Public Statements & Remarks

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 landscape.

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 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.

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]

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.

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]

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 regulators.

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 addresses?

    • 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 Practices?

    • 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 exchanges?

    • 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.


[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 percent).

[2] Under Commission Regulation 38.2, exchanges are now exempt from Regulation 1.64.

[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, § 210.01.

[5] Second Amended and Restated Bylaws of Chicago Mercantile Exchange Holdings, Inc., Art. III, § 3.5 (applicable to the board of trade through the Certificate of Incorporation of Chicago Mercantile Exchange, Inc., Art. V, § 3 (requiring that the board of directors of CME, Inc., be identical to that of CME Holdings, Inc.).

[6] Amended and Restated Certificate of Incorporation of NYMEX Holdings, Inc., Art. VI, § (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, § 302(c).

[8] Minneapolis Grain Exchange Rulebook, Ch. II, §§ 200.00 and 210.00.

[9] Note 5, supra.

[10] CME Comment Letter at 2.


Last Updated: July 25, 2007