US Department of the Treasury

March 6, 2003

Page 9

March 6, 2003 Revised

USA PATRIOT Act Task Force

1500 Pennsylvania Avenue NW

Washington, DC 20220

Re: Anti-Money Laundering Rules Affecting Futures Commission Merchants

Ladies and Gentlemen:

In response to the Department of the Treasury’s (“Treasury’s”) USA PATRIOT Act Task Force invitation, the Futures Industry Association (“FIA”)[1] welcomes this opportunity to present these additional views concerning the appropriate scope and substance of anti-money laundering rules and regulations implementing the USA PATRIOT Act of 2001 (“PATRIOT Act”)[2] as such rules and regulations may affect futures commission merchants (“FCMs”).

The Derivatives Markets

To place the following discussion in the proper context, we believe it would be helpful to describe the market environment in which the FCM community to which these rules would apply operates. US FCMs act as intermediaries on behalf of international commercial entities and other institutional participants, including banks, insurance companies and other financial institutions that use the derivatives markets both to manage the risks they incur in their cash market activities and for speculative purposes. Registered and unregistered investment companies, including hedge funds and commodity pools, are significant participants in the derivatives markets and are essential to providing the liquidity that these markets demand. (Registered and unregistered investment companies are collectively referred to in this letter as “collective investment vehicles.”).

These participants also trade on markets worldwide. In 2002, volume on US derivatives markets comprised less than one third of the approximately six billion derivatives contracts traded globally. The Chicago Mercantile Exchange and the Chicago Board of Trade, once the dominant derivatives exchanges, now rank fourth and fifth, respectively, behind European and Asian exchanges.[3]

In light of the institutional nature of the market participants that dominate the derivatives markets and the international scope of their activities, the FCMs that, directly or indirectly, serve these participants not surprisingly have both the international presence and the regulatory capital that these participants require to support their trading activities on derivatives exchanges and all other financial markets. For example, approximately 90 percent of the approximately $62.5 billion customer funds on deposit with FCMs for trading on US and non-US markets as of December 31, 2002 was held by just 20 of the larger FCMs.[4] Of these 20 firms, 12 have regulatory net capital in excess of $1 billion and seven have net capital in excess of $2 billion. All but three of the 20 are also registered with the Securities and Exchange Commission (“SEC”) as broker-dealers and two of the three have affiliates that are registered as broker-dealers. Moreover, all 20 firms have non-US affiliates and eight have non-US parents.

The Essential Role of Intermediaries

FIA has advised Treasury of the myriad relationships that FCMs have with intermediaries both domestic and international in connection with providing services to derivatives market participants. Foreign brokers and non-clearing member FCMs open omnibus accounts with FCMs that are clearing members of the several derivatives exchanges. US FCMs, in turn, open omnibus accounts with foreign brokers to execute and clear trades on non-US derivatives exchanges on behalf of their customers. Further, as noted above, collective investment vehicles are significant participants in the derivatives markets.

In addition, advisors and introducing brokers, both foreign and domestic, introduce customers to FCMs whose accounts the FCMs carry on a fully disclosed basis. In this regard, among the larger FCMs, it is estimated that a majority of all derivatives market transactions are executed and cleared on behalf of customers whose accounts are managed by advisors. Finally, and perhaps most significantly, FCMs provide execution-only services for an overwhelming number of participants through so-called give-up arrangements.

Omnibus Accounts and Collective Investment Vehicles

In the July 23, 2002 Federal Register release proposing rules governing the customer identification procedures of FCMs, Treasury acknowledged that, in appropriate circumstances, the proposed rules would authorize FCMs to rely on intermediaries to perform the customer identification function.[5] This is especially true when the intermediary is a collective investment vehicle or opens an omnibus account with the FCM. In these circumstances, an FCM will have a direct principal/agent relationship solely with the collective investment vehicle or other entity itself and, as the Agencies recognized, “may have little or no information about the identities and transaction activities of the underlying participants or beneficiaries of such accounts.” The release further states:

In most instances, given Treasury’s risk-based approach to anti-money laundering programs for financial institutions generally, it is expected that the focus of each futures commission merchant’s and introducing broker’s CIP [Customer Identification Program] will be the intermediary itself, and not the underlying participants or beneficiaries. Thus, futures commission merchants and introducing brokers should assess the risks associated with different types of intermediaries based upon an evaluation of relevant factors, including the type of intermediary; its location; the statutory and regulatory regime that applies to a foreign intermediary (e.g., whether the jurisdiction complies with the European Union anti-money laundering directives or has been identified as non-cooperative by the Financial Action Task Force); the futures commission merchant’s or introducing broker’s historical experience with the intermediary; references from other financial institutions regarding the intermediary; and whether the intermediary is itself a BSA financial institution required to have an anti-money laundering program. 67 Fed.Reg. 48328, 48331.

FIA endorsed the Agencies’ position at that time and wishes to reemphasize here the importance of being able to rely on these intermediaries in appropriate circumstances. Only these intermediaries—collective investment vehicles and entities that open omnibus accounts—have a direct relationship with the underlying participants or beneficiaries.[6] Consequently, only they are in a position to undertake the procedures necessary to confirm the identity of such persons. For purely competitive reasons, such intermediaries are unlikely to disclose willingly the identities of the participants in or beneficiaries of an account. A contrary position, therefore, requiring FCMs to institute a customer identification program with respect to the underlying participants or beneficiaries in such accounts, would impose an insurmountable burden on FCMs.

The rationale supporting reliance on these intermediaries is equally compelling when the intermediary is a foreign broker or a foreign collective investment vehicle, although the factors an FCM should take into account in assessing such intermediaries obviously differ. In this regard, consistent with the Agencies’ earlier position, we respectfully submit that, provided the non-US intermediary operates in a jurisdiction that is a member of the Financial Action Task Force (“FATF”) and the US FCM has no reason to know that the intermediary is not fulfilling its obligations under applicable laws and regulations, US FCMs should be able to rely on such intermediaries. Of course, if the US FCM has any knowledge that would cause it to conclude that its reliance is not reasonable, the US FCM could not rely on the non-US intermediary’s customer identification program simply because the non-US intermediary conducts business from a jurisdiction that is a member of FATF.[7]

Fully Disclosed Accounts

The previous discussion assumes a relationship between an FCM and an intermediary in which the FCM generally acts as an agent for the intermediary alone and has “little or no information about the identities and transaction activities of the underlying participants or beneficiaries of such accounts.” There are circumstances, however, in which the intermediary and the FCM each have a direct relationship with the underlying customer. Each performs services directly for and on behalf of the customer. For example, an advisor will have discretionary trading authority over a customer’s account, which is carried by an FCM. Similarly, an introducing broker will introduce a customer’s account to an FCM.

In each instance, the FCM carries the customer’s account on a fully disclosed basis. It is the introducing broker or advisor, however, that, from a practical standpoint, has the more direct relationship with the customer and is in a better position to undertake the procedures necessary to verify the customer’s identity.[8] In these circumstances, consistent with the Treasury’s risk-based approach to customer identification programs, FIA submits that the FCM, in appropriate circumstances, may reasonably rely on the intermediary with which it shares a customer to verify the identity of the customer.[9]

This is especially true where the introducing broker or advisor is located in the US. Such intermediaries are “financial institutions” under the USA PATRIOT Act and, therefore, are now or will be subject to substantially the same anti-money laundering requirements as FCMs. Under the Treasury’s risk-based approach, an FCM on the one hand and an advisor or introducing broker on the other, each of which has a direct relationship with the owner of an account, should be permitted to allocate responsibility between them for verifying the identity of the customer.[10] This approach will also reduce the administrative burden on legitimate customers that otherwise could have to respond to numerous identification verification inquiries.

Although non-US advisors and introducing brokers are not subject to the USA PATRIOT Act and the regulations promulgated thereunder, they are, in many cases, subject to a comparable anti-money laundering regulatory scheme. We submit, therefore, that, in appropriate circumstances, the regulations implementing the PATRIOT Act should permit a US FCM and a non-US advisor or broker to agree that the advisor or broker will perform the customer verification function. Specifically, as we urged above with respect to intermediated accounts, provided the non-US advisor or broker operates in a FATF member jurisdiction and the US FCM has no reason to know that the intermediary is not fulfilling its obligations under applicable laws and regulations, US FCMs should be able to rely on such intermediaries.[11] We understand that this approach, whether with respect to US advisors or introducing brokers or non-US advisors or brokers, does not relieve an FCM of the obligation to verify the identity of its customers. It simply permits the FCM to rely upon another party to perform this function when such reliance is reasonable.[12]

Give-Up Relationships

As indicated above, one type of relationship involving multiple intermediaries is the so-called give-up relationship. In a give-up relationship, a customer elects to execute transactions through one or more FCMs, known as executing brokers. The executing broker then “gives-up” the trade to another FCM, known as the carrying or clearing broker, which (a) carries the customer’s account and (b) is responsible for handling such customer’s funds.[13]

Give-up arrangements first evolved in the United States where, on New York exchanges, booths for receiving customer orders on the trading floors were dominated by independent floor brokers, not exchange member FCMs. These floor brokers would solicit the execution business of institutional customers directly from such customers independent of the FCMs that cleared the customers’ accounts. The practice spread to the Chicago exchanges, as floor brokers there competed for execution business. Various FCMs initially became involved as executing brokers in their capacities as primary clearing members for the floor brokers that executed the customers’ trades. They soon recognized execution business as an important additional source of revenue and began to compete with other clearing firms for that portion of the customers’ business.[14] With the transition from trading floors to electronic trading platforms, the role of the floor broker obviously has diminished. The competition for execution business nevertheless remains strong.[15]

Give-up arrangements generally fall within one of two types, each of which involves directly three parties. The executing FCM and the carrying broker are participants in each type of arrangement. In one, however, the third party is the customer; in the other, the third party is the customer’s advisor to which the customer, more often than not a large institutional customer, has granted discretionary trading authority, including the authority to enter into give-arrangements on the customer’s behalf. Typically, in these latter circumstances, the identity of the customers on whose behalf it is acting are not disclosed to the executing FCM. Only the carrying broker will know the identity of the advisor’s customers. The executing FCM will know only the customers’ account numbers or an identifier for bunched orders placed on behalf of multiple accounts over which the advisor exercises discretionary trading authority. The substantial number of give-up arrangements today fall into this latter category.[16]

In a give-up arrangement, therefore, it is the carrying broker that has the more direct, more comprehensive relationship with the customer. Only the carrying broker: (1) enters into an account agreement with the customer, establishing the parties’ respective rights and obligations, and in the process, conducts a credit review and obtains documentation from the customer covering areas such as identity verification, legal entity structure and authority to trade; (2) is responsible for maintaining records of, and is able to monitor on a daily basis, each of the customer’s transactions that it carries; and (3) most important for purposes of the anti-money laundering programs, accepts customer funds to margin or secure such transactions and disburses such funds in accordance with the customer’s instructions. We respectfully urge Treasury to conclude that, in cases involving give-up arrangements and particularly in light of the discreet function that the executing FCM plays in the customer relationship, executing FCMs and carrying brokers may allocate responsibility for fulfilling their mutual customer identification obligations.[17]

The Effect on International Give-Up Relationships

The ability to allocate this responsibility among parties to a give-up arrangement is essential to an efficient international market structure. For example, a customer in London that has an account with a UK carrying broker may enter into a give-up relationship with a London-based executing broker to execute transactions on its behalf both in the UK and the US (or the customer may begin the relationship solely for the purpose of executing transactions on European exchanges and determine at a later time to use the executing broker for transactions in the US). In either case, the UK executing broker will use its US affiliate to execute trades in the US. (Typically, the customer will call the US executing broker directly.) Similarly, the UK carrying broker usually will use its US affiliate to clear the trades and then pass them through the customer omnibus account that the UK carrying broker maintains with its US affiliate.