MEMORANDUM

TO: The Commission

FROM: Division of Trading and Markets

RE: The New York Mercantile Exchange's Proposed Demutualization Plan

RECOMMENDATION: That the Commission approve the proposed new Certificate of Incorporation for New York Mercantile Exchange, Inc. ("NYMEX, Inc."), the proposed extinguishment of the New York Mercantile Exchange's ("Existing NYMEX") current Articles of Incorporation, proposed new sections to Existing NYMEX's Bylaws, proposed amendments to Existing NYMEX Bylaws and Rules and a request to transfer all existing contract market designations to NYMEX, Inc., to implement Existing NYMEX's proposed demutualization plan.

CONSULTED: Division of Economic Analysis
Division of Enforcement
Office of the General Counsel

STAFF CONTACT: Riva Spear Adriance (x5494)
Dennis Hermonstyne (x5478)

I. Introduction

By letters dated March 29 through July 20, 2000, the New York Mercantile Exchange ("Existing NYMEX") submitted certain proposed rules and rule amendments to the Commodity Futures Trading Commission ("Commission"), pursuant to Section 5a(a)(12)(A) of the Commodity Exchange Act ("Act") and Commission Regulation 1.41(c), to implement its proposed demutualization plan.1 Under this plan, Existing NYMEX would convert from a New York not-for-profit membership corporation into a Delaware for-profit entity that would be organized as a stock holding company with a subsidiary membership company.2 The demutualization plan was approved by an affirmative weighted vote of 97.5% of the Existing NYMEX members casting votes at a special membership meeting held on June 20, 2000.3

As part of the proposed demutualization plan, Existing NYMEX and the New York Mercantile Exchange, Inc. ("NYMEX, Inc.") are requesting that all of Existing NYMEX's contract market designations be transferred to NYMEX, Inc.4 In addition, the following materials are submitted to the Commission for its review and approval: (1) the Certificate of Incorporation of NYMEX Holdings;5 (2) the Bylaws of the NYMEX Holdings;6 (3) the Certificate of Incorporation of NYMEX, Inc.;7 (4) amendments to the Bylaws of NYMEX, Inc.;8 and (5) amendments to the current NYMEX Rulebook ("NYMEX Rulebook").9

II. Existing NYMEX's Proposed Demutualization Plan

Existing NYMEX is seeking to fundamentally change its organizational structure by converting from a New York not-for-profit membership corporation into a Delaware for-profit entity that will be organized as a stock holding company with a subsidiary membership company. To accomplish this change in structure, Existing NYMEX would undergo a two-step merger with both steps occurring simultaneously. In the first step, Existing NYMEX (a New York not-for-profit membership organization) would merge with and into NYMEX, Inc. (a Delaware non-stock corporation). NYMEX, Inc. would be the surviving company of this merger.10 Each Existing NYMEX member would receive one NYMEX, Inc., Class A membership and one NYMEX, Inc. Class B membership for each NYMEX Division membership owned. Existing NYMEX has 900 authorized memberships: 816 outstanding memberships and 84 unissued memberships. In the first step of the merger, the 84 unissued Existing NYMEX memberships would be cancelled without consideration. In the second step, NYMEX, Inc. would merge with a subsidiary of NYMEX Holdings (a for-profit Delaware stock holding company) known as NYMEX Merger Sub, Inc. NYMEX, Inc. would survive this merger and become a subsidiary of NYMEX Holdings. Each member's NYMEX, Inc., Class B membership would be exchanged for one share of NYMEX Holdings common stock, extinguishing their Class B membership.11 NYMEX Holdings' interest in its subsidiary would be converted into a Class B membership, making NYMEX Holdings the sole NYMEX, Inc. Class B member. The Commodity Exchange, Inc. (COMEX), a wholly-owned subsidiary of Existing NYMEX, would be a subsidiary of NYMEX, Inc.12

According to Existing NYMEX, through the adoption of the demutualization plan, Existing NYMEX is seeking to:

(1) Improve the current governance and managerial structure to facilitate accelerated decision-making;

(2) Better serve its owners by changing the current financial decision-making model to emphasize stockholder value;

(3) Provide greater flexibility to enter into strategic business transactions;

(4) Maximize stockholder value by separating trading rights from equity ownership; and

(5) Provide a signal and currency for working with strategic partners.13

However, before the demutualization plan may be completed, certain other contingencies must be fulfilled.14 First, Existing NYMEX is seeking to obtain a favorable ruling from the Internal Revenue Service ("IRS") concerning the federal tax implications of the demutualization plan.15 Such a ruling would enable the exchange of membership interests in Existing NYMEX for shares of NYMEX Holdings common stock to be accomplished on a tax-free basis. Consequently, existing members would not recognize any gain or loss strictly as a result of receiving NYMEX Holdings common stock in exchange for their Class B membership interests. Second, Existing NYMEX must obtain Commission approval of the various new rules and rule amendments described herein and of the request to transfer all existing contract market designations to NYMEX, Inc.16

A. Conversion of Existing Membership Interests into NYMEX, Inc. Memberships and Shares of NYMEX Holdings Common Stock

As a result of the two-step merger described above, existing membership interests in the Existing NYMEX would be converted into one NYMEX, Inc. Class A membership and one share of NYMEX Holdings common stock. NYMEX Holdings would hold the sole outstanding Class B membership in NYMEX, Inc. Hence, there would be 816 Class A memberships in NYMEX, Inc., 816 shares of common stock in NYMEX Holdings and One Class B membership in NYMEX, Inc. The Class A membership would confer trading privileges and the Class B membership would confer equity rights. COMEX Division members would not receive NYMEX, Inc. Class A or Class B memberships or shares of NYMEX Holdings common stock. After the merger, the distribution of Class A and Class B memberships and shares of common stock would be as follows:

Current
Membership Division

Class A Memberships In NYMEX, Inc.17

Shares Of Common Stock In NYMEX Holdings18

Class B Membership
In NYMEX, Inc.19

COMEX Trading Privilege
And Rights20

1 NYMEX membership 1 membership 1 share

____

____

1 Comex membership ____ ____ ____ Trading Privilege and Rights
NYMEX Holdings ____ ____ 1 membership

____

The demutualization transaction is not an initial public offering ("IPO"). As discussed in more detail below, ownership of NYMEX, Inc. and NYMEX Holdings would initially be limited to members of Existing NYMEX following the completion of the demutualization transaction.21 During this initial period, NYMEX, Inc. Class A memberships and NYMEX Holdings Common Stock would be "stapled," and could only be transferred as a single unit. While the Class A memberships are stapled, members of NYMEX, Inc. could only transfer their NYMEX, Inc. Class A memberships in conjunction with the NYMEX Holdings common stock and only to another member or a member-elect.22 The decision whether to unstaple the Class A memberships from the common stock to pursue an IPO would rest with the management and the board of directors of NYMEX Holdings, although the NYMEX Holdings stockholders must approve any such decision.23

B. Trading Rights Associated with NYMEX, Inc. Class A and B Memberships

As noted above, NYMEX, Inc. Class A memberships would represent the trading rights of its associated membership Division, including floor access rights and privileges. The Class B membership would represent an economic interest in NYMEX, Inc. As the holder of the sole Class B membership, NYMEX Holdings would have the sole right to dividend and liquidation proceeds from NYMEX, Inc.24

1. Floor and NYMEX ACCESS Trading Rights

A NYMEX, Inc. Class A member would have the right to trade on the floor of NYMEX, Inc. and to act as a floor broker and/or trader as long as the member retained its Class A membership.25 NYMEX, Inc. rules would allow each Class A member and COMEX Division member to trade electronically through NYMEX ACCESS when the floor was closed.26 As is currently true, persons with electronic trading privileges could apply for designations as electronic traders for those contracts for which trading privileges had been granted.27

2. Leasing of Trading Rights

The trading privileges associated with Class A membership could be leased out to another member, member-elect or non-member provided that such individual or entity satisfied the ownership and eligibility criteria imposed by NYMEX, Inc.28 Currently, Lessees of trading privileges in Existing NYMEX have voting rights. However, after the demutualization, Lessees of Class A memberships would have no voting rights with respect to their Class A memberships.29

3. Clearing Fees

Existing NYMEX's clearinghouse is owned by Existing NYMEX. After the demutualization, the clearinghouse would be owned by NYMEX, Inc., so the relationship between NYMEX, Inc. and its clearinghouse would not differ from the current relationship. COMEX's clearinghouse, the COMEX Clearing Association, Inc., would be consolidated into Existing NYMEX's clearinghouse prior to the demutualization.30 Hence, COMEX, as a subsidiary of NYMEX, Inc., would have its contracts cleared through NYMEX, Inc.'s clearinghouse. Member fees or any member benefits, including fee rebate plans and member retention plans, would not change as a result of the demutualization.31 The NYMEX, Inc. board of directors would continue to have the authority to set member fees, dues, assessments and benefits in its discretion.32

C. Voting Rights

1. Election of the NYMEX Holdings and NYMEX, Inc.
Board of Directors

After the demutualization, the Board of Directors for NYMEX, Inc. and NYMEX Holdings would each be composed of the same members that are currently serving on Existing NYMEX's board of directors. During the period when the NYMEX, Inc. Class A memberships are stapled to the NYMEX Holdings common stock, the NYMEX, Inc. board would mirror the NYMEX Holdings board as NYMEX Holdings would be required to designate its directors to serve as the directors of NYMEX, Inc.33

Each NYMEX Holdings stockholder would be entitled to cast one vote per share for the election of the directors and the designation of the Chairman and Vice Chairman of NYMEX Holdings. The boards of NYMEX, Inc. and NYMEX Holdings would each have a total of 22 directors. The boards of NYMEX Holdings and NYMEX, Inc. would be divided into three classes serving staggered three-year terms.34 Each class would comprise one-third of the directors of the entire board.35 While the NYMEX Holdings' directors could be removed with or without cause, NYMEX Holdings, as the Class B member, would only be entitled to remove a director of the board of NYMEX, Inc. for cause.36

2. Membership and Stockholder Rights

Holders of NYMEX, Inc. Class A memberships would only be entitled to vote with the Class B member on proposed amendments to the NYMEX, Inc. Bylaws.37 Like members of Existing NYMEX, NYMEX, Inc. members would have the right to petition the NYMEX, Inc. board to inform it of their position on issues of importance to the membership.38 However, because an Existing NYMEX resolution provided the petition rights, the NYMEX, Inc. board could remove the resolution, thus stripping the members of their petition rights. The petition rights are, and have been, nonetheless only advisory.39 The NYMEX Holdings board would exercise the Class B Membership voting right. Each NYMEX Holdings stockholder would be entitled to one vote per share on all matters presented to the stockholders, including amendments to the NYMEX Holdings Certificate of Incorporation and Bylaws.40 The holder of the Class B membership would have the sole voting right on changes to the NYMEX, Inc. Certificate of Incorporation and extraordinary transactions.41

3. Other Matters

Under Delaware stock corporate law, the voting rights of members of Existing NYMEX would change. Currently, approval by two-thirds of those voting is necessary to authorize charter amendments or extraordinary transactions such as a merger, a sale of all the corporate assets or a dissolution for Existing NYMEX under New York law. In contrast, Delaware law allows approval by a simple majority of the outstanding voting shares. Because fewer votes would be needed to authorize such activities it could be easier for NYMEX Holdings to undertake such activities. Furthermore, as explained above, in the case of NYMEX, Inc., voting on amendments to the Certificate of Incorporation or extraordinary transactions would be the sole right of the board of NYMEX Holdings.42

As stockholders in NYMEX Holdings, Existing NYMEX members would gain voting rights under Delaware law. Each stockholder would be entitled to one vote per share on all matters presented to the stockholders. Currently each member of Existing NYMEX has one vote regardless of the number of memberships. Furthermore, Delaware law gives stockholders the right to dissent from an extraordinary transaction involving a merger, consolidation, sale of all the corporate assets or a dissolution. If there is no public market for the shares, Delaware law gives stockholders the right to receive payment equal to the appraised value of the shares. Under New York law, no such dissent right exists.

D. Other Differences in Ownership Rights

Currently, owners of Existing NYMEX memberships are entitled to share ratably in any liquidating distributions. Holders of NYMEX, Inc. Class A memberships would not be entitled to any liquidating distributions from NYMEX, Inc. Only NYMEX Holdings, the sole shareholder in NYMEX, Inc. would be entitled to share ratably in any liquidating distributions of NYMEX, Inc., while NYMEX Holdings stockholders, in turn, would be entitled to share ratably in any liquidating distributions of NYMEX Holdings.43

E. Restrictions on the Transfer, Sale, or Lease of NYMEX, Inc. Memberships and NYMEX Holdings Common Stock

Although NYMEX Holdings common stock and NYMEX, Inc. Class A memberships could eventually be bought and sold by the general public, they initially would be stapled together and could not be separately transferred.44 A NYMEX Holdings IPO could only be effected upon approval of the unstapling by the stockholders in NYMEX Holdings.

F. Governance

1. Board of Directors

The initial members of the NYMEX Holdings and NYMEX, Inc. board of directors would consist of all the members of the Existing NYMEX board at the time of the completion of the demutualization plan. In future elections, the NYMEX Holdings stockholders would elect the NYMEX Holdings board. NYMEX Holdings and NYMEX, Inc. would have identical boards as long as the NYMEX, Inc. Class A memberships and the NYMEX Holdings common stock were stapled together.45 The NYMEX Holdings board, on behalf of the Class B member, would elect the directors of NYMEX Holdings as directors of NYMEX, Inc.46 The NYMEX, Inc. board would have control over and management of, the property, business and finances of NYMEX, Inc., as well as the authority to impose fees, charges, dues and assessments.47

2. Executive Officers

The initial executive officers of NYMEX Holdings and NYMEX, Inc. would consist of all the executive officers of Existing NYMEX at the time of the completion of the demutualization plan.

3. Exchange Employees

The initial employees of NYMEX, Inc. would consist of the employees of Existing NYMEX at the time of the completion of the demutualization plan.48 After the demutualization, the employees of NYMEX, Inc. would provide services to NYMEX Holdings, but NYMEX, Inc. would provide for the pay of all such employees. Any efforts on the part of NYMEX, Inc. to reorganize its governance and management structures should necessitate rule changes that would be submitted to the Commission for prior review pursuant to Section 5a(a)(12) of the Act and Commission Regulation 1.41.

4. Board Committees

The NYMEX, Inc. board of directors will have ten committees. The ten committees will be an Executive Committee, an Adjudication Committee, an Appeals Committee, an Arbitration Committee, a Business Conduct Committee, a Bylaws Committee, a Control Committee, a Finance Committee, a Floor Committee and a Membership Committee.49 Initially, committee members would be individuals who currently serve in similar capacities on comparable Existing NYMEX committees.50 The NYMEX, Inc. board would elect members of these committees following the implementation of the demutualization plan.51 In the case of the board of NYMEX Holdings, the directors would designate an Executive Committee and other committees from among its members.52

III. Proposed NYMEX, Inc. Rules and Rule Amendments53

Under the demutualization plan, as described above, there would be a separation of trading privileges and economic interest, although until the unstapling occurs, a natural person or legal entity could not acquire shares of NYMEX Holdings stock as an investment, without being a member of NYMEX, Inc.54 The Rules of NYMEX, Inc. would be amended to reflect these changes.55

A. Certificate of Incorporation and Bylaws of NYMEX, Inc.

The Certificate of Incorporation of NYMEX, Inc. describes the size and selection of the board of directors for NYMEX, Inc., including the staged three-year staggering of the terms of the directors beginning in March of 2001.56 The Bylaws of NYMEX, Inc. cover a number of topics relating to corporate governance. The submission states that, under the demutualization plan, the compliance and surveillance responsibilities of Existing NYMEX would be carried out by NYMEX, Inc.57 It further states that NYMEX, Inc. would act as the designated contract market and it would fulfill all the self-regulatory functions in the same manner as Existing NYMEX.58

B. Other Conforming Amendments

Under the proposed rule changes, most of the substantive rules would not be changed. The proposed amendments to the Existing NYMEX Rulebook chiefly involve governance issues. As noted above, one of the primary goals of the demutualization plan is to streamline Existing NYMEX's governance and managerial structure in order to accelerate and improve the decision-making process.59 Some of the rules in the Existing NYMEX Bylaws and the governance chapter of the existing NYMEX Rulebook would, therefore, be changed to reflect the changes in governance of NYMEX Holdings and NYMEX, Inc.60 Existing NYMEX, NYMEX Holdings and NYMEX, Inc. represent that NYMEX, Inc. would continue to comply with Commission regulations 1.59,61 1.63,62 1.6463 and 1.69.64 Notably, the board of NYMEX Holdings has passed resolutions adopting the standards of 1.59, 1.6365 and 1.69,66 and the composition requirements of Commission Regulation 1.64 were incorporated into the NYMEX Holdings Bylaws.67

IV. Discussion

A. Demutualization Issues

1. Conflicts of Interest

As previously discussed in the CME Memo, for-profit exchanges must consider shareholder interests, perhaps at the expense of the interests of market users.68 The Division noted, however, that the potential for such conflicts of interest also is present under the current exchange organization.69

In its submission, Existing NYMEX has pointed out that it has a strong business incentive to preserve its reputation as a well-regulated exchange and views its reputation for market integrity to be significant for NYMEX, Inc. as well. For the same reason, as the parent of NYMEX, Inc., NYMEX Holdings will have a strong business incentive to preserve the reputation of its subsidiary as a well-regulated exchange. In addition, unlike a new exchange, Existing NYMEX has already invested in the development of its compliance program. Consequently, the conflict between maximizing profits and stockholder value as opposed to the fulfillment of self-regulatory obligations would be lessened.

As discussed in the CME Memo, the Commission has oversight authority in situations involving possible conflicts of interest.70 For instance, Section 5a(a)(12) requires that rule proposals be submitted for Commission review and thus serves as a safeguard that exchange rule changes are not inconsistent with the Act and the Commission's regulations. Similarly, the Commission's oversight of the exchange's rule enforcement responsibilities serves to determine whether exchanges are maintaining a program to secure compliance with the Act, the Commission's regulations and the exchanges' rules.

2. Funding of Self-Regulatory Obligations

a. SRO Responsibilities

The Act and Commission regulations impose self-regulatory responsibilities on designated contract markets.71 As pointed out in the CME Memo, the Commission's oversight authority of the adequacy of exchange programs for carrying out compliance and disciplinary regulatory responsibilities includes consideration of any lack of funding that contributes to an inadequate program. The Division recommends that the Commission remind NYMEX, Inc. that it remains subject to self-regulatory responsibilities under the Act and the Commission's regulations and that the Commission will continue to do Rule Enforcement Reviews evaluating exchange compliance.

b. Representations

In their submissions, Existing NYMEX, NYMEX Holdings and NYMEX, Inc. represent that NYMEX, Inc. would be the legal successor-in-interest to Existing NYMEX, would meet all the requirements for contract market designation, would assume all the assets and liabilities of Existing NYMEX and would comply with all self-regulatory requirements applicable to designated contract markets under the Act and the Commissions regulations including, but not limited to, the surveillance and enforcement requirements, the governing board and disciplinary committee composition requirements, and the prohibition against conflicts of interest and insider trading.72 The rules and practices for complying with self-regulatory responsibilities would remain the same.73

The Division believes that the Commission has the oversight ability and authority under the Act and the Commission's regulations to hold an exchange accountable for failures to uphold its regulatory responsibilities.

3. Outsourcing of Exchange SRO Obligations

As mentioned in Section IV.A.2.b. above, under the demutualization plan NYMEX, Inc. does not plan at this time to change its rules or practices concerning its SRO responsibilities. Therefore, there is no issue concerning the outsourcing of exchange SRO obligations applicable to the consideration of Existing NYMEX's demutualization plan. Any outsourcing would necessitate rule changes that must be submitted to the Commission for review under Section 5a(a)(12) of the Act.

4. Exchange Governance

While members and market users extensively overlap in a member-owned exchange, demutualization could result in a reduction over time in the percentage of shareholders that are also market users. During the period when the NYMEX, Inc. Class A memberships and the NYMEX Holdings common stock are stapled, the market users would, except for lessees, be shareholders. However, after the unstapling, the percentage of stockholders who are market users could fall and the NYMEX Holdings and NYMEX, Inc. boards could differ.

Notwithstanding the composition of exchange ownership, Section 5a(a)(14) of the Act and Commission Regulation 1.64 require that exchange governing boards include meaningful representation of a variety of market users as well as other interests. On the other hand, the board of directors of a for-profit entity has the responsibility to represent the interests of its shareholders rather than the interests of market users, and corporate governance laws contain their own conditions for governing board composition. However, Delaware, the state in which NYMEX, Inc. will be incorporated, specifically allows a corporation to dictate other qualifications for directors. As mentioned above, the NYMEX, Inc. Bylaws would require that the directors of NYMEX, Inc. meet the composition requirements of Commission Regulation 1.64.74 Relatedly, the NYMEX Holdings Certificate of Incorporation applies the composition requirements of Commission Regulation 1.64 to its board of directors.75

Commission Regulation 1.63 limits service on SRO governing boards and committees by persons with disciplinary histories. As mentioned above, Existing NYMEX Rule 3.03, providing for the application of Regulation 1.63, would not be changed.76 In addition, NYMEX Holdings has passed a resolution applying the standards of Commission Regulation 1.63 to its board.77

While NYMEX, Inc. would be the designated contract market and would be funded through the revenues generated by its operations, NYMEX Holdings would have access to the revenue stream and finances of NYMEX, Inc.78 [Deleted Material]

In the event of a funding or financial problem, a member-owned exchange relies on its ability to assess its members. If NYMEX, Inc. faced financial difficulties that interfered with its ability to carry out its self-regulatory responsibilities, whether due to loss of business at the exchange, inappropriate expenses taken on by the exchange or the redirection of its revenue by NYMEX Holdings, the exchange could respond in one of two ways. NYMEX, Inc. would be able to assess its members in a similar manner to Existing NYMEX's current assessment abilities.79 NYMEX, Inc. would also have the ability to look towards its parent either to raise funds or to redirect funds from another subsidiary of NYMEX Holdings.80 While a member-owned exchange can, and some have, set up a non-regulated subsidiary,81 the Division sees some benefits in the holding company structure. When the exchange is a subsidiary of a holding company, it is separated and protected from other subsidiaries of the holding company. If another subsidiary of the holding company develops financial difficulties, the exchange would not be liable.82 Accordingly, from this perspective, NYMEX, Inc. could be more insulated from the financial failures of eNYMEX or other subsidiaries than would be the case in alternative corporate structures.

NYMEX, Inc., as the designated contract market, would be the entity regulated by the Commission. [Deleted Material] Accordingly, the Division recommends that the Commission, in its Letter and Order, specifically remind NYMEX Holdings that the Act and the Commission's regulations would apply to NYMEX Holdings as owner, parent and principal of its subsidiary, NYMEX, Inc., a designated contract market, to the same extent that the Act and the Commission's regulations apply to any person that owns, controls or is a principal of another person. The Division also recommends that the Commission specifically base its approval of the transfer of contract market designations to NYMEX, Inc. on the adoption by NYMEX Holdings of the standards set forth in Commission Regulations 1.59, 1.63, 1.64 and 1.69 in its Bylaws or Resolutions.

V. Conclusion and Recommendation

Based on the foregoing, the Division believes Existing NYMEX's demutualization plan, including its associated amendments, is not inconsistent with the Act or the Commission's regulations. Accordingly, the Division recommends that the Commission approve the proposed Certificate of Incorporation of NYMEX, Inc., the proposed extinguishment of Existing NYMEX's current Certificate of Incorporation, proposed new NYMEX, Inc. Bylaws 927, 928, 929, 930, 931, and 932; and the proposed amendments to: (1) Bylaw Sections 100, 102, 103, 106-110, 150, 153-155, 200-206, 300-314, 351-354, 356, 400, 401-409, 500-504, 600, 700-703, 800-802, 850-863, and 901-926; and (2) Rules 1.03, 1.08, 1.11, 1.12, 1.16-1.19, 1.22, 2.01, 2.41-2.43, 2.52, 2.53, 2.55, 2.56, 2.61, 2.70, 2.75C, 2.77, 3.00, 3.03, 3.10-3.14, 3.17, 3.20-3.22, 3.24, 3.29, 3.35-3.37, 3.39, 3.41, 3.42, 3.44, 3.45, 5.01, 6.05, 6.21, 6.21B, 6.26, 8.00, 8.01, 8.07, 8.21, 8.24, 8.58, 8.62, 8.69, 8.99, 9.00, 9.02, 9.03A, 9.17, 9.18, 10.02, 11.01-11.03, 11.05, 11.06, 11.08-11.08A-2, 11.13, 11.14, 11.20 and 11.21; pursuant to Section 5a(a)(12)(A), 7a(a)(12)(A), of the Act and Commission Regulation 1.41(c).

The Division also recommends that the Commission confirm to NYMEX, Inc., that the status of each rule of the NYMEX Rulebook, under the Act and the Commission's regulations, is not affected by the consummation of the demutualization plan except as each rule is amended herein.

Furthermore, since the effect of Existing NYMEX's plan is to change the ownership structure of Existing NYMEX without altering its self-regulatory rules or practices and without altering the terms and conditions of the contracts that have been designated by the Commission for trading on Existing NYMEX, the Division, pursuant to consultation with the Division of Economic Analysis, recommends that the Commission issue the attached order transferring all Existing NYMEX's current contract market designations to NYMEX, Inc., including the transfer of all existing open interest in all such contracts, and designating NYMEX, Inc. as a contract market for all such contracts. The transfer of these designations, and all related open interest, should take effect at precisely the same time as the merger itself.

The Division further recommends that the Commission remind Existing NYMEX, NYMEX Holdings and NYMEX, Inc. that any subsequent NYMEX Holdings or NYMEX, Inc. rule changes associated with the demutualization plan must be submitted for Commission review. The Division also recommends that the Commission remind Existing NYMEX, NYMEX Holdings and NYMEX, Inc. that subsequent rule changes necessitated by the unstapling of the NYMEX, Inc. trading rights from the NYMEX Holdings equity interest must be submitted for Commission review. The Division further recommends that the Commission remind Existing NYMEX and NYMEX, Inc. that any rule changes necessitated by the consolidation of the COMEX Clearing Association, Inc. into Existing NYMEX's clearinghouse must be submitted for Commission review. In addition, the Division recommends that the Commission remind NYMEX, Inc. that, as it agreed to in its representations, it will remain subject to all self-regulatory responsibilities applicable to a designated contract market under the Act and the Commission's regulations. Finally, the Division recommends that the Commission remind NYMEX Holdings that the Act and the Commission's regulations would apply to NYMEX Holdings as owner, parent and principal of its subsidiary, NYMEX, Inc., a designated contract market, to the same extent that the Act and the Commission's regulations apply to any person that owns, controls or is a principal of another person.


1 Existing NYMEX is the second contract market to submit a demutualization proposal to the Commission. On June 15, 2000, the Commission approved rules and procedures implementing the demutualization plan of the Chicago Mercantile Exchange ("CME") and issued an order transferring all CME contract market designations to the new entity upon fulfillment of a number of conditions. See generally, Letter from Jean A. Webb, Secretary to the Commission, to Carl A. Royal, Senior Vice President and Special Counsel, CME, and Craig S. Donohue, Managing Director, Business Development and Corporate/Legal Affairs, Chicago Mercantile Exchange Inc. (June 15, 2000). The Chicago Board of Trade ("CBT") is also pursuing a reorganization plan and the Commission received the first submission on that restructuring proposal on June 30, 2000. At a vote on June 28, 2000, CBT members approved Step One of CBT's restructuring plan.

2 Existing NYMEX has stated its intention to create eNYMEX, an internet-based trading system, after the demutualization is completed. eNYMEX would be a subsidiary of NYMEX Holdings, Inc. ("NYMEX Holdings"). Division of Trading and Markets ("Division") staff conversation with Christopher K. Bowen, Senior Vice President and General Counsel, Existing NYMEX (June 7, 2000). The proposed creation and development of eNYMEX is not a part of Existing NYMEX's subject proposed demutualization plan and therefore this memo does not consider, endorse or comment upon any plan Existing NYMEX has for eNYMEX.

3 The vote was 430 to 11. Existing NYMEX's Board of Directors unanimously approved the demutualization plan on January 5, 2000 and on May 12, 2000. Subsequently, the Board unanimously recommended that the membership approve the plan at the June 20, 2000, membership meeting. Approval of the plan required a two-thirds majority vote of those members casting votes by proxy or in person at the meeting.

4 See Letter from Christopher K. Bowen, Senior Vice President and General Counsel, Existing NYMEX to Riva Spear Adriance, Special Counsel, Division 2 (April 14, 2000).

5 The proposed NYMEX Holdings Certificate of Incorporation is attached to this Memorandum as Appendix D.

6 The proposed NYMEX Holdings Bylaws are attached to this Memorandum as Appendix E.

7 The proposed NYMEX, Inc. Certificate of Incorporation is attached to this Memorandum as Appendix F.

8 The proposed NYMEX, Inc. Bylaws are attached to this Memorandum as Appendix G.

9 These rule amendments are attached to this Memorandum as Appendix H. The NYMEX Rulebook, as amended herein, would govern the trading activities on NYMEX, Inc. Most of the rules are not being amended and would apply to NYMEX, Inc. in their current form. See infra Section III.B. According to Existing NYMEX, rules are being amended to reflect the new share structure of the company and to conform to the requirements of Delaware for-profit corporation law. See Letter from Christopher K. Bowen, Senior Vice President and General Counsel, Existing NYMEX to Jean A. Webb, Secretary to the Commission 7 (March 29, 2000). As Existing NYMEX, under its demutualization plan, is carrying out a merger into a new entity, the Division has asked for, and received, the representations of Existing NYMEX, NYMEX Holdings and NYMEX, Inc. that NYMEX, Inc., upon completion of the mergers, will meet the requirements for contract market designation. However, unlike the contract market designation process for a new contract market, the Division reviewed the amendments of, and additions to, the NYMEX Rulebook for inconsistency with the Act and the Commission's regulations rather than reviewing a new set of rules in their entirety.

10 This merger would be effected under an agreement and plan of merger between the Existing NYMEX and NYMEX, Inc.

11 This merger would be effected under an agreement and plan of merger between NYMEX Holdings and NYMEX, Inc.

12 COMEX, as a subsidiary of Existing NYMEX, is a separate entity whose parent would change from Existing NYMEX to NYMEX, Inc. as a result of the demutualization. In the past when ownership of a separately designated contract market has been transferred to a new entity without changes to the designated contract market itself, the Commission has not transferred contract market designations. See, e.g., the merger of COMEX into a subsidiary of Existing NYMEX. See also the merger of MidAmerica Commodity Exchange into a subsidiary of CBT. See generally infra note 20. No changes to COMEX rules or governance related to the demutualization plan are currently before the Commission.

13 See NYMEX Holdings S-4 Registration Statement 8 (May 12, 2000).

14 The Securities and Exchange Commission ("SEC") declared NYMEX Holdings' registration statement effective on May 12, 2000.

15 This ruling request was filed with the IRS on January 31, 2000. Notably, CME's demutualization proposal was subject to the same contingency at the time that the Commission approved the rules and procedures implementing its demutualization plan.

16 Existing NYMEX represents that none of the rule changes under the demutualization plan will affect the rights and obligations of participants with open positions transferred from Existing NYMEX to NYMEX, Inc., and that the rule changes do not relate to how such contracts are cleared. See generally Letter from Christopher K. Bowen, Senior Vice President and General Counsel, Existing NYMEX to Jean Webb, Secretary to the Commission (July 14, 2000). The Division also notes that market participants have been notified of changes to the NYMEX Rulebook, the concurrent transfer of the contract market designations from Existing NYMEX to NYMEX, Inc. and related transfer of all open interest upon consummation of the merger of Existing NYMEX into NYMEX, Inc. under the demutualization plan.

17 The Class A membership represents the trading privileges associated with a NYMEX Division membership. NYMEX, Inc. would have a total of 816 Class A memberships. See infra Section II.B.

18 The shares of NYMEX Holdings common stock would only provide Existing NYMEX members with equity and voting rights in NYMEX Holdings. A total of 816 shares would be issued to the Existing NYMEX members.

19 The Class B membership represents an economic interest in NYMEX, Inc., including the sole right to dividends and liquidation proceeds. Upon completion of the demutualization, there would be one Class B membership. NYMEX Holdings would be the sole holder of this Class B membership. See infra Section II.B.

20 Members of the COMEX Division would continue to have the same trading privileges on COMEX as they had at Existing NYMEX. The other rights and obligations which a COMEX Division member has would be unaffected.

21 See infra Section II.E.

22 A member-elect is a person who has been qualified for membership and must purchase a Class A membership within 45 days of his election. See NYMEX Holdings S-4 Registration Statement, supra note 13 at 71, 72. See also NYMEX, Inc. Bylaws Section 109 and NYMEX, Inc. Certificate of Incorporation Article 5.

23 See NYMEX Holdings Bylaws, Article II Section 7. See also NYMEX Holdings S-4 Registration Statement, supra note 13 at 1.

24 See NYMEX, Inc. Certificate of Incorporation, Article 6(c).

25 As previously mentioned, COMEX Division members would not receive any NYMEX, Inc. Class A or Class B memberships. Therefore any mention of members above does not include COMEX members unless otherwise specifically noted. See supra Section II.A. See also supra note 12. The criteria for eligibility and for membership and procedures for becoming a Class A member would be the same as the criteria and procedures currently applicable for Existing NYMEX members. See NYMEX Holdings S-4 Registration Statement, supra note 13 at 74.

26 See NYMEX, Inc. Rule 11.01. While most contracts are traded on the floor during the day, certain energy contracts are traded exclusively on NYMEX ACCESS throughout the daytime and night sessions.

27 As of March 1, 2000, 700 users were authorized to trade on NYMEX ACCESS.

28 See NYMEX, Inc. Bylaws, Section 153 and NYMEX Holdings S-4 Registration Statement, supra note 12 at 72.

29 See NYMEX Holdings S-4 Registration Statement, supra note 12 at 1,4. See also NYMEX, Inc. Bylaws Section 155(b).

30 See NYMEX Holdings S-4 Registration Statement, supra note 12 at 32. Any efforts on the part of Existing NYMEX to consolidate the COMEX Clearing Association, Inc. into Existing NYMEX's clearinghouse should necessitate rule changes that would be submitted to the Commission for prior review pursuant to Section 5a(a)(12) of the Act and Commission Regulation 1.41. The Division recommends that the Commission so remind Existing NYMEX and NYMEX, Inc.

31 Fees on cleared trades would continue to be based on each contract side traded and would continue to differentiate between members' day-trades and trades held overnight. Traders who leased trading privileges on COMEX would continue to be charged a clearing surcharge, while lessee traders on NYMEX, Inc. would be assessed the same trading fee as members.

32 See NYMEX Holdings S-4 Registration Statement, supra note 12 at 82.

33 The NYMEX, Inc. Certificate of Incorporation requires that the board of NYMEX, Inc. mirror the board of NYMEX Holdings. See NYMEX, Inc. Certificate of Incorporation, Article 7.

34 See NYMEX Holdings Certificate of Incorporation, Article 6(B).

35 The Chairman and Vice Chairman of the NYMEX Holdings board would be designated directly by the stockholders. The Chairman would be a member of Class I and the Vice Chairman a member of Class II. See NYMEX Holdings Certificate of Incorporation, Article 6(C). Fifteen of the directors would be required to be members. Each class of directors would consist of at least one member of five groups: (1) Floor Broker, (2) Futures Commission Merchant, (3) Trade, (4) Local Trader, and (5) At Large. See NYMEX Holdings Certificate of Incorporation, Article 6(D). In addition, the board would have five Public Directors who would not be members or employees of the exchange. They would be elected directly by the stockholders. See NYMEX Holdings Certificate of Incorporation, Article 6(e). The terms of the Class I directors would first expire at the annual meeting of stockholders held in March of 2001. The terms of the Class II directors would first expire at the annual meeting of stockholders held in March of 2002. The terms of the Class III directors would first expire at the annual meeting of stockholders held in March of 2003. At each annual meeting of stockholders, the successors for each expired class of director would be elected. See NYMEX Holdings Certificate of Incorporation, Article 6(B). At any time, directors of NYMEX Holdings could be removed from office by the affirmative vote of the holders of a majority of the outstanding shares entitled to elect such person as a director. See NYMEX Holdings Certificate of Incorporation, Article 10.

36 The refusal, failure, neglect or inability of a director to discharge his duties or any action that adversely affects the best interest of NYMEX, Inc. would be grounds for removal for cause. See NYMEX, Inc. Bylaws, Section 304(B). The NYMEX Holdings board would exercise this authority on behalf of NYMEX Holdings. See id.

37 Possible votes for proposed amendments to the NYMEX, Inc. Bylaws, would total 817, 816 Class A members and one Class B member. The NYMEX Holdings vote, as the Class B member, would be only one vote out of 817, all equally weighted. See NYMEX, Inc. Certificate of Incorporation, Article 6(a).

38 A petition can encourage the board to vote in a particular direction. However, as is currently the case, the NYMEX, Inc. board is not obligated to adhere to a petition directive nor could a petition overturn a board decision. See Existing NYMEX Resolution 14,533.

39 Moreover, under the Chicago Mercantile Exchange, Inc. demutualization plan, its members were completely stripped of their referendum rights. See Division, Chicago Mercantile Exchange Proposed Demutualization Plan Memorandum 20-21 (June 15, 2000) ("CME Memo").

40 See Bylaws of NYMEX Holdings, Article II Section 7.

41 A proposed merger, consolidation, sale of assets or dissolution would constitute an extraordinary transaction. See NYMEX, Inc. Certificate of Incorporation, Article 7(b).

42 See supra note 41. See also supra Section II.C.2.

43 See supra Section II.B. See also NYMEX Holdings S-4 Registration Statement, supra note 13 at 83.

44 Transfers of stapled NYMEX, Inc. Class A memberships and the common stock of NYMEX Holdings would be subject to the same transfer process that currently applies to the transfer of membership interests in the Existing NYMEX. See Section III.A. and IV.A.4. During the "stapled" period, the board of NYMEX Holdings would actively explore opportunities to enhance shareholder value, including an IPO of NYMEX Holdings' shares. See NYMEX Holdings S-4 Registration Statement, supra note 13 at 1.

45 See supra Section II.C.1.

46 See NYMEX, Inc. Certificate of Incorporation, Article 7.

47 See NYMEX, Inc. Bylaws, Article 3 Section 301.

48 While no staffing reductions are currently planned, Existing NYMEX is considering possible staff reductions. Existing NYMEX and NYMEX, Inc. represent that any proposed reductions would not have any adverse impact upon either entity's ability to fulfill its self-regulatory responsibilities. See Letter from Daniel Rappaport, Chairman, Existing NYMEX and NYMEX, Inc. to Riva Spear Adriance, Special Counsel, Division 1 (July 20, 2000). See also Letter from Christopher K. Bowen, supra note 4 at 4.

49 See NYMEX, Inc. Bylaws, Article 4 Sections 400(b) and (c).

50 See Letter from Christopher K. Bowen, supra note 4 at 9.

51 The Executive Committee would have the authority of the Board of Directors, except as the Board of Directors otherwise provides. See NYMEX, Inc. Bylaws, Article 3 Section 301(A).

52 The Executive Committee would have the authority of the NYMEX Holdings board of directors, except as the board of directors otherwise provided, the other committees would have such authority as the board of directors granted them. The NYMEX Holdings board of directors would have power at any time to change the membership of its committees, to fill vacancies in their membership and to discharge any committees. See NYMEX Holdings Bylaws, Article V. Section 1.

53 The Commission's approval of proposed rules and rule amendments would be limited to those of NYMEX, Inc.

54 See supra Section II.E. See also supra note 44.

55 For example, in the current rules, the term "membership" is used to describe the trading, economic and voting rights associated with being a member. In the amended rules, a NYMEX, Inc. Class A membership would refer only to a member's trading privileges and the right to approve changes to the Bylaws of NYMEX, Inc. The NYMEX, Inc. Class B membership would refer to the economic and voting rights.

56 The NYMEX Holdings Certificate of Incorporation would have a similar provision.

57 See Letter from Christopher K. Bowen, supra note 4 at 3.

58 See infra Section III.B.

59 See supra Section II.

60 The NYMEX Holdings board has passed resolutions for NYMEX, Inc. Rules 3.03 and 3.22, and to adopt the standards of 1.59, 1.63 and 1.69. The resolution for Rules 3.03 and 3.22 would reflect the changes to the criteria for board nomination, composition and governance and would insure that Commission Regulations 1.63 and 1.64 are applied to the NYMEX Holdings board of directors. See NYMEX Holdings Board Resolutions, dated July 12, 2000. See also infra note 66.

61 Existing NYMEX's insider trading rules would not be amended and, therefore, would apply to NYMEX, Inc. See Existing NYMEX Rule 3.02 (Restrictions on Board and Committee Members who possess material non public information), Rule 6.31 (Trading Prohibitions of Certain Persons), and Rule 6.31A (Trading Prohibition for Exchange Employees). See also supra Section II.F.1.

62 Existing NYMEX Rule 3.03 would apply the prohibitions on board and committee service by persons with a history of disciplinary violations, as delineated in Commission Regulation 1.63, to the governing board of NYMEX, Inc. See Existing NYMEX Rules 3.03 (Disqualification from board and committee service). Regulation 1.63 prohibits a person from serving on a governing board if, within the last three years, he or she was found to have committed a "disciplinary offense." Under the current Board selection process pursuant to Existing NYMEX Rules, the Membership Subcommittee screens the candidates being considered as nominees for election to the Board to determine whether each proposed nominee is eligible for the position or positions for which he was recommended. See Existing NYMEX Rule 3.22 (Membership Committee).

63 According to Existing NYMEX, the proposed amendment to Existing NYMEX Bylaw 300 was intended to ensure that Regulation 1.64 requirements would continue to be met. Regulation 1.64 sets forth certain composition requirements for self-regulatory organization ("SRO") governing boards. NYMEX, Inc. Bylaw 300 incorporates the composition requirements of Commission Regulation 1.64 by reference. See NYMEX, Inc. Bylaws, Section 300. See supra Sections II.E. See also infra IV.A.4. The Division would be able to monitor compliance with the composition requirements of Commission Regulation 1.64 through (1) the requirement under Commission Regulation 1.64(d) that each SRO submit a list of its governing board members within 30 days of a governing board election; and (2) its Rule Enforcement Reviews.

64 Existing NYMEX Rule 3.04 which sets forth the conflict of interest procedures contained in Commission Regulation 1.69, would not be amended and therefore would apply to NYMEX, Inc. See Existing NYMEX Rule 3.04 (Conflicts of Interest).

65 As the board composition would be voted on by stockholders, NYMEX Holdings board has passed resolutions to insure that a process similar to current NYMEX Rule 3.22 is used to screen the proposed nominees for the NYMEX Holdings board. See NYMEX Holdings Resolution dated July 12, 2000.

66 NYMEX Holdings has agreed that it would be appropriate to apply the standards of Commission Regulations 1.59 and 1.69 to the members of its board to prevent possible trading on information received as the parent of NYMEX, Inc. or possible voting in situations of a conflict of interest.

67 As previously mentioned, the Certificate of Incorporation of NYMEX, Inc. requires that a board member of NYMEX Holdings also be a board member of NYMEX, Inc. See NYMEX, Inc. Certificate of Incorporation, Article 7. See supra Section II.C.1. Hence, as long as the NYMEX, Inc. Class A memberships remain stapled to the NYMEX Holdings common stock, the compositional requirements of Commission Regulation 1.64 would be applied to board members of NYMEX Holdings. See also NYMEX Holdings Board Resolutions, dated July 12, 2000. The NYMEX Holdings Certificate of Incorporation sets forth the requirements to qualify as a director of NYMEX Holdings and incorporates the current section of Existing NYMEX's Bylaws that complies with Commission Regulation 1.64. See Existing NYMEX Bylaws, Section 306. See NYMEX Holdings Certificate of Incorporation, Article 6. See also Letter from Christopher K. Bowen, supra note 4 at 2.

68 See Division, CME Memo 20-21 (June 15, 2000).

69 Id. at 21.

70 Id. at 22.

71 See id. at 22-24.

72 Letters from Christopher K. Bowen, supra note 4 at 3-4 and Christopher K. Bowen, supra note 16 at 1.

73 As in the case of issues concerning conflicts of interest, Existing NYMEX, NYMEX Holdings, and NYMEX, Inc. support the above mentioned representations through references to their strong business incentive to preserve the current reputation of NYMEX as a well-regulated exchange with market integrity. See Letter from Christopher K. Bowen, supra note 9 at 3. See also Letter from Christopher K. Bowen, supra note 16 at 4.

74 See supra Sections III.A. and III.B. See also NYMEX, Inc. Bylaws, Article 3 Section 300 (A).

75 See supra note 67. See also supra Section III.B.

76 See supra Section III.B.

77 See supra note 62. See also supra Section III.B.

78 See Letter from Christopher K. Bowen, supra note 4 at 2,3.

79 See Existing NYMEX Bylaws, Article 3, Section 301 (A) (stating "[t]he Board may also adopt, amend, rescind, or interpret the Rules of the Exchange and impose such fees, charges, dues and assessments, all as it deems necessary and appropriate"). NYMEX, Inc. intends to adopt this Bylaw section unchanged.

80 While, NYMEX Holdings does not currently have another subsidiary, Existing NYMEX has stated that the creation of eNYMEX would occur after the demutualization is completed. See supra note 2. Furthermore, Existing NYMEX has also stated that through adoption of the demutualization plan, it seeks to pursue business strategies as well as improve its ability to work with other strategic partners. Existing NYMEX states that possible opportunities might be an initial public offering of shares of NYMEX Holdings; a strategic business combination with another exchange; a private sale of equity interest in NYMEX Holdings to one or more investors; or the formation of subsidiary exchanges designed to exploit discrete lines of business through electronic trading. See supra note 44. Such new business would take place through NYMEX Holdings, diversifying its income stream and possibly bringing additional income from sources other than the regulated contract market.

81 See, e.g., the various subsidiaries developed by CBT.

82 See Financial Services Legislation: Hearings before the Senate Committee on Banking, Housing and Urban Affairs, 106th Cong. 1st Sess. (February 23, 1999) (Statement of Alan Greenspan, Chairman of the Federal Reserve Board) (commenting that the holding company structure provides better protection for and promotes the safety, soundness and stability of the banking and financial system).