Commodity Futures Commission Comments on CBOE Letter

[1] In the above-referenced comment letter, the Chicago Board Options Exchange ("CBOE"), set forth three criteria which it stated it believed should be met for a person or entity to qualify as a "dealer" in security futures contracts ("SFCs"), for purposes of Section 1256 of the Internal Revenue Code. The Commodity Futures Trading Commission (the "Commission" or "CFTC") wishes to clarify the record as to the net capital treatment of floor trader accounts at a futures commission merchant ("FCM") under the Commission's net capital rule.

[2] On page 3, paragraph 1 of the CBOE letter, it is stated that a securities firm carrying the trades of an options market-maker must take an "immediate capital haircut for the positions held in the market-maker's account." The paragraph goes on to state that ". . . the requirement in the CFTC's net capital rule for an FCM that clears the trades of a floor trader at a futures exchange is significantly more relaxed." Exhibit A to the letter, page A-3, provides the CBOE's basis for its view that the CFTC rule is more relaxed than the net capital rule of the Securities and Exchange Commission ("SEC") as it applies to the accounts of options market makers. The Commission believes that the explanation provided below of how the net capital rule is applied to the accounts of floor traders at an FCM suggests a different conclusion would be appropriate.

[3] In particular, two statements contained in the letter should be addressed. First, although the CBOE is correct where, on page A-3, it states: "The CFTC's net capital rule applies to FCMs and non- guaranteed introducing brokers; it does not apply to floor traders.", the Commission believes this statement could mislead the reader by implying that the CFTC's net capital rule does not address the risk of floor trader accounts. For FCM net capital purposes, the account of a floor trader is classified as a "customer" account. Therefore, floor trader accounts are included in the determination of an FCM's capital requirements and in the calculation of any capital charges. That is, the equity in the account enters into the calculation of the minimum financial requirements and charges are taken for being under margin requirements and for being in deficit, if applicable. As explained below, the net capital treatment of floor trader accounts applies to under-margin account charges and the futures regulators do not permit sham transactions in customer accounts to obviate such charges.

[4] Second, the CBOE appears to have misunderstood the application of CFTC rules where, at the bottom of page A-3 its letter states: ". . . the FCM that clears the transactions of a futures floor trader CAN AVOID ANY CAPITAL CHARGE for the floor trader's transactions simply by having the floor trader liquidate the positions that gave rise to a margin call during the three-day grace period. The floor trader can then establish another position, liquidate that position within four days, and repeat the process again and again, without ever creating a capital charge for himself or his FCM clearing firm." In fact, an FCM must take an under-margin account charge for any under-margin account and an account would be considered under-margined if the customer (including a floor trader) had not submitted funds to meet a margin call. Although the CBOE is correct in noting that a customer (including a floor trader) has a three-day grace 1 period in which to submit its margin payment, futures industry regulatory requirements permit the grace period only if a margin call is bona fide. A margin call would not be considered bona fide if it is "met" by liquidating positions that are re- instated shortly afterwards. Therefore, the result of the correct application of the Commission's capital rule is that FCMs are not permitted to avoid capital charges in this way. Please see attached Exhibit A for further references and explanation regarding application of the Commission's net capital rule in this regard.

[5] Because of the complexity of the CFTC and SEC capital rules, the Commission suggests that both agencies be jointly consulted before any conclusions are reached regarding the operation of these rules. The Commission would be happy to participate in further analysis and discussions of this issue.

Sincerely,