FR Doc E9-9508[Federal Register: April 27, 2009 (Volume 74, Number 79)]
[Rules and Regulations]
[Page 18982-18990]
From the Federal Register Online via GPO Access [wais.access.gpo.gov]
[DOCID:fr27ap09-4]
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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: Final rule.
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SUMMARY: The Commission hereby adopts its final definition of ``public
director'' for the acceptable practices to Section 5(d)(15) (``Core
Principle 15'') of the Commodity Exchange Act (``CEA'' or ``Act'').\1\
In addition, the Commission is lifting the stay it had previously
placed on these acceptable practices. All designated contract markets
(``DCMs'') must demonstrate full compliance with Core Principle 15, via
the acceptable practices or otherwise, within one year of this
document's publication in the Federal Register. The acceptable
practices and their procedural history
[[Page 18983]]
are summarized below, as is the final definition of public director.
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\1\ The Act is codified at 7 U.S.C. 1 et seq. (2000). The
acceptable practices for the DCM core principles reside in Appendix
B to Part 38 of the Commission's Regulations, 17 CFR Part 38, App.
B. Core Principle 15 states: ``CONFLICTS OF INTEREST--The board of
trade shall establish and enforce rules to minimize conflicts of
interest in the decision making process of the contract market and
establish a process for resolving such conflicts of interest.'' CEA
Section 5(d)(15). 7 U.S.C. 7(d)(15).
DATES: Effective date: The stay is lifted on paragraph (b) of Core
Principle 15 in Appendix B to 17 CFR Part 38 effective May 27, 2009.
The amendments to the acceptable practices in appendix B to part 38 are
effective May 27, 2009. Compliance date: All DCMs must demonstrate full
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compliance with Core Principle 15 by April 27, 2010.
FOR FURTHER INFORMATION CONTACT: Rachel F. Berdansky, 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,
Washington, DC 20581.
SUPPLEMENTARY INFORMATION:
I. Background
A. Summary of the Acceptable Practices
As noted above, the Commission hereby adopts its final definition
of public director and lifts its stay on the acceptable practices for
Core Principle 15.\2\ These important acceptable practices consist of
four interrelated provisions, including three operating provisions
(sections (1), (3), and (4)) and one which provides necessary
definitions (section (2)). The operating provisions pertain to DCM
boards of directors, the insulation and oversight of self-regulatory
functions through regulatory oversight committees (``ROCs''), and the
composition of disciplinary panels. More specifically, section (1)
requires that a DCM's board and any executive committee of the board be
composed of at least 35% public directors. Section (3) requires that a
DCM's regulatory programs fall under the authority of a board-level ROC
consisting exclusively of public directors. Section (4) requires that a
DCM's disciplinary panels include at least one public person. To fully
implement the acceptable practices, DCMs must enact all three sections.
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\2\ As explained in the procedural history below, the Commission
stayed the entire acceptable practices for Core Principle 15 in
November of 2007. See Section B (``Procedural History of the
Acceptable Practices and the Definition of Public Director'').
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Sections (1), (3), and (4) of the acceptable practices are each
dependent on the presence of one or more ``public'' persons, either
public directors serving on the board, public directors serving on the
ROC, or public members serving on disciplinary panels. Thus, the
acceptable practices include an important fourth provision--section
(2)--that defines ``public director'' and also impacts disciplinary
panel members. The definition of public director includes several
subsections. The first and most important, subsection (2)(i), is an
overarching materiality test which requires that a public director
``have no material relationship with the contract market.'' The
definition also includes a series of bright-line tests in subsections
(2)(ii)(A)-(2)(ii)(D), with specific relationships defined as per se
material. Finally, subsections (2)(iii), (2)(iv) and (2)(v) pertain to
a one-year look back period, affiliate relationships, and disclosure
requirement, respectively.\3\
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\3\ While not required under these acceptable practices, the
Commission believes that DCMs benefit from endeavoring to recruit
their public directors from a broad and culturally diverse pool of
qualified candidates.
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Given the acceptable practices' long procedural history, outlined
below, industry participants may benefit from a brief review of their
underlying rationale, purpose, and importance. Above all, the
Commission emphasizes its full commitment to Core Principle 15's
acceptable practices in their entirety. As the Commission noted when it
adopted them, the acceptable practices ``recognize DCMs' unique public
interest responsibilities as self-regulatory organizations (``SROs'')
in the U.S. futures industry.'' \4\ They remind all DCMs that they
``bear special responsibility to regulate effectively, impartially, and
with due consideration of the public interest.'' \5\ They also clearly
enumerate certain conflicts of interest for which DCMs must be alert.
To comply with Core Principle 15, all DCMs must be ``particularly
vigilant'' for ``conflicts between and among any of their self-
regulatory responsibilities, their commercial interests, and the
several interests of their management, members, owners, customers and
market participants, other industry participants, and other
constituencies.'' \6\
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\4\ 72 FR 6936 at 6937 (February 14, 2007).
\5\ 17 CFR Part 38, App. B, Core Principle 15 (Acceptable
Practices).
\6\ Id.
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When the Commission adopted the acceptable practices on January 31,
2007, it noted new structural conflicts of interest in self-regulation
as for-profit DCMs operate in a competitive, global environment. The
Commission expressed concern with the presence of potentially
conflicting demands--regulatory responsibility vs. commercial
imperatives--within a single for-profit entity. It concluded that such
conflicts, arising from new business models, new ownership structures,
and increased competition, could be addressed through ``reforms within
the DCMs themselves, including reforms of DCMs' governing bodies.'' \7\
The acceptable practices reflect both concrete measures that DCMs may
implement and principles of modern self-regulation based on public
representation and the insulation of regulatory functions. They embody
the Commission's settled position that ``additional public directors on
governing bodies, greater independence at key levels of decision
making, and careful insulation of regulatory functions and personnel
from commercial pressures are important elements in ensuring vigorous,
effective, and impartial self-regulation now and in the future.'' \8\
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\7\ 72 FR at 6937.
\8\ Id.
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One principle embodied in the acceptable practices is the inclusion
of public persons on DCM boards, executive committees, and disciplinary
panels. Subsection (1)(i) of the acceptable practices requires that at
least 35% of a DCM's directors be public directors, with an identical
minimum ratio of public directors required for executive committees of
the board or similarly empowered bodies under subsection (1)(ii). As
the Commission explained when adopting the acceptable practices, it
``strongly believes that DCMs are best able to meet their statutory
obligations if their boards and executive committees include a
sufficient number of public directors. * * * Such boards and committees
will gain an independent perspective that is best provided by directors
with no current industry ties or other relationships which may pose a
conflict of interest.'' \9\ The principle of public representation is
also present in section (4) of the acceptable practices, which requires
at least one public person on all disciplinary panels.\10\
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\9\ 72 FR at 6947.
\10\ A public person is not required for cases limited to
decorum, attire, or the timely submission of accurate records
required for clearing or verifying each day's transactions.
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A second principle embodied in the acceptable practices is the ROC
required under subsections (3)(i) and (3)(ii). ROCs are tasked with
overseeing DCM regulatory programs, including monitoring those programs
for sufficiency, effectiveness, and independence. Their
responsibilities also include reviewing the size and allocation of
DCMs' regulatory budgets and resources; reviewing the number, hiring,
termination, and compensation of regulatory personnel; and supervising
DCMs' chief regulatory officers, who should report directly to their
ROCs. As described by the Commission, ``properly
[[Page 18984]]
functioning ROCs should be robust oversight bodies * * *.'' \11\ They
should also ``represent the interests and needs of regulatory officers
and staff; the resource needs of regulatory functions; and the
independence of regulatory decisions.'' \12\ ROCs should consist
exclusively of public directors. ``[A]nything less invites into
regulatory oversight operations precisely those directors whose
industry affiliations lend themselves to conflicts of interest in
decision making.'' \13\
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\11\ 72 FR at 6950.
\12\ Id. at 6950-6951.
\13\ Id. at 6951.
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The three operating provisions described above--board composition,
disciplinary panel composition, and ROC--are all dependent upon the
definition of public director in section (2). Now, as that definition
is finalized and the stay on the acceptable practices is lifted, all
industry participants should be aware that the Commission's highest
goal for self-regulation remains unchanged: Self-regulation must be
vigorous, effective, and impartial. DCMs, in particular, are reminded
that although they are free to comply with Core Principle 15 by means
other than the acceptable practices, they must address the specific
conflicts of interest that the Commission has identified and adopt
measures that are substantive and responsive.
B. Procedural History of the Acceptable Practices and the Definition of
Public Director
On January 31, 2007, the Commission adopted its first acceptable
practices for Core Principle 15, which requires all DCMs to minimize
conflicts of interest in their decision making process. The acceptable
practices focus on conflicts between DCMs' regulatory responsibilities
and their commercial interests, and they offer all DCMs a safe harbor
by which they may demonstrate core principle compliance. The acceptable
practices for Core Principle 15 contain four provisions, including
three ``operating'' provisions and one provision which primarily
defines public director. All four provisions were published in the
Federal Register on February 14, 2007.\14\ Existing DCMs were given a
two-year phase-in period to implement the acceptable practices or
otherwise demonstrate full compliance with Core Principle 15.
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\14\ 72 FR 6936 (February 14, 2007).
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On March 26, 2007, the Commission published the ``2007 proposed
amendments,'' which made certain clarifications and other changes to
the definition of public director.\15\ The proposed amendments did not
alter the acceptable practices in any other respect. In proposing the
amendments, the Commission emphasized that they should not be read as a
diminution of the public representation, conflict-of-interest
mitigation, and self-regulatory insulation intended by the acceptable
practices. To that end, all three operating provisions in the
acceptable practices remained as originally adopted.
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\15\ 72 FR 14051 (March 26, 2007). In addition to the clarifying
amendments, the Commission also proposed to correct a technical
drafting error.
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The Commission received six comment letters in response to the 2007
proposed amendments, but after careful consideration determined not to
act upon them.\16\ Instead, on November 23, 2007, the Commission gave
notice via the Federal Register that the acceptable practices for Core
Principle 15 were stayed indefinitely and in their entirety.\17\
Likewise, the two-year compliance period for existing DCMs also was
stayed. With the definition of public director in flux, the Commission
concluded that a stay was an appropriate measure while it arrived at a
final definition of public director.
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\16\ The six comment letters are summarized in 74 FR 3475
(January 21, 2009).
\17\ 72 FR 65658 (November 23, 2007).
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Finally, on January 21, 2009, the Commission proposed and sought
public comment on the ``2009 amendments,'' which also apply only to the
definition of public director, and which are adopted herein.\18\ In
publishing the 2009 amendments, the Commission asserted its continued
commitment to ``the fundamental philosophy underpinning the acceptable
practices for Core Principle 15: that potential conflicts of interest
in self-regulation by for-profit and publicly-traded DCMs * * * can be
addressed successfully through appropriate measures embedded in DCMs'
governance structures.'' \19\ The Commission also reaffirmed ``its
support for public representation on DCM boards of directors and
disciplinary panels, including the 35% public board standard first
enunciated in the acceptable practices,'' and its ``strong commitment
to ROCs, consisting exclusively of public directors, to oversee all
facets of DCMs' self-regulatory programs and staff.'' \20\ The 2009
amendments and public comments thereon are summarized below. As stated
previously, the Commission is adopting the 2009 amendments in their
entirety.
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\18\ 74 FR 3475.
\19\ 74 FR at 3476-3477.
\20\ Id. at 3477.
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C. Summary of the 2009 Amendments
The 2009 amendments fall into four broad categories, all of which
pertain to section (2) of the acceptable practices--the definition of
public director. First, the Commission has amended subsection (2)(ii)
to make its vocabulary more consistent with that in subsection (2)(i),
but without altering its meaning. As originally adopted, the provision
stated that ``* * * a director shall not be considered public if [the
bright-line tests are not met].'' Now, subsection (2)(ii) reads ``* * *
a director shall be considered to have a `material relationship' with
the contract market if [the bright-line tests are not met].'' Because
the overarching material relationship test in subsection (2)(i)
precludes a person with a material relationship from serving as a
public director, the purpose and effect of the provision remains
unchanged.
Second, the Commission has amended subsections (2)(ii)(A) and
(2)(iv) to save a DCM's public directors from bright-line tests that
they would have failed if they also served as directors of the DCM's
affiliates. For this purpose, ``affiliate'' is now defined in
subsection (2)(ii)(A) to include ``parents or subsidiaries of the
contract market or entities that share a common parent with the
contract market'' (``sister companies''). Previously, a DCM's public
directors could also serve as directors of its parent company, but not
as directors of its subsidiary or sister companies. With this
amendment, the latter two relationships no longer suffer automatic
exclusion.
Third, the Commission has amended subsection (2)(ii)(B). As
originally adopted, this subsection precluded DCM members, employees of
members, and persons affiliated with members from service as public
directors. ``[A]ffiliated with a member'' was defined as being an
officer or director of a member, or having ``any other relationship
with the member such that his or her impartiality could be called into
question in matters concerning the member.'' Under that original text,
subsection (2)(ii)(B) effectively inserted another material
relationship determination in what was an otherwise bright-line test.
Now, the Commission has streamlined subsection (2)(ii)(B) in three
ways. First, any material relationship determination made pursuant to
section (2) takes place under the overarching material relationship
test of subsection (2)(i), and not under the bright-line tests of
subsection (2)(ii). Second, subsection
[[Page 18985]]
(2)(ii)(B) sets forth the exact membership relationships that are
automatically precluded. Finally, the subsection allows a DCM to
conduct a material relationship analysis to determine whether
employment by a member should preclude a specific individual from
serving as a public director.
Finally, the Commission has amended subsection (2)(ii)(C) and its
bright-line tests. Here again, the Commission has simplified the
provision to ensure that the bright-line tests are clearly articulated.
As originally adopted, subsection (2)(ii)(C) created a $100,000
combined annual payments test for potential public directors and the
firms with which they may be affiliated (``payment recipients''). A
particular payment's relevance to the $100,000 bright-line test depends
upon the source (``payment provider'') and nature of the payment. In
this regard, the subsection did not specify which payments should count
towards the $100,000 annual cap--all payments or only those for certain
types of services. In addition, the subsection also contained potential
ambiguity with respect to the universe of potential payment providers
and payment recipients.
The first amendment to subsection (2)(ii)(C) defines the nature of
``payment,'' specifying that it is payment for ``legal, accounting, or
consulting services.'' The second amendment clarifies that the relevant
payment recipients include the potential public director and any firm
in which the director is an officer, partner, or director (``direct''
and ``indirect'' compensation, respectively). The third amendment to
subsection (2)(ii)(C) clarifies that the relevant payment providers
include the DCM and any parent, sister, or subsidiary company of the
DCM. Notably, the new payment providers provision no longer captures
DCM members or persons or entities affiliated with members, although
such relationships should still be scrutinized carefully under the
overarching materiality test of subsection (2)(i). Finally, the
Commission has amended subsection (2)(ii)(C) to take into account
payments to a public director in excess of $100,000 by sister and
subsidiary companies of the DCM. This is consistent with the
Commission's intent, previously articulated, not to automatically
prohibit overlapping public directors between DCMs and their
affiliates.
D. The 2009 Amendments and the Material Relationship Test
As described above, the 2009 amendments touch only on the bright-
line tests for public director. The most important element of the
definition--the overarching ``material relationship'' test in
subsection (2)(i)--remains unchanged. As before, ``[t]o 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.'' And, as before, ``[a] material
relationship is one that reasonably could affect the independent
judgment or decision making of the director.''
The practical consequence of the amended bright-line tests is that
formerly disqualifying bright-line relationships must now be analyzed
under the material relationship test recited above. However, DCMs
should be aware that shifting the point of analysis in no way
diminishes the importance of the relationships under review, nor does
it mean that a formerly disqualifying relationship is now generally
permissible. Instead, the amended bright-line tests make it incumbent
upon DCMs to carefully evaluate the facts to determine whether a
potential public director's relationships could reasonably affect his
or her independent judgment or decision making as a director of a DCM.
The Commission will carefully review those determinations in evaluating
DCMs' compliance with Core Principle 15.
Finally, while reemphasizing the importance of the material
relationship test in the definition of public director, the Commission
also notes its continued commitment to specific bright-line tests for
director-DCM relationships that are clearly material. Accordingly, the
2009 amendments to the bright-line tests retain most of the original
tests' substantive content. As with the original bright-lines, those
adopted herein touch on a potential public director's (A) Employment
relationships with the contract market; (B) direct and indirect
membership relationships with the contract market; (C) direct and
indirect compensation relationships with the contract market; and (D)
familial relationships with the contract market. The one-year look back
period also remains intact, as does the requirement that a DCM disclose
to the Commission those members of its board that are public directors
and the basis for those determinations. Commission staff will also
closely scrutinize the implementation of the material relationship and
bright-line tests when conducting future reviews of DCM governance.
E. Public Comments on the 2009 Amendments
Before summarizing and responding to individual comment letters,
the Commission wishes to address a recurring theme in the comments made
by DCMs throughout the development of these bright-line tests for
public director. DCMs have regularly argued that the tests will exclude
otherwise desirable candidates from serving on their boards, or that it
will be too difficult to determine with certainty whether an individual
qualifies as a public director under the acceptable practices. The
Commission has been responsive to DCMs' concerns, even proposing
alternative bright-line tests on two occasions after the acceptable
practices were adopted. However, after these efforts, some DCMs
continue to repeat this same criticism, including in their comments on
the 2009 amendments.
The Commission is confident that the definition of public director
adopted herein can be used effectively by all DCMs. Armed with this
streamlined definition, DCMs should be able to implement the acceptable
practices fully and easily. Moreover, if for some reason it is unclear
whether a person qualifies as a public director, a solution is readily
available: He or she is free to serve as a non-public director. Under
the acceptable practices, almost two-thirds of a DCM's board is filled
at its discretion, subject to the fitness requirements of Core
Principle 14. Thus, if a DCM believes that an individual adds
exceptional value, it is free to install him or her as a non-public
director. Furthermore, with respect to the 35% of directors who must be
public under the acceptable practices, the difficulties alleged by DCMs
might arise only if they attempt to seat directors who are too close to
the DCM or to the futures industry, rather than authentically public
persons.
The Commission has previously stated that ``the most significant
contribution made by public directors * * * is precisely their outside,
non-industry perspective.'' \21\ Directors who are truly unrelated to
the futures industry and its participants should have little difficulty
qualifying as public directors, and DCMs should have little difficulty
in implementing the acceptable practices if they avoid public director
candidates who are in the professional or personal orbit of the futures
industry.
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\21\ 72 FR at 6949.
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[[Page 18986]]
1. Specific Comments Received and the Commission's Response
The Commission received five comment letters in response to the
2009 amendments, including comments from ICE Futures U.S., Inc. (``ICE
Futures''), the Futures Industry Association (``FIA''), CBOE Futures
Exchange, LLC (``CFE''), CME Group, Inc. (``CME Group''), and the
Kansas City Board of Trade (``KCBT'').\22\ Commission staff reviewed
all five letters carefully. Most were generally supportive of the
proposed amendments, while also suggesting further changes. The five
letters and the Commission's responses thereto are summarized below.
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\22\ As explained below, CME Group is the parent company of four
DCMs: the Chicago Board of Trade, the Chicago Mercantile Exchange,
the Commodity Exchange, and the New York Mercantile Exchange.
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a. CBOE Futures Exchange, LLC.
CFE's comment letter reiterates the exchange's belief that the
acceptable practices will have a ``positive impact'' with respect to
futures exchange governance and minimizing conflicts of interest, and
that they ``will serve to enhance the self-regulatory process.'' \23\
The comment letter also summarizes the 2009 amendments and affirms the
exchange's agreement with most of them. CFE states that it supports
those amendments that ``clarify (i) The types of payments that would
disqualify a person from serving as a public director,\24\ (ii) that a
person who serves as a director of a futures exchange affiliate is not
disqualified from serving as a public director of the futures exchange
if the person otherwise qualifies to serve in that capacity, and (iii)
that receipt of director compensation from a futures exchange affiliate
does not disqualify the recipient from serving as a public director of
the futures exchange if the person otherwise qualifies to serve in that
capacity.'' \25\
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\23\ CFE comment letter (``CL'') at 1.
\24\ While ICE Futures and CME Group also support the amendments
pertaining to payment for services rendered, CFE's support is
offered in a very specific context, as explained below.
\25\ CFE CL at 1.
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While generally supportive of the 2009 amendments, CFE's comment
letter also raises certain concerns, both from the exchange's
perspective and from the Commission's. First, CFE declares its
opposition to an amendment in subsection (2)(ii)(B) removing employees
of DCM member firms from automatic disqualification. In addition, the
exchange offers certain interpretations with respect to the potential
adverse impact of this amendment. Second, CFE states its support for
the amendments to subsection (2)(ii)(C) (pertaining to a bright-line
test for payment for services rendered). Here again, CFE offers its own
interpretation as to what the subsection now permits. The Commission
believes that both of CFE's comments and interpretations merit further
discussion. They are treated below, in order.
CFE disagrees ``with the elimination by the CFTC's proposal of the
previous disqualification of an employee of a member of a futures
exchange from serving as a public director of that futures exchange.''
\26\ This comment refers to amended subsection (2)(ii)(B), which no
longer subjects a DCM member's employees to automatic disqualification
from service as a public director (unless they are officers or
directors). CFE observes, accurately, that ``the CFTC has stated that
one of the primary objectives of the Acceptable Practices is to
insulate the regulatory functions of a futures exchange via public
directors who are not conflicted by industry ties * * *.'' \27\ The
exchange argues that ``permitting a member employee to serve as a
futures exchange public director, and allowing the possibility that all
35% of the public directors of a futures exchange could be member
employees, is inconsistent with that goal * * *.'' \28\
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\26\ Id.
\27\ CFE CL at 2.
\28\ Id.
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The Commission agrees with CFE's overall sentiment, and although it
stands by the amendments to subsection (2)(ii)(B), it is vital that no
DCM misinterpret them. The Commission is concerned with any suggestion
that the acceptable practices now allow a DCM's public directors to
consist exclusively of members' employees. While the Commission is not
prejudging any potential relationship that might be presented to it in
the future, it is difficult to imagine that employees of member firms
will routinely pass the material relationship test of subsection
(2)(i).
DCMs are reminded that all director relationships, including
employment, remain subject to the acceptable practices' overarching
material relationship test. They should also be aware that the removal
of a relationship from the bright-line tests does not mean that such
relationship is now always permitted. Indeed, in the example offered by
CFE, the Commission agrees that a board whose public directors are all
employees of member firms is inconsistent with the intent of the
acceptable practices. In that regard, the Commission emphasizes the
language with which it proposed to amend subsection (2)(ii)(B), stating
``the amendments merely shift the point of analysis from the bright-
lines of subsection (2)(ii) to the overarching material relationship
test of subsection (2)(i).'' \29\ The Commission further affirmed--and
this is of special importance with respect to member employees--that it
``remains concerned about any relationship between potential public
directors and DCM members that could `affect the independent judgment
or decision making of the director' '' (emphasis added).\30\
Accordingly, no DCM should interpret the removal of member employment
from the bright-line tests as an invitation to seat a member's employee
as a public director without careful consideration. Any finding that a
member's employee qualifies as public will require full disclosure and
explanation under subsection (2)(v) of the acceptable practices, which
requires DCMs to disclose to the Commission the basis for any
determination that a director qualifies as public.
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\29\ 74 FR at 3478.
\30\ Id.
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CFE's second comment and interpretation relates to subsection
(2)(ii)(C). There, the exchange asserts that the amendments ``make
clear that a public director of the National Futures Association
(``NFA'') is not disqualified as serving as a public director of CFE
because NFA provides regulatory services to CFE * * *.'' \31\ CFE is
correct that amended subsection (2)(ii)(C) now limits the bright-line
definition of ``payment'' to payment for legal, accounting, or
consulting services. Previously, the term was undefined and thus
potentially broader in scope, to include payment for regulatory
services to a regulatory service provider (``RSP'') such as NFA.
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\31\ CFE CL at 1.
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The Commission cautions, however, that subsection (2)(ii)(C) is
just one element in a multi-prong test for evaluating whether an
individual is qualified to serve as a public director. While the
clarification of subsection (2)(ii)(C) is this instance may leave RSP
directors outside the scope of one bright-line test, such directors
remain subject to other elements in the definition of public director.
Most significant among these is the overarching material relationship
test of subsection (2)(i). As with other potential relationships, the
Commission will not prejudge what might be presented to it in the
future. However, a DCM should move cautiously in any scenario where it
outsources its regulatory functions to an RSP and seeks to install a
director of
[[Page 18987]]
its RSP as public director on its board, including its ROC. In this
context, the DCM should recall that ROC members are charged with
evaluating the quality of regulatory services provided to the DCM.
Certain questions naturally arise under these circumstances. Would the
RSP director be able to evaluate the RSP's performance objectively?
Would he or she be able to impartially counsel the exchange to seek
regulatory services elsewhere if the RSP, on whose board he/she also
sits, was underperforming? Even if the RSP director was only being
considered for service on the board, and not for the ROC, would his or
her board actions with respect to the RSP be as objective as those of a
public director with no RSP ties? Questions such as these must be
addressed fully in any material relationship analysis.
b. The Futures Industry Association and the Kansas City Board of
Trade.
The FIA's comment letter expresses its support for the 2009
amendments.\32\ Echoing the Commission's own sentiments, the FIA notes
that ``it is vitally important that DCMs include a significant number
of Board Members that are recognized to be independent of the DCM and
its members.'' \33\ FIA also maintains that ``no one could fairly
contest the Commission's definition of a public director as someone
with no material relationship with the DCM,'' and that ``the Commission
has proposed a workable and effective set of automatically
disqualifying relationships'' for potential public directors.\34\ FIA's
positive comments are balanced with the observation that it and others
might ``quibble'' with the 35% standard for public directors on DCM
boards, and that it might ``recommend expanding the [bright-line tests]
in some areas or restricting it in others.'' \35\ Overall, however, FIA
``urge[s] the Commission to adopt the [2009 amendments] quickly and to
make its Acceptable Practices effective as soon as practicable.'' \36\
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\32\ FIA CL at 1.
\33\ Id.
\34\ FIA CL at 1 and 2.
\35\ Id.
\36\ FIA CL at 2.
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KCBT's brief comment letter notes its ``support for the revised
public director definition published for comment in connection with the
SRO governance core principle guidelines.'' \37\ The exchange is
``appreciative of the Commission narrowing the applicability of the
$100,000 in professional services payments to a public director (or the
firm such public director represents) by a DCM or its affiliates.''
\38\
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\37\ KCBT CL at 1.
\38\ Id.
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c. ICE Futures U.S., Inc.
ICE Futures' comment letter contains both supportive statements and
suggestions for further modifications to the 2009 amendments. First,
the exchange ``commend[s] the decision to free a DCM's public directors
from bright-line tests that would have been failed if the directors
also served on the board of the DCM's affiliates.'' \39\ This comment,
which pertains to ``interlocking directorships'' under subsection
(2)(iv), was echoed by CFE and CME Group.\40\
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\39\ ICE Futures CL at 2.
\40\ CME Group states, for example, ``[t]he Commission has
appropriately recognized that an individual may be a director of
both a DCM and its parent, subsidiary, or entity that shares a
common parent with the DCM, and not lose his or her status as a
public director.'' CME CL at 3.
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The amendments to subsection (2)(iv) expand the universe of DCM
affiliates on whose board public directors may serve.\41\ Previously,
public directors could only serve on the board of a DCM's parent, but
the 2009 amendments also permit interlocking directorships with a DCM's
subsidiaries or entities sharing a common parent with the DCM. While
ICE Futures and others find this amendment helpful, DCMs are reminded
that as with all other public director relationships, the materiality
test is still in place. In addition, interlocking public directorships
are permitted only if the DCM director otherwise meets the definition
of public director. DCMs should be particularly vigilant for
circumstances where the interlocking directorship involves an entity
that could come under the DCM's regulatory authority. An affiliate that
trades or brokers in the DCM's markets, for example, could pose a
conflict of interest.
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\41\ Subsection (2)(ii)(A) is also relevant, as it defines
``affiliate'' as used in subsection (2)(iv).
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In addition to the comments summarized above, ICE Futures also
suggests further amendments to the bright-line tests for public
director. The exchange's concerns center around subsection (2)(ii)(C),
which, as amended, defines a bright-line test for potential public
directors based on direct and indirect compensation in excess of
$100,000 for legal, accounting, and consulting services rendered. ICE
Futures argues that, ``[b]ecause this prohibition is so broad, and the
dollar threshold so low, it needlessly sweeps into its net payments
that would be considered de minimis by the firm being compensated and
relationships that might not automatically create a conflict of
interest.'' \42\
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\42\ ICE Futures CL at 2.
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It should be noted that ICE Futures' comment seems limited to
indirect compensation to a public director via the firm with which he
or she is associated; the exchange's apparent preference is that
indirect compensation not constitute part of the bright-line tests at
all. It contends that ``[t]he DCM should be entrusted to evaluate all
the relevant facts and circumstances * * * and determine whether the
independent judgment of a public director would be compromised by the
indirect compensation arrangements.'' \43\
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\43\ ICE Futures CL at 3.
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If indirect compensation is not removed from the bright-line tests,
then the exchange argues that the Commission should at least
``significantly increase the dollar threshold for indirect
compensation.'' \44\ ICE Futures offers the listing standards of the
New York Stock Exchange (``NYSE'') as an ``instructive'' guide in
establishing what it considers a more appropriate cut-off on payments
for services rendered.\45\
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\44\ Id.
\45\ While the Commission understands the attraction of adopting
a single payment cap based on the more widely used listing standards
of the NYSE, it does not believe that the listing standards are an
appropriate guide. The Commission continues to think that the
listing standards serve a distinct purpose--the protection of
shareholders through boards of directors that are sufficiently
independent from management. In contrast, the acceptable practices
for Core Principle 15, including the bright-line tests for public
director, seek to protect self-regulation through DCM boards of
directors and other bodies that include a sufficient number of truly
public persons.
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The Commission understands that the $100,000 threshold in
subsection (2)(ii)(C) is a significant bright-line test, and that
others might have chosen to draw the line at a higher dollar value or
as a percentage of revenues. However, it continues to believe that
$100,000 in combined annual payments is an appropriate cap in
compensation for a public director or a firm on which he or she serves
as an officer, director, or partner. The $100,000 cap applies to
payments from the DCM or any affiliate of the DCM for legal,
accounting, or consulting services. As the Commission explained when it
reduced the ratio of public directors required by the acceptable
practices from 50% (as originally proposed) to 35% (as adopted), ``the
Commission believes that a strict definition of public director is
especially necessary now that it will apply to 35% of a DCM's
directors, rather than the 50% originally
[[Page 18988]]
proposed.'' \46\ The Commission also reiterates its previous
observation that a potential public director who fails one or more
bright-line tests--the $100,000 payment cap, for example--is free to
serve as a non-public director if the DCM deems it important.
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\46\ 72 FR at 6949.
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Finally, the Commission reminds DCMs that other relationships
involving payment for services rendered--even those not specifically
listed in subsection (2)(ii)(C)--should be scrutinized closely under
the material relationship test. Such other relationships could include
payments from other sources (e.g., a DCM member firm rather than the
DCM itself); payments based on other relationships (e.g., employee
rather than director or partner); and payments for lesser amounts
(e.g., $95,000 to a firm where the DCM director serves as partner and
to which $95,000 represents significant revenue). In short, DCMs must
continue to consider the payment provider, the payment recipient, and
the services provided when making materiality determinations under
subsection (2)(ii)(C). DCMs also must disclose to the Commission which
members of its board are public directors, and the basis for those
determinations.\47\ The Commission expects that all potentially
material relationships will have been examined carefully.
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\47\ Subsection (2)(v) of the acceptable practices.
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d. CME Group Inc.
CME Group is the publicly-traded parent company of four DCMs: the
Chicago Board of Trade (``CBOT''), the Chicago Mercantile Exchange
(``CME''), the Commodity Exchange (``COMEX''), and the New York
Mercantile Exchange (``NYMEX''). Its comment letter includes a brief
history of the acceptable practices for Core Principle 15 and the
amendments to the bright-line tests for public director. CME Group
closes its comment letter by stating, ``[i]n sum, we believe that the
Commission has substantially improved its proposed definition of public
director, in connection with the non-exclusive safe harbor acceptable
practices for compliance with Core Principle 15.'' \48\
---------------------------------------------------------------------------
\48\ CME Group CL at 4.
---------------------------------------------------------------------------
Like CFE and ICE Futures, CME Group approves of provisions in the
2009 amendments that allow for interlocking public directors across a
DCM, its subsidiaries, and entities sharing a common parent with the
DCM. CME Group also approves of provisions in the amendments that
eliminate the bright-line test for employees of DCM member firms.\49\
Finally, CME Group supports amendments to subsection (2)(ii)(C) with
respectto direct and indirect payments to directors for services
rendered. All three amendments have already been discussed above in the
context of CFE's and ICE Futures' comment letters. As the Commission
noted there, potential public directors remain subject to the material
relationship test of subsection (2)(i) in all three circumstances.
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\49\ However, as explained previously, employees of DCM members,
while no longer automatically disqualified from serving as public
directors, are not automatically permitted to do so either. Instead,
each one faces a robust and individualized material relationship
analysis which must be disclosed to the Commission. In this regard,
the Commission notes that blanket determinations by a DCM that
particular categories of persons qualify as public directors without
individual examination is insufficient to satisfy the acceptable
practices for Core Principle 15.
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In addition to the supportive statements summarized above, CME
Group also requests that the Commission ``consider a further refinement
[to the bright-line tests] with respect to immediate family members.''
\50\ Referring to subsection (2)(ii)(D), it argues ``we do not believe
that an individual should be considered to have a per se material
relationship with a DCM merely because his immediate family member is a
director or an officer of a member.'' \51\ The Commission's response is
similar to that given ICE Futures' request for a more relaxed bright-
line test for indirect payments for services rendered. Because the
final acceptable practices require that only 35% of a DCM's directors
be public, a strict definition of public director is appropriate. In
this regard, the Commission believes that a close family bond certainly
could affect the independent judgment or decision making of the
director and should therefore be precluded automatically. The
acceptable practices' material relationship test is instructive: the
Commission is concerned with relationships that ``reasonably could
affect'' the director; proof of certain effect is not required.
---------------------------------------------------------------------------
\50\ CME Group CL at 3.
\51\ Id.
---------------------------------------------------------------------------
CME Group's comment letter also includes broader legal and policy
arguments that the Commission has previously addressed at length.
Nonetheless, they require a brief response here so that no DCM is
confused as to what is required under Core Principle 15. DCMs should be
aware that the acceptable practices are voluntary safe harbors which
they may use to demonstrate compliance with Core Principle 15, and that
they are free to comply by other means. The Commission will fairly
evaluate any alternatives presented to it. What DCMs are not free to
do, however, is to substitute their interpretations of Core Principle
15 for the Commission's.
CME Group argues that it ``continues to believe that the board
composition acceptable practices are not related to Core Principle 15
and conflict with the clear Congressional intent in the Commodity
Futures Modernization Act of 2000 (``CFMA'') to impose no composition
requirements on the boards of publicly owned futures exchanges.'' \52\
CME Group's beliefs notwithstanding, the Commission has interpreted its
statutory authority and acted upon it. CME Group's four regulated DCMs
are required to comply with Core Principle 15, and all the core
principles, as they are interpreted by the Commission.
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\52\ CME Group CL at 2.
---------------------------------------------------------------------------
To comply with Core Principle 15, DCMs must specifically address
the conflicts of interest discussed at length during the development of
these acceptable practices. The Commission has been clear in its
requirements, and the preamble to the acceptable practices explains
them as well. As stated in the acceptable practices, ``[all DCMs] bear
special responsibility to regulate effectively, impartially, and with
due consideration of the public interest. * * * Under Core Principle
15, they are also required to minimize conflicts of interest in their
decision-making process. To comply with this core principle, [DCMs]
should be particularly vigilant for such conflicts between and among
their self-regulatory responsibilities, their commercial interests, and
the several interests of their management, members, owners, customers
and market participants, and other constituencies.''
Within these boundaries, DCMs may demonstrate compliance with Core
Principle 15 as they deem best. The Commission has repeatedly affirmed
that the acceptable practices are not mandatory. What is mandatory,
however, is that all DCMs mitigate conflicts of interest in their
decision making process, including the conflicts that the Commission
has identified between their commercial interests and their regulatory
responsibilities.
Indeed, CME Group's own comment letter expresses the potential
conflict of interest between regulatory and commercial decision making.
Referring to commercial interests, CME Group claims, ``[w]e believe
that each publicly traded DCM has an obligation to its shareholders to
follow the listing rules
[[Page 18989]]
of the relevant securities exchange and to nominate for election as
directors a mix of individuals based on their ability to create value
for the corporation.'' \53\ While the Commission acknowledges all DCMs'
commercial interests, it also reminds them of their regulatory
responsibilities.
---------------------------------------------------------------------------
\53\ CME Group CL at 2.
---------------------------------------------------------------------------
In the case of CME Group, the Commission notes that its subsidiary
DCMs--CBOT, CME, COMEX, and NYMEX--are not traded on national
securities exchanges or subject to listing standards. While CME Group
may be required to comply with certain listing rules and to maximize
shareholder value, its regulated DCMs have additional statutory and
regulatory obligations. Above all, regardless of their corporate
structures, all DCMs must regulate effectively, impartially, and with
due consideration of the national public interest as provided for in
the Act.
The Commission is confident that regulatory and commercial
interests can be reconciled in effective self-regulation. However,
continued success depends on all DCMs recognizing the potential for
conflicts; acknowledging the primacy of regulatory interests; and
implementing effective solutions to protect self-regulatory functions,
decisions, and personnel from improper commercial influence and
considerations. As the Commission stated when it adopted the acceptable
practices for Core Principle 15, and as it continues to believe now:
[I]t is crucial for all DCMs and their owners to understand that
DCMs have two responsibilities: A responsibility to their ownership
and a responsibility to the public interest as defined in the Act.
Whereas the [listing standards] serve those with a direct fiduciary
claim upon a company * * * the new acceptable practices serve the
public, whose claim upon DCMs is entirely independent of ownership,
membership, or any other DCM affiliation. In short, through the new
acceptable practices for Core Principle 15, the Commission seeks to
ensure adequate representation of a public voice that otherwise is
not guaranteed any formal standing within a DCM, and which receives
no effective representation under any regulatory regime other than
the Commission's.\54\
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\54\ 72 FR 6936, 6949.
II. Related Matters
A. Cost-Benefit Analysis
Section 15(a) of the Act requires the Commission to consider the
costs and benefits of its actions before issuing a new regulation or
order under the Act.\55\ By its terms, Section 15(a) requires the
Commission to ``consider the costs and benefits'' of a subject rule or
order, without requiring it to quantify the costs and benefits of its
action or to determine whether the benefits of the action outweigh its
costs. Section 15(a) requires that the costs and benefits of new
regulations be evaluated in light of five broad areas of market and
public 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. In conducting its analysis,
the Commission may, in its discretion, give greater weight to any one
of the five enumerated areas of concerns and may determine that,
notwithstanding its costs, a particular rule 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 CEA.\56\
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\55\ 7 U.S.C. 19(a).
\56\ E.g., Fishermen's Dock Co-op., Inc. v. Brown, 75 F.3d 164
(4th Cir. 1996); Center for Auto Safety v. Peck, 751 F.2d 1336 (D.C.
Cir. 1985) (agency has discretion to weigh factors in undertaking
cost benefit analyses).
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On February 14, 2007, the Commission published final acceptable
practices for Core Principle 15 that included prophylactic measures
designed to minimize conflicts of interest in DCMs' decision making
processes. The final rulemaking thoroughly considered the costs and
benefits of the acceptable practices and responded to comments relating
to the costs of adhering to their requirements.
The 2009 amendments to the definition of public director bring
further clarity and finality to the acceptable practices for Core
Principle 15. The Commission believes that the amendments are fully
consistent with the design and purpose of the acceptable practices as
originally conceived. Furthermore, through more consistent,
streamlined, and precise articulations, the amendments will facilitate
DCMs' implementation of the acceptable practices and thereby advance
important public interest considerations with respect to conflicts of
interest in DCM self-regulation. In particular, the acceptable
practices offer all DCMs a safe harbor for compliance with Core
Principle 15, which requires them to ``establish and enforce rules to
minimize conflicts of interest in the decision making process of the
contract market * * *.'' \57\ The acceptable practices' safe harbor is
based on the inclusion of public directors on their boards; the
creation and empowerment of ROCs consisting exclusively of public
directors; and the presence of public persons on DCM disciplinary
panels. Thus, each of these provisions depends heavily on a clear and
settled definition of public director. The Commission believes that the
2009 amendments will not impose any additional costs upon DCMs. To the
contrary, they may reduce the costs of compliance through improvements
in the bright-line tests for public director, such that the tests truly
operate as bright-lines and the definition of public director is well-
settled.
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\57\ 7 U.S.C. 7(d)(15).
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After considering the above mentioned factors and issues, the
Commission has determined to adopt these amendments to the acceptable
practices for Core Principle 15. The Commission received no comments on
its Section 15(a) analysis of the amendments and hereby adopts them as
proposed.
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 2009 amendments affect DCMs, which
the Commission has previously determined are not small entities for
purposes of the Regulatory Flexibility Act.\58\ Accordingly, the Acting
Chairman, on behalf of the Commission, hereby certifies pursuant to 5
U.S.C. 605(b) that the 2009 amendments will not have a significant
economic impact on a substantial number of small entities.
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\58\ See 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 2009 amendments to the acceptable practices for Core Principle
15 will not impose any new recordkeeping or information collection
requirements, or other collections of information that require approval
of the Office of Management and Budget, under 44 U.S.C. 3501 et seq.
Additionally, the Commission received no comments on the accuracy of
the estimate of additional recordkeeping or information collection
requirements. Accordingly, the Paperwork Reduction Act does not apply.
III. Text of Amendments
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
[[Page 18990]]
particular, Sections 3, 5, 5c(a) and 8a(5) of the Act, the Commission
hereby amends Part 38 of Title 17 of the Code of Federal Regulations as
follows:
PART 38--DESIGNATED CONTRACT MARKETS
0
1. The authority citation for part 38 continues to read as follows:
Authority: 7 U.S.C. 2, 5, 6, 6c, 7, 7a-2, and 12a, as amended
by Appendix E of Public Law 106-554, 114 Stat. 2763A-365.
0
2. The stay is lifted on paragraph (b) of Core Principle 15 in Appendix
B to 17 CFR Part 38.
0
3. In Appendix B to Part 38 revise paragraphs (b)(2)(ii) through
(b)(2)(v) of Core Principle 15 to read as follows:
Appendix B to Part 38--Guidance on, and Acceptable Practices in,
Compliance With Core Principles
* * * * *
Core Principle 15 of section 5(d) of the Act: CONFLICTS OF INTEREST
* * * * *
(b) * * *
(2) * * *
(ii) In addition, a director shall be considered to have a
``material relationship'' with the contract market if any of the
following circumstances exist:
(A) The director is an officer or employee of the contract
market or an officer or employee of its affiliate. In this context,
``affiliate'' includes parents or subsidiaries of the contract
market or entities that share a common parent with the contract
market;
(B) The director is a member of the contract market, or an
officer or director of a member. ``Member'' is defined according to
Section 1a(24) of the Commodity Exchange Act and Commission
Regulation 1.3(q);
(C) The director, or a firm with which the director is an
officer, director, or partner, receives more than $100,000 in
combined annual payments from the contract market, or any affiliate
of the contract market (as defined in Subsection (2)(ii)(A)), for
legal, accounting, or consulting services. Compensation for services
as a director of the contract market or as a director of an
affiliate of the contract market does not count toward the $100,000
payment limit, nor does deferred compensation for services prior to
becoming a director, so long as such compensation is in no way
contingent, conditioned, or revocable;
(D) Any of the relationships above apply to a member of the
director's ``immediate family,'' i.e., spouse, parents, children and
siblings.
(iii) All of the disqualifying circumstances described in
Subsection (2)(ii) shall be subject to a one-year look back.
(iv) A contract market's public directors may also serve as
directors of the contract market's affiliate (as defined in
Subsection (2)(ii)(A)) if they otherwise meet the definition of
public director in this Section (2).
(v) A contract market shall disclose to the Commission which
members of its board are public directors, and the basis for those
determinations.
* * * * *
Issued in Washington, DC, on April 21, 2009 by the Commission.
David A. Stawick,
Secretary to the Commission.
[FR Doc. E9-9508 Filed 4-24-09; 8:45 am]
Last Updated: April 27, 2009