[Federal Register: November 25, 2005 (Volume 70, Number 226)]
[Page 71090-71092]
From the Federal Register Online via GPO Access [wais.access.gpo.gov]



Self-Regulation and Self-Regulatory Organizationsin the Futures

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

ACTION: Request for additional comments on self-regulation and self-
regulatory organizations ("SROs").\1\


    \1\ For purposes of this Request, SROs include designated
contract markets ("DCMs"), derivatives clearing organizations
("DCOs"), and registered futures associations.

SUMMARY: This Request for Comments ("Request") continues the
Commission's ongoing review of self-regulation and self-regulatory
organizations in the U.S. futures industry ("SRO Study"). The Request
seeks public comment on a range of SRO issues, including governance,
minimizing conflicts of interest within self-regulation, the
composition of SROs' boards of directors and disciplinary committees,
and the impact of increasing competition, changing business models and
new ownership structures on SROs' self-regulatory responsibilities.\2\
Commenters are also asked to consider the impact of securities
exchanges' listing standards and the unique role of registered futures
associations ("RFAs") and other third-party regulatory service
providers. The questions presented update the Commission's prior fact-
finding on self-regulation, build on industry developments since that
time, and offer interested parties an additional opportunity to comment
as the SRO Study nears conclusion. The questions raised in this Request
will also form the basis of an upcoming Commission roundtable on self-
regulation. The roundtable will provide a forum for industry
participants to present their views on both the challenges and
opportunities of self-regulation in a rapidly evolving futures

    \2\ SROs' self-regulatory responsibilities include, among other
things, market surveillance, trade practice surveillance, and audits
and examinations of member firms (e.g., ensuring compliance with
financial integrity, financial reporting, sales practice, and
recordkeeping requirements). An SRO's specific responsibilities will
depend upon whether it is a DCM, DCO, or RFA.

DATES: Responses must be received January 9, 2006.

ADDRESSES: Written responses should be sent to Jean A. Webb, Secretary,
Commodity Futures Trading Commission, Three Lafayette Center, 1155 21st
Street, NW., Washington, DC 20581. Responses may also be submitted via
e-mail at [email protected]. "Self-Regulation and Self-Regulatory
Organizations" must be in the subject field of responses submitted via
e-mail, and clearly indicated in written submissions. This document is
also available for comment at  href="http://frwebgate.access.gpo.gov/cgi-bin/leaving.cgi?from=leavingFR.html&log=linklog&to=http://www.regulations.gov" shape="rect">http://frwebgate.access.gpo.gov/cgi-bin/leaving.cgi?from=leavingFR.html&log=linklog&to=http://www.regulations.gov.

FOR FURTHER INFORMATION CONTACT: Stephen Braverman, Deputy Director,
(202) 418-5487; Rachel Berdansky, Special Counsel, (202) 418-5429; or
Sebastian Pujol Schott, Attorney-Advisor, (202) 418-5641. Division of
Market Oversight, Commodity Futures Trading Commission, Three Lafayette
Center, 1155 21st Street, NW., Washington, DC 20581.


I. Introduction

    Since its initiation in May of 2003, the SRO Study has proceeded
through two phases.\3\ Phase I included staff interviews with over 100
individuals representing every segment of the futures industry,
including futures commission merchants ("FCMs"), DCMs, DCOs, and
industry associations. Staff also interviewed industry executives,
academics, consultants, and individuals associated with securities-side
entities. Based on these interviews, the Commission identified several
issues for further attention and launched Phase II of the SRO Study in
February of 2004.\4\

    \3\ The SRO Study was initiated in an address by former
Commission Chairman James E. Newsome at the Futures Industry
Association Law and Compliance Luncheon (May 28, 2003), available
at:  href="http://frwebgate.access.gpo.gov/cgi-bin/leaving.cgi?from=leavingFR.html&log=linklog&to=http://www.cftc.gov/opa/speeches03/opanewsm-40.htm" shape="rect">http://frwebgate.access.gpo.gov/cgi-bin/leaving.cgi?from=leavingFR.html&log=linklog&to=http://www.cftc.gov/opa/speeches03/opanewsm-40.htm.

    \4\ As a prelude to Phase II, the Commission encouraged every
SRO to reexamine its policies, employee training efforts, and day-
to-day practices to confirm that there are safeguards in place to
prevent the misuse use of confidential information obtained by SROs
during audits, investigations, or other self-regulatory activities.
The Commission continues to examine confidentiality of information
as it moves forward with the SRO Study. See CFTC Progresses with
Study of Self-Regulation, CFTC Press Release No. 4890-04 (Feb. 6,
2004), available at:  href="http://frwebgate.access.gpo.gov/cgi-bin/leaving.cgi?from=leavingFR.html&log=linklog&to=http://www.cftc.gov/opa/press04/opa4890-04.htm" shape="rect">http://frwebgate.access.gpo.gov/cgi-bin/leaving.cgi?from=leavingFR.html&log=linklog&to=http://www.cftc.gov/opa/press04/opa4890-04.htm.


    Phase II of the SRO Study has pursued two lines of inquiry. The
first addresses issues relating to the cooperative regulatory agreement
by which DCMs and the National Futures Association ("NFA") coordinate
compliance examinations of FCMs ("DSRO System"). In April of 2004,
Commission staff sought public comment on the governance and operation
of the Joint Audit Committee ("JAC") and on the effectiveness of JAC
and NFA examination programs.\5\ Commission staff also sought comment
on certain proposed amendments to the Joint Audit Agreement. The
proposed amendments, among other things, add additional parties to the
JAC, add certain voting eligibility provisions, and memorialize certain
DSRO assignment procedures. The comments received and the proposed
amendments to the JAC remain under consideration by Commission staff.

    \5\ CFTC Seeks Comment on How Self-Regulatory Exams of Futures
Firms Are Coordinated, CFTC Press Release No. 4910-04 (Apr. 7,
2004), available at: http://www.cftc.gov/opa/press04/opa4910-04.htm.


    The second line of inquiry in Phase II of the SRO Study focuses
primarily on conflicts of interest in self-regulation, and those
factors that may tend to increase or ameliorate such conflicts. In June
of 2004, the Commission sought public comment on SRO board composition,
changing ownership structures and business models among SROs, and the
organization and oversight of SROs' regulatory departments and
personnel, among other things.\6\ Simultaneously, the Commission
distributed to each SRO a questionnaire to help evaluate the governance
structures, policies, and procedures of the self-regulators under the
Commission's authority. The comments solicited in 2004 and in the
earlier interviews generated an array of responses and approaches to
self-regulation that the Commission is now re-examining in light of
industry developments and findings since that time.

    \6\ SRO Governance, 69 FR 32,326 (June 9, 2004) and 69 FR 42,971
(July 19, 2004) (extending comment period to Sept. 30, 2004).

    One significant development in self-regulation since the beginning
of the SRO Study is the creation of exchange "regulatory oversight
committees" ("ROCs"). In each case, the ROCs are board-level
committees, composed only

[[Page 71091]]

of independent non-member directors, with varying degrees of
responsibility and authority. Among futures exchanges, both the New
York Board of Trade ("NYBOT") and the parent company of the Chicago
Mercantile Exchange ("CME") have created advisory ROCs with oversight
of the exchanges' self-regulatory activities.\7\ Both ROCs remain
subject to their respective boards of directors. In contrast, the
Futures Industry Association ("FIA") has recommended exchange ROCs
that create a "functional separation of compliance and business
staffs," including the hiring, firing, and compensation of such
staff.\8\ The Securities and Exchange Commission ("SEC") has proposed
its own version of the ROC for U.S. securities exchanges.\9\ Its
proposal places ROCs within majority independent non-member boards of

    \7\ NYBOT Rule 3.40, available at:  href="http://frwebgate.access.gpo.gov/cgi-bin/leaving.cgi?from=leavingFR.html&log=linklog&to=http://www.nybot.com/aboutNYBOT/rulebooks/nybot/download/Ch%203%20Committees.pdf" shape="rect">http://frwebgate.access.gpo.gov/cgi-bin/leaving.cgi?from=leavingFR.html&log=linklog&to=http://www.nybot.com/aboutNYBOT/rulebooks/nybot/download/Ch%203%20Committees.pdf

Chicago Mercantile Exchange Holdings, Inc., Charter of the Market
Regulatory Oversight Committee, available at:  href="http://frwebgate.access.gpo.gov/cgi-bin/leaving.cgi?from=leavingFR.html&log=linklog&to=http://investor.cme.com/downloads/regulation.pdf" shape="rect">http://frwebgate.access.gpo.gov/cgi-bin/leaving.cgi?from=leavingFR.html&log=linklog&to=http://investor.cme.com/downloads/regulation.pdf

    \8\ The Governance of Self Regulatory Organizations, FIA Comment
Letter at 4 and 5 (Sept. 30, 2004), available at:  href="http://frwebgate.access.gpo.gov/cgi-bin/leaving.cgi?from=leavingFR.html&log=linklog&to=http://www.cftc.gov/files/foia/comment04/foicf0405c009.pdf" shape="rect">http://frwebgate.access.gpo.gov/cgi-bin/leaving.cgi?from=leavingFR.html&log=linklog&to=http://www.cftc.gov/files/foia/comment04/foicf0405c009.pdf

    \9\ Fair Administration and Governance of Self-Regulatory
Organizations, 69 FR 71126 (Dec. 8, 2004).

    As the questions below indicate, the Commission is interested in
commenters' evaluation of the existing and proposed ROCs. Responses
should address whether ROCs are necessary, how effective they are
likely to be, and any potential drawbacks. Responses should also
address what responsibilities and authority should be vested in ROCs,
how their members should be nominated and elected, and the appropriate
relationship between boards, ROCs, and SROs' senior regulatory
officers. Finally, as the Commission considers a range of options to
help insulate self-regulation from improper influence and commercial
interests, commenters should address whether such insulation is best
accomplished through new board composition standards, ROCs, or a
combination of both.
    Of the issues raised in the SRO Study, exchange disciplinary
committees and the impact of changing ownership structures and business
models have generated the most divergent opinions and approaches. Thus,
although the Commission has previously solicited public comments on
these matters, they require further exploration in an effort to
reconcile the divergent views expressed by industry participants,
outside experts, and others. Through this Request for Comments and the
upcoming roundtable, the Commission will complete its research and
prepare to conclude the SRO Study.
    With respect to disciplinary committees, the central question is
one of composition. The Chicago Board of Trade ("CBOT") and Kansas
City Board of Trade ("KCBT"), for example, typically use member-only
disciplinary committees.\10\ In contrast, other futures exchanges
include independent persons on their committees, although only as a
minority of the committee. The FIA recommends a fundamentally different
approach: Majority-independent disciplinary committees.\11\ The NFA is
bound by Commission Regulation 1.64(c) which requires, among other
things, that SRO disciplinary committees include at least one non-
member of the SRO whenever the respondent is a member of the board or
of a major disciplinary committee, or whenever the conduct alleged
includes manipulation or attempted manipulation or results in direct
harm to a non-member.\12\ In the case of DCMs, Regulation 1.64(c) also
required that a majority of disciplinary committee members represent an
exchange membership category other than that of the respondent.\13\
However, DCMs are now exempt from Regulation 1.64.\14\

    \10\ See e.g., KCBT Rules 244.00 and 247.00 and CBOT Rules
540.12, 542.00, and 543.00.
    \11\ See The Governance of Self Regulatory Organizations, FIA
Comment Letter at 8.
    \12\ 17 CFR 1.64(c).
    \13\ See Sec.  1.64(a)(1) (excluding clearing organizations from
the requirements of Sec.  1.64).
    \14\ See 17 CFR 38.2.

    In issuing this Request for Comments, the Commission is
particularly interested in specific examples of instances where a
disciplinary committee's composition may have influenced the outcome of
a disciplinary matter. Interested parties should also comment on the
appropriate composition of disciplinary committees and the optimal
number and role of independent committee members.
    The impact on self-regulation of changing ownership structures and
business models has generated an equally broad array of opinions in the
SRO Study. Starting with the CME in 2003, exchanges' continuing
transformation from member-owned, not-for-profit entities to publicly-
traded, for-profit businesses requires careful attention from the
Commission. With the CBOT's initial public offering ("IPO") and
listing completed in October 2005, the two largest U.S. futures
exchanges, accounting for almost 87% of all futures volume in the U.S.,
are now public, for-profit companies. In addition, the New York
Mercantile Exchange is preparing to sell a 10% stake in the exchange to
a private equity group in anticipation of a 2006 IPO. At that time,
over 97% of U.S. futures trades will be transacted on exchanges whose
incentives, owners, and demands are different from the not-for-profit,
member-owned model that has prevailed for over 100 years, and upon
which member self-regulation is based.
    The Commission is particularly interested in specific examples of
instances where an SRO's new commercial motives and incentives may have
altered its self-regulatory behavior. More generally, commenters should
address whether and how demutualized, for-profit, publicly-traded
entities might alter their regulatory behavior in an effort to gain
competitive advantage, reduce costs, satisfy shareholder and earnings
expectations, or meet other non-regulatory objectives. Such regulatory
behavior could include over-regulation, under-regulation, or selective
or discriminatory regulation. Specific examples, either in the SRO or
DSRO context, are welcome.
    Finally, the Commission wishes to draw interested parties'
attention to the listing standards of the New York Stock Exchange
("NYSE"), which impact both the CME and the CBOT as their parent
companies are listed on that exchange. Certain governance provisions in
the listing standards are another new development since the beginning
of the SRO Study.\15\ In particular, the NYSE now requires that the
boards of directors of listed companies be majority independent, and
provides detailed guidelines for determining a director's independence.
The Commission notes, however, that both the governance and
independence provisions in the listing standards are directed at
shareholder protection and broad corporate governance. Although listed
futures exchanges and their shareholders may benefit from these
provisions, they may not be relevant to fair, effective, and vigorous

    \15\ Section 303A of the NYSE's Listed Company Manual, which
includes both the requirement that a majority of listed companies'
directors be independent and bright-line tests for independence,
received final approval from the SEC on November 4, 2003, with
further amendments as late as November 3, 2004. The Listed Company
Manual is available at:  href="http://frwebgate.access.gpo.gov/cgi-bin/leaving.cgi?from=leavingFR.html&log=linklog&to=http://www.nyse.com/Frameset.html?displayPage=/lcm/lcm_section.html" shape="rect">http://frwebgate.access.gpo.gov/cgi-bin/leaving.cgi?from=leavingFR.html&log=linklog&to=http://www.nyse.com/Frameset.html?displayPage=/lcm/lcm_section.html


    The Commission is interested in receiving comments on the
relationship between SROs' Commission-mandated self-regulatory
responsibilities and the

[[Page 71092]]

NYSE listing standards applicable to their parent companies, if any
such relationship exists. Both the CME and the CBOT have determined
that their member-directors are "independent" for purposes of the
listing standards. Interested parties should comment on whether that
determination is relevant to futures self-regulation.

II. Questions

    The Commission has formulated the following questions based on its
research, responses to previous Federal Register requests for comments,
the views expressed by interview participants, and industry
developments. Responses from interested parties will advance the
Commission's understanding of issues relevant to conflicts of interest
in self-regulation, SRO governance, and other relevant matters.
Interested parties should also raise any additional issues that they
believe will help the Commission's understanding of the issues
presented. If interested parties believe that they have previously
addressed any questions or issues related to this Request, and have no
new information to add, they should feel free to refer the Commission
to those responses.
    Possible conflicts of interest, such as those that may exist
between an SRO's regulatory responsibilities, its commercial interests,
its members, and other constituents, are central to many of the
questions articulated below. Where appropriate, parties should identify
the specific conflict addressed in their response, and how their
proposal resolves that conflict. With the SRO Study drawing to a
conclusion, the Commission will carefully consider the need for
additional guidance to insulate self-regulation from conflicts of
interest and improper influence. Any such guidance will reflect the
Commission's continuing commitment to industry self-regulation,
flexible core principles, and responsible Commission oversight.
    1. Is the present system of self-regulation an effective regulatory
model for the futures industry?
    2. As the futures industry adapts to increased competition, new
ownership structures, and for-profit business models, what conflicts of
interest could arise between:
    (i) An SRO's self-regulatory responsibilities and the interests of
its members, shareholders, and other stakeholders; and
    (ii) An SRO's self-regulatory responsibilities and its commercial
    3. Given the ongoing industry changes cited above, please describe
how self-regulation can continue to operate effectively. What measures
have SROs taken thus far, and what additional measures are needed, to
ensure fair, vigorous, and effective self-regulation by competitive,
publicly-traded, for-profit SROs?
    4. What is the appropriate composition of SROs' boards of directors
to ensure the fairness and effectiveness of their self-regulatory
    5. Should SROs' boards include independent directors, and, if so,
what level of representation should they have? What factors are
relevant to determining a director's independence?
    6. Should self-regulation be overseen by an independent entity
within an SRO?
    (i) If so, what functions and authority should be vested in such an
    (ii) At least two futures exchanges have implemented board-level
regulatory oversight committees ("ROCs") to oversee their regulatory
functions in an advisory capacity. Commenters are invited to address
any strengths or weaknesses in this approach.
    7. The parent companies of some SROs are subject to the listing
standards of the securities exchanges on which they are traded. Are
such listing standards relevant to self-regulation and to conflicts of
interest within DCMs?
    8. What is the appropriate composition of SROs' disciplinary
committees to ensure both expertise and impartiality in decision-
    (i) Should a majority of committee members be independent? Should
the composition of SROs' disciplinary committees reflect the diversity
of the constituency? Should similar safeguards apply to other key
committees and if so, which committees?
    (ii) Should SRO disciplinary committees report to the board of
directors, an independent internal body, or an outside body?
    9. What information should SROs make available to the public to
increase transparency (e.g., governance, compensation structure,
regulatory programs and other related matters)? Are the disclosure
requirements applicable to publicly traded companies adequate for SROs?
    10. What conflicts of interest standards, if any, should apply
specifically to DCOs, both stand-alone DCOs and those integrated within
    11. What conflict of interest standards, if any, should be
applicable to third-party regulatory service providers, including
registered futures associations, to ensure fair, vigorous, and
effective self-regulation on their part?

    Issued in Washington, DC, on November 18, 2005, by the
Jean A. Webb,
Secretary of the Commission.
 [FR Doc. E5-6510 Filed 11-23-05; 8:45 am]