM in noncustomer 
accounts (``risk margin-based capital requirement'').
2. Amendments to Rule 15c3-1(e)(2)(ii)
    The Commission also is proposing to amend Rule 15c3-1(e)(2)(ii) to 
conform it to CFTC Rule 1.17(e)(1)(ii). Rule 15c3-1(e)(2)(ii) prohibits 
a broker-dealer/FCM from withdrawing equity capital if the withdrawal 
would cause the broker-dealer/FCM's net capital to fall below, among 
other standards, a specified percentage of its minimum net capital 
dollar amount or a specified level of aggregate indebtedness, or its 
``net capital would be less than 7 percent of the funds required to be 
segregated pursuant to the Commodity Exchange Act and the regulations 
thereunder'' after the withdrawal. The Commission is proposing to 
replace the seven percent of segregated funds requirement with the 
amended CFTC Rule 1.17(e)(1)(ii) requirement of 120 percent of the risk 
margin-based capital requirement.

B. Amendments to Appendix D to Rule 15c3-1

    The Commission also is proposing to amend certain provisions of 
Appendix D to Rule 15c3-1 (``Rule 15c3-1d''),\13\ which contains 
minimum and non-exclusive requirements for satisfactory broker-dealer 
subordination agreements. Specifically, the Commission is proposing to 
amend paragraphs (b)(6)(iii), (b)(7), (b)(8)(i)(A), (b)(10)(ii)(B), 
(c)(2), (c)(5)(i)(B), (c)(5)(ii)(A), and (c)(7) of Rule 15c3-1d, which 
relate to repayment and prepayment of subordinated debt. Both Rule 
15c3-1 and CFTC Rule 1.17 prohibit a broker-dealer or an FCM, 
respectively, from repaying or prepaying subordinated debt if the 
payments would cause the broker-dealer's or FCM's net capital to fall 
below certain thresholds.
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    \13\ 17CFR 240.15c3-1d.
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1. Amendments to Rule 15c3-1d(b)(6)(iii)
    The Commission is proposing to replace the segregated funds 
requirement of Rule 15c3-1d(b)(6)(iii) with a risk margin-based capital 
requirement to conform it to the CFTC's amended Rule 
1.17(h)(2)(vi)(C)(2). Rule 15c3-1d(b)(6)(iii) permits a subordinated 
lender to reduce the unpaid principal amount of a secured demand note 
pledged to a broker-dealer with the consent of the broker-dealer and 
its DEA. The reduction, however, may not cause the broker-dealer's 
aggregate indebtedness to exceed a specified level of net capital or 
its net capital to fall below a specified level of aggregate debit 
items or, if the broker-dealer also is registered as an FCM, its net 
capital to fall below seven percent of the funds that must be 
segregated under the CEA and its rules, if that segregated amount is 
greater. The proposed amendment to Rule 15c3-1d(b)(6)(iii) would 
conform to amended CFTC Rule 1.17(h)(2)(vi)(C)(2) and replace the seven 
percent of segregated funds requirement with 120 percent of the risk 
margin-based capital requirement.
2. Amendments to Rule 15c3-1d(b)(7)
    The Commission is proposing to replace the segregated funds 
requirement of Rule 15c3-1d(b)(7) with a risk margin-based capital 
requirement to conform it to the CFTC's amended Rule 
1.17(h)(2)(vii)(A)(2). Rule 15c3-1d(b)(7) permits a broker-dealer to 
prepay subordinated debt if the prepayment occurs at least one year 
after the effective date of the subordination agreement and the broker-
dealer meets certain other requirements. A broker-dealer/FCM may not 
prepay subordinated debt, however, if the prepayment would cause its 
aggregated indebtedness to exceed a specified level of net capital or 
its net capital to fall below a specified percentage of the minimum net 
capital dollar amount, fall below a specified level of aggregate debit 
items or, if the broker-dealer also is registered as an FCM, its net 
capital to fall below seven percent of the funds that must be 
segregated under the CEA and its rules, if that amount is greater. The 
proposed amendment to Rule 15c3-1d(b)(7) would conform to amended CFTC 
Rule 1.17(h)(2)(vii)(A)(2) and replace the seven percent of segregated 
funds requirement with 120 percent of the risk margin-based capital 
requirement.
3. Amendments to Rule 15c3-1d(b)(8)(i)(A)
    The Commission is proposing to replace the segregated funds 
requirement of Rule 15c3-1d(b)(8)(i)(A) with a risk margin-based 
capital requirement to conform it to the CFTC's amended Rule 
1.17(h)(2)(viii)(A)(2). Rule 15c3-1d(b)(8)(i)(A) requires a broker-
dealer/FCM to suspend repayment of subordinated debt if the repayment 
would cause its aggregated indebtedness to exceed a specified level of 
net capital or its net capital to fall below a specified level of 
aggregate debit items or, if the broker-dealer also is registered as an 
FCM, its net capital to fall below six percent of the funds required to 
be segregated under the CEA and its rules, if that amount is greater. 
The proposed amendment to Rule 15c3-1d(b)(8)(i)(A) would conform to 
amended CFTC Rule 1.17(h)(2)(viii)(A)(2) and replace the six percent of 
segregated funds requirement with 120 percent of the risk margin-based 
capital requirement.
4. Amendments to Rule 15c3-1d(b)(10)(ii)(B)
    The Commission also is proposing to replace the segregated funds 
requirement of Rule 15c3-1d(b)(10)(ii)(B) to reflect the CFTC's risk 
margin-based capital requirements. Rule 15c3-1d(b)(10)(ii)(B) limits 
the events of default that may accelerate a broker-dealer/FCM's 
obligation to repay subordinated debt. Those events of default occur if 
a broker-dealer/FCM's aggregate indebtedness exceeds 1500 percent of 
its net capital, its net capital computed under Rule 15c3-1(a)(1)(ii) 
is less than two percent of aggregate debit

[[Page 60638]]

items as computed under Rule 15c3-3a, or its net capital is less than 
four percent of the funds required to be segregated under the CEA and 
its rules, if that amount is greater. The proposed amendment to Rule 
15c3-1(b)(10)(ii)(B) would replace the four percent of segregated funds 
requirement with the risk margin-based capital requirements of proposed 
Rule 15c3-1(a)(1)(iii).
5. Amendments to Rule 15c3-1d(c)(2)
    Furthermore, the Commission is proposing to replace the segregated 
funds requirement of Rule 15c3-1d(c)(2) with a risk margin-based 
capital requirement to conform it to the CFTC's amended Rule 
1.17(h)(3)(ii)(B). Rule 15c3-1d(c)(2) requires a broker-dealer/FCM to 
notify its DEA if repayment of its subordinated debt would cause its 
aggregate indebtedness to exceed 1200 percent of its net capital; its 
net capital to be less than 120 percent of the minimum dollar amount 
required by Rule 15c3-1; less than five percent of aggregate debit 
items computed in accordance with Rule 15c3-3a; or its net capital to 
be less than six percent of the funds required to be segregated under 
the CEA and its rules, if that amount is greater. The proposed 
amendment to Rule 15c3-1d(c)(2) would conform to amended CFTC Rule 
1.17(h)(3)(ii)(B) and replace the six percent of segregated funds 
requirement with 120 percent of the risk margin-based capital 
requirement.
6. Amendments to Rule 15c3-1d(c)(5)(i)(B)
    The Commission also is proposing to replace the segregated funds 
requirement of Rule 15c3-1d(c)(5)(i)(B) with a risk margin-based 
capital requirement to conform it to the CFTC's amended Rule 
1.17(h)(3)(v)(B). Rule 15c3-1d(5)(i)(B) permits a broker-dealer to 
enter into temporary subordination agreements (terms of no more than 45 
days), subject to specified conditions, so that the broker-dealer may 
engage in securities underwriting and other extraordinary activities. A 
broker-dealer/FCM operating under Rule 15c3-1(a)(1)(ii) may not enter 
into a temporary subordination agreement, however, if its net capital 
is less than five percent of its aggregate debit items computed under 
Rule 15c3-3a or seven percent of the funds required to be segregated 
under the CEA or its rules, if that amount is greater. The proposed 
amendment to Rule 15c3-1d(c)(5)(i)(B) would conform to amended CFTC 
Rule 1.17(h)(3)(v)(B) and replace the seven percent of segregated funds 
requirement with 120 percent of the risk margin-based capital 
requirement.
7. Amendments to Rule 15c3-1d(c)(5)(ii)(A)
    Finally, the Commission is proposing to replace the segregated 
funds requirement of Rule 15c3-1d(c)(5)(ii)(A) with a risk margin-based 
capital requirement to conform it to the CFTC's amended Rule 
1.17(h)(2)(vii)(B)(2). Rule 15c3-1d(c)(5)(ii)(A) permits a broker-
dealer to enter into a revolving subordinated loan agreement that 
provides for prepayment within less than one year. A broker-dealer/FCM 
may not prepay subordinated debt, however, if, as a result of the 
prepayment, its aggregate indebtedness would exceed 900 percent of its 
net capital; its net capital would be less than 200 percent of the 
minimum dollar amount required under Rule 15c3-1; its net capital would 
be less than six percent of aggregate debit items computed under Rule 
15c3-3a (for broker-dealer operating under Rule 15c3-1(a)(1)(ii)); or 
its net capital would be less than ten percent of the funds required to 
be segregated under the CEA or its rules, if that amount is greater. 
The proposed amendment to Rule 15c3-1d(c)(5)(ii)(A) would conform to 
amended CFTC Rule 1.17(h)(2)(vii)(B)(2) and replace the ten percent of 
segregated funds requirement with 125 percent of the risk margin-based 
capital requirement.
8. Applicability of Amendments to Rule 15c3-1d to Existing 
Subordination Agreements
    Under the proposed amendments to Rule 15c3-1d(c)(7), satisfactory 
subordination agreements that comply with Rule 15c3-1d, as in effect 
before adoption of these proposed amendments to that rule, would 
continue to be deemed satisfactory until their maturity date, if the 
agreements are not amended or renewed. However, all subordination 
agreements would be required to meet the requirements of amended Rule 
15c3-1d within five years of adoption of these proposed amendments to 
that rule. Amendments to, or renewals of, subordination agreements 
would be required to comply with the proposed amendments to Rule 15c3-
1d, as would any new subordination agreements. This proposed 
``grandfathering'' provision is intended to allow broker-dealer/FCMs 
sufficient time to comply with the proposed amendments to subordinated 
debt rules in a manner that is not unduly burdensome on either the 
broker-dealer/FCMs or their DEAs, which must approve subordinated debt 
agreements under Appendix D.

C. Rationale for the Amendments to Rules 15c3-1 and 15c3-1d

    The Commission believes that the proposed amendments to Rules 15c3-
1 and 15c3-1d are necessary and appropriate. First, compliance with 
both the current Commission and the amended CFTC rules could impose 
duplicative or conflicting obligations on a broker-dealer/FCM because 
the rules may apply different standards. Under current Rule 15c3-
1(a)(1)(iii) and amended CFTC Rule 1.17, a broker-dealer/FCM must 
maintain net capital equal to at least the greatest of its requirements 
under Rule 15c3-1(a)(1)(i) or (ii), four percent of the funds required 
to be segregated under the CEA and its applicable rules, or the risk 
margin-based capital requirement under amended CFTC Rule 1.17. That is, 
a broker-dealer/FCM must maintain net capital equal to at least the 
Commission minimum applicable to broker-dealers, the now-eliminated 
CFTC segregated funds minimum, or the new CFTC minimum applicable to 
FCMs. Section 15 of the Exchange Act requires the Commission to issue 
those rules, in consultation with the CFTC, that are necessary to avoid 
imposing duplicative or conflicting financial responsibility 
regulations on broker-dealer/FCMs.\14\ The proposed amendments to Rules 
15c3-1 and 15c3-1d are intended to avoid imposing potentially 
duplicative or conflicting regulations on broker-dealer/FCMs by 
eliminating the four percent of segregated funds requirement and 
replacing it with a risk margin-based capital requirement identical to 
that contained in amended CFTC Rule 1.17.
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    \14\ Section 15 of the Exchange Act requires the Commission, in 
consultation with the CFTC, to: issue such rules, regulations, or 
orders as are necessary to avoid duplicative or conflicting 
regulations applicable to any broker or dealer registered with the 
Commission pursuant to section 15(b) (except paragraph (11) 
thereof), that is also registered with the Commodity Futures Trading 
Commission pursuant to section 4f(a) of the Commodity Exchange Act * 
* * with respect to application of * * * financial responsibility 
rules. 15 U.S.C. 78o(c)(3)(B).
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    Second, the risk margin-based capital requirement applicable to 
FCMs should be an adequate substitute for the previous segregated funds 
standard. The risk margin-based requirement has been in place at 
futures exchanges for a number of years without significant problems.
    Third, the proposed amendments to Rule 15c3-1 also are necessary to 
avoid potentially placing a broker-dealer/FCM at a competitive 
disadvantage with respect to entities registered solely as broker-
dealers or FCMs. Sole registrants might be subject to lower regulatory

[[Page 60639]]

costs than a combined broker-dealer/FCM, which could be required to 
maintain higher capital than either the broker-dealer or FCM net 
capital rules would require a sole registrant to maintain.
    Fourth, the proposed amendments should provide the Commission with 
enhanced ability to monitor the financial position of broker-dealer/
FCMs. The proposed amendments to Rule 15c3-1 would permit the 
Commission to oversee a broker-dealer/FCM for capital problems arising 
from the firm's futures business. A broker-dealer/FCM might be in a 
financial position in which its net capital otherwise is sufficient for 
the securities aspect of Rule 15c3-1, but is insufficient for purposes 
of the risk margin-based capital requirement for its futures business. 
Under the proposed amendments to Rule 15c3-1, a broker-dealer's failure 
to maintain sufficient risk margin-based capital, which is a violation 
of CFTC Rule 1.17, also would be a violation of the Commission's net 
capital rule. The Commission, therefore, could force the broker-dealer/
FCM to take corrective action (or require it to cease conducting 
business), an ability the Commission would not have without the 
proposed amendments.

D. Amendments to Rule 17a-11, Notification Provisions for Brokers and 
Dealers

    We are proposing to amend paragraph (c) of Rule 17a-11,\15\ which 
generally requires a broker-dealer to notify the Commission and its DEA 
if it fails to maintain certain levels of net capital. Specifically, 
the Commission is proposing to amend paragraph (c) of Rule 17a-11 to 
redesignate existing paragraph (c)(4) as paragraph (c)(5); and add a 
new paragraph (c)(4).
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    \15\ 17 CFR 240.17a-11(c).
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    Proposed new paragraph (c)(4) would require a broker-dealer/FCM to 
notify the Commission and its DEA under circumstances in which the 
CFTC's rules would require an FCM to provide notification to the CFTC 
that its adjusted net capital had fallen below a particular threshold. 
We are proposing these amendments to help protect customers from 
broker-dealer failures. Current Rule 17a-11 does not require a broker-
dealer/FCM to notify the Commission if its adjusted net capital under 
the CFTC's net capital rule falls below specified requirements. The 
proposed notification requirement should provide an early warning to 
the Commission that a broker-dealer/FCM may be experiencing financial 
difficulties whatever the source and allow the Commission to take 
corrective action with respect to the firm, if necessary. The proposed 
amendments to Rule 17a-11 also are consistent with amended CFTC Rule 
1.12(b)(2),\16\ which requires an FCM to notify the CFTC and its 
designated self-regulatory organization if its adjusted net capital 
falls below 110% of its risk margin-based requirements under 
1.17(a)(1)(i)(B).
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    \16\ 17 CFR 1.12(b)(2).
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III. Request for Comments

    We invite interested persons to submit written comments on all 
aspects of the proposed amendments. Further, we invite comment on other 
matters that might have an effect on the proposals contained in the 
release.

IV. Paperwork Reduction Act

    Certain provisions of the proposed amendments to Rule 17a-11 \17\ 
contain ``collection of information requirements'' within the meaning 
of the Paperwork Reduction Act of 1995.\18\ The Commission has 
submitted the proposed amendments to the Office of Management and 
Budget (``OMB'') for review in accordance with 44 U.S.C. 3507(d) and 5 
CFR 1320.11. The Commission is revising the collection of information 
entitled, ``Rule 17a-11 (17 CFR 240.17a-11) Notification Provision for 
Brokers and Dealers,'' OMB Control Number 3235-0085. 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.
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    \17\ There is no new collection of information imposed on 
broker-dealer/FCMs under the amendments to Rules 15c3-1 and 15c3-1d. 
The Commission's and CFTC's rules, both in previous form and as 
amended, require broker-dealer/FCMs to comply with the net capital 
rules of both agencies. Accordingly, the proposed amendments to 
Rules 15c3-1 and 15c3-1d do not impose any new requirements on 
broker-dealer/FCMs.
    \18\ 44 U.S.C. 3501 et seq.
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A. Collection of Information under these Amendments

    As discussed, the Commission is proposing to amend Rule 17a-11 to 
provide the Commission with an early warning of a broker-dealer/FCM's 
low capital level, which should help protect customers from broker-
dealer failures. The proposed amendments to paragraph 17a-11(c)(4) 
would require a broker-dealer/FCM to notify the Commission and its DEA 
under circumstances in which the CFTC's rules would require an FCM to 
provide notification that its adjusted net capital had fallen below a 
particular threshold.

B. Proposed Use of Information

    The Commission would use the information collected under the 
proposed amendments to Rule 17a-11 to determine if a broker-dealer is 
in compliance with financial responsibility rules. Specifically, the 
Commission would use the information to monitor whether broker-dealer/
FCMs are complying with the net capital rule and relevant notification 
requirements.

C. Respondents

    The proposed amendments to Rule 17a-11 would apply only to broker-
dealer/FCMs. As of July 31, 2006, there were approximately 67 broker-
dealer/FCMs.\19\ A broker-dealer/FCM would be required to notify the 
Commission and its DEA under circumstances in which the CFTC's rules 
would require an FCM to provide notification that its adjusted net 
capital had fallen below a particular threshold.
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    \19\ Selected FCM Financial Data as of July 31, 2006, CFTC 
Division of Clearing and Intermediary Oversight.
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D. Total Annual Reporting and Recordkeeping Burden

    Under the proposed amendment to Rule 17a-11(c)(4), a broker-dealer/
FCM would be required to notify the Commission and its DEA under 
circumstances in which the CFTC's rules would require an FCM to provide 
notification that its adjusted net capital had fallen below a 
particular threshold. The Commission staff estimates that 5 out of 67 
broker-dealer/FCMs will file Rule 17a-11 notifications annually.\20\ 
The staff further estimates that these broker-dealer/FCMs would spend 
annually approximately 1.25 hours (or .25 hours each x 5 broker-dealer/
FCMs) to send the notifications.\21\
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    \20\ There were approximately 5,980 registered broker-dealers as 
of December 31, 2005. Approximately 450, or 7.5% (450/5,980), of 
those firms filed early warning notices under Rule 17a-11. The 
Commission, therefore, expects that 5 broker-dealer/FCMs 
(approximately 7.5% of 67 broker-dealer/FCMs) would file early 
warning notices annually under Rule 17a-11.
    \21\ A broker-dealer/FCM is already required to draft and send 
these notifications to the CFTC or DSROs pursuant to CFTC Rules. 
Consequently, the only additional cost relates to the additional 
time it would take the broker-dealer/FCM's staff to send the 
notification to the Commission and its DEA. The Staff estimates, 
based on its experience, that it would take an individual 15 minutes 
to send these additional notifications.
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E. Collection of Information Is Mandatory

    The collection of information under the proposed amendments to Rule 
17a-11 is mandatory if a broker-dealer/FCM's net capital falls below 
the Commission's or the CFTC's early warning thresholds.

[[Page 60640]]

F. Confidentiality

    The collection of information under the proposed amendments to Rule 
17a-11(c)(4) would be provided to the Commission and to a broker-
dealer/FCM's DEA, but would not be subject to public availability.

G. Record Retention Period

    Rule 17a-4(b)(4) requires a broker-dealer to preserve copies of all 
communications sent relating to its business as such for no less than 
three years, the first two years in an accessible place.

H. Request for Comment

    Under 44 U.S.C. 3506(c)(2)(B), the Commission solicits comments to:
    (i) Evaluate whether the proposed collection of information is 
necessary for the proper performance of the functions of the 
Commission, including whether the information would have practical 
utility;
    (ii) Evaluate the accuracy of the Commission's estimate of the 
burden of the proposed collection of information;
    (iii) Enhance the quality, utility, and clarity of the information 
to be collected; and
    (iv) Minimize the burden of the collection of information on those 
required to respond, including through the use of automated collection 
techniques or other forms of information technology.
    Persons who desire to submit comments on the collection of 
information requirements should direct them to OMB, Attention: Desk 
Officer for the Securities and Exchange Commission, Office of 
Information and Regulatory Affairs, Washington, DC 20503, and should 
also send a copy of their comments to Nancy M. Morris, Secretary, 
Securities and Exchange Commission, 100 F Street, NE., Washington, DC 
20549-1090, and refer to File No. S7-16-06. OMB is required to make a 
decision concerning the collections of information between 30 and 60 
days after publication of this document in the Federal Register; 
therefore, comments to OMB are best assured of having full effect if 
OMB receives them within 30 days of this publication. The Commission 
has submitted the proposed collections of information to OMB for 
approval. Requests for the materials submitted to OMB by the Commission 
with regard to these collections of information should be in writing, 
refer to File No. S7-16-06, and be submitted to the Securities and 
Exchange Commission, Records Management, Office of Filings and 
Information Services, 100 F Street, NE., Washington, DC 20549.

V. Costs and Benefits of the Proposed Amendments

A. Introduction

    As discussed, the Commission is proposing to amend Exchange Act 
Rules 15c3-1(a)(1)(iii) and (e)(2)(ii); 15c3-1d(b)(6)(iii), (b)(7), 
(b)(8)(i)(A), (b)(10)(ii)(B), (c)(2), (c)(5)(i)(B), (c)(5)(ii)(A), and 
(c)(7); and 17a-11(c)(3), (c)(4), and (c)(5). The CFTC amended Rules 
1.17 and 1.12 to adopt certain new net capital requirements applicable 
to FCMs.\22\ Broker-dealer/FCMs must comply with both the CFTC's and 
the Commission's net capital rules under Rule 15c3-1(a)(1)(iii). 
Accordingly, the Commission is amending Rules 15c3-1 and 15c3-1d to 
conform those rules to the CFTC's amendments. Finally, the Commission 
is amending Rule 17a-11 to provide itself with an early warning that a 
broker-dealer/FCM may be experiencing financial difficulties.
---------------------------------------------------------------------------

    \22\ See supra, note 4.
---------------------------------------------------------------------------

    The Commission has identified below certain costs and benefits 
associated with its proposed amendments. We encourage commenters to 
discuss, analyze, and supply relevant data regarding any additional 
costs or benefits.

B. Benefits

    We believe that the proposed amendments to Rules 15c3-1 and 15c3-1d 
will benefit both broker-dealer/FCMs and investors. As discussed, the 
Commission is proposing to amend Rule 15c3-1(a)(1)(iii) by eliminating 
the rule's segregated funds requirement and replacing it with the risk 
margin-based capital requirement. Rule 15c3-1(a)(1)(iii) requires a 
broker-dealer/FCM to maintain net capital of not less than the greater 
of its requirement under Rule 15c3-1 or four percent of the funds 
required to be segregated under the CEA and its rules. The four percent 
of segregated funds requirement was intended to conform Rule 15c3-
1(a)(1)(iii) to Rule 1.17, the CFTC's adjusted net capital rule, and 
ensure that a broker-dealer/FCM complied with the net capital rules of 
both the CFTC and the Commission. Rule 1.17, as amended, eliminates the 
four percent of segregated funds requirement and replaces it with a new 
risk margin-based capital requirement. Proposed Rule 15c3-1(a)(1)(iii) 
would require a broker-dealer/FCM to maintain net capital of not less 
than the greater of its requirement under Rule 15c3-1 or a risk margin-
based capital requirement identical to the one contained in CFTC Rule 
1.17, as amended.
    We also are proposing to amend Rule 15c3-1(e)(2)(ii) to conform it 
to the CFTC's new risk margin-based capital requirement. Rule 15c3-
1(e)(2)(ii) prohibits a broker-dealer/FCM from withdrawing equity 
capital if the withdrawal would cause the broker-dealer/FCM's net 
capital to fall below, among other standards, a specified percentage of 
its minimum net capital dollar amount, a specified level of aggregate 
indebtedness, or a specified percentage of the funds required to be 
segregated under the CEA. CFTC Rule 1.17(e)(1)(ii), as amended, 
prohibits an FCM from withdrawing equity capital if the withdrawal 
would cause the FCM's adjusted net capital to fall below a specified 
percentage of risk margin-based capital, rather than a specified 
percentage of segregated funds. The proposed amendments would 
substitute the segregated funds requirement in Rule 15c3-1(e)(2)(ii) 
with a risk margin-based requirement calculated under Rule 15c3-
1(a)(1)(iii).
    Furthermore, the Commission is proposing amendments to various 
provisions of Rule 15c3-1d, which contains minimum and non-exclusive 
requirements for satisfactory subordination agreement involving broker-
dealers. Repayment and prepayment of subordinated debt under Rule 15c3-
1d generally is permissible only if the broker-dealer/FCM maintains net 
capital equal to at least a specified percentage of net capital 
calculated under Rule 15c3-1 and a specified percentage of segregated 
funds. Rather than permitting repayment or prepayment of subordinated 
debt if an FCM maintains a specified percentage of segregated funds, 
the CFTC's Rule 1.17, as amended, permits repayment or prepayment if 
the FCM maintains net capital equal to at least a specified percentage 
of its risk margin-based capital requirement. Accordingly, the 
Commission is proposing to amend Rule 15c3-1d by substituting the risk 
margin-based capital requirement for the segregated funds requirement 
to avoid subjecting broker-dealer/FCMs to conflicting or duplicative 
regulation.
    The Commission believes that the risk margin-based capital 
requirement is appropriate. Each of the amendments to Rules 15c3-1 and 
15c3-1d substitutes the risk margin-based capital requirement for the 
segregated funds standard. The risk margin-based capital requirement 
should be an adequate substitute for the segregated funds standard 
based on its implementation and use by the futures exchanges and FCMs' 
comfort level with the requirement.

[[Page 60641]]

    As noted, the Commission also believes that the amendments to Rules 
15c3-1 and 15c3-1d would benefit both broker-dealer/FCMs and investors. 
First, the proposed amendments would prevent the imposition of 
potentially conflicting or duplicative regulation on a broker-dealer/
FCM. Current Rule 15c3-1(a)(1)(iii) requires a broker-dealer/FCM to 
maintain net capital equal to the greater of its net capital 
requirement under Rule 15c3-1 or four percent of the funds required to 
be segregated under the CEA and its rules. The four percent of 
segregated funds requirement reflects the previous version of CFTC Rule 
1.17 and has been substituted in current CFTC Rule 1.17 with the risk 
margin-based capital requirement. The proposed amendments would 
substitute the risk margin-based capital requirement for the segregated 
funds requirement in Rules 15c3-1 and 15c3-1d and, therefore, free a 
broker-dealer/FCM from complying with a capital requirement no longer 
applicable to FCMs that are sole registrants.
    Second, the proposed amendments would help to avoid potentially 
placing a broker-dealer/FCM at a competitive disadvantage with respect 
to an entity registered solely as a broker-dealer or FCM. Neither a 
broker-dealer nor an FCM is subject to the four percent of segregated 
funds requirement; a broker-dealer/FCM is subject to such a requirement 
unless the proposed amendments are adopted. Accordingly, the proposed 
amendments could free a broker-dealer/FCM from making three separate 
capital computations (one based on Rule 15c3-1(a)(1)(i) or (ii), one 
based on CFTC Rule 1.17, and one based on the four percent of 
segregated requirement under current Rule 15c3-1(a)(1)(iii)) and 
holding unnecessarily more net capital than its sole registrant 
competitors.
    Third, the proposed amendments would enhance the Commission's 
ability to monitor the financial condition of a broker-dealer/FCM. 
Under the proposed amendments to Rule 15c3-1, a broker-dealer's failure 
to maintain sufficient risk margin-based capital, which is a violation 
of CFTC Rule 1.17, also would be a violation of the Commission's net 
capital rule. The Commission, therefore, could force the broker-dealer/
FCM to take corrective action (or require it to cease conducting 
business), an ability the Commission would not have without the 
proposed amendments.
    Finally, the proposed amendments to Rule 17a-11 would help protect 
customers from broker-dealer failures. Current Rule 17a-11 does not 
require a broker-dealer/FCM to notify the Commission if its adjusted 
net capital falls below specified requirements. The proposed amendments 
to Rule 17a-11 would require a broker-dealer/FCM to notify the 
Commission if its net capital falls below certain thresholds determined 
in accordance with Rule 15c3-1 or if the CFTC's rules would require it 
to notify the CFTC or a DSRO that its adjusted net capital had breached 
certain thresholds. This notification requirement should provide an 
early warning to the Commission that a broker-dealer/FCM may be 
experiencing financial difficulties.

C. Costs

    There would be no costs associated with the proposed amendments to 
Rules 15c3-1 and 15c3-1d. A broker-dealer/FCM already must comply with 
the net capital rules of both the Commission and the CFTC. Likewise, a 
broker-dealer/FCM already must comply with Rule 15c3-1d and comparable 
CFTC subordinated debt rules.
    The proposed amendments would help ensure that broker-dealer/FCMs 
are not subject to inconsistent or duplicative regulation under Rules 
15c3-1 and 15c3-1d by eliminating the four percent of segregated funds 
standard in those rules and replacing it with the risk margin-based 
capital requirement. With respect to 15c3-1d, the applicable thresholds 
no longer will be calculated based upon a segregated funds, but upon 
risk margin-based, capital, which the broker-dealer/FCM already 
calculates under CFTC Rule 1.17.
    As discussed, proposed Rule 17a-11(c)(4) would require a broker-
dealer/FCM to notify the Commission and its DEA under circumstances in 
which the CFTC's rules would require an FCM to notify the CFTC or a 
DRSO that its adjusted net capital had fallen below a particular 
threshold. The cost of notification in these circumstances should be 
minimal because the broker-dealer/FCM already must notify the CFTC.\23\ 
We estimate the annual cost of notification under Rule 17a-11(c)(4) 
would be $331 (.25 hours x $265 per hour for a financial reporting 
manager \24\ x 5 broker-dealer/FCMs).\25\
---------------------------------------------------------------------------

    \23\ See supra, note 21.
    \24\ A financial reporting manager is a person at a broker-
dealer with responsibility for helping to ensure that the broker-
dealer complies with its financial reporting requirements with 
respect to the Commission, other federal or state agencies and SROs.
    \25\ Security Industry Association's (``SIA'') Report on 
Management & Professional Earnings in the Securities Industry 2005, 
modified to account for an 1800-hour work-year and multiplied by 
5.35 to account for bonuses, firm size, employee benefits and 
overhead. The amount also reflects the average between New York City 
salaries and Non-New York City salaries. This is the latest report 
on financial industry salaries that is available from the SIA.
---------------------------------------------------------------------------

VI. Consideration of Burden on Competition, and Promotion of 
Efficiency, Competition, and Capital Formation

    Section 3(f) of the Exchange Act \26\ requires the Commission, 
whenever it engages in rulemaking and must consider or determine if an 
action is necessary or appropriate in the public interest, to consider 
if the action will promote efficiency, competition, and capital 
formation. Under section 23(a)(2) of the Exchange Act,\27\ the 
Commission must consider the impact of its rulemaking on competition. 
It also 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.
---------------------------------------------------------------------------

    \26\ 15 U.S.C. 78c(f).
    \27\ 15 U.S.C. 78w(a)(2).
---------------------------------------------------------------------------

    We preliminarily believe that the amendments to Rules 15c3-1, 15c3-
1d, and 17a-11 would promote efficiency, competition, and capital 
formation. The amendments to Rules 15c3-1 and 15c3-1d should promote 
efficiency because they would help to ensure that broker-dealer/FCMs 
are not subject to net capital requirements beyond those that the 
Commission already imposes on broker-dealers and those that the CFTC 
already imposes on FCMs. That is, the amendments would not subject 
broker-dealer/FCMs to any new requirements and, consequently, would not 
impose any new costs. Furthermore, the proposed amendments to Rule 17a-
11(c)(4) should promote efficiency because they would require a broker-
dealer/FCM to notify the Commission that it has fallen below a 
specified percentage of its adjusted net capital requirement under CFTC 
rules, a notification that it already must provide to the CFTC. This 
notification should help the Commission address potential financial 
difficulties at a broker-dealer/FCM before a liquidation becomes 
necessary and, therefore, should help protect customers. Each of these 
provisions also should help foster competition because they would allow 
firms to function jointly as broker-dealer/FCMs without imposing 
regulatory requirements beyond those already applicable to broker-
dealers and FCMs individually.
    We preliminarily believe that the proposed amendments to Rules 
15c3-1, 15c3-1d and 17a-11would promote capital formation. By 
eliminating potentially duplicative or conflicting regulation, the 
proposed amendments to

[[Page 60642]]

Rules 15c3-1 and 15c3-1d should help to ensure that a broker-dealer/FCM 
does not unnecessarily use its assets to meet regulatory capital 
requirements, freeing those assets for business uses. Similarly, the 
proposed amendments to Rule 17a-11 should help the Commission to 
identify a broker-dealer/FCM that faces potential financial 
difficulties and allow the Commission to take corrective action to help 
that broker-dealer/FCM preserve its capital which, in turn, should help 
protect the broker-dealer/FCM's customers.
    Finally, we preliminarily believe that the proposed amendments do 
not impose any competitive burden that is not necessary and appropriate 
in furtherance of the purposes of the Exchange Act. As discussed, the 
Commission is proposing amendments to Rules 15c3-1 and 15c3-1d to 
conform those rules to the CFTC's amended net capital rule. The 
proposed rules are intended to eliminate inconsistent and duplicative 
regulation on broker-dealer/FCMs. Furthermore, we preliminarily believe 
that the proposed amendments to Rule 17a-11 are necessary to provide 
the Commission with an early warning of potential capital 
insufficiencies at broker-dealer/FCMs. This early warning should help 
the Commission to protect customers and the integrity of the markets. 
The amendments to Rule 17a-11(c)(4), moreover, would require only that 
a broker-dealer/FCM forward to the Commission a notice that it already 
must provide to the CFTC.

VII. Regulatory Flexibility Act Certification

    The Commission hereby certifies, pursuant to 5 U.S.C. 605(b), that 
the proposed amendments to Rule 15c3-1, Rule 15c3-1d, and Rule 17a-11, 
if adopted, would not have a significant economic impact on a 
substantial number of small entities. The proposed amendments would 
apply only to broker-dealers also registered as FCMs. As of July 31, 
2006, there were approximately 67 broker-dealer/FCMs.\28\ Only one of 
those broker-dealers would qualify as a small entity.\29\ Accordingly, 
we do not believe that the proposed amendments would have a significant 
economic impact on a substantial number of small entities.
---------------------------------------------------------------------------

    \28\ Selected FCM Financial Data as of July 31, 2006, CFTC 
Division of Clearing and Intermediary Oversight.
    \29\ See 17 CFR 240.0-10.
---------------------------------------------------------------------------

    We encourage written comments regarding this certification. We 
request that commenters describe the nature of any impact on small 
entities and provide empirical data to support the extent of the 
impact.

VIII. Consideration of Impact on The Economy

    For purposes of the Small Business Regulatory Enforcement Fairness 
Act of 1996, or ``SBREFA,'' \30\ we must advise OMB as to whether the 
proposed regulation constitutes a ``major'' rule. Under SBREFA, a rule 
is considered ``major'' if, upon adoption, it results or is likely to 
result in:
---------------------------------------------------------------------------

    \30\ Pub. L. No. 104-121, Title II, 110 Stat. 857 (1996) 
(codified in various sections of 5 U.S.C., 15 U.S.C. and as a note 
to 5 U.S.C. 601).
---------------------------------------------------------------------------

     An annual effect on the economy of $100 million or more 
(either in the form of an increase or a decrease);
     A major increase in costs or prices for consumers or 
individual industries; or
     Significant adverse effect on competition, investment or 
innovation.
    If a rule is ``major,'' its effectiveness will generally be delayed 
for 60 days pending Congressional review. We request comment on the 
potential impact of the proposed regulation on the economy on an annual 
basis. Commenters are requested to provide empirical data and other 
factual support for their view to the extent possible.

IX. Statutory Authority

    The Commission is proposing amendments to Rule 15c3-1, Rule 15c3-
1d, and Rule 17a-11 under the Exchange Act pursuant to the authority 
conferred by the Exchange Act, including Sections 15, 17 and 23(a).\31\
---------------------------------------------------------------------------

    \31\ 15 U.S.C. 78o, 78q and 78w(a).
---------------------------------------------------------------------------

Text of Proposed Rule Amendments

List of Subjects in 17 CFR Part 240

    Brokers, Reporting and recordkeeping requirements, Securities.
    In accordance with the foregoing, the Commission hereby proposes 
that Title 17, Chapter II of the Code of Federal Regulation be amended 
as follows.

PART 240--GENERAL RULES AND REGULATIONS, SECURITIES EXCHANGE ACT OF 
1934

    1. The authority citation for part 240 continues to read, in part, 
as follows:

    Authority: 15 U.S.C. 77c, 77d, 77g, 77j, 77s, 77z-2, 77z-3, 
77eee, 77ggg, 77nnn, 77sss, 77ttt, 78c, 78d, 78e, 78f, 78g, 78i, 
78j, 78j-l, 78k, 78k-1, 78l, 78m, 78n, 78o, 78p, 78q, 78s, 78u-5, 
78w, 78x, 78ll, 78mm, 79q, 79t, 80a-20, 80a-23, 80a-29, 80a-37, 80b-
3, 80b-4, 80b-11, and 7201 et seq.; and 18 U.S.C. 1350, unless 
otherwise noted.

* * * * *
    2. Section 240.15c3-1 is amended by revising paragraphs (a)(1)(iii) 
and (e)(2)(ii) to read as follows:


Sec.  240.15c3-1  Net capital requirements for brokers or dealers.

    (a) * * *
    (1) * * *
    (iii) No broker or dealer registered as a futures commission 
merchant shall permit its net capital to be less than the greater of 
its requirement under paragraph (a)(1)(i) or (ii) of this section, or 
eight percent of the total risk margin requirement for positions 
carried by the futures commission merchant in customer accounts plus 
four percent of the total risk margin requirement for positions carried 
by the futures commission merchant in noncustomer accounts, as defined 
in the Commodity Exchange Act (7 U.S.C. 1 et seq.) and the rules 
thereunder.
* * * * *
    (e) * * *
    (2) * * *
    (ii) The broker-dealer is registered as a futures commission 
merchant, its net capital would be less than 120 percent of the 
aggregate amount of its total risk margin requirements for positions 
carried in customer and noncustomer accounts under paragraph 
(a)(1)(iii) of this section;
* * * * *
    3. Section 240.15c3-1d is amended by removing the authority 
citation at the end of the section and revising paragraphs (b)(6)(iii), 
(b)(7), (b)(8)(i)(A), (b)(10)(ii)(B), (c)(2), (c)(5)(i)(B), 
(c)(5)(ii)(A), and (c)(7) to read as follows:


Sec.  240.15c3-1d  Satisfactory Subordination Agreements (Appendix D to 
17 CFR 240.15c3-1).

* * * * *
    (b) * * *
    (6) * * *
    (iii) The secured demand note agreement also may provide that, in 
lieu of the procedures specified in the provisions required by 
paragraph (b)(6)(ii) of this section, the lender, with the prior 
written consent of the broker or dealer and the Examining Authority for 
the broker or dealer, may reduce the unpaid principal amount of the 
secured demand note. After giving effect to such reduction, the 
aggregate indebtedness of the broker or dealer may not exceed 1000 
percent of its net capital or, in the case of a broker or dealer 
operating pursuant to paragraph (a)(1)(ii) of Sec.  240.15c3-1, net 
capital may not be less than 5 percent of aggregate debit items 
computed in accordance with Sec.  240.15c3-3a, or, if registered as a 
futures commission merchant, 120

[[Page 60643]]

percent of the aggregate amount of its total risk margin requirements 
for positions carried in customer and noncustomer accounts under 
paragraph (a)(1)(iii) of Sec.  240.15c3-1, if greater. No single 
secured demand note shall be permitted to be reduced by more than 15 
percent of its original principal amount and after such reduction no 
excess collateral may be withdrawn. No Examining Authority shall 
consent to a reduction of the principal amount of a secured demand note 
if, after giving effect to such reduction, net capital would be less 
than 120 percent of the minimum dollar amount required by Sec.  
240.15c3-1.

Permissive Prepayments

    (7) A broker or dealer at its option, but not at the option of the 
lender may, if the subordination agreement so provides, make a Payment 
of all or any portion of the Payment Obligation thereunder prior to the 
scheduled maturity date of such Payment Obligation (hereinafter 
referred to as a ``Prepayment''), but in no event may any Prepayment be 
made before the expiration of one year from the date such subordination 
agreement became effective. This restriction shall not apply to 
temporary subordination agreements that comply with the provisions of 
paragraph (c)(5) of this Appendix D. No Prepayment shall be made, if, 
after giving effect thereto (and to all Payments of Payment Obligations 
under any other subordinated agreements then outstanding the maturity 
or accelerated maturities of which are scheduled to fall due within six 
months after the date such Prepayment is to occur pursuant to this 
provision or on or prior to the date on which the Payment Obligation in 
respect of such Prepayment is scheduled to mature disregarding this 
provision, whichever date is earlier) without reference to any 
projected profit or loss of the broker or dealer, either aggregate 
indebtedness of the broker or dealer would exceed 1000 percent of its 
net capital or its net capital would be less than 120 percent of the 
minimum dollar amount required by Sec.  240.15c3-1 or, in the case of a 
broker or dealer operating pursuant to paragraph (a)(1)(ii) of Sec.  
240.15c3-1, its net capital would be less than 5 percent of its 
aggregate debit items computed in accordance with Sec.  240.15c3-3a, or 
if registered as a futures commission merchant, 120 percent of the 
aggregate amount of its total risk margin requirements for positions 
carried in customer and noncustomer accounts under paragraph 
(a)(1)(iii) of Sec.  240.15c3-1, if greater, or its net capital would 
be less than 120 percent of the minimum dollar amount required by 
paragraph (a)(1)(ii) of Sec.  240.15c3-1. Notwithstanding the 
provisions of this paragraph, no Prepayment shall occur without the 
prior written approval of the Examining Authority for such broker or 
dealer.

Suspended Repayment

    (8)(i) * * *
    (A) The aggregate indebtedness of the broker or dealer would exceed 
1200 percent of its net capital, or in the case of a broker or dealer 
operating pursuant to paragraph (a)(1)(ii) of Sec.  240.15c3-1, its net 
capital would be less than 5 percent of aggregate debit items computed 
in accordance with Sec.  240.15c3-3a or, if registered as a futures 
commission merchant, 120 percent of the aggregate amount of its total 
risk margin requirements for positions carried in customer and 
noncustomer accounts under paragraph (a)(1)(iii) of Sec.  240.15c3-1, 
if greater, or
* * * * *
    (10) * * *
    (ii) * * *
    (B) The aggregate indebtedness of the broker or dealer exceeding 
1500 percent of its net capital or, in the case of a broker or dealer 
that has elected to operate under paragraph (a)(1)(ii) of Sec.  
240.15c3-1, its net capital is less than 2 percent of its aggregate 
debit items computed in accordance with Sec.  240.15c3-3a or, if 
registered as a futures commission merchant, the aggregate amount of 
its total risk margin requirements for positions carried in customer 
and noncustomer accounts under paragraph (a)(1)(iii) of Sec.  240.15c3-
1, if greater, throughout a period of 15 consecutive business days, 
commencing on the day the broker or dealer first determines and 
notifies the Examining Authority for the broker or dealer, or the 
Examining Authority or the Commission first determines and notifies the 
broker or dealer of such fact;
* * * * *
    (c) * * *
    (2) Every broker or dealer shall immediately notify the Examining 
Authority for such broker or dealer if, after giving effect to all 
Payments of Payment Obligations under subordination agreements then 
outstanding that are then due or mature within the following six months 
without reference to any projected profit or loss of the broker or 
dealer either the aggregate indebtedness of the broker or dealer would 
exceed 1200 percent of its net capital or its net capital would be less 
than 120 percent of the minimum dollar amount required by Sec.  
240.15c3-1, or, in the case of a broker or dealer operating pursuant to 
paragraph (a)(1)(ii) of Sec.  240.15c3-1, its net capital would be less 
than 5 percent of aggregate debit items computed in accordance with 
Sec.  240.15c3-3a, or, if registered as a futures commission merchant, 
120 percent of the aggregate amount of its total risk margin 
requirements for positions carried in customer and noncustomer accounts 
under paragraph (a)(1)(iii) of Sec.  240.15c3-1, if greater, or less 
than 120 percent of the minimum dollar amount required by paragraph 
(a)(1)(ii) of Sec.  240.15c3-1.
* * * * *
    (5) * * *
    (i) * * *
    (B) In the case of a broker or dealer operating pursuant to 
paragraph (a)(1)(ii) of Sec.  240.15c3-1, its net capital is less than 
5 percent of aggregate debits computed in accordance with Sec.  
240.15c3-3a, or, if registered as a futures commission merchant, less 
than 120 percent of the aggregate amount of its total risk margin 
requirements for positions carried in customer and noncustomer accounts 
under paragraph (a)(1)(iii) of Sec.  240.15c3-1, if greater, or less 
than 120 percent of the minimum dollar amount required by paragraph 
(a)(1)(ii) of this section, or
* * * * *
    (ii) * * *
    (A) After giving effect thereto (and to all Payments of Payment 
Obligations under any other subordinated agreements then outstanding, 
the maturity or accelerated maturities of which are scheduled to fall 
due within six months after the date such prepayment is to occur 
pursuant to this provision or on or prior to the date on which the 
Payment Obligation in respect of such prepayment is scheduled to mature 
disregarding this provision, whichever date is earlier) without 
reference to any projected profit or loss of the broker or dealer, 
either aggregate indebtedness of the broker or dealer would exceed 900 
percent of its net capital or its net capital would be less than 200 
percent of the minimum dollar amount required by Sec.  240.15c3-1 or, 
in the case of a broker or dealer operating pursuant to paragraph 
(a)(1)(ii) of Sec.  240.15c3-1, its net capital would be less than 6 
percent of aggregate debit items computed in accordance with Sec.  
240.15c3-3a, or, if registered as a futures commission merchant, 125 
percent of the aggregate amount of its total risk margin requirements 
for positions carried in customer and noncustomer accounts under 
paragraph (a)(1)(iii) of Sec.  240.15c3-1, if greater, or its net 
capital

[[Page 60644]]

would be less than 200 percent of the minimum dollar amount required by 
paragraph (a)(1)(ii) of this section or
* * * * *
    (7) Subordination agreements in effect before adoption. Any 
subordination agreement that incorporates the net capital requirements 
in paragraphs (b)(6)(iii), (b)(7), (b)(8)(i), (b)(10)(ii)(B), (c)(2), 
(c)(5)(i)(B), and (c)(5)(ii)(A) of this section, as in effect before 
adoption of the amendments incorporating the risk margin-based capital 
requirement in those paragraphs, and that has been deemed to be 
satisfactorily subordinated pursuant to Sec.  240.15c3-1 as in effect 
before adoption of those amendments, shall continue to be deemed a 
satisfactory subordination agreement until the maturity of the 
agreement. Provided, That if the agreement is amended or renewed for 
any reason, then the agreement shall not be deemed a satisfactory 
subordination agreement unless the amended or renewed agreement meets 
the requirements of this Appendix D. Provided, further, That all 
subordination agreements must meet the requirements of this Appendix D 
within 5 years of the adoption of the amendments incorporating the risk 
margin-based capital requirements.
    4. Section 240.17a-11 is amended by:
    a. Revising the introductory text of paragraph (c);
    b. In paragraph (c)(3) remove the period at the end of the 
paragraph and in its place add ``; or'';
    c. Redesignating paragraph (c)(4) as paragraph (c)(5); and
    d. Adding new paragraph (c)(4) to read as follows:


Sec.  240.17a-11  Notification provisions for brokers and dealers.

* * * * *
    (c) Every broker or dealer shall send notice promptly (but within 
24 hours) after the occurrence of the events specified in paragraph 
(c)(1), (c)(2), (c)(3), (c)(4) or (c)(5) of this section in accordance 
with paragraph (g) of this section:
* * * * *
    (4) For a broker or dealer registered as a futures commission 
merchant, if the Commodity Exchange Act (7 U.S.C. 1 et seq.) and the 
rules promulgated under the Commodity Exchange Act would require a 
futures commission merchant to provide notification to the Commodity 
Futures Trading Commission or a designated self-regulatory organization 
that its adjusted net capital has fallen below a specified threshold; 
or
* * * * *

     Dated: October 5, 2006.

    By the Commission.
J. Lynn Taylor,
Assistant Secretary.
[FR Doc. E6-16956 Filed 10-12-06; 8:45 am]
BILLING CODE 8011-01-P
Justia Annotations