[Federal Register Volume 69, Number 111 (Wednesday, June 9, 2004)]
[Notices]
[Pages 32326-32329]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 04-13027]


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COMMODITY FUTURES TRADING COMMISSION


The Governance of Self-Regulatory Organizations

AGENCY: Commodity Futures Trading Commission.

ACTION: Request for comments.

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SUMMARY: This Request for Comments continues the Commodity Futures 
Trading Commission's (``CFTC or Commission'') ongoing review of self-
regulatory organizations (``SROs''). The request discusses recent 
changes in the U.S. futures industry and the Commission's governance 
requirements prior to and after passage of the Commodity Futures 
Modernization Act (``CFMA''). Based on this discussion, the request 
seeks answers from industry participants and other interested persons 
to a series of questions on SRO governance and self-regulation.

DATES: Responses must be received by July 26, 2004.

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]. ``SRO Governance'' 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 
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.

SUPPLEMENTARY INFORMATION: 

I. Introduction

    The Commodity Exchange Act (``Act''),\1\ among other things, seeks 
to enhance regulatory efficiency in the futures industry through self-
regulation by exchanges, clearinghouses, and other organizations 
registered with or designated by the Commission.\2\ Simultaneously, the 
Act recognizes the public interest inherent in transactions executed on 
U.S. futures exchanges and provides for oversight by the Commission.\3\ 
As the primary industry regulator, the Commission strives for 
transparent, competitive, and financially sound futures markets that 
operate free from manipulation, and to protect market participants from 
fraud and other abusive practices.
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    \1\ 7 U.S.C. 1, et seq. (2000).
    \2\ SROs include designated contract markets (``DCMs'' or 
``exchanges''), derivatives transaction execution facilities, 
registered futures associations, and derivatives clearing 
organizations (``DCOs'').
    \3\ 7 U.S.C. 5.
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    Acknowledging both the importance of industry self-regulation and 
its own obligation to foster and maintain market integrity, CFTC 
Chairman James E.

[[Page 32327]]

Newsome announced in May of 2003 that the Commission would review ``the 
roles, responsibilities, and capabilities of SROs in the context of 
market changes'' \4\ To that end, Commission staff has undertaken a 
comprehensive study of self-regulation in the futures industry (``SRO 
Study'').
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    \4\ See Address by Commission Chairman James E. Newsome at the 
Futures Industry Association Law and Compliance Luncheon (May 28, 
2003), available at http://www.cftc.gov/opa/speeces03/opanewsm-40.htm.
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    The Commission's review of self-regulation has progressed against a 
backdrop of rapid transformation in the futures industry; both the 
competitive environment and the industry's business models are evolving 
rapidly. For example, in November of 2000, the Chicago Mercantile 
Exchange became the first U.S.-based futures exchange to transform from 
a not-for profit mutual organization to a demutualized publicly traded 
for-profit entity. The New York Mercantile Exchange has also 
demutualized, although it is not publicly traded. Other exchanges are 
considering demutualization, or are simply entering the market as for-
profit, non-mutualized entities. These structural changes have 
coincided with increased competition in futures trading; a dramatic 
rise in the volume of trading, both open outcry and electronic; the 
entrance of new participants; and expanding roles for others. Each of 
these developments may have implications for SROs in the performance of 
their regulatory functions.
    Since the initiation of the SRO Study, Commission staff has 
interviewed more than 100 individuals representing futures commission 
merchants (``FCMs''), DCMs, DCOs and futures industry associations. 
Staff also has interviewed industry executives, academics, consultants, 
and individuals associated with securities-side entities. The 
interviews covered a broad range of issues relevant to self-regulation 
in the futures industry, and constituted an important component of the 
ongoing SRO Study.
    Based on these interviews, the Commission identified two issues for 
immediate attention: (1) Ensuring the confidentiality of certain 
information obtained by SROs in the course of their self-regulatory 
activities; and (2) examining the cooperative regulatory agreement by 
which SROs coordinate compliance examinations of FCMs (``DSRO 
System''). Interim measures with respect to both issues were announced 
in a February 2004 press release.\5\ First, the Commission encouraged 
every SRO to reexamine its policies, procedures, and practices to 
confirm that it has adequate safeguards to prevent the inappropriate 
use of confidential information obtained during audits, investigations, 
and other self-regulatory activities. SROs also were encouraged to 
publicize their safeguards. Second, the Commission announced a review 
of the DSRO System, including its cooperative agreements and programs. 
As a part of that review, the Commission subsequently issued a Request 
for Comment on proposed amendments to the cooperative agreement by 
which various SROs allocate certain supervisory responsibilities among 
themselves so that each FCM has a single designated self-regulatory 
organization (``DSRO'').\6\
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    \5\ See CFTC Progresses with Study of Self-Regulation, CFTC 
Press Release No. 4890-04 (Feb. 6, 2004), available at http://www.cftc.gov/opa/press04/opa4890-04.htm
    \6\ See 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/opa4890-04.htm
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    The February press release also reaffirmed that governance is a 
central focus of the SRO Study,noting that SRO governance can 
substantially impact key aspects of self-regulation and the increased 
national attention given to SRO governance issues. Accordingly, the 
Commission announced that it would issue this Request for Comments on 
the topic of SRO governance.

II. Regulatory Background

    On December 21, 2000, Congress adopted the CFMA, which, among other 
things, replaced ``one-size-fits-all'' regulations for futures markets 
with flexible core principles and granted the Commission explicit 
authority over DCOs.\7\ Prior to the adoption of the CFMA, SRO 
governance was addressed primarily through Section 5a of the Act, as 
amended by the Futures Trading Practices Act of 1992 (``FTPA''). The 
FTPA required greater diversity of representation on SRO boards and 
disciplinary committees, imposed fitness standards for service on 
boards and disciplinary and oversight committees, and required SROs to 
adopt procedures to avoid conflicts of interest in deliberations by 
persons serving on such bodies. As directed by Congress, the Commission 
promulgated regulations to enact the FTPA's governance provisions. 
First, Regulation 1.64 addressed composition requirements for SRO 
boards and disciplinary committees.\8\ Second, Regulation 1.69 
established specific factors to be considered with respect to barring a 
person serving on a board, disciplinary or oversight committee from 
voting on a decision if the person had a potential financial or 
personal interest. Third, Regulation 1.63, which already established 
fitness standards for members of SRO boards and disciplinary 
committees, was amended to include individuals serving on SRO oversight 
panels.
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    \7\ Commodity Futures Modernization Act of 2000, Public Law 106-
554, 114 Stat. 2763 (Dec. 21, 2000).
    \8\ Commission Regulation 1.64 required that each exchange 
establish meaningful representation for (1) FCMs; (2) floor traders; 
(3) floor brokers; (4) commercial interests; (5) participants in a 
variety of pits or principal groups of commodities traded on the 
exchange; and (6) other market users such as banks and pension 
funds. The regulation further required that at least ten percent of 
each exchange board consist of commercials and that at least 20 
percent of the board include non-members. With respect to 
composition of disciplinary committees, each exchange was required 
to ensure that the composition of each major disciplinary committee 
included sufficient different membership interests. In this 
connection, the regulation required that a majority of each 
disciplinary committee and hearing panels of those committees 
include persons that represented membership interests other than 
that of the subject respondent. If a matter involved a member of the 
exchange governing board or a member of a disciplinary committee, or 
involved manipulation or conduct that caused direct financial harm 
to non-member, the exchange was required to include at least one 
non-member on the committee or panel considering the case.
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    The CFMA struck former Section 5a of the Act and adopted new 
statutory provisions with respect to exchange governance. The CFMA 
enumerates 18 core principles applicable to DCMs, three of which 
directly relate to exchange governance: Core Principle 14- Governance 
Fitness Standards; Core Principle 15- Conflicts of Interest; and Core 
Principle 16- Composition of Boards Mutually Owned Contract Markets.\9\
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    \9\ Core Principle 14 states that a ``board of trade shall 
establish and enforce appropriate fitness standards for directors, 
members of any disciplinary committee, members of the contract 
market, and any other persons with direct access to the facility 
(including any persons affiliated with any of the persons in this 
paragraph).'' Core Principle 15 states that a ``board of trade shall 
establish and enforce rules to minimize conflicts of interest in the 
decision making process of the contract market and establish a 
process for resolving such conflicts of interest.'' Core Principle 
16 states, ``in the case of a mutually owned contract market, the 
board of trade shall ensure that the composition of the governing 
board reflects market participants.'' Sections 5(d)(14), (15), and 
(16) of the Act.
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    The Commission adopted Part 38 of its regulations to implement 
those core principles applicable to DCMs.\10\ Appendix B to Part 38 
provides ``application guidance'' for the 18 core

[[Page 32328]]

principles.\11\ The guidance for Core Principle 14 provides that a DCM 
should have appropriate fitness standards for various categories of 
individuals. With respect to members who have voting privileges and 
individuals who exercise governing or disciplinary authority, at a 
minimum,these fitness standards should include those bases for refusal 
to register a person that are enumerated under section 8a(2) of the 
Act.\12\ the fitness standards also should require that individuals 
with governing authority not have a significant history of disciplinary 
violations, such as the disqualifications listed under Commission 
Regulation 1.63.\13\
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    \10\ Pursuant to section 38.2, DCMs are exempt from regulations 
1.63,with the exception of 1.63(c); 1.64; and 1.69. See note 13 for 
an explanation guidance to demonstrate core principle compliance.
    \11\ A DCM may use the application guidance to demonstrate core 
principle compliance.
    \12\ Section 8a(2) permits the Commission to refuse to register 
any person under any of eight enumerated conditions. For example, 
the Commission may refuse to register persons (1) whose registration 
under suspension or has been revoked; (2) whose registration has 
been refused within the preceding five years dud to violations of 
the Act or regulations thereunder; (3) who are permanently or 
temporarily enjoined from holding certain positions in the futures 
or securities industries; or (4) who have been convicted within the 
previous 10 years of certain felonies.
    \13\ Regulation 1.63(c) prohibits a person from serving on an 
SRO disciplinary committee, arbitration panel, oversight panel, or 
governing board if the person is subject to any one of six 
enumerated conditions. For example, a person may not serve on an 
exchange disciplinary committee if he or she was found within the 
prior three years by a final decision of an SRO, administrative law 
judge, court, or the Commission to have committed a ``disciplinary 
offense.'' A disciplinary offense generally includes any violation 
of the rules of a SRO other than those rules relating to decorum or 
attire, financial requirements, or reporting or recordkeeping unless 
the reporting or recordkeeping violations resulted in fines totaling 
more than $5,000 within any calendar year.
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    The guidance for Core Principle 15 provides that a DCM should have 
procedures to identify and resolve conflicts of interest in decision-
making. A DCM also should have appropriate limitations regarding the 
use or disclosure of material non-public information gained through the 
performance of official duties by board members, committee members, and 
exchange employees or gained through an exchange ownership interest. 
Finally, the guidance for Core Principle 16 provides that the board 
composition of a mutually-owned DCM should fairly represent the 
diversity of interests of the DCM's market participants.\14\
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    \14\ Appendix B also lists ``acceptable practices'' for several 
of the core principles; however, the Commission has not adopted 
acceptable practices for Core Principles 14, 15, or 16.
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III. Questions

    The Commission has formulated the following questions based on its 
research, the views expressed by interview participants, and industry 
developments. Responses from interested parties will advance the 
Commission's understanding of issues relevant to SRO governance. Each 
enumerated question should be addressed individually; parties also may 
address any other topics they believe are relevant to SRO governance.
    Possible conflicts of interest, such as those that may exist 
between an SRO's regulatory functions and its business functions, or 
between an SRO's members, 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.

A. Board Composition

    1. What is the appropriate composition of SRO boards to best 
protect the public interest and serve SROs' needs? If you believe that 
SRO boards should consist of market participants, what participant 
communities should be represented and how should representation be 
allocated among those communities (e.g., quotas, volume-based)? Should 
the composition of SRO boards be different for the various types of 
SROs (e.g., DCM or DCO)?
    2. How and by whom should SRO boards be nominated and elected? If 
directors should represent particular communities, should each 
community nominate and/or elect its representatives to the board? If 
the board consists of independent directors, what nomination and 
election procedures are necessary to ensure independence?
    3. Should SRO boards include independent directors and, if so, what 
level of representation should they have? What are appropriate 
definitions of ``independent director'' and ``public director?'' Should 
all independent directors be public directors? Please address whether 
SRO members can be considered independent. Also, please address whether 
the New York Stock Exchange's definition of independent--the 
requirements include independence from the exchange's management, 
members, and member organizations--is an appropriate model for the 
futures industry.\15\
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    \15\ Article IV, Section 2, of the New York Stock Exchange's 
Constitution states that: The directors elected by the members shall 
be independent of management of the Exchange, the members, and 
issuers of securities listed on the Exchange and shall include 
directors who will enable the Exchange to comply with the 
requirements of Section 6(b)(3) of the Act. Among other things, no 
director elected by the members shall be (a) a member, allied 
member, lessor member or approved person; (b) an officer of employee 
of the Exchange; (c) a person employed by an affiliated, directly or 
indirectly, with a member organization, or with a broker or dealer 
that engages in a business involving substantial direct contact with 
securities customers; or (d) an executive officer of an issuer of 
securities that are listed on the Exchange. In addition, no director 
shall qualify as independent unless the Board affirmatively 
determines that the director has no material relationship with the 
Exchange.
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B. Regulatory Structure

    4. Are the governance standards applicable to listed companies 
sufficient for futures exchanges or their listed parent companies? Or, 
given that futures exchanges are not typical corporations in that they 
bear self-regulatory responsibilities, should they adopt higher 
governance standards, particularly with respect to self-regulatory 
activities? Please explain.
    5. Should SRO's regulatory functions be overseen by a body that is 
internal to the SRO, but independent of management, members, and 
business functions? If so, what specific functions should fall within 
its purview (e.g., regulatory budget; personnel decisions; compensation 
of regulatory staff; compliance and disciplinary programs; other 
aspects of self-regulation)?
    6. Please address whether any rule enforcement, disciplinary, or 
other functions currently performed by exchanges should be performed 
instead by an independent regulatory services provider.

C. Forms of Ownership

    7. What impact do varying business models have on SRO's self-
regulatory behavior? Consider for-profit/not-for profit, member-owned/
shareholder owned, and publicly traded/privately held business models.
    8. More specifically, is an SRO subject to new influences in the 
performance of its self-regulatory functions when it converts from a 
member-owned, not-for-profit organization to a publicly traded, for-
profit company? Might a for-profit, publicly traded SRO attempt to 
attract volume or increase its profits through lax self-regulation? Or, 
is ti more likely that the SRO will seek to protects its brand and add 
value through effective self-regulation?

D. Disciplinary Committees

    9. How should SRO disciplinary committees be structured so as to 
ensure both expertise and impartiality?
    10. Please address whether SRO discplinary committees should have 
independent, non-SRO member chairs and/or committee membership. Should 
the level of representation for independent, non-SRO members vary

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according to the type of discplinary case?
    11. How and by whom should SRO disciplinary committes be appointed? 
Should the terms of committee members be limited? Please explain.

E. Other Issues

    12. What additional information, if any, should SROs make available 
to the public to increase transparency with respect to their governance 
and regulatory structures (e.g., board member affiliations; regulatory 
staffing and budget; disciplinary committee membership and 
affiliations, etc.)?
    13. Would additional core principles for SROs help to clarify their 
responsibilities with respect to governance, or would regulatory 
guidance be more appropriate.
    14. What steps should be taken to manage or eliminate conflicts of 
interest involving SRO board and disciplinary committee members?
    15. Should registered futures associations that are functioning as 
SROs also be subject to governance standards?

    Issued in Washington, DC, on June 2, 2004, by the Commission.
Jean A. Webb,
Secretary of the Commission.
[FR Doc. 04-13027 Filed 6-8-04; 8:45 am]
BILLING CODE 6351-01-M