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  • [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.

    ---------------------------------------------------------------------------

    \22\ CEA Section 3(a), 7 U.S.C. 5(a).

    \23\ CEA Section 3(b), 7 U.S.C. 5(a).

    ---------------------------------------------------------------------------

    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\

    ---------------------------------------------------------------------------

    \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).

    ---------------------------------------------------------------------------

    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\

    ---------------------------------------------------------------------------

    \27\ FIA Comment Letter ("CL") 7 at 3-4.

    ---------------------------------------------------------------------------

    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\

    ---------------------------------------------------------------------------

    \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.

    ---------------------------------------------------------------------------

    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.

    ---------------------------------------------------------------------------

    \30\ There is no legislative history concerning Core Principle

    16 other than the statutory language itself.

    ---------------------------------------------------------------------------

    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.

    ---------------------------------------------------------------------------

    \31\ See, e.g., KCBT CL 8 at 2 and Roberts & Moran CL 27 at 1-2.

    ---------------------------------------------------------------------------

    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.

    ---------------------------------------------------------------------------

    \32\ NYMEX CL 28 at 6.

    \33\ See Commission Reg. 40.1(h), 17 CFR 40.1(h).

    ---------------------------------------------------------------------------

    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.

    ---------------------------------------------------------------------------

    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.

    ---------------------------------------------------------------------------

    \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.

    ---------------------------------------------------------------------------

    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\

    ---------------------------------------------------------------------------

    \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).

    ---------------------------------------------------------------------------

    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\

    ---------------------------------------------------------------------------

    \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).

    ---------------------------------------------------------------------------

    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.

    ---------------------------------------------------------------------------

    \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.

    ---------------------------------------------------------------------------

    \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.

    ---------------------------------------------------------------------------

    \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\

    ---------------------------------------------------------------------------

    \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.

    ---------------------------------------------------------------------------

    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.

    ---------------------------------------------------------------------------

    \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).

    ---------------------------------------------------------------------------

    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.

    ---------------------------------------------------------------------------

    \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.

    ---------------------------------------------------------------------------

    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\

    ---------------------------------------------------------------------------

    \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)).

    ---------------------------------------------------------------------------

    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.

    ---------------------------------------------------------------------------

    \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.

    ---------------------------------------------------------------------------

    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\

    ---------------------------------------------------------------------------

    \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.

    ---------------------------------------------------------------------------

    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\

    ---------------------------------------------------------------------------

    \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.

    ---------------------------------------------------------------------------

    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\

    ---------------------------------------------------------------------------

    \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.

    ---------------------------------------------------------------------------

    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.

    ---------------------------------------------------------------------------

    \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.

    ---------------------------------------------------------------------------

    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.

    ---------------------------------------------------------------------------

    \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.

    ---------------------------------------------------------------------------

    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\

    ---------------------------------------------------------------------------

    \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.

    ---------------------------------------------------------------------------

    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.

    ---------------------------------------------------------------------------

    \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.

    ---------------------------------------------------------------------------

    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.

    ---------------------------------------------------------------------------

    \73\ The board of directors of the Chicago Board Options

    Exchange, which owns CFE, is 50% public (independent non-member).

    ---------------------------------------------------------------------------

    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.

    ---------------------------------------------------------------------------

    \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).

    ---------------------------------------------------------------------------

    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.

    ---------------------------------------------------------------------------

    \75\ CEA Sec. 3(b), 7 U.S.C. 5(b).

    ---------------------------------------------------------------------------

    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\

    ---------------------------------------------------------------------------

    \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").

    ---------------------------------------------------------------------------

    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\

    ---------------------------------------------------------------------------

    \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.

    ---------------------------------------------------------------------------

    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\

    ---------------------------------------------------------------------------

    \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.

    ---------------------------------------------------------------------------

    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.

    ---------------------------------------------------------------------------

    \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.

    ---------------------------------------------------------------------------

    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.

    ---------------------------------------------------------------------------

    \81\ 7 U.S.C. 19(a).

    ---------------------------------------------------------------------------

    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\

    ---------------------------------------------------------------------------

    \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).

    ---------------------------------------------------------------------------

    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\

    ---------------------------------------------------------------------------

    \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.

    ---------------------------------------------------------------------------

    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.

    ---------------------------------------------------------------------------

    \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.

    ---------------------------------------------------------------------------

    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\ >

    ---------------------------------------------------------------------------

    \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.

    ---------------------------------------------------------------------------

    \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.

    ---------------------------------------------------------------------------

    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.

    ---------------------------------------------------------------------------

    \90\ CME CL 29 at 8.

    \91\ Del. Code Ann. tit. 8, Sec. 141(a).

    ---------------------------------------------------------------------------

    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.

    ---------------------------------------------------------------------------

    \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).

    ---------------------------------------------------------------------------

    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.

    ---------------------------------------------------------------------------

    \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.

    ---------------------------------------------------------------------------

    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.

    ---------------------------------------------------------------------------

    \94\ NYMEX CL 32 at 20.

    \95\ Id.

    \96\ Id.

    ---------------------------------------------------------------------------

    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.

    ---------------------------------------------------------------------------

    \97\ Policy Statement and Establishment of Definitions of

    "Small Entities" for Purposes of the Regulatory Flexibility Act,

    47 FR 18618, 18619 (Apr. 30, 1982).

    ---------------------------------------------------------------------------

    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



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