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e9-9508

  • FR Doc E9-9508[Federal Register: April 27, 2009 (Volume 74, Number 79)]

    [Rules and Regulations]

    [Page 18982-18990]

    From the Federal Register Online via GPO Access [wais.access.gpo.gov]

    [DOCID:fr27ap09-4]

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    COMMODITY FUTURES TRADING COMMISSION

    17 CFR Part 38

    RIN 3038-AC28

    Conflicts of Interest in Self-Regulation and Self-Regulatory

    Organizations

    AGENCY: Commodity Futures Trading Commission (``Commission'').

    ACTION: Final rule.

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    SUMMARY: The Commission hereby adopts its final definition of ``public

    director'' for the acceptable practices to Section 5(d)(15) (``Core

    Principle 15'') of the Commodity Exchange Act (``CEA'' or ``Act'').\1\

    In addition, the Commission is lifting the stay it had previously

    placed on these acceptable practices. All designated contract markets

    (``DCMs'') must demonstrate full compliance with Core Principle 15, via

    the acceptable practices or otherwise, within one year of this

    document's publication in the Federal Register. The acceptable

    practices and their procedural history

    [[Page 18983]]

    are summarized below, as is the final definition of public director.

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    \1\ The Act is codified at 7 U.S.C. 1 et seq. (2000). The

    acceptable practices for the DCM core principles reside in Appendix

    B to Part 38 of the Commission's Regulations, 17 CFR Part 38, App.

    B. Core Principle 15 states: ``CONFLICTS OF INTEREST--The board of

    trade shall establish and enforce rules to minimize conflicts of

    interest in the decision making process of the contract market and

    establish a process for resolving such conflicts of interest.'' CEA

    Section 5(d)(15). 7 U.S.C. 7(d)(15).

    DATES: Effective date: The stay is lifted on paragraph (b) of Core

    Principle 15 in Appendix B to 17 CFR Part 38 effective May 27, 2009.

    The amendments to the acceptable practices in appendix B to part 38 are

    effective May 27, 2009. Compliance date: All DCMs must demonstrate full

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    compliance with Core Principle 15 by April 27, 2010.

    FOR FURTHER INFORMATION CONTACT: Rachel F. Berdansky, Deputy Director

    for Market Compliance, 202-418-5429, or Sebastian Pujol Schott, Special

    Counsel, 202-418-5641, Division of Market Oversight, Commodity Futures

    Trading Commission, Three Lafayette Centre, 1155 21st Street,

    Washington, DC 20581.

    SUPPLEMENTARY INFORMATION:

    I. Background

    A. Summary of the Acceptable Practices

    As noted above, the Commission hereby adopts its final definition

    of public director and lifts its stay on the acceptable practices for

    Core Principle 15.\2\ These important acceptable practices consist of

    four interrelated provisions, including three operating provisions

    (sections (1), (3), and (4)) and one which provides necessary

    definitions (section (2)). The operating provisions pertain to DCM

    boards of directors, the insulation and oversight of self-regulatory

    functions through regulatory oversight committees (``ROCs''), and the

    composition of disciplinary panels. More specifically, section (1)

    requires that a DCM's board and any executive committee of the board be

    composed of at least 35% public directors. Section (3) requires that a

    DCM's regulatory programs fall under the authority of a board-level ROC

    consisting exclusively of public directors. Section (4) requires that a

    DCM's disciplinary panels include at least one public person. To fully

    implement the acceptable practices, DCMs must enact all three sections.

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    \2\ As explained in the procedural history below, the Commission

    stayed the entire acceptable practices for Core Principle 15 in

    November of 2007. See Section B (``Procedural History of the

    Acceptable Practices and the Definition of Public Director'').

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    Sections (1), (3), and (4) of the acceptable practices are each

    dependent on the presence of one or more ``public'' persons, either

    public directors serving on the board, public directors serving on the

    ROC, or public members serving on disciplinary panels. Thus, the

    acceptable practices include an important fourth provision--section

    (2)--that defines ``public director'' and also impacts disciplinary

    panel members. The definition of public director includes several

    subsections. The first and most important, subsection (2)(i), is an

    overarching materiality test which requires that a public director

    ``have no material relationship with the contract market.'' The

    definition also includes a series of bright-line tests in subsections

    (2)(ii)(A)-(2)(ii)(D), with specific relationships defined as per se

    material. Finally, subsections (2)(iii), (2)(iv) and (2)(v) pertain to

    a one-year look back period, affiliate relationships, and disclosure

    requirement, respectively.\3\

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    \3\ While not required under these acceptable practices, the

    Commission believes that DCMs benefit from endeavoring to recruit

    their public directors from a broad and culturally diverse pool of

    qualified candidates.

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    Given the acceptable practices' long procedural history, outlined

    below, industry participants may benefit from a brief review of their

    underlying rationale, purpose, and importance. Above all, the

    Commission emphasizes its full commitment to Core Principle 15's

    acceptable practices in their entirety. As the Commission noted when it

    adopted them, the acceptable practices ``recognize DCMs' unique public

    interest responsibilities as self-regulatory organizations (``SROs'')

    in the U.S. futures industry.'' \4\ They remind all DCMs that they

    ``bear special responsibility to regulate effectively, impartially, and

    with due consideration of the public interest.'' \5\ They also clearly

    enumerate certain conflicts of interest for which DCMs must be alert.

    To comply with Core Principle 15, all DCMs must be ``particularly

    vigilant'' for ``conflicts between and among any of their self-

    regulatory responsibilities, their commercial interests, and the

    several interests of their management, members, owners, customers and

    market participants, other industry participants, and other

    constituencies.'' \6\

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    \4\ 72 FR 6936 at 6937 (February 14, 2007).

    \5\ 17 CFR Part 38, App. B, Core Principle 15 (Acceptable

    Practices).

    \6\ Id.

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    When the Commission adopted the acceptable practices on January 31,

    2007, it noted new structural conflicts of interest in self-regulation

    as for-profit DCMs operate in a competitive, global environment. The

    Commission expressed concern with the presence of potentially

    conflicting demands--regulatory responsibility vs. commercial

    imperatives--within a single for-profit entity. It concluded that such

    conflicts, arising from new business models, new ownership structures,

    and increased competition, could be addressed through ``reforms within

    the DCMs themselves, including reforms of DCMs' governing bodies.'' \7\

    The acceptable practices reflect both concrete measures that DCMs may

    implement and principles of modern self-regulation based on public

    representation and the insulation of regulatory functions. They embody

    the Commission's settled position that ``additional public directors on

    governing bodies, greater independence at key levels of decision

    making, and careful insulation of regulatory functions and personnel

    from commercial pressures are important elements in ensuring vigorous,

    effective, and impartial self-regulation now and in the future.'' \8\

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    \7\ 72 FR at 6937.

    \8\ Id.

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    One principle embodied in the acceptable practices is the inclusion

    of public persons on DCM boards, executive committees, and disciplinary

    panels. Subsection (1)(i) of the acceptable practices requires that at

    least 35% of a DCM's directors be public directors, with an identical

    minimum ratio of public directors required for executive committees of

    the board or similarly empowered bodies under subsection (1)(ii). As

    the Commission explained when adopting the acceptable practices, it

    ``strongly believes that DCMs are best able to meet their statutory

    obligations if their boards and executive committees include a

    sufficient number of public directors. * * * Such boards and committees

    will gain an independent perspective that is best provided by directors

    with no current industry ties or other relationships which may pose a

    conflict of interest.'' \9\ The principle of public representation is

    also present in section (4) of the acceptable practices, which requires

    at least one public person on all disciplinary panels.\10\

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    \9\ 72 FR at 6947.

    \10\ A public person is not required for cases limited to

    decorum, attire, or the timely submission of accurate records

    required for clearing or verifying each day's transactions.

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    A second principle embodied in the acceptable practices is the ROC

    required under subsections (3)(i) and (3)(ii). ROCs are tasked with

    overseeing DCM regulatory programs, including monitoring those programs

    for sufficiency, effectiveness, and independence. Their

    responsibilities also include reviewing the size and allocation of

    DCMs' regulatory budgets and resources; reviewing the number, hiring,

    termination, and compensation of regulatory personnel; and supervising

    DCMs' chief regulatory officers, who should report directly to their

    ROCs. As described by the Commission, ``properly

    [[Page 18984]]

    functioning ROCs should be robust oversight bodies * * *.'' \11\ They

    should also ``represent the interests and needs of regulatory officers

    and staff; the resource needs of regulatory functions; and the

    independence of regulatory decisions.'' \12\ ROCs should consist

    exclusively of public directors. ``[A]nything less invites into

    regulatory oversight operations precisely those directors whose

    industry affiliations lend themselves to conflicts of interest in

    decision making.'' \13\

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    \11\ 72 FR at 6950.

    \12\ Id. at 6950-6951.

    \13\ Id. at 6951.

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    The three operating provisions described above--board composition,

    disciplinary panel composition, and ROC--are all dependent upon the

    definition of public director in section (2). Now, as that definition

    is finalized and the stay on the acceptable practices is lifted, all

    industry participants should be aware that the Commission's highest

    goal for self-regulation remains unchanged: Self-regulation must be

    vigorous, effective, and impartial. DCMs, in particular, are reminded

    that although they are free to comply with Core Principle 15 by means

    other than the acceptable practices, they must address the specific

    conflicts of interest that the Commission has identified and adopt

    measures that are substantive and responsive.

    B. Procedural History of the Acceptable Practices and the Definition of

    Public Director

    On January 31, 2007, the Commission adopted its first acceptable

    practices for Core Principle 15, which requires all DCMs to minimize

    conflicts of interest in their decision making process. The acceptable

    practices focus on conflicts between DCMs' regulatory responsibilities

    and their commercial interests, and they offer all DCMs a safe harbor

    by which they may demonstrate core principle compliance. The acceptable

    practices for Core Principle 15 contain four provisions, including

    three ``operating'' provisions and one provision which primarily

    defines public director. All four provisions were published in the

    Federal Register on February 14, 2007.\14\ Existing DCMs were given a

    two-year phase-in period to implement the acceptable practices or

    otherwise demonstrate full compliance with Core Principle 15.

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    \14\ 72 FR 6936 (February 14, 2007).

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    On March 26, 2007, the Commission published the ``2007 proposed

    amendments,'' which made certain clarifications and other changes to

    the definition of public director.\15\ The proposed amendments did not

    alter the acceptable practices in any other respect. In proposing the

    amendments, the Commission emphasized that they should not be read as a

    diminution of the public representation, conflict-of-interest

    mitigation, and self-regulatory insulation intended by the acceptable

    practices. To that end, all three operating provisions in the

    acceptable practices remained as originally adopted.

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    \15\ 72 FR 14051 (March 26, 2007). In addition to the clarifying

    amendments, the Commission also proposed to correct a technical

    drafting error.

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    The Commission received six comment letters in response to the 2007

    proposed amendments, but after careful consideration determined not to

    act upon them.\16\ Instead, on November 23, 2007, the Commission gave

    notice via the Federal Register that the acceptable practices for Core

    Principle 15 were stayed indefinitely and in their entirety.\17\

    Likewise, the two-year compliance period for existing DCMs also was

    stayed. With the definition of public director in flux, the Commission

    concluded that a stay was an appropriate measure while it arrived at a

    final definition of public director.

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    \16\ The six comment letters are summarized in 74 FR 3475

    (January 21, 2009).

    \17\ 72 FR 65658 (November 23, 2007).

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    Finally, on January 21, 2009, the Commission proposed and sought

    public comment on the ``2009 amendments,'' which also apply only to the

    definition of public director, and which are adopted herein.\18\ In

    publishing the 2009 amendments, the Commission asserted its continued

    commitment to ``the fundamental philosophy underpinning the acceptable

    practices for Core Principle 15: that potential conflicts of interest

    in self-regulation by for-profit and publicly-traded DCMs * * * can be

    addressed successfully through appropriate measures embedded in DCMs'

    governance structures.'' \19\ The Commission also reaffirmed ``its

    support for public representation on DCM boards of directors and

    disciplinary panels, including the 35% public board standard first

    enunciated in the acceptable practices,'' and its ``strong commitment

    to ROCs, consisting exclusively of public directors, to oversee all

    facets of DCMs' self-regulatory programs and staff.'' \20\ The 2009

    amendments and public comments thereon are summarized below. As stated

    previously, the Commission is adopting the 2009 amendments in their

    entirety.

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    \18\ 74 FR 3475.

    \19\ 74 FR at 3476-3477.

    \20\ Id. at 3477.

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    C. Summary of the 2009 Amendments

    The 2009 amendments fall into four broad categories, all of which

    pertain to section (2) of the acceptable practices--the definition of

    public director. First, the Commission has amended subsection (2)(ii)

    to make its vocabulary more consistent with that in subsection (2)(i),

    but without altering its meaning. As originally adopted, the provision

    stated that ``* * * a director shall not be considered public if [the

    bright-line tests are not met].'' Now, subsection (2)(ii) reads ``* * *

    a director shall be considered to have a `material relationship' with

    the contract market if [the bright-line tests are not met].'' Because

    the overarching material relationship test in subsection (2)(i)

    precludes a person with a material relationship from serving as a

    public director, the purpose and effect of the provision remains

    unchanged.

    Second, the Commission has amended subsections (2)(ii)(A) and

    (2)(iv) to save a DCM's public directors from bright-line tests that

    they would have failed if they also served as directors of the DCM's

    affiliates. For this purpose, ``affiliate'' is now defined in

    subsection (2)(ii)(A) to include ``parents or subsidiaries of the

    contract market or entities that share a common parent with the

    contract market'' (``sister companies''). Previously, a DCM's public

    directors could also serve as directors of its parent company, but not

    as directors of its subsidiary or sister companies. With this

    amendment, the latter two relationships no longer suffer automatic

    exclusion.

    Third, the Commission has amended subsection (2)(ii)(B). As

    originally adopted, this subsection precluded DCM members, employees of

    members, and persons affiliated with members from service as public

    directors. ``[A]ffiliated with a member'' was defined as being an

    officer or director of a member, or having ``any other relationship

    with the member such that his or her impartiality could be called into

    question in matters concerning the member.'' Under that original text,

    subsection (2)(ii)(B) effectively inserted another material

    relationship determination in what was an otherwise bright-line test.

    Now, the Commission has streamlined subsection (2)(ii)(B) in three

    ways. First, any material relationship determination made pursuant to

    section (2) takes place under the overarching material relationship

    test of subsection (2)(i), and not under the bright-line tests of

    subsection (2)(ii). Second, subsection

    [[Page 18985]]

    (2)(ii)(B) sets forth the exact membership relationships that are

    automatically precluded. Finally, the subsection allows a DCM to

    conduct a material relationship analysis to determine whether

    employment by a member should preclude a specific individual from

    serving as a public director.

    Finally, the Commission has amended subsection (2)(ii)(C) and its

    bright-line tests. Here again, the Commission has simplified the

    provision to ensure that the bright-line tests are clearly articulated.

    As originally adopted, subsection (2)(ii)(C) created a $100,000

    combined annual payments test for potential public directors and the

    firms with which they may be affiliated (``payment recipients''). A

    particular payment's relevance to the $100,000 bright-line test depends

    upon the source (``payment provider'') and nature of the payment. In

    this regard, the subsection did not specify which payments should count

    towards the $100,000 annual cap--all payments or only those for certain

    types of services. In addition, the subsection also contained potential

    ambiguity with respect to the universe of potential payment providers

    and payment recipients.

    The first amendment to subsection (2)(ii)(C) defines the nature of

    ``payment,'' specifying that it is payment for ``legal, accounting, or

    consulting services.'' The second amendment clarifies that the relevant

    payment recipients include the potential public director and any firm

    in which the director is an officer, partner, or director (``direct''

    and ``indirect'' compensation, respectively). The third amendment to

    subsection (2)(ii)(C) clarifies that the relevant payment providers

    include the DCM and any parent, sister, or subsidiary company of the

    DCM. Notably, the new payment providers provision no longer captures

    DCM members or persons or entities affiliated with members, although

    such relationships should still be scrutinized carefully under the

    overarching materiality test of subsection (2)(i). Finally, the

    Commission has amended subsection (2)(ii)(C) to take into account

    payments to a public director in excess of $100,000 by sister and

    subsidiary companies of the DCM. This is consistent with the

    Commission's intent, previously articulated, not to automatically

    prohibit overlapping public directors between DCMs and their

    affiliates.

    D. The 2009 Amendments and the Material Relationship Test

    As described above, the 2009 amendments touch only on the bright-

    line tests for public director. The most important element of the

    definition--the overarching ``material relationship'' test in

    subsection (2)(i)--remains unchanged. As before, ``[t]o qualify as a

    public director of a contract market, an individual must first be

    found, by the board of directors, on the record, to have no material

    relationship with the contract market.'' And, as before, ``[a] material

    relationship is one that reasonably could affect the independent

    judgment or decision making of the director.''

    The practical consequence of the amended bright-line tests is that

    formerly disqualifying bright-line relationships must now be analyzed

    under the material relationship test recited above. However, DCMs

    should be aware that shifting the point of analysis in no way

    diminishes the importance of the relationships under review, nor does

    it mean that a formerly disqualifying relationship is now generally

    permissible. Instead, the amended bright-line tests make it incumbent

    upon DCMs to carefully evaluate the facts to determine whether a

    potential public director's relationships could reasonably affect his

    or her independent judgment or decision making as a director of a DCM.

    The Commission will carefully review those determinations in evaluating

    DCMs' compliance with Core Principle 15.

    Finally, while reemphasizing the importance of the material

    relationship test in the definition of public director, the Commission

    also notes its continued commitment to specific bright-line tests for

    director-DCM relationships that are clearly material. Accordingly, the

    2009 amendments to the bright-line tests retain most of the original

    tests' substantive content. As with the original bright-lines, those

    adopted herein touch on a potential public director's (A) Employment

    relationships with the contract market; (B) direct and indirect

    membership relationships with the contract market; (C) direct and

    indirect compensation relationships with the contract market; and (D)

    familial relationships with the contract market. The one-year look back

    period also remains intact, as does the requirement that a DCM disclose

    to the Commission those members of its board that are public directors

    and the basis for those determinations. Commission staff will also

    closely scrutinize the implementation of the material relationship and

    bright-line tests when conducting future reviews of DCM governance.

    E. Public Comments on the 2009 Amendments

    Before summarizing and responding to individual comment letters,

    the Commission wishes to address a recurring theme in the comments made

    by DCMs throughout the development of these bright-line tests for

    public director. DCMs have regularly argued that the tests will exclude

    otherwise desirable candidates from serving on their boards, or that it

    will be too difficult to determine with certainty whether an individual

    qualifies as a public director under the acceptable practices. The

    Commission has been responsive to DCMs' concerns, even proposing

    alternative bright-line tests on two occasions after the acceptable

    practices were adopted. However, after these efforts, some DCMs

    continue to repeat this same criticism, including in their comments on

    the 2009 amendments.

    The Commission is confident that the definition of public director

    adopted herein can be used effectively by all DCMs. Armed with this

    streamlined definition, DCMs should be able to implement the acceptable

    practices fully and easily. Moreover, if for some reason it is unclear

    whether a person qualifies as a public director, a solution is readily

    available: He or she is free to serve as a non-public director. Under

    the acceptable practices, almost two-thirds of a DCM's board is filled

    at its discretion, subject to the fitness requirements of Core

    Principle 14. Thus, if a DCM believes that an individual adds

    exceptional value, it is free to install him or her as a non-public

    director. Furthermore, with respect to the 35% of directors who must be

    public under the acceptable practices, the difficulties alleged by DCMs

    might arise only if they attempt to seat directors who are too close to

    the DCM or to the futures industry, rather than authentically public

    persons.

    The Commission has previously stated that ``the most significant

    contribution made by public directors * * * is precisely their outside,

    non-industry perspective.'' \21\ Directors who are truly unrelated to

    the futures industry and its participants should have little difficulty

    qualifying as public directors, and DCMs should have little difficulty

    in implementing the acceptable practices if they avoid public director

    candidates who are in the professional or personal orbit of the futures

    industry.

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    \21\ 72 FR at 6949.

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    [[Page 18986]]

    1. Specific Comments Received and the Commission's Response

    The Commission received five comment letters in response to the

    2009 amendments, including comments from ICE Futures U.S., Inc. (``ICE

    Futures''), the Futures Industry Association (``FIA''), CBOE Futures

    Exchange, LLC (``CFE''), CME Group, Inc. (``CME Group''), and the

    Kansas City Board of Trade (``KCBT'').\22\ Commission staff reviewed

    all five letters carefully. Most were generally supportive of the

    proposed amendments, while also suggesting further changes. The five

    letters and the Commission's responses thereto are summarized below.

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    \22\ As explained below, CME Group is the parent company of four

    DCMs: the Chicago Board of Trade, the Chicago Mercantile Exchange,

    the Commodity Exchange, and the New York Mercantile Exchange.

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    a. CBOE Futures Exchange, LLC.

    CFE's comment letter reiterates the exchange's belief that the

    acceptable practices will have a ``positive impact'' with respect to

    futures exchange governance and minimizing conflicts of interest, and

    that they ``will serve to enhance the self-regulatory process.'' \23\

    The comment letter also summarizes the 2009 amendments and affirms the

    exchange's agreement with most of them. CFE states that it supports

    those amendments that ``clarify (i) The types of payments that would

    disqualify a person from serving as a public director,\24\ (ii) that a

    person who serves as a director of a futures exchange affiliate is not

    disqualified from serving as a public director of the futures exchange

    if the person otherwise qualifies to serve in that capacity, and (iii)

    that receipt of director compensation from a futures exchange affiliate

    does not disqualify the recipient from serving as a public director of

    the futures exchange if the person otherwise qualifies to serve in that

    capacity.'' \25\

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    \23\ CFE comment letter (``CL'') at 1.

    \24\ While ICE Futures and CME Group also support the amendments

    pertaining to payment for services rendered, CFE's support is

    offered in a very specific context, as explained below.

    \25\ CFE CL at 1.

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    While generally supportive of the 2009 amendments, CFE's comment

    letter also raises certain concerns, both from the exchange's

    perspective and from the Commission's. First, CFE declares its

    opposition to an amendment in subsection (2)(ii)(B) removing employees

    of DCM member firms from automatic disqualification. In addition, the

    exchange offers certain interpretations with respect to the potential

    adverse impact of this amendment. Second, CFE states its support for

    the amendments to subsection (2)(ii)(C) (pertaining to a bright-line

    test for payment for services rendered). Here again, CFE offers its own

    interpretation as to what the subsection now permits. The Commission

    believes that both of CFE's comments and interpretations merit further

    discussion. They are treated below, in order.

    CFE disagrees ``with the elimination by the CFTC's proposal of the

    previous disqualification of an employee of a member of a futures

    exchange from serving as a public director of that futures exchange.''

    \26\ This comment refers to amended subsection (2)(ii)(B), which no

    longer subjects a DCM member's employees to automatic disqualification

    from service as a public director (unless they are officers or

    directors). CFE observes, accurately, that ``the CFTC has stated that

    one of the primary objectives of the Acceptable Practices is to

    insulate the regulatory functions of a futures exchange via public

    directors who are not conflicted by industry ties * * *.'' \27\ The

    exchange argues that ``permitting a member employee to serve as a

    futures exchange public director, and allowing the possibility that all

    35% of the public directors of a futures exchange could be member

    employees, is inconsistent with that goal * * *.'' \28\

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    \26\ Id.

    \27\ CFE CL at 2.

    \28\ Id.

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    The Commission agrees with CFE's overall sentiment, and although it

    stands by the amendments to subsection (2)(ii)(B), it is vital that no

    DCM misinterpret them. The Commission is concerned with any suggestion

    that the acceptable practices now allow a DCM's public directors to

    consist exclusively of members' employees. While the Commission is not

    prejudging any potential relationship that might be presented to it in

    the future, it is difficult to imagine that employees of member firms

    will routinely pass the material relationship test of subsection

    (2)(i).

    DCMs are reminded that all director relationships, including

    employment, remain subject to the acceptable practices' overarching

    material relationship test. They should also be aware that the removal

    of a relationship from the bright-line tests does not mean that such

    relationship is now always permitted. Indeed, in the example offered by

    CFE, the Commission agrees that a board whose public directors are all

    employees of member firms is inconsistent with the intent of the

    acceptable practices. In that regard, the Commission emphasizes the

    language with which it proposed to amend subsection (2)(ii)(B), stating

    ``the amendments merely shift the point of analysis from the bright-

    lines of subsection (2)(ii) to the overarching material relationship

    test of subsection (2)(i).'' \29\ The Commission further affirmed--and

    this is of special importance with respect to member employees--that it

    ``remains concerned about any relationship between potential public

    directors and DCM members that could `affect the independent judgment

    or decision making of the director' '' (emphasis added).\30\

    Accordingly, no DCM should interpret the removal of member employment

    from the bright-line tests as an invitation to seat a member's employee

    as a public director without careful consideration. Any finding that a

    member's employee qualifies as public will require full disclosure and

    explanation under subsection (2)(v) of the acceptable practices, which

    requires DCMs to disclose to the Commission the basis for any

    determination that a director qualifies as public.

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    \29\ 74 FR at 3478.

    \30\ Id.

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    CFE's second comment and interpretation relates to subsection

    (2)(ii)(C). There, the exchange asserts that the amendments ``make

    clear that a public director of the National Futures Association

    (``NFA'') is not disqualified as serving as a public director of CFE

    because NFA provides regulatory services to CFE * * *.'' \31\ CFE is

    correct that amended subsection (2)(ii)(C) now limits the bright-line

    definition of ``payment'' to payment for legal, accounting, or

    consulting services. Previously, the term was undefined and thus

    potentially broader in scope, to include payment for regulatory

    services to a regulatory service provider (``RSP'') such as NFA.

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    \31\ CFE CL at 1.

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    The Commission cautions, however, that subsection (2)(ii)(C) is

    just one element in a multi-prong test for evaluating whether an

    individual is qualified to serve as a public director. While the

    clarification of subsection (2)(ii)(C) is this instance may leave RSP

    directors outside the scope of one bright-line test, such directors

    remain subject to other elements in the definition of public director.

    Most significant among these is the overarching material relationship

    test of subsection (2)(i). As with other potential relationships, the

    Commission will not prejudge what might be presented to it in the

    future. However, a DCM should move cautiously in any scenario where it

    outsources its regulatory functions to an RSP and seeks to install a

    director of

    [[Page 18987]]

    its RSP as public director on its board, including its ROC. In this

    context, the DCM should recall that ROC members are charged with

    evaluating the quality of regulatory services provided to the DCM.

    Certain questions naturally arise under these circumstances. Would the

    RSP director be able to evaluate the RSP's performance objectively?

    Would he or she be able to impartially counsel the exchange to seek

    regulatory services elsewhere if the RSP, on whose board he/she also

    sits, was underperforming? Even if the RSP director was only being

    considered for service on the board, and not for the ROC, would his or

    her board actions with respect to the RSP be as objective as those of a

    public director with no RSP ties? Questions such as these must be

    addressed fully in any material relationship analysis.

    b. The Futures Industry Association and the Kansas City Board of

    Trade.

    The FIA's comment letter expresses its support for the 2009

    amendments.\32\ Echoing the Commission's own sentiments, the FIA notes

    that ``it is vitally important that DCMs include a significant number

    of Board Members that are recognized to be independent of the DCM and

    its members.'' \33\ FIA also maintains that ``no one could fairly

    contest the Commission's definition of a public director as someone

    with no material relationship with the DCM,'' and that ``the Commission

    has proposed a workable and effective set of automatically

    disqualifying relationships'' for potential public directors.\34\ FIA's

    positive comments are balanced with the observation that it and others

    might ``quibble'' with the 35% standard for public directors on DCM

    boards, and that it might ``recommend expanding the [bright-line tests]

    in some areas or restricting it in others.'' \35\ Overall, however, FIA

    ``urge[s] the Commission to adopt the [2009 amendments] quickly and to

    make its Acceptable Practices effective as soon as practicable.'' \36\

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

    \32\ FIA CL at 1.

    \33\ Id.

    \34\ FIA CL at 1 and 2.

    \35\ Id.

    \36\ FIA CL at 2.

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

    KCBT's brief comment letter notes its ``support for the revised

    public director definition published for comment in connection with the

    SRO governance core principle guidelines.'' \37\ The exchange is

    ``appreciative of the Commission narrowing the applicability of the

    $100,000 in professional services payments to a public director (or the

    firm such public director represents) by a DCM or its affiliates.''

    \38\

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

    \37\ KCBT CL at 1.

    \38\ Id.

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

    c. ICE Futures U.S., Inc.

    ICE Futures' comment letter contains both supportive statements and

    suggestions for further modifications to the 2009 amendments. First,

    the exchange ``commend[s] the decision to free a DCM's public directors

    from bright-line tests that would have been failed if the directors

    also served on the board of the DCM's affiliates.'' \39\ This comment,

    which pertains to ``interlocking directorships'' under subsection

    (2)(iv), was echoed by CFE and CME Group.\40\

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

    \39\ ICE Futures CL at 2.

    \40\ CME Group states, for example, ``[t]he Commission has

    appropriately recognized that an individual may be a director of

    both a DCM and its parent, subsidiary, or entity that shares a

    common parent with the DCM, and not lose his or her status as a

    public director.'' CME CL at 3.

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

    The amendments to subsection (2)(iv) expand the universe of DCM

    affiliates on whose board public directors may serve.\41\ Previously,

    public directors could only serve on the board of a DCM's parent, but

    the 2009 amendments also permit interlocking directorships with a DCM's

    subsidiaries or entities sharing a common parent with the DCM. While

    ICE Futures and others find this amendment helpful, DCMs are reminded

    that as with all other public director relationships, the materiality

    test is still in place. In addition, interlocking public directorships

    are permitted only if the DCM director otherwise meets the definition

    of public director. DCMs should be particularly vigilant for

    circumstances where the interlocking directorship involves an entity

    that could come under the DCM's regulatory authority. An affiliate that

    trades or brokers in the DCM's markets, for example, could pose a

    conflict of interest.

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

    \41\ Subsection (2)(ii)(A) is also relevant, as it defines

    ``affiliate'' as used in subsection (2)(iv).

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

    In addition to the comments summarized above, ICE Futures also

    suggests further amendments to the bright-line tests for public

    director. The exchange's concerns center around subsection (2)(ii)(C),

    which, as amended, defines a bright-line test for potential public

    directors based on direct and indirect compensation in excess of

    $100,000 for legal, accounting, and consulting services rendered. ICE

    Futures argues that, ``[b]ecause this prohibition is so broad, and the

    dollar threshold so low, it needlessly sweeps into its net payments

    that would be considered de minimis by the firm being compensated and

    relationships that might not automatically create a conflict of

    interest.'' \42\

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

    \42\ ICE Futures CL at 2.

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

    It should be noted that ICE Futures' comment seems limited to

    indirect compensation to a public director via the firm with which he

    or she is associated; the exchange's apparent preference is that

    indirect compensation not constitute part of the bright-line tests at

    all. It contends that ``[t]he DCM should be entrusted to evaluate all

    the relevant facts and circumstances * * * and determine whether the

    independent judgment of a public director would be compromised by the

    indirect compensation arrangements.'' \43\

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

    \43\ ICE Futures CL at 3.

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

    If indirect compensation is not removed from the bright-line tests,

    then the exchange argues that the Commission should at least

    ``significantly increase the dollar threshold for indirect

    compensation.'' \44\ ICE Futures offers the listing standards of the

    New York Stock Exchange (``NYSE'') as an ``instructive'' guide in

    establishing what it considers a more appropriate cut-off on payments

    for services rendered.\45\

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

    \44\ Id.

    \45\ While the Commission understands the attraction of adopting

    a single payment cap based on the more widely used listing standards

    of the NYSE, it does not believe that the listing standards are an

    appropriate guide. The Commission continues to think that the

    listing standards serve a distinct purpose--the protection of

    shareholders through boards of directors that are sufficiently

    independent from management. In contrast, the acceptable practices

    for Core Principle 15, including the bright-line tests for public

    director, seek to protect self-regulation through DCM boards of

    directors and other bodies that include a sufficient number of truly

    public persons.

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

    The Commission understands that the $100,000 threshold in

    subsection (2)(ii)(C) is a significant bright-line test, and that

    others might have chosen to draw the line at a higher dollar value or

    as a percentage of revenues. However, it continues to believe that

    $100,000 in combined annual payments is an appropriate cap in

    compensation for a public director or a firm on which he or she serves

    as an officer, director, or partner. The $100,000 cap applies to

    payments from the DCM or any affiliate of the DCM for legal,

    accounting, or consulting services. As the Commission explained when it

    reduced the ratio of public directors required by the acceptable

    practices from 50% (as originally proposed) to 35% (as adopted), ``the

    Commission believes that a strict definition of public director is

    especially necessary now that it will apply to 35% of a DCM's

    directors, rather than the 50% originally

    [[Page 18988]]

    proposed.'' \46\ The Commission also reiterates its previous

    observation that a potential public director who fails one or more

    bright-line tests--the $100,000 payment cap, for example--is free to

    serve as a non-public director if the DCM deems it important.

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

    \46\ 72 FR at 6949.

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

    Finally, the Commission reminds DCMs that other relationships

    involving payment for services rendered--even those not specifically

    listed in subsection (2)(ii)(C)--should be scrutinized closely under

    the material relationship test. Such other relationships could include

    payments from other sources (e.g., a DCM member firm rather than the

    DCM itself); payments based on other relationships (e.g., employee

    rather than director or partner); and payments for lesser amounts

    (e.g., $95,000 to a firm where the DCM director serves as partner and

    to which $95,000 represents significant revenue). In short, DCMs must

    continue to consider the payment provider, the payment recipient, and

    the services provided when making materiality determinations under

    subsection (2)(ii)(C). DCMs also must disclose to the Commission which

    members of its board are public directors, and the basis for those

    determinations.\47\ The Commission expects that all potentially

    material relationships will have been examined carefully.

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

    \47\ Subsection (2)(v) of the acceptable practices.

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

    d. CME Group Inc.

    CME Group is the publicly-traded parent company of four DCMs: the

    Chicago Board of Trade (``CBOT''), the Chicago Mercantile Exchange

    (``CME''), the Commodity Exchange (``COMEX''), and the New York

    Mercantile Exchange (``NYMEX''). Its comment letter includes a brief

    history of the acceptable practices for Core Principle 15 and the

    amendments to the bright-line tests for public director. CME Group

    closes its comment letter by stating, ``[i]n sum, we believe that the

    Commission has substantially improved its proposed definition of public

    director, in connection with the non-exclusive safe harbor acceptable

    practices for compliance with Core Principle 15.'' \48\

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

    \48\ CME Group CL at 4.

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

    Like CFE and ICE Futures, CME Group approves of provisions in the

    2009 amendments that allow for interlocking public directors across a

    DCM, its subsidiaries, and entities sharing a common parent with the

    DCM. CME Group also approves of provisions in the amendments that

    eliminate the bright-line test for employees of DCM member firms.\49\

    Finally, CME Group supports amendments to subsection (2)(ii)(C) with

    respectto direct and indirect payments to directors for services

    rendered. All three amendments have already been discussed above in the

    context of CFE's and ICE Futures' comment letters. As the Commission

    noted there, potential public directors remain subject to the material

    relationship test of subsection (2)(i) in all three circumstances.

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

    \49\ However, as explained previously, employees of DCM members,

    while no longer automatically disqualified from serving as public

    directors, are not automatically permitted to do so either. Instead,

    each one faces a robust and individualized material relationship

    analysis which must be disclosed to the Commission. In this regard,

    the Commission notes that blanket determinations by a DCM that

    particular categories of persons qualify as public directors without

    individual examination is insufficient to satisfy the acceptable

    practices for Core Principle 15.

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

    In addition to the supportive statements summarized above, CME

    Group also requests that the Commission ``consider a further refinement

    [to the bright-line tests] with respect to immediate family members.''

    \50\ Referring to subsection (2)(ii)(D), it argues ``we do not believe

    that an individual should be considered to have a per se material

    relationship with a DCM merely because his immediate family member is a

    director or an officer of a member.'' \51\ The Commission's response is

    similar to that given ICE Futures' request for a more relaxed bright-

    line test for indirect payments for services rendered. Because the

    final acceptable practices require that only 35% of a DCM's directors

    be public, a strict definition of public director is appropriate. In

    this regard, the Commission believes that a close family bond certainly

    could affect the independent judgment or decision making of the

    director and should therefore be precluded automatically. The

    acceptable practices' material relationship test is instructive: the

    Commission is concerned with relationships that ``reasonably could

    affect'' the director; proof of certain effect is not required.

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

    \50\ CME Group CL at 3.

    \51\ Id.

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

    CME Group's comment letter also includes broader legal and policy

    arguments that the Commission has previously addressed at length.

    Nonetheless, they require a brief response here so that no DCM is

    confused as to what is required under Core Principle 15. DCMs should be

    aware that the acceptable practices are voluntary safe harbors which

    they may use to demonstrate compliance with Core Principle 15, and that

    they are free to comply by other means. The Commission will fairly

    evaluate any alternatives presented to it. What DCMs are not free to

    do, however, is to substitute their interpretations of Core Principle

    15 for the Commission's.

    CME Group argues that it ``continues to believe that the board

    composition acceptable practices are not related to Core Principle 15

    and conflict with the clear Congressional intent in the Commodity

    Futures Modernization Act of 2000 (``CFMA'') to impose no composition

    requirements on the boards of publicly owned futures exchanges.'' \52\

    CME Group's beliefs notwithstanding, the Commission has interpreted its

    statutory authority and acted upon it. CME Group's four regulated DCMs

    are required to comply with Core Principle 15, and all the core

    principles, as they are interpreted by the Commission.

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

    \52\ CME Group CL at 2.

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

    To comply with Core Principle 15, DCMs must specifically address

    the conflicts of interest discussed at length during the development of

    these acceptable practices. The Commission has been clear in its

    requirements, and the preamble to the acceptable practices explains

    them as well. As stated in the acceptable practices, ``[all DCMs] bear

    special responsibility to regulate effectively, impartially, and with

    due consideration of the public interest. * * * Under Core Principle

    15, they are also required to minimize conflicts of interest in their

    decision-making process. To comply with this core principle, [DCMs]

    should be particularly vigilant for such conflicts between and among

    their self-regulatory responsibilities, their commercial interests, and

    the several interests of their management, members, owners, customers

    and market participants, and other constituencies.''

    Within these boundaries, DCMs may demonstrate compliance with Core

    Principle 15 as they deem best. The Commission has repeatedly affirmed

    that the acceptable practices are not mandatory. What is mandatory,

    however, is that all DCMs mitigate conflicts of interest in their

    decision making process, including the conflicts that the Commission

    has identified between their commercial interests and their regulatory

    responsibilities.

    Indeed, CME Group's own comment letter expresses the potential

    conflict of interest between regulatory and commercial decision making.

    Referring to commercial interests, CME Group claims, ``[w]e believe

    that each publicly traded DCM has an obligation to its shareholders to

    follow the listing rules

    [[Page 18989]]

    of the relevant securities exchange and to nominate for election as

    directors a mix of individuals based on their ability to create value

    for the corporation.'' \53\ While the Commission acknowledges all DCMs'

    commercial interests, it also reminds them of their regulatory

    responsibilities.

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

    \53\ CME Group CL at 2.

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

    In the case of CME Group, the Commission notes that its subsidiary

    DCMs--CBOT, CME, COMEX, and NYMEX--are not traded on national

    securities exchanges or subject to listing standards. While CME Group

    may be required to comply with certain listing rules and to maximize

    shareholder value, its regulated DCMs have additional statutory and

    regulatory obligations. Above all, regardless of their corporate

    structures, all DCMs must regulate effectively, impartially, and with

    due consideration of the national public interest as provided for in

    the Act.

    The Commission is confident that regulatory and commercial

    interests can be reconciled in effective self-regulation. However,

    continued success depends on all DCMs recognizing the potential for

    conflicts; acknowledging the primacy of regulatory interests; and

    implementing effective solutions to protect self-regulatory functions,

    decisions, and personnel from improper commercial influence and

    considerations. As the Commission stated when it adopted the acceptable

    practices for Core Principle 15, and as it continues to believe now:

    [I]t is crucial for all DCMs and their owners to understand that

    DCMs have two responsibilities: A responsibility to their ownership

    and a responsibility to the public interest as defined in the Act.

    Whereas the [listing standards] serve those with a direct fiduciary

    claim upon a company * * * the new acceptable practices serve the

    public, whose claim upon DCMs is entirely independent of ownership,

    membership, or any other DCM affiliation. In short, through the new

    acceptable practices for Core Principle 15, the Commission seeks to

    ensure adequate representation of a public voice that otherwise is

    not guaranteed any formal standing within a DCM, and which receives

    no effective representation under any regulatory regime other than

    the Commission's.\54\

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

    \54\ 72 FR 6936, 6949.

    II. Related Matters

    A. Cost-Benefit Analysis

    Section 15(a) of the Act requires the Commission to consider the

    costs and benefits of its actions before issuing a new regulation or

    order under the Act.\55\ By its terms, Section 15(a) requires the

    Commission to ``consider the costs and benefits'' of a subject rule or

    order, without requiring it to quantify the costs and benefits of its

    action or to determine whether the benefits of the action outweigh its

    costs. Section 15(a) requires that the costs and benefits of new

    regulations be evaluated in light of five broad areas of market and

    public concern: (1) Protection of market participants and the public;

    (2) efficiency, competitiveness, and financial integrity of futures

    markets; (3) price discovery; (4) sound risk management practices; and

    (5) other public interest considerations. In conducting its analysis,

    the Commission may, in its discretion, give greater weight to any one

    of the five enumerated areas of concerns and may determine that,

    notwithstanding its costs, a particular rule is necessary or

    appropriate to protect the public interest or to effectuate any of the

    provisions or to accomplish any of the purposes of the CEA.\56\

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

    \55\ 7 U.S.C. 19(a).

    \56\ E.g., Fishermen's Dock Co-op., Inc. v. Brown, 75 F.3d 164

    (4th Cir. 1996); Center for Auto Safety v. Peck, 751 F.2d 1336 (D.C.

    Cir. 1985) (agency has discretion to weigh factors in undertaking

    cost benefit analyses).

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

    On February 14, 2007, the Commission published final acceptable

    practices for Core Principle 15 that included prophylactic measures

    designed to minimize conflicts of interest in DCMs' decision making

    processes. The final rulemaking thoroughly considered the costs and

    benefits of the acceptable practices and responded to comments relating

    to the costs of adhering to their requirements.

    The 2009 amendments to the definition of public director bring

    further clarity and finality to the acceptable practices for Core

    Principle 15. The Commission believes that the amendments are fully

    consistent with the design and purpose of the acceptable practices as

    originally conceived. Furthermore, through more consistent,

    streamlined, and precise articulations, the amendments will facilitate

    DCMs' implementation of the acceptable practices and thereby advance

    important public interest considerations with respect to conflicts of

    interest in DCM self-regulation. In particular, the acceptable

    practices offer all DCMs a safe harbor for compliance with Core

    Principle 15, which requires them to ``establish and enforce rules to

    minimize conflicts of interest in the decision making process of the

    contract market * * *.'' \57\ The acceptable practices' safe harbor is

    based on the inclusion of public directors on their boards; the

    creation and empowerment of ROCs consisting exclusively of public

    directors; and the presence of public persons on DCM disciplinary

    panels. Thus, each of these provisions depends heavily on a clear and

    settled definition of public director. The Commission believes that the

    2009 amendments will not impose any additional costs upon DCMs. To the

    contrary, they may reduce the costs of compliance through improvements

    in the bright-line tests for public director, such that the tests truly

    operate as bright-lines and the definition of public director is well-

    settled.

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

    \57\ 7 U.S.C. 7(d)(15).

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

    After considering the above mentioned factors and issues, the

    Commission has determined to adopt these amendments to the acceptable

    practices for Core Principle 15. The Commission received no comments on

    its Section 15(a) analysis of the amendments and hereby adopts them as

    proposed.

    B. Regulatory Flexibility Act

    The Regulatory Flexibility Act, 5 U.S.C. 601 et seq. requires

    federal agencies, in promulgating rules, to consider the impact of

    those rules on small entities. The 2009 amendments affect DCMs, which

    the Commission has previously determined are not small entities for

    purposes of the Regulatory Flexibility Act.\58\ Accordingly, the Acting

    Chairman, on behalf of the Commission, hereby certifies pursuant to 5

    U.S.C. 605(b) that the 2009 amendments will not have a significant

    economic impact on a substantial number of small entities.

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

    \58\ See Policy Statement and Establishment of Definitions of

    ``Small Entities'' for Purposes of the Regulatory Flexibility Act,

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

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

    C. Paperwork Reduction Act of 1995

    The 2009 amendments to the acceptable practices for Core Principle

    15 will not impose any new recordkeeping or information collection

    requirements, or other collections of information that require approval

    of the Office of Management and Budget, under 44 U.S.C. 3501 et seq.

    Additionally, the Commission received no comments on the accuracy of

    the estimate of additional recordkeeping or information collection

    requirements. Accordingly, the Paperwork Reduction Act does not apply.

    III. Text of Amendments

    List of Subjects in 17 CFR Part 38

    Commodity futures, Reporting and recordkeeping requirements.

    In light of the foregoing, and pursuant to the authority in the

    Act, and in

    [[Page 18990]]

    particular, Sections 3, 5, 5c(a) and 8a(5) of the Act, the Commission

    hereby amends Part 38 of Title 17 of the Code of Federal Regulations as

    follows:

    PART 38--DESIGNATED CONTRACT MARKETS

    0

    1. The authority citation for part 38 continues to read as follows:

    Authority: 7 U.S.C. 2, 5, 6, 6c, 7, 7a-2, and 12a, as amended

    by Appendix E of Public Law 106-554, 114 Stat. 2763A-365.

    0

    2. The stay is lifted on paragraph (b) of Core Principle 15 in Appendix

    B to 17 CFR Part 38.

    0

    3. In Appendix B to Part 38 revise paragraphs (b)(2)(ii) through

    (b)(2)(v) of Core Principle 15 to read as follows:

    Appendix B to Part 38--Guidance on, and Acceptable Practices in,

    Compliance With Core Principles

    * * * * *

    Core Principle 15 of section 5(d) of the Act: CONFLICTS OF INTEREST

    * * * * *

    (b) * * *

    (2) * * *

    (ii) In addition, a director shall be considered to have a

    ``material relationship'' with the contract market if any of the

    following circumstances exist:

    (A) The director is an officer or employee of the contract

    market or an officer or employee of its affiliate. In this context,

    ``affiliate'' includes parents or subsidiaries of the contract

    market or entities that share a common parent with the contract

    market;

    (B) The director is a member of the contract market, or an

    officer or director of a member. ``Member'' is defined according to

    Section 1a(24) of the Commodity Exchange Act and Commission

    Regulation 1.3(q);

    (C) The director, or a firm with which the director is an

    officer, director, or partner, receives more than $100,000 in

    combined annual payments from the contract market, or any affiliate

    of the contract market (as defined in Subsection (2)(ii)(A)), for

    legal, accounting, or consulting services. Compensation for services

    as a director of the contract market or as a director of an

    affiliate of the contract market does not count toward the $100,000

    payment limit, nor does deferred compensation for services prior to

    becoming a director, so long as such compensation is in no way

    contingent, conditioned, or revocable;

    (D) Any of the relationships above apply to a member of the

    director's ``immediate family,'' i.e., spouse, parents, children and

    siblings.

    (iii) All of the disqualifying circumstances described in

    Subsection (2)(ii) shall be subject to a one-year look back.

    (iv) A contract market's public directors may also serve as

    directors of the contract market's affiliate (as defined in

    Subsection (2)(ii)(A)) if they otherwise meet the definition of

    public director in this Section (2).

    (v) A contract market shall disclose to the Commission which

    members of its board are public directors, and the basis for those

    determinations.

    * * * * *

    Issued in Washington, DC, on April 21, 2009 by the Commission.

    David A. Stawick,

    Secretary to the Commission.

    [FR Doc. E9-9508 Filed 4-24-09; 8:45 am]

    Last Updated: April 27, 2009



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