CME rules require that proprietary trading be conducted by bona-fide employees. Recently, several issues have been raised regarding the "employee" requirement for proprietary trading qualifying for preferential clearing fees. Such concerns extend to proprietary trading conducted by clearing members, in-active clearing members, and Rule 106.H., I., J., and N. members.

Our marketplace, both the trading environment and customer base, has evolved and expanded over the years. We have seen a tremendous growth in interest from proprietary trading groups to trade our markets electronically. With these changes, we believe it is beneficial to reiterate and solidify our requirements for proprietary trading entitled to preferential clearing fees.

In order to receive preferential clearing fees, proprietary trading must be conducted within the division of membership held and meet all of the following requirements:

1. Only bona-fide employees and owners of the firm may conduct the proprietary trading activity. Bona-fide employees are evidenced through:

• Issuance of a W-2;

• Inclusion in the firm’s payroll tax records; and

• The trader has no income until the firm pays the trader.

2. The proprietary account is 100% owned by the firm. A proprietary account is evidenced through:

• Only the firm’s capital is at risk of loss - no traders may have their own capital at risk;

• All profits and losses of the account are written off to income;

• All profits and losses of the account are taxed to the firm; and

• The trader does not make any capital contribution to the account.

There are two exceptions to the above requirements. First, independent contractors and other self-employed individuals on a Rule 106.F. Employee Transfer may trade the proprietary account of a clearing member or in-active clearing member and receive equity member clearing fee rates. Second, proprietary trading activity conducted with discretion by a Rule 106.D. Futures Industry Transfer (Lessee) on the floor is charged a clearing fee rate based on the lowest level of membership status of the lessee or account owner. For example, the proprietary account of a clearing member traded by a Rule 106.D. lessee on the floor will receive Rule 106.D. clearing fee rates.

Recently it has come to our attention that independent contractors and other self-employed individuals are frequently trading the proprietary accounts of our members. Similar to employees, these individuals generally are compensated based on performance (percentage of profits) and have no responsibility for loss in the account. However, as an independent contractor, a trader is compensated through a Form 1099 and may receive favorable capital gains tax treatment. Thus, the trader receives a benefit of membership.

In order to clearly and accurately establish the account as a proprietary account of the member (versus a joint account), the proprietary trading must be conducted by employees of the firm. Keep in mind that a member trader and member firm may have a joint account and receive preferential clearing fee rates on contracts under the lowest division of membership held.

To further clarify GLOBEX and Open Outcry Exchange clearing fee policies regarding proprietary trading:

GLOBEX

Clearing fees are charged on contracts traded through GLOBEX based on the membership status of the operator and account owner except when the operator is an employee of a member firm. In such case, when a member employee is the terminal operator, the clearing fees are only based on the membership status of the account owner. The employee must be issued a W-2 and be included on the firm’s payroll records.

Thus, all proprietary trading activity conducted within the division of membership held on GLOBEX by a member firm employee is entitled to preferential clearing fees. Once again, the employee must be issued a W-2 and included on the firm’s payroll records as detailed above.

For example, a clearing member’s proprietary trading activity conducted by an employee (issued a W-2 and included on the firm’s payroll records) through GLOBEX will receive equity member clearing fee rates. However, a clearing member’s proprietary trading activity conducted by an independent contractor through GLOBEX will receive clearing fee rates based on the membership status of the operator/independent contractor – most likely customer clearing fee rates.

Open Outcry

The proprietary trading of a clearing member is entitled to equity member rates on all contracts when an employee owning a membership conducts it on the floor of the Exchange. All proprietary trading activity conducted on the Exchange floor by an Rule 106.F. Employee Transfer member is entitled to equity member clearing fees regardless if the Rule 106.F. member is an employee or not of the clearing member. Finally, the proprietary trading of a clearing member conducted with discretion by a Rule 106.D. Futures Industry Transfer (Lessee) on the floor will be charged Rule 106.D. lessee clearing fees regardless if the Rule 106.D. lessee is a clearing member employee or not.

Implementation

All proprietary trading must conform to Exchange policy in order to receive preferential clearing fee rates. As much of the proprietary activity is currently being conducted by independent contractors and other self-employed individuals, we are allowing a grace period until June 30, 2002 for all such traders to be converted to employees issued a W-2 and included on the firm’s payroll records unless they are trading on a Rule 106.F. membership. In order to qualify for the preferential clearing fees on proprietary trading, the above requirements must be met by June 30, 2002. Thereafter, these policies will be strictly enforced.

During the first week of June 2002, you will receive a letter reiterating these policies. In addition, you will be asked to return an attestation that your firm either does not conduct proprietary trading activity or that all of your firm’s proprietary trading activity is conducted by employees issued W-2s and included on the firm’s payroll records or by traders on Rule 106.F. memberships. The attestations will be due back to the Audit Department by June 30, 2002.

If you have any questions, please contact the Audit Department at (312) 930-3230 or e-mail us at audits@cme.com.