[Federal Register: July 7, 2006 (Volume 71, Number 130)]

[Proposed Rules]

[Page 38739-38751]

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


[[Page 38739]]


Part IV

Commodity Futures Trading Commission


17 CFR Part 38

Conflict of Interest in Self-Regulation and Self-Regulatory

Organizations; Proposed Rule

[[Page 38740]]



17 CFR Part 38

RIN 3038-AC28

Conflicts of Interest in Self-Regulation and Self-Regulatory


AGENCY: Commodity Futures Trading Commission ("Commission").

ACTION: Proposed Acceptable Practices for compliance with section

5(d)(15) of the Commodity Exchange Act ("CEA" or "Act").\1\



\1\ Acceptable Practices for the Core Principles reside in

Appendix B to Part 38 of the Commission's Regulations, 17 CFR part

38, App. B.


SUMMARY: The Commission hereby proposes Acceptable Practices for

section 5(d)(15) of the Act ("Core Principle 15").\2\ The proposed

Acceptable Practices would provide designated contract markets

("DCMs") with a safe harbor for compliance with selected aspects of

Core Principle 15's requirement that they minimize conflicts of

interest in their decisionmaking. The proposed Acceptable Practices are

summarized as follows.


\2\ Core Principle 15 for designated contract markets provides

as follows: "CONFLICTS OF INTEREST--The board of trade shall

establish and enforce rules to minimize conflicts of interest in the

decisionmaking process of the contract market and establish a

process for resolving such conflicts of interest." CEA Sec.

5(d)(15), 7 U.S.C. Sec. 7(d)(15).


First, the Board Composition Acceptable Practice proposes that

exchanges minimize potential conflicts of interest by maintaining

governing boards composed of at least fifty percent "public"

directors, as defined below. Second, the proposed Regulatory Oversight

Committee Acceptable Practice calls upon exchanges to establish a

board-level Regulatory Oversight Committee, composed solely of public

directors, to oversee regulatory functions. Third, the Disciplinary

Panel Acceptable Practice proposes that each disciplinary panel at all

exchanges include at least one public participant, and that no panel be

dominated by any group or class of exchange members.\3\ Finally, the

proposed Acceptable Practices provide a definition of "public" for

exchange directors and for members of disciplinary panels.


\3\ See CEA Section 1a(24), 7 U.S.C. 1a(24) (defining the term

"member" to include both exchange members and non-member market

participants with trading privileges); see also 17 CFR 1.3(q).


Collectively, the proposed Acceptable Practices promote

independence in decisionmaking by self-regulatory organizations

("SROs"),\4\ and constitute a proactive yet measured step toward

ensuring that SROs maintain fair, vigorous, and effective self-

regulation in a rapidly evolving futures industry. The Commission

welcomes comment on the proposed Acceptable Practices.\5\


\4\ For purposes of these Acceptable Practices, the term

"SROs" refers to DCMs and is used interchangeably with the terms

"exchanges," "boards of trade" and "contract markets." As part

of its SRO study, the CFTC considered whether the current level of

"public" representation on boards of registered futures

associations ("RFAs") is still sufficient. That question and

related issues concerning RFAs remain under review and will be

addressed separately.

\5\ This Release is the latest development in the Commission's

SRO review that commenced in May 2003. The Acceptable Practices

proposed herein are based on comments received in response to prior

requests for comments published in the Federal Register, interviews

with industry participants, testimony given at a February 15, 2006

public hearing before the Commission, and other sources identified

herein as part of the basis for the instant proposals. Prior Federal

Register releases, responses thereto, the hearing transcript, and a

summary of interview comments, described with greater specificity

elsewhere herein, are available on the Commission's Web site at

http://www.cftc.gov, or are available through the Acting Secretary of the

Commission, whose name and address are listed above.


DATES: Comments should be submitted on or before August 7, 2006.

ADDRESSES: Comments should be sent to Eileen Donovan, Acting Secretary,

Commodity Futures Trading Commission, Three Lafayette Centre, 1155 21st

Street, NW., Washington, DC 20581. Comments may be submitted via e-mail

at [email protected] "Regulatory Governance" must be in the subject

field of responses submitted via e-mail, and clearly indicated in

written submissions. Comments may also be submitted at http://www.regulations.gov.

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

Director for Market Compliance, (202) 418-5429; or Sebastian Pujol

Schott, Special Counsel, (202) 418-5641, Division of Market Oversight,

Commodity Futures Trading Commission, Three Lafayette Centre, 1155 21st

Street, NW., Washington, DC 20581.


Table of Contents

I. Introduction

II. The SRO Review

A. Procedural History of the SRO Review

B. Issues Raised by the SRO Review

III. Description of Proposed Acceptable Practices

A. Board Composition; "Public" Director Defined

B. Regulatory Oversight Committee

C. Disciplinary Panels

IV. Analysis of Issues and Rationale for Acceptable Practices

A. Board Composition; "Public" Director

B. Regulatory Oversight Committee

C. Disciplinary Panels

V. Related Matters

A. Cost-Benefit Analysis

B. Regulatory Flexibility Act

C. Paperwork Reduction Act of 1995

VI. Text of Proposed Acceptable Practices

I. Introduction

Exchanges are "affected with a national public interest" in that

they "provid[e] a means for managing and assuming price risks,

discovering prices, or disseminating pricing information through

trading in liquid, fair, and financially secure trading facilities."

\6\ Exchanges are also the front-line regulators in the U.S. futures

industry.\7\ There are potential conflicts of interest inherent in an

exchange's responsibilities as a regulator of its market and members,

and the commercial interests embedded in its market operation.

Nevertheless, with proper checks and balances to address such

conflicts, coupled with vigilant Commission oversight, self-regulation

can continue to serve as an effective and efficient means of promoting

market integrity.


\6\ CEA Section 3(a), 7 U.S.C. Sec. 5(a).

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


Increasing competition,\8\ changing ownership structures,\9\ and


[[Page 38741]]

business models are dramatically transforming the U.S. futures

industry. Today U.S. futures exchanges must compete vigorously with

other exchanges, electronic trading facilities and foreign markets to

attract order flow, and also must meet customer demand for twenty-four

hour trading, immediate order execution, lower transaction costs, and

access to global markets. This heightened competition places strain on

exchanges' dual roles as regulators and as markets, and raises

questions about their ability to deal with pressures to subordinate

regulatory responsibilities to commercial imperatives. The trend

towards demutualization represents an additional challenge to

exchanges' performance of self-regulatory duties. Traditional SRO

conflicts have been joined by the possibility that self-regulatory

functions may be marginalized by potentially conflicting commercial



\8\ Increasing competition exists between U.S. and foreign

exchanges, and between domestic exchanges. The New York Mercantile

Exchange ("NYMEX") and the IntercontinentalExchange offer

competing contracts in Brent and WTI crude futures. Euronext.liffe,

a subsidiary of Euronext, and the Chicago Mercantile Exchange

("CME") offer competing Eurodollar contracts. Within the U.S., the

Chicago Board of Trade ("CBOT") and NYMEX offer several competing

gold and silver contracts.

New exchanges comprise a further source of new competition.

Since 2002, the Commission has designated six new contract markets,

all of which entered the marketplace as non-mutual, for-profit

entities. There is also competition between trading formats--open

outcry and electronic. NYMEX gold and silver contracts, for example,

trade primarily on the floor of the exchange, while CBOT offers its

gold and silver contracts only electronically. In addition, the new

contract markets referred to above trade only electronically, and

electronic trading now accounts for over 60% of all trading volume

on U.S. futures exchanges.

Finally, enhanced competition is evident between exchanges and

their large, institutional futures commission merchant ("FCM")

members. They may compete directly, with FCMs internalizing order

flow or exchanges disintermediating FCMs. They may also compete

indirectly, as occurs, for example, when FCMs establish or invest in

new exchanges offering substitutable contracts. Examples include the

Cantor Financial Futures Exchange (no longer trading), designated in

1998; BrokerTec Futures Exchange, designated in 2001; and U.S.

Futures Exchange, designated in 2004. The FCM-owners of new

exchanges may both compete against, and be subject to the regulation

of, the established SROs of which they are members.

\9\ The principal change in ownership structure is the

demutualization of member-owned exchanges and their conversion to

publicly traded stock corporations. In December 2002, CME became the

first U.S. futures exchange to transform from a membership mutual

organization to a publicly traded, for-profit entity. Class A shares

of its parent company, CME Holdings, Inc., are now listed on the New

York Stock Exchange ("NYSE"). In October 2005, after undergoing a

similar restructuring, the CBOT became the second U.S. futures

exchange to demutualize and offer its parent's stock for trading on

the NYSE.

While demutualization has been an important development for the

largest and most well-established futures exchanges, the advent of

exchanges structured as for-profit limited liability companies

("LLCs") is another significant trend.

\10\ Five domestic and international studies reviewed by the

Commission address this issue, and are noteworthy for the extent to

which they parallel concerns raised by futures industry

participants. Although the studies focus primarily on the securities

industry, some include futures markets as well, and the Commission

believes that the concerns raised by demutualization and competition

may be similar for both the futures and securities industries and


The Securities Industry Association's ("SIA") White Paper on

Reinventing Self-Regulation, (Jan. 5, 2000, updated Oct. 14, 2003),

observed, "the combined roles of SROs as market overseers and as

competitors may affect SROs" ability and willingness to perform all

their regulatory functions adequately, fairly, and efficiently"

(SIA 2003 at 3).

The International Organization of Securities Commissions"

("IOSCO") Issues Paper on Exchange Demutualization, (June 2001),

determined that although many concerns with respect to self-

regulation are not new, "demutualization and increased competition

may exacerbate them" (IOSCO at 5).

A U.S. Government Accountability Office's ("GAO") report to

Congress entitled "Securities Markets: Competition and Multiple

Regulators Heighten Concerns about Self-Regulation (May 2002) found

that some securities SRO members were "concerned that SROs could

adopt rules that unfairly impeded the ability of members to compete

against the SROs." Others were concerned that "an SRO, in its

regulatory capacity, could obtain proprietary information from a

member and, in its capacity as a market operator, inappropriately

use the information" (GAO at 7). Some securities SRO members also

expressed concern that "a demutualized, for-profit market operator

might be more likely to misuse its regulatory authority or be less

diligent in fulfilling its regulatory responsibilities in a desire

to increase profits" (GAO at 8). Abuse of authority could be

manifested, for example, through "rules that unfairly disadvantage

members or other markets or inappropriately sanction or otherwise

discipline members against which the SROs compete." (Id.)

A discussion paper prepared for the World Bank's ("WB")

Financial Sector Strategy Department by an independent consultant,

Implications of Demutualization for the Self-Regulatory and Public

Interest Roles of Securities Exchanges (John W. Carson, January

2003) (not necessarily representing the views or policies of the

World Bank), identified four "widely accepted" propositions with

respect to conflicts of interest and demutualization: (1) Conflicts

of interest in self-regulation have always existed; (2)

demutualization may increase the degree of those conflicts; (3)

demutualization introduces new conflicts of interest; and (4)

demutualization may reduce old conflicts (WB at 8). The World Bank

Study offered several recommendations with respect to self-

regulation: (1) "At a minimum, the threat of increased conflict in

exercising regulatory authority demands that new safeguards be put

in place to reduce the possibility of either the business units or

customers attempting to influence regulatory decisions;" (2) it is

imperative that decisions on opening investigations, when to expand

or close investigations, when to pursue disciplinary action, and

what penalty to seek are all made in an independent and unbiased

manner, without regard to business considerations and impact on

important customer relationships;" and (3) "strong measures are

required to ensure that the integrity of an exchange's regulatory

program is maintained and that it handles regulatory issues and

decisions in a neutral and unbiased mnaner" (WB at 42-43).

Finally, an International Monetary Fund ("IMF") Working Paper,

Demutualization of Securities Exchanges: A Regulatory Perspective

(Jennifer Elliott, September 2002) (not necessarily representing the

views of the IMF) identified two broad conflicts of interest

associated with demutualization. According to the Working Paper,

"the forces that have generated pressure on exchanges to

demutualize have also created new conflicts of interest and forced

regulators and exchanges to reconsider what and how regulatory

functions are delivered by the exchanges" (IMF at 7). One new

conflict of interest is that "shareholders, who are interested in

profit, may under fund the exchange's regulatory function. While in

theory, the exchange should only benefit from an adequate regulatory

standards [sic], exchanges may succumb to competitive pressure."

(IMF at 16). "The second conflict of interest is the disincentive

to regulate market participants (who represent order flow and are a

direct source of revenue for the exchange)" (Id).


In view of these developments, the Commission conducted a review of

self-regulation in the futures industry to consider whether, and how,

SROs can continue to fulfill their statutorily-mandated

responsibilities as regulators.\11\ Three key principles emerged from

this review. First, self-regulation continues to be the most effective

and efficient regulatory model available to the futures industry; the

self-regulatory system nevertheless must be updated and enhanced, as

appropriate and necessary, to keep pace with the changing marketplace.

Second, market forces, driven by global competition and changing

ownership structures, pose a heightened risk that SROs may fail to

fairly and vigorously carry out their regulatory responsibilities; such

conflicts, whether actual or perceived, must be addressed proactively

in the first instance by the SROs themselves. Third, the current market

environment mandates enhanced and transparent governance as an

essential business practice for maintaining market integrity and the

public trust.\12\


\11\ See Section II.A., infra.

\12\ In recent years, the U.S. financial industry has undertaken

major initiatives to strengthen corporate governance structures.

These initiatives respond, for the most part, to a perceived lack of

effective board oversight and emphasize board independence and

accountability. See Section II.B., infra.


The Acceptable Practices proposed today constitute the Commission's

considered view of best practices relating to SRO governance and

administration in order to address the concerns raised by SROs' dual

roles in light of increasing competition and demutualization. The

Acceptable Practices promote an optimal SRO governance structure, which

would minimize the potential for conflicts with the SRO's regulatory

duties. Specifically, the Acceptable Practices would ensure that there

is adequate independence within the SRO's board to insulate regulatory

functions from the interests of the exchange's management, members, and

other business interests of the market itself. An SRO is not simply a

corporation, but a corporation charged with the public trust. As such,

the board--the governing body of the SRO--must be structured in a way

that best fosters public confidence in the integrity of its

organization, and further, ensures that SRO functions take no less

preeminence than that accorded to the exchange's commercial interests.

The Acceptable Practices also would enhance the role of outside

impartiality in other key SRO functions, including a board-level

Regulatory Oversight Committee ("ROC") and disciplinary panels, to

further enhance the transparency and accountability of SRO decisions

impacting self-regulation. Finally, the proposed Acceptable Practices

carefully define "public" directors to identify those who can help

ensure that SRO regulatory programs remain effective, yet unburdened by

potential conflicts or pressures from the exchange's commercial or

member interests.

In summary, the Acceptable Practices proposed today are measured

steps--in the form of carefully-tailored internal safeguards and checks

and balances--to promote the independence of SRO functions. At the same

time, they ensure that industry expertise, experience, and

[[Page 38742]]

knowledge continue to play a vital role in SRO governance and

administration and thus, preserve the "self" in self-regulation. In

this manner, these proposed Acceptable Practices keep pace with

changing market dynamics and proactively ensure that the self-

regulatory model remains as vigorous, as fair, and as effective as

required to protect the integrity of U.S. futures markets and the

public confidence in them for years to come.

II. The SRO Review

A. Procedural History of the SRO Review

The Commission's Acceptable Practices are based on a comprehensive

review of self-regulation and SROs in the U.S. futures industry ("SRO

Review"). Phase I of the SRO Review explored the roles,

responsibilities, and capabilities of SROs in the context of industry

changes. Staff examined the designated self-regulatory organization

("DSRO") system of financial surveillance, the treatment of

confidential information, the composition of exchanges' disciplinary

committees and panels, and other aspects of the self-regulatory

process. At the conclusion of Phase I, the Commission identified two

issues for immediate attention: (1) An examination of the cooperative

regulatory agreement by which DSROs coordinate compliance examinations

of FCMs; and (2) ensuring the confidentiality of certain information

obtained by SROs and DSROs in the course of their regulatory

activities. Measures with respect to both issues were announced by the

Commission in February 2004. These issues are not addressed in this



\13\ The most recent amendments to the DSROs' cooperative

agreement were submitted to the Commission and published for

comment. Futures Market Self-Regulation, 69 FR 19166 (Apr. 12,

2004). See also Press Release, Commodity Futures Trading Commission,

Commission Progresses with Study of Self-Regulation (Feb. 6, 2004),

available at: http://www.cftc.gov/opa/press04/opa4890-04.htm.


After detailed interviews with an array of industry participants,

the Commission initiated Phase II of the SRO Review and broadened its

inquiry to address SRO governance and the interplay between exchanges'

self-regulatory responsibilities and their commercial interests.

In June 2004, the Commission issued a Federal Register Request for

Comments ("Request") on the governance of futures industry SROs.\14\

The Request sought input on the proper composition of exchange boards,

optimal regulatory structures, the impact of different business and

ownership models on self-regulation, the proper composition of exchange

disciplinary committees and panels, and other issues.


\14\ Governance of Self-Regulatory Organizations, 69 FR 32326

(June 9, 2004). In this release, comment letters ("CLs") in

response to the SRO Governance Request for Comments are referred to

by the name of the party submitting the letter and page number.

These letters are available at: http://www.cftc.gov/foia/comment04/foi04--005_1.htm.

A summary of interview comments (with names of

persons interviewed redacted) also is available at this Web site.


In November 2005, the Commission updated its previous findings

through a second Federal Register Request for Comments ("Second

Request") that focused on the most recent industry developments.\15\

The Second Request examined the board-level ROCs recently established

at some SROs in the futures and securities industries. It considered

the impact of the listing standards of the New York Stock Exchange

("NYSE") on publicly-traded futures exchanges; whether the standards

were relevant to self-regulation; and how the standards might inform

the Commission's own regulations. The Second Request also explored the

role of outside regulatory service providers, including RFAs, and SRO

governance and the composition of boards and disciplinary committees.


\15\ Self-Regulation and Self-Regulatory Organizations in the

Futures Industry, 70 FR 71090 (Nov. 25, 2005). Comment letters

received in response to this release are available at http://www.cftc.gov/foia/comment05/foi05--007_1.htm.


Phase II of the SRO Review concluded with a public Commission

hearing on "Self-Regulation and Self-Regulatory Organizations in the

U.S. Futures Industry" ("Hearing"). The day-long Hearing, held at

Commission headquarters in Washington, DC on February 15, 2006,

included senior executives and compliance officials from a wide range

of U.S. futures exchanges, representatives of small and large FCMs,

academics and other outside experts, and an industry trade group. The

Hearing afforded the Commission an opportunity to question panelists on

four broad subject areas: (1) board composition; (2) alternative

regulatory structures, including ROCs and third-party regulatory

service providers; (3) transparency and disclosure; and (4)

disciplinary committees.\16\


\16\ The Hearing Transcript ("Hearing Tr.") is available at



B. Issues Raised by the SRO Review

The SRO Review provided the Commission staff and industry

participants and observers a unique opportunity to comment on the

present state of self-regulation in the U.S. futures industry. Through

interviews with over 100 industry participants and observers, comments

received in response to Federal Register notices, and the Hearing, the

Commission gathered a wide range of views on the successes and

challenges facing self-regulation now and into the future.

In general, commenters and interview participants saw continuing

vitality in the central premise of self-regulation: that regulation

works best when conducted close to the markets by individuals with

market-specific expertise. At the same time, though, throughout the

course of the SRO Review and in the surrounding public debate on the

merits of self-regulation in the financial sector generally, many

identified increased competition, evolving business models, and new

ownership structures as critical changes capable of adversely impacting

exchanges' regulatory behavior.\17\


\17\ See e.g., Futures Industry Association ("FIA"), CL at 2

(Jan. 23, 2006); Comments of Professor Roberta S. Karmel, Centennial

Professor of Law, Brooklyn Law School ("Karmel"), Hearing Tr. at

32 ("[T]echnology and competition are creating more serious

conflicts and, in fact, it is these forces that propel

demutualization in the first place"); Comments of Christopher K.

Hehmeyer, Co-Chairman, Goldenberg Hehmeyer & Co., id. at 151

("[E]xchanges have done very well. But it would only take a couple

of bad quarters, God forbid, on the part of the exchanges, for there

to be pressures on some of the conflicts that haven't revealed

themselves in the past."); Comments of Susan M. Phillips, Dean,

George Washington University School of Business ("Phillips"), id.

at 116 ("Obviously, the whole exchange environment is changing

dramatically, probably more so now than at any time in history.

There are a lot of pressures on exchanges.").

See also IOSCO at 4. ("[A]s competition increases and exchanges

move from mutual or cooperative entities to for-profit enterprises,

new elements enter the environment. The commercial nature of the

exchange becomes more evident: maximizing profits becomes an

explicit objective."). Others have noted that, even absent

demutualization or for-profit exchanges, "intense competition alone

will * * * increase conflicts due to the need to reduce costs, be

more responsive to customers, and ensure that competing markets do

not gain advantage by imposing a lighter regulatory burden." WB at



Specifically, some interview and Hearing participants and

commenters expressed concern that for-profit, publicly traded exchanges

may under-invest in regulatory personnel or technology to control costs

and thereby meet the short-term expectations of stock holders and

analysts.\18\ The

[[Page 38743]]

exchanges' growing conflicts may also manifest themselves in under-

regulation of those market participants who generate significant income

or liquidity for the exchange--for example, FCMs that bring significant

customer volume, market makers that provide significant liquidity, or

high-volume locals. Conversely, concerns were raised that exchange

participants who are not favored by, or compete with, the exchange may

suffer from discriminatory or over-regulation.\19\


\18\ See, e.g., FIA CL (Jan. 23, 2006) at 1 (observing that SROs

may use their regulatory authority for anti-competitive purposes or

to adopt rules that benefit parochial interests at the expense of

the public interest); and Citigroup CL (Jan. 23, 2006) at 1-2

(echoing support for the views expressed in FIA's comment letter);

see also Comments of Jeffrey Jennings, Managing Director and Global

Head of Futures, Lehman Brothers ("Jennings"), Hearing Tr. at 53

("[A]s the exchanges become for-profit * * * we have to recognize

the issues that that raises, and the risks of there being some sort

of conflicts of interest. * * *").

\19\ Whether stemming from increased competition,

demutualization, or for-profit structures, potential conflicts of

interest in self-regulation may be all the more evident when

exchanges regulate their competitors. For example, when firms

operate their own market and also are users of an exchange, the

exchange could discriminate in disciplinary matters, trading rules,

fees, and other areas in which it has jurisdiction over the

competitor. It has been suggested that, as with other conflicts of

interest, "the conflicts inherent in an exchange regulating its

competitors, while not new, become more apparent where the exchange

is also a for-profit enterprise." IOSCO at 5.


Exchanges, in turn, have argued that increased competition,

demutualization, and other industry developments will strengthen self-

regulation, not weaken it.\20\ They stated that their competitive

advantage rests in offering fair and transparent markets that are free

from fraud, manipulation, and other abusive practices. Exchanges also

noted that demutualization and public listing create a new class of

exchange owners whose long-term interests are aligned with effective

self-regulation and fair markets.


\20\ See, e.g., CME CL (Jan. 23, 2006) at 2 and NYMEX CL (Jan.

23, 2006) at 3.


Against this backdrop of market changes raising implications for

the SROs" performance of their regulatory functions, the U.S.

financial industry has seen the emergence of governance "best

practices" and standards designed to enhance corporate responsibility.

These best practices and standards are found in a wide spectrum of the

U.S. business community, ranging from securities self-regulatory

organizations to major corporations and financial participants. All of

these initiatives emphasize corporate governance as the key tool for

the fulfillment of corporate responsibilities.\21\


\21\ See, e.g., Fair Administration and Governance of Self-

Regulatory Organizations, 69 FR 71126 (Dec. 8, 2004) ("Fair

Administration"); World Bank--Corporate Governance Principles of

Best Practices, available at: http://www.worldbank.org/html/fpd/privatesector/cg/codes.htm

; CalPERS Governance Principles, available

at: http://www.calpers-governance.org/principles/default.asp.


The cumulative impact of an evolving industry, operating in an ever

more competitive, global environment, and the growing attention to the

need for enhanced corporate governance, provide the basis for the

Commission's review of self-regulation in the futures industry and the

Acceptable Practices proposed herein.\22\


\22\ In the face of such developments, a Hearing participant

observed that "it is incumbent upon us all that the U.S. futures

industry establish standards that recognize and are responsive to

the realities of our changing industry and marketplace and are fair

and without any appearance of conflicts." Jennings, Hearing Tr. at



III. Description of Proposed Acceptable Practices

Section 5(d)(15) of the CEA ("Core Principle 15") requires that

exchanges "minimize conflicts of interest in the decision making

process." \23\ Underlying the Core Principle's mandate is the

recognition that management of conflicts of interest, which could

potentially compromise the independence of an exchange's decision

making, is fundamental to the effective operations of the exchange--no

less than customer protection and market integrity mandated by other

Core Principles. Core Principle 15 requires the exchanges to have

systems in place to address not only an individual's personal conflicts

of interest, but also the broader potential conflicts of interest

inherent in self-regulation.


\23\ Any board of trade that is registered with the Securities

and Exchange Commission ("SEC") as a national securities exchange,

is a national securities association registered pursuant to section

15(A)(a) of the Securities Exchange Act of 1934, or is an

alternative trading system, and that operates as a designated

contract market in securities futures products under Section 5f of

the Act and SEC Regulation 41.31, is exempt from the core principles

enumerated in Section 5 of the Act, and the Acceptable Practices



As discussed earlier, with respect to SROs that operate as both

markets and front-line regulators, these conflicts may be further

exacerbated by emerging market trends. At present, however, there are

no Acceptable Practices for Core Principle 15. The Commission's core

mission is to promote and protect the integrity of the U.S. futures

markets and to promote public confidence and trust in those markets.

Now, as the futures industry undergoes one of the most significant

transformations in its long history, self-regulation must keep pace.

Accordingly, the Commission believes that it is appropriate and

necessary to provide guidance to SROs in the form of Acceptable

Practices for Core Principle 15.

Core Principle 15 is illustrative of the new regulatory approach

ushered in by the Commodity Futures Modernization Act of 2000

("CFMA"),\24\ which replaced prescriptive rules governing futures

exchanges with broad, flexible core principles. The core principles set

standards of performance for the exchanges, and at the same time, allow

exchanges considerable leeway in how to meet those standards. To

facilitate compliance, the Commission has adopted Acceptable Practices

for other core principles. Through its Acceptable Practices, the

Commission provides exchanges with a safe harbor for complying with

selected requirements of a core principle, but such Acceptable

Practices, as stated in the Act, are not the exclusive means for

compliance.\25\ Once implemented, Acceptable Practices provide

regulatory certainty that exchanges may rely upon when seeking

designation as contract markets or when subject to periodic Rule

Enforcement Reviews by the Commission.\26\


\24\ Appendix E of Pub. L. No. 106-554, 114 Stat. 2763 (2000).

\25\ See CEA Section 5c(a)(2), 7 U.S.C. Sec. 7a-2(a)(2).

\26\ The Commission has explained that "boards of trade that

follow the specific practices outlined under [the Acceptable

Practices] * * * will meet the selected requirements of the

applicable core principle." 17 CFR part 38, App. B, ] 2.


The Acceptable Practices proposed in this Release are designed to

offer exchanges a roadmap for complying with selected requirements of

Core Principle 15. The Acceptable Practices that we propose today would

enable SROs to demonstrate that they are structurally capable of

protecting their regulatory functions and decision making from

conflicts of interest.\27\

As with Acceptable Practices generally, exchanges may choose not to

comply with the proposed Acceptable Practices for Core Principle 15.

They still will be required, however, to demonstrate that their

policies and practices with respect to governance and decision making

are in compliance with Core Principle 15 by other means.\28\


\27\ In recent amendments to Appendix B of Part 38, the

Commission has explained that "the enumerated acceptable practices

under each core principle are neither the complete nor the exclusive

requirements for meeting that core principle. With respect to the

completeness issue, the selected requirements in the acceptable

practices section of a particular core principle may not address all

the requirements necessary for compliance with the core principle."

Technical and Clarifying Amendments to Rules for Exempt Markets,

Derivatives Transaction Execution Facilities and Designated Contract

Markets, and Procedural Changes for Derivatives Clearing

Organization Registration Applications, 71 FR 1953, 1958 (Jan. 12,

2006). The Acceptable Practices that we propose today do not reach,

and are not intended to reach, individual, personal conflicts of

interest. A contract market must address these conflicts as well as

the structural conflicts that are the subject of these proposed

Acceptable Practices in order to demonstrate full compliance with

Core Principle 15's requirements.

\28\ In this regard, the CFTC will take into account the

governance and regulatory conflicts of interests specific to the

exchange and how they are being managed.


[[Page 38744]]

The elements of the proposed Acceptable Practices under Core

Principle 15 are summarized below. The Commission proposes as a new

Acceptable Practice under Core Principle 15 that at least fifty percent

of the board members of exchanges' boards of directors and executive

committees (or similarly empowered bodies) be "public" directors, as

defined below ("Board Composition Acceptable Practice"). Day-to-day

regulatory operations should be supervised by a Chief Regulatory

Officer ("CRO") reporting directly to a ROC ("Regulatory Oversight

Committee Acceptable Practice"). The Acceptable Practices define

"public director" for persons serving on boards, ROCs, and

disciplinary panels. An individual may qualify as a public director

upon an affirmative determination by the board that the individual has

no material relationship with the exchange.

In addition, the Acceptable Practices strengthen impartial

adjudication by providing that SRO disciplinary panels should not be

dominated by any group or class of SRO participants, and that each

panel should include at least one public member ("Disciplinary Panel

Acceptable Practice"). By increasing the public voice on governing

boards and disciplinary committees and creating an independent board-

level ROC, combined with Commission oversight, the Acceptable Practices

seek to maintain the existing high standards of fair and effective

self-regulation in the futures industry, while proactively adapting

them to the market and business realities of a new era for the

industry. Each of these Acceptable Practices is described below.

A. Board Composition; "Public" Director Defined

The Board Composition Acceptable Practice provides that exchanges

should elect governing boards composed of at least fifty percent public

directors. In addition, it provides that SROs' executive committees (or

similarly empowered bodies) should be at least fifty percent public.

The Acceptable Practice offers guidance on the definition of

"public" director. The proposed definition provides that a director

is "public" only if the board of directors affirmatively determines

that the director has no "material relationship" with the exchange.

The nominating committee of the board of directors should affirmatively

determine on the record that a director or nominee has no material

relationship with the exchange, and should state on the record the

basis for its determination and the scope of its scrutiny. The

committee should reevaluate that determination at least on an annual


"Material relationships" are those that reasonably could affect

the independent judgment or decision making of the director. Material

relationships are not exclusively compensatory or financial. Any

relationship between a director and the exchange that may interfere

with a director's ability to deliberate objectively and impartially on

any matter is a material relationship. In this regard, material

relationships are not limited to those where a director has an

immediate interest in a particular matter before him or her.

In addition to the general materiality test, the proposed

definition of "public" director identifies specific circumstances or

relationships that would preclude a determination that a person

qualifies as a "public" director. Specifically, a director could not

be "public" if any of the following circumstances existed: \29\


\29\ These specific circumstances--or "bright-line" tests--are

neither exclusive nor exhaustive. A director does not qualify as

"public" unless the board affirmatively determines that the

director has no material relationship with the exchange, including

but not limited to, the bright-line tests identified herein.


--The director is an officer or employee of the exchange or a director,

officer or employee of its affiliate; \30\


\30\ As used in this context, an affiliate includes parents or

subsidiaries of the contract market or entities that share a common

parent with the contract market.


--The director is a member of the exchange, or a person employed by or

affiliated with a member. In this context, a director is affiliated

with a member if the director is an officer or director of the member;

--The director receives more than $100,000 in payments from the

exchange, any affiliate of the exchange, or a member or anyone

affiliated with a member; \31\

--Any of the relationships above apply to a member of the director's

immediate family, i.e., spouse, parents, children, and siblings.


\31\ Compensation for services as a director will not be counted

towards the $100,000 threshold test.


--All of the disqualifying circumstances described above are subject to

a one-year look back. Thus, for example, a director who, within the

past year, was a member of the exchange, would not qualify as a

"public" director.

Comments are solicited on whether there are additional categories

of circumstances which should automatically disqualify a person from

consideration as a "public" director. Also, commenters have suggested

that members should not be precluded from serving as a "public"

director. They have offered as examples persons who engage in de

minimis trading, or members who lease their seats to others. The

Commission seeks the public's views on whether these or similar

circumstances could rebut the presumption of member disqualification as

a "public" director.

B. Regulatory Oversight Committee

The Regulatory Oversight Committee Acceptable Practice recognizes

the importance of insulating core regulatory functions from improper

influences and pressures stemming from the exchange's commercial

affairs. To comply with the Regulatory Oversight Committee Acceptable

Practice, every exchange should establish, as a standing committee of

its board of directors, a ROC with oversight responsibility for all

facets of the SRO's regulatory program. This includes broad authority

to oversee: (1) Trade practice surveillance; (2) market surveillance;

(3) audits, examinations, and other regulatory responsibilities with

respect to member firms; \32\ (4) the conduct of investigations; (5)

the size and allocation of regulatory budgets and resources; (6) the

number of regulatory officers and staff; (7) the compensation of

regulatory officers and staff; (8) the hiring and termination of

regulatory officers and staff; and (9) the oversight of disciplinary

committees and panels.


\32\ SROs' regulatory responsibilities with respect to member

firms include ensuring compliance with financial integrity,

financial reporting, sales practice, recordkeeping, and other

requirements. Commission Regulation 1.52 permits cooperative

agreements among exchanges to coordinate compliance examinations of

FCMs such that each FCM is assigned a primary examiner (its DSRO).

ROCs should have authority over SROs self-regulatory functions, both

when the SROs are fulfilling SRO responsibilities and when they are

fulfilling DSRO responsibilities.


The ROC's primary role is to assist the board in fulfilling its

responsibility of ensuring the sufficiency, effectiveness, and

independence of self-regulatory functions.\33\ In this capacity, the

ROC should have the authority, discretion and necessary resources to

conduct its own inquiries; consult directly with regulatory staff;

interview employees, officers, members, and others; review relevant

documents; retain independent legal counsel, auditors, and other

professional services; and otherwise exercise its independent analysis


[[Page 38745]]

judgment to fulfill its regulatory obligations.\34\


\33\ In its review of exchanges for compliance with Core

Principles, the Commission will look at board documentation of the

reasons for its actions and its acceptance or rejection of

recommendations by the ROC, as well as by other committees.

\34\ Nevertheless, a ROC should not rely on outside

professionals or firms that also provide services to the full board,

other board committees, or other units of the exchange.


ROCs would be expected to identify aspects of the regulatory scheme

that work well and those that need improvement, and, as necessary, to

make recommendations to the governing board for changes that would

ensure fair, vigorous, and effective regulation. ROCs should also be

given an opportunity to review and, if they wish, present formal

opinions to management and the board on any proposed rule or

programmatic changes originating outside of the ROCs, but which their

CROs believe may have a significant regulatory impact.\35\ Exchanges

should provide their CROs and ROCs with sufficient time to consider

such proposals before acting on them. In addition to periodic reports

to the board, ROCs should prepare for the governing board and the

Commission an annual report assessing the effectiveness, sufficiency,

and independence of the SRO's regulatory program, including any

proposals to remedy unresolved regulatory deficiencies. ROCs are also

expected to keep thorough minutes and records of meetings,

deliberations, and analyses, and make these available to Commission

staff upon request.\36\


\35\ ROCs' deliberations with respect to such proposed rule

changes should be memorialized in thorough meeting minutes, and

their formal opinions made available to Commission staff upon


\36\ The Commission's review of Core Principle 15 compliance

will include, inter alia, the ROC's records, annual reports, meeting

minutes, analyses conducted or commissioned by the ROC, examinations

of proposed and existing rules, and evaluations and recommendations

concerning the effectiveness, sufficiency, and independence of the

exchange's regulatory programs. See Section 8(a)(1) of the Act, 7

U.S.C. Sec. 12(a)(1), authorizing the Commission to "make such

investigations as it deems necessary to ascertain the facts

regarding the operations of boards of trade and other persons

subject to the provisions of this Act."


Finally, the proposed Acceptable Practice envisions that the CRO of

the SRO will report directly to, and regularly consult with, the ROC.

ROCs may delegate their day-to-day authority over self-regulatory

functions and personnel to the CRO. Although ROCs remain responsible

for ensuring the sufficiency, effectiveness, and independence of self-

regulation within their SROs, they are not expected to assume

managerial roles.

C. Disciplinary Panels

The proposed Disciplinary Panel Acceptable Practice would preclude

any group or class of exchange members from dominating or exercising

disproportionate influence on any disciplinary panel. In addition, the

Commission proposes that all disciplinary panels include at least one

"public" participant. To qualify as "public," panel members should

meet the same test as public directors.

For purposes of this Acceptable Practice, "disciplinary panel"

means any person, panel of persons, or any subgroup thereof, which is

authorized by an SRO to issue disciplinary charges, to conduct

proceedings, to settle disciplinary charges, to impose disciplinary

sanctions, or to hear appeals thereof, except in cases limited to

decorum, attire, the timely submission of accurate records required for

clearing or verifying each day's transactions or other similar

activities. If an exchange's rules provide for an appeal to the board

of directors, or a committee of the board, then that appellate body

should include at least one person who meets the qualifications for

membership on the board's ROC. "Disciplinary panel" does not include

exchange regulatory staff authorized to issue warning letters or

summary fines imposed pursuant to established schedules.

To take advantage of this safe harbor, and thereby comply with Core

Principle 15's requirement to minimize conflicts of interest in

decisionmaking, the Commission is proposing that exchanges amend their

disciplinary panel composition rules and policies to incorporate the

terms of the Disciplinary Panel Acceptable Practices. Finally, under

this Acceptable Practice, disciplinary committees and panels would fall

under the oversight of the ROC.

IV. Analysis and Rationale for Proposed Acceptable Practices

A. Board Composition; "Public" Director

The Board Composition Acceptable Practice is designed to promote

and safeguard the independence of the board of directors. It reaffirms

the basic corporate principle that good governance is the cornerstone

of a strong corporation and that a company's long-term success is best

secured by enhancing the presence of independent participants at the

highest level of corporate decisionmaking, the board of directors.

In any corporation, the paramount duty of the board of directors is

to act, at all times, in the best interest of the corporation. It is

the board that has the ultimate decisionmaking authority within a

corporation and that must be accountable for any failure in the

fulfillment of its corporate duties. In effect, the board represents

the first line of defense against corporate misconduct. In the case of

a corporation that also operates as an SRO, the board may have to make

decisions in circumstances where its role as a fiduciary to the

shareholders conflicts with its duty as a custodian of the public

trust.\37\ Increased competition and demutualization may further

exacerbate these potentially competing claims and render the board

susceptible to pressures that may impact its ability to carry out self-

regulatory duties to their fullest extent.


\37\ Any decisions made by SROs' boards of directors, although

not directly regulatory, implicate the public interest and the

intersection between regulatory responsibilities and commercial

imperatives. SROs' boards of directors determine transaction fees;

market data fees; and membership criteria. They control the

employment and compensation of senior executives, including the

president of the exchange, and they are sometimes responsible for

the appointment of public directors. Boards make fundamental

governance decisions, including those made with respect to the

strategic direction of the SRO and the oversight of self-regulation.

In addition, SROs' public interest obligations are cited in the very

purposes of the Act, which include "to serve the public interest *

* * through a system of effective self-regulation of trading

facilities." CEA Section 3(b), 7 U.S.C. 5(b).

As noted at the Hearing, "exchanges which also function as for-

profit institutions as well as SROs are truly occupying an

absolutely unique space in corporate America." Jennings,

Hearing.Tr. at 79.


The Commission's proposed Board Composition Acceptable Practice

constitutes a strong, proactive approach to ensuring the continued

success of self-regulation in the futures industry. With respect to

exchange boards of directors, their dual regulatory and commercial

roles suggest that a fifty percent "public" board is an appropriate

balance and should best enable directors to carry out their



\38\ Industry participants and observers noted that independence

of an exchange's board of directors is key to effective and

impartial self-regulation due to its role as the ultimate arbiter of

decisions affecting both commercial and regulatory functions of the

exchange. To address the conflicts of interest inherent in this dual

role, most participants agreed on the benefits of including

"public" directors on exchange boards. See e.g., Jennings, Hearing

Tr. at 29 ("[I]t is a fundamental requirement that exchange boards

must have a significant representation of independent public

directors. I believe it is appropriate that at least fifty percent

of the exchange board must comprise this group."); and Phillips,

Hearing Tr. at 159 (addressing reviews of exchanges' rulemaking

authority, "* * * it comes back to the governance process and the

independence of the board to really make those kinds of reviews

meaningful."). However, industry participants did not agree on what

specifically constitutes an appropriate board composition, or

whether existing exchange board compositions are adequate.


The Commission notes that its proposed Board Composition

[[Page 38746]]

Acceptable Practice is consistent with the trend of major governance

initiatives across the corporate and SRO communities in the United

States. In November 2003, the New York Stock Exchange ("NYSE") and

NASDAQ both implemented new governance standards for their listed

companies. Among the most important provisions is the requirement that

listed companies' boards have a majority of independent directors. In

addition, listed companies must have fully independent nominating,

corporate governance, compensation, and audit committees. While the

conflicts driving these governance initiatives may differ from those

arising in the futures self-regulatory context, the NYSE and NASDAQ

standards for listed companies reflect their recognition that good

corporate governance is founded on strengthening the independence and

accountability of the board.

Two futures exchanges, the CME and the CBOT are now subject to the

NYSE listing standards outlined above, and others may join them as

futures exchanges continue to demutualize and seek public listing of

their shares. The Commission is satisfied that the listing standards

provide a measure of shareholder protection for the owners of publicly-

traded futures exchanges. However, the Commission is equally satisfied

that these listing standards are not designed for public companies that

also bear a special responsibility of public protection and fair and

effective self-regulation. Although it may be true, as the publicly-

traded futures SROs have determined, that SRO members are independent

under the NYSE listing standards, the proposed Board Composition

Acceptable Practice provides that members are not independent for

purposes of protecting the public interest against conflicts of

interest in self-regulation.

Finally, the fifty percent minimum standard strikes a favorable

balance between inside expertise and "outside" impartiality and

ensures that other exchange stakeholders, such as members and exchange

management, are adequately represented. In this manner, the "self" in

self-regulation is retained, along with its efficiencies and expertise,

while the ultimate benefactors of the self-regulatory system--market

participants and the public--are assured that their interests are well-

represented at the highest level.

(i) Definition of "Public" Director

To facilitate compliance, the Commission has modeled aspects of its

"public" director definition, and more specifically, the materiality

test, on what have now become accepted standards for defining

independent directors. For example, the NYSE governance standards,

noted above, mandate that to qualify as independent, directors must

meet both a series of bright-line tests capturing certain present and

past employment, compensation, business, familial, and other

relationships; and a categorical "no material relationship" test.

Similarly, under the Commission's proposed definition, the

determination of whether a person qualifies as a "public" director

entails (1) proposed "bright-line" tests, such as membership,

employment, and business and financial ties with the exchange, aimed at

identifying many of the circumstances that necessarily impair

independent decision making; and (2) a facts and circumstances

analysis. As to the facts and circumstances analysis, the board, taking

into account all of the relevant factors relating to the person's

relationship with the exchange, must make a reasonable finding on the

record that the person is capable of independent decision-making. This

analysis is broader than the bright-line tests.

Similar standards have already been implemented in a variety of

related contexts: by the Public Company Accounting Reform and Investor

Protection Act of 2002 (Sarbanes-Oxley Act of 2002) with respect to

independent directors serving on the audit committees of public

companies;\39\ and by the NYSE for its own board of directors.\40\ The

SEC has also proposed similar standards for independent directors on

the boards of securities exchanges.\41\


\39\ Pub. L. No. 107-204, 116 Stat. 745 (2002).

\40\ Constitution of the New York Stock Exchange, Art. IV, Sec.


\41\ Fair Administration, supra note 21.


The Acceptable Practice addressing board qualifications is named

the "Public Director Acceptable Practice" rather than the

"Independent Director Acceptable Practice" to emphasize the national

public interest in futures trading and the role that SROs play in

serving and protecting that interest.\42\ The appropriate definition

of, and qualifications for, an unconflicted director were debated

vigorously during the SRO Review.\43\ The debate often centered on

whether the NYSE listing standards are sufficient for self-regulatory

purposes. Several commenters and Hearing participants noted that the

NYSE independent director standard principally operates to protect

shareholder interests against undue management influence, and that more

is needed to protect the public interest in an institution that

exercises regulatory duties.\44\ The Commission generally agrees that

the listing standards are not sufficient for public companies that also

bear special responsibility to the public to self-regulate fairly and

effectively. Simply stated, self-regulation and shareholder protection

are two distinct missions: they may be complementary, but they are not



\42\ See CEA Section 3(b), 7 U.S.C. Sec. 5(b).

\43\ FIA for example, commented that "[i]ndependent SRO

directors should be independent not only of management but also of

all activity on the exchange" because "[t]he special nature of an

SRO's powers and functions * * * makes it essential to have truly

independent directors with no direct, current ties to the industry

the SRO regulates." FIA CL (Jan. 23, 2006) at 3. NYMEX, on the

other hand, was of the view that active industry participation did

not impair impartiality so long as a director had no ties to the

exchange itself. See NYMEX CL (Jan. 23, 2006) at 7: NYMEX stated

that its "Public Directors would qualify as independent directors"

under NYSE listing standards and noted that "it is possible for

markets subject to [NYSE] listing standards to conclude that

exchange members qualify as independent directors." NYMEX noted the

"specialized" nature of futures trading and emphasized the

importance of board expertise. Id. The CME as well stated that

independence should be determined on a case by case basis. CME CL

(Jan. 23, 2006) at 7.

\44\ See, e.g., Karmel, Hearing Tr. at 33 ("The New York Stock

Exchange and NASDAQ listing standards, as others have already said,

do not squarely address the key issue of whether exchange members

should be considered independent or not when they serve as directors

of an exchange board or a regulatory subsidiary"; and FIA CL (Jan.

23. 2006) at 3.


B. Regulatory Oversight Committee

ROCs would provide independent oversight of core regulatory

functions, including trade practice, market, and financial

surveillance, for all exchanges. ROCs also would oversee the

performance of disciplinary committees. Because these functions are

fundamental manifestations of SROs' regulatory authority, the

Commission believes that they should be overseen in the most impartial

manner possible within the context of self-regulation--by public

directors who are neither members of the SRO nor otherwise dependent

upon the commercial enterprise.\45\


\45\ The Commission's proposed Regulatory Oversight Acceptable

Practice is similar to measures already implemented or recommended

by some exchanges in response to acknowledged self-regulatory

concerns. The CME, for example, has formed an advisory board-level

committee to "ensure the independent exercise" of self-regulatory

obligations ("Market Regulation Oversight Committee" or "MROC").

Every member of the committee must be an independent director. The

MROC reviews and reports to CME's board, on an annual basis, with

respect to: (1) The independence of CME's regulatory functions from

its business operations; (2) the independence of CME management and

regulatory personnel from improper influence by industry directors

regarding regulatory matters; (3) CME's compliance with its SRO

responsibilities; (4) appropriate funding and resources to ensure

effective performance of SRO responsibilities; and (5) appropriate

compensation for CME employees involved in regulatory activities.


[[Page 38747]]

The public directors on the ROC would be free to consider the

unique responsibilities of the SRO to act in the public interest, to

plan for effective self-regulation in the long-term, and to insulate

regulatory decisions from short-term pressures that may be brought to

bear in an increasingly competitive environment. The Commission

believes that SROs generally stand to benefit from establishing ROCs.

ROCs' determinations with respect to their core competencies would

be subject to review by the full board of directors, including member

directors, and ROCs would be free to consult widely within the SRO

throughout their deliberations, thus ensuring that member expertise

remains central to self-regulation in the futures industry. At the same

time, by placing initial oversight responsibility in the hands of

public directors, arming them with the tools and resources necessary to

make fully informed decisions, and providing an independent reporting

line for senior regulatory officers, SROs would ensure that regulatory

decisions are insulated from improper influences. The ROC structure,

combined with careful Commission review of the interaction between the

ROC and the board, fosters the continued integrity of futures self-

regulation, effective management of conflicts of interest within SRO

governance, and full consideration of the public interest in every

decision of regulatory consequence.

C. Disciplinary Panels

Diversity in committee and panel composition has long been

recognized as an effective tool for minimizing conflicts of interest in

SRO disciplinary adjudication, a long-standing objective of the

Commission. Prior to enactment of the CFMA, the Act set specific

standards for the composition of SRO disciplinary committees, requiring

that: (1) Exchanges provide for a diversity membership on all major

disciplinary committees and (2) respondents in exchange disciplinary

actions not be tried exclusively by their peers.

The CFMA continues the Act's commitment to fair disciplinary

procedures. The Acceptable Practices for Core Principle 2, for example,

require that exchanges discipline members and market participants

pursuant to "clear and fair standards." \46\ As stated earlier, Core

Principle 15 requires exchanges to "minimize conflicts of interest in

the decision making process." This requirement extends to disciplinary

committees and panels, which must be free of both individual and group

(e.g., floor versus FCM) conflicts of interest.


\46\ 17 CFR Part 38, App. B, Core Principle 2, Acceptable



The Commission believes that fair disciplinary procedures with

minimal conflicts of interest require unbiased disciplinary panels

representing a diversity of opinions and experiences. At the very

least, this presumes panels that are not weighted in favor of any

single class of exchange participants. Also, including a public person

provides an outside perspective and helps to ensure that the public's

interests are represented and protected. The Commission is confident

that proper composition can minimize potential conflicts of interest

and promote fairness on disciplinary panels, as required by Regulation

170.3 and Core Principles 2 and 15.

The SRO Review has found no indication of widespread inadequacy in

exchange disciplinary committees, as many FCMs suggested. To the

contrary, some exchanges maintain very diverse committees, including

nonmember representatives. For example, CME's seven-person Probable

Cause and Business Conduct panels each include three non-members.\47\

Furthermore, the Commission has found that, at most exchanges, FCMs are

more likely to appear before clearing house risk committees or

financial compliance/surveillance committees (where FCMs are typically

well-represented) than on business conduct committees or similar

committees (which may include broker, local, commercial, FCM, and

public panelists).


\47\ CME Rules 402, 406.


In addition, periodic Rule Enforcement Reviews conducted by the

Commission's Division of Market Oversight, which carefully examine

disciplinary sanctions, typically find that they are fair and do not

discriminate among different classes of exchange participants. Rule

Enforcement Reviews also examine exchange disciplinary procedures, and

consistently find that these are adequate.

The Commission is generally satisfied with the composition and

performance of most SRO disciplinary committees and panels, and

believes that significant new measures are not required at this time.

The Commission has found that disciplinary committees typically have

adequate diversity, sometimes including FCMs and nonmembers, and seek

to balance expertise with impartiality. Accordingly, the Commission's

proposed Disciplinary Panel Acceptable Practice acknowledges SROs'

current practices and the requirements of the Act, and identifies

minimal panel composition standards as a means of protecting the

continued integrity of the disciplinary process. It helps to minimize

conflicts of interest by ensuring a basic degree of diversity, and the

inclusion of at least one public person on SRO disciplinary panels.

To take advantage of the safe harbor offered by the proposed

Disciplinary Panel Acceptable Practice, and comply with Core Principle

15's requirement to minimize conflicts of interest in decision making,

the Commission is proposing that SROs' amend their rules and policies

to ensure that they preclude any group or class of exchange members

from dominating or otherwise exercising disproportionate influence on

any disciplinary panel. The Commission is also proposing that SROs

ensure that their rules and policies provide for public persons on

disciplinary panels, except in cases limited to decorum and attire.\48\

Public panel members should meet the definition of "public" for

directors serving on Regulatory Oversight Committees.


\48\ The proposed Disciplinary Panel Acceptable Practice is

broader than Regulation 1.64, in that it requires a public member to

participate in some categories of cases that, under Regulation 1.64,

may be heard by a panel with no public members. The Commission

believes the expansion of public participation is an appropriate

response to the growth in the size and complexity of the futures

markets, and the new profit element in exchange operations.

Moreover, a public member's presence on disciplinary panels will

enhance the appearance as well as the reality of fairness and

impartiality in exchange disciplinary proceedings, and thus promote

confidence in our markets among the public and market participants.


V. Related Matters

A. Cost-Benefit Analysis

Section 15(a) of the Act, as amended by Section 119 of the CFMA,

requires the Commission to consider the costs and benefits of its

action before issuing a new regulation or order under the Act. By its

terms, Section 15(a) does not require the Commission to quantify the

costs and benefits of its action or to determine whether the benefits

of the action outweigh its costs. Rather, Section 15(a) simply requires

the Commission to "consider the costs and benefits" of the subject

rule or order.

Section 15(a) further specifies that the costs and benefits of the

proposed rule or order shall be evaluated in light of five broad areas

of market and public

[[Page 38748]]

concern: (1) Protection of market participants and the public; (2)

efficiency, competitiveness, and financial integrity of futures

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

(5) other public interest considerations. The Commission may, in its

discretion, give greater weight to any one of the five enumerated areas

of concern and may, in its discretion, determine that, notwithstanding

its costs, a particular rule or order is necessary or appropriate to

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

to accomplish any of the purposes of the Act.

The Acceptable Practices proposed herein are safe harbors for

compliance with Core Principle 15's conflict of interest provisions.

They offer exchanges the opportunity to meet the requirements of the

Core Principle through a regulatory governance structure that insulates

their regulatory functions from their commercial interests. The

Acceptable Practices propose that exchanges implement boards of

directors that are at least fifty percent public. The Acceptable

Practices further propose that all exchange-SROs place oversight of

their core regulatory functions in the hands of board-level ROCs

composed exclusively of "public" directors. They also offer guidance

on what constitutes a "public" director. In addition, the Acceptable

Practices suggest minimum composition standards for exchange

disciplinary committees.

The proposed Acceptable Practices are consistent with legislative,

regulatory, and voluntarily undertaken changes in governance

requirements and practices in other financial sectors, such as the

securities markets, and are intended to enhance protection of the

public. The Commission has endeavored, in offering these Acceptable

Practices to propose the least intrusive safe harbors and regulatory

requirements that can reasonably be expected to meet the requirements

of Core Principle 15 of the Act. These Acceptable Practices advance the

Commission's mandate of assuring the continued existence of competitive

and efficient markets and to protect the public interest in markets

free of fraud and abuse.

They nevertheless may be expected to entail some costs, including,

among the most foreseeable, those attendant to recruiting and

appointing additional directors, amending corporate documents, making

necessary rule changes and certifying them to the Commission, and

appointing a CRO.

After considering these factors, the Commission has determined to

propose the Acceptable Practices with respect to contract markets. The

Commission specifically invites public comment on its application of

the criteria contained in the Act. Commenters are also invited to

submit any quantifiable data that they may have concerning the costs

and benefits of the proposed Acceptable Practices with their comment


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 proposed Acceptable Practices affect

contract markets. The Commission has previously determined that

contract markets are not small entities for purposes of the Regulatory

Flexibility Act.\49\ Accordingly, the Chairman, on behalf of the

Commission, hereby certifies pursuant to 5 U.S.C. 605(b) that the

proposed Acceptable Practices will not have a significant economic

impact on a substantial number of small entities.


\49\ 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 Acceptable Practices contain information collection

requirements. As required by the Paperwork Reduction Act of 1995 (44

U.S.C. 3504(h)), the Commission has submitted a copy of this section to

the Office of Management and Budget ("OMB") for its review.

Collection of Information: Rules Relating to Part 38, Establishing

Procedures for Entities to become designated as Contract Markets, OMB

Control Number 3038-0052. The Acceptable Practices increase the burden

previously approved by OMB.

The estimated burden was calculated as follows:

Estimated number of respondents: 12.

Annual responses by each respondent: 1.

Total annual responses: 12.

Estimated average hours per response: 70.

Annual reporting burden: 840.

Organizations and individuals desiring to submit comments on the

information collection requirements should direct them to the Office of

Information and Regulatory Affairs, Office of Management and Budget,

Room 10202, New Executive Office Building, 725 17th Street, NW.,

Washington, DC 20503; Attention: Desk Officer for the Commodity Futures

Trading Commission.

The Commission considers comments by the public on this proposed

collection of information in:

Evaluating whether the proposed collection of information is

necessary for the proper performance of the functions of the

Commission, including whether the information will have a practical


Evaluating the accuracy of the Commission's estimate of the burden

of the proposed collection of information, including the validity of

the methodology and assumptions used;

Enhancing the quality, usefulness, and clarity of the information to

be collected; and

Minimizing the burden of collecting information on those who are to

respond, including through the use of appropriate automated

electronic, mechanical, or other technological collection techniques

or other forms of information technology (e.g., permitting

electronic submission of responses).

OMB is required to make a decision concerning the collection of

information contained in these Acceptable Practices between 30 and 60

days after publication of this document in the Federal Register.

Therefore, a comment to OMB is best assured of having its full effect

if OMB receives it within 30 days of publication. This does not affect

the deadline for the public to comment to the Commission on the

Acceptable Practices.

Copies of the information collection submission to OMB are

available from the Commission Clearance Officer, Three Lafayette

Centre, 1155 21st Street, NW., Washington DC 20581, (202) 418-5160.

VI. Text of Proposed Acceptable Practices

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

Commission proposes to amend Part 38 of Title 17 of the Code of Federal

Regulations as follows:


1. The authority citation for part 38 is revised to read as


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

Appendix E of Pub. L. 106-554, 114 Stat. 2763A-365.

2. In Appendix B to Part 38 amend Core Principle 15 by adding

paragraph (b) "Acceptable Practices" as follows:

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

Compliance With Core Principles

* * * * *

[[Page 38749]]

Core Principle 15 of Section 5(d) of the Act: Conflicts of Interest

* * * * *

(b) Acceptable Practices. All designated contract markets

("DCMs" or "contract markets") bear special responsibility to

regulate effectively, impartially, and with due consideration of the

public interest, as provided for in Section 3 of the Act. Under Core

Principle 15, they are also required to minimize conflicts of

interest in their decision making processes. To comply with this

Core Principle, contract markets should be particularly vigilant for

conflicts between their self-regulatory responsibilities, their

commercial interests, and the interests of their management,

members, owners, customers and market participants, other industry

participants, and other constituencies.

Acceptable Practices for minimizing conflicts of interest shall

include the following elements:

(1) Board Composition for Contract Markets

(A) At least fifty percent of the directors on a contract

market's board of directors shall be public directors; and

(B) The executive committees (or similarly empowered bodies)

shall be at least fifty percent public.

(2) Public Director

(A) To qualify as a public director of a contract market, an

individual must first be found, by the board of directors on the

record, to have no material relationship with the contract market. A

"material relationship" is one that reasonably could affect the

independent judgment or decision making of the director.

(B) In addition, a director shall not be considered "public"

if any of the following circumstances exist:

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

market or a director, officer or employee of its affiliate;

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

person employed by or affiliated with a member. "Member" is

defined according to Section 1a(24) of the Commodity Exchange Act

and Commission Regulation 1.3(q). In this context, a director is

affiliated with a member if the director is an officer or director

of the member;

(iii) The director receives more than $100,000 in payments from

the contract market, any affiliate of the contract market or from a

member or anyone affiliated with a member, provided that

compensation for services as a director will not be counted towards

the $100,000 threshold test;

(iv) A director shall be precluded from serving as a public

director if any of the relationships above apply to a member of the

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

and siblings; and

(v) An affiliate includes parents or subsidiaries of the

contract market or entities that share a common parent with the

contract market.

(C) All of the disqualifying circumstances described in

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

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

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


(3) Regulatory Oversight Committee

(A) A board of directors of any contract market shall establish

a Regulatory Oversight Committee ("ROC") as a standing committee,

consisting of only public directors as defined in Section (2), to

assist it in minimizing potential conflicts of interest. The ROC

shall oversee the contract market's regulatory program on behalf of

the board. The board shall delegate sufficient authority, dedicate

sufficient resources, and allow sufficient time for the ROC to

fulfill its mandate.

(B) The ROC shall:

(i) Monitor the contract market's regulatory program for

sufficiency, effectiveness, and independence;

(ii) Oversee all facets of the program, including trade practice

and market surveillance; audits, examinations, and other regulatory

responsibilities with respect to member firms (including ensuring

compliance with financial integrity, financial reporting, sales

practice, recordkeeping, and other requirements); and the conduct of


(iii) Review the size and allocation of the regulatory budget

and resources; and the number, hiring and termination, and

compensation of regulatory personnel;

(iv) Supervise the contract market's chief regulatory officer,

who will report directly to the ROC;

(v) Prepare periodic reports for the board of directors and an

annual report assessing the contract market's self-regulatory

program for the board of directors and the Commission, which sets

forth the regulatory program's expenses, describes its staffing and

structure, catalogues disciplinary actions taken during the year,

and reviews the performance of disciplinary committees and panels;

(vi) Recommend changes that would ensure fair, vigorous, and

effective regulation; and

(vii) Review regulatory proposals and advise the board as to

whether and how such changes may impact regulation.

(4) Disciplinary Panels

All contract markets shall minimize conflicts of interest in

their disciplinary processes through disciplinary panel composition

rules that preclude any group or class of industry participants from

dominating or exercising disproportionate influence on such panels.

Contract markets can further minimize conflicts of interest by

including at least one person who would qualify as a public director

as defined in Section (2) above, on disciplinary panels, except in

cases limited to decorum and attire. If contract market rules

provide for appeal to the board of directors, or to a committee of

the board, then that appellate body shall also include at least one

person who would qualify as a public director as defined in Section

(2) above.

* * * * *

Issued in Washington, DC, on June 28, 2006 by the Commission.

Eileen A. Donovan,

Acting Secretary of the Commission.

Note: The following appendix will not appear in the Code of

Federal Regulations.


Commissioner Frederick W. Hatfield, writing separately.

Since the passage of the Commodity Futures Modernization Act of

2000 (CFMA), the U.S. futures industry has experienced dynamic

growth. With rapid growth comes new challenges. U.S. futures

exchanges are today faced with increased competition, domestically

and from abroad, changing ownership structures, and new business

models. As regulators, it is incumbent upon us to ensure that

regulatory guidelines continue to keep pace with the ever changing

environment of the industry. Accordingly, I applaud Chairman Jeffery

and Commission staff for their thoughtful and exhaustive pursuit of

fair, vigorous and effective self-regulation in this evolving market


In this review, I have been guided by two questions: have the

exchanges produced self-regulatory structures that are up to the

challenges of the changing marketplace and if not, are we as

regulators suggesting a better model? I look forward to receiving

comments on the Board Composition Acceptable Practice proposal.

However, in my view, establishing a board level Regulatory Oversight

Committee (ROC) comprised of nonmember public directors and a

disciplinary panel structure, as described in the proposal, goes a

long way toward ensuring that an exchange's regulatory duties will

not be compromised by conflicts emanating from commercial goals.

The primary function of the proposed ROCs is to ensure that

regulatory programs and staff are free of improper influence from

exchange owners, management, members, investors, customers, and

commercial considerations. As the proposal recognizes, "[t]he ROC

structure, combined with careful Commission review of the

interaction between the ROC and the board, fosters the continued

integrity of futures self-regulation, effective management of

conflicts of interest within SRO governance, and full consideration

of the public interest in every decision of regulatory

consequence." Section B. Regulatory Oversight Committee, last

paragraph. Despite this recognition, the proposed safe harbor would

require, in addition to public director ROCs, that at least fifty

percent of the governing boards and exchange executive committees

also be comprised of public directors.

Interest in SRO board composition has an established history in

the Commodity Exchange Act (Act) and in the Commission's

regulations. Prior to passage of the CFMA, Section 5a(14) of the Act

mandated diversity of representation on exchanges' boards of

directors.\1\ With passage of the CFMA, the

[[Page 38750]]

requirements of Section 5a(14) were removed for exchanges, as

Congress and the Commission moved to a more flexible, principles-

based oversight regime that does not include specific composition

targets for exchanges' boards of directors.\2\ Mutually owned

exchanges are still subject to mandatory board composition standards

under Section 5(c)(16) of the Act (Core Principle 16), which

requires "that the composition of the governing board reflect

market participants." The Application Guidance for Core Principle

16 identifies this as a "diversity of interests" requirement.


\1\ This provision of the Act was implemented by Commission

Regulation 1.64, which required exchanges to establish meaningful

representation for the following groups: (1) Futures commission

merchants (FCMs); (2) floor brokers and traders; (3) independent

non-members; (4) producers, consumers, processors, distributors, and

merchandisers of commodities traded on the particular exchange

("commercials"); (5) participants in a variety of pits or

principal groups of commodities traded on the exchange; and (6)

other market users or participants. Specific composition targets

existed only for commercials (ten percent) and nonmembers (twenty


\2\ Under Commission Regulation 38.2, exchanges are now exempt

from Regulation 1.64.


As part of the SRO Review, Commission staff examined the

corporate documents of the major exchanges under CFTC authority and

found that all require diversity of their boards of directors,

including nonmember directors.\3\ These diversity requirements are

similar regardless of the exchanges' ownership structures, and they

are present at all of the major exchanges. The Kansas City Board of

Trade, for example, requires that nominating committees give

"special consideration to the desirability of having all interests

of the Corporation represented on the Board of Directors." \4\ The

Chicago Mercantile Exchange (CME) requires that its board of

directors have "meaningful representation of a diversity of

interests, including floor brokers, floor traders, futures

commission merchants, [and commercials.]." \5\


\3\ The corporate documents included the certificates of

incorporation, bylaws, and rulebooks of the exchanges and their

holding companies, if applicable.

\4\ Kansas City Board of Trade Rulebook, Ch. II, Sec. 210.01.

\5\ Second Amended and Restated Bylaws of Chicago Mercantile

Exchange Holdings, Inc., Art. III, Sec. 3.5 (applicable to the

board of trade through the Certificate of Incorporation of Chicago

Mercantile Exchange, Inc., Art. V, Sec. 3 (requiring that the board

of directors of CME, Inc., be identical to that of CME Holdings,



Some exchanges employ specific numerical targets for their

various participant categories and public directors. For example,

the New York Mercantile Exchange requires three public directors,

one FCM, one floor broker, one commercial, and one local trader.\6\

The New York Board of Trade requires five public directors.\7\ The

Minneapolis Grain Exchange requires four nonmember directors, and at

least four commercials, two FCMs, two floor traders, and one floor

broker.\8\ The CME requires that independent, nonmember directors

constitute twenty percent of its board and that commercials

constitute ten percent of the board.\9\ Moreover, the CME currently

exceeds its own requirements, with seven of its twenty directors

(thirty-five percent) being independent, nonindustry persons.


\6\ Amended and Restated Certificate of Incorporation of NYMEX

Holdings, Inc., Art. VI, Sec. (c) (applicable to the board of trade

through the Amended and Restated Certificate of Incorporation of New

York Mercantile Exchange, Inc., Art. VII (the board of directors

NYMEX Holdings, Inc., constitutes the board of NYMEX, Inc.).

\7\ New York Board of Trade Bylaws, Art. II, Sec. 302(c).

\8\ Minneapolis Grain Exchange Rulebook, Ch. II, Sec. Sec.

200.00 and 210.00.

\9\ Note 5, supra.


Most of those who commented or testified during the course of

the SRO study generally agreed that diverse boards best serve the

needs of exchanges and the public. Participants also agreed on the

benefits of including public directors on exchange boards, and our

review demonstrates that this is a model that most exchanges are

following. In their comments and testimony, however, exchanges

unanimously opposed having mandatory board composition requirements.

CME argued, for example, that "no one composition criteria can

address the individual needs" of the diverse exchanges and business

models active in the industry.\10\


\10\ CME Comment Letter at 2.


In my view, having a ROC that serves to insulate the regulatory

functions of an exchange from its commercial interests, combined

with a disciplinary panel structure that strengthens impartial

adjudication and reduces potential conflicts of interest by

including at least one public person on every panel and ensuring

that such panels are not dominated by any group or class of exchange

participants, may well be sufficient to ensure fair, vigorous, and

effective self-regulation and should demonstrate compliance with

Core Principle 15. Such an approach would be narrowly tailored to

focus specifically on regulatory governance and functions, and would

be in keeping with the flexibility the CFMA intended to afford

exchanges to conduct business without undue interference from


I am concerned that the Board Composition proposal also would

create an additional and perhaps unnecessary layer of regulation for

publicly traded exchanges, which are already subject to myriad new

and enhanced corporate governance requirements, including, among

others, Securities and Exchange Commission registration

requirements, the audit committee provisions of the Sarbanes-Oxley

Act of 2002, and the listing standards of the New York Stock

Exchange (NYSE). I agree that the dual function of exchanges as

commercial enterprises and self-regulatory organizations sets them

apart from corporations engaged in business for the sole purpose of

earning profits for the benefit of shareholders. In my opinion,

however, the foregoing corporate governance standards, combined with

properly structured ROCs and disciplinary committees, and the

Commission's continuing obligation to monitor exchanges through rule

enforcement reviews and otherwise, have provided multiple levels of

safeguards that should be sufficient to ensure that exchanges"

self-regulatory obligations are not compromised.

I recognize that what the Commission is contemplating is an

acceptable practice rather than a mandatory requirement. In

promulgating such guidance, however, the Commission should strive to

establish standards that that are not overly broad and that are

viewed as necessary, in most circumstances, to accomplish regulatory

goals. Accordingly, I welcome comment on the advisability of

adopting the proposed Board Composition Acceptable Practice,

especially with respect to the following questions:

Is there an existing problem that this proposal


Will those exchanges that are not now subject to

mandatory diversity requirements feel compelled to sacrifice

voluntary diversity in order to increase the percentage of public

directors and still maintain boards that are of manageable size, or

will boards become larger? Is it feasible to comply with the

acceptable practice and maintain the proper level of diversity? What

are the relative costs and benefits of doing so?

How would the acceptable practice affect mutually owned

exchanges that are subject to the mandatory diversity requirements

of Core Principle 16?

How would the proposed requirement that exchange

executive committees have at least fifty percent public

representation affect the day-to-day operations of the exchanges?

Is there any evidence that the proposed Board

Composition Acceptable Practice will provide greater regulatory

assurance than the proposed ROC and Disciplinary Panel Acceptable


Do the corporate governance requirements currently

applicable to publicly traded exchanges, combined with properly

structured ROCs and disciplinary panels and continuing Commission

oversight, provide sufficient assurance that conflicts of interests

will be kept to a minimum in the decision making process of those


If the Commission adopts the Board Composition

Acceptable Practice, should it be accompanied by a phase-in period

and if so, what would be the appropriate length of time for

exchanges to modify their boards?

I join with my Chairman and fellow Commissioners in requesting

comment on this endeavor and look forward to reviewing the responses

to these questions and any other views the Commission receives as we

continue to consider the important issues raised in the proposal.

Commissioner Michael V. Dunn, writing separately.

The proposed acceptable practices published today represent an

important step forward in ensuring the fairness and transparency of

our commodity markets. I wish to comment on two aspects of the


First, the proposed rule notes that exchanges that elect to

forgo the safe harbor of the best practices outlined in this

proposal can still demonstrate compliance with Core Principle 15

through showing they have procedures and safeguards in place to

address potential conflicts of interest. For these exchanges, the

Commission will continue its current practice of reviewing the

activities of these exchanges to ensure they are in compliance with

Core Principle 15. Therefore, while the proposed acceptable

practices offer a safe harbor for complying with Core Principle 15,

they are not the only method of demonstrating compliance.

Second, efficient, transparent, and open markets bring great

benefits to their

[[Page 38751]]

participants and the public. The Commodity Futures Modernization Act

of 2000 (CFMA), sought to safeguard these values by placing a much

greater emphasis on industry self-regulation: setting out core

principles registrants have to meet and giving industry flexibility

in choosing how to comply.

While the Commission has final responsibility to ensure the

fairness and transparency of the markets it regulates, its

effectiveness in doing so relies heavily upon the presence of a

robust self-regulatory system. Registered Futures Associations

(RFAs) are provided for in the CEA to complement the Commission's

oversight of commodities markets and to bring industry knowledge and

experience to bear on regulatory issues affecting those markets.\1\

In its June 2004 request for comments on SRO governance that led to

this proposal, the Commission asked, "Should registered futures

associations that are functioning as SROs also be subject to

governance standards?" In its response, the National Futures

Association ("NFA"), the sole RFA, wrote that "registered futures

associations should be subject to the same governance standards as

the other SROs," as long as these standards are flexible.


\1\ See generally Section 17 of the Act, 7 U.S.C. 21. An RFA

must be determined by the Commission to be in the public interest.

Id. at Section 17(b)(1), 7 U.S.C. 21(b)(1).


As the sole RFA, NFA occupies a unique position in the futures

markets' system of self-regulation. NFA is entrusted with overseeing

a wide variety of futures market intermediaries, cutting across

different segments of the futures industry, including futures

commission merchants, commodity pool operators ("CPOs"), commodity

trading advisers ("CTA"), and introducing broker-dealers

("IBs"). NFA's functions are as varied as the members it oversees.

NFA performs registration and fitness screening functions, conducts

audits and surveillance of its members to enforce compliance with

financial requirements, establishes and enforces rules and standards

for customer protection, and conducts arbitration of futures-related

disputes. NFA also has taken certain functions delegated to it by

the Commission and more recently, has assumed trade practice and

market surveillance activities for a number of exchanges.\2\


\2\ When an RFA extends its sphere of operation beyond

traditional, self-regulatory roles to include such ancillary

activities, it appropriately should reexamine the methods it uses to

manage and minimize conflicts of interests, to determine whether

these methods remain adequate to meet changed circumstances.


In light of the concerns raised in this proposal regarding

conflicts of interest and self-regulation, I believe the Commission

needs to review the conflicts of RFAs as well as exchanges. In this

proposal, the Commission indicates in footnote 4 that we will be

considering this matter further, and I look forward to that


[FR Doc. 06-6030 Filed 7-6-06; 8:45 am]


Updated July 14, 2006

Last Updated: June 26, 2007