foi060707a
[Federal Register: July 7, 2006 (Volume 71, Number 130)]
[Proposed Rules]
[Page 38739-38751]
From the Federal Register Online via GPO Access [wais.access.gpo.gov]
[DOCID:fr07jy06-29]
[[Page 38739]]
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Part IV
Commodity Futures Trading Commission
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17 CFR Part 38
Conflict of Interest in Self-Regulation and Self-Regulatory
Organizations; Proposed Rule
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COMMODITY FUTURES TRADING COMMISSION
17 CFR Part 38
RIN 3038-AC28
Conflicts of Interest in Self-Regulation and Self-Regulatory
Organizations
AGENCY: Commodity Futures Trading Commission ("Commission").
ACTION: Proposed Acceptable Practices for compliance with section
5(d)(15) of the Commodity Exchange Act ("CEA" or "Act").\1\
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\1\ Acceptable Practices for the Core Principles reside in
Appendix B to Part 38 of the Commission's Regulations, 17 CFR part
38, App. B.
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SUMMARY: The Commission hereby proposes Acceptable Practices for
section 5(d)(15) of the Act ("Core Principle 15").\2\ The proposed
Acceptable Practices would provide designated contract markets
("DCMs") with a safe harbor for compliance with selected aspects of
Core Principle 15's requirement that they minimize conflicts of
interest in their decisionmaking. The proposed Acceptable Practices are
summarized as follows.
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\2\ Core Principle 15 for designated contract markets provides
as follows: "CONFLICTS OF INTEREST--The board of trade shall
establish and enforce rules to minimize conflicts of interest in the
decisionmaking process of the contract market and establish a
process for resolving such conflicts of interest." CEA Sec.
5(d)(15), 7 U.S.C. Sec. 7(d)(15).
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First, the Board Composition Acceptable Practice proposes that
exchanges minimize potential conflicts of interest by maintaining
governing boards composed of at least fifty percent "public"
directors, as defined below. Second, the proposed Regulatory Oversight
Committee Acceptable Practice calls upon exchanges to establish a
board-level Regulatory Oversight Committee, composed solely of public
directors, to oversee regulatory functions. Third, the Disciplinary
Panel Acceptable Practice proposes that each disciplinary panel at all
exchanges include at least one public participant, and that no panel be
dominated by any group or class of exchange members.\3\ Finally, the
proposed Acceptable Practices provide a definition of "public" for
exchange directors and for members of disciplinary panels.
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\3\ See CEA Section 1a(24), 7 U.S.C. 1a(24) (defining the term
"member" to include both exchange members and non-member market
participants with trading privileges); see also 17 CFR 1.3(q).
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Collectively, the proposed Acceptable Practices promote
independence in decisionmaking by self-regulatory organizations
("SROs"),\4\ and constitute a proactive yet measured step toward
ensuring that SROs maintain fair, vigorous, and effective self-
regulation in a rapidly evolving futures industry. The Commission
welcomes comment on the proposed Acceptable Practices.\5\
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\4\ For purposes of these Acceptable Practices, the term
"SROs" refers to DCMs and is used interchangeably with the terms
"exchanges," "boards of trade" and "contract markets." As part
of its SRO study, the CFTC considered whether the current level of
"public" representation on boards of registered futures
associations ("RFAs") is still sufficient. That question and
related issues concerning RFAs remain under review and will be
addressed separately.
\5\ This Release is the latest development in the Commission's
SRO review that commenced in May 2003. The Acceptable Practices
proposed herein are based on comments received in response to prior
requests for comments published in the Federal Register, interviews
with industry participants, testimony given at a February 15, 2006
public hearing before the Commission, and other sources identified
herein as part of the basis for the instant proposals. Prior Federal
Register releases, responses thereto, the hearing transcript, and a
summary of interview comments, described with greater specificity
elsewhere herein, are available on the Commission's Web site at
http://www.cftc.gov, or are available through the Acting Secretary of the
Commission, whose name and address are listed above.
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DATES: Comments should be submitted on or before August 7, 2006.
ADDRESSES: Comments should be sent to Eileen Donovan, Acting Secretary,
Commodity Futures Trading Commission, Three Lafayette Centre, 1155 21st
Street, NW., Washington, DC 20581. Comments may be submitted via e-mail
at [email protected]. "Regulatory Governance" must be in the subject
field of responses submitted via e-mail, and clearly indicated in
written submissions. Comments may also be submitted at http://www.regulations.gov.
FOR FURTHER INFORMATION CONTACT: Rachel F. Berdansky, Acting Deputy
Director for Market Compliance, (202) 418-5429; or Sebastian Pujol
Schott, Special Counsel, (202) 418-5641, Division of Market Oversight,
Commodity Futures Trading Commission, Three Lafayette Centre, 1155 21st
Street, NW., Washington, DC 20581.
SUPPLEMENTARY INFORMATION:
Table of Contents
I. Introduction
II. The SRO Review
A. Procedural History of the SRO Review
B. Issues Raised by the SRO Review
III. Description of Proposed Acceptable Practices
A. Board Composition; "Public" Director Defined
B. Regulatory Oversight Committee
C. Disciplinary Panels
IV. Analysis of Issues and Rationale for Acceptable Practices
A. Board Composition; "Public" Director
B. Regulatory Oversight Committee
C. Disciplinary Panels
V. Related Matters
A. Cost-Benefit Analysis
B. Regulatory Flexibility Act
C. Paperwork Reduction Act of 1995
VI. Text of Proposed Acceptable Practices
I. Introduction
Exchanges are "affected with a national public interest" in that
they "provid[e] a means for managing and assuming price risks,
discovering prices, or disseminating pricing information through
trading in liquid, fair, and financially secure trading facilities."
\6\ Exchanges are also the front-line regulators in the U.S. futures
industry.\7\ There are potential conflicts of interest inherent in an
exchange's responsibilities as a regulator of its market and members,
and the commercial interests embedded in its market operation.
Nevertheless, with proper checks and balances to address such
conflicts, coupled with vigilant Commission oversight, self-regulation
can continue to serve as an effective and efficient means of promoting
market integrity.
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\6\ CEA Section 3(a), 7 U.S.C. Sec. 5(a).
\7\ CEA Section 3(b), 7 U.S.C. Sec. 5(b).
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Increasing competition,\8\ changing ownership structures,\9\ and
evolving
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business models are dramatically transforming the U.S. futures
industry. Today U.S. futures exchanges must compete vigorously with
other exchanges, electronic trading facilities and foreign markets to
attract order flow, and also must meet customer demand for twenty-four
hour trading, immediate order execution, lower transaction costs, and
access to global markets. This heightened competition places strain on
exchanges' dual roles as regulators and as markets, and raises
questions about their ability to deal with pressures to subordinate
regulatory responsibilities to commercial imperatives. The trend
towards demutualization represents an additional challenge to
exchanges' performance of self-regulatory duties. Traditional SRO
conflicts have been joined by the possibility that self-regulatory
functions may be marginalized by potentially conflicting commercial
interests.\10\
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\8\ Increasing competition exists between U.S. and foreign
exchanges, and between domestic exchanges. The New York Mercantile
Exchange ("NYMEX") and the IntercontinentalExchange offer
competing contracts in Brent and WTI crude futures. Euronext.liffe,
a subsidiary of Euronext, and the Chicago Mercantile Exchange
("CME") offer competing Eurodollar contracts. Within the U.S., the
Chicago Board of Trade ("CBOT") and NYMEX offer several competing
gold and silver contracts.
New exchanges comprise a further source of new competition.
Since 2002, the Commission has designated six new contract markets,
all of which entered the marketplace as non-mutual, for-profit
entities. There is also competition between trading formats--open
outcry and electronic. NYMEX gold and silver contracts, for example,
trade primarily on the floor of the exchange, while CBOT offers its
gold and silver contracts only electronically. In addition, the new
contract markets referred to above trade only electronically, and
electronic trading now accounts for over 60% of all trading volume
on U.S. futures exchanges.
Finally, enhanced competition is evident between exchanges and
their large, institutional futures commission merchant ("FCM")
members. They may compete directly, with FCMs internalizing order
flow or exchanges disintermediating FCMs. They may also compete
indirectly, as occurs, for example, when FCMs establish or invest in
new exchanges offering substitutable contracts. Examples include the
Cantor Financial Futures Exchange (no longer trading), designated in
1998; BrokerTec Futures Exchange, designated in 2001; and U.S.
Futures Exchange, designated in 2004. The FCM-owners of new
exchanges may both compete against, and be subject to the regulation
of, the established SROs of which they are members.
\9\ The principal change in ownership structure is the
demutualization of member-owned exchanges and their conversion to
publicly traded stock corporations. In December 2002, CME became the
first U.S. futures exchange to transform from a membership mutual
organization to a publicly traded, for-profit entity. Class A shares
of its parent company, CME Holdings, Inc., are now listed on the New
York Stock Exchange ("NYSE"). In October 2005, after undergoing a
similar restructuring, the CBOT became the second U.S. futures
exchange to demutualize and offer its parent's stock for trading on
the NYSE.
While demutualization has been an important development for the
largest and most well-established futures exchanges, the advent of
exchanges structured as for-profit limited liability companies
("LLCs") is another significant trend.
\10\ Five domestic and international studies reviewed by the
Commission address this issue, and are noteworthy for the extent to
which they parallel concerns raised by futures industry
participants. Although the studies focus primarily on the securities
industry, some include futures markets as well, and the Commission
believes that the concerns raised by demutualization and competition
may be similar for both the futures and securities industries and
exchanges.
The Securities Industry Association's ("SIA") White Paper on
Reinventing Self-Regulation, (Jan. 5, 2000, updated Oct. 14, 2003),
observed, "the combined roles of SROs as market overseers and as
competitors may affect SROs" ability and willingness to perform all
their regulatory functions adequately, fairly, and efficiently"
(SIA 2003 at 3).
The International Organization of Securities Commissions"
("IOSCO") Issues Paper on Exchange Demutualization, (June 2001),
determined that although many concerns with respect to self-
regulation are not new, "demutualization and increased competition
may exacerbate them" (IOSCO at 5).
A U.S. Government Accountability Office's ("GAO") report to
Congress entitled "Securities Markets: Competition and Multiple
Regulators Heighten Concerns about Self-Regulation (May 2002) found
that some securities SRO members were "concerned that SROs could
adopt rules that unfairly impeded the ability of members to compete
against the SROs." Others were concerned that "an SRO, in its
regulatory capacity, could obtain proprietary information from a
member and, in its capacity as a market operator, inappropriately
use the information" (GAO at 7). Some securities SRO members also
expressed concern that "a demutualized, for-profit market operator
might be more likely to misuse its regulatory authority or be less
diligent in fulfilling its regulatory responsibilities in a desire
to increase profits" (GAO at 8). Abuse of authority could be
manifested, for example, through "rules that unfairly disadvantage
members or other markets or inappropriately sanction or otherwise
discipline members against which the SROs compete." (Id.)
A discussion paper prepared for the World Bank's ("WB")
Financial Sector Strategy Department by an independent consultant,
Implications of Demutualization for the Self-Regulatory and Public
Interest Roles of Securities Exchanges (John W. Carson, January
2003) (not necessarily representing the views or policies of the
World Bank), identified four "widely accepted" propositions with
respect to conflicts of interest and demutualization: (1) Conflicts
of interest in self-regulation have always existed; (2)
demutualization may increase the degree of those conflicts; (3)
demutualization introduces new conflicts of interest; and (4)
demutualization may reduce old conflicts (WB at 8). The World Bank
Study offered several recommendations with respect to self-
regulation: (1) "At a minimum, the threat of increased conflict in
exercising regulatory authority demands that new safeguards be put
in place to reduce the possibility of either the business units or
customers attempting to influence regulatory decisions;" (2) it is
imperative that decisions on opening investigations, when to expand
or close investigations, when to pursue disciplinary action, and
what penalty to seek are all made in an independent and unbiased
manner, without regard to business considerations and impact on
important customer relationships;" and (3) "strong measures are
required to ensure that the integrity of an exchange's regulatory
program is maintained and that it handles regulatory issues and
decisions in a neutral and unbiased mnaner" (WB at 42-43).
Finally, an International Monetary Fund ("IMF") Working Paper,
Demutualization of Securities Exchanges: A Regulatory Perspective
(Jennifer Elliott, September 2002) (not necessarily representing the
views of the IMF) identified two broad conflicts of interest
associated with demutualization. According to the Working Paper,
"the forces that have generated pressure on exchanges to
demutualize have also created new conflicts of interest and forced
regulators and exchanges to reconsider what and how regulatory
functions are delivered by the exchanges" (IMF at 7). One new
conflict of interest is that "shareholders, who are interested in
profit, may under fund the exchange's regulatory function. While in
theory, the exchange should only benefit from an adequate regulatory
standards [sic], exchanges may succumb to competitive pressure."
(IMF at 16). "The second conflict of interest is the disincentive
to regulate market participants (who represent order flow and are a
direct source of revenue for the exchange)" (Id).
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In view of these developments, the Commission conducted a review of
self-regulation in the futures industry to consider whether, and how,
SROs can continue to fulfill their statutorily-mandated
responsibilities as regulators.\11\ Three key principles emerged from
this review. First, self-regulation continues to be the most effective
and efficient regulatory model available to the futures industry; the
self-regulatory system nevertheless must be updated and enhanced, as
appropriate and necessary, to keep pace with the changing marketplace.
Second, market forces, driven by global competition and changing
ownership structures, pose a heightened risk that SROs may fail to
fairly and vigorously carry out their regulatory responsibilities; such
conflicts, whether actual or perceived, must be addressed proactively
in the first instance by the SROs themselves. Third, the current market
environment mandates enhanced and transparent governance as an
essential business practice for maintaining market integrity and the
public trust.\12\
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\11\ See Section II.A., infra.
\12\ In recent years, the U.S. financial industry has undertaken
major initiatives to strengthen corporate governance structures.
These initiatives respond, for the most part, to a perceived lack of
effective board oversight and emphasize board independence and
accountability. See Section II.B., infra.
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The Acceptable Practices proposed today constitute the Commission's
considered view of best practices relating to SRO governance and
administration in order to address the concerns raised by SROs' dual
roles in light of increasing competition and demutualization. The
Acceptable Practices promote an optimal SRO governance structure, which
would minimize the potential for conflicts with the SRO's regulatory
duties. Specifically, the Acceptable Practices would ensure that there
is adequate independence within the SRO's board to insulate regulatory
functions from the interests of the exchange's management, members, and
other business interests of the market itself. An SRO is not simply a
corporation, but a corporation charged with the public trust. As such,
the board--the governing body of the SRO--must be structured in a way
that best fosters public confidence in the integrity of its
organization, and further, ensures that SRO functions take no less
preeminence than that accorded to the exchange's commercial interests.
The Acceptable Practices also would enhance the role of outside
impartiality in other key SRO functions, including a board-level
Regulatory Oversight Committee ("ROC") and disciplinary panels, to
further enhance the transparency and accountability of SRO decisions
impacting self-regulation. Finally, the proposed Acceptable Practices
carefully define "public" directors to identify those who can help
ensure that SRO regulatory programs remain effective, yet unburdened by
potential conflicts or pressures from the exchange's commercial or
member interests.
In summary, the Acceptable Practices proposed today are measured
steps--in the form of carefully-tailored internal safeguards and checks
and balances--to promote the independence of SRO functions. At the same
time, they ensure that industry expertise, experience, and
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knowledge continue to play a vital role in SRO governance and
administration and thus, preserve the "self" in self-regulation. In
this manner, these proposed Acceptable Practices keep pace with
changing market dynamics and proactively ensure that the self-
regulatory model remains as vigorous, as fair, and as effective as
required to protect the integrity of U.S. futures markets and the
public confidence in them for years to come.
II. The SRO Review
A. Procedural History of the SRO Review
The Commission's Acceptable Practices are based on a comprehensive
review of self-regulation and SROs in the U.S. futures industry ("SRO
Review"). Phase I of the SRO Review explored the roles,
responsibilities, and capabilities of SROs in the context of industry
changes. Staff examined the designated self-regulatory organization
("DSRO") system of financial surveillance, the treatment of
confidential information, the composition of exchanges' disciplinary
committees and panels, and other aspects of the self-regulatory
process. At the conclusion of Phase I, the Commission identified two
issues for immediate attention: (1) An examination of the cooperative
regulatory agreement by which DSROs coordinate compliance examinations
of FCMs; and (2) ensuring the confidentiality of certain information
obtained by SROs and DSROs in the course of their regulatory
activities. Measures with respect to both issues were announced by the
Commission in February 2004. These issues are not addressed in this
release.\13\
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\13\ The most recent amendments to the DSROs' cooperative
agreement were submitted to the Commission and published for
comment. Futures Market Self-Regulation, 69 FR 19166 (Apr. 12,
2004). See also Press Release, Commodity Futures Trading Commission,
Commission Progresses with Study of Self-Regulation (Feb. 6, 2004),
available at: http://www.cftc.gov/opa/press04/opa4890-04.htm.
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After detailed interviews with an array of industry participants,
the Commission initiated Phase II of the SRO Review and broadened its
inquiry to address SRO governance and the interplay between exchanges'
self-regulatory responsibilities and their commercial interests.
In June 2004, the Commission issued a Federal Register Request for
Comments ("Request") on the governance of futures industry SROs.\14\
The Request sought input on the proper composition of exchange boards,
optimal regulatory structures, the impact of different business and
ownership models on self-regulation, the proper composition of exchange
disciplinary committees and panels, and other issues.
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\14\ Governance of Self-Regulatory Organizations, 69 FR 32326
(June 9, 2004). In this release, comment letters ("CLs") in
response to the SRO Governance Request for Comments are referred to
by the name of the party submitting the letter and page number.
These letters are available at: http://www.cftc.gov/foia/comment04/foi04--005_1.htm.
A summary of interview comments (with names of
persons interviewed redacted) also is available at this Web site.
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In November 2005, the Commission updated its previous findings
through a second Federal Register Request for Comments ("Second
Request") that focused on the most recent industry developments.\15\
The Second Request examined the board-level ROCs recently established
at some SROs in the futures and securities industries. It considered
the impact of the listing standards of the New York Stock Exchange
("NYSE") on publicly-traded futures exchanges; whether the standards
were relevant to self-regulation; and how the standards might inform
the Commission's own regulations. The Second Request also explored the
role of outside regulatory service providers, including RFAs, and SRO
governance and the composition of boards and disciplinary committees.
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\15\ Self-Regulation and Self-Regulatory Organizations in the
Futures Industry, 70 FR 71090 (Nov. 25, 2005). Comment letters
received in response to this release are available at http://www.cftc.gov/foia/comment05/foi05--007_1.htm.
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Phase II of the SRO Review concluded with a public Commission
hearing on "Self-Regulation and Self-Regulatory Organizations in the
U.S. Futures Industry" ("Hearing"). The day-long Hearing, held at
Commission headquarters in Washington, DC on February 15, 2006,
included senior executives and compliance officials from a wide range
of U.S. futures exchanges, representatives of small and large FCMs,
academics and other outside experts, and an industry trade group. The
Hearing afforded the Commission an opportunity to question panelists on
four broad subject areas: (1) board composition; (2) alternative
regulatory structures, including ROCs and third-party regulatory
service providers; (3) transparency and disclosure; and (4)
disciplinary committees.\16\
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\16\ The Hearing Transcript ("Hearing Tr.") is available at
http://www.cftc.gov/files/opa/opapublichearing021506final.pdf.
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B. Issues Raised by the SRO Review
The SRO Review provided the Commission staff and industry
participants and observers a unique opportunity to comment on the
present state of self-regulation in the U.S. futures industry. Through
interviews with over 100 industry participants and observers, comments
received in response to Federal Register notices, and the Hearing, the
Commission gathered a wide range of views on the successes and
challenges facing self-regulation now and into the future.
In general, commenters and interview participants saw continuing
vitality in the central premise of self-regulation: that regulation
works best when conducted close to the markets by individuals with
market-specific expertise. At the same time, though, throughout the
course of the SRO Review and in the surrounding public debate on the
merits of self-regulation in the financial sector generally, many
identified increased competition, evolving business models, and new
ownership structures as critical changes capable of adversely impacting
exchanges' regulatory behavior.\17\
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\17\ See e.g., Futures Industry Association ("FIA"), CL at 2
(Jan. 23, 2006); Comments of Professor Roberta S. Karmel, Centennial
Professor of Law, Brooklyn Law School ("Karmel"), Hearing Tr. at
32 ("[T]echnology and competition are creating more serious
conflicts and, in fact, it is these forces that propel
demutualization in the first place"); Comments of Christopher K.
Hehmeyer, Co-Chairman, Goldenberg Hehmeyer & Co., id. at 151
("[E]xchanges have done very well. But it would only take a couple
of bad quarters, God forbid, on the part of the exchanges, for there
to be pressures on some of the conflicts that haven't revealed
themselves in the past."); Comments of Susan M. Phillips, Dean,
George Washington University School of Business ("Phillips"), id.
at 116 ("Obviously, the whole exchange environment is changing
dramatically, probably more so now than at any time in history.
There are a lot of pressures on exchanges.").
See also IOSCO at 4. ("[A]s competition increases and exchanges
move from mutual or cooperative entities to for-profit enterprises,
new elements enter the environment. The commercial nature of the
exchange becomes more evident: maximizing profits becomes an
explicit objective."). Others have noted that, even absent
demutualization or for-profit exchanges, "intense competition alone
will * * * increase conflicts due to the need to reduce costs, be
more responsive to customers, and ensure that competing markets do
not gain advantage by imposing a lighter regulatory burden." WB at
31.
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Specifically, some interview and Hearing participants and
commenters expressed concern that for-profit, publicly traded exchanges
may under-invest in regulatory personnel or technology to control costs
and thereby meet the short-term expectations of stock holders and
analysts.\18\ The
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exchanges' growing conflicts may also manifest themselves in under-
regulation of those market participants who generate significant income
or liquidity for the exchange--for example, FCMs that bring significant
customer volume, market makers that provide significant liquidity, or
high-volume locals. Conversely, concerns were raised that exchange
participants who are not favored by, or compete with, the exchange may
suffer from discriminatory or over-regulation.\19\
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\18\ See, e.g., FIA CL (Jan. 23, 2006) at 1 (observing that SROs
may use their regulatory authority for anti-competitive purposes or
to adopt rules that benefit parochial interests at the expense of
the public interest); and Citigroup CL (Jan. 23, 2006) at 1-2
(echoing support for the views expressed in FIA's comment letter);
see also Comments of Jeffrey Jennings, Managing Director and Global
Head of Futures, Lehman Brothers ("Jennings"), Hearing Tr. at 53
("[A]s the exchanges become for-profit * * * we have to recognize
the issues that that raises, and the risks of there being some sort
of conflicts of interest. * * *").
\19\ Whether stemming from increased competition,
demutualization, or for-profit structures, potential conflicts of
interest in self-regulation may be all the more evident when
exchanges regulate their competitors. For example, when firms
operate their own market and also are users of an exchange, the
exchange could discriminate in disciplinary matters, trading rules,
fees, and other areas in which it has jurisdiction over the
competitor. It has been suggested that, as with other conflicts of
interest, "the conflicts inherent in an exchange regulating its
competitors, while not new, become more apparent where the exchange
is also a for-profit enterprise." IOSCO at 5.
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Exchanges, in turn, have argued that increased competition,
demutualization, and other industry developments will strengthen self-
regulation, not weaken it.\20\ They stated that their competitive
advantage rests in offering fair and transparent markets that are free
from fraud, manipulation, and other abusive practices. Exchanges also
noted that demutualization and public listing create a new class of
exchange owners whose long-term interests are aligned with effective
self-regulation and fair markets.
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\20\ See, e.g., CME CL (Jan. 23, 2006) at 2 and NYMEX CL (Jan.
23, 2006) at 3.
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Against this backdrop of market changes raising implications for
the SROs" performance of their regulatory functions, the U.S.
financial industry has seen the emergence of governance "best
practices" and standards designed to enhance corporate responsibility.
These best practices and standards are found in a wide spectrum of the
U.S. business community, ranging from securities self-regulatory
organizations to major corporations and financial participants. All of
these initiatives emphasize corporate governance as the key tool for
the fulfillment of corporate responsibilities.\21\
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\21\ See, e.g., Fair Administration and Governance of Self-
Regulatory Organizations, 69 FR 71126 (Dec. 8, 2004) ("Fair
Administration"); World Bank--Corporate Governance Principles of
Best Practices, available at: http://www.worldbank.org/html/fpd/privatesector/cg/codes.htm
; CalPERS Governance Principles, available
at: http://www.calpers-governance.org/principles/default.asp.
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The cumulative impact of an evolving industry, operating in an ever
more competitive, global environment, and the growing attention to the
need for enhanced corporate governance, provide the basis for the
Commission's review of self-regulation in the futures industry and the
Acceptable Practices proposed herein.\22\
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\22\ In the face of such developments, a Hearing participant
observed that "it is incumbent upon us all that the U.S. futures
industry establish standards that recognize and are responsive to
the realities of our changing industry and marketplace and are fair
and without any appearance of conflicts." Jennings, Hearing Tr. at
28.
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III. Description of Proposed Acceptable Practices
Section 5(d)(15) of the CEA ("Core Principle 15") requires that
exchanges "minimize conflicts of interest in the decision making
process." \23\ Underlying the Core Principle's mandate is the
recognition that management of conflicts of interest, which could
potentially compromise the independence of an exchange's decision
making, is fundamental to the effective operations of the exchange--no
less than customer protection and market integrity mandated by other
Core Principles. Core Principle 15 requires the exchanges to have
systems in place to address not only an individual's personal conflicts
of interest, but also the broader potential conflicts of interest
inherent in self-regulation.
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\23\ Any board of trade that is registered with the Securities
and Exchange Commission ("SEC") as a national securities exchange,
is a national securities association registered pursuant to section
15(A)(a) of the Securities Exchange Act of 1934, or is an
alternative trading system, and that operates as a designated
contract market in securities futures products under Section 5f of
the Act and SEC Regulation 41.31, is exempt from the core principles
enumerated in Section 5 of the Act, and the Acceptable Practices
thereunder.
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As discussed earlier, with respect to SROs that operate as both
markets and front-line regulators, these conflicts may be further
exacerbated by emerging market trends. At present, however, there are
no Acceptable Practices for Core Principle 15. The Commission's core
mission is to promote and protect the integrity of the U.S. futures
markets and to promote public confidence and trust in those markets.
Now, as the futures industry undergoes one of the most significant
transformations in its long history, self-regulation must keep pace.
Accordingly, the Commission believes that it is appropriate and
necessary to provide guidance to SROs in the form of Acceptable
Practices for Core Principle 15.
Core Principle 15 is illustrative of the new regulatory approach
ushered in by the Commodity Futures Modernization Act of 2000
("CFMA"),\24\ which replaced prescriptive rules governing futures
exchanges with broad, flexible core principles. The core principles set
standards of performance for the exchanges, and at the same time, allow
exchanges considerable leeway in how to meet those standards. To
facilitate compliance, the Commission has adopted Acceptable Practices
for other core principles. Through its Acceptable Practices, the
Commission provides exchanges with a safe harbor for complying with
selected requirements of a core principle, but such Acceptable
Practices, as stated in the Act, are not the exclusive means for
compliance.\25\ Once implemented, Acceptable Practices provide
regulatory certainty that exchanges may rely upon when seeking
designation as contract markets or when subject to periodic Rule
Enforcement Reviews by the Commission.\26\
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\24\ Appendix E of Pub. L. No. 106-554, 114 Stat. 2763 (2000).
\25\ See CEA Section 5c(a)(2), 7 U.S.C. Sec. 7a-2(a)(2).
\26\ The Commission has explained that "boards of trade that
follow the specific practices outlined under [the Acceptable
Practices] * * * will meet the selected requirements of the
applicable core principle." 17 CFR part 38, App. B, ] 2.
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The Acceptable Practices proposed in this Release are designed to
offer exchanges a roadmap for complying with selected requirements of
Core Principle 15. The Acceptable Practices that we propose today would
enable SROs to demonstrate that they are structurally capable of
protecting their regulatory functions and decision making from
conflicts of interest.\27\
As with Acceptable Practices generally, exchanges may choose not to
comply with the proposed Acceptable Practices for Core Principle 15.
They still will be required, however, to demonstrate that their
policies and practices with respect to governance and decision making
are in compliance with Core Principle 15 by other means.\28\
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\27\ In recent amendments to Appendix B of Part 38, the
Commission has explained that "the enumerated acceptable practices
under each core principle are neither the complete nor the exclusive
requirements for meeting that core principle. With respect to the
completeness issue, the selected requirements in the acceptable
practices section of a particular core principle may not address all
the requirements necessary for compliance with the core principle."
Technical and Clarifying Amendments to Rules for Exempt Markets,
Derivatives Transaction Execution Facilities and Designated Contract
Markets, and Procedural Changes for Derivatives Clearing
Organization Registration Applications, 71 FR 1953, 1958 (Jan. 12,
2006). The Acceptable Practices that we propose today do not reach,
and are not intended to reach, individual, personal conflicts of
interest. A contract market must address these conflicts as well as
the structural conflicts that are the subject of these proposed
Acceptable Practices in order to demonstrate full compliance with
Core Principle 15's requirements.
\28\ In this regard, the CFTC will take into account the
governance and regulatory conflicts of interests specific to the
exchange and how they are being managed.
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[[Page 38744]]
The elements of the proposed Acceptable Practices under Core
Principle 15 are summarized below. The Commission proposes as a new
Acceptable Practice under Core Principle 15 that at least fifty percent
of the board members of exchanges' boards of directors and executive
committees (or similarly empowered bodies) be "public" directors, as
defined below ("Board Composition Acceptable Practice"). Day-to-day
regulatory operations should be supervised by a Chief Regulatory
Officer ("CRO") reporting directly to a ROC ("Regulatory Oversight
Committee Acceptable Practice"). The Acceptable Practices define
"public director" for persons serving on boards, ROCs, and
disciplinary panels. An individual may qualify as a public director
upon an affirmative determination by the board that the individual has
no material relationship with the exchange.
In addition, the Acceptable Practices strengthen impartial
adjudication by providing that SRO disciplinary panels should not be
dominated by any group or class of SRO participants, and that each
panel should include at least one public member ("Disciplinary Panel
Acceptable Practice"). By increasing the public voice on governing
boards and disciplinary committees and creating an independent board-
level ROC, combined with Commission oversight, the Acceptable Practices
seek to maintain the existing high standards of fair and effective
self-regulation in the futures industry, while proactively adapting
them to the market and business realities of a new era for the
industry. Each of these Acceptable Practices is described below.
A. Board Composition; "Public" Director Defined
The Board Composition Acceptable Practice provides that exchanges
should elect governing boards composed of at least fifty percent public
directors. In addition, it provides that SROs' executive committees (or
similarly empowered bodies) should be at least fifty percent public.
The Acceptable Practice offers guidance on the definition of
"public" director. The proposed definition provides that a director
is "public" only if the board of directors affirmatively determines
that the director has no "material relationship" with the exchange.
The nominating committee of the board of directors should affirmatively
determine on the record that a director or nominee has no material
relationship with the exchange, and should state on the record the
basis for its determination and the scope of its scrutiny. The
committee should reevaluate that determination at least on an annual
basis.
"Material relationships" are those that reasonably could affect
the independent judgment or decision making of the director. Material
relationships are not exclusively compensatory or financial. Any
relationship between a director and the exchange that may interfere
with a director's ability to deliberate objectively and impartially on
any matter is a material relationship. In this regard, material
relationships are not limited to those where a director has an
immediate interest in a particular matter before him or her.
In addition to the general materiality test, the proposed
definition of "public" director identifies specific circumstances or
relationships that would preclude a determination that a person
qualifies as a "public" director. Specifically, a director could not
be "public" if any of the following circumstances existed: \29\
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\29\ These specific circumstances--or "bright-line" tests--are
neither exclusive nor exhaustive. A director does not qualify as
"public" unless the board affirmatively determines that the
director has no material relationship with the exchange, including
but not limited to, the bright-line tests identified herein.
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--The director is an officer or employee of the exchange or a director,
officer or employee of its affiliate; \30\
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\30\ As used in this context, an affiliate includes parents or
subsidiaries of the contract market or entities that share a common
parent with the contract market.
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--The director is a member of the exchange, or a person employed by or
affiliated with a member. In this context, a director is affiliated
with a member if the director is an officer or director of the member;
--The director receives more than $100,000 in payments from the
exchange, any affiliate of the exchange, or a member or anyone
affiliated with a member; \31\
--Any of the relationships above apply to a member of the director's
immediate family, i.e., spouse, parents, children, and siblings.
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\31\ Compensation for services as a director will not be counted
towards the $100,000 threshold test.
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--All of the disqualifying circumstances described above are subject to
a one-year look back. Thus, for example, a director who, within the
past year, was a member of the exchange, would not qualify as a
"public" director.
Comments are solicited on whether there are additional categories
of circumstances which should automatically disqualify a person from
consideration as a "public" director. Also, commenters have suggested
that members should not be precluded from serving as a "public"
director. They have offered as examples persons who engage in de
minimis trading, or members who lease their seats to others. The
Commission seeks the public's views on whether these or similar
circumstances could rebut the presumption of member disqualification as
a "public" director.
B. Regulatory Oversight Committee
The Regulatory Oversight Committee Acceptable Practice recognizes
the importance of insulating core regulatory functions from improper
influences and pressures stemming from the exchange's commercial
affairs. To comply with the Regulatory Oversight Committee Acceptable
Practice, every exchange should establish, as a standing committee of
its board of directors, a ROC with oversight responsibility for all
facets of the SRO's regulatory program. This includes broad authority
to oversee: (1) Trade practice surveillance; (2) market surveillance;
(3) audits, examinations, and other regulatory responsibilities with
respect to member firms; \32\ (4) the conduct of investigations; (5)
the size and allocation of regulatory budgets and resources; (6) the
number of regulatory officers and staff; (7) the compensation of
regulatory officers and staff; (8) the hiring and termination of
regulatory officers and staff; and (9) the oversight of disciplinary
committees and panels.
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\32\ SROs' regulatory responsibilities with respect to member
firms include ensuring compliance with financial integrity,
financial reporting, sales practice, recordkeeping, and other
requirements. Commission Regulation 1.52 permits cooperative
agreements among exchanges to coordinate compliance examinations of
FCMs such that each FCM is assigned a primary examiner (its DSRO).
ROCs should have authority over SROs self-regulatory functions, both
when the SROs are fulfilling SRO responsibilities and when they are
fulfilling DSRO responsibilities.
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The ROC's primary role is to assist the board in fulfilling its
responsibility of ensuring the sufficiency, effectiveness, and
independence of self-regulatory functions.\33\ In this capacity, the
ROC should have the authority, discretion and necessary resources to
conduct its own inquiries; consult directly with regulatory staff;
interview employees, officers, members, and others; review relevant
documents; retain independent legal counsel, auditors, and other
professional services; and otherwise exercise its independent analysis
and
[[Page 38745]]
judgment to fulfill its regulatory obligations.\34\
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\33\ In its review of exchanges for compliance with Core
Principles, the Commission will look at board documentation of the
reasons for its actions and its acceptance or rejection of
recommendations by the ROC, as well as by other committees.
\34\ Nevertheless, a ROC should not rely on outside
professionals or firms that also provide services to the full board,
other board committees, or other units of the exchange.
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ROCs would be expected to identify aspects of the regulatory scheme
that work well and those that need improvement, and, as necessary, to
make recommendations to the governing board for changes that would
ensure fair, vigorous, and effective regulation. ROCs should also be
given an opportunity to review and, if they wish, present formal
opinions to management and the board on any proposed rule or
programmatic changes originating outside of the ROCs, but which their
CROs believe may have a significant regulatory impact.\35\ Exchanges
should provide their CROs and ROCs with sufficient time to consider
such proposals before acting on them. In addition to periodic reports
to the board, ROCs should prepare for the governing board and the
Commission an annual report assessing the effectiveness, sufficiency,
and independence of the SRO's regulatory program, including any
proposals to remedy unresolved regulatory deficiencies. ROCs are also
expected to keep thorough minutes and records of meetings,
deliberations, and analyses, and make these available to Commission
staff upon request.\36\
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\35\ ROCs' deliberations with respect to such proposed rule
changes should be memorialized in thorough meeting minutes, and
their formal opinions made available to Commission staff upon
request.
\36\ The Commission's review of Core Principle 15 compliance
will include, inter alia, the ROC's records, annual reports, meeting
minutes, analyses conducted or commissioned by the ROC, examinations
of proposed and existing rules, and evaluations and recommendations
concerning the effectiveness, sufficiency, and independence of the
exchange's regulatory programs. See Section 8(a)(1) of the Act, 7
U.S.C. Sec. 12(a)(1), authorizing the Commission to "make such
investigations as it deems necessary to ascertain the facts
regarding the operations of boards of trade and other persons
subject to the provisions of this Act."
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Finally, the proposed Acceptable Practice envisions that the CRO of
the SRO will report directly to, and regularly consult with, the ROC.
ROCs may delegate their day-to-day authority over self-regulatory
functions and personnel to the CRO. Although ROCs remain responsible
for ensuring the sufficiency, effectiveness, and independence of self-
regulation within their SROs, they are not expected to assume
managerial roles.
C. Disciplinary Panels
The proposed Disciplinary Panel Acceptable Practice would preclude
any group or class of exchange members from dominating or exercising
disproportionate influence on any disciplinary panel. In addition, the
Commission proposes that all disciplinary panels include at least one
"public" participant. To qualify as "public," panel members should
meet the same test as public directors.
For purposes of this Acceptable Practice, "disciplinary panel"
means any person, panel of persons, or any subgroup thereof, which is
authorized by an SRO to issue disciplinary charges, to conduct
proceedings, to settle disciplinary charges, to impose disciplinary
sanctions, or to hear appeals thereof, except in cases limited to
decorum, attire, the timely submission of accurate records required for
clearing or verifying each day's transactions or other similar
activities. If an exchange's rules provide for an appeal to the board
of directors, or a committee of the board, then that appellate body
should include at least one person who meets the qualifications for
membership on the board's ROC. "Disciplinary panel" does not include
exchange regulatory staff authorized to issue warning letters or
summary fines imposed pursuant to established schedules.
To take advantage of this safe harbor, and thereby comply with Core
Principle 15's requirement to minimize conflicts of interest in
decisionmaking, the Commission is proposing that exchanges amend their
disciplinary panel composition rules and policies to incorporate the
terms of the Disciplinary Panel Acceptable Practices. Finally, under
this Acceptable Practice, disciplinary committees and panels would fall
under the oversight of the ROC.
IV. Analysis and Rationale for Proposed Acceptable Practices
A. Board Composition; "Public" Director
The Board Composition Acceptable Practice is designed to promote
and safeguard the independence of the board of directors. It reaffirms
the basic corporate principle that good governance is the cornerstone
of a strong corporation and that a company's long-term success is best
secured by enhancing the presence of independent participants at the
highest level of corporate decisionmaking, the board of directors.
In any corporation, the paramount duty of the board of directors is
to act, at all times, in the best interest of the corporation. It is
the board that has the ultimate decisionmaking authority within a
corporation and that must be accountable for any failure in the
fulfillment of its corporate duties. In effect, the board represents
the first line of defense against corporate misconduct. In the case of
a corporation that also operates as an SRO, the board may have to make
decisions in circumstances where its role as a fiduciary to the
shareholders conflicts with its duty as a custodian of the public
trust.\37\ Increased competition and demutualization may further
exacerbate these potentially competing claims and render the board
susceptible to pressures that may impact its ability to carry out self-
regulatory duties to their fullest extent.
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\37\ Any decisions made by SROs' boards of directors, although
not directly regulatory, implicate the public interest and the
intersection between regulatory responsibilities and commercial
imperatives. SROs' boards of directors determine transaction fees;
market data fees; and membership criteria. They control the
employment and compensation of senior executives, including the
president of the exchange, and they are sometimes responsible for
the appointment of public directors. Boards make fundamental
governance decisions, including those made with respect to the
strategic direction of the SRO and the oversight of self-regulation.
In addition, SROs' public interest obligations are cited in the very
purposes of the Act, which include "to serve the public interest *
* * through a system of effective self-regulation of trading
facilities." CEA Section 3(b), 7 U.S.C. 5(b).
As noted at the Hearing, "exchanges which also function as for-
profit institutions as well as SROs are truly occupying an
absolutely unique space in corporate America." Jennings,
Hearing.Tr. at 79.
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The Commission's proposed Board Composition Acceptable Practice
constitutes a strong, proactive approach to ensuring the continued
success of self-regulation in the futures industry. With respect to
exchange boards of directors, their dual regulatory and commercial
roles suggest that a fifty percent "public" board is an appropriate
balance and should best enable directors to carry out their
responsibilities.\38\
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\38\ Industry participants and observers noted that independence
of an exchange's board of directors is key to effective and
impartial self-regulation due to its role as the ultimate arbiter of
decisions affecting both commercial and regulatory functions of the
exchange. To address the conflicts of interest inherent in this dual
role, most participants agreed on the benefits of including
"public" directors on exchange boards. See e.g., Jennings, Hearing
Tr. at 29 ("[I]t is a fundamental requirement that exchange boards
must have a significant representation of independent public
directors. I believe it is appropriate that at least fifty percent
of the exchange board must comprise this group."); and Phillips,
Hearing Tr. at 159 (addressing reviews of exchanges' rulemaking
authority, "* * * it comes back to the governance process and the
independence of the board to really make those kinds of reviews
meaningful."). However, industry participants did not agree on what
specifically constitutes an appropriate board composition, or
whether existing exchange board compositions are adequate.
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The Commission notes that its proposed Board Composition
[[Page 38746]]
Acceptable Practice is consistent with the trend of major governance
initiatives across the corporate and SRO communities in the United
States. In November 2003, the New York Stock Exchange ("NYSE") and
NASDAQ both implemented new governance standards for their listed
companies. Among the most important provisions is the requirement that
listed companies' boards have a majority of independent directors. In
addition, listed companies must have fully independent nominating,
corporate governance, compensation, and audit committees. While the
conflicts driving these governance initiatives may differ from those
arising in the futures self-regulatory context, the NYSE and NASDAQ
standards for listed companies reflect their recognition that good
corporate governance is founded on strengthening the independence and
accountability of the board.
Two futures exchanges, the CME and the CBOT are now subject to the
NYSE listing standards outlined above, and others may join them as
futures exchanges continue to demutualize and seek public listing of
their shares. The Commission is satisfied that the listing standards
provide a measure of shareholder protection for the owners of publicly-
traded futures exchanges. However, the Commission is equally satisfied
that these listing standards are not designed for public companies that
also bear a special responsibility of public protection and fair and
effective self-regulation. Although it may be true, as the publicly-
traded futures SROs have determined, that SRO members are independent
under the NYSE listing standards, the proposed Board Composition
Acceptable Practice provides that members are not independent for
purposes of protecting the public interest against conflicts of
interest in self-regulation.
Finally, the fifty percent minimum standard strikes a favorable
balance between inside expertise and "outside" impartiality and
ensures that other exchange stakeholders, such as members and exchange
management, are adequately represented. In this manner, the "self" in
self-regulation is retained, along with its efficiencies and expertise,
while the ultimate benefactors of the self-regulatory system--market
participants and the public--are assured that their interests are well-
represented at the highest level.
(i) Definition of "Public" Director
To facilitate compliance, the Commission has modeled aspects of its
"public" director definition, and more specifically, the materiality
test, on what have now become accepted standards for defining
independent directors. For example, the NYSE governance standards,
noted above, mandate that to qualify as independent, directors must
meet both a series of bright-line tests capturing certain present and
past employment, compensation, business, familial, and other
relationships; and a categorical "no material relationship" test.
Similarly, under the Commission's proposed definition, the
determination of whether a person qualifies as a "public" director
entails (1) proposed "bright-line" tests, such as membership,
employment, and business and financial ties with the exchange, aimed at
identifying many of the circumstances that necessarily impair
independent decision making; and (2) a facts and circumstances
analysis. As to the facts and circumstances analysis, the board, taking
into account all of the relevant factors relating to the person's
relationship with the exchange, must make a reasonable finding on the
record that the person is capable of independent decision-making. This
analysis is broader than the bright-line tests.
Similar standards have already been implemented in a variety of
related contexts: by the Public Company Accounting Reform and Investor
Protection Act of 2002 (Sarbanes-Oxley Act of 2002) with respect to
independent directors serving on the audit committees of public
companies;\39\ and by the NYSE for its own board of directors.\40\ The
SEC has also proposed similar standards for independent directors on
the boards of securities exchanges.\41\
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\39\ Pub. L. No. 107-204, 116 Stat. 745 (2002).
\40\ Constitution of the New York Stock Exchange, Art. IV, Sec.
2.
\41\ Fair Administration, supra note 21.
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The Acceptable Practice addressing board qualifications is named
the "Public Director Acceptable Practice" rather than the
"Independent Director Acceptable Practice" to emphasize the national
public interest in futures trading and the role that SROs play in
serving and protecting that interest.\42\ The appropriate definition
of, and qualifications for, an unconflicted director were debated
vigorously during the SRO Review.\43\ The debate often centered on
whether the NYSE listing standards are sufficient for self-regulatory
purposes. Several commenters and Hearing participants noted that the
NYSE independent director standard principally operates to protect
shareholder interests against undue management influence, and that more
is needed to protect the public interest in an institution that
exercises regulatory duties.\44\ The Commission generally agrees that
the listing standards are not sufficient for public companies that also
bear special responsibility to the public to self-regulate fairly and
effectively. Simply stated, self-regulation and shareholder protection
are two distinct missions: they may be complementary, but they are not
substitutes.
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\42\ See CEA Section 3(b), 7 U.S.C. Sec. 5(b).
\43\ FIA for example, commented that "[i]ndependent SRO
directors should be independent not only of management but also of
all activity on the exchange" because "[t]he special nature of an
SRO's powers and functions * * * makes it essential to have truly
independent directors with no direct, current ties to the industry
the SRO regulates." FIA CL (Jan. 23, 2006) at 3. NYMEX, on the
other hand, was of the view that active industry participation did
not impair impartiality so long as a director had no ties to the
exchange itself. See NYMEX CL (Jan. 23, 2006) at 7: NYMEX stated
that its "Public Directors would qualify as independent directors"
under NYSE listing standards and noted that "it is possible for
markets subject to [NYSE] listing standards to conclude that
exchange members qualify as independent directors." NYMEX noted the
"specialized" nature of futures trading and emphasized the
importance of board expertise. Id. The CME as well stated that
independence should be determined on a case by case basis. CME CL
(Jan. 23, 2006) at 7.
\44\ See, e.g., Karmel, Hearing Tr. at 33 ("The New York Stock
Exchange and NASDAQ listing standards, as others have already said,
do not squarely address the key issue of whether exchange members
should be considered independent or not when they serve as directors
of an exchange board or a regulatory subsidiary"; and FIA CL (Jan.
23. 2006) at 3.
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B. Regulatory Oversight Committee
ROCs would provide independent oversight of core regulatory
functions, including trade practice, market, and financial
surveillance, for all exchanges. ROCs also would oversee the
performance of disciplinary committees. Because these functions are
fundamental manifestations of SROs' regulatory authority, the
Commission believes that they should be overseen in the most impartial
manner possible within the context of self-regulation--by public
directors who are neither members of the SRO nor otherwise dependent
upon the commercial enterprise.\45\
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\45\ The Commission's proposed Regulatory Oversight Acceptable
Practice is similar to measures already implemented or recommended
by some exchanges in response to acknowledged self-regulatory
concerns. The CME, for example, has formed an advisory board-level
committee to "ensure the independent exercise" of self-regulatory
obligations ("Market Regulation Oversight Committee" or "MROC").
Every member of the committee must be an independent director. The
MROC reviews and reports to CME's board, on an annual basis, with
respect to: (1) The independence of CME's regulatory functions from
its business operations; (2) the independence of CME management and
regulatory personnel from improper influence by industry directors
regarding regulatory matters; (3) CME's compliance with its SRO
responsibilities; (4) appropriate funding and resources to ensure
effective performance of SRO responsibilities; and (5) appropriate
compensation for CME employees involved in regulatory activities.
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[[Page 38747]]
The public directors on the ROC would be free to consider the
unique responsibilities of the SRO to act in the public interest, to
plan for effective self-regulation in the long-term, and to insulate
regulatory decisions from short-term pressures that may be brought to
bear in an increasingly competitive environment. The Commission
believes that SROs generally stand to benefit from establishing ROCs.
ROCs' determinations with respect to their core competencies would
be subject to review by the full board of directors, including member
directors, and ROCs would be free to consult widely within the SRO
throughout their deliberations, thus ensuring that member expertise
remains central to self-regulation in the futures industry. At the same
time, by placing initial oversight responsibility in the hands of
public directors, arming them with the tools and resources necessary to
make fully informed decisions, and providing an independent reporting
line for senior regulatory officers, SROs would ensure that regulatory
decisions are insulated from improper influences. The ROC structure,
combined with careful Commission review of the interaction between the
ROC and the board, fosters the continued integrity of futures self-
regulation, effective management of conflicts of interest within SRO
governance, and full consideration of the public interest in every
decision of regulatory consequence.
C. Disciplinary Panels
Diversity in committee and panel composition has long been
recognized as an effective tool for minimizing conflicts of interest in
SRO disciplinary adjudication, a long-standing objective of the
Commission. Prior to enactment of the CFMA, the Act set specific
standards for the composition of SRO disciplinary committees, requiring
that: (1) Exchanges provide for a diversity membership on all major
disciplinary committees and (2) respondents in exchange disciplinary
actions not be tried exclusively by their peers.
The CFMA continues the Act's commitment to fair disciplinary
procedures. The Acceptable Practices for Core Principle 2, for example,
require that exchanges discipline members and market participants
pursuant to "clear and fair standards." \46\ As stated earlier, Core
Principle 15 requires exchanges to "minimize conflicts of interest in
the decision making process." This requirement extends to disciplinary
committees and panels, which must be free of both individual and group
(e.g., floor versus FCM) conflicts of interest.
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\46\ 17 CFR Part 38, App. B, Core Principle 2, Acceptable
Practices.
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The Commission believes that fair disciplinary procedures with
minimal conflicts of interest require unbiased disciplinary panels
representing a diversity of opinions and experiences. At the very
least, this presumes panels that are not weighted in favor of any
single class of exchange participants. Also, including a public person
provides an outside perspective and helps to ensure that the public's
interests are represented and protected. The Commission is confident
that proper composition can minimize potential conflicts of interest
and promote fairness on disciplinary panels, as required by Regulation
170.3 and Core Principles 2 and 15.
The SRO Review has found no indication of widespread inadequacy in
exchange disciplinary committees, as many FCMs suggested. To the
contrary, some exchanges maintain very diverse committees, including
nonmember representatives. For example, CME's seven-person Probable
Cause and Business Conduct panels each include three non-members.\47\
Furthermore, the Commission has found that, at most exchanges, FCMs are
more likely to appear before clearing house risk committees or
financial compliance/surveillance committees (where FCMs are typically
well-represented) than on business conduct committees or similar
committees (which may include broker, local, commercial, FCM, and
public panelists).
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\47\ CME Rules 402, 406.
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In addition, periodic Rule Enforcement Reviews conducted by the
Commission's Division of Market Oversight, which carefully examine
disciplinary sanctions, typically find that they are fair and do not
discriminate among different classes of exchange participants. Rule
Enforcement Reviews also examine exchange disciplinary procedures, and
consistently find that these are adequate.
The Commission is generally satisfied with the composition and
performance of most SRO disciplinary committees and panels, and
believes that significant new measures are not required at this time.
The Commission has found that disciplinary committees typically have
adequate diversity, sometimes including FCMs and nonmembers, and seek
to balance expertise with impartiality. Accordingly, the Commission's
proposed Disciplinary Panel Acceptable Practice acknowledges SROs'
current practices and the requirements of the Act, and identifies
minimal panel composition standards as a means of protecting the
continued integrity of the disciplinary process. It helps to minimize
conflicts of interest by ensuring a basic degree of diversity, and the
inclusion of at least one public person on SRO disciplinary panels.
To take advantage of the safe harbor offered by the proposed
Disciplinary Panel Acceptable Practice, and comply with Core Principle
15's requirement to minimize conflicts of interest in decision making,
the Commission is proposing that SROs' amend their rules and policies
to ensure that they preclude any group or class of exchange members
from dominating or otherwise exercising disproportionate influence on
any disciplinary panel. The Commission is also proposing that SROs
ensure that their rules and policies provide for public persons on
disciplinary panels, except in cases limited to decorum and attire.\48\
Public panel members should meet the definition of "public" for
directors serving on Regulatory Oversight Committees.
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\48\ The proposed Disciplinary Panel Acceptable Practice is
broader than Regulation 1.64, in that it requires a public member to
participate in some categories of cases that, under Regulation 1.64,
may be heard by a panel with no public members. The Commission
believes the expansion of public participation is an appropriate
response to the growth in the size and complexity of the futures
markets, and the new profit element in exchange operations.
Moreover, a public member's presence on disciplinary panels will
enhance the appearance as well as the reality of fairness and
impartiality in exchange disciplinary proceedings, and thus promote
confidence in our markets among the public and market participants.
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V. Related Matters
A. Cost-Benefit Analysis
Section 15(a) of the Act, as amended by Section 119 of the CFMA,
requires the Commission to consider the costs and benefits of its
action before issuing a new regulation or order under the Act. By its
terms, Section 15(a) does not require the Commission to quantify the
costs and benefits of its action or to determine whether the benefits
of the action outweigh its costs. Rather, Section 15(a) simply requires
the Commission to "consider the costs and benefits" of the subject
rule or order.
Section 15(a) further specifies that the costs and benefits of the
proposed rule or order shall be evaluated in light of five broad areas
of market and public
[[Page 38748]]
concern: (1) Protection of market participants and the public; (2)
efficiency, competitiveness, and financial integrity of futures
markets; (3) price discovery; (4) sound risk management practices; and
(5) other public interest considerations. The Commission may, in its
discretion, give greater weight to any one of the five enumerated areas
of concern and may, in its discretion, determine that, notwithstanding
its costs, a particular rule or order is necessary or appropriate to
protect the public interest or to effectuate any of the provisions or
to accomplish any of the purposes of the Act.
The Acceptable Practices proposed herein are safe harbors for
compliance with Core Principle 15's conflict of interest provisions.
They offer exchanges the opportunity to meet the requirements of the
Core Principle through a regulatory governance structure that insulates
their regulatory functions from their commercial interests. The
Acceptable Practices propose that exchanges implement boards of
directors that are at least fifty percent public. The Acceptable
Practices further propose that all exchange-SROs place oversight of
their core regulatory functions in the hands of board-level ROCs
composed exclusively of "public" directors. They also offer guidance
on what constitutes a "public" director. In addition, the Acceptable
Practices suggest minimum composition standards for exchange
disciplinary committees.
The proposed Acceptable Practices are consistent with legislative,
regulatory, and voluntarily undertaken changes in governance
requirements and practices in other financial sectors, such as the
securities markets, and are intended to enhance protection of the
public. The Commission has endeavored, in offering these Acceptable
Practices to propose the least intrusive safe harbors and regulatory
requirements that can reasonably be expected to meet the requirements
of Core Principle 15 of the Act. These Acceptable Practices advance the
Commission's mandate of assuring the continued existence of competitive
and efficient markets and to protect the public interest in markets
free of fraud and abuse.
They nevertheless may be expected to entail some costs, including,
among the most foreseeable, those attendant to recruiting and
appointing additional directors, amending corporate documents, making
necessary rule changes and certifying them to the Commission, and
appointing a CRO.
After considering these factors, the Commission has determined to
propose the Acceptable Practices with respect to contract markets. The
Commission specifically invites public comment on its application of
the criteria contained in the Act. Commenters are also invited to
submit any quantifiable data that they may have concerning the costs
and benefits of the proposed Acceptable Practices with their comment
letter.
B. Regulatory Flexibility Act
The Regulatory Flexibility Act, 5 U.S.C. 601 et seq., requires
federal agencies, in promulgating rules, to consider the impact of
those rules on small entities. The proposed Acceptable Practices affect
contract markets. The Commission has previously determined that
contract markets are not small entities for purposes of the Regulatory
Flexibility Act.\49\ Accordingly, the Chairman, on behalf of the
Commission, hereby certifies pursuant to 5 U.S.C. 605(b) that the
proposed Acceptable Practices will not have a significant economic
impact on a substantial number of small entities.
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\49\ Policy Statement and Establishment of Definitions of
"Small Entities" for Purposes of the Regulatory Flexibility Act,
47 FR 18618, 18619 (Apr. 30, 1982).
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C. Paperwork Reduction Act of 1995
The Acceptable Practices contain information collection
requirements. As required by the Paperwork Reduction Act of 1995 (44
U.S.C. 3504(h)), the Commission has submitted a copy of this section to
the Office of Management and Budget ("OMB") for its review.
Collection of Information: Rules Relating to Part 38, Establishing
Procedures for Entities to become designated as Contract Markets, OMB
Control Number 3038-0052. The Acceptable Practices increase the burden
previously approved by OMB.
The estimated burden was calculated as follows:
Estimated number of respondents: 12.
Annual responses by each respondent: 1.
Total annual responses: 12.
Estimated average hours per response: 70.
Annual reporting burden: 840.
Organizations and individuals desiring to submit comments on the
information collection requirements should direct them to the Office of
Information and Regulatory Affairs, Office of Management and Budget,
Room 10202, New Executive Office Building, 725 17th Street, NW.,
Washington, DC 20503; Attention: Desk Officer for the Commodity Futures
Trading Commission.
The Commission considers comments by the public on this proposed
collection of information in:
Evaluating whether the proposed collection of information is
necessary for the proper performance of the functions of the
Commission, including whether the information will have a practical
use;
Evaluating the accuracy of the Commission's estimate of the burden
of the proposed collection of information, including the validity of
the methodology and assumptions used;
Enhancing the quality, usefulness, and clarity of the information to
be collected; and
Minimizing the burden of collecting information on those who are to
respond, including through the use of appropriate automated
electronic, mechanical, or other technological collection techniques
or other forms of information technology (e.g., permitting
electronic submission of responses).
OMB is required to make a decision concerning the collection of
information contained in these Acceptable Practices between 30 and 60
days after publication of this document in the Federal Register.
Therefore, a comment to OMB is best assured of having its full effect
if OMB receives it within 30 days of publication. This does not affect
the deadline for the public to comment to the Commission on the
Acceptable Practices.
Copies of the information collection submission to OMB are
available from the Commission Clearance Officer, Three Lafayette
Centre, 1155 21st Street, NW., Washington DC 20581, (202) 418-5160.
VI. Text of Proposed Acceptable Practices
List of Subjects in 17 CFR Part 38
Commodity futures, Reporting and recordkeeping requirements.
In light of the foregoing, and pursuant to the authority in the
Act, and in particular, Sections 3, 5, 5c(a) and 8a(5) of the Act, the
Commission proposes to amend Part 38 of Title 17 of the Code of Federal
Regulations as follows:
PART 38--DESIGNATED CONTRACT MARKETS
1. The authority citation for part 38 is revised to read as
follows:
Authority: 7 U.S.C. 2, 5, 6, 6c, 7, 7a-2 and 12a, as amended by
Appendix E of Pub. L. 106-554, 114 Stat. 2763A-365.
2. In Appendix B to Part 38 amend Core Principle 15 by adding
paragraph (b) "Acceptable Practices" as follows:
Appendix B to Part 38--Guidance on, and Acceptable Practices in,
Compliance With Core Principles
* * * * *
[[Page 38749]]
Core Principle 15 of Section 5(d) of the Act: Conflicts of Interest
* * * * *
(b) Acceptable Practices. All designated contract markets
("DCMs" or "contract markets") bear special responsibility to
regulate effectively, impartially, and with due consideration of the
public interest, as provided for in Section 3 of the Act. Under Core
Principle 15, they are also required to minimize conflicts of
interest in their decision making processes. To comply with this
Core Principle, contract markets should be particularly vigilant for
conflicts between their self-regulatory responsibilities, their
commercial interests, and the interests of their management,
members, owners, customers and market participants, other industry
participants, and other constituencies.
Acceptable Practices for minimizing conflicts of interest shall
include the following elements:
(1) Board Composition for Contract Markets
(A) At least fifty percent of the directors on a contract
market's board of directors shall be public directors; and
(B) The executive committees (or similarly empowered bodies)
shall be at least fifty percent public.
(2) Public Director
(A) To qualify as a public director of a contract market, an
individual must first be found, by the board of directors on the
record, to have no material relationship with the contract market. A
"material relationship" is one that reasonably could affect the
independent judgment or decision making of the director.
(B) In addition, a director shall not be considered "public"
if any of the following circumstances exist:
(i) The director is an officer or employee of the contract
market or a director, officer or employee of its affiliate;
(ii) The director is a member of the contract market, or a
person employed by or affiliated with a member. "Member" is
defined according to Section 1a(24) of the Commodity Exchange Act
and Commission Regulation 1.3(q). In this context, a director is
affiliated with a member if the director is an officer or director
of the member;
(iii) The director receives more than $100,000 in payments from
the contract market, any affiliate of the contract market or from a
member or anyone affiliated with a member, provided that
compensation for services as a director will not be counted towards
the $100,000 threshold test;
(iv) A director shall be precluded from serving as a public
director if any of the relationships above apply to a member of the
director's "immediate family," i.e., spouse, parents, children,
and siblings; and
(v) An affiliate includes parents or subsidiaries of the
contract market or entities that share a common parent with the
contract market.
(C) All of the disqualifying circumstances described in
Subsection (2)(B) shall be subject to a one-year look back.
(D) A contract market shall disclose to the Commission which
members of its board are public directors, and the basis for those
determinations.
(3) Regulatory Oversight Committee
(A) A board of directors of any contract market shall establish
a Regulatory Oversight Committee ("ROC") as a standing committee,
consisting of only public directors as defined in Section (2), to
assist it in minimizing potential conflicts of interest. The ROC
shall oversee the contract market's regulatory program on behalf of
the board. The board shall delegate sufficient authority, dedicate
sufficient resources, and allow sufficient time for the ROC to
fulfill its mandate.
(B) The ROC shall:
(i) Monitor the contract market's regulatory program for
sufficiency, effectiveness, and independence;
(ii) Oversee all facets of the program, including trade practice
and market surveillance; audits, examinations, and other regulatory
responsibilities with respect to member firms (including ensuring
compliance with financial integrity, financial reporting, sales
practice, recordkeeping, and other requirements); and the conduct of
investigations;
(iii) Review the size and allocation of the regulatory budget
and resources; and the number, hiring and termination, and
compensation of regulatory personnel;
(iv) Supervise the contract market's chief regulatory officer,
who will report directly to the ROC;
(v) Prepare periodic reports for the board of directors and an
annual report assessing the contract market's self-regulatory
program for the board of directors and the Commission, which sets
forth the regulatory program's expenses, describes its staffing and
structure, catalogues disciplinary actions taken during the year,
and reviews the performance of disciplinary committees and panels;
(vi) Recommend changes that would ensure fair, vigorous, and
effective regulation; and
(vii) Review regulatory proposals and advise the board as to
whether and how such changes may impact regulation.
(4) Disciplinary Panels
All contract markets shall minimize conflicts of interest in
their disciplinary processes through disciplinary panel composition
rules that preclude any group or class of industry participants from
dominating or exercising disproportionate influence on such panels.
Contract markets can further minimize conflicts of interest by
including at least one person who would qualify as a public director
as defined in Section (2) above, on disciplinary panels, except in
cases limited to decorum and attire. If contract market rules
provide for appeal to the board of directors, or to a committee of
the board, then that appellate body shall also include at least one
person who would qualify as a public director as defined in Section
(2) above.
* * * * *
Issued in Washington, DC, on June 28, 2006 by the Commission.
Eileen A. Donovan,
Acting Secretary of the Commission.
Note: The following appendix will not appear in the Code of
Federal Regulations.
APPENDIX--STATEMENTS OF COMMISSIONERS HATFIELD AND DUNN
Commissioner Frederick W. Hatfield, writing separately.
Since the passage of the Commodity Futures Modernization Act of
2000 (CFMA), the U.S. futures industry has experienced dynamic
growth. With rapid growth comes new challenges. U.S. futures
exchanges are today faced with increased competition, domestically
and from abroad, changing ownership structures, and new business
models. As regulators, it is incumbent upon us to ensure that
regulatory guidelines continue to keep pace with the ever changing
environment of the industry. Accordingly, I applaud Chairman Jeffery
and Commission staff for their thoughtful and exhaustive pursuit of
fair, vigorous and effective self-regulation in this evolving market
landscape.
In this review, I have been guided by two questions: have the
exchanges produced self-regulatory structures that are up to the
challenges of the changing marketplace and if not, are we as
regulators suggesting a better model? I look forward to receiving
comments on the Board Composition Acceptable Practice proposal.
However, in my view, establishing a board level Regulatory Oversight
Committee (ROC) comprised of nonmember public directors and a
disciplinary panel structure, as described in the proposal, goes a
long way toward ensuring that an exchange's regulatory duties will
not be compromised by conflicts emanating from commercial goals.
The primary function of the proposed ROCs is to ensure that
regulatory programs and staff are free of improper influence from
exchange owners, management, members, investors, customers, and
commercial considerations. As the proposal recognizes, "[t]he ROC
structure, combined with careful Commission review of the
interaction between the ROC and the board, fosters the continued
integrity of futures self-regulation, effective management of
conflicts of interest within SRO governance, and full consideration
of the public interest in every decision of regulatory
consequence." Section B. Regulatory Oversight Committee, last
paragraph. Despite this recognition, the proposed safe harbor would
require, in addition to public director ROCs, that at least fifty
percent of the governing boards and exchange executive committees
also be comprised of public directors.
Interest in SRO board composition has an established history in
the Commodity Exchange Act (Act) and in the Commission's
regulations. Prior to passage of the CFMA, Section 5a(14) of the Act
mandated diversity of representation on exchanges' boards of
directors.\1\ With passage of the CFMA, the
[[Page 38750]]
requirements of Section 5a(14) were removed for exchanges, as
Congress and the Commission moved to a more flexible, principles-
based oversight regime that does not include specific composition
targets for exchanges' boards of directors.\2\ Mutually owned
exchanges are still subject to mandatory board composition standards
under Section 5(c)(16) of the Act (Core Principle 16), which
requires "that the composition of the governing board reflect
market participants." The Application Guidance for Core Principle
16 identifies this as a "diversity of interests" requirement.
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\1\ This provision of the Act was implemented by Commission
Regulation 1.64, which required exchanges to establish meaningful
representation for the following groups: (1) Futures commission
merchants (FCMs); (2) floor brokers and traders; (3) independent
non-members; (4) producers, consumers, processors, distributors, and
merchandisers of commodities traded on the particular exchange
("commercials"); (5) participants in a variety of pits or
principal groups of commodities traded on the exchange; and (6)
other market users or participants. Specific composition targets
existed only for commercials (ten percent) and nonmembers (twenty
percent).
\2\ Under Commission Regulation 38.2, exchanges are now exempt
from Regulation 1.64.
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As part of the SRO Review, Commission staff examined the
corporate documents of the major exchanges under CFTC authority and
found that all require diversity of their boards of directors,
including nonmember directors.\3\ These diversity requirements are
similar regardless of the exchanges' ownership structures, and they
are present at all of the major exchanges. The Kansas City Board of
Trade, for example, requires that nominating committees give
"special consideration to the desirability of having all interests
of the Corporation represented on the Board of Directors." \4\ The
Chicago Mercantile Exchange (CME) requires that its board of
directors have "meaningful representation of a diversity of
interests, including floor brokers, floor traders, futures
commission merchants, [and commercials.]." \5\
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\3\ The corporate documents included the certificates of
incorporation, bylaws, and rulebooks of the exchanges and their
holding companies, if applicable.
\4\ Kansas City Board of Trade Rulebook, Ch. II, Sec. 210.01.
\5\ Second Amended and Restated Bylaws of Chicago Mercantile
Exchange Holdings, Inc., Art. III, Sec. 3.5 (applicable to the
board of trade through the Certificate of Incorporation of Chicago
Mercantile Exchange, Inc., Art. V, Sec. 3 (requiring that the board
of directors of CME, Inc., be identical to that of CME Holdings,
Inc.).
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Some exchanges employ specific numerical targets for their
various participant categories and public directors. For example,
the New York Mercantile Exchange requires three public directors,
one FCM, one floor broker, one commercial, and one local trader.\6\
The New York Board of Trade requires five public directors.\7\ The
Minneapolis Grain Exchange requires four nonmember directors, and at
least four commercials, two FCMs, two floor traders, and one floor
broker.\8\ The CME requires that independent, nonmember directors
constitute twenty percent of its board and that commercials
constitute ten percent of the board.\9\ Moreover, the CME currently
exceeds its own requirements, with seven of its twenty directors
(thirty-five percent) being independent, nonindustry persons.
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\6\ Amended and Restated Certificate of Incorporation of NYMEX
Holdings, Inc., Art. VI, Sec. (c) (applicable to the board of trade
through the Amended and Restated Certificate of Incorporation of New
York Mercantile Exchange, Inc., Art. VII (the board of directors
NYMEX Holdings, Inc., constitutes the board of NYMEX, Inc.).
\7\ New York Board of Trade Bylaws, Art. II, Sec. 302(c).
\8\ Minneapolis Grain Exchange Rulebook, Ch. II, Sec. Sec.
200.00 and 210.00.
\9\ Note 5, supra.
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Most of those who commented or testified during the course of
the SRO study generally agreed that diverse boards best serve the
needs of exchanges and the public. Participants also agreed on the
benefits of including public directors on exchange boards, and our
review demonstrates that this is a model that most exchanges are
following. In their comments and testimony, however, exchanges
unanimously opposed having mandatory board composition requirements.
CME argued, for example, that "no one composition criteria can
address the individual needs" of the diverse exchanges and business
models active in the industry.\10\
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\10\ CME Comment Letter at 2.
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In my view, having a ROC that serves to insulate the regulatory
functions of an exchange from its commercial interests, combined
with a disciplinary panel structure that strengthens impartial
adjudication and reduces potential conflicts of interest by
including at least one public person on every panel and ensuring
that such panels are not dominated by any group or class of exchange
participants, may well be sufficient to ensure fair, vigorous, and
effective self-regulation and should demonstrate compliance with
Core Principle 15. Such an approach would be narrowly tailored to
focus specifically on regulatory governance and functions, and would
be in keeping with the flexibility the CFMA intended to afford
exchanges to conduct business without undue interference from
regulators.
I am concerned that the Board Composition proposal also would
create an additional and perhaps unnecessary layer of regulation for
publicly traded exchanges, which are already subject to myriad new
and enhanced corporate governance requirements, including, among
others, Securities and Exchange Commission registration
requirements, the audit committee provisions of the Sarbanes-Oxley
Act of 2002, and the listing standards of the New York Stock
Exchange (NYSE). I agree that the dual function of exchanges as
commercial enterprises and self-regulatory organizations sets them
apart from corporations engaged in business for the sole purpose of
earning profits for the benefit of shareholders. In my opinion,
however, the foregoing corporate governance standards, combined with
properly structured ROCs and disciplinary committees, and the
Commission's continuing obligation to monitor exchanges through rule
enforcement reviews and otherwise, have provided multiple levels of
safeguards that should be sufficient to ensure that exchanges"
self-regulatory obligations are not compromised.
I recognize that what the Commission is contemplating is an
acceptable practice rather than a mandatory requirement. In
promulgating such guidance, however, the Commission should strive to
establish standards that that are not overly broad and that are
viewed as necessary, in most circumstances, to accomplish regulatory
goals. Accordingly, I welcome comment on the advisability of
adopting the proposed Board Composition Acceptable Practice,
especially with respect to the following questions:
Is there an existing problem that this proposal
addresses?
Will those exchanges that are not now subject to
mandatory diversity requirements feel compelled to sacrifice
voluntary diversity in order to increase the percentage of public
directors and still maintain boards that are of manageable size, or
will boards become larger? Is it feasible to comply with the
acceptable practice and maintain the proper level of diversity? What
are the relative costs and benefits of doing so?
How would the acceptable practice affect mutually owned
exchanges that are subject to the mandatory diversity requirements
of Core Principle 16?
How would the proposed requirement that exchange
executive committees have at least fifty percent public
representation affect the day-to-day operations of the exchanges?
Is there any evidence that the proposed Board
Composition Acceptable Practice will provide greater regulatory
assurance than the proposed ROC and Disciplinary Panel Acceptable
Practices?
Do the corporate governance requirements currently
applicable to publicly traded exchanges, combined with properly
structured ROCs and disciplinary panels and continuing Commission
oversight, provide sufficient assurance that conflicts of interests
will be kept to a minimum in the decision making process of those
exchanges?
If the Commission adopts the Board Composition
Acceptable Practice, should it be accompanied by a phase-in period
and if so, what would be the appropriate length of time for
exchanges to modify their boards?
I join with my Chairman and fellow Commissioners in requesting
comment on this endeavor and look forward to reviewing the responses
to these questions and any other views the Commission receives as we
continue to consider the important issues raised in the proposal.
Commissioner Michael V. Dunn, writing separately.
The proposed acceptable practices published today represent an
important step forward in ensuring the fairness and transparency of
our commodity markets. I wish to comment on two aspects of the
proposal.
First, the proposed rule notes that exchanges that elect to
forgo the safe harbor of the best practices outlined in this
proposal can still demonstrate compliance with Core Principle 15
through showing they have procedures and safeguards in place to
address potential conflicts of interest. For these exchanges, the
Commission will continue its current practice of reviewing the
activities of these exchanges to ensure they are in compliance with
Core Principle 15. Therefore, while the proposed acceptable
practices offer a safe harbor for complying with Core Principle 15,
they are not the only method of demonstrating compliance.
Second, efficient, transparent, and open markets bring great
benefits to their
[[Page 38751]]
participants and the public. The Commodity Futures Modernization Act
of 2000 (CFMA), sought to safeguard these values by placing a much
greater emphasis on industry self-regulation: setting out core
principles registrants have to meet and giving industry flexibility
in choosing how to comply.
While the Commission has final responsibility to ensure the
fairness and transparency of the markets it regulates, its
effectiveness in doing so relies heavily upon the presence of a
robust self-regulatory system. Registered Futures Associations
(RFAs) are provided for in the CEA to complement the Commission's
oversight of commodities markets and to bring industry knowledge and
experience to bear on regulatory issues affecting those markets.\1\
In its June 2004 request for comments on SRO governance that led to
this proposal, the Commission asked, "Should registered futures
associations that are functioning as SROs also be subject to
governance standards?" In its response, the National Futures
Association ("NFA"), the sole RFA, wrote that "registered futures
associations should be subject to the same governance standards as
the other SROs," as long as these standards are flexible.
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\1\ See generally Section 17 of the Act, 7 U.S.C. 21. An RFA
must be determined by the Commission to be in the public interest.
Id. at Section 17(b)(1), 7 U.S.C. 21(b)(1).
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As the sole RFA, NFA occupies a unique position in the futures
markets' system of self-regulation. NFA is entrusted with overseeing
a wide variety of futures market intermediaries, cutting across
different segments of the futures industry, including futures
commission merchants, commodity pool operators ("CPOs"), commodity
trading advisers ("CTA"), and introducing broker-dealers
("IBs"). NFA's functions are as varied as the members it oversees.
NFA performs registration and fitness screening functions, conducts
audits and surveillance of its members to enforce compliance with
financial requirements, establishes and enforces rules and standards
for customer protection, and conducts arbitration of futures-related
disputes. NFA also has taken certain functions delegated to it by
the Commission and more recently, has assumed trade practice and
market surveillance activities for a number of exchanges.\2\
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\2\ When an RFA extends its sphere of operation beyond
traditional, self-regulatory roles to include such ancillary
activities, it appropriately should reexamine the methods it uses to
manage and minimize conflicts of interests, to determine whether
these methods remain adequate to meet changed circumstances.
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In light of the concerns raised in this proposal regarding
conflicts of interest and self-regulation, I believe the Commission
needs to review the conflicts of RFAs as well as exchanges. In this
proposal, the Commission indicates in footnote 4 that we will be
considering this matter further, and I look forward to that
consideration.
[FR Doc. 06-6030 Filed 7-6-06; 8:45 am]
BILLING CODE 6351-01-P
Updated July 14, 2006
Last Updated: June 26, 2007