[Federal Register: February 14, 2007 (Volume 72, Number 30)]
[Rules and Regulations]
[Page 6936-6958]
From the Federal Register Online via GPO Access [wais.access.gpo.gov]
[DOCID:fr14fe07-9]
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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 ("SROs")
AGENCY: Commodity Futures Trading Commission.
ACTION: Final rule.
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SUMMARY: The Commission hereby adopts final acceptable practices for
minimizing conflicts of interest in decision making by designated
contract markets ("DCMs" or "exchanges"),\1\ pursuant to Section
5(d)(15) ("Core Principle 15") \2\ of the Commodity Exchange Act
("CEA" or "Act").\3\ The final acceptable practices are the first
issued for Core Principle 15 and are applicable to all DCMs.\4\ They
focus upon structural conflicts of interest within modern self-
regulation, and offer DCMs a "safe harbor" by which they may minimize
such conflicts and comply with Core Principle 15. To receive safe
harbor treatment, DCMs must implement the final acceptable practices in
their entirety, including instituting boards of directors that are at
least 35% public and establishing oversight of all regulatory functions
through Regulatory Oversight Committees ("ROCs') consisting
exclusively of public directors.
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\1\ The acceptable practices for core principles reside in
Appendix B to Part 38 of the Commission's Regulations, 17 CFR Part
38, App. B.
\2\ 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
Sec. 5(d)(15), 7 U.S.C. 7(d)(15).
\3\ The Act is codified at 7 U.S.C. 1 et seq. (2000).
\4\ 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 security futures products under Section 5f of the
Act and Commission Regulation 41.31, is exempt from the core
principles enumerated in Section 5 of the Act, and the acceptable
practices thereunder, including those adopted herein.
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DATES: Effective Date: March 16, 2007.
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, Washington, DC 20581.
SUPPLEMENTARY INFORMATION:
Table of Contents
I. Introduction
A. Overview of the Acceptable Practices
B. Background
II. Procedural History
III. Public Comments Received and the Commission's Response
A. Legal Comments
1. Overview of Commission's Authority to Issue the Acceptable
Practices
2. Specific Legal Issues Raised by Commenters
B. Policy Comments
1. General Comments
2. Comments With Respect to the Board Composition Acceptable
Practice
3. Comments With Respect to the Public Director Acceptable
Practice
4. Comments With Respect to the ROC Acceptable Practice
[[Page 6937]]
5. Comments With Respect to the Disciplinary Committee
Acceptable Practice
IV. Specific Requests for Modifications and/or Clarifications that
the Commission has Determined to Grant or Deny
A. Phase-in Period for the New Acceptable Practices
B. Selection of Public Directors
C. Compensation of Public Directors
D. Overlapping Public Directors
E. Jurisdiction of Disciplinary Panels and Definition of
"Public" for Persons Serving on Disciplinary Panels
F. "No Material Relationship Test"
G. Elimination of ROCs' Periodic Reporting Requirement
V. Related Matters
VI. Text of Acceptable Practices for Core Principle 15
I. Introduction
A. Overview of the Acceptable Practices
The final acceptable practices recognize DCMs' unique public-
interest responsibilities as self-regulatory organizations ("SROs")
in the U.S. futures industry. They address conflicts of interest that
exist within DCMs as they operate in an increasingly competitive
environment and transform from member-owned, not-for-profit entities
into diverse enterprises with a variety of business models and
ownership structures. While continuing to meet their regulatory
responsibilities, DCMs must now compete effectively to generate
profits, advance their commercial interests, maximize the value of
their stock, and/or serve multiple membership, ownership, customer, and
other constituencies. The presence of these potentially conflicting
demands within a single entity--regulatory authority coupled with
commercial incentives to misuse such authority--constitutes the new
structural conflict of interest addressed by the acceptable practices
adopted herein.
The Commission has determined that the structural conflicts
outlined above are appropriately addressed through reforms within DCMs
themselves, including reforms of DCMs' governing bodies. Accordingly,
the Commission offers the new acceptable practices for Core Principle
15 as an appropriate method for minimizing such conflicts. The
Commission believes 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. The new
acceptable practices incorporate and emphasize each of these elements,
and offer all DCMs clear instruction as to how they may comply with
Core Principle 15.
Although DCMs are free to comply with Core Principle 15 by other
means, the Commission stresses that they all must address structural
conflicts of interest and adopt substantive measures to protect their
regulatory decision making from improper commercial considerations.
DCMs must ensure that regulatory decisions are made on their own
merits, and that they are not compromised by the commercial interests
of the DCMs or the interests of their numerous constituencies.
Likewise, DCMs' regulatory operations and personnel must be insulated
from improper influence and commercial considerations to ensure
appropriate regulatory outcomes.
The new acceptable practices are set forth in four component parts,
and DCMs must meet all four to receive safe harbor treatment under Core
Principle 15. Each component part is summarized as follows:
First, the Board Composition Acceptable Practice calls upon all
DCMs to minimize conflicts of interest in self-regulation by
establishing boards of directors that contain at least 35% "public
directors" (as defined by a separate Public Director Acceptable
Practice discussed below). The Board Composition Acceptable Practice
further requires that DCMs ensure that any executive committees (or
similarly empowered bodies) also meet the 35% public director standard.
This 35% standard in the new acceptable practices represents a
modification from the 50% public director standard in the proposed
acceptable practice.\5\
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\5\ Conflicts of Interest in Self-Regulation and Self-Regulatory
Organizations ("Proposed Rule"), 71 FR 38740 (July 7, 2006).
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Second, the Regulatory Oversight Committee Acceptable Practice
mandates that all DCMs establish Regulatory Oversight Committees,
composed only of public directors, to oversee core regulatory functions
and ensure that they remain free of improper influence. The Commission
notes that ROCs are intended to insulate self-regulatory functions and
personnel from improper influence. In fulfilling this role, however,
ROCs are not expected to assume managerial responsibilities, or to
isolate self-regulatory functions and personnel from others within the
DCM. ROCs' oversight and insulation should be aided by their DCMs'
chief regulatory officers ("CROs"). A full description of the
responsibilities and authority of ROCs may be found in the text of the
final acceptable practices.
Third, the Disciplinary Panel Acceptable Practice states that DCM
disciplinary panels should not be dominated by any group or class of
DCM members or participants, and must include at least one "public
person" on every panel. Under the Disciplinary Panel Acceptable
Practice, disciplinary panels must keep thorough minutes of their
meetings, including a full articulation of the rationale supporting
their disciplinary decisions.
Finally, the Public Director Acceptable Practice establishes
specific definitions of "public" for DCM directors and for members of
disciplinary panels. Public directors are persons who have no
"material relationship" with their DCM, i.e., any relationship which
could reasonably affect their independent judgment or decision making.
In addition, public directors must meet a series of "bright-line
tests" which identify specific circumstances and relationships which
the Commission believes are clearly material. For members of
disciplinary panels, the definition of "public" includes the bright-
line tests, but not the materiality criterion.
The final acceptable practices also include clarifications to the
acceptable practices originally proposed by the Commission on July 7,
2006. For example, the final acceptable practices clarify that a DCM's
public directors may also serve as public directors of its holding
company under certain circumstances. These clarifications were made in
response to public comments on the proposed acceptable practices.
In addition, although the final acceptable practices are effective
30 days after publication in the Federal Register, the Commission will
permit currently established DCMs to implement responsive measures over
a phase-in period of two years or two regularly-scheduled board
elections, whichever occurs sooner.\6\ Responsive measures include
implementing the final acceptable practices or otherwise fully
complying with the requirements of Core Principle 15, including
requirements to minimize the structural conflicts of interest discussed
herein. The phase-in period and the modified public director
requirements for boards and executive committees are the only
significant changes between the proposed acceptable practices and those
adopted today.
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\6\ "Currently established" DCMs are those that are already
designated at the time this release is published in the Federal
Register.
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[[Page 6938]]
B. Background
U.S. futures markets are a critical component of the U.S. and world
economies, providing significant economic benefits to market
participants and the public at large. They provide an important hedging
vehicle to individuals and firms in myriad industries, resulting in
more efficient production, lower costs for consumers, and other
economic benefits. By offering a competitive marketplace and focal
point where traders can freely interact based on their assessments of
supply and demand, futures markets also provide a vital forum for
discovering prices that are generally considered to be superior to
administered prices or prices determined privately. For this reason,
futures markets are widely utilized throughout the global economy.
Participants in the markets include virtually all economic actors, and
the prices discovered on a daily basis materially affect a wide range
of businesses in the agricultural, energy, financial, and other
sectors.
For the reasons outlined above, DCMs are not just typical
commercial enterprises, but are commercial enterprises affected with a
significant national public interest. Actions that distort prices or
otherwise undermine the integrity of the futures markets have broad,
detrimental implications for the economy as a whole and the public in
general. Congress recognized the importance of futures trading in the
Act, when it explicitly stated that futures transactions "are entered
into regularly in interstate and international commerce and are
affected with a national public interest * * *." \7\ It defined the
public interest to include "liquid, fair, and financially secure
trading facilities." \8\ Congress also identified the purposes of the
Act: "to deter and prevent price manipulation or any other disruptions
to market integrity; to ensure the financial integrity of all
transactions subject to this Act and the avoidance of systemic risk;
and to protect all market participants from fraudulent or other abusive
sales practices and misuses of customer assets." \9\ To accomplish
these purposes, Congress established a statutory system of DCM self-
regulation, combined with Commission oversight, to promote
"responsible innovation and fair competition among boards of trade,
other markets and market participants." \10\ Meeting these statutory
obligations and purposes requires DCM self-regulation that is as
vigorous, impartial, and effective as possible.
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\7\ CEA Sec. 3(a), 7 U.S.C. 5(a).
\8\ Id.
\9\ CEA Sec. 3(b), 7 U.S.C. 5(b).
\10\ Id.
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All DCMs face unique and potentially conflicting regulatory
obligations and commercial demands as they work to meet the statutory
requirements outlined above. On the commercial side, they must attract
trading to their markets, maximize the value of their stock, generate
profits, satisfy the financial needs of their numerous stakeholders and
constituencies, and/or meet the diverse business needs of their market
participants. At the same time, as self-regulatory organizations, DCMs
must exercise their authority judiciously, impartially, and in the
public interest. As essential forums for the execution of futures
transactions and for price discovery, DCMs must ensure fair and
financially secure trading facilities. DCMs must also help to "serve"
and "foster" the national public interest through self-regulatory
responsibilities that include ensuring market integrity, financial
integrity, and the strict protection of market participants.\11\
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\11\ Id.
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When DCMs were first entrusted with these extensive regulatory
responsibilities, they were almost exclusively member-owned, not-for-
profit exchanges facing little competition for customers or in their
prominent contracts. Although conflicts of interest in self-regulation
were a concern even then, such conflicts typically centered on
individual exchange members policing one another. Today's DCMs,
however, are vibrant commercial enterprises competing globally in an
industry whose ownership structures, business models, trading
practices, and products are evolving rapidly. As a result, DCMs now
face potential conflicts of interest between their critical self-
regulatory responsibilities and their powerful commercial imperatives.
Specifically, DCMs must: defend and expand their markets against others
offering similar products or services; generate returns for their
owners; and provide liquid markets where their members and customers
may profit. At the same time, they must continue to meet fundamental
public interest responsibilities through vigorous and impartial self-
regulation. To reconcile these obligations, DCMs must acknowledge and
guard against conflicts between their regulatory responsibilities and
their commercial interests, and take measures to prevent improper
influence upon self-regulation by their numerous constituencies,
including members, owners, customers, and others.
As explained in the proposing release, rapid and ongoing changes in
the futures industry have raised concerns as to whether existing self-
regulatory structures are equipped to manage evolving conflicts of
interest. Self-regulation's traditional conflict--that members will
fail to police their peers with sufficient zeal--has been joined by the
possibility that competing DCMs could abuse their regulatory authority
to gain competitive advantage or satisfy commercial imperatives. Such
conflicts of interest must be addressed promptly and proactively to
prevent them from becoming real abuses, and to ensure continued public
confidence in the integrity of the U.S. futures markets.
After three-and-a-half years of careful study, the Commission has
determined that the conflicts of interest identified above are inherent
in any system of self-regulation conducted by competing DCMs, many of
which operate under new ownership structures and business models, and
all of which are possessed of strong commercial imperatives. The
Commission has further determined that successfully addressing such
conflicts, and complying with Core Principle 15, requires appropriate
responses within DCMs. Only by reconciling the inherent tension between
their self-regulatory responsibilities and their commercial interests,
whether via the new acceptable practices or otherwise, can DCMs
successfully minimize conflicts of interest in their decision-making
processes and thereby ensure the integrity of self-regulation in the
U.S. futures industry.
The new acceptable practices for Core Principle 15 are a direct
response to the industry changes outlined above. As required by the
Act, they "promote responsible innovation and fair competition" among
U.S. DCMs, and ensure that self-regulation remains compatible with the
modern business practices of today's DCMs.\12\ The new acceptable
practices embody the Commission's firm belief that effective self-
regulation in an increasingly competitive, publicly traded, for-profit
environment requires independent decision making at key levels of DCMs'
regulatory governance structures. The Commission further believes that
the new acceptable practices constitute an ideal solution to emerging
structural conflicts of interest in self-regulation. Both proactive and
carefully targeted, the new acceptable practices for Core Principle 15
advance the public interest and ensure the continued strength and
[[Page 6939]]
integrity of self-regulation in a rapidly evolving industry.
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\12\ Id.
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The conflicts of interest described above require careful responses
by all DCMs. The Commission believes that DCMs can comply with Core
Principle 15 by minimizing conflicts of interest between their
regulatory responsibilities and their commercial interests or those of
their membership, ownership, management, customer, and other
constituencies. However, whether DCMs choose to comply with Core
Principle 15 via the acceptable practices adopted herein or by other
means, the Commission recognizes that necessary measures may take time
to implement. Accordingly, and at the request of public commenters, the
Commission is adopting a phase-in period for full compliance with Core
Principle 15. Within two years of this document's effective date, or
two regularly-scheduled board elections, whichever occurs first, all
DCMs must be in full compliance with Core Principle 15, either by
availing themselves of the new acceptable practices or undertaking
other effective measures to address the structural conflicts of
interest identified herein. Commission staff will contact all DCMs in
six months of the effective date of these final acceptable practices to
learn of their plans for full compliance. Established DCMs must
demonstrate substantial compliance with Core Principle 15, and plans
for full compliance, well before the phase-in period's expiration. New
candidates for designation as contract markets should be prepared to
demonstrate compliance with Core Principle 15, or a plan for
compliance, upon application.
II. Procedural History
The four acceptable practices for Core Principle 15 adopted today
are the culmination of a comprehensive review of self-regulation in the
U.S. futures industry ("SRO Review" or "Review") launched by the
Commission in May of 2003. Phase I of the Review explored the roles,
responsibilities, and capabilities of SROs in the context of industry
changes. Staff examined the designated self-regulatory organization
system of financial surveillance, the treatment of confidential
information, the composition of DCM disciplinary committees and panels,
and other aspects of the self-regulatory process. Phase I of the Review
also included staff interviews with over 100 persons including
representatives of DCMs, clearing houses, futures commission merchants
("FCMs"), industry associations, and securities-industry entities, as
well as current and retired industry executives, academics, and
consultants.
In June of 2004, the Commission initiated Phase II of the SRO
Review and broadened its inquiry to explicitly address SRO governance
and the interplay between DCMs' self-regulatory responsibilities and
their commercial interests. In June of 2004, the Commission issued a
Federal Register Request for Comments ("Request") on the governance
of futures industry SROs.\13\ The Request sought input on the proper
composition of DCM boards, optimal regulatory structures, the impact of
different business and ownership models on self-regulation, the proper
composition of DCM disciplinary committees and panels, and other
issues.
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\13\ Governance of Self-Regulatory Organizations, 69 FR 32326
(June 9, 2004). Comment letters received are available at: http://www.cftc.gov/foia/comment04/foi04--005_1.htm
.
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In November of 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.\14\
The Second Request examined the board-level ROCs recently established
at some SROs in the futures and securities industries. It also asked
commenters to consider the impact of New York Stock Exchange ("NYSE")
listing standards on publicly traded futures exchanges; whether the
standards were relevant to self-regulation; and how the standards might
inform the Commission's own regulations.\15\
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\14\ Self-Regulation and Self-Regulatory Organizations in the
Futures Industry, 70 FR 71090 (Nov. 25, 2005). Comment letters
received are available at http://www.cftc.gov/foia/comments05/foi05_007_1.htm
.
\15\ The NYSE's corporate governance listing standards require
listed companies to: have a majority of independent directors; meet
materiality and bright-line tests for independence; convene
regularly scheduled executive sessions of the board without
management present; institute nominating/governance, compensation,
and audit committees consisting exclusively of public directors;
etc. See NYSE Listed Company Manual, Sec. Sec. 303A:00-14,
available at: http://www.nyse.com/regulation/listed/1101074746736.html.
The NASDAQ Stock Market has adopted corporate
governance listing standards similar to the NYSE's. See the NASDAQ
Stock Market Listing Standards and Fees, available at: http://www.nasdaq.com/about/nasdaq_listing_req_fees.pdf.
DCMs whose
parent companies are listed on the NYSE include the CBOT, CME,
NYBOT, and NYMEX. Although these DCMs themselves are not required to
comply with the listing standards, they may be in de facto
compliance if they have chosen to name identical boards of directors
for both the listed parent and the DCM.
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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 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 is available at http://www.cftc.gov/files/opa/opapublichearing021506final.pdf
.
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Finally, in July of 2006, the Commission published the Proposed
Rule and sought public comment on new acceptable practices for Core
Principle 15.\17\ The Commission proposed that at least 50% of the
directors on DCM boards and executive committees (or similarly
empowered bodies) be public directors. It also proposed that day-to-day
regulatory operations be overseen and insulated through a CRO reporting
directly to a board-level ROC consisting exclusively of public
directors. The proposed acceptable practices also defined "public
director" for persons serving on boards and ROCs, and defined "public
person" for disciplinary panel members. To qualify as a public
director under the proposal, the director in question would require an
affirmative determination that he or she had no material relationship
with the DCM. In addition, public directors and public persons would
both have been required to meet a series of "bright-line" tests. The
inability to satisfy both the material relationship and bright-line
test requirements would automatically preclude them from serving as
public directors or public disciplinary panel members. Finally, the
proposed acceptable practices called for DCM disciplinary panels that
were not dominated by any group or class of SRO participants, and that
included at least one public person.
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\17\ See supra note 5.
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The proposal's original 30-day comment period, scheduled to close
on August 7, 2006, was extended by an additional 30 days, to September
7, 2006. The Commission received a total of 34 comment letters in
response to the proposed acceptable practices for Core Principle 15,
significant aspects of which are discussed below.\18\
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\18\ Comment letters in response to the Proposed Rules are
available at: http://www.cftc.gov/foia/comment06/foi06_004_1.htm.
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[[Page 6940]]
III. Public Comments Received and the Commission's Response
The 34 comment letters received in response to the proposed
acceptable practices included responses from 10 industry associations
and trade groups, nine individuals (including directors of exchanges
writing separately), eight DCMs, six futures commission merchants
("FCMs"), one group of DCM public directors, one U.S. Senator, and
one U.S. Congressman.\19\
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\19\ The commenters were: Bear Stearns; Citigroup; Morgan
Stanley; the Chicago Mercantile Exchange ("CME"); the New York
Mercantile Exchange ("NYMEX"); U.S. Sen. Pat Roberts and
Congressman Jerry Moran; the National Grain Trade Council; Daniel L.
Gibson; the National Grain and Feed Association; the New York Board
of Trade ("NYBOT"); Public Members of the NYBOT; the Chicago Board
of Trade ("CBOT"); Philip McBride Johnson; the CBOE Futures
Exchange ("CFE"); Dennis M. Erwin; HedgeStreet; Colby Moss;
Horizon Milling, LLC; John Legg; the National Futures Association;
Robert J. Rixey; Michael Braude; Lehman Brothers; the Kansas City
Board of Trade ("KCBT"); the Futures Industry Association
("FIA"); the Florida Citrus Producers Association; the National
Cotton Council of America; Cargill Juice North America; Nickolas
Neubauer; the American Cotton Shippers Association; Barry Bell;
Fimat; J.P. Morgan Futures Inc.; and the Minneapolis Grain Exchange
("MGEX").
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The Commission thoroughly reviewed and considered all comments
received. In response to persuasive arguments by various commenters,
the final acceptable practices include two significant modifications
from those originally proposed. Specifically, the final acceptable
practices include: (1) a reduction in the required number of public
directors on boards and executive committees, from at least 50% public
to at least 35% public; and (2) a phase-in period to implement the
acceptable practices, or otherwise come into full compliance with Core
Principle 15, of two years or two regularly scheduled board elections,
whichever occurs sooner.
In addition, in response to comments received, the Commission has
made several clarifications and non-substantive revisions to the final
acceptable practices. The Commission has also provided further
discussion or elaboration in this preamble in order to provide further
clarification on specific aspects of the acceptable practices,
consistent with the Commission's original intent.
Specifically, in the text of the final acceptable practices, the
Commission has clarified: that a public director may serve on the
boards of both a DCM and of its parent company; that public directors
are allowed deferred compensation in excess of $100,000 under certain
circumstances; and that public persons serving on disciplinary panels
are subject only to the bright-line tests used to define public
directors. The Commission has also clarified that the acceptable
practices do not address the manner in which DCMs select their public
directors, whether by election, appointment, or other means.
Some commenters called for greater requirements than in the
proposed acceptable practices, and others called for less requirements.
The Commission carefully considered those comments, but decided not to
make any changes other than those outlined above. As stated previously,
the Commission believes that adopting the new acceptable practices
strikes a careful balance between an appropriate approach to minimizing
conflicts of interest in self-regulation, as required by Core Principle
15, and the overall flexibility offered by the core principle regime.
Moreover, the Commission believes that the acceptable practices adopted
herein are necessary and appropriate to fulfill the purposes of the Act
and advance the public interest.
The substantive comments received, and the Commission's responses
thereto, are presented below. They are organized as follows:
Legal Comments: comments questioning the Commission's authority
to issue the proposed acceptable practices, including comments with
respect to the meaning of Core Principle 15 and its interaction with
other core principles;
Policy Comments: comments requesting more or stricter guidance
than that proposed by the Commission; comments requesting that the
Commission issue no acceptable practices, or fewer or less detailed
acceptable practices; and comments questioning the rationale behind
the proposed acceptable practices, including:
• General comments;
• Comments with respect to board composition;
• Comments with respect to the definition of public
director;
• Comments with respect to Regulatory Oversight
Committees;
• Comments with respect to disciplinary committees;
Comments Requesting Modifications and Clarifications, including:
• Phase-in period for the new acceptable practices;
• Selection of public directors;
• Compensation of public directors;
• Overlapping public directors;
• Jurisdiction of disciplinary panels and definition of
"public" for persons serving on disciplinary panels;
• "No material relationship" test for public directors;
• elimination of ROCs' periodic reporting requirements.
A. Legal Comments: Public Comments Received and the Commission's
Response.
1. Overview of the Commission's Authority To Issue the Acceptable
Practices
The Commission's issuance of the acceptable practices for Core
Principle 15 respects the letter and spirit of the Act. The
Commission's authority to do so is firmly rooted in Core Principle 15's
mandate to DCMs to minimize conflicts of interest in decision making.
Core Principle 15 requires DCMs to maintain systems to minimize
structural conflicts of interest inherent in self-regulation, as well
as individual conflicts of interest faced by particular persons.\20\
The acceptable practices are rationally related to the purposes of Core
Principle 15.
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\20\ 71 FR 38740, 38743.
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The Board Composition Acceptable Practice recognizes that the
governing board of a DCM is its ultimate decision maker and therefore
the logical place to begin to address conflicts. Participation by
public directors in board decision making is a widely accepted and
effective means to reduce conflicts of interest.\21\ By providing for
significant public participation on the board, the seat of DCM
governance and policymaking, the acceptable practice ensures that
conflicts of interest are minimized at the highest level of decision
making.
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\21\ See, e.g., NYSE Listed Company Manual, Sec. 303A
(commentary).
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The ROC Acceptable Practice recognizes the importance of insulating
core regulatory functions from improper influences and pressures
stemming from a DCM's commercial affairs. It operates to minimize
conflicts of interest in decisions made in the ordinary course of
business. Finally, the Disciplinary Panel Acceptable Practice, by
mandating participation on most disciplinary panels of at least one
person who meets the bright-line tests for public director, minimizes
conflicts of interest that may undermine the fundamental fairness
required of DCM disciplinary proceedings. In sum, these acceptable
practices represent an effective means to implement Core Principle 15
and are fully consistent with its mandate that DCMs minimize conflicts
of interest in all decision making. They therefore lie well within the
Commission's authority.
Congress has determined that there is a national public interest in
risk management and price discovery.\22\ The individual provisions of
the Act operate
[[Page 6941]]
in furtherance of those interests by instituting and enforcing a system
of "effective self-regulation of trading facilities, clearing systems,
market participants and market professionals under the oversight of the
Commission." \23\ Core Principle 15 must be read in light of those
public interests and purposes.
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\22\ CEA Section 3(a), 7 U.S.C. 5(a).
\23\ CEA Section 3(b), 7 U.S.C. 5(a).
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The safe harbor created by the new acceptable practices removes the
guesswork from compliance with Core Principle 15. Congress
intentionally wrote the core principles to be broad and flexible, and
to help DCMs and the Commission to adjust to changing circumstances.
Flexibility, however, may give rise to uncertainty. In order to provide
DCMs with greater certainty in the context of flexible core principles,
Congress, in adopting the Commodity Futures Modernization Act
("CFMA"),\24\ added Section 5c(a)(1) to the CEA, which specifically
authorizes the Commission, consistent with the purposes of the CEA, to
"issue interpretations, or approve interpretations submitted to the
Commission * * * to describe what would constitute an acceptable
business practice for Core Principles." \25\ As a general rule, the
Commission believes that issuing acceptable practices and other
guidance under the core principles is beneficial, given the CFMA's lack
of legislative history that might otherwise have been a source of
guidance. Safe harbors, such as those created by the acceptable
practices being issued today, remove uncertainty while setting high
standards consistent with the purposes of the CEA and the authority
granted by Congress to the Commission to issue such acceptable
practices. Nothing in these acceptable practices, as safe harbors,
infringes upon the Congressional directive in Section 5c(a)(2) of the
CEA that acceptable practices not be the "exclusive means for
complying" with core principles, as DCMs remain free to demonstrate
core principle compliance by other means.\26\
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\24\ The CFMA is published at Appendix E of Pub. L. 106-554, 114
Stat. 2763 (2000).
\25\ 7 U.S.C. 7a-2(a)(1).
\26\ 7 U.S.C. 7a-2(a)(2).
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Pursuant to its duty under the CEA to consider the costs and
benefits of its action in issuing the acceptable practices, as
discussed separately below, the Commission believes that the acceptable
practices will minimize conflicts of interest in DCM decision making
and promote public confidence in the futures markets. These are
significant benefits to the futures industry, market participants, and
the public. While commenters alleged that compliance would be costly,
none of them provided an estimate of those costs in response to the
Commission's specific request for quantitative data. The Commission has
no basis to conclude that compliance would not be a reasonable cost of
doing business in an industry subject to federal oversight--a cost that
may be phased in gradually over two years or two election cycles.
Finally, the Board Composition Acceptable Practice operates without
impeding the duties owed to shareholders by the directors of a public
corporation. Demutualized DCMs typically have reorganized themselves as
subsidiaries of parent holding companies. The acceptable practice
applies to the board of a DCM itself--not to the parent. Accordingly,
the Board Composition Acceptable Practice is unquestionably within the
Commission's authority to issue acceptable practices under the core
principles applicable to DCMs. The composition of a DCM governing board
may be identical to that of its parent--that decision is a matter for
the business judgment of the persons involved. Nevertheless, the boards
are separate bodies, even if their memberships overlap. DCM directors
have a fiduciary duty to stockholders, to be sure, but stockholders of
a DCM own an entity that, as a matter of federal law, is required to
minimize conflicts of interest under Core Principle 15 and that serves
a public interest through its business activity. Stockholders are well
served when the DCMs that they own comply with applicable laws and
regulations.
We now turn to the legal issues raised by the commenters with
respect to the Commission's authority to issue the acceptable
practices.
2. Specific Legal Issues Raised by Commenters
FIA, five major FCMs, and one exchange, CFE, filed comments
generally in favor of the proposed acceptable practices and endorsed
the Commission's analysis of its authority to issue them. CME, CBOT,
NYMEX, and other commenters, in opposition, challenged the Commission's
interpretation of Core Principle 15 and the statutory authority under
which the proposals were issued.
As stated above, Core Principle 15 requires DCMs to establish and
maintain systems that address conflicts of interest inherent in the
structure of self-regulation, as well as personal conflicts faced by
individuals. FIA endorsed this analysis, stating that the proposed
acceptable practices are "well-grounded" in the Commission's
statutory authority and "rationally related" to the purposes of Core
Principle 15.\27\
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\27\ FIA Comment Letter ("CL") 7 at 3-4.
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Commenters challenging the Commission's authority to promulgate the
acceptable practices for Core Principle 15 contend that they: (1)
Conflict with Core Principle 16; (2) are contrary to the text of the
statute; (3) are contrary to Congressional intent in enacting the CFMA;
(4) lack factual support; (5) conflict with guidance for Core Principle
14; and (6) impermissibly shift the burden to DCMs to demonstrate
compliance with Core Principle 15. As discussed below, none of these
contentions is persuasive.
a. The Acceptable Practices For Core Principle 15 Do Not Conflict
With Core Principle 16.
CME challenged Core Principle 15's applicability to the acceptable
practices, contending that because Core Principle 16 is the only core
principle that mentions board composition, it is the only source of
authority the Commission may use for this purpose, and that it is
limited to mutually-owned DCMs.\28\ Similarly, NYBOT and KCBT contended
that as member-owned DCMs, they are subject to Core Principle 16's
requirement to maintain governing boards that "reflect[ ] market
participants," and should not face any other board composition
provision.\29\
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\28\ CME CL 29 at 4-5. Core Principle 16 states: "COMPOSITION
OF BOARDS OF MUTUALLY OWNED CONTRACT MARKETS.--In the case of a
mutually owned contract market, the board of trade shall ensure that
the composition of the governing board reflects market
participants." CEA Sec. 5(d)(16), 7 U.S.C. 7(d)(16).
\29\ NYBOT CL 21 at 4; KCBT CL 8 at 3.
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Core Principle 16 requires a mutually owned board of trade to
ensure that the composition of its governing board reflects market
participants. Based on its plain language, Core Principle 16 is limited
to that goal,\30\ and has no bearing on the entirely separate goal of
Core Principle 15 to "minimize conflicts of interest in the decision-
making process of the contract market," whether or not it is mutually
owned. Core Principle 16 applies only to mutually owned contract
markets and directs that their governing boards must fairly represent
market participants. Core Principle 15 applies to all contract markets,
no matter how organized, and directs them to minimize conflicts of
interest. Conflicts may be structural as well as personal. Core
Principle 15 embraces both and supports the public director membership
requirement for
[[Page 6942]]
boards of DCMs. Accordingly, Core Principle 16 does not limit the
Commission's authority to issue acceptable practices to increase public
director representation on DCM boards in order to minimize conflicts of
interest under Core Principle 15.
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\30\ There is no legislative history concerning Core Principle
16 other than the statutory language itself.
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b. The Acceptable Practices for Core Principle 15 Are Not Contrary
to the CEA's Text.
Other opposing comments based on the text of Core Principle 15
substitute the Commission's straightforward reading of the statute with
targeted interpretations of individual words and phrases. The
Commission believes that these comments do not rise to the stature of
significant questions of statutory interpretation. For instance,
various commenters contended that Core Principle 15 says "minimize"
conflicts of interest, not "eliminate" them, as they argue the
Commission seeks to do with the Board Composition Acceptable
Practice.\31\ However, if the Commission had sought to "eliminate"
conflicts of interest, the Commission could have imposed a 100% public
director requirement. Certainly any less-than-100% public director
requirement may not eliminate all conflicts of interest.
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\31\ See, e.g., KCBT CL 8 at 2 and Roberts & Moran CL 27 at 1-2.
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Another such comment stated that Core Principle 15 applies to
"rules" and "process," but board composition is contained in DCM
"bylaws" (not rules), and a change to board composition is not a
"process." \32\ Contrary to this commenter's restrictive
interpretation of the term, "rule" is defined broadly in Commission
regulations to include by-laws.\33\ Thus, the mere mention of "rules"
in Core Principle 15 has no bearing on the Commission's authority. In
addition, Core Principle 15 provides that a DCM 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. The two requirements are not mutually
exclusive.
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\32\ NYMEX CL 28 at 6.
\33\ See Commission Reg. 40.1(h), 17 CFR 40.1(h).
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Another commenter stated that Core Principle 15 provides that a DCM
shall "enforce" rules, and thereby contemplates action against
individuals rather than the DCM itself.\34\ In fact, Core Principle 15
states "establish and enforce" rules. Use of the conjunctive belies
any contention that Core Principle 15 was intended to be directed
solely to individuals.
---------------------------------------------------------------------------
\34\ NYMEX CL 28 at 6.
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Numerous comments of this type were received, none of which
constitutes a serious challenge to the Commission's legal authority and
reasonable interpretation of Core Principle 15.
c. The Acceptable Practices for Core Principle 15 Are Not Contrary
to Congressional Intent in Enacting the CFMA.
Several commenters, including NYMEX and CBOT, contended that the
Board Composition Acceptable Practice is contrary to Congress' intent
in enacting Core Principle 15 and the CFMA.
Specifically, CBOT stated that prior to the CFMA's enactment, the
CEA treated board composition and conflicts of interest in two distinct
provisions of the statute. In passing the CFMA, Congress omitted the
board composition provision and kept the conflicts of interest
provision. CBOT interpreted this as evidence that Congress did not view
board composition as a mechanism to minimize conflict of interests.\35\
We believe that the legal import of silence as a statutory canon of
construction in these circumstances is a weak indicator of
Congressional intent.\36\ Moreover, inclusion of public directors on
company boards is a widely accepted means to reduce conflicts of
interest.\37\ Congress has in other contexts recognized the utility of
public directors in controlling conflicts of interest.\38\ Interpreting
the CFMA as the CBOT advocates would require the Commission to infer
that Congress was unaware of its own enactments, as well as the
aforementioned wide acceptance of public directors for reducing
conflicts, which the Commission is not prepared to do.
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\35\ CBOT CL at 5-6.
\36\ See, e.g., U.S. v. Vonn, 535 U.S. 55, 65 (2002); Pauley v.
Bethenergy Mines, Inc., 501 U.S. 680, 703 (1991) (internal citation
omitted).
\37\ See, e.g., NYSE Corporate Governance Rule 303A
(commentary).
\38\ See Section 10(a) of the Investment Company Act of 1940, 7
U.S.C. 80a-10(a); Burks v. Lasker, 441 U.S. 471, 484 (1979).
---------------------------------------------------------------------------
Similarly, NYMEX commented that when the CFMA was enacted there was
a general understanding among DCMs, Commission staff, and legislators
that Congress did not intend the Commission to establish board
composition requirements for demutualized DCMs, which would instead be
subject to corporate governance and NYSE listing standards.\39\ A
congressional comment letter stated that it does not "appear" that
Congress intended the Commission to address board composition in the
instance of small mutually-owned DCMs like KCBT.\40\
---------------------------------------------------------------------------
\39\ NYMEX CL 28 at 5-6.
\40\ Roberts & Moran CL 27 at 1-2.
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No commenter, however, cited any legislative history supporting
these views, and no rule of statutory or legal interpretation compels
the Commission to adopt them. The Commission may interpret the CEA
according to its reasoned discretion and agency expertise given the
absence of any contrary indication of Congressional intent at the time
the CFMA was enacted.
Various commenters also asserted that the proposed acceptable
practices in general are counter to the spirit of the CFMA, which
transformed the Commission into an oversight agency.\41\ They contended
also that the 50% public board member requirement in the proposed Board
Composition Acceptable Practice is stricter than the former statutory
requirement that DCM boards have 20% independent directors.\42\ This
comment would apply equally to the minimum 35% requirement contained in
the final acceptable practice. These commenters, however, overlook the
essential fact that the acceptable practices--unlike the pre-CFMA 20%
rule--are safe harbors, not statutory mandates. Persons taking this
view appear to want the Commission to do nothing at all--neither issue
rules nor announce nonbinding acceptable practices that embody high
standards.
---------------------------------------------------------------------------
\41\ See, e.g., NYMEX CL 28 at 9-10.
\42\ See, e.g., CME CL 29 at 12.
---------------------------------------------------------------------------
One commenter argued that the Commission did not subject DCMs to
Commission Rule 1.64 (containing the board composition requirement for
non-member representation) \43\ when it adopted Commission Rule 38.2
\44\ shortly after the enactment of the CFMA, thus suggesting that the
Commission's interpretation was that Core Principle 15 did not impose a
board composition requirement.\45\
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\43\ 17 CFR 1.64.
\44\ Commission Rule 38.2 contains an exemption for DCMs from
all Commission regulations except those specifically enumerated. 17
CFR 38.2.
\45\ NYMEX CL 28 at 15.
---------------------------------------------------------------------------
The Commission did not adopt acceptable practices for all of the
core principles when it promulgated Commission Rule 38.2. Nor did the
Commission permanently reserve from exemption all regulations that are
reflected in core principles. Indeed, in January 2006, the Commission
added Commission Rule 1.60 to the enumerated list of regulations to
which DCMs are subject pursuant to Commission Rule 38.2.\46\
Accordingly,
[[Page 6943]]
the fact that Commission Rule 1.64 was not specifically exempted when
Commission Rule 38.2 was promulgated is not a reliable indicator of the
Commission's interpretation of Core Principle 15. Moreover, not long
after Commission Rule 38.2 was issued, the Commission began the SRO
Review to examine governance issues in order to determine whether
action was warranted. Thus, even if the omission of Commission Rule
1.64 from the enumerated regulations in Commission Rule 38.2 were
somehow indicative of a contemporaneous interpretation by the
Commission of Core Principle 15, a matter that the Commission does not
concede, the Commission's evolving views--based on the extensive record
developed during the course of the SRO Review--support its current
interpretation that Core Principle 15 authorizes it to adopt the Board
Composition Acceptable Practice.
---------------------------------------------------------------------------
\46\ See 71 FR 1953 (Jan. 12, 2006).
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d. Acceptable Practices Are Justified As A Prophylactic Measure.
Several commenters contended that the acceptable practices lack
factual support demonstrating a need for their issuance. They argued
that the Commission did not point to any specific event or documented
self-regulatory failure or allegation of such failure in support of the
acceptable practices.\47\ Several commenters contended that the studies
cited by the Commission in the proposing release applied only to the
securities industry, and thus were inapposite to conditions in the
futures industry.\48\
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\47\ See CME CL 29 at 9; NYMEX CL 28 at 11-12; NYBOT CL 22 at 4;
CBOT CL 21 at 3.
\48\ See, e.g., NYMEX CL 28 at 11-13; CME CL 29 at 9; NYBOT CL
22 at 2; Comment of Donald L. Gibson, CL 25 at 1.
---------------------------------------------------------------------------
These comments are misplaced. Although the Commission did not
specifically identify futures industry self-regulatory lapses in
support of the acceptable practices, it identified significant trends
in the futures industry, including increased competition and changing
ownership structures, that justify the acceptable practices as a
prophylactic measure to minimize conflicts in decision making and to
promote public confidence in the futures markets in the altered,
demutualized, and more competitive landscape. Commenters pointed to
nothing in the CEA, nor has the Commission found anything, to suggest
that Congress intended to restrict the authority of the Commission to
make "precautionary or prophylactic responses to perceived risks,"
that would render the Commission's action a violation of the CEA.\49\
---------------------------------------------------------------------------
\49\ Chamber of Commerce v. SEC, 412 F.3d 133, 141 (D.C. Cir.
2005).
---------------------------------------------------------------------------
e. Acceptable Practices for Core Principle 15 Do Not Conflict with
Guidance to Core Principle 14.
Another issue raised is whether the new acceptable practices for
Core Principle 15 conflict with guidance issued for Core Principle
14.\50\ One commenter asserted that guidance to Core Principle 14
suggests that directors of DCMs should, at a minimum, be market
participants, contrary to the proposed "public director"
definition.\51\ This contention misreads the guidance for Core
Principle 14. Minimum standards for directors provided in the guidance
are derived from the bases for refusal to register persons under CEA
Section 8a(2),\52\ and from the types of serious disciplinary offenses
that would disqualify persons from board and committee service under
Commission Rule 1.63.\53\ Nothing in the Application Guidance for Core
Principle 14 requires directors to be market participants. Moreover, a
significant number of DCMs currently have directors on their boards who
are not market participants.
---------------------------------------------------------------------------
\50\ Core Principle 14 provides that a "Board of Trade shall
establish and enforce appropriate fitness standards for directors
[and others]." CEA Sec. 5(d)(14), 7 U.S.C. 7(d)(14).
\51\ CME CL 29 at 9.
\52\ 7 U.S.C. 12a(2).
\53\ 17 CFR 1.63. See 17 CFR Part 38, Appendix B, Core Principle
14 ("Application Guidance").
---------------------------------------------------------------------------
f. Acceptable Practices for Core Principle 15 Do Not Impermissibly
Shift the Burden to DCMs for Demonstrating Compliance.
Finally, CME, CBOT, and NYMEX contended that the Board Composition
Acceptable Practice impermissibly shifts the burden of demonstrating a
DCM's compliance with Core Principle 15 from the Commission to the DCM
if a DCM elects not to comply with the acceptable practices.
There is no burden shifting here. All DCMs are required to
demonstrate to the Commission how they are complying with the core
principles. Without such a factual demonstration, the Commission could
not determine whether a contract market is in compliance with the core
principles, and thus the Commission could not meet its obligations
under the CEA.\54\ Compliance with these acceptable practices merely
eliminates the need for a DCM to demonstrate to the Commission that it
is complying with certain aspects of Core Principle 15. It follows that
a contract market that does not comply with the acceptable practices
must demonstrate to the Commission that it is complying with Core
Principle 15 by other means, as stated in the release.
---------------------------------------------------------------------------
\54\ See CEA Sec. 5c(d), 7 U.S.C. 7a-2(d).
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B. Policy Comments: Public Comments Received and the Commission's
Response
1. General Comments
The Commission received a series of general comments, as discussed
more fully below, both in support of and in opposition to the overall
direction and findings of the proposed acceptable practices.
a. The proposed acceptable practices are inflexible; DCMs should be
free to determine their own methods of core principle compliance.
Several commenters stated that, consistent with the CFMA, DCMs, and
not the Commission, should determine the composition of their boards
and committees, and should have the discretion to establish their own
definition of "public director." One commenter noted that the concept
of membership has evolved as markets have become increasingly
electronic and global, and now encompasses a growing number of new
types of market participants (which consequently reduces the population
of potential public directors). Commenters argued that DCMs should be
permitted to tap these new types of members for service as directors,
bringing market knowledge and differing perspectives to their boards,
rather than adding public directors, who, as defined by the Commission,
will lack experience and expertise. It was further argued that DCMs
should be permitted to decide for themselves how to constitute their
boards in order to obtain the necessary knowledge, experience, and
expertise that will permit them to serve their economic functions and
the public interest.
With respect to the other committees and panels addressed in the
proposal, commenters stated that each DCM should be permitted to
determine the appropriate size and composition of its executive
committee, and likewise should be permitted: To determine whether to
establish an ROC; to determine the extent of an ROC's responsibilities;
and to determine the most appropriate composition for such committee.
Commenters also stated that each DCM should be permitted to determine
the composition and the structure of its disciplinary committees in
order to ensure that decisions are informed by knowledge and
experience.
Numerous commenters opined that the proposals are inflexible,
arbitrary, or
[[Page 6944]]
overly prescriptive. Among other things, commenters stated that the
regulatory proposals: could stifle vital day-to-day market functions;
Could swing the balance too far towards rigid, arbitrary requirements
when there is no demonstrable need for such action; are contrary to the
spirit and intent of the CFMA and the market-oriented, principle-based
structure authorized by that legislation; unnecessarily micromanage the
operations of DCMs; fail to recognize the changing definition and
increasing breadth of the concept of DCM membership; inflexibly impose
uniform requirements upon all DCMs without regard to the nature of a
particular DCM or the products traded on that DCM; and should be
presented not as a model for DCMs to adopt, but rather as examples of
ways for DCMs to meet core principle requirements.
Commenters also expressed concern that a bright-line test regarding
the proper number of public directors will become the de facto
requirement for all DCMs and will severely limit the ability of DCMs to
undertake other approaches to achieving the general performance
standard set by the core principles. Some commenters also contended
that requiring a DCM that does not meet the proposed acceptable
practices to demonstrate compliance with Core Principle 15 through
other means impermissibly shifts the burden of proof to DCMs to justify
departures from the acceptable practices, when the Act gives DCMs
reasonable discretion in how they comply with the core principles.
Another commenter noted that since the Commission has proposed absolute
numerical standards as a means of avoiding conflicts of interest, there
is no legitimate way to prove compliance by other means.
b. Safeguards are already in place to protect against conflicts of
interest at publicly traded, mutually-owned, and other DCMs.
Numerous commenters opined that the proposals are not necessary
because there are sufficient safeguards already in place to ensure that
potential conflicts of interest are adequately identified and
controlled and that self-regulation remains effective. Several
commenters argued that small DCMs already have in place adequate
controls to address potential conflicts of interest, and that the
Commission conducts an independent review of each DCM's compliance
department through its rule enforcement review ("RER") program.\55\
Several commenters noted that their board composition standards already
require public directors (albeit at a level lower than the proposed 50%
requirement). Those commenters opined that their existing procedures
for avoiding conflicts and including public participation are
sufficient and more effective than the proposed 50% public member
requirement.
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\55\ The Commission's Division of Market Oversight conducts
periodic RERs at all DCMs to assess their compliance with particular
core principles over a one-year target period. Staff's analyses,
conclusions, and recommendations regarding any identified deficiency
are included in a publicly available written report.
---------------------------------------------------------------------------
Commenters also argued that fear of a possible conflict of interest
between a demutualized DCM's regulatory responsibilities and the
demands of a for-profit company is without foundation. These comments
asserted that demutualization actually encourages rather than
discourages effective self-regulation because market integrity is key
to attracting and retaining business. Commenters stated that large,
publicly traded DCMs already have numerous safeguards in place to
ensure that they act in the best interest of their shareholders and do
not act to the detriment of a particular group of shareholders. In
addition, some commenters opined that corporate governance requirements
currently applicable to publicly traded DCMs, combined with the
reasonable exercise of discretion by DCMs pursuant to Core Principle
1,\56\ provide sufficient assurance that conflicts of interest will be
kept to a minimum in the decision-making process. One DCM commented
that the proposed acceptable practices are unnecessary given, inter
alia, the NYSE and NASDAQ listing standards to which some DCM parent
companies are subject. In addition, it was observed that when a
potential conflict does arise, DCMs have developed specific board
governance procedures to ensure proper disclosure and to remove the
potential conflict from the decision-making process. One commenter
stated that the proposals are unnecessary because, if the Commission's
general concern is that a DCM will adopt rules that will disadvantage
members who are their competitors, it may address that concern through
its review of self-certified rules to ensure that such rules comply
with the Act and regulations.
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\56\ Core Principle 1 states: "IN GENERAL--To maintain the
designation of a board of trade as a contract market, the board of
trade shall comply with the core principles specified in this
subsection. The board of trade shall have reasonable discretion in
establishing the manner in which it complies with the core
principles." CEA Sec. 5(d)(1), 7 U.S.C. 7(d)(1).
---------------------------------------------------------------------------
Several commenters argued that the proposals should not be applied
to mutually-owned DCMs, as none of the factors cited by the Commission
as justification for the proposed acceptable practices apply to them.
These commenters further argued that applying the acceptable practices
to mutually-owned DCMs to the same degree as large publicly traded DCMs
would be burdensome in terms of cost, administration, and efficiency.
1a. The Commission's Response to the General Comments
i. Proactive measures are justified to protect the integrity of
self-regulation in the U.S. futures industry.
The Commission's response to the comments summarized above is
three-fold. First, the Commission believes that the argument that there
are no specific regulatory failures justifying new acceptable practices
for Core Principle 15 is misplaced. As discussed more fully in the
cost-benefit analyses in Section V-A, the Commission did identify
industry changes that it believes create new structural conflicts of
interest within self-regulation, increase the risk of customer harm,
could lead to an abuse of self-regulatory authority, and threaten the
integrity of, and public confidence in, self-regulation in the U.S.
futures industry. Increased competition, demutualization and other new
ownership structures, for-profit business models, and other factors are
highly relevant to the impartiality, vigor, and effectiveness with
which DCMs exercise their self-regulatory responsibilities. The
Commission strongly believes that credible threats to effective self-
regulation must be dealt with promptly and proactively, and is
confident that precautionary and prophylactic methods are fully
justified and well within its authority.
Second, the Commission firmly rejects commenters' implicit argument
that its oversight authority may be exercised only in response to
crises or failures in self-regulation. To the contrary, the
Commission's mandate, given by the Congress, is affirmative and
forward-looking, including promoting "responsible innovation" and
"fair competition" in the U.S. futures industry.\57\ As catalogued
throughout the SRO Review, rapid innovation and increasing competition
are powerful new realities for all DCMs. The Commission's statutory
obligation is to ensure that these realities evolve as fairly and
responsibly as possible, and always in a manner that serves the public
interest. The Commission believes that the new acceptable practices for
Core Principle 15 serve exactly those purposes by ensuring a strong
public voice at key levels of SRO
[[Page 6945]]
decision making, particularly as it effects self-regulation.
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\57\ CEA Sec. 3(b), 7 U.S.C. 5(b) .
---------------------------------------------------------------------------
Finally, prior to adopting these acceptable practices, the
Commission initiated an exhaustive, three-and-one-half year research
program that resulted in a uniquely informed regulatory process. The
Commission determined, as have many other regulatory and self-
regulatory bodies, that "independent" directors can be of great
benefit to the deliberations and decisions of corporate boards and
their committees. The Commission further determined, as have others,
that DCMs charged with self-regulatory responsibilities are distinct
from typical corporations, and thereby require careful attention to how
their independent directors are defined. Finally, the Commission
determined, as have others, that DCMs' independent directors should be
of a special type--"public" directors--and should meet higher
standards, including non-membership in the DCM. All three decisions
have ample precedent in exchange governance and self-regulation, both
in the futures and the securities industries, are based on the
extensive record amassed during the SRO Review and on the Commission's
expertise and unique knowledge of the futures industry, and are well-
grounded in the Commission's statutory authority to issue acceptable
practices for core principle compliance.
ii. Some comments do not stand up to factual scrutiny.
Some general comments in opposition to the proposed acceptable
practices do not stand up to factual scrutiny. For example, DCMs whose
parent companies are publicly traded and subject to NYSE listing
standards (50% "independent" board of directors and key committees
that are 100% independent) argued that those standards are sufficient
to ensure effective self-regulation. The argument fails on two grounds.
First, by their very terms, the NYSE's listing standards are
designed for shareholder protection, not the effective self-regulation
of futures exchanges in the public interest. Second, DCM holding
companies have determined that DCM members are independent under the
NYSE's listing standards.\58\ By doing so, they have demonstrated the
inappropriateness of relying on the listing standards as a means of
identifying public directors for effective self-regulation. Notably,
the NYSE itself recognized this same point when reforming its own
governance and self-regulatory structure, which is substantially more
demanding than what it requires of its listed companies, or than what
the Commission's new acceptable practices will require of DCMs.\59\
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\58\ See, e.g., CME's Categorical Independence Standards: "* *
* the Board of Directors has determined that a director who acts as
a floor broker, floor trader, employee or officer of a futures
commission merchant, CME clearing member firm, or other similarly
situation person that intermediates transactions in or otherwise
uses CME products and services shall be presumed to be
"independent," if he or she otherwise satisfies all of the above
categorical standards and the independence standards of the [NYSE]
and The Nasdaq Stock Market, Inc. * * *" CME Holdings Inc.,
Definitive Proxy Statement (Form DEF 14A), App. A, (March 10 2006).
Accord CBOT Holdings Inc., Definite Proxy Statement (Form DEF 14A),
App. A, (March 29, 2006). Both holding companies are listed on the
NYSE and subject to its listing standards.
\59\ NYSE Group's board of directors consists exclusively of
directors who are independent both of member organizations and
listed companies. In addition, NYSE Group and NASD recently
announced plans to consolidate their member firm regulation into a
single new SRO for all securities broker/dealers. Market regulation
and listed company compliance will remain with NYSE Regulation, a
not-for-profit subsidiary of NYSE Group. A majority of NYSE
Regulation's directors must be independent of member organizations
and listed companies, and unaffiliated with any other NYSE Group
board. See http://www.nyse.com/regulation/1089235621148.html.
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The related argument that the proposed acceptable practices should
not be applied to mutually-owned DCMs is also without merit. It ignores
the futures industry's rapid and continuing evolution. When the SRO
Review began in 2003, three of the four largest DCMs were member-owned.
Now, all four are subsidiaries of public companies.\60\ Only two
member-owned futures exchanges remain in the United States, and one is
actually structured as a Delaware for-profit stock corporation that has
paid dividends for nine consecutive years, including $11,000 per share
in 2006 and $7,000 per share in 2005.\61\ More importantly, all DCMs,
regardless of ownership structure, operate in an increasingly
competitive environment where improper influence may be brought to bear
upon regulatory functions, personnel, and decisions.
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\60\ CME, CBOT, and NYMEX are wholly-owned subsidiaries of CME
Holdings Inc., CBOT Holdings Inc., and NYMEX Holdings Inc.,
respectively. NYBOT is a wholly owned subsidiary of
IntercontinentalExchange Inc. In each case, the DCMs are now
subsidiaries of for-profit, publicly traded stock corporations
listed on the NYSE.
\61\ The two mutually-owned exchanges are the Kansas City Board
of Trade and the Minneapolis Grain Exchange. However, as noted
above, KCBT is structured as a for-profit, dividend-paying, stock
corporation. See http://www.kcbt.com/news_2.asp?id=457 (KCBT press
release announcing ninth consecutive annual dividend, including
$11,000 per share in 2006) and http://www.kcbt.com/news_2.asp?id=347
(KCBT press release announcing eighth consecutive
annual dividend, including $7,000 per share in 2005).
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Another misplaced series of comments argued that existing
Commission processes, such as RERs, provide sufficient safeguards to
ensure the future integrity of self-regulation. RERs are in fact
central to the Commission's oversight regime for DCMs, and constitute
the primary method by which the Commission verifies core principle
compliance. However, RERs are retrospective in nature (focusing on a
target period in the past) and cannot guarantee future performance.
When self-regulatory failures are discovered, they are typically
corrected via recommendations made by the Commission's Division of
Market Oversight and implemented by the relevant DCM on a forward-
looking basis. In contrast, the objective of effective self-regulation
and Commission oversight is to prevent such failures from ever
occurring. The Commission does not believe that RERs should be a
substitute for issuing acceptable practices for compliance with a
particular core principle. The Commission has found that acceptable
practices improve core principle compliance by providing all DCMs with
greater clarity regarding the Commission's expectations, and a safe-
harbor upon which they may fully rely. Neither RERs nor any other
existing Commission process, such as the review of self-certified
rules, is an adequate substitute for carefully tailored acceptable
practices.\62\ This is particularly true when the new acceptable
practices concern a core principle that has no previous acceptable
practices or respond to a rapidly changing area of the futures
industry.
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\62\ The argument that RERs make acceptable practices
unnecessary is further misplaced as it ignores the beneficial
interaction between the two oversight tools. For example, acceptable
practices facilitate core principle compliance and advance the RER
process by providing both DCMs and Commission staff with information
as to the areas of concern which must be addressed under a
particular core principle. The final acceptable practices for Core
Principle 15 are no exception, as they highlight the type of
structural conflicts of interest which all DCMs must address.
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iii. The Commission may implement detailed acceptable practices as
safe-harbors for core principle compliance.
Notwithstanding those comments generally opposed to the proposed
acceptable practices for Core Principle 15, the Commission continues to
strongly believe that the recent structural changes in the U.S. futures
industry require an appropriate response within DCMs to ensure that
self-regulation remains compatible with competitive, for-profit DCMs.
Accordingly, the new acceptable practices for Core Principle 15
establish
[[Page 6946]]
appropriate governance and self-regulatory structures, while preserving
DCMs' flexibility to adopt alternate measures if necessary.
Those commenters that opposed the new acceptable practices for
their "inflexibility" misunderstand the nature of the core principle
regime and the interaction between core principles and acceptable
practices. The 18 core principles for DCMs establish standards of
performance and grant DCMs discretion in how to meet those standards.
However, compliance with the core principles is not static and does not
exist in a vacuum; instead, core principles are broad precepts whose
specific application is subject to change as DCMs and the futures
industry evolve. Furthermore, as discussed in Section III, core
principle compliance is an affirmative and continuing obligation for
all DCMs, and it is incumbent upon them to demonstrate compliance to
the Commission's satisfaction.\63\
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\63\ See 17 CFR Part 38, App. B, ] 1 ("This appendix provides
guidance on complying with the core principles, both initially and
on an ongoing basis to maintain designation under Section 5(d) of
the Act and this part" (emphasis added)).
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The flexibility inherent in the core principles permits each DCM to
comply in the manner most appropriate to it. At the same time, such
flexibility provides both the Commission and the futures industry with
the latitude to grow in their understanding of self-regulation and its
requirements. One common example is the Commission's approach to the
safe storage of trade data under Core Principle 10,\64\ which evolved
following the events of September 11, 2001.\65\ Similarly, the
Commission's expectations for the management of conflicts of interest
under Core Principle 15 now include an understanding that in a highly
competitive futures industry, where almost all DCMs are for-profit and
many are subsidiaries of publicly traded companies, the conflicts that
may arise are not purely personal or individual. Simply stated, whether
or not DCMs choose to implement the new acceptable practices, the
conflicts of interest which they must address to comply with Core
Principle 15 now include structural conflicts between their self-
regulatory responsibilities and their commercial interests.
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\64\ Core Principle 10 states: "TRADE INFORMATION--The board of
trade shall maintain rules and procedures to provide for the
recording and safe storage of all identifying trade information in a
manner that enables the contract market to use the information for
purposes of assisting in the prevention of customer and market
abuses and providing evidence of any violations of the rules of the
contract market." CEA Sec. 5(d)(10), 7 U.S.C. 7(d)(10).
\65\ On September 11, 2001, the physical location of three DCMs
was destroyed, and both the Commission and the industry recognized
the importance of redundancy capabilities, including safe storage of
trade information, that are sufficiently distant from primary
locations.
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All acceptable practices, including those for Core Principle 15,
are designed to assist DCMs by offering "pre-approved" roadmaps or
safe-harbors for core principle compliance. Although it may be a
preferred method of compliance, no acceptable practice is mandatory.
Instead, as safe-harbors, acceptable practices provide all DCMs with
valuable regulatory certainty upon which they may rely, should they
choose to do so, when seeking initial designation, when subject to
periodic RERs by the Division of Market Oversight, or at any other time
in which the Commission requires a DCM to demonstrate core principle
compliance.\66\
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\66\ The Commission has explained that "boards of trade that
follow the specific practices outlined under [the acceptable
practices] * * * will meet the applicable core principle." 17 CFR
38, App. B, ] 2.
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Because they offer such broad and beneficial safe-harbors,
acceptable practices are sometimes detailed and exact in their
requirements. If the Commission effectively "pre-approves" a specific
self-regulatory structure for minimizing conflicts of interests under
Core Principle 15, as it is doing here, then it must be sufficiently
specific in describing that structure and all of its components. In the
alternative, the Commission would be offering not a safe-harbor upon
which DCMs may fully rely, but only additional guidance, subject to
varying interpretations, raising many questions, and providing few
answers and even less certainty. That is not the intent of these
acceptable practices.
In addition, the Commission notes that the presence of "must,"
"shall," and similar words in the new acceptable practices indicates
only that these things must be done to receive the benefits of the
safe-harbor, not that the acceptable practices themselves are required.
What is now required of all DCMs under Core Principle 15 is to
demonstrate that they have effectively insulated their self-regulatory
functions, personnel, and decisions from improper influence and
commercial considerations, including those stemming from their numerous
member, customer, owner, and other constituencies. If a DCM chooses not
to implement the new acceptable practices for Core Principle 15, then
the Commission will evaluate the DCM's alternative plan, either through
RERs, the rule submission process, or other means. During any such
review, the DCM will be required to present and demonstrate what
procedures, arrangements, and methods it has adopted or will adopt to
minimize structural conflicts of interest in self-regulation. The DCM
will further be required to demonstrate that its approach is capable of
responding effectively to conflicts that may arise in the future.
2. Comments With Respect to the Board Composition Acceptable Practice
The proposed Board Composition Acceptable Practice calling for at
least 50% public director representation on DCM boards and executive
committees drew substantial comment, both for and against. In their
comment letters, the FIA and five large FCMs strongly supported the 50%
public director benchmark for DCM boards. The FIA particularly noted
that the proposal provides DCMs with flexibility as to how they want to
address the diversity of interest groups in that the proposal does not
specify any fixed number of board members. The FIA also recommended
that a subgroup of public directors should serve as a nominating
committee to select new or re-nominate existing public directors. One
exchange also generally supported the proposals, commenting that the
proposed governance standards and ROCs will enhance DCM governance and
serve to protect market participants and the public interest.
Many commenters, however, opposed the proposed 50% public director
composition requirement. Several commenters were concerned that the
proposal would dilute the voices of trade, commodity, and farmer
interests in DCM governance, as well as the voices of market users,
members, shareholders, and other stakeholders in the DCM. Commenters
were also concerned about the need for experience and expertise on DCM
boards.\67\
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\67\ One commenter stated that filling governance positions with
those totally devoid of any connection to the marketplace would
necessarily lead to major decisions regarding the operation of
futures markets being made by those with no expertise in such
decision making and no vested interest in the long-term best
interests of those markets. It was suggested that this will result
in either grossly mismanaged DCMs or the appearance of conflicts of
interest as public directors defer to the less diverse non-public
directors and officers.
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Several commenters stated that, in order to meet the proposed 50%
board composition requirement, either the board would have to be made
unreasonably large, or a DCM would have to reduce the number of
directors drawn from its commercial interest and other memberships.
Commenters also contended that it would be difficult to
[[Page 6947]]
attract a sufficient number of qualified public directors.\68\
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\68\ One mutually-owned DCM commented that payment of a stipend
to directors will create additional financial burdens on smaller,
non-profit DCMs and create the possibility of less qualified
directors serving on the board. Another commenter noted that public
directors with no industry experience might be less inclined to
invest in the self-regulatory functions of the DCM.
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Many of the comments regarding executive committee composition
raised the same points as comments regarding the board composition
requirement. Such comments included the need for a diversity of
representation on executive committees, the need for experience and
expertise, and the difficulty of attracting qualified public directors.
In addition, several commenters argued that members of an executive
committee have a special need for expertise due to its unique
involvement in day-to-day operational and managerial issues.
2a. The Commission's Response to Comments on the Board Composition
Acceptable Practice
After carefully reviewing the comments above, the Commission has
decided to modify the proposed Board Composition Acceptable Practice,
and reduce the required ratio of public directors on boards and
executive committees from at least 50% to at least 35%. The Commission
is confident that the new Board Composition Acceptable Practice,
together with the other acceptable practices adopted herein,
effectively accomplishes what Core Principle 15 requires--
"minimiz[ing] conflicts of interest in the decision-making process of
the contract market"--while simultaneously respecting the legitimate
needs of efficiency and expertise in that process.
Both the proposed and final Board Composition Acceptable Practices
recognize the importance of DCM boards of directors in effective self-
regulation. Boards of directors bear ultimate responsibility for all
regulatory decisions, and must ensure that DCMs' unique statutory
obligations are duly considered in their decision making. While
exchange boards do have fiduciary obligations to their owners, they are
also required by the Act to ensure effective self-regulation, to
protect market participants from fraud and abuse, and to compete and
innovate in a fair and responsible manner. To meet these obligations,
boards of directors, and any committees to which they delegate
authority, including executive committees, must make certain that DCMs'
regulatory responsibilities are not displaced by their commercial
interests or those of their numerous constituencies.
The Commission 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.\69\ While determining
a "sufficient" level of public representation is not an exact
process, the Commission has concluded that the public interest will be
furthered if the boards and executive committees of all DCMs are at
least 35% public. 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.
These public directors, representing over one-third of their boards,
will approach their responsibilities without the conflicting demands
faced by industry insiders. They will be free to consider both the
needs of the DCM and of its regulatory mission, and may best appreciate
the manner in which vigorous, impartial, and effective self-regulation
will serve the interests of the DCM and the public at large.
Furthermore, boards of directors that are at least 35% public will help
to promote widespread confidence in the integrity of U.S. futures
markets and self-regulation. Public participation on such boards will
enhance the independence and accountability of all self-regulatory
actions. As regulatory authority flows from the board of directors to
all decision-makers within a DCM, such independence should permeate
every level of self-regulation and successfully minimize conflicts of
interest as required by Core Principle 15.
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\69\ As noted previously, some commenters made similar arguments
with respect to executive committee composition and board
composition. Those arguments are addressed jointly in this Section.
Some commenters also argued that executive committees require a
special degree of expertise due to their unique role in day-to-day
operational and managerial issues. The Commission notes that this
argument runs counter to commenters' opposition to the ROC
Acceptable Practice on the grounds that directors and board
committees should not take part in day-to-day operational and
managerial issues. The Commission believes that executive
committees' unique role stems from their authority to act in place
of the full board of directors. Regardless of the decision being
made, if a DCM decides that such decision is best made by a small
group of directors to whom full board authority has been delegated,
then the ratio of public directors in that group should be no less
than the ratio on the full board. Anything less would deprive a key
level of DCM decision making from the benefits attendant to
sufficient public representation and independence, and diminish the
effectiveness of the Board Composition Acceptable Practice.
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As stated above, the Commission is confident that boards of
directors and executive committees that are at least 35% public will
effectively protect the public interest; at the same time, the
Commission believes that they are appropriately responsive to the
comments. Under the new 35% standard, DCMs will have more latitude to
include a broader diversity of non-public directors, such as commercial
representatives and other highly experienced industry professionals,
and to appoint more member directors and other emerging classes of
trading privilege holders. There will also be sufficient room for
stockholders and other outside investors, DCM officers, and persons
representing affiliated entities or business partners.
The Commission believes that a public director level of at least
35% will not require DCMs to increase the size of their boards or
executive committees, nor will they lose the ability to convene boards
and committees on short notice. Furthermore, at the 35% level, DCMs
should find it easier to attract a sufficient number of qualified
public directors to serve on their boards and executive committees,
thereby substantially reducing any disproportionate burden on smaller
or start-up DCMs. Finally, while this modification makes ROCs with 100%
public representation all the more necessary, it also provides ROC
directors with access to a larger pool of industry expertise from among
their fellow board members, with whom they may freely consult whenever
needed.
At the same time, the Commission has determined that the 35%
standard adopted in the final Board Composition Acceptable Practice is
sufficient to ensure strong representation of the public interest in
DCM decision making. While a DCM may determine that a 50% public
director standard is more appropriate for its circumstances,\70\ the
Commission believes that the 35% standard for safe harbor purposes
under Core Principle 15 will be effective while also responsive to
reasonable concerns voiced in the public comments.
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\70\ Certain DCMs, such as large exchange subsidiaries of
publicly traded companies, may be better served by a higher ratio of
public directors, and may be better able to attract them. Although
the Commissions believes that the 35% standard adopted herein is an
appropriate minimum standard for all DCMs, the core principle regime
grants DCMs the flexibility to adopt higher ratios of public
directors should they wish.
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The Commission has concluded that the most effective way to address
DCM conflicts of interest, while still maintaining the self-regulatory
model, is to place a sufficient number of public persons on DCM boards
of directors, executive committees, and other decision-making bodies.
Ultimately, however, the Commission's objective is
[[Page 6948]]
not to engineer specific board-level decisions, but rather to encourage
a process that ensures that every decision will be both well-informed
by inside expertise and well-balanced by the public interest. Following
implementation of the Board Composition and companion acceptable
practices, the Commission will carefully monitor DCM decision making,
and reserves the right to modify the required ratio of public directors
as necessary.
3. Comments With Respect to the Public Director Acceptable Practice
Many commenters addressed the proposed acceptable practices'
definition of "public" for DCM directors and members of disciplinary
panels. With respect to the definition generally, the FIA supported the
Commission's definition but noted that it had proposed a more stringent
public director standard of no involvement with the futures or
derivatives business. Several commenters expressed the general concern
that the Commission's definition of public would lead to a lack of
experience and expertise among DCM directors and members of
disciplinary panels. One commenter contended that the definition was
not needed for NYSE-listed DCMs as the definition of independence
contained in the NYSE listing requirements was sufficient to ensure the
appropriate level of independence in a DCM's decision-making processes.
With respect to the proposed definition's exclusion of persons
having a material relationship with the contract market, one commenter
asked that the Commission clarify that DCM boards may make material
relationship determinations without any independent nominating
committee involvement. That commenter also asked that the Commission
clarify whether it would represent a material relationship with the
futures exchange for an individual, who otherwise satisfied the
proposed qualification criteria, to be a lessor member of a DCM
affiliate with a de minimus equity percentage interest in the DCM
affiliate. Another commenter questioned whether the material
relationship test would prevent an otherwise qualified individual from
becoming a public director if its family farming operation used the
DCM's contracts as risk management tools.\71\
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\71\ The use of a DCM's contracts to hedge risks in commercial
activities otherwise unrelated to futures trading does not
automatically constitute a material relationship. However, a board
of directors should consider all relevant factors carefully when
making its materiality determination. For example, if the farm
operator cited above conducted its hedging activities as an exchange
member, as broadly defined herein, such membership would disqualify
it and persons affiliated with it from serving as public directors.
Likewise, if futures trading is a central economic activity for an
individual or firm, rather than incidental to other commercial
activity, then the board should consider whether such futures
trading rises to the level of a material relationship that could
affect a director's decision making. For example, a director voting
on a proposed exchange rule that would facilitate or deter a
particular trading strategy will have a material conflict if their
personal or firm trading is likely to benefit or be harmed by such
new rule.
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The proposed definition stated that a director will not be
considered "public" if the director is a member of the contract
market or a person employed by or affiliated with a member. In
response, one commenter stated that such a restriction would be a
mistake because it would exclude from the board people with both
industry knowledge and substantial shareholdings, including persons who
hold membership but who are retired or lease their membership to
others, members that are marginally involved in trading, persons who
are members at other DCMs, and holders of corporate memberships whose
firms likely conduct business at multiple DCMs. One commenter stated
that the proposal's definition of member does not take into account the
various types of membership, some of which may raise greater potential
for conflicts of interest, while others may raise very little
potential.
The proposed definition also stated that a director will not be
considered "public" if the director is an officer or employee of the
DCM or a director, officer, or employee of its affiliate. In response,
one commenter argued against the disqualification of an otherwise
public DCM because he or she is also serving as a director at an
affiliate of the DCM. Another commenter requested that the Commission
clarify that a director of a DCM would not be considered non-public
because he or she was also a director of the DCM's holding company.
Several comments addressed the proposed definition's determination
that a director will not be considered "public" if the director
receives more than $100,000 in payments, not including compensation for
services as a director, from the DCM, any affiliate of the DCM or from
a member or anyone affiliated with a member. The FIA argued that the
Commission should adopt a "no-payment-from-contract-market" standard,
noting that payment of up to $100,000 would result in at least some
allegiance to DCM management. Additionally, the FIA commented that if
the $100,000 compensation limit is retained, the Commission should
clarify that it is an overall cap of permissible compensation from
contract markets and their members. The FIA also opined that receipt of
more than $100,000 by a potential director's firm (rather than by the
director) from a DCM member constitutes indirect payment or
compensation and should not prevent an otherwise qualified director
from being considered public.
By contrast, one DCM stated that the public director definition
should be modified to eliminate the $100,000 compensation provision
because it is an arbitrary level and may amount to de minimis
compensation in the context of the person's total compensation.\72\
Another exchange requested that the Commission clarify that pensions
and other forms of deferred compensation for prior services that are
not contingent on continued service would not automatically disqualify
a person from serving as a public director.
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\72\ This commenter stated that each DCM board should consider
compensation from the DCM or its members as one factor in
determining whether the person has a material relationship with the
DCM.
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One commenter addressed the proposed definition's determination
that a person will be precluded from serving as a public director if
any of the relationships identified in the definition apply to a member
of the director's immediate family. That commenter stated that an
individual should not be prohibited from serving as a public director
based on the affiliation of an immediate family member with a member
firm unless the family member is an executive officer of the member
firm. The same commenter further noted that the exclusion should not
apply to family members who do not live in the same household as the
director.
The proposed definition also included a one-year look back
provision with respect to the identified disqualifying circumstances.
With respect to this provision, the FIA commented that a two-year look
back would be more realistic and effective. In contrast, an exchange
commented that the proposed one-year look back is more than sufficient
and noted that that the longer the look back period, the less likely
that individuals will plan to return to the industry.
3a. The Commission's Response to Comments on the Public Director
Acceptable Practice
The Commission carefully considered all of the comments with
respect to the Public Director Acceptable Practice, and generally found
that many of the
[[Page 6949]]
discrete requests for clarification regarding the definition of
"public" were reasonable. Accordingly, the Commission made
appropriate responsive modifications to the final Public Director
Acceptable Practice, as discussed in Section IV below.
The Commission has determined, however, that a less stringent
definition of public director, as requested by some, is contrary to the
acceptable practices' stated objectives: minimizing conflicts of
interest through independent decision making, encouraging a strong
regard for the public interest, and insulating regulatory functions via
public directors and persons who are not conflicted by industry ties.
Furthermore, 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 proposed. More
importantly, the Commission strongly believes that, rather than being a
drawback, the most significant contribution made by public directors to
the DCM decision-making process is precisely their outside, non-
industry perspective. The Commission is confident that a board
consisting of at least 35% public directors, as defined in the Public
Director Acceptable Practice, is more than capable of reaching
intelligent collective decisions, even on technical matters requiring
detailed knowledge of futures trading, while at the same time
exercising its regulatory authority in a manner consistent with the
public interest.
The Commission rejects the contention that it will be impossible to
find a sufficient number of qualified public directors to serve on DCM
boards. Similarly, it rejects the argument that the materiality and
bright-line tests may result in inexperienced directors with limited
knowledge of the futures industry. To the contrary, the Commission
believes that DCMs are fully capable of finding a sufficient number of
qualified directors to constitute at least 35% public boards. DCMs may
draw from a large pool of talented candidates with relevant or related
experience, including retired futures industry insiders; scholars whose
research focuses on the futures markets and related disciplines;
officers and executives of many sophisticated corporate entities;
persons with expertise in the securities industry, which may translate
well into futures; and other members of the legal, business, and
regulatory communities.
The Commission notes that a wide variety of DCMs--large and small,
mutually-owned and publicly traded, for-profit and not-for-profit--
already have boards of directors that are at least 20% non-member, as
once required by Commission Regulation 1.64. One securities exchange
that is the parent company of a DCM has a board that is at least 50%
non-member,\73\ and the NYSE's board of directors is 100% non-member.
Accordingly, many exchanges have already demonstrated an ability to
successfully recruit, retain, and thrive with significant numbers of
public directors.
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\73\ The board of directors of the Chicago Board Options
Exchange, which owns CFE, is 50% public (independent non-member).
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It is noteworthy that the three largest-volume DCMs, all of which
are subsidiaries of publicly traded companies, are already required to
have boards that are at least 50% "independent," as defined by the
NYSE. In certain respects, the Commission's definition of "public
director" overlaps with the NYSE's "independent directors"
definition. Thus, these DCMs could potentially select at least some of
their public directors from among their independent directors who do
not have current ties to the futures industry. At the same time, the
argument that the NYSE listing standards render the proposed Public
Director Acceptable Practices unnecessary is misplaced. Despite the
similarities between the acceptable practices and the NYSE's definition
of independent, one overarching difference remains-- the listing
standards are designed to protect shareholders, through boards of
directors that are sufficiently independent from management.\74\ In
contrast, the new acceptable practices for Core Principle 15, while
recognizing that DCMs are commercial enterprises, serve the national
public interest in vigorous, impartial, and effective self-regulation.
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\74\ The NYSE's commentary to its listing standards emphasizes
that "as the concern is independence from management, the Exchange
does not view ownership of even a significant amount of stock, by
itself, as a bar to an independence finding." NYSE Listed Company
Manual, Sec. 303A.02 (commentary) (emphasis added).
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The Commission agrees with many of the commenters that effective
self-regulation is in the long-term interest of DCM owners, including
shareholders. However, it 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.\75\ Whereas the NYSE listing standards serve those with a
direct fiduciary claim upon a company (shareholders (owners)), 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.
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\75\ CEA Sec. 3(b), 7 U.S.C. 5(b).
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Some commenters argued that the proposed Public Director Acceptable
Practice, and the bright-line tests in particular, do not take into
account different types of DCM memberships and the different degrees of
conflict which they may or may not engender. Although different
commenters focused on different groups of industry participants, their
underlying argument was the same: that industry participants should be
permitted to serve as public directors to a lesser or greater extent.
The Commission's response to this and similar comments summarized above
is two-fold.
First, if DCMs value the presence of industry insiders on their
boards, they may place them among the 65% of directors who are not
required to be public under the final acceptable practices. The
Commission has facilitated this option by reducing the required ratio
of public directors. Second, and as stated previously, the purpose of
the Public Director Acceptable Practice is to ensure independent
decision making and strong consideration of the public interest by DCM
boards of directors. While all directors are required to consider DCMs'
statutory obligations and public responsibilities, public directors are
particularly meaningful because they have no fiduciary duty to lessees
or lessors of trading seats, corporate members, persons who trade small
amounts, or any other persons affiliated with the futures industry and
inquired about in the comments. Allowing persons with current industry
affiliation to serve as public directors would necessarily reintroduce
into board deliberations and ROC oversight the very conflicts of
interest that Core Principle 15 and the new acceptable practices seek
to minimize.
The Commission also notes that the most significant determination
to be made under the Public Director Acceptable Practice is the board's
finding that a potential public director has no material relationship
with the DCM. The Commission has left this determination to the board's
discretion, and offers the bright-line tests only as a beginning to the
board's inquiry. The material relationship test requires a
[[Page 6950]]
DCM's board to make an affirmative, on-the-record finding that a
director has no material relationship with the DCM, and to disclose the
basis for that determination. The bright-line tests simply facilitate
the board's inquiry by noting obviously material relationships, and
freeing the board to focus on other relationships that may be less
apparent but that are equally detrimental to impartial representation
of the public interest. As such, the bright-line tests, like any other
acceptable practices, must be sufficiently detailed to merit the
benefits accorded to a safe-harbor. Consistent with this approach, the
Commission reaffirms the familial relationships excluded under the
bright-line tests, the one-year look-back provision, and all other
elements of the proposed Public Director Acceptable Practice, except
for those specifically treated in Section IV.\76\
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\76\ In Section IV, the Commission makes clarifications with
respect to, inter alia, the manner in which DCMs select their public
directors, the compensation of public directors, and public
directors serving on both a parent company and a subsidiary DCM
("overlapping public directors").
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4. Comments With Respect to the Regulatory Oversight Committee
Acceptable Practice
The proposed Regulatory Oversight Committee Acceptable Practice
called upon DCMs to establish a board-level ROC, composed solely of
public directors, to oversee regulatory functions. Many commenters
focused on the composition of the proposed ROC, voicing many of the
same concerns they had with respect to the proposed 50% public director
board requirement. Two DCMs commented that each DCM should be permitted
to determine whether to establish a ROC, the extent of the ROC's
responsibilities, and the most appropriate composition thereof. One DCM
argued that the level of public representation should be the same for
ROCs and boards.
A number of commenters expressed concern with the difficulty in
recruiting qualified public directors (similar to the concerns
expressed with respect to recruiting qualified directors for the board
generally) to serve on ROCs, and noted the need for experience,
expertise, and diversity on any such body. One DCM commented that an
ROC should be able to include public representatives who are not public
directors of the exchange, but who are otherwise qualified to be.
The FIA and a large FCM supported the proposed Regulatory Oversight
Committee Acceptable Practice. The FCM commented that adoption of the
proposal will enhance the credibility and effectiveness of DCMs in
their capacity as self-regulators.
One DCM commented that while an ROC is an appropriate way to
reinforce impartiality in DCM self-regulation, it may not be the best
approach for all DCMs (particularly smaller ones) to charge the
committee with managerial duties and overseeing daily market regulation
functions. Another DCM commented that ROCs should not remove DCMs'
chief regulatory officers from the appropriate direction and input of
DCM management. Commenters also argued that ROCs' proposed duties could
conflict with the responsibilities of the chief executive officer, the
board, and DCM personnel, and could well undercut their authority.
Many commenters addressed ROCs' stated responsibilities. Several of
these commenters argued that the level of authority assigned to an
ROC's public directors is contrary to commonly accepted corporate
management best practices because management functions are removed from
management and become directors' responsibilities. A number of
commenters offered recommendations as to what should be the
responsibilities of an ROC. One DCM requested that the Commission
clarify that if an ROC were to have any authority with respect to
overseeing budgets and the hiring and compensation of regulatory
officers and staff, that such authority would supplement rather than
replace these normal management and board responsibilities. It was
further argued that the Commission should make clear that it is not the
function of an ROC to plan or conduct trade practice investigations or
market surveillance or to review the results of particular
investigations or audits, but rather to serve an oversight role. It
also was suggested that the Commission should remove language that
states that an ROC shall supervise the DCM's CRO because it is
inconsistent with the Commission's stated position that an ROC should
not serve as a manager. Another DCM commented that ROCs should be
granted unhindered access to regulatory staff along with the authority
to ensure that regulatory staff has sufficient resources and that
nothing interferes with staff's fulfillment of the regulatory program.
In other comments addressing the proposed responsibilities of ROCs,
a large FCM and the FIA contended that ROCs (or their chairmen) should
approve the composition of DCM disciplinary panels. The FIA also
recommended that ROCs be granted the power to hire, supervise, and
determine the compensation of DCMs' CROs and set (or recommend to the
board) DCMs' self-regulatory budgets. Further, in the interest of more
transparency for DCM rulemakings, the FIA recommended that ROCs should
consider and approve any new DCM rule or rule change or, if the
Commission elects not to call for committee approval of all such rules
and rule changes, than any new DCM rule or rule change that a DCM
decides to self-certify to the Commission.
4a. The Commission's Response to Comments on the Regulatory Oversight
Committee Acceptable Practice
Criticisms of the proposed ROC Acceptable Practice often mirrored
those leveled against the proposed Board Composition Acceptable
Practice and the proposed acceptable practices in general. After
careful consideration, the Commission has determined to implement the
ROC Acceptable Practice for Core Principle 15 as proposed.\77\
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\77\ As stated in the proposing release, the Commission
emphasizes that ROCs are expected to identify aspects of their DCMs'
regulatory system that work well and those that need improvement,
and to make any necessary recommendations to their boards for
changes that will help to ensure vigorous, impartial, and effective
self-regulation. ROCs should be given the 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 they or their CROs believe may have a
significant regulatory impact. DCMs should provide their ROCs and
CROs with sufficient time to consider such proposals before acting
on them. ROCs should prepare for their boards and the Commission an
annual report assessing the effectiveness, sufficiency, and
independence of the DCM's regulatory program, including any
proposals to remedy unresolved regulatory deficiencies. ROCs should
also keep thorough minutes and records of their meetings,
deliberations, and analyses, and make these available to the
Commission upon request. In the future, when reviewing DCMs'
compliance with the core principles, the Commission will examine any
recommendations made by ROCs to their boards and the boards'
reactions thereto.
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The Commission stresses that ROCs are oversight bodies, and that
the enumerated powers granted to them in the ROC Acceptable Practice
merely complement normal board functions. ROCs are not intended to
supplant their boards of directors, nor are they expected to assume
managerial responsibilities or to perform direct compliance work. Under
the acceptable practices for Core Principle 15, DCM self-regulation
remains exactly that--self-regulation, but with a stronger and more
defined voice for the public responsibilities inherent to all DCMs.
Properly functioning ROCs should be robust oversight bodies capable of
firmly representing the interests of vigorous, impartial, and effective
self-regulation. ROCs should also represent the interests and needs of
regulatory
[[Page 6951]]
officers and staff; the resource needs of regulatory functions; and the
independence of regulatory decisions. In this manner, ROCs will
insulate DCM self-regulatory functions, decisions, and personnel from
improper influence, both internal and external.
Many of the comments in opposition to the ROC Acceptable Practice--
for example, that whether to establish ROCs should be left at DCMs'
discretion and that it will be difficult to find qualified public
directors--have already been addressed, and the Commission's previous
responses need only brief summarizing here. The Commission strongly
believes that new structural conflicts of interest within self-
regulation require an appropriate response within DCMs. The Commission
further believes that ROCs, consisting exclusively of public directors,
are a vital element of any such response. With respect to those public
directors, the Commission is confident that DCMs can recruit a
sufficient number of qualified persons, as they have done for their
boards in the past. Finally, the Commission notes that while DCMs must
respond to conflicts between their regulatory responsibilities and
their commercial interests; the exact manner in which they do so
remains at their discretion.
A second line of comments with respect to the ROC Acceptable
Practice argued that ROCs should include industry directors, and that
the ratio of public directors on ROCs should be the same as on boards.
The Commission believes that these comments ignore the very purpose of
the ROC Acceptable Practice. As stated previously, the new acceptable
practices ensure that DCMs' decision-making bodies include an
appropriate number of persons who are not conflicted by industry ties.
For ROCs--the overseers of DCMs' regulatory functions--the appropriate
number is 100% public. The Commission believes that anything less
invites into regulatory oversight operations precisely those directors
whose industry affiliations lend themselves to conflicts of interest in
decision making.
What constitutes a "sufficient" number of public persons for DCM
decision making depends upon the decision-making body in question and
its responsibilities. Thus, DCM disciplinary panels are required to be
diverse and have only one public person because their responsibility--
expert and impartial adjudications--often requires a detailed knowledge
of futures trading best provided by industry participants. At the same
time, that expertise is balanced by the impartiality of at least one
public panelist and a diversity of industry representatives. For boards
of directors, however, with both regulatory responsibilities and
commercial interests, the minimum 35% ratio properly recognizes boards'
dual role as the ultimate regulatory and commercial authorities within
DCMs. Industry directors on DCMs' boards are fully justified precisely
because of the numerous commercial decisions that they must make.
Within this construct, ROC's discrete regulatory responsibilities
assume added significance. The sole purpose of ROCs is to insulate
self-regulatory functions, personnel, and decisions from improper
influence, and to advocate effectively on their behalf. ROCs make no
direct commercial decisions, and therefore, have no need for industry
directors as members. The public directors serving on ROCs are a buffer
between self-regulation and those who could bring improper influence to
bear upon it. The Commission notes that at least three DCMs--CME,
NYBOT, and U.S. Futures Exchange--have already established board-level
committees similar to the ROCs described in the ROC Acceptable
Practice, and they consist exclusively of public directors. The same is
true of the securities exchange parent company of one DCM that
submitted comments.
Commenters who requested greater industry participation on ROCs
should recall that ROCs will be subject to the final authority of their
boards of directors, which may include a sufficient number of industry
directors. DCM boards, including industry directors, will have ample
opportunity to consult with and advise ROC public directors, to
interact with regulatory officers and personnel, and ultimately to
enact any regulatory policies or decisions that they deem appropriate.
As stated previously, ROCs are designed to insulate self-regulation,
not isolate it. At the same time, under the ROC Acceptable Practice,
ROCs have the absolute right to whatever resources and authority they
may require to fulfill their responsibilities, including resources
within their DCMs. More specifically, ROCs have the authority and
resources necessary to conduct their own inquiries; consult directly
with their regulatory officers and staffs; interview DCM employees,
officers, members, and others; review relevant documents; retain
independent legal counsel, consultants, and other professional service
providers and industry experts; and otherwise exercise their
independent analysis and judgment as needed to fulfill their regulatory
responsibilities.\78\
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\78\ ROCs should not rely on outside professionals or firms that
also provide services to the full board, other board committees, or
other units or management of their DCMs.
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The related concern that ROCs will undercut the authority of DCM
boards of directors is misplaced. ROCs should function as any other
committee of the board, making recommendations which are afforded great
weight and deference, and reaching final decisions if such power is
delegated to it, but ultimately subject to the board's authority. The
very text of the ROC Acceptable Practice calls for ROCs to "monitor,"
"oversee," and "review," none of which implies binding authority or
a usurpation of the full board of directors. At most, it implies a
change in workflow.\79\
Similarly, concerns that ROCs will become managerial bodies or
interfere with established managerial relationships are equally
misplaced. To be clear, the Commission expects ROCs to oversee DCMs'
self-regulatory functions and personnel, not to manage them. ROCs'
responsibilities, detailed in Section 3 of the final acceptable
practices, include traditional oversight functions or functions that
can easily be delegated to a DCM's CRO.\80\ Some
[[Page 6952]]
examples of traditional committee responsibilities that can easily be
performed by an ROC without undue interference in managerial
relationships include: recommending rule changes or going on the record
as opposed to a rule change originating elsewhere within the DCM;
determining an appropriate regulatory budget in conjunction with the
CRO and then forwarding that determination for consideration by the
full board; arriving at employment decisions with respect to senior
regulatory personnel and then forwarding those determinations for
consideration by the full board; annual review and reporting on
regulatory performance to the full board, etc.
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\79\ For example, whereas the compensation of senior DCM
executives typically may be recommended to the board by a
compensation committee, the compensation of the CRO will be
recommended by the ROC. This provides insulation to the CRO and the
regulatory personnel beneath him or her, but does not infringe upon
the board's final decision-making authority. Similarly, a ROC,
rather than a budget committee, should be the body that formally
recommends the appropriate level of regulatory expenditures for the
DCM. Again, the salutary effect is to insulate a crucial self-
regulatory decision, but not to remove it from the ultimate purview
of the full board of directors. In these and similar instances, the
Commission will be in a position to evaluate how boards treat ROC
recommendations, thus adding Commission review as an additional
level of self-regulatory insulation.
\80\ The text of the final acceptable practices makes clear that
ROCs' shall "supervise the contract market's chief regulatory
officer, who will report directly to the ROC." This two-way
relationship--delegation of certain responsibilities from the ROC to
the CRO combined with supervision of the CRO by the ROC--is a key
element of the insulation and oversight provided by the ROC
structure. It permits regulatory functions and personnel, including
the CRO, to continue operating in an efficient manner while
simultaneously protecting them from any improper influence which
could otherwise be brought to bear upon them. The ROC Acceptable
Practice identifies key levers of influence, including authority
over the conduct of investigations, the size and allocation of the
regulatory budget, and employment and compensation decisions with
respect to regulatory personnel, among others, and then places them
within the insulated ROC/CRO-regulatory personnel relationship.
While in no way diminishing the ultimate authority of the board of
directors, this three-part relationship is intended to protect
regulatory functions and personnel, including the CRO, from improper
influence in the daily conduct of regulatory activities and broader
programmatic regulatory decisions.
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ROCs' most important responsibility will simply be to insulate
self-regulatory functions and personnel from improper influence. Such
insulation does not usurp established authority, but rather acts as a
filter through which it must pass, and be cleansed of any efforts to
exercise improper influence or drive regulatory decisions according to
commercial interest. One facet of the insulation provided by an ROC
clearly is the relationship between it and its CRO, and through him or
her, all regulatory functions, personnel, and decisions. The Commission
has endeavored to identify the levers of influence that may be used to
pressure an individual, or an entire regulatory department, and to
place ROCs alongside those levers. Matters such as the hiring,
termination, and compensation of regulatory personnel, and size of
regulatory budgets, are clearly areas where insulation from improper
influences may be beneficial. The insulation provided by the ROC
Acceptable Practice, however, need not interfere with the established
relationships between management, staff, and others necessary to
effective self-regulation.
5. Comments With Respect to the Disciplinary Committee Acceptable
Practice
Several commenters addressed the proposed Disciplinary Panel
Acceptable Practice provision that all DCM disciplinary panels include
at least one public participant and that no panel be dominated by any
group or class of DCM members. The FIA and large FCMs that commented
were generally supportive of the proposed Disciplinary Panel Acceptable
Practice, with the FIA commenting that one public member of a DCM
disciplinary panel should be a prerequisite for safe harbor relief, but
that a 50% public independent member standard for such panels would be
much more in keeping with the spirit of the proposed acceptable
practices. One large FCM noted that the proposal's composition
requirement would avoid the perception of conflict and lack of fairness
and impartiality. Another large FCM commented that it supports the
proposed provision that would require rules precluding any group or
class of industry participants from dominating or exercising
disproportionate influence on disciplinary panels.
Although two large DCMs commented that it is not necessary for the
Commission to prescribe diversity on disciplinary panels, most of the
smaller DCMs that commented in this area were supportive of the
proposed acceptable practice. One smaller DCM that hires hearing
officers to determine whether to bring a disciplinary action, however,
commented that this proposed acceptable practice is not necessary for
that DCM as it did not have any widespread inadequacies.
Two commenters addressed what should be the qualifications of the
public person serving on disciplinary panels; one agreed that having a
public person on disciplinary panels is a sound proposition, but
recommended that such person need not be subject to the same qualifying
criteria as public directors. Another requested that the Commission
clarify that the proposed board determination and reporting
requirements with respect to public directors generally are unnecessary
for public persons serving on disciplinary panels. The same commenter
also requested clarification that the Disciplinary Panel Acceptable
Practice's exclusion of decorum or attire cases from the requirement
that one public person serve on disciplinary panels also applies to
cases limited to certain recordkeeping matters (e.g., the timely
submission of accurate records required for clearing or verifying each
day's transactions or other similar activities).
5a. The Commission's Response to Comments on the Disciplinary Panel
Acceptable Practice
After carefully reviewing these comments, the Commission is
satisfied that the Disciplinary Panel Acceptable Practice should be
implemented as proposed. The Commission believes that fair disciplinary
procedures, with minimal conflicts of interest, require disciplinary
bodies that represent a diversity of perspectives and experiences. The
presence of at least one public person on disciplinary bodies also
provides an outside voice and helps to ensure that the public's
interests are represented and protected. This approach is consistent
with the Commission's overall objective of ensuring an appropriate
level of public representation at every level of DCM decision making,
while simultaneously calibrating the required number of public persons
to the nature and responsibility of the decision-making body in
question.
The Disciplinary Panel Acceptable Practice accomplishes these dual
objectives of diversity and public representation, while also
maintaining the expertise necessary to evaluate sometimes complex
disciplinary matters. The Commission also is comfortable that its RER
process is well-positioned to evaluate the performance of DCM
disciplinary committees and panels, such that a substantially higher
proportion of public representation or other ameliorative steps are not
required. RERs typically examine all of a DCM's disciplinary cases
during a target period in detail, including reviews of disciplinary
committee and panel minutes, investigation reports, settlement offers,
and sanctions imposed. The Commission also pays careful attention to
the recommendations of DCM compliance staff, to disciplinary bodies'
responses to those recommendations, and to the analysis and rationale
offered by disciplinary bodies in support of their decisions. If
disciplinary committees and panels are underperforming, the Commission
will be able to recognize any shortcomings and take appropriate
measures.
The work of disciplinary panels requires more specialized knowledge
of futures trading than almost any other governing arm of a DCM.
Neither the strategic business decisions made by boards of directors,
nor the oversight conducted by ROCs, for example, require as much
technical futures trading expertise as disciplinary panel service.
Accordingly, the Commission believes that increasing the proportion of
public representatives on disciplinary panels to 50%, as suggested by
one commenter, would eliminate too much expertise from the disciplinary
process and is unwarranted.
The Commission recognizes that a small number of DCMs may have
unique disciplinary structures. However, the Commission strongly
believes that diverse panels, including at least one public person, are
appropriate for all DCMs. Should an individual DCM choose to comply
with this element of Core Principle 15 by other means, the Commission
will examine and monitor it to ensure full core principle compliance.
Other specific requests for modifications and/or clarifications
with respect to the Disciplinary Panel
[[Page 6953]]
Acceptable Practice are treated separately in Section IV(E) below.
IV. Specific Requests for Modifications and/or Clarifications That the
Commission Has Determined To Grant or Deny
Several commenters made specific requests for modifications and/or
clarifications that the Commission has determined to grant in some
instances and deny in others. The specific modifications and/or
clarifications do not represent changes in the proposed acceptable
practices, but rather implement the Commission's original intent. They
are described below.
A. Phase-in Period for the New Acceptable Practices
Several commenters indicated concern that adoption of the proposed
acceptable practices, particularly the requirement to restructure the
board, would be burdensome, time consuming and costly. For instance,
one large DCM commented that implementation of the acceptable practices
would necessitate major changes and cause significant disruption for
DCMs, virtually none of which currently meet the proposed 50% public
director standard (or the minimum 35% standard adopted in this final
release). Another large DCM commented that publicly held DCMs
implementing the acceptable practices would have to amend their
certificates of incorporation, by-laws, and various public disclosures
and respond to any shareholder challenge. As a result of the perceived
time requirement, several commenters requested that, if the proposals
are adopted, the Commission should provide for an adequate phase-in
period.
The Commission hereby grants an appropriate phase-in period. The
new acceptable practices for Core Principle 15 are effective 30 days
after publication in the Federal Register. Under the phase-in period
described below, DCMs may take up to two years or two regularly-
scheduled board elections, whichever occurs first, to fully implement
the new acceptable practices or otherwise demonstrate full compliance
with Core Principle 15. The Commission expects that DCMs will begin
making preparations and taking conforming steps early in the phase-in
period. Accordingly, six months after publishing these acceptable
practices in the Federal Register, the Commission will survey all DCMs
to evaluate their plans for full compliance with Core Principle 15. The
Commission also will monitor all DCMs throughout the phase-in period to
evaluate their progress toward full compliance.
Although DCMs are not required to implement the new acceptable
practices, the Commission has determined that full compliance with Core
Principle 15 requires all DCMs to address structural conflicts of
interest between their regulatory responsibilities and their commercial
interests or those of their numerous constituencies. Such measures must
be present throughout DCMs' decision-making processes. DCMs choosing to
adopt measures other than the final acceptable practices adopted herein
should consider and address key areas of decision making that are
subject to conflicts of interest. These may include decisions with
respect to regulatory budgets, expenditures, and funding; employment,
compensation, and similar decisions involving regulatory personnel; the
constitution of disciplinary panels; the promulgation of rules with a
potential regulatory impact; decision making with respect to the
investigation, prosecution, and sanctioning of disciplinary offenses;
and the chain of command in compliance programs (including trade
practice surveillance, market surveillance, and financial surveillance)
beyond regulatory officers. The Commission will consider all of these
factors in evaluating compliance with Core Principle 15.
B. Selection of Public Directors
With respect to the placement of public directors on boards, one
DCM commented that the proposing release calls upon DCMs to "elect"
boards composed of at least 50% public members, but that at that
particular DCM public governors are not elected but are identified and
appointed by the board itself. Further, election of public members
might discourage potential candidates because having to stand for
election creates the potential for elected individuals to be beholden
to their electing constituency, especially if the position is
compensated. Another commenter noted that the proposing release
suggests a role for nominating committees in the selection of public
directors, and asked for clarification that nominating committees are
not required to be involved. Conversely, the FIA recommended that a
subgroup of public directors should serve as a nominating committee to
select new or re-nominate existing public directors.
The Commission hereby clarifies that DCMs may select their public
directors in the manner most appropriate to them. Compliance with the
new acceptable practices for Core Principle 15 does not require the use
of nominating committees, the "election" of public directors, or the
selection of public directors by any pre-specified means. DCMs are free
to select their public directors by any process they choose, as long as
their public directors meet the requirements set forth in the new
acceptable practices. In addition, the Commission expects that the
tenures and terms of public directors will be no less secure than that
of other directors of the DCM. For example, if other directors can be
removed only for cause, then that same protection should extend to
public directors. Similarly, if other directors are selected for two-
year terms, then public directors should be as well, etc.
The Commission considered FIA's request for a special nominating
committee for public directors. However, in promulgating these
acceptable practices, the Commission has been careful to focus on
outcomes--the insulation of regulatory functions, a pure public voice
in board deliberations, and fair disciplinary proceedings-while
providing only as much instruction as necessary to achieve the safe
harbor.
C. Compensation of Public Directors
As summarized in Section III above, several commenters requested
clarifications or amendments with respect to the compensation of public
directors under the Public Director Acceptable Practice. Section
(2)(B)(iii) of the proposed acceptable practices specified that a
public director may not receive more than $100,000 in payments from the
DCM (or any affiliate of the DCM, or from a member or anyone affiliated
with a member) other than for services as a director. One commenter
asked whether deferred compensation for prior services would count
toward the $100,000 payment limit for public directors. It does not.
The Commission hereby affirms that public directors may receive
deferred compensation for prior services in excess of $100,000, and
that such compensation will not count towards the $100,000 payment
limit for public directors. To comply with the acceptable practices,
DCMs must ensure that any such compensation is truly deferred
compensation for prior services. Thus, the agreement by which the
public director is being compensated should predate his or her
selection as a public director. Furthermore, it should in no way be
conditioned upon the directors' future performance, services, or
behavior, and in no way be revocable by the compensating party.
FIA requested clarification that the $100,000 payments cap for
public directors, for services other than as a
[[Page 6954]]
director, is a cumulative cap on compensation from DCMs and their
membership. The Commission hereby confirms that FIA's understanding is
correct. The $100,000 payment cap is an annual, cumulative cap on
payments to the public director from all "relevant" sources (i.e.,
the DCM, any affiliate of the DCM, or any member or affiliate of a
member of the DCM) combined. As explained previously, the $100,000 cap
also includes indirect payments made by a DCM, its affiliates, and its
members or affiliates of its members to the director. In addition, the
$100,000 payment cap is an annual cap, as summarized above.
Finally, FIA argued that the Commission should preclude public
directors from receiving any compensation from the DCM, but that
compensation received by a director's firm, rather than the director
itself should not count towards any compensation cap. The Commission
considered both comments carefully, but determined that neither is
appropriate. The Public Director Acceptable Practice's compensation
cap, higher than that requested by FIA, combined with its narrow limits
on where such compensation may originate, strikes the proper balance
between an effective but not overly restrictive definition of public
director.
The Commission strongly believes that significant compensation paid
by a DCM or its affiliates to a firm could adversely impact the
independence of a director affiliated with that firm. In the
Commission's opinion, any such relationship between a DCM and a
director, through the director's firm, clearly rises to the level of a
"material relationship" that would preclude the director from serving
as a public director. Accordingly, the Commission hereby clarifies that
a director affiliated with a firm receiving over $100,000 in
compensation from the DCM or an affiliate of the DCM may not qualify as
a public director.
D. Overlapping Public Directors
At least one commenter requested clarification with respect to
overlapping public directors at DCMs whose ownership structures include
a parent-subsidiary relationship. In the proposed acceptable practices,
Sections (2)(B)(i) and (2)(B)(v), when read together, suggested that
the same person could not serve as a public director at both the parent
company and its subsidiary DCM. The question is most likely to arise in
the context of DCMs that are subsidiaries of publicly traded companies,
and whose boards of directors overlap in whole or in part with those of
their public parents.
The Commission hereby clarifies that overlapping public directors
are permitted. However, such directors must still meet the Commission's
definition of public director, as set forth in the Public Director
Acceptable Practice. In effect, overlapping public directors must carry
the Commission's definition of "public" director from their DCMs to
the holding companies' boards of directors. Conforming language has
been added to the final acceptable practices.
E. Jurisdiction of Disciplinary Panels and Definition of "Public" for
Persons Serving on Disciplinary Panels
One commenter asked the Commission to confirm that DCM disciplinary
panels considering cases involving the timely submission of accurate
records required for clearing or verifying each day's transactions need
not include a public person. The Commission included such language in
the preamble to the proposed Disciplinary Panel Acceptable Practices,
but neglected to include it in the text of the acceptable practices
themselves. The Commission is correcting that oversight and modifying
the final acceptable practices for Core Principle 15 to make clear that
disciplinary panels considering cases involving the timely submission
of accurate records required for clearing or verifying each day's
transactions need not include a public member.
The same commenter requested clarification that public members of
DCM disciplinary panels need only meet the "bright-line" tests for
public directors contained in Section (2)(B)(i-v) and (2)(C) of the
proposed acceptable practices. That was, in fact, the Commission's
intent. Public members of disciplinary panels are not subject to the
broader "no material relationship" test of Section (2)(i), nor the
disclosure requirements of Section (2)(v) in the final acceptable
practices. The Commission is confident that the new bright-line tests,
combined with DCMs' existing personal conflicts of interest provisions,
are sufficient to ensure impartial public representatives on
disciplinary panels. Furthermore, the Commission also believes that
requiring DCMs to conduct and disclose a material relationship test for
disciplinary panel members would constitute an unjustifiable burden at
this time. Conforming changes have been made in the final acceptable
practices.
F. "No Material Relationship Test"
Section (2)(B)(ii) of the proposed acceptable practices precludes a
DCM director from being considered public if he or she is a member of
the DCM, or employed by or affiliated with a member. A director is
"affiliated with a member" if he or she is an officer or director of
the member. The Commission hereby adds an additional element to that
definition: a DCM director is affiliated with a member if he or she has
any relationship with the member such that his impartiality could be
called in question in matters concerning the member.
The Commission believes that this additional element of
"affiliated" is a natural outgrowth of its original proposal. In
particular, the proposed acceptable practices already precluded a DCM's
public directors from also serving as employees, officers, or directors
of a member. Combined with the materiality test in Section (2)(A) of
the proposed acceptable practices, the Commission's intent to capture a
broad array of relationships is clear. Properly applied, the proposed
Public Director Acceptable Practice already excluded from service as
public directors persons whose relationship with a member firm could
call their impartiality into question. Whether the relevant
relationships are employment, or similar to employment--independent
contracting, legal services, consulting, or other relationships--they
are precluded by the Public Director Acceptable Practice. Conforming
language has been added to the final acceptable practices.
G. Elimination of ROCs' Periodic Reporting Requirements
Finally, the Commission is removing certain language from Section
3(B)(v) of the proposed acceptable practices. Among other things, this
section called for ROCs to "prepare periodic reports for the board of
directors and an annual report assessing the contract market's self-
regulatory program. * * *" While the annual reporting obligation
remains in full effect, the Commission has determined that an explicit
requirement to prepare periodic reports for the board is unnecessary at
this time. DCM boards of directors are free to request reports,
updates, and information from committees whenever they wish, and
committees are free to provide them even if not requested. Nothing in
the ROC Acceptable Practice is intended to change that dynamic.
[[Page 6955]]
V. Related Matters
A. Cost-Benefit Analysis
Section 15(a) of the CEA,\81\ 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 CEA. 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.
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\81\ 7 U.S.C. 19(a).
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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 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 CEA.\82\
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\82\ E.g, Fishermen's Dock Co-op., Inc. v. Brown. 75 F.3d 164
(4th Cir. Va. 1996); Center for Auto Safety v. Peck, 751 F.2d 1336
(D.C. Cir. 1985) (agency has discretion to weigh factors in
undertaking costs-benefits analyses).
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In the proposing release, the Commission considered the costs and
benefits of the acceptable practices, requested comment on the
application of the criteria contained in Section 15(a) of the CEA, and
invited commenters to submit any quantifiable data that they might
have.
DCM commenters asserted that the costs of compliance outweighed any
benefit, particularly the costs of amending governing documents in the
manner required by Delaware corporate law. A number of DCMs and
individuals contended that the Board Composition Acceptable Practice
(and the other proposed acceptable practices) is unnecessary and that
the Commission's cost-benefit analysis is flawed. Commenters asserted
that the acceptable practices present no or minimal benefit, since the
Commission failed to demonstrate any problems in the futures industry
to warrant issuance of any of the acceptable practices.\83\ Several
commenters distinguished between securities industry reforms, which
followed public scandals, and the recent absence of such events in the
futures industry.\84\
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\83\ See, e.g., CME CL 29 at 9; NYMEX CL 28 at 10-11; NYBOT CL
22 at 4; CBOT CL 21 at 3.
\84\ See, e.g., NYMEX CL 28 at 11-13; CME CL 29 at 9; NYBOT CL
22 at 2; Comment of Donald L. Gibson, CL 25 at 1.
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As noted above, however, the Commission identified significant
futures industry trends, including increased competition and changing
ownership structures, which justify the acceptable practices as a
prophylactic measure to minimize conflicts of interest in DCM decision
making and to promote public confidence in the futures markets in the
altered landscape. Minimizing conflicts and promoting public confidence
in the futures markets are significant benefits for the futures
industry, market participants, and the national public interest served
by the futures markets.
KCBT and NYBOT commented that, as small, non-public DCMs, they do
not present the types of conflicts the Commission sought to address in
expanding public participation on DCM governing boards.\85\
HedgeStreet, a small electronic DCM, expressed similar views.\86\ The
Commission sees no rational basis for the proposition that size
insulates a DCM from conflicts of interest. The potential impact
arising from an improperly managed conflict may well be less at a
smaller DCM than at a large one. The magnitude of potential harm is not
the appropriate standard for taking prophylactic measures. What matters
is whether the means proposed will impact small DCMs
disproportionately. Neither KCBT, NYBOT, nor HedgeStreet have
identified a disproportionate burden. Nor have they shown how their
status as non-public DCMs immunizes them from conflicts. As the
Commission made clear in proposing the acceptable practices, DCMs that
become public, stockholder-owned corporations face an additional, new
layer of conflict. Conflicts are inherent in other forms of ownership
as well. Such conflicts may be minimized at all sizes and forms of DCMs
by an increase in the percentage of public directors.
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\85\ KCBT at CL 8 at 2; NYBOT CL at 4. NYBOT has informed the
Commission of its intent to be acquired by ICE and run as a for-
profit subsidiary. Accordingly, its comment has little relevance to
its own contemplated future circumstances.
\86\ See HedgeStreet CL 17.
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If any DCM faces a particular burden peculiar to its individual
circumstances in complying with the acceptable practices, that DCM may,
as a matter of statute, choose an alternative method of complying with
Core Principle 15 that is responsive to its circumstances. However,
such DCM must still demonstrate, to the Commission's satisfaction, that
its alternative method effectively addresses conflicts of interest in
decision making under Core Principle 15, including structural conflicts
of interest.
DCM commenters asserted that complying with the Board Composition
Acceptable Practice will be an expensive undertaking requiring
amendment of corporate charters and other documents, and that the
Commission gave too little consideration to these costs. For example,
NYMEX states:
The process of preparing * * * bylaw changes requires a
commitment of time both by in-house exchange staff as well as by
specialized legal advisors. This process can be fairly time-
intensive with regard to review by such professionals of various
drafts of amendments and other material for shareholders in relation
to the successive SEC filings. There are the obvious costs generated
by numerous runs by the applicable print shop specializing in SEC
filing productions as well as the not inconsiderable costs of
overnight shipping of the shareholder materials to hundreds if not
thousands of shareholders of record.\87\ >
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\87\ NYMEX CL at 20 n.32.
Arguments such as these are not persuasive. NYMEX describes a
process, and asserts that it entails a cost, but fails even to estimate
that cost, or to place the cost in any kind of context that would allow
the Commission to judge the level of burden. Other comments alleging
burdensome costs are similarly flawed. The Commission has no basis to
conclude that compliance is other than a reasonable cost of doing
business in an industry subject to federal oversight. Moreover, the
costs may be phased in over a period of time. In this final release,
although the acceptable practices will be effective immediately, the
Commission is adopting a phase-in period of two years or two board
election cycles, whichever occurs first.
The DCMs' contentions that any level of compliance is burdensome
because they already are subject to other governance regimes miss the
mark. CME, CBOT, and NYMEX essentially contended that the governance
provisions of the Delaware General Corporation Law under which they are
organized, and the NYSE Listing Standards, contain sufficient
provisions to assure sound governance.\88\ The
[[Page 6956]]
member-owned DCMs, NYBOT, KCBT, and their supporters, state that the
diversity standards of Core Principle 16 provide an adequate bulwark
against conflicts of interest, and that the membership presence on
their boards will be diluted if a large contingent of public directors
is admitted.\89\ These arguments overlook the overarching purpose of
the Board Composition Acceptable Practice, which is expressly to
minimize conflicts of interest by addressing the keystone of all
corporate decision making--the board of directors.
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\88\ CME CL 29 at 14; CBOT CL 21 at 6-7; NYMEX CL 28 at 5-6, 15.
\89\ NYBOT CL 22 at 3-4; KCBT CL 8 at 1-2; for their supporters,
see, e.g., comment of Michael Braude, CL 10 at 1.
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CME stated that the responsibility imposed on public directors to
act in the public interest actually conflicts with the duty owed to
shareholders under Delaware corporate law and the NYSE Listing
Standards.\90\ The Commission's review of corporate law authority
reveals no such conflict. These proposals are entirely consistent with
bedrock corporate law principles: as Delaware corporations, they are
run "by or under the Board of Directors." \91\ Directors act as
fiduciaries of stockholders, to be sure, but that does not mean the
performance of their duties is limited to serving the narrow interests
of stockholders. Those affairs include complying with the various
statutes to which the corporation is subject. Shareholders are well-
served or ill-served by the quality of the directors' discharge of
their statutory duties.
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\90\ CME CL 29 at 8.
\91\ Del. Code Ann. tit. 8, Sec. 141(a).
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Corporate law experts generally agree that outside directors
benefit corporate governance generally. "[M]ost persons in academia
and business agree that outside directors play an important role in the
effective functioning of the board." \92\ The suggestion of some
commenters that public directors have an inherent conflict between the
public interest and their duty to shareholders is misplaced. The
acceptable practices address DCM governing boards, not the boards of
parent public holding companies. DCMs--and their governing bodies--are
vested with a public interest duty under the plain text of the CEA.
Moreover, the public interest duty applies to nonpublic as well as
public directors. The Commission is aware of overlapping board
memberships--i.e., that the members of a DCM governing board may be the
same individuals as those who serve on the parent board. This is
entirely permissible. When an individuals sits, deliberates and acts in
respect of the governance of the registered entity, he or she must do
so consistently with the public interest mandate of the CEA.
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\92\ D. Pease, "Outside Directors: Their Importance to the
Corporation and Protection from Liability," 12 Del. J. Corp. L. 25,
31 et seq. (1987) (citing extensive authority and noting the legal
advantages of outside directors).
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A number of commenters who wrote in support of KCBT and NYBOT
assumed that public directors will lack interest and experience, and
add little to board deliberations.\93\ These commenters, however,
offered no empirical evidence to support their speculation. The
Commission notes that many DCM boards already include public directors
who have been deemed qualified and competent by the DCMs. As discussed
previously, the boards of exchanges such as the KCBT, MGEX, NYMEX,
NYBOT, and CME, are typically 20% or more non-member. Moreover, the
acceptable practices do not preclude non-member producers, retired and
former industry persons, academics, and others from being considered
public directors, which should provide a significant pool of futures
industry experience from which to draw. DCMs that fear adding public
directors will expand their boards to an unwieldy size may comply with
the acceptable practices by phasing in public directors into existing
seats.
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\93\ See, e.g., Comment of Dennis M. Erwin, CL 18 at 1; Comment
of John Legg, CL 14 at 1; and Comment of Robert J. Rixey, CL 11 at
1.
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One commenter contended that in prior cost-benefit analyses, the
Commission has addressed each of the five considerations under Section
15(a) separately, and that this approach would have facilitated public
comment.\94\ However, the Commission has not always addressed each
consideration separately in its rulemakings, nor is it required by the
statute to do so. Section 15(a) requires that costs and benefits be
evaluated in terms of the five considerations, but the Commission may
give greater weight to any one of them. The cost-benefit analysis in
the proposed acceptable practices provided sufficient notice to the
public regarding the considerations to which the Commission accorded
the greatest weight. The same commenter asserted that the Commission
should endeavor to apply the relevant factors separately to each major
proposal.\95\ Again, however, the statute does not require that the
Commission apply the factors in this fashion, but allows it to consider
the costs and benefits in light of the impact of its proposal as a
whole. Finally, the commenter encouraged the Commission to consider
regulatory alternatives in its cost-benefit analysis.\96\ As noted
above, however, the only alternative suggested by the commenters was
that the Commission do nothing. They suggested no other alternative
that would address the concerns cited by the Commission in proposing
the acceptable practices. In the Commission's judgment, these
acceptable practices serve to protect the public interest in a manner
that minimizes the costs to the industry while demonstrating compliance
with Core Principle 15.
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\94\ NYMEX CL 32 at 20.
\95\ Id.
\96\ Id.
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As was discussed in the proposing release, the acceptable practices
described herein are safe harbors for compliance with Core Principle
15's conflict of interest provisions. They offer DCMs the opportunity
to meet the requirements of Core Principle 15 through a regulatory
governance structure that insulates their regulatory functions from
their commercial interests. The Board Composition Acceptable Practice
provides that DCMs implement boards of directors and executive
committees thereof that are at least 35% public. The ROC Acceptable
Practice further provides that all DCMs place oversight of core
regulatory functions in the hands of board-level ROCs composed
exclusively of "public" directors. The Public Director Acceptable
Practice offers guidance on what constitutes a "public" director. In
addition, the Disciplinary Panel Acceptable Practice suggests minimum
composition standards for DCM disciplinary committees. As noted above,
although the acceptable practices will be effective immediately, the
Commission is allowing a phase-in period for DCMs to implement them.
The proposed acceptable practices are consistent with legislative
and regulatory requirements, and voluntarily undertaken changes in
governance practices in other financial sectors, such as the securities
markets, and are intended to enhance protection of the public. The
Commission has endeavored to establish the least intrusive safe harbors
and regulatory requirements that reasonably can be expected to meet the
requirements of Core Principle 15 of the CEA. 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
[[Page 6957]]
rule changes and certifying them to the Commission, and appointing a
Chief Regulatory Officer. In light of the reduction of the percentage
of public board members from 50% in the Board Composition Acceptable
Practice as proposed to at least 35%, and the phase-in period, the
Commission believes that these costs will not impose a significant
burden and can be borne over time. After considering the costs and
benefits of the acceptable practices, and considering the comments
received in response to its proposal, the Commission has determined to
issue the acceptable practices for Core Principle 15 with respect to
DCMs.
B. 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
and the acceptable practices to the Office of Management and Budget
("OMB") for its review.
The revision of collection of information has been reviewed and
approved by the Office of Management and Budget pursuant to the
Paperwork Reduction Act, under control number 3038-0052. An agency may
not conduct or sponsor, and a person is not required to respond to, a
collection of information unless it displays a currently valid control
number. In the Notice of Proposed Acceptable Practices, the Commission
estimated the paperwork burden that could be imposed by the acceptable
practices and solicited comment thereon. 71 FR 38740, 38748 (July 7,
2006). No specific or sufficiently material comment was received.
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.
C. 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 final acceptable practices affect
designated contract markets. The Commission has previously determined
that designated contract markets are not small entities for purposes of
the Regulatory Flexibility Act.\97\ Accordingly, the Chairman, on
behalf of the Commission, hereby certifies pursuant to 5 U.S.C. 605(b)
that the final acceptable practices will not have a significant
economic impact on a substantial number of small entities.
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\97\ 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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VI. Text of Acceptable Practices for Core Principle 15
List of Subjects in 17 CFR Part 38
Commodity futures, Reporting and recordkeeping requirements.
0
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 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 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.
0
2. In Appendix B to Part 38 amend Core Principle 15 by adding paragraph
(b) "Acceptable Practices" 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) 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
such 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.
Acceptable Practices for minimizing conflicts of interest shall
include the following elements:
(1) Board Composition for Contract Markets
(i) At least thirty-five percent of the directors on a contract
market's board of directors shall be public directors; and
(ii) The executive committees (or similarly empowered bodies)
shall be at least thirty-five percent public.
(2) Public Director
(i) 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.
(ii) In addition, a director shall not be considered "public"
if any of the following circumstances exist:
(A) The director is an officer or employee of the contract
market or a director, 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 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 person is
"affiliated" with a member if he or she is an officer or director
of the member, or if he or she has any other relationship with the
member such that his or her impartiality could be called into
question in matters concerning the member;
(C) The director, or a firm with which the director is
affiliated, as defined above, receives more than $100,000 in
combined annual payments from the contract market, any affiliate of
the contract market, or from a member or any person or entity
affiliated with a member of the contract market. Compensation for
services as a director 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 parent company if they otherwise
meet the definition of public 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.
(3) Regulatory Oversight Committee
(i) 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 actual and 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.
(ii) The ROC shall:
(A) Monitor the contract market's regulatory program for
sufficiency, effectiveness, and independence;
(B) 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
[[Page 6958]]
compliance with financial integrity, financial reporting, sales
practice, recordkeeping, and other requirements); and the conduct of
investigations;
(C) Review the size and allocation of the regulatory budget and
resources; and the number, hiring and termination, and compensation
of regulatory personnel;
(D) Supervise the contract market's chief regulatory officer,
who will report directly to the ROC;
(E) Prepare 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;
(F) Recommend changes that would ensure fair, vigorous, and
effective regulation; and
(G) 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 in all disciplinary panels at least one person who would
qualify as a public director, as defined in Subsections (2)(ii) and
(2)(iii) above, except in cases limited to decorum, attire, or the
timely submission of accurate records required for clearing or
verifying each day's transactions. 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
Subsections (2)(ii) and (2)(iii) above.
* * * * *
Issued in Washington, DC, on January 31, 2007 by the Commission.
Eileen A. Donovan,
Acting Secretary of the Commission.
[FR Doc. E7-2528 Filed 2-13-07; 8:45 am]
BILLING CODE 6351-01-P
Last Updated: May 9, 2012