[Federal Register Volume 69, Number 235 (Wednesday, December 8, 2004)]
[Proposed Rules]
[Pages 71126-71254]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 04-26153]



[[Page 71125]]

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Part II





Securities and Exchange Commission





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17 CFR Parts 240, 242, and 249



Self-Regulatory Organizations--Various Amendments; Proposed Rule

  Federal Register / Vol. 69, No. 235 / Wednesday, December 8, 2004 / 
Proposed Rules  

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SECURITIES AND EXCHANGE COMMISSION

17 CFR Parts 240, 242, and 249

[Release No. 34-50699; File No. S7-39-04]
RIN 3235-AJ33


Fair Administration and Governance of Self-Regulatory 
Organizations; Disclosure and Regulatory Reporting by Self-Regulatory 
Organizations; Recordkeeping Requirements for Self-Regulatory 
Organizations; Ownership and Voting Limitations for Members of Self-
Regulatory Organizations; Ownership Reporting Requirements for Members 
of Self-Regulatory Organizations; Listing and Trading of Affiliated 
Securities by a Self-Regulatory Organization

AGENCY: Securities and Exchange Commission.

ACTION: Proposed rule.

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SUMMARY: The Securities and Exchange Commission (``Commission'') is 
proposing to adopt new rules and amend existing rules and forms under 
the Securities Exchange Act of 1934 (``Exchange Act''). The proposals 
pertain to the governance, administration, transparency and ownership 
of self-regulatory organizations (``SROs'') that are national 
securities exchanges or registered securities associations and the 
periodic reporting of information by these SROs regarding their 
regulatory programs. The proposals also relate to the listing and 
trading by SROs of their own or affiliated securities.
    First, the proposals would impose new governance standards on 
national securities exchanges and registered securities associations by 
requiring a majority of the members of the exchange's or association's 
board of directors to be independent. In addition, key committees of 
the board would be required to be composed solely of independent 
directors. The proposals would define the term ``independent 
director.'' The proposals also would require exchanges and associations 
to establish policies and procedures to maintain a separation between 
their regulatory functions and their market operations and other 
commercial interests, and require that funds received from regulatory 
fines, fees, and penalties be used for regulatory purposes.
    Further, the proposals would require national securities exchanges 
and registered securities associations to prohibit any member that is a 
broker or dealer from owning and voting more than 20% of the ownership 
interest in the exchange or the association, or a facility of the 
exchange or association. To supplement these ownership and voting 
provisions, the proposals also would require each member of an exchange 
or association that is a broker or dealer to file a report with the 
Commission when the member acquires ownership of more than 5% of any 
interest in the exchange or association, or any facility thereof. Also, 
the Commission proposes to require national securities exchanges and 
national securities associations to maintain their books and records in 
the United States. Together, these proposals are designed to strengthen 
the governance and administration of SROs and address the possible 
concentration of ownership by member firms.
    In addition, the Commission proposes to amend its forms for 
registration as a national securities exchange or registered securities 
association to require that these SROs file with the Commission and 
publicly disclose enhanced information relating to their governance, 
regulatory programs, finances, ownership structure, and other matters. 
Further, the Commission's rules governing the procedures for filing 
amendments to these registration forms would be revised to require more 
frequent updating of the required information and the posting of the 
required information on the SROs' Internet Web sites. These proposals 
are designed to provide greater transparency to key aspects of the 
governance, ownership structure, and regulatory operations of national 
securities exchanges and registered securities associations.
    The Commission also proposes to require national securities 
exchanges and registered securities associations to file with the 
Commission, in an electronic format, quarterly and annual reports on 
particular aspects of their regulatory programs. This proposal is 
intended to enhance the Commission's oversight and surveillance of 
exchanges and associations by requiring them to provide the Commission 
with detailed regulatory information on a regular basis, thereby 
assisting the Commission to oversee more effectively the SROs' 
regulatory programs and better identify any trends or issues that may 
arise.
    Finally, the Commission proposes to impose requirements on a 
national securities exchange or registered securities association that 
chooses to list or trade its own security, the security of any trading 
facility, or the security of an affiliate of itself or a facility. The 
proposed requirements are designed to assure that these SROs are able 
to enforce effectively their listing standards with respect to, and 
supervise trading in, their own or a facility's securities, or the 
securities of affiliates of the SRO or a facility.

DATES: Comments should be submitted on or before January 24, 2005.

ADDRESSES: Comments may be submitted by any of the following methods:

Electronic Comments

     Use the Commission's Internet comment form (http://www.sec.gov/rules/proposed.shtml); or
     Send an e-mail to [email protected]. Please include 
File Number S7-39-04 on the subject line; or
     Use the Federal eRulemaking Portal (http://www.regulations.gov). Follow the instructions for submitting comments.

Paper Comments

     Send paper comments in triplicate to Jonathan G. Katz, 
Secretary, Securities and Exchange Commission, 450 Fifth Street, NW., 
Washington, DC 20549-0609.
    All submissions should refer to File Number S7-39-04. This file 
number should be included on the subject line if e-mail is used. To 
help us process and review your comments more efficiently, please use 
only one method. The Commission will post all comments on the 
Commission's Internet Web site (http://www.sec.gov/rules/proposed.shtml). Comments are also available for public inspection and 
copying in the Commission's Public Reference Room, 450 Fifth Street, 
NW., Washington, DC 20549. All comments received will be posted without 
change; we do not edit personal identifying information from 
submissions. You should submit only information that you wish to make 
available publicly.

FOR FURTHER INFORMATION CONTACT: SRO Governance and Disclosure: Nancy 
J. Sanow, Assistant Director, at (202) 942-0796, Susie Cho, Special 
Counsel, at (202) 942-0748, Leah Mesfin, Special Counsel, at (202) 942-
0196, Geraldine Idrizi, Attorney, at (202) 942-7317, and A. Michael 
Pierson, Attorney, at (202) 942-0192; Reporting Requirements for SROs: 
Nancy J. Sanow, Assistant Director, at (202) 942-0796, and Richard 
Holley III, Attorney, at (202) 942-8086; and SRO Ownership and Voting 
Restrictions, SRO Self-Listing, and Reporting Requirements for Members: 
Heather Seidel, Attorney Fellow, at (202) 942-0788, Sonia Trocchio, 
Special Counsel, at (202) 942-0753, David Hsu, Special Counsel, at 
(202) 942-0731, and Jennifer Dodd, Attorney, at (202) 824-5471; all of 
whom are in the Division of

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Market Regulation, Securities and Exchange Commission, 450 Fifth Street 
NW, Washington DC 20549-1001.

SUPPLEMENTARY INFORMATION: We are proposing to add new Rules 3b-19, 6a-
5, 17a-26, 17a-27, and Regulation AL under the Exchange Act; amend 
Rules 6a-2, 15Aa-1, and 17a-1 under the Exchange Act; redesignate Rule 
15Aj-1 under the Exchange Act as Rule 15Aa-2 and amend redesignated 
Rule 15Aa-2; amend Form 1 under the Exchange Act; redesignate Form X-
15AA-1 under the Exchange Act as Form 2 and amend redesignated Form 2; 
and remove Forms X-15AJ-1 and X-15AJ-2 under the Exchange Act.

Table of Contents

I. Background
    A. Self-Regulation under the Exchange Act
    B. Overview of Recent Developments
    1. Governance Concerns
    2. Concerns Relating to Weaknesses of SRO Regulatory Programs
    3. Competitive Concerns
    4. Concerns Relating to New Ownership Structures
II. Fair Administration and Governance of National Securities 
Exchanges and Registered Securities Associations
    A. Background and Need for Proposed Rules 6a-5 and 15Aa-3
    B. Description of Proposed Rules 6a-5 and 15Aa-3
    1. Scope of Proposed Rules 6a-5 and 15Aa-3
    2. Board Consisting of a Majority of Independent Directors
    a. Determination of Independence
    b. Independent Board Requirements
    c. Fair Representation
    3. Standing Committees
    4. Other Committees of the Board
    5. Other Requirements Applicable to Directors and Officers
    6. Executive Sessions of the Board
    7. Separation of Chairman of the Board and CEO Positions
    8. Separation of Regulatory and Market Operations
    a. Independence of Regulatory Program
    b. Use of Regulatory Fees, Fines, and Penalties
    c. Confidentiality of Regulatory and Trading Information
    9. Member Voting and Ownership Limitations
    a. Members' Interests Aggregated with Their Related Persons
    b. Solicitation of Revocable Proxies
    c. Requirement to Divest Ownership Interest and Restrict Voting
    d. Ability to Obtain Information
    10. Code of Conduct and Ethics and Governance Guidelines
    11. Exemption Provision
    12. Implementation
    C. Request for Comment
III. Proposed Regulation AL--National Securities Exchanges and 
Registered Securities Associations Listing Affiliated Securities
    A. Background and Need for Proposed Regulation AL
    B. Description of Proposed Regulation AL
    1. Definition of Affiliated Security
    2. Initial Listing
    3. Continued Listing and Trading
    4. Parity in Application of Listing and Trading Rules
    5. Exemption Provision
    C. Request for Comment
IV. Disclosure by Eros
    A. Overview of Proposed Amendments to Registration Forms for 
Exchanges and Associations
    B. Description of Registration Processes
    1. Registration as a National Securities Exchange or Exemption 
from Such Registration Based on Limited Volume
    2. Registration as a Registered Securities Association or 
Affiliated Securities Association
    C. Proposed Revisions to Form 1 and New Form 2
    1. Scope of Disclosures Required by Revised Form 1 and New Form 
2
    2. Composition, Structure, and Responsibilities of the Board
    3. Composition, Structure, and Responsibilities of Committees 
and Executive Boards
    4. Governance
    a. Governance Guidelines
    b. Code of Conduct and Ethics
    5. Organizational Charts
    6. Regulatory Program
    7. Audited Financial Statements and Other Financial Information
    a. Budget and Revenues Devoted to Regulatory Activities
    b. Revenues and Expenses
    c. Other Financial Disclosures
    8. Relationship between SROs, Facilities, and Their Affiliates
    9. Ownership
    10. Listing and Trading of Affiliated Securities
    11. Location of Books and Records
    12. Miscellaneous Matters Specific to New Form 2
    13. Current Disclosures to be Retained in Revised Form 1 and 
Added to New Form 2
    a. Constitution, Articles of Incorporation, Bylaws, and Rules
    b. Rulings and Interpretations
    c. Officers
    d. Financial Statements of Affiliates
    e. General Information Relating to Affiliates and SRO Trading 
Facilities
    f. Operation of SRO Trading Facilities
    g. Membership Forms
    h. Financial Responsibility and Minimum Capital Requirements of 
Members
    i. Listing Applications
    j. Criteria for Membership
    k. List of Members
    l. Securities Listed and Traded
    D. Timing and Format of Revised Form 1 and New Form 2
    E. Proposed Changes to Rule 15Aa-1
    F. Proposed Repeal of Forms X-15AJ-1 and X-15AJ-2
    G. Request for Comment
V. Periodic Reporting Obligations of Exchanges and Associations
    A. Background and Need for Proposed Rule 17a-26
    B. Scope and Timing of Reports Required by Proposed Rule 17a-26
    1. Quarterly Reports
    2. Annual Reports
    C. Format of Reports
    D. Quarterly Reporting of Regulatory Information
    1. Information on the SRO's Surveillance Program
    2. Information on Complaints Received
    3. Investigations, Examinations, and Enforcement Actions
    4. Information on Listings Programs
    5. Copies of Board and Committee Meeting Agenda
    E. Annual Reporting of Regulatory Information
    1. Cumulative Summary of Quarterly Information
    2. Processes for Carrying Out Regulatory Responsibilities
    3. Evaluation of the Regulatory Program
    4. Internal Controls
    5. Employment Arrangements with Regulatory Personnel
    6. Copies of Standing Committee Evaluations
    7. Compliance with Regulatory Plans
    F. Audit Report of Electronic SRO Trading Facilities
    G. Certifications
    H. Interim Changes
    I. Confidentiality of Reports
    J. Compliance Date
    K. Exemptions and Extensions of Time for Filing Reports
    L. Filing of Reports
    M. Request for Comment
VI. Proposed Rule 17a-27
    A. Background and Need for Proposed Rule 17a-27
    B. Description of Proposed Rule 17a-27
    1. Brokers and Dealers Subject to the Rule
    2. Information Required to be Filed
    3. Timing of Filing
    4. Filings with the Exchange or Association
    5. Exemptions
    C. Request for Comment
VII. Implementation
VIII. General Request for Comment
IX. Paperwork Reduction Act Analysis
    A. Proposed Rule 3b-19
    B. Proposed Amendments to Rule 6a-2, Revised Form 1, Rule 15Aa-
2, and New Form 2
    1. Summary of Collections of Information
    2. Proposed Use of Information
    3. Respondents
    4. Reporting and Recordkeeping Burden
    5. Collections of Information are Mandatory
    6. Record Retention Period
    C. Proposed Rules 6a-5 and 15Aa-3
    1. Summary of Collection of Information
    2. Proposed Use of Information
    3. Respondents
    4. Reporting and Recordkeeping Burden
    5. Collection of Information is Mandatory
    6. Record Retention Period
    D. Proposed Regulation AL
    1. Summary of Collection of Information
    2. Proposed Use of Information
    3. Respondents
    4. Reporting and Recordkeeping Burden
    5. Collection of Information is Mandatory
    6. Record Retention Period
    E. Proposed Amendments to Rule 17a-1
    F. Proposed Rule 17a-26

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    1. Summary of Collection of Information
    2. Proposed Use of Information
    3. Respondents
    4. Reporting and Recordkeeping Burden
    5. Collection of Information is Mandatory
    6. Record Retention Period
    G. Proposed Rule 17a-27
    1. Summary of Collection of Information
    2. Proposed Use of Information
    3. Respondents
    4. Reporting and Recordkeeping Burden
    5. Collection of Information is Mandatory
    6. Record Retention Period
    H. Request for Comment
X. Consideration of Costs and Benefits
    A. Costs and Benefits of Proposed Rules 6a-5 and 15Aa-3
    1. Benefits
    2. Costs
    3. Request for Comment
    B. Costs and Benefits of Proposed Regulation AL
    1. Benefits
    2. Costs
    3. Request for Comment
    C. Costs and Benefits of Proposed Rule 6a-2 and Revised Form 1, 
and Rule 15Aa-2 and New Form 2
    1. Benefits
    2. Costs
    3. Request for Comment
    D. Costs and Benefits of Proposed Amendments to Rule 17a-1
    1. Benefits
    2. Costs
    3. Request for Comment
    E. Costs and Benefits of Proposed Rule 17a-26
    1. Benefits
    2. Costs
    3. Request for Comment
    F. Costs and Benefits of Proposed Rule 17a-27
    1. Benefits
    2. Costs
    3. Request for Comment
XI. Consideration of Burden on Competition, and Promotion of 
Efficiency, Competition, and Capital Formation
XII. Consideration of Impact on the Economy
XIII. Regulatory Flexibility Act Certification
XIV. Statutory Authority and Text of Proposed Rules

I. Background

A. Self-Regulation Under the Exchange Act

    The system of regulation for our Nation's securities markets and 
market participants is grounded on the principle of self-regulation. 
Thus, the Exchange Act \1\ sets forth a regulatory model that combines 
both industry and government responsibility, based on the notion that 
regulation is most effective when it is done as closely as possible to 
the regulated activity. Congress enhanced this framework for the 
regulation of securities markets and market participants since the 
adoption of the Exchange Act, most notably in the Securities Acts 
Amendments of 1975.\2\ While Congress at that time again weighed the 
risks of permitting the securities industry to regulate itself against 
the burdens of attempting to assure regulation directly through the 
government on a wide scale,\3\ it refrained from changing the 
underlying principle of self-regulation. Thus, although the Commission 
has ultimate responsibility for oversight of the U.S. securities 
markets and their participants, the SROs continue to have ``front-
line'' responsibility for overseeing trading on their markets and their 
members' compliance with applicable statutory and regulatory 
provisions.\4\
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    \1\ 15 U.S.C. 78a, et seq.
    \2\ Securities Acts Amendments of 1975, Pub. L. 94-29, 89 Stat. 
97 (1975).
    \3\ S. Rep. No. 75, 94th Cong., 1st Sess. (1975) at 201.
    \4\ Section 3(a)(26) of the Exchange Act, 15 U.S.C. 78c(a)(26), 
defines a self-regulatory organization as any national securities 
exchange, registered securities association, or registered clearing 
agency, or (solely for purposes of Sections 19(b), 19(c), and 23(b) 
of the Exchange Act, 15 U.S.C. 78s(b), 78s(c), and 78w(b)), the 
Municipal Securities Rulemaking Board. The proposed rulemaking would 
apply only to those SROs that are national securities exchanges 
registered under Section 6(a) of the Exchange Act, 15 U.S.C. 78f(a), 
and securities associations registered under Section 15A(a) of the 
Exchange Act, 15 U.S.C. 78o-3(a).
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    Congress, however, gave the Commission a wide range of tools to 
oversee this self-regulatory system and to compel SROs to act when they 
fail to provide adequate protection to investors.\5\ For example, the 
Commission is empowered to approve SRO rules \6\ and to abrogate, add 
to, or delete from SRO rules.\7\ The Commission also is authorized to 
review disciplinary actions taken by SROs against their members.\8\ In 
addition, the Commission has the authority to require exchanges and 
associations to keep records and to file reports with the 
Commission.\9\ All records of exchanges and associations are subject, 
at any time, or from time to time, to reasonable periodic, special, or 
other examinations by the Commission.\10\ If the Commission identifies 
deficiencies, it will bring them to the attention of the SRO and can 
inspect the SRO to ascertain whether corrective action has been taken. 
Moreover, the Commission has the authority to impose limitations on the 
operations of an SRO if it finds that the SRO has violated or is unable 
to comply with any provisions of the Exchange Act or rules or 
regulations thereunder, or with any of the SRO's own rules, or has 
failed to enforce compliance with any such provision by its 
members.\11\ Further, the Commission has the authority to suspend or 
revoke the registration of an SRO,\12\ and remove from office or 
censure any officer or director of an SRO.\13\
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    \5\ See supra note 2.
    \6\ Section 19(b)(1) of the Exchange Act, 15 U.S.C. 78s(b)(1), 
requires an SRO to file with the Commission copies of any proposed 
rule or any proposed change in, addition to, or deletion from the 
rules of such SRO, accompanied by a concise general statement of the 
basis and purpose of such proposed rule change, for Commission 
approval. This filing requirement is supplemented by Rule 19b-4 
under the Exchange Act, 17 CFR 240.19b-4.
    \7\ Section 19(c) of the Exchange Act, 15 U.S.C. 78s(c), permits 
the Commission, by rule, to abrogate, add to, or delete from the 
rules of an SRO as the Commission deems necessary or appropriate to 
insure the fair administration of the SRO, to conform its rules to 
requirements of the Exchange Act and the rules and regulations 
thereunder applicable, or otherwise in furtherance of the purposes 
of the Exchange Act.
    \8\ Section 19(d)(2) of the Exchange Act, 15 U.S.C. 78s(d)(2), 
states that notice of any final disciplinary sanction, denial of 
membership or participation, or limitation of access to services to 
a person, member, or person associated with a member shall be 
subject to review by the appropriate regulatory agency for such 
member, participant, applicant, or other person. Section 3(a)(34)(E) 
of the Exchange Act, 15 U.S.C. 78c(a)(34)(E), states that when used 
with respect to a member of a national securities exchange or 
registered securities association, the appropriate regulatory 
authority is the Commission.
    \9\ Section 17(a)(1) of the Exchange Act, 15 U.S.C. 78q(a)(1), 
states that exchanges and associations, among others, are required 
to make, keep and furnish any records, and make and disseminate any 
reports, that the Commission, by rule, prescribes as necessary or 
appropriate in the public interest, for the protection of investors, 
or otherwise in furtherance of the purposes of the Exchange Act.
    \10\ Section 17(b) of the Exchange Act, 15 U.S.C. 78q(b), states 
that all records of a national securities exchange or registered 
securities association, among others, are subject at any time, or 
from time to time, to such reasonable periodic, special, or other 
examinations by representatives of the Commission, as the Commission 
deems necessary or appropriate in the public interest, for the 
protection of investors, or otherwise in furtherance of the purposes 
of the Exchange Act.
    \11\ Section 19(h)(1) of the Exchange Act, 15 U.S.C. 78s(h)(1).
    \12\ Id.
    \13\ Section 19(h)(4) of the Exchange Act, 15 U.S.C. 78s(h)(4).
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    As part of its duties, an SRO must conduct surveillance of trading 
in its markets and examine the operations of its members. In addition, 
an exchange or association may not be registered with the Commission 
unless it is so organized and has the capacity to carry out the 
purposes of the Exchange Act and to comply with, and enforce its 
members' compliance with, the federal securities laws and rules 
thereunder, as well as its own rules.\14\ An exchange or association 
also may not be registered unless the rules of the exchange or 
association, among other things: (1) Provide for a fair representation 
of its members on the board of directors; \15\ (2) provide for an 
equitable allocation of

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dues, fees, and charges among its members; \16\ (3) are designed to 
prevent fraudulent and manipulative acts and practices; \17\ (4) are 
designed to promote just and equitable principles of trade; \18\ (5) 
are designed to perfect the mechanism of a free and open market and a 
national market system; \19\ (6) protect investors and the public 
interest; \20\ and (7) provide a process for disciplining its 
members.\21\ Accordingly, the Exchange Act makes clear that SROs are 
charged with an important public trust to carry out their self-
regulatory responsibilities effectively and fairly, while fostering 
free and open markets, protecting investors, and promoting the public 
trust.\22\
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    \14\ Sections 6(b)(1) and 15A(b)(2) of the Exchange Act, 15 
U.S.C. 78f(b)(1) and 78o-3(b)(2).
    \15\ Sections 6(b)(3) and 15A(b)(4) of the Exchange Act, 15 
U.S.C. 78f(b)(3) and 78o-3(b)(4).
    \16\ Sections 6(b)(4) and 15A(b)(5) of the Exchange Act, 15 
U.S.C. 78f(b)(4) and 78o-3(b)(5).
    \17\ Sections 6(b)(5) and 15A(b)(6) of the Exchange Act, 15 
U.S.C. 78f(b)(5) and 78o-3(b)(6).
    \18\ Id.
    \19\ Id.
    \20\ Id.
    \21\ Sections 6(b)(7) and 15A(b)(7) of the Exchange Act, 15 
U.S.C. 78f(b)(7) and 78o-(b)(7).
    \22\ See Sections 6(b)(5) and 15A(b)(6) of the Exchange Act, 15 
U.S.C. 78f(b)(5) and 78o-3(b)(6).
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B. Overview of Recent Developments

    Recent developments have prompted the Commission to review aspects 
of its oversight and regulation of national securities exchanges and 
registered securities associations and to consider whether changes are 
necessary to respond to those developments.
1. Governance Concerns
    In the wake of corporate scandals that threatened investor 
confidence in the securities markets,\23\ the governance of companies 
listed on securities exchanges and The Nasdaq Stock Market (``Nasdaq'') 
became the focus of attention.\24\ After allegations of improprieties 
by several issuers and their executives, Congress enacted the Sarbanes-
Oxley Act of 2002 (``Sarbanes-Oxley Act'') \25\ to improve the accuracy 
and reliability of corporate disclosures and the effective oversight of 
the financial reporting process.\26\ During this period, the New York 
Stock Exchange, Inc. (``NYSE'') and Nasdaq each undertook a review of 
its own corporate governance listing standards and proposed changes to 
strengthen those standards.\27\ The new NYSE and Nasdaq corporate 
governance listing rules, which were approved by the Commission in 
November 2003, establish a more comprehensive definition of 
``independence'' for directors and require the majority of members on 
listed companies' boards to satisfy the new independence standard.\28\ 
In addition, the new NYSE and Nasdaq rules include a number of 
provisions that mandate and facilitate independent director oversight 
of functions relating to corporate governance, auditing, director 
nominations, and compensation.\29\
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    \23\ See, e.g., John Waggoner and Thomas A. Fogarty, Scandals 
Shred Investors' Faith: Because of Enron, Andersen, and Rising Gas 
Prices, the Public Is More Wary Than Ever of Corporate America, USA 
Today, May 5, 2002, and Louis Aguilar, Scandals Jolting Faith of 
Investors, Denver Post, June 27, 2002.
    \24\ Nasdaq is a facility of the National Association of 
Securities Dealers, Inc. (``NASD''). Pursuant to proposed Rule 15Aa-
3(b)(11), which would define the term ``facility'' with regard to a 
registered securities association, Nasdaq would continue to be a 
facility of the NASD.
    \25\ Sarbanes-Oxley Act of 2002, Pub. L. 107-204, 116 Stat. 745 
(2002).
    \26\ H.R. Conf. Rep. No. 610, 107th Cong., 2nd Sess. (2002).
    \27\ See Securities Exchange Act Release Nos. 47672 (April 11, 
2003), 68 FR 19051 (April 17, 2003) (publishing for comment File No. 
SR-NYSE-2002-23); 48137 (July 8, 2003), 68 FR 42152 (July 16, 2003) 
(publishing for comment File No. SR-NASD-2002-80); 48123 (July 2, 
2003), 68 FR 41191 (July 10, 2003) (publishing for comment File No. 
SR-NASD-2002-77); 48124 (July 2, 2003), 68 FR 41193 (July 10, 2003) 
(publishing for comment File No. SR-NASD-2002-138); 48125 (July 2, 
2003), 68 FR 41194 (July 10, 2003) (publishing for comment File No. 
SR-NASD-2002-139); and 47516 (March 17, 2003), 68 FR 14451 (March 
25, 2003) (publishing for comment File No. SR-NASD-2002-141).
    \28\ See Securities Exchange Act Release No. 48745 (November 4, 
2003), 68 FR 64154 (November 12, 2003) (order approving File Nos. 
SR-NYSE-2002-33, SR-NASD-2002-77, SR-NASD-2002-80, SR-NASD-2002-138, 
SR-NASD-2002-139, and SR-NASD-2002-141).
    \29\ See id.
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    In light of the governance changes proposed by the NYSE and Nasdaq 
for their listed issuers, in March 2003, the Commission's Chairman 
requested that the SROs review the adequacy of their own governance 
practices.\30\ In his letter to each SRO, the Chairman noted that the 
SROs play a critical role in our securities markets as standard setters 
for listed companies, operators of trading markets, and front-line 
regulators of securities firms.\31\ Further, the Chairman referred to 
the enhanced corporate governance listing standards proposed by the 
NYSE and Nasdaq as a high standard that the SROs should demand not only 
of listed issuers, but also of themselves.\32\
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    \30\ See Letters from William H. Donaldson, Chairman, 
Commission, to Salvatore F. Sodano, Chairman & CEO, American Stock 
Exchange LLC (``Amex''); Kenneth R. Leibler, Chairman & CEO, Boston 
Stock Exchange, Inc. (``BSE''); William J. Brodsky, Chairman & CEO, 
Chicago Board Options Exchange, Inc. (``CBOE''); David A. Herron, 
CEO, Chicago Stock Exchange, Inc. (``CHX''); David Colker, President 
& CEO, Cincinnati Stock Exchange, Inc. (``CSE''); David Krell, CEO, 
International Securities Exchange, Inc. (``ISE''); Philip D. DeFeo, 
Chairman & CEO, Pacific Exchange, Inc. (``PCX''); Meyer S. Frucher, 
Chairman & CEO, Philadelphia Stock Exchange, Inc. (``Phlx''); Robert 
R. Glauber, Chairman & CEO, NASD; Richard G. Ketchum, President & 
Deputy Chairman, Nasdaq; and Richard A. Grasso, Chairman & CEO, NYSE 
(March 26, 2003). Copies of these letters are available in the 
Commission's Public Reference Room under File No. S7-39-04.
    \31\ See id.
    \32\ See id.
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    Several months later, while the NYSE was reviewing its own 
governance practices, the media published reports of the proposed 
extension of the employment agreement of its then Chairman and Chief 
Executive Officer (``CEO''), as well as an anticipated substantial 
payout of his accrued compensation. In response, the Commission's 
Chairman sent a letter to the Chairman of the NYSE's Compensation and 
Human Resources Committee and Special Governance Committee requesting 
information regarding the compensation of the NYSE Chairman and CEO and 
the decision-making processes at the NYSE that led to the pay 
package.\33\ Shortly thereafter, the Commission's Chairman sent letters 
to the other SROs requesting that they provide details about the extent 
of public representation on their boards and key committees (including 
the Compensation Committee); the decision-making processes with respect 
to the nomination of directors, their assignment to committees, and the 
compensation of executives; and the SROs' past practices and current 
plans for public disclosure of these processes and the compensation 
arrangements of key executives.\34\
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    \33\ See Letter from William H. Donaldson, Chairman, Commission, 
to The Honorable H. Carl McCall, Chairman, Human Resources and 
Compensation Committee, Chairman, Special Committee on Governance of 
the NYSE, NYSE, dated September 2, 2003. A copy of this letter is 
available in the Commission's Public Reference Room under File No. 
S7-39-04.
    \34\ See Letters from William H. Donaldson, Chairman, 
Commission, to Salvatore F. Sodano, Chairman & CEO, Amex; Kenneth R. 
Leibler, Chairman & CEO, BSE; William J. Brodsky, Chairman & CEO, 
CBOE; Robert; David A. Herron, CEO, CHX; David Colker, President & 
CEO, CSE; David Krell, President & CEO, ISE; Philip D. DeFeo, 
Chairman & CEO, PCX; Meyer S. Frucher, Chairman & CEO, Phlx; Robert 
R. Glauber, Chairman & CEO, NASD; and Robert Greifeld, President & 
CEO, Nasdaq (September 23, 2003). Copies of these letters are 
available in the Commission's Public Reference Room under File No. 
S7-39-04.
---------------------------------------------------------------------------

    During this period, the NYSE announced the resignation of its 
Chairman and CEO and shortly thereafter named an interim Chairman. In 
November 2003, the NYSE filed with the Commission a proposal to amend 
the NYSE Constitution to implement a series of governance changes at 
the NYSE.\35\ The proposal called for the

[[Page 71130]]

establishment of a new board of directors composed wholly of 
independent directors; an advisory board of executives that would be 
representative of the exchange's various constituencies; independent 
board committees with specific oversight authority for compensation, 
audit functions, the nominations process and regulatory matters; and an 
autonomous regulatory unit that would report directly to the regulatory 
oversight committee. The Commission approved the NYSE's governance 
revisions in December 2003.\36\
---------------------------------------------------------------------------

    \35\ See Securities Exchange Act Release No. 48764 (November 7, 
2003), 68 FR 64380 (November 13, 2003).
    \36\ See Securities Exchange Act Release No. 48946 (December 17, 
2003), 68 FR 74678 (December 24, 2003).
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2. Concerns Relating to Weaknesses of SRO Regulatory Programs
    In addition to the enhanced focus on SRO governance, recent 
Commission enforcement actions involving SROs have highlighted 
weaknesses in the effectiveness of certain SRO regulatory programs. In 
September 2003, for example, the Commission settled an administrative 
enforcement action against the CHX for failure to enforce its trading 
rules.\37\ The Commission's order, among other things, included 
findings that the CHX's surveillance program failed adequately to 
detect violations by its members of the firm quote rule,\38\ trading 
ahead prohibitions,\39\ and the limit order display rule \40\ from 1998 
through 2001. As part of the undertakings imposed by the settlement, 
the CHX was required, among other things, to create a regulatory 
oversight committee comprised almost exclusively of individuals with no 
material business relationship with the exchange.\41\ In addition, the 
CHX was required to file with the Commission various certifications by 
its officials confirming its ongoing compliance with its statutory 
obligations.
---------------------------------------------------------------------------

    \37\ See In the Matter of Chicago Stock Exchange, Securities 
Exchange Act Release No. 48566 (September 30, 2003) (``CHX Order'').
    \38\ See CHX Article XX, Rule 7.01; see also Exchange Act Rule 
11Ac1-1, 17 CFR 240.11Ac1-1.
    \39\ See CHX Article XXX, Rule 2.
    \40\ See CHX Article XX, Rule 7.05; see also Exchange Act Rule 
11Ac1-4, 15 CFR 240.11Ac1-4.
    \41\ The CHX's regulatory oversight committee must advise the 
CHX's board of governors about regulatory, compliance, and 
enforcement matters and assist the board in monitoring the design, 
implementation, and effectiveness of the CHX's compliance program. 
See CHX Order, supra note 37.
---------------------------------------------------------------------------

    Also, recent Commission enforcement actions involving SRO members 
have pointed to weaknesses in the effectiveness of SROs' regulatory 
programs. In 2004, for example, the Commission settled enforcement 
actions against the seven NYSE specialist firms. The Commission found 
that, between 1999 and 2003, these specialist firms violated federal 
securities laws and NYSE rules by executing orders for their dealer 
accounts ahead of executable public customer orders.\42\ As part of the 
settlement, the firms agreed to pay a total of more than $247 million 
in penalties and disgorgement, and agreed to implement steps to improve 
their compliance procedures and systems.
---------------------------------------------------------------------------

    \42\ See In the Matter of Bear Wagner Specialists LLC, 
Securities Exchange Act Release No. 49498 (March 30, 2004); In the 
Matter of Fleet Specialist, Inc., Securities Exchange Act Release 
No. 49499 (March 30, 2004); In the Matter of LaBranche & Co. LLC, 
Securities Exchange Act Release No. 49500 (March 30, 2004); In the 
Matter of Spear, Leeds & Kellogg Specialists LLC, Securities 
Exchange Act Release No. 49501 (March 30, 2004); and In the Matter 
of Van der Moolen Specialists USA, LLC, Securities Exchange Act 
Release No. 49502 (March 30, 2004). These five firms agreed to pay a 
total of $241.8 million in penalties and disgorgement, and agreed to 
implement steps to improve their compliance procedures and systems. 
In July 2004, the Commission and the NYSE settled enforcement 
actions against two other NYSE specialist firms. See In the Matter 
of SIG Specialists, Inc., Securities Exchange Act Release No. 50076 
(July 26, 2004); and In the Matter of Performance Specialist Group 
LLC, Securities Exchange Act Release No. 50075 (July 26, 2004). 
These firms agreed to pay a total of $5.2 million in penalties and 
disgorgement, consisting of $1.7 million in civil money penalties 
and $3.5 million in disgorgement, and agreed to implement steps to 
improve their compliance procedures and systems.
---------------------------------------------------------------------------

    Moreover, the Commission's staff recently has conducted inspections 
of SROs that have raised questions regarding whether, in certain 
circumstances, SROs have governance structures that are sufficiently 
independent, or whether SROs have maintained regulatory programs that 
are sufficiently rigorous to detect, deter, and discipline for members' 
violations of the federal securities laws and rules and SRO rules.
    Taken together, developments involving SRO governance, as well as 
the concerns raised by recent enforcement actions \43\ and inspections 
involving SROs, have prompted the Commission to consider new regulatory 
measures with respect to SROs. The Commission therefore has determined 
to propose rules that would strengthen the governance of national 
securities exchanges and registered securities associations and the 
independence of their regulatory programs. Moreover, the Commission is 
proposing to enhance the level of information that would be publicly 
available about SROs, including with respect to their governance 
structures, finances, regulatory programs, and significant owners. 
Finally, the Commission believes that oversight of SROs would be 
enhanced, and inspections could be better targeted to problematic 
areas, if the Commission were to receive more extensive and frequent 
data about SRO regulatory programs in a systematic fashion. Therefore, 
the Commission is proposing a new SRO reporting rule that is intended 
to facilitate more effective Commission monitoring of SROs' regulatory 
programs. While the Commission is proposing other measures that would 
increase the transparency of SROs' operations, the information 
submitted under this proposed rule is intended to be used as part of 
the Commission's examination program and thus may not be publicly 
available.
---------------------------------------------------------------------------

    \43\ See, e.g., CHX Order, supra note 37; In the Matter of 
Certain Activities of Options Exchanges, Securities Exchange Act 
Release No. 43268 (September 11, 2000) (proceeding against Amex, 
CBOE, PCX, and Phlx for engaging in anticompetitive activities and 
for failing adequately to enforce compliance with their own rules); 
and In the Matter of NYSE, Inc., Securities Exchange Act Release No. 
41574 (June 29, 1999) (proceeding against NYSE for failure to 
enforce compliance with federal securities laws and NYSE rules 
prohibiting proprietary and on-floor trading by NYSE floor broker 
members in violation of Section 19(g) of the Exchange Act, 15 U.S.C. 
78s(g)).
---------------------------------------------------------------------------

3. Competitive Concerns
    More broadly, the Commission's review of SROs also was prompted by 
marketplace developments and the increasingly competitive environment 
faced by SROs that operate trading facilities. For example, in recent 
years, market participants have developed a variety of alternative 
trading systems (``ATSs'') that furnish execution services historically 
provided by exchanges.\44\ Under Regulation ATS,\45\ ATSs may choose 
whether (a) to register as national securities exchanges, and thus 
assume the responsibilities of SROs; or (b) to register as broker-
dealers under Sections 15(b) or 15C of the Exchange Act,\46\ subject to 
certain additional reporting and conduct requirements.\47\ Regulation 
ATS was designed to impose essential elements of market-oriented 
regulation on ATSs, while maintaining

[[Page 71131]]

sufficient regulatory flexibility to foster market innovation.\48\
---------------------------------------------------------------------------

    \44\ Alternative trading systems include electronic 
communications networks (``ECNs'') such as INET ATS (``INET''), a 
subsidiary of Instinet Group, Inc. An ECN is an electronic system 
that widely disseminates to third parties orders entered therein by 
an exchange market maker or over-the-counter (``OTC'') market maker, 
and permits such orders to be executed against in whole or in part. 
The term specifically excludes internal broker-dealer order routing 
systems and crossing systems, i.e., systems that cross multiple 
orders at one or more specified times at a single price set by the 
ECN and do not allow orders to be crossed or executed against 
directly by participants outside of such times. 17 CFR 240.11Ac1-
1(a)(8).
    \45\ See Regulation ATS, 17 CFR 242.300, et seq.
    \46\ 15 U.S.C. 78o(b) and 78o-5.
    \47\ See Regulation ATS, 17 CFR 242.300, et seq.
    \48\ See Securities Exchange Act Release No. 40760 (December 8, 
1998), 63 FR 70844 (December 22, 1998) (adopting Regulation ATS).
---------------------------------------------------------------------------

    The highly-competitive environment of recent years also has induced 
alliances among particular SROs and ATSs to combine the regulatory 
status of the SRO with the market share of the ATS. In 2001, for 
example, the Commission approved a proposal by PCX to establish the 
Archipelago Exchange (``Arca-Ex'') as a facility of its subsidiary, PCX 
Equities, Inc. (``PCX Equities'').\49\ In addition, several ECNs have 
made arrangements to execute and report trades through a particular 
exchange, and to share the market data revenues generated thereby.\50\
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    \49\ See Securities Exchange Act Release No. 44983 (October 25, 
2001), 66 FR 55225 (November 1, 2001) (establishing Arca-Ex as the 
equities trading facility of PCX Equities).
    \50\ For example, INET has arranged to execute and report its 
trades through the National Stock Exchange, Inc. (``NSX'') (formerly 
known as CSE).
---------------------------------------------------------------------------

    Moreover, the SROs face increased competition from foreign trading 
markets that operate under regulatory regimes that differ from the U.S. 
regulatory model. These foreign markets may not be subject to the same 
kind of regulatory requirements that markets operated by U.S. SROs must 
satisfy. For example, issuers listed on U.S. exchanges or Nasdaq 
generally are subject to different disclosure standards than issuers 
whose securities are listed and traded solely on foreign markets. These 
differences in the U.S. reporting regime may deter some foreign issuers 
from U.S. registration, with the result that their securities cannot be 
traded on U.S. exchanges or Nasdaq, but can be traded on foreign 
markets or on U.S. trading systems (such as ECNs) that are not operated 
by SROs.
    The effect of these developments is that markets operated by SROs 
have faced increased competition from foreign trading markets and from 
electronic trading systems, such as ECNs, that have made substantial 
inroads into the market share of the traditional SRO markets, 
especially with respect to Nasdaq securities. Furthermore, historic 
differences in the securities traded by particular SROs are 
disappearing. For example, the NYSE and Amex historically dominated 
trading in their listed securities, and market makers dominated trading 
in Nasdaq stocks. Today, however, for Nasdaq stocks, automated order-
driven market centers (such as Nasdaq's SuperMontage, Arca-Ex, and 
INET) have captured more than 50% of share volume.\51\ For Amex-listed 
stocks (for which approximately 39% of share volume now is represented 
by two extremely active exchange-traded funds (``ETFs'')--the QQQ and 
SPDR), Amex now handles approximately 21% of the volume, with the 
remaining balance split among Arca-Ex, INET, and others.\52\ The NYSE 
has retained approximately 80% of the volume in its listed stocks, but 
other market centers are attempting to raise the level of competition 
and increase their share of trading.\53\ Moreover, the NYSE and Amex 
have sought to add automated facilities that are integrated with and 
complement their traditional exchange floors.\54\
---------------------------------------------------------------------------

    \51\ The figure is based on Nasdaq/UTP Plan market data (as of 
September 2004). Copies of this data are available in the 
Commission's Public Reference Room under File No. S7-39-04.
    \52\ The figure is based on Network B, CTS Activity market data 
(as of September 2004). Copies of this data are available in the 
Commission's Public Reference Room under File No. S7-39-04.
    \53\ The figure is based on Network A, CTS Activity market data 
(as of September 2004). Copies of this data are available in the 
Commission's Public Reference Room under File No. S7-39-04.
    \54\ See Securities Exchange Act Release Nos. 50173 (August 10, 
2004), 69 FR 50407 (August 16, 2004) (notice of proposed rule change 
proposing improvements to NYSE's existing automatic execution 
facility, NYSE Direct+[reg]) and 49921 (June 25, 2004), 69 FR 40690 
(July 6, 2004) (approval of proposed rule change by Amex to enhance 
its Auto-Ex technology for exchange-traded funds and Nasdaq stocks 
traded on the exchange).
---------------------------------------------------------------------------

    The historic differences between SROs that operate options trading 
markets have also eroded. From 1977 until 1999, most actively traded 
options were traded on only one exchange. In 1989, the Commission 
adopted Rule 19c-5 under the Exchange Act, prohibiting exchanges from 
having rules that limit their ability to list any stock options class 
because that options class is listed on another options exchange.\55\ 
The options exchanges, however, did not widely implement multiple 
listing of options until 1999. By that time, the U.S. Department of 
Justice (``DOJ'') and the Commission had begun to investigate the four 
floor-based options exchanges (Amex, CBOE, PCX, and Phlx) for engaging 
in anticompetitive activities--in particular, for refraining from 
listing options listed on another exchange--and for failing to enforce 
adequately compliance with their own rules.\56\ In addition, during 
that period the ISE had filed an application with the Commission to 
register as a national securities exchange that would trade 
options.\57\
---------------------------------------------------------------------------

    \55\ See Securities Exchange Act Release No. 26870 (May 26, 
1989), 54 FR 23963 (June 5, 1989).
    \56\ See Securities Exchange Act Release No. 43268, supra note 
43. See also U.S. v. American Stock Exchange LLC, et al., 2000 WL 
33400154 (D.D.C. 2000).
    \57\ See Securities Exchange Act Release No. 41439 (May 24, 
1999), 64 FR 29367 (June 1, 1999). The Commission approved the ISE's 
registration application in 2000. See Securities Exchange Act 
Release No. 42455 (February 24, 2000), 65 FR 11388 (March 2, 2000).
---------------------------------------------------------------------------

    As part of their settlement with the Commission, the floor-based 
options exchanges were ordered to collectively spend $77 million on 
surveillance and enforcement. The settlement of the Commission's 
enforcement action and the entry of a consent decree in the DOJ case, 
along with the proposed entry of the ISE as a national securities 
exchange that intended to trade options, were the catalysts for the 
expansion of multiple listing of equity options. Today, virtually all 
actively traded equity options trade on multiple markets, a development 
that has enhanced competition among the options exchanges.\58\ The 
entry of electronic options trading markets has further raised the 
level of competition.\59\
---------------------------------------------------------------------------

    \58\ In August 1999, 32% of equity options were traded on more 
than one exchange. By September 2000, that number had risen to 45%. 
Securities Exchange Act Release No. 43085 (July 28, 2000), 65 FR 
47918 (August 4, 2000) (proposing to extend Exchange Act Rule 11Ac1-
1 to options). Over the same period, the percentage of aggregate 
option volume traded on only one exchange fell from 60% to 15%. Id. 
According to the Options Clearing Corporation, by September 2003, 
98.3% of equity options classes traded on more than one exchange. 
Id.
    \59\ For example, the Boston Options Exchange (``BOX''), a 
facility of the BSE, commenced trading in 2004. See Securities 
Exchange Act Release No. 49067 (January 14, 2004), 64 FR 2761 
(January 21, 2004) (order approving the operating agreement of BOX).
---------------------------------------------------------------------------

    The recent developments outlined above have led the Commission to 
consider whether the increasing competitive pressures placed on SROs 
that operate trading facilities warrant additional measures that are 
designed to focus the SROs on their statutorily-mandated 
responsibilities as market regulators. Pursuant to the Exchange Act, 
SROs are charged with a public trust to implement and enforce the 
federal securities laws and rules, as well as their own rules with 
respect to their members.\60\ Yet, as membership organizations, and in 
some cases as shareholder-owned organizations, SROs are expected to 
promote the economic interests of their members and their owners. In 
addition, SROs, as operators of trading markets, are critical to the 
success and viability of our capital markets. In this capacity, SROs 
play a key role in the price discovery process, are innovators of new 
products, and, through the listing mechanism, provide

[[Page 71132]]

issuers with an opportunity to access capital. This business model 
understandably would prompt SROs to be concerned with preserving and 
enhancing their competitive positions. As competition increases among 
marketplaces and SROs actively pursue strategies to increase their 
market share, there is a possibility that SROs could face increasing 
pressure from members and owners with respect to the degree of emphasis 
placed on their regulatory obligations. In the Commission's view, this 
factor underscores the need to consider measures that foster and 
enhance the independence of SROs' governance, the transparency of their 
processes, and the effectiveness of their regulatory programs.
---------------------------------------------------------------------------

    \60\ See Sections 6(b)(1) and 15A(b)(2) of the Exchange Act, 15 
U.S.C. 78f(b)(1) and 78o-3(b)(2).
---------------------------------------------------------------------------

4. Concerns Relating to New Ownership Structures
    Finally, SROs have been challenged by the recent trend to 
demutualize and reorganize as shareholder-owned entities.\61\ SROs 
historically have been structured as mutual, not-for-profit 
organizations owned, for the most part, by members that are registered 
broker-dealers. In 1998, the Commission expressed the view that 
exchanges could be organized as for-profit entities.\62\ Since that 
time, and especially over the past few years, a number of SROs have 
demutualized and explicitly separated the right to trade in their 
markets from the economic ownership rights in those SROs. SROs have put 
forth various reasons for demutualizing, but common themes are an 
increased ability to more quickly respond to competitive pressures and 
additional potential sources of capital.\63\
---------------------------------------------------------------------------

    \61\ See Securities Exchange Act Release Nos. 45803 (April 23, 
2002), 67 FR 21306 (April 30, 2002) (order approving the 
restructuring of ISE from a limited liability company to a 
corporation); 49718 (May 17, 2004), 69 FR 29611 (May 24, 2004) 
(order approving the demutualization of PCX); and 49098 (January 16, 
2004), 69 FR 3974 (January 27, 2004) (order approving the 
demutualization of Phlx).
    \62\ See supra note 48 (citing to the adopting release for 
Regulation ATS).
    \63\ See Securities Exchange Act Release Nos. 49451 (March 19, 
2004), 69 FR 16305 (March 29, 2004) (PCX stating that by 
``restructuring its business as a stock corporation with business 
control and management vested in a Board of Directors, the entity 
will have greater flexibility to develop and execute strategies 
designed to improve its competitive position than it has under the 
current membership-cooperative structure'' and that it anticipates 
that ``by restructuring as a stock corporation, PCX management will 
be better able to respond quickly to competitive pressures and to 
make changes to its operations as market conditions warrant, without 
diminishing the integrity of its regulatory programs.'') and 49098, 
supra note 61 (stating that Phlx proposed to effect a 
demutualization for a number of reasons, including to ``expand its 
sources of capital and revenue; to facilitate its ability to enter 
into relationships with strategic or financial partners who may be 
crucial for the Exchange's future development, capital formation and 
viability; to facilitate the introduction of new products and thus 
potentially increase transaction volume and Exchange revenues; and 
to better position itself to react to new opportunities and 
challenges'').
---------------------------------------------------------------------------

    In addition, some SROs have trading facilities that are owned and 
operated by persons other than the SRO itself or its members. For 
example, Archipelago Holdings, Inc. (``Archipelago Holdings'') operates 
Arca-Ex, the equities trading facility of PCX Equities, and BOX, an 
options trading facility of the BSE, is operated by the Boston Options 
Exchange Group, LLC.\64\ Demutualized SROs, and separate facilities of 
SROs, also may choose to become publicly traded companies. For 
instance, Archipelago Holdings, the parent company of Arca-Ex, recently 
completed an initial public offering, and ISE has filed a registration 
statement under the Securities Act of 1933 (``Securities Act'') with 
regard to its intended initial public offering.\65\ In addition, 
Nasdaq's common stock is publicly traded in the OTC market.
---------------------------------------------------------------------------

    \64\ See Securities Exchange Act Release Nos. 44983, supra note 
49 and 49067, supra note 59.
    \65\ See Securities Exchange Act Release No. 50170 (August 9, 
2004), 69 FR 50419 (August 16, 2004) (order approving PCX rule 
filing relating to the Certificate of Incorporation and Bylaws of 
Archipelago Holdings) and ISE Registration Statement on Form S-1, 
File No. 333-117145.
---------------------------------------------------------------------------

    The impact of demutualization is the creation of another SRO 
constituency--a dispersed group of public shareholders--with a natural 
tendency to promote business interests. To the extent that a well-
regulated market is considered by an SRO's owners to be in their 
commercial interest, demutualization could better align the goals of 
SRO owners with their statutory obligations. On the other hand, it 
could also exacerbate the concern, discussed above, that SROs may put 
their commercial interests ahead of their responsibilities as 
regulators. The trend toward demutualization of SROs is yet another 
reason why the Commission is proposing regulatory changes to better 
assure the ability of SROs to carry out effectively their regulatory 
obligations.
    The Commission believes that the proposals--summarized above and 
discussed in detail below--to enhance the governance, administration, 
transparency and oversight of all SROs would effectively address many 
of the concerns raised by the demutualization of SROs. In addition, the 
Commission believes that it is appropriate to consider limits on member 
ownership of an exchange, association or facility, and heightened 
procedures in the case of SRO ``self-listing.''
    Finally, while the Commission believes that the proposals contained 
herein would significantly enhance the governance, administration, 
transparency, and oversight of SROs, legitimate questions remain as to 
whether more radical structural changes are warranted. Indeed, in 
addition to the proposals contained in this release, the Commission is 
today issuing a Concept Release that discusses in detail the strengths 
and weaknesses of the self-regulatory model and seeks commenters' views 
on a wide range of issues relating to self-regulation.\66\ The Concept 
Release examines the attributes of the current self-regulatory system, 
explores additional changes that could be made to the existing system 
to address the weaknesses of self-regulation, and discusses other 
models that, if implemented, would require a more extensive 
restructuring--or elimination--of the current system of self-
regulation.\67\
---------------------------------------------------------------------------

    \66\ See Securities Exchange Act Release No. 50700 (November 18, 
2004).
    \67\ See id.
---------------------------------------------------------------------------

II. Fair Administration and Governance of National Securities Exchanges 
and Registered Securities Associations

A. Background and Need for Proposed Rules 6a-5 and 15Aa-3

    As operators of trading markets, front-line regulators of 
securities firms, and standard-setters for listed issuers, national 
securities exchanges and registered securities associations are 
critical to the integrity of the U.S. securities markets. Recent events 
have highlighted, however, that the securities industry's system of 
self-regulation has not always worked as effectively or fairly as it 
should.\68\ In addition, the dual roles of exchanges and associations 
as both market overseers and market operators, the increased 
competition among markets, and the growing trend of exchanges to 
demutualize have raised concerns about their ability and efforts to 
fulfill their regulatory duties vigorously and impartially.\69\ As 
exchanges and associations continue to face these and other new 
challenges, the Commission is proposing to address issues of SRO 
governance and administration, and to explore changes that could foster 
robust fulfillment of SROs' self-regulatory duties.
---------------------------------------------------------------------------

    \68\ See supra Section I.B.
    \69\ Congress was aware of the conflicting roles faced by 
exchanges when it designed the regulatory scheme for U.S. securities 
markets. See, e.g., S. Rep. No. 73-792, at 4-5 (1934); H.R. Rep. No. 
73-1383, at 14-16 (1934); and S. Rep. No. 73-1455, at 80-81 (1934).
---------------------------------------------------------------------------

    Accordingly, the Commission is proposing new Rule 6a-5 under the

[[Page 71133]]

Exchange Act, which pertains to the fair administration and governance 
of national securities exchanges, and new Rule 15Aa-3 under the 
Exchange Act, which pertains to the fair administration and governance 
of registered securities associations.\70\ The proposals would apply to 
exchanges and associations minimum governance standards that are 
commensurate with standards required of listed issuers. Among other 
provisions, the proposed rules would require an exchange's or 
association's governing board to be composed of a majority of 
independent directors, with key board committees to be composed solely 
of independent directors. The Commission believes that the proposed 
rules would promote a structure that would facilitate the ability of 
SROs to perform their responsibilities under the Exchange Act with 
objectivity and vigor. In the Commission's view, proposed Rules 6a-5 
and 15Aa-3 would further the goals of the Exchange Act, which, among 
other things, requires national securities exchanges and registered 
securities associations to be so organized and have the capacity to 
carry out the purposes of the Exchange Act.\71\ The Commission also 
believes that by mandating a governance structure that is less 
susceptible to competing internal interests, proposed Rules 6a-5 and 
15Aa-3 would help promote investor confidence in the way in which our 
securities markets are administered.
---------------------------------------------------------------------------

    \70\ Proposed Rules 6a-5 and 15Aa-3 are substantially similar. 
Rule 15Aa-3(b)(11), however, proposes to define the term 
``facility'' for purposes of associations. Currently, the only 
securities association registered under Section 15A(a) of the 
Exchange Act, 15 U.S.C. 78o-3(a), is the NASD.
    \71\ See Sections 6(b)(1) and 15A(b)(2) of the Exchange Act, 15 
U.S.C. 78f(b)(1) and 78o-3(b)(2).
---------------------------------------------------------------------------

    The proposed governance rules also would require each exchange and 
association to separate its regulatory function from its market 
operations and other commercial interests, whether through functional 
or organizational separation. Although a premise underlying self-
regulation is that regulation works best when it is carried out in 
proximity to the regulated activity, it is equally important that there 
be sufficient independence within the self-regulatory process to 
adequately check undue interference or influence from the persons or 
entities being regulated. In the Commission's view, the proposed rules 
would help insulate the regulatory activities of an exchange or 
association from the conflicts of interest that otherwise may arise by 
virtue of its market operations.
    In addition, the proposed rules would require an exchange or 
association to establish ownership and voting limitations on the 
interest of its members that are brokers or dealers in the exchange, 
association, or a facility of the exchange or association through which 
the member is permitted to effect transactions. Members who trade on an 
exchange or through a facility of an exchange or association have 
traditionally had ownership interests in such exchange or facility. 
Recent developments, including the trend towards demutualization, have 
raised the concern that a member's interest could become so large as to 
cast doubt on whether the exchange or association could fairly and 
objectively exercise its self-regulatory responsibilities with respect 
to that member. For example, an exchange may hesitate to diligently 
monitor and surveil the trading conduct of a member that is a 
controlling shareholder of the exchange or a facility of the exchange, 
or to diligently enforce its rules and the federal securities laws with 
regard to conduct by such member that violates these provisions. The 
Commission believes that the proposed rules would help mitigate the 
conflicts of interest that could occur if a member were to control a 
significant stake in its regulator, and are necessary and appropriate 
to help ensure that an exchange or association can effectively carry 
out its statutory obligations under Section 6(b) or 15A(b) of the 
Exchange Act, respectively.\72\
---------------------------------------------------------------------------

    \72\ 15 U.S.C. 78f(b) and 78o-3(b).
---------------------------------------------------------------------------

    Finally, the Commission believes that the proposed rules are 
consistent with, and should enhance, the ``fair representation'' 
requirements applicable to exchanges and associations. As more fully 
discussed below, the proposals are designed to reinforce the Exchange 
Act requirement that the rules of an exchange or association ``assure a 
fair representation of its members in the selection of its directors 
and administration of its affairs and provide that one or more 
directors shall be representative of issuers and investors and not be 
associated with a member of the exchange [or association], broker, or 
dealer.'' \73\
---------------------------------------------------------------------------

    \73\ 15 U.S.C. 78f(b)(3) and 78o-3(b)(4).
---------------------------------------------------------------------------

B. Description of Proposed Rules 6a-5 and 15Aa-3

1. Scope of Proposed Rules 6a-5 and 15Aa-3
    Under proposed Rules 6a-5 and 15Aa-3, each national securities 
exchange and registered securities association, respectively, would be 
required to comply with, have rules that comply with, and have the 
capacity to carry out the purposes of, the provisions of the applicable 
governance rule.\74\ A national securities exchange registered pursuant 
to Section 6(g)(1) of the Exchange Act,\75\ and a limited purpose 
national securities association registered pursuant to Section 
15A(k)(1) of the Exchange Act,\76\ would not be subject to these 
requirements.\77\ While the proposed rules would establish minimum 
standards for the governance and administration of an exchange or 
association, an exchange or association, of course, could determine to 
establish more rigorous standards.
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    \74\ See proposed Rules 6a-5(a) and 15Aa-3(a).
    \75\ 15 U.S.C. 78f(g)(1).
    \76\ 15 U.S.C. 78o-3(k)(1).
    \77\ See proposed Rules 6a-5(s)(1) and 15Aa-3(s)(1). The 
Commission does not have primary responsibility for regulating 
exchanges registered under Section 6(g)(1) of the Exchange Act and 
national securities associations registered under Section 15A(k)(1) 
of the Exchange Act (``limited purpose national securities 
associations''). See 15 U.S.C. 78f(g)(1) and 78o-3(k)(1). This 
responsibility instead lies with the Commodity Futures Trading 
Commission (``CFTC''). For this reason, such exchanges and 
associations are exempt from the requirements to file with the 
Commission proposed rule changes, except for certain specified types 
of rules. Importantly, exchanges registered under Section 6(g)(1) of 
the Exchange Act and limited purpose national securities 
associations are not required to file with the Commission proposed 
changes to rules related to their governance, ownership, or 
fulfillment of their self-regulatory responsibilities. Because the 
Commission does not have primary responsibility for the regulation 
of these exchanges and associations, the Commission is proposing to 
exempt such exchanges and associations from proposed Rules 6a-5 and 
15Aa-3.
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    Certain provisions of the proposed rules would be applied to any 
``regulatory subsidiary'' of the exchange or association in the same 
manner as they would apply to the exchange or association.\78\ The term 
``regulatory subsidiary'' would be defined in proposed Rules 6a-
5(b)(18) and 15Aa-3(b)(19) as any person that, directly or indirectly, 
is controlled by the exchange or association and that provides, whether 
pursuant to contract, agreement or rule, regulatory services \79\ to or 
on behalf of the exchange or association. In recent years, several 
exchanges, as well as the NASD, have formed subsidiaries and have 
delegated, pursuant to rules approved by the Commission, to those 
subsidiaries certain regulatory functions historically conducted by the 
exchange or the NASD directly.\80\ These

[[Page 71134]]

subsidiaries remain subject to the self-regulatory authority of the SRO 
and the SRO ultimately retains responsibility for fulfilling the self-
regulatory duties imposed on it by the Exchange Act. To account for the 
fact that some SROs have delegated regulatory responsibilities under 
specified conditions to their subsidiaries, exchanges and associations 
would be required to apply various provisions of the proposed rules to 
any such subsidiaries, but only to the extent that the subsidiary has a 
separate governing board and key board committees. Accordingly, this 
proposal recognizes that a regulatory subsidiary of an exchange or 
association is an integral part of the SRO, and by carrying out certain 
self-regulatory duties on behalf of the exchange or association, it 
should be subject to the same governance standards applicable to the 
SRO itself.\81\
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    \78\ Under paragraph (a) of proposed Rules 6a-5 and 15Aa-3, 
paragraphs (c), (d), (e), (f), (g), (h), (i), (j), (k), (l), (m), 
(n), (p), and (q) of the proposed rules would apply to regulatory 
subsidiaries.
    \79\ Regulatory services are intended to cover any of those 
activities that generally would fall within the scope of the SRO's 
regulatory obligations.
    \80\ See, e.g., Securities Exchange Act Release Nos. 42759 (May 
5, 2000), 65 FR 30654 (May 12, 2000) (order approving creation of 
PCX Equities, a wholly-owned subsidiary of PCX) and 49065 (January 
13, 2004), 69 FR 2768 (January 20, 2004) (order approving creation 
of Boston Options Exchange Regulation, LLC (``BOXR''), a wholly-
owned subsidiary of the BSE).
    For example, NASD Regulation, Inc. is responsible for carrying 
out most regulatory functions otherwise within the jurisdiction of 
the NASD; and the NASD's subsidiary, Nasdaq, pursuant to a plan of 
delegation, carries out certain regulatory functions on behalf of 
the NASD. Nasdaq would be subject to proposed Rule 15Aa-3 on two 
bases: It is both a facility of an association and it is an 
affiliate that provides regulatory services to or on behalf of the 
NASD. In addition, the BSE's subsidiary, BOXR, carries out certain 
regulatory functions on behalf of the BSE; and PCX's subsidiary, PCX 
Equities, carries out certain regulatory functions on behalf of PCX.
    \81\ To date, the Commission has permitted an SRO to delegate 
its regulatory responsibilities only to a subsidiary of the SRO or 
to another SRO. The SRO that delegates such responsibilities, 
however, retains primary responsibility for ensuring compliance with 
the Exchange Act, and rules thereunder, and the rules of the SRO.
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    Each SRO subject to Rule 6a-5 or 15Aa-3 would implement the 
applicable rule's requirements through rule filings with the Commission 
pursuant to Section 19(b) of the Exchange Act.\82\ SROs are required to 
file any proposed change in, addition to, or deletion from its 
rules.\83\ A ``stated policy, practice, or interpretation,'' as defined 
in Rule 19b-4(b)(1) under the Exchange Act,\84\ is deemed a proposed 
rule change, and includes ``any material aspect of the operation of the 
facilities of the [SRO].'' \85\ The Commission believes that any 
changes made by an SRO to its or any facility's \86\ articles of 
incorporation, constitution, bylaws, and rules, or any instrument 
corresponding to the foregoing, that relate to or are made to comply 
with proposed Rules 6a-5 or 15Aa-3 would relate to a material aspect of 
the operation of the facilities of the exchange or association and 
therefore would be required to be filed under Section 19(b).\87\
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    \82\ 15 U.S.C. 78s(b).
    \83\ Id.
    \84\ 17 CFR 240.19b-4(b)(1).
    \85\ Id.
    \86\ The term ``facility'' is defined in Section 3(a)(2) of the 
Exchange Act and, when used with respect to an exchange, includes 
its premises, tangible or intangible property whether on the 
premises or not, any right to the use of such premises or property 
or any service thereof for the purpose of effecting or reporting a 
transaction on an exchange (including, among other things, any 
system of communication to or from the exchange, by ticker or 
otherwise, maintained by or with the consent of the exchange), and 
any right of the exchange to the use of any property or service. See 
15 U.S.C. 78c(a)(2). In many cases, a facility of the exchange is 
within the same legal entity as the exchange itself and thus only 
the exchange would need to meet the proposed governance rule's 
requirements.
    The term ``facility,'' when used with respect to an association, 
would be defined in new Rule 15Aa-3(b)(11) as its premises, tangible 
or intangible property whether on the premises or not, any right to 
the use of such premises or property or any service thereof for the 
purpose of effecting or reporting a transaction (including, among 
other things, any system of communication to or from the 
association, by ticker or otherwise, maintained by or with the 
consent of the association), and any right of the association to the 
use of any property or service. If a facility of the association is 
within the same legal entity as the association itself, only the 
association would need to meet the proposed governance rule's 
requirements.
    \87\ For instance, as discussed below in Section II.B.9., an 
exchange or association would be required to limit its members' 
interest in a facility of the exchange or association, as well as 
the exchange or association itself, which may involve changes to the 
rules of the SRO, including any of the governing documents of the 
exchange or association, or a facility of the exchange or 
association.
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2. Board Consisting of a Majority of Independent Directors
    Rules 6a-5 and 15Aa-3 would impose a series of substantive 
requirements with respect to the composition of the exchange's and 
association's board \88\ that are designed to assure the independence 
of the board and the fair administration and governance of the exchange 
or association. To this end, the Commission proposes that the board of 
each exchange and association be composed of a majority of independent 
directors.\89\ This provision would further the statutory goals that an 
exchange and association be so organized and have the capacity to carry 
out the Exchange Act's purposes and to comply, and enforce compliance 
by members and their associated persons, with the Exchange Act and 
rules thereunder and the SRO's own rules.\90\ We note that this 
proposal is consistent with accepted corporate governance ``best 
practices'' regarding board independence.\91\ The requirement to have a 
majority of independent directors also comports with exchange and 
association rules applicable to listed companies that recently were 
approved by the Commission to address similar governance concerns and 
the conflicts of interest that can arise between a company's management 
and its public shareholders.\92\
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    \88\ The term ``board'' would be defined in the proposed rules 
as the Board of Directors or Board of Governors of the exchange or 
association, or any equivalent body. See proposed Rules 6a-5(b)(5) 
and 15Aa-3(b)(6).
    \89\ See proposed Rules 6a-5(c)(1) and 15Aa-3(c)(1). The term 
``director'' would be defined in proposed Rules 6a-5(b)(8) and 15Aa-
3(b)(9) as any member of the board.
    \90\ See Sections 6(b)(1) and 15A(b)(2) of the Exchange Act, 15 
U.S.C. 78f(b)(1) and 78o-3(b)(2).
    \91\ See, e.g., James H. Cheek III, et al., Report of the 
American Bar Association Task Force on Corporate Responsibility 
(2003) (``ABA Task Force Report''); Derek Higgs, Review of the Role 
and Effectiveness of Non-Executive Directors (2003) (``Higgs 
Report''); and The Business Roundtable, Principals of Corporate 
Governance (May 2002) (``Business Roundtable Report'').
    \92\ See, e.g., Securities Exchange Act Release No. 48745, supra 
note 28; NYSE Listed Company Manual Section 303A.01; and NASD Rule 
4350(c)(1).
---------------------------------------------------------------------------

    The Commission's proposed approach to SRO governance is multi-
faceted and multi-pronged. It combines public disclosure of important 
governance information with guidelines for independent board 
representation and reliance on totally independent board committees for 
oversight of critical SRO functions and responsibilities.\93\ The 
proposed rules are designed to enhance the governance of exchanges and 
associations, while at the same time providing them with a measure of 
flexibility in determining their own governance models, so long as the 
minimum requirements are satisfied. SROs, of course, can elect to 
implement a greater proportion of independent directors.\94\
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    \93\ Because of the unique role played by the SROs and the 
related conflicts, and in the context of the package of proposals in 
this release, the Commission at this time has determined to propose 
a majority independent director requirement for SROs. We are 
soliciting comment on this proposal. See also infra note 191.
    \94\ The NYSE Constitution, for example, requires that the 
NYSE's board of directors be entirely independent of the management 
of the exchange, the membership of the exchange, and issuers of 
securities listed on the exchange. See NYSE Constitution, Article 
IV, Sec. 2.
---------------------------------------------------------------------------

    The Commission believes that requiring SRO boards to have a 
majority of independent directors, in combination with the other 
proposed requirements `` for example, the proposed requirement 
mandating completely independent Standing Committees (as defined below) 
of the board \95\ `` should help address the conflicts of interest that 
otherwise might arise when persons with a nexus to the SRO are involved 
in key decisions.\96\

[[Page 71135]]

These proposals together also should increase the likelihood that 
exchange and association boards will act in accordance with the 
mandates of the Exchange Act and in the best interests not only of the 
SRO and its members or shareholders, but also of the investing public. 
The Exchange Act sets broad parameters regarding the composition of an 
exchange's or association's governing body.\97\ The proposed rules are 
intended to provide greater clarity to those statutory provisions.
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    \95\ See infra Section II.B.3. for a discussion on the Standing 
Committees of the board.
    \96\ See, e.g., ABA Task Force Report, supra note 91, at 31.
    \97\ See Sections 6(b) and 15A(b) of the Exchange Act, 15 U.S.C. 
78f(b) and 78o-3(b).
---------------------------------------------------------------------------

    The exchanges, the NASD, and Nasdaq generally divide their boards 
between industry \98\ and non-industry \99\ (including public) \100\ 
directors, with a number of exchanges requiring that at least 50% of 
the board be composed of public or non-industry directors.\101\ The 
proposed governance rules' definition of independence is based largely 
on the current notion of a ``public'' director. Like the recently-
adopted NYSE and NASD rules for listed issuers,\102\ the proposed 
governance rules also would include specific circumstances that 
preclude a director from being considered an independent director.\103\ 
The Commission believes that requiring exchanges and associations to 
adhere to the high standards set forth in the proposed rules should 
help foster a greater degree of independent decision-making by the 
exchanges' and associations' governing bodies. In the Commission's 
view, the proposed rules should promote the goals of the Exchange Act 
that SROs be so organized and have the capacity to carry out their 
purposes.\104\
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    \98\ An ``industry'' director is generally an individual who is 
an officer, director or employee of a broker or dealer or an 
affiliate of a broker or dealer, a consultant or employee of the 
exchange itself, or an exchange permit holder. See, e.g., NASD 
Bylaws, Articles I(n) and I(o) and Phlx Bylaws, Article I, Section 
1-1(m).
    \99\ A ``non-industry'' director may be an individual who has 
some relationship with the SRO or the financial services industry; 
thus, a non-industry director could not be considered truly 
``public.'' For example, officers and employees of issuers listed on 
the exchange are considered non-industry directors. See, e.g., Phlx 
Bylaws, Article I, Section 1-1(t) and CHX Bylaws, Article III, 
Section 10(1).
    \100\ A ``public'' director is generally an individual who has 
no material business relationship with a broker or dealer or with 
the exchange or association. See, e.g., NASD Bylaws, Articles I(ee) 
and I(ff); Phlx Bylaws, Article I, Section 1-1(y); and CHX Bylaws, 
Article III, Section 10(2).
    \101\ For example, the BSE's board is composed of the Chairman, 
the Vice-Chairman and twenty other directors, ten of whom must 
represent the securities industry and ten of whom must represent the 
public. See BSE Constitution, Article II, Section 1. At least 50% of 
the directors on PCX's board are required to be persons from the 
public and cannot be affiliated with a broker or dealer or employed 
by, or involved in any material business relationship with, PCX or 
its affiliates. See PCX Bylaws, Article III, Section 3.02(a).
    \102\ See Securities Exchange Act Release No. 48745, supra note 
28; NYSE Listed Company Manual Section 303A.02(b); and NASD Rules 
4350, 4200(a)(15), and IM-4200.
    \103\ See proposed Rules 6a-5(b)(12) and 15Aa-3(b)(13).
    \104\ See Sections 6(b) and 15A(b) of the Exchange Act, 15 
U.S.C. 78f(b) and 78o-3(b).
---------------------------------------------------------------------------

    a. Determination of Independence. The proposals would specify that 
no director may qualify as an independent director unless the board 
affirmatively determines that the director has no material relationship 
with the exchange or association.\105\ The term ``material 
relationship'' would be defined as a relationship, whether compensatory 
or otherwise, that reasonably could affect the independent judgment or 
decision-making of the director.\106\ The proposals would require the 
board to make this independence determination upon the director's 
nomination and thereafter no less frequently than annually and as often 
as necessary in light of the director's circumstances (e.g., a job 
change or marriage that would disqualify the director from being 
considered independent).\107\ The Commission believes that requiring an 
exchange's or association's board to make an affirmative determination 
of independence, and to reevaluate that decision at least annually, 
would increase the accountability of such board and would further the 
proposals' goal of requiring the board to be composed of a majority of 
truly independent directors.\108\ The proposed rules would define the 
term ``independent director'' as a director who has no material 
relationship with the exchange or association or any affiliate of the 
exchange or association, any member \109\ of the exchange or 
association or any affiliate of such member, or any issuer of 
securities that are listed or traded on the exchange or a facility of 
the exchange or association.\110\ The Commission believes that the 
rigorous proposed definitions of ``independent director'' and 
``material relationship'' should help assure that SRO boards are 
controlled by persons not subject to potential conflicts of interest, 
and thereby further the goals of Sections 6(b)(1) and 15A(b)(2) of the 
Exchange Act.\111\
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    \105\ See proposed Rules 6a-5(c)(2) and 15Aa-3(c)(2).
    \106\ See proposed Rules 6a-5(b)(13) and 15Aa-3(b)(14).
    \107\ See proposed Rules 6a-5(c)(2) and 15Aa-3(c)(2).
    \108\ Moreover, pursuant to proposed changes to exchange and 
association registration forms, this determination would be required 
to be disclosed, thereby fostering greater transparency of the SROs' 
governance processes. See proposed revised Form 1 and proposed new 
Form 2, infra Section IV.
    \109\ For purposes of the proposed governance rules, the term 
``member'' has the same meaning as set forth in Section 3(a)(3) of 
the Exchange Act, 15 U.S.C. 78c(a)(3). See proposed Rules 6a-
5(b)(14) and 15Aa-3(b)(15).
    \110\ See proposed Rules 6a-5(b)(12) and 15Aa-3(b)(13). See also 
infra note 230 (for a definition of ``affiliate'').
    \111\ 15 U.S.C. 78f(b)(1) and 78o-3(b)(2). See generally 
Sections 6(b) and 15A(b) of the Exchange Act, 15 U.S.C. 78f(b) and 
78o-3(b).
---------------------------------------------------------------------------

    In addition to the general criteria of no material relationship, 
the proposed rules would identify certain specific circumstances when a 
director would not be considered independent.\112\ A director would not 
be considered independent if any of the following circumstances 
existed:
---------------------------------------------------------------------------

    \112\ See proposed Rules 6a-5(b)(12) and 15Aa-3(b)(13).
---------------------------------------------------------------------------

     The director, or an immediate family member,\113\ is, or 
within the past three years was, employed by or otherwise has or had a 
material relationship with the exchange or association or any affiliate 
of the exchange or association;\114\
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    \113\ The term ``immediate family member'' would be defined in 
the proposed rules as a person's spouse, parents, children, and 
siblings, whether by blood, marriage, or adoption, or anyone 
residing in such person's house. See proposed Rules 6a-5(b)(11) and 
15Aa-3(b)(12).
    \114\ See proposed Rules 6a-5(b)(12)(i) and 15Aa-3(b)(13)(i).
---------------------------------------------------------------------------

     The director is, or within the past three years was, a 
member or employed by or affiliated with a member or any affiliate of a 
member, or the director has an immediate family member that is, or 
within the past three years was, an executive officer of a member or 
any affiliate of a member;\115\
---------------------------------------------------------------------------

    \115\ See proposed Rules 6a-5(b)(12)(ii) and 15Aa-3(b)(13)(ii).
---------------------------------------------------------------------------

     The director, or an immediate family member, has received 
during any twelve month period within the past three years more than 
$60,000 in payments from the exchange or association, any affiliate of 
the exchange or association or from a member or any affiliate of a 
member; however, payments received in the form of compensation \116\ 
for board or board committee services, compensation to an immediate 
family member who is not an executive officer of the exchange or 
association, any affiliate of the exchange or association or of a 
member or any affiliate of a member, and pension and other forms of 
deferred compensation for prior services, not contingent on

[[Page 71136]]

continued service, would not disqualify a director as independent;\117\
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    \116\ See proposed Rules 6a-5(b)(6) and 15Aa-3(b)(7) for the 
definition of the term ``compensation.''
    \117\ See proposed Rules 6a-5(b)(12)(iii) and 15Aa-
3(b)(13)(iii). The Commission believes that compensation received as 
deferred compensation for prior service should not by itself exclude 
a director from being considered independent. However, the director 
would still need to satisfy the core definition of independence 
contained in the proposed rules.
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     The director, or an immediate family member, is a partner 
in, or controlling \118\ shareholder or executive officer of, any 
organization to which, or from which, the exchange or association or 
any affiliate of the exchange or association made or received payments 
for property or services in the current or any of the past three full 
fiscal years that exceed 2% of the recipient's consolidated gross 
revenues for that year, or $200,000, whichever is more, other than 
certain payments arising solely from investments in the securities of 
the exchange or association or any facility or affiliate of the 
exchange or association or payments under non-discretionary charitable 
contribution matching programs;\119\
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    \118\ See proposed Rules 6a-5(b)(7) and 15Aa-3(b)(8) for the 
definition of the term ``control.''
    \119\ See proposed Rules 6a-5(b)(12)(iv) and 15Aa-3(b)(13)(iv).
---------------------------------------------------------------------------

     The director, or an immediate family member, is, or within 
the past three years was, an executive officer of an issuer of 
securities listed or primarily traded on the exchange or a facility of 
the exchange or association;\120\
---------------------------------------------------------------------------

    \120\ See proposed Rules 6a-5(b)(12)(v) and 15Aa-3(b)(13)(v).
---------------------------------------------------------------------------

     The director, or an immediate family member, is, or within 
the past three years was, employed as an executive officer of another 
entity where any of the exchange's or association's executive officers 
serve on that entity's compensation committee;\121\
---------------------------------------------------------------------------

    \121\ See proposed Rules 6a-5(b)(12)(vi) and 15Aa-3(b)(13)(vi).
---------------------------------------------------------------------------

     The director, or an immediate family member, is a current 
partner of the outside auditor of the exchange or association or any 
affiliate of the exchange or association, or was a partner or employee 
of the outside auditor of the exchange or association or any affiliate 
of the exchange or association who worked on the audit of the exchange 
or association or any affiliate of the exchange or association, at any 
time within the past three years; \122\ or
---------------------------------------------------------------------------

    \122\ See proposed Rules 6a-5(b)(12)(vii) and 15Aa-
3(b)(13)(vii).
---------------------------------------------------------------------------

     In the case of a director that is a member of the Audit 
Committee,\123\ such director (other than in his or her capacity as a 
member of the Audit Committee, the board, or any other board 
committee), accepts, directly or indirectly, any consulting, advisory, 
or other compensatory fee from the exchange or association, any 
affiliate of the exchange or association, or a member or any affiliate 
of a member, other than fixed amounts of pension and other forms of 
deferred compensation for prior service, provided such compensation is 
not contingent in any way on continued service.\124\
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    \123\ See infra Section II.B.3. for a discussion of the Audit 
Committee.
    \124\ See proposed Rules 6a-5(b)(12)(viii) and 15Aa-
3(b)(13)(viii). This requirement is commensurate with an 
independence requirement for non-investment company issuers 
contained in Rule 10A-3(b)(1)(ii) under the Exchange Act, 17 CFR 
240.10A-3(b)(1)(ii), which pertains to listing standards relating to 
audit committees. The proposed requirement is designed to help 
assure that there are no fee arrangements between the exchange or 
association or any of its affiliates and the Audit Committee member 
that would impair the independence of the Audit Committee member.
---------------------------------------------------------------------------

    The Commission believes that the proposed circumstances that would 
preclude a determination of a director's independence--in effect, 
concluding that a ``material relationship'' exists under certain 
circumstances--should better assure that a majority of an SRO's board 
is truly independent, and thus should promote the statutory requirement 
that SROs be so organized and have the capacity to carry out the 
Exchange Act's purposes.\125\ The proposed circumstances that would 
preclude a director from being considered independent are similar to 
criteria that are contained in SRO listing standards, which recently 
were approved by the Commission and are designed to address similar 
governance concerns and the conflicts of interest that can arise 
between a company's management and its public shareholders.\126\ For 
example, the three-year look-back provision \127\ is a feature of NYSE, 
NASD, and Amex rules for listed issuers;\128\ the $60,000 restriction 
on payments received and the 2%/$200,000 threshold for payments 
received or made for property or services \129\ are similar to factors 
contained in NASD and Amex listing rules;\130\ and the definition of 
``immediate family member \131\ is substantially the same as the 
definition of the term ``family member'' in the NASD's listing 
rules.\132\ The Commission further notes that because SROs are member 
organizations and operate markets with listing requirements, the 
proposed rules would take into account specific relationships between 
the director and a member or listed company that could challenge the 
impartiality of the director.\133\
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    \125\ See Sections 6(b)(1) and 15A(b)(2) of the Exchange Act, 15 
U.S.C. 78f(b)(1) and 78o-3(b)(2).
    \126\ See, e.g., Securities Exchange Act Release Nos. 48745, 
supra note 28 and 48863 (December 1, 2003), 68 FR 68432 (December 8, 
2003) (order approving governance standards for issuers of 
securities listed on Amex).
    \127\ See proposed Rules 6a-5(b)(12)(i) through (vii) and 15Aa-
3(b)(13)(i) through (vii).
    \128\ See NYSE Listed Company Manual Section 303A.02(b); NASD 
Rules 4350, 4200(a)(15), and IM-4200; and Amex Company Guide, Part 
I, Section 121A.
    \129\ See proposed Rules 6a-5(b)(12)(iii) and (iv) and 15Aa-
3(b)(13)(iii) and (iv).
    \130\ See NASD Rules 4350, 4200(a)(15), and IM-4200 and Amex 
Company Guide, Part I, Section 121A.
    \131\ See proposed Rules 6a-5(b)(11) and 15Aa-3(b)(12).
    \132\ See NASD Rule 4200(a)(14).
    \133\ For example, the proposed governance rules state that a 
director would not be considered independent in the circumstance 
where a director is, or within the past three years was, a member or 
employed by or affiliated with a member, or the director has an 
immediate family member that is, or within the past three years was, 
an executive officer of a member or any affiliate of a member. 
Similarly, a director would not be considered independent in the 
circumstance where a director, or an immediate family member, is or 
within the past three years was an executive officer of an issuer of 
securities listed or primarily traded on the exchange or a facility 
of the association. See proposed Rules 6a-5(b)(12)(ii) and (iv) and 
15Aa-3(b)(13)(ii) and (iv).
---------------------------------------------------------------------------

    In the Commission's view, the proposed relationship tests that 
would preclude a determination that a director is independent strike an 
appropriate balance and promote the goal of providing clear standards 
regarding the determination of independence.\134\ The Commission 
believes that these criteria are indicative of whether directors can 
reach independent decisions that affect the SRO without competing 
pressures or conflicts of interest. For example, the fact that a 
director was an executive officer of a listed issuer more than three 
years prior to his or her nomination to the board is unlikely to have 
an influence on his or her decisions as a board member. On the other 
hand, a director's recent employment with a member does raise such 
concerns and would preclude a finding that he or she is independent. 
The Commission believes that these specific circumstances appropriately 
identify those relationships, such as recent employment, a business or 
financial relationship, or family ties, that are likely to impair the 
independence of a director. Further, there are practical reasons for 
relying on criteria that are similar to factors currently in place at 
the SROs for their listed issuers, as the SROs already are experienced 
in

[[Page 71137]]

interpreting and applying those standards. The Commission emphasizes 
that the absence of any of the proposed relationship tests, of course, 
would not necessarily result in a determination of independence, as the 
board must still affirmatively determine that the director has no 
material relationship with the SRO.
---------------------------------------------------------------------------

    \134\ See, e.g., Higgs Report, supra note 91, at 37 and Richard 
C. Breeden, Restoring Trust: Report on Corporate Governance for the 
Future of MCI, Inc. (August 2002) (``Breeden Report''), at 61.
---------------------------------------------------------------------------

    b. Independent Board Requirements. The proposed governance rules 
would require exchanges and associations to establish policies and 
procedures to require each director, on his or her own initiative and 
upon request of the exchange or association, to inform the exchange or 
association of the existence or establishment of any relationship or 
interest that may reasonably be considered to bear on whether such 
director is an independent director.\135\ Exchanges and associations 
also would be required to establish procedures for interested persons 
to communicate their concerns relating to any matter within the 
authority or jurisdiction of a Standing Committee directly to the 
independent directors.\136\
---------------------------------------------------------------------------

    \135\ See proposed Rules 6a-5(c)(3) and 15Aa-3(c)(3).
    \136\ See proposed Rules 6a-5(c)(9) and 15Aa-3(c)(9).
---------------------------------------------------------------------------

    The proposed governance rules also would require that at least 20% 
of the total number of directors be selected by members.\137\ In 
addition, the proposed governance rules would require that at least one 
director be representative of issuers and at least one director be 
representative of investors and, in each case, such director must not 
be associated with a member or broker or dealer.\138\ The Commission 
believes that these provisions are consistent with the ``fair 
representation'' and ``issuer and investor representation'' 
requirements of the Exchange Act, which are discussed below.\139\
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    \137\ See proposed Rules 6a-5(c)(4) and 15Aa-3(c)(4). See infra 
Section II.B.2.c. for a discussion of the statutory ``fair 
representation'' requirement.
    \138\ See proposed Rules 6a-5(c)(5) and 15Aa-3(c)(5).
    \139\ See infra Section II.B.2.c.
---------------------------------------------------------------------------

    Further, the proposed governance rules would require that when the 
board of an exchange or association considers any matter that is 
recommended by or otherwise is within the authority or jurisdiction of 
a Standing Committee, a majority of the directors who vote on the 
matter must be independent directors.\140\ For example, assume an 
exchange has a board composed of nine independent directors and eight 
non-independent directors. If two independent directors do not 
participate in a board meeting but all the non-independent directors 
participate in such meeting, the matter could be voted upon only by the 
seven independent directors present and six of the eight non-
independent directors present.\141\ This proposal is intended to 
preserve and bolster the requirement that the majority of the board be 
independent, and is designed to assure that matters before the board 
that are within the authority or jurisdiction of the fully-independent 
Standing Committees are considered by and voted on by a majority of 
independent directors.
---------------------------------------------------------------------------

    \140\ See proposed Rules 6a-5(c)(6) and 15Aa-3(c)(6). See infra 
Section II.B.3. for a discussion of the Standing Committees of the 
board.
    \141\ Each SRO with non-independent directors would have to 
establish procedures for determining which non-independent directors 
would vote under such circumstances, consistent with the ``fair 
representation'' requirements discussed below.
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    In addition, the proposed governance rules would require that if 
the exchange or association fails to comply with the requirement that 
the board be composed of a majority of independent directors because 
there is a vacancy on the board or a director ceases to be independent, 
the exchange or association must remedy such non-compliance by the 
earlier of the exchange's or association's next annual meeting or one 
year from the date of the occurrence of the event that caused the non-
compliance.\142\ This provision is consistent with the standard imposed 
on listed issuers and, in our view, should assure prompt remediation, 
yet provide exchanges and associations with a reasonable period of 
time, consistent with their governance procedures, to cure any failure 
to satisfy the majority independence requirement.
---------------------------------------------------------------------------

    \142\ See proposed Rules 6a-5(c)(8) and 15Aa-3(c)(8).
---------------------------------------------------------------------------

    c. Fair Representation. Section 6(b)(3) of the Exchange Act 
requires that the rules of an exchange assure a fair representation of 
its members in the selection of its directors and administration of its 
affairs (``fair representation requirement''), and must provide that 
one or more directors be representative of issuers and investors and 
not be associated with a member of the exchange, broker or dealer 
(``issuer and investor representation requirements'').\143\ Section 
15A(b)(4) of the Exchange Act contains an identical requirement with 
respect to the rules of an association.\144\
---------------------------------------------------------------------------

    \143\ 15 U.S.C. 78f(b)(3).
    \144\ 15 U.S.C. 78o-3(b)(4).
---------------------------------------------------------------------------

    Consistent with the fair representation requirement, the proposed 
governance rules would require that the Nominating Committee \145\ 
administer a fair process that provides members \146\ with the 
opportunity to select at least 20% of the total number of directors 
(``member candidates'').\147\ This requirement is not intended to 
prohibit exchanges and associations from having boards composed solely 
of independent directors. If an exchange's or association's board is 
composed wholly of independent directors, the candidate or candidates 
selected by members would have to be independent. This ``20% standard'' 
for member candidates comports with previously-approved SRO rule 
changes that raised the issue of fair representation.\148\ The 
Commission preliminarily believes that the proposed 20% requirement 
strikes a proper balance by giving members a practical voice in the 
governance of the exchange or association and the administration of its 
affairs, without jeopardizing the overall independence of the board.
---------------------------------------------------------------------------

    \145\ See infra Section II.B.3. for a discussion of the fully-
independent Nominating Committee.
    \146\ See supra note 109 for the definition of the term 
``member.''
    \147\ See proposed Rules 6a-5(f)(3) and 15Aa-3(f)(3).
    \148\ See Securities Exchange Act Release Nos. 48946, supra note 
36 and 49718, supra note 61. The Commission notes that it previously 
has taken the position that the fair representation requirement 
could be satisfied if the exchange's or association's rules provided 
that members constitute at least 20% of the individuals serving on 
the Nominating Committee. See, e.g., Securities Exchange Act Release 
Nos. 49098 and 49718, supra note 61. Because the proposed governance 
rules would mandate that the Nominating Committee consist solely of 
independent directors, an exchange or association no longer would 
have the option of satisfying the fair representation requirement by 
having at least 20% member representation on its Nominating 
Committee. Although the Commission previously approved SRO proposals 
that allowed members to constitute at least 20% of the exchange's or 
association's Nominating Committee, the Commission now believes that 
the governance of exchanges and associations would be strengthened 
by requiring a fully independent Nominating Committee.
---------------------------------------------------------------------------

    An exchange or association would have some leeway in implementing 
the fair process for members to select board candidates. For example, 
the Commission believes that the exchange or association would have a 
fair process if it established an advisory panel of members that 
reports to the Nominating Committee, and that is directly responsible 
for nominating member candidates for the board. Another type of fair 
process would be for the member advisory panel to make recommendations 
to the Nominating Committee, with the Nominating Committee required to 
nominate the member candidates identified by the member advisory panel. 
The member candidates, of course, would be required to satisfy all 
relevant eligibility criteria for directors (including independence 
requirements, if applicable). The fair process must also ensure that 
the member candidates actually are provided seats on the board.

[[Page 71138]]

    To further address the fair representation requirement, proposed 
Rules 6a-5(c)(7) and 15Aa-3(c)(7) would require exchanges and 
associations to adopt rules to establish a fair process for the 
nomination of alternative candidates by members through a petition 
process. This requirement would provide members with the means to 
nominate one or more alternative candidates representative of members. 
The percentage of members that is necessary to put forth such 
alternative member candidate or candidates would be required to be 
specified in the exchange's or association's rules, and could not 
exceed 10% of the total number of members.\149\ The Commission believes 
that this 10% requirement strikes an appropriate balance in that it 
provides members a practical mechanism to put forth alternative 
candidates, without jeopardizing the overall integrity of the 
nominating process. The Nominating Committee would be required to 
administer the petition process established by the exchange's or 
association's rules.\150\
---------------------------------------------------------------------------

    \149\ See proposed Rules 6a-5(c)(7) and 15Aa-3(c)(7). SROs 
currently have rules that permit members to engage in a petition 
process to nominate candidates. For example, pursuant to Phlx rules, 
members representing not less than 50 votes may, by written 
petition, independently nominate an individual for the position of 
on-floor governor, and members representing not less than 75 votes 
may propose an entire ticket, or any portion thereof, for on-floor 
governor positions which are vacant. See Phlx Bylaws, Article III, 
Section 3-7. A similar process is employed at the NYSE where members 
may propose by written petition potential nominees for positions to 
be filled at elections. Any such nominee must be endorsed by not 
less than 40 members, and not less than 100 members may petition for 
an entire ticket, or any portion thereof. See NYSE Constitution, 
Article III, Section 1.
    \150\ See proposed Rules 6a-5(f)(3) and 15Aa-3(f)(3).
---------------------------------------------------------------------------

    To address the issuer and investor representation requirement, the 
Nominating Committee would be required to nominate at least one 
director who is representative of issuers and at least one director who 
is representative of investors and who, in each case, is not associated 
with a member or broker or dealer.\151\ This provision simply would 
codify in Commission rules the requirements set forth in Sections 
6(b)(3) and 15A(b)(4) of the Exchange Act.\152\
---------------------------------------------------------------------------

    \151\ See proposed Rules 6a-5(f)(4) and 15Aa-3(f)(4). For 
example, the Nominating and Governance Committee of the NYSE 
currently is required to recommend to the board at least one 
individual who is representative of issuers and at least one 
individual who is representative of investors. See NYSE 
Constitution, Article IV, Sections 2 and 12.
    \152\ 15 U.S.C. 78f(b)(3) and 78o-3(b)(4).
---------------------------------------------------------------------------

    The Commission notes that it recently approved the NYSE's proposal 
to establish a fully independent board, finding that such a board could 
be consistent with the Exchange Act and the fair representation and 
issuer and investor representation requirements.\153\ As discussed 
above, the Commission only is proposing to require exchanges and 
associations to elect majority-independent boards, although an SRO may 
elect to impose a more rigorous requirement. The Commission believes 
that an exchange's or association's board could be wholly-independent 
based on the independence criteria contained in the proposed governance 
rules, provided that its rules satisfy the fair representation 
requirement and issuer and investor representation requirements (i.e., 
by requiring that at least 20% of the independent directors are 
selected by members, that at least one independent director is 
representative of issuers, and at least one independent director is 
representative of investors).
---------------------------------------------------------------------------

    \153\ See Securities Exchange Act Release No. 48946, supra note 
36.
---------------------------------------------------------------------------

3. Standing Committees
    Recent developments have highlighted the critical role that board 
committees play in the governance of exchanges and associations and the 
importance of having key committees function independently of the 
pressures that otherwise could be exerted on them by management, 
members or other interested parties.\154\ The Commission is proposing 
that each exchange and association, at a minimum, have the following 
standing committees, or their equivalent: Nominating Committee; 
Governance Committee; Compensation Committee; Audit Committee; and 
Regulatory Oversight Committee (collectively, ``Standing 
Committees'').\155\ The proposed governance rules also would require 
that each Standing Committee be composed solely of independent 
directors.\156\ The Commission preliminarily believes that the 
functions to be performed by these committees are important to the 
effective administration of an exchange or association. Moreover, these 
are the committees that generally are charged with overseeing the SRO's 
regulatory responsibilities, including the SRO's commitment of 
financial resources to fund those responsibilities. Thus, the 
Commission believes that requiring all of the members of these Standing 
Committees to be independent would result in a greater degree of 
objective decision-making with respect to the exchange's or 
association's core responsibilities and would further the Exchange 
Act's goal that SROs be so organized and have the capacity to carry out 
their self-regulatory obligations.\157\
---------------------------------------------------------------------------

    \154\ See supra Section I.B.
    \155\ See proposed Rules 6a-5(b)(21) and (e)(1) and 15Aa-
3(b)(22) and (e)(1). An SRO would not be precluded from allowing a 
single committee to carry out the functions of two Standing 
Committees as long as the committee consisted solely of independent 
directors, e.g., the functions of the Nominating Committee and the 
Governance Committee could be carried out by a single committee. 
Also, to the extent that a Standing Committee of the exchange or 
association carries out responsibilities on behalf of a regulatory 
subsidiary, the regulatory subsidiary would not be required to have 
a Standing Committee that performs the same functions. See proposed 
Rules 6a-5(a) and 15Aa-3(a).
    \156\ See proposed Rules 6a-5(f)(1), (g)(1), (h)(1), (i)(1), and 
(j)(1) and 15Aa-3(f)(1), (g)(1), (h)(1), (i)(1), and (j)(1). This 
provision is consistent with the recommendations in the Higgs 
Report, ABA Task Force Report and the Breeden Report. See Higgs 
Report, supra note 91, at 60-61; ABA Task Force Report, supra note 
91, at 63-67; and Breeden Report, supra note 134, at 103.
    \157\ See Sections 6(b)(1) and 15A(b)(2) of the Exchange Act, 15 
U.S.C. 78f(b)(1) and 78o-3(b)(2).
---------------------------------------------------------------------------

    The proposed governance rules would require each Standing Committee 
to have the authority to direct and supervise inquiries into any matter 
brought to its attention within the scope of its duties and to obtain 
advice and assistance from independent legal counsel and other advisors 
as it determines necessary to carry out its duties.\158\ In addition, 
each Standing Committee, other than the Governance Committee, would be 
required to conduct an annual performance self-evaluation.\159\ Rather 
than conduct an annual self-evaluation of the committee's performance, 
the Governance Committee would be required to conduct an annual 
performance evaluation of the governance of the exchange or association 
as a whole, including the effectiveness of the board and its 
committees.\160\ The Commission believes that these self-evaluations 
should assist the exchange or association in identifying strengths and 
deficiencies in the governance, administration, regulatory programs,

[[Page 71139]]

and financial matters of the exchange or association.\161\
---------------------------------------------------------------------------

    \158\ See proposed Rules 6a-5(e)(2) and 15Aa-3(e)(2). The 
Business Roundtable Report noted that it may be appropriate for 
boards and committees to seek advice from outside advisors and that 
board and committee access to outside advisors is an important 
element of corporate governance. See Business Roundtable Report, 
supra note 91, at 27-28.
    \159\ See proposed Rules 6a-5(f)(5), (h)(3), (i)(3) and (j)(6) 
and 15Aa-3(f)(5), (h)(3), (i)(3) and (j)(6). The proposed rules 
would require each exchange and association to provide sufficient 
funding and other resources, as determined by each Standing 
Committee, to permit the Standing Committees to fulfill their 
responsibilities and to retain independent legal counsel and other 
advisors. See proposed Rules 6a-5(e)(3) and 15Aa-3(e)(3).
    \160\ See proposed Rules 6a-5(g)(3) and 15Aa-3(g)(3).
    \161\ The ABA Task Force Report recommended periodic evaluations 
by the directors of the effectiveness and adequacy of meetings of 
the board and its committees. See ABA Task Force Report, supra note 
91, at 72. The Business Roundtable Report similarly recommended that 
the ``performance of the full board should be evaluated annually, as 
should the performance of its committees,'' to allow the board to 
determine whether it and its committees were following the 
procedures necessary to function effectively. See Business 
Roundtable Report, supra note 91, at 28.
---------------------------------------------------------------------------

    In order to function effectively, each Standing Committee would 
need to be clear as to its role. Accordingly, the proposed rules would 
require that each Standing Committee have a written charter that 
addresses such committee's purpose and responsibilities, which, at a 
minimum, must be as follows:
     Nominating Committee: to identify individuals qualified to 
become board members, consistent with criteria approved by the board 
and administer a process for the nomination of individuals to the 
board.\162\
---------------------------------------------------------------------------

    \162\ See proposed Rules 6a-5(f)(2) and 15Aa-3(f)(2).
---------------------------------------------------------------------------

     Governance Committee: to develop and recommend to the 
board a set of governance principles applicable to the exchange or 
association and to oversee the evaluation of the board and 
management.\163\
---------------------------------------------------------------------------

    \163\ See proposed Rules 6a-5(g)(2) and 15Aa-3(g)(2).
---------------------------------------------------------------------------

     Compensation Committee: to have direct responsibility to 
review and approve corporate goals and objectives relevant to the 
compensation of the executive officers of the exchange or association; 
evaluate the performance of the executive officers in light of those 
goals and objectives; and consider and approve recommendations with 
respect to the compensation level of the executive officers, based on 
this evaluation.\164\
---------------------------------------------------------------------------

    \164\ See proposed Rules 6a-5(h)(2) and 15Aa-3(h)(2).
---------------------------------------------------------------------------

     Audit Committee: to assist the board in oversight of the 
integrity of the exchange's or association's financial statements; the 
exchange's or association's compliance with related legal and 
regulatory requirements; the qualifications and independence of the 
exchange's or association's auditor, including direct responsibility 
for the hiring, firing, and compensation of the auditor, overseeing the 
auditor's engagement, meeting regularly in executive session with the 
auditor, reviewing the auditor's reports with respect to the exchange's 
or association's internal controls, and pre-approving all audit and 
non-audit services performed by the auditor; determining the budget and 
staffing of the exchange's or association's internal audit department; 
and establishing procedures for the receipt of complaints regarding 
accounting, internal accounting controls, or auditing matters of the 
exchange or association and the confidential submission by employees of 
the exchange or association of concerns regarding questionable 
accounting or auditing matters.\165\
---------------------------------------------------------------------------

    \165\ See proposed Rules 6a-5(i)(2) and 15Aa-3(i)(2). The 
complaint procedures for the Audit Committee are commensurate with 
the complaint procedures contained in Rule 10A-3(b)(3) under the 
Exchange Act, 17 CFR 240.10A-3(b)(3), which pertain to audit 
committees of listed issuers.
---------------------------------------------------------------------------

     Regulatory Oversight Committee: to assure the adequacy and 
effectiveness of the exchange's or association's regulatory program; 
assess the exchange's or association's regulatory performance; 
determine the regulatory plan, programs, budget, and staffing for the 
regulatory functions of the exchange or association; assess the 
performance of, and recommend compensation and personnel actions 
involving, the Chief Regulatory Officer \166\ and other senior 
regulatory personnel \167\ to the Compensation Committee; monitor and 
review regularly with the Chief Regulatory Officer matters relating to 
the exchange's or association's surveillance, examination, and 
enforcement units; assure that the exchange's or association's 
disciplinary and arbitration proceedings are conducted in accordance 
with the exchange's or association's rules and policies and any other 
applicable laws or rules, including those of the Commission; prior to 
the exchange's or association's approval of an affiliated security 
\168\ for listing, certify that such security meets the exchange's or 
association's rules for listing; and approve any reports filed with the 
Commission as required by proposed Regulation AL (Sec.  242.800).\169\
---------------------------------------------------------------------------

    \166\ See proposed Rules 6a-5(n)(3) and 15Aa-3(n)(3), which 
would require exchanges and associations to appoint a Chief 
Regulatory Officer. See also infra Section II.B.8.a.
    \167\ ``Senior regulatory personnel'' means those individuals, 
including the proposed Chief Regulatory Officer, who are the senior 
managers of the SRO's regulatory program.
    \168\ The term ``affiliated security'' is proposed to be defined 
as any security issued by an affiliated issuer, except that it would 
not include any option exempt from the Securities Act pursuant to 
Rule 238 thereunder, 17 CFR 230.238, and any security futures 
product exempt from the Securities Act pursuant to Section 3(a)(14) 
thereof, 15 U.S.C. 77c(a)(14). See proposed Rules 6a-5(b)(3) and 
15Aa-3(b)(3). An ``affiliated issuer'' is proposed to be defined to 
mean an exchange, an association, an SRO trading facility of the 
exchange or association, an affiliate of the exchange or 
association, or an affiliate of an SRO trading facility of the 
exchange or association. See proposed Rules 6a-5(b)(2) and 15Aa-
3(b)(2). ``SRO trading facility'' is proposed to be defined in 
proposed Rules 6a-5(b)(20) and 15Aa-3(b)(21) as any facility of a 
national securities exchange or registered securities association, 
respectively, that executes orders in securities.
    \169\ See proposed Rules 6a-5(j)(2) and 15Aa-3(j)(2). See infra 
Section III. for a discussion of proposed Regulation AL.
---------------------------------------------------------------------------

    The Commission believes that the foregoing proposed 
responsibilities of the Standing Committees would foster the 
effectiveness of such committees and further the objective of good 
governance on the part of SROs. Exchanges and associations, of course, 
could elect to assign additional responsibilities to the Standing 
Committees, as long as they were otherwise consistent with the proposed 
governance rules.
    In addition, any committee, subcommittee, or panel that is 
responsible for conducting hearings, rendering decisions, and imposing 
sanctions with respect to disciplinary matters would be subject to the 
jurisdiction of the Regulatory Oversight Committee.\170\ Although the 
Regulatory Oversight Committee would be required to be composed solely 
of independent directors,\171\ the Commission believes that, to satisfy 
the fair representation requirement, the exchange or association must 
provide for member participation on any committee, subcommittee, or 
panel that is responsible for conducting hearings, rendering decisions, 
and imposing sanctions with respect to member disciplinary 
matters.\172\ In order to satisfy this requirement, the proposal would 
require that at least 20% of the members of any such committee, 
subcommittee, or panel be members of the exchange or association.\173\ 
The Commission believes that this provision furthers the requirement of 
the Exchange Act that an exchange or association assure a fair 
representation of members in the administration of its affairs.\174\ By 
proposing to require members to be represented on bodies that consider 
disciplinary matters relating to members, members would be assured 
input into a key aspect of SRO administration that is of critical 
importance to them. The Commission believes that the proposed 20% 
requirement would provide members with a practical voice in 
disciplinary matters without compromising the overall independence of 
the disciplinary process, which would be overseen by

[[Page 71140]]

the fully independent Regulatory Oversight Committee, or the ability of 
the exchange or association to carry out its obligations under the 
Exchange Act. The Commission notes that this 20% standard is consistent 
with prior SRO proposals that were approved by the Commission and that 
provided members with a voice in the exchange's or association's 
disciplinary process.\175\ The Commission notes, however, that unlike 
previously-approved structures, the proposal would require any 
committee, subcommittee, or panel containing members to report to the 
fully-independent Regulatory Oversight Committee. This requirement 
would be necessary because the Regulatory Oversight Committee, which is 
proposed to be fully independent, is intended to be the committee 
responsible for oversight of regulatory matters, including disciplinary 
matters.
---------------------------------------------------------------------------

    \170\ See proposed Rules 6a-5(j)(4) and 15Aa-3(j)(4).
    \171\ See proposed Rules 6a-5(j)(1) and 15Aa-3(j)(1).
    \172\ See proposed Rules 6a-5(j)(3) and 15Aa-3(j)(3).
    \173\ See id.
    \174\ See Sections 6(b)(3) and 15A(b)(4) of the Exchange Act, 15 
U.S.C. 78f(b)(3) and 78o-3(b)(4).
    \175\ See, e.g., Securities Exchange Act Release Nos. 50057 
(July 22, 2004), 69 FR 45091 (July 28, 2004) (notice of filing of 
proposed rule change including to require that the Amex Adjudicatory 
Council, which has the authority to act for the Amex Board of 
Governors with respect to, among other things, any appeal or review 
of a disciplinary proceeding, be composed of three industry 
governors and three independent governors) and 49718, supra note 61 
(order approving the proposed rules pertaining to the 
demutualization of PCX and finding that permit holders would retain 
a voice in the administration of the affairs of the reorganized PCX, 
including the rulemaking and the disciplinary process, through 
participation on various committees).
---------------------------------------------------------------------------

    The Regulatory Oversight Committee also would be required to 
oversee the preparation of the exchange's or association's annual 
regulatory report, as required by proposed Rule 17a-26 of the Exchange 
Act.\176\
---------------------------------------------------------------------------

    \176\ See proposed Rules 6a-5(j)(5) and 15Aa-3(j)(5); proposed 
Rule 17a-26. See infra Section V. for a discussion of proposed Rule 
17a-26.
---------------------------------------------------------------------------

4. Other Committees of the Board
    The proposed governance rules would permit an exchange or 
association to establish such other committees of the board as it 
determines to be appropriate; however, if such committee has the 
authority to act on behalf of the board, that committee would be 
required to be composed of a majority of independent directors.\177\ 
For example, if the exchange or association has established an 
Executive Committee that is empowered to act on the board's behalf, 
such committee would be required to be composed of a majority of 
independent directors. Further, the exchange or association could not 
delegate to any committee not consisting solely of independent 
directors the authority to act on matters that otherwise are within the 
jurisdiction of a Standing Committee.\178\
---------------------------------------------------------------------------

    \177\ See proposed Rules 6a-5(k)(1) and 15Aa-3(k)(1).
    \178\ See id.
---------------------------------------------------------------------------

    In addition, the Commission is proposing that at least 20% of the 
persons serving on any committee that is not a Standing Committee and 
any committee, subcommittee, or panel that is subject to the 
jurisdiction of a Standing Committee, and that is responsible for 
providing advice with respect to trading rules or disciplinary rules, 
be members of the exchange or association.\179\ The Commission believes 
that, consistent with the Exchange Act's fair representation 
requirement, members should be provided with the opportunity to 
formally provide input on the development of, or changes to, trading 
and disciplinary rules. Rulemaking in this area is a key aspect of SRO 
administration and can have a significant impact on members. The 
Commission preliminarily believes that, as in prior contexts, the 20% 
requirement affords members a practical voice in the formulation of 
rules important to them. The Commission notes that it has previously 
approved SRO proposed rule changes that provide members with a role in 
developing rules relating to trading and disciplinary matters.\180\
---------------------------------------------------------------------------

    \179\ See proposed Rules 6a-5(k)(2) and 15Aa-3(k)(2).
    \180\ See, e.g., Securities Exchange Act Release No. 49718, 
supra note 61 (order approving the PCX Options Trading Permit 
Advisory Committee, which among other things, acts in an advisory 
capacity regarding rule changes related to disciplinary matters and 
trading rules and which must be made up entirely of options trading 
permit holders).
---------------------------------------------------------------------------

5. Other Requirements Applicable to Directors and Officers
    The duties and responsibilities imposed by the Exchange Act on 
exchanges and associations make clear that these SROs are charged with 
an important public trust and play an integral role in, among other 
things, maintaining securities markets that are free from fraudulent or 
manipulative acts or practices and that promote just and equitable 
principles of trade.\181\ Exchanges and associations also are charged 
with appropriately disciplining their members pursuant to fair 
procedures.\182\ To further these and other statutorily-imposed 
requirements applicable to exchanges and associations, the proposed 
governance rules would require that the rules of the exchange or 
association prohibit a person subject to any statutory 
disqualification, within the meaning of Section 3(a)(39) of the 
Exchange Act,\183\ from being a director or officer of the exchange or 
association.\184\ The Commission believes that the integrity of the 
exchange or association--as well as its ability to perform its 
statutorily required functions--could be seriously undermined if 
individuals subject to these serious regulatory or legal sanctions were 
permitted to serve on the board or as an officer of the exchange or 
association.
---------------------------------------------------------------------------

    \181\ See Sections 6(b)(5) and 15A(b)(6) of the Exchange Act, 15 
U.S.C. 78f(b)(5) and 78o-3(b)(6).
    \182\ See Sections 6(b)(6)-(7) and 15A(b)(7)-(8) of the Exchange 
Act, 15 U.S.C. 78f(b)(6)-(7) and 78o-3(b)(7)-(8).
    \183\ 15 U.S.C. 78c(a)(39).
    \184\ See proposed Rules 6a-5(l)(1) and 15Aa-3(l)(1).
---------------------------------------------------------------------------

    In addition, the proposed rules would require exchanges and 
associations to explicitly mandate that each director, in discharging 
his or her responsibilities as a member of the board, reasonably 
consider all requirements applicable to the exchange or association 
under the Exchange Act.\185\ Exchanges and associations, as regulated 
entities, have certain obligations under the Exchange Act,\186\ and 
their directors must take these obligations into account when 
discharging their responsibilities. We note that directors have 
fiduciary obligations under state law. The Commission believes, 
however, that expressly requiring directors to take into account the 
exchange's or association's obligations under the Exchange Act should 
help promote greater awareness and accountability on the part of 
directors, thus furthering the objectives of the Exchange Act.
---------------------------------------------------------------------------

    \185\ See proposed Rules 6a-5(l)(2) and 15Aa-3(l)(2).
    \186\ See, e.g., 15 U.S.C. 78f(b) and 78o-3(b).
---------------------------------------------------------------------------

6. Executive Sessions of the Board
    The Commission believes that independent directors must be provided 
with the opportunity to discuss any important matters regarding the 
exchange or association in a frank and open manner, free from the 
presence of management.\187\ Therefore, the Commission proposes that 
the independent directors of the exchange's or association's board meet 
regularly in executive session.\188\ The Commission, however, is not 
proposing a minimum frequency for the independent directors to meet 
regularly in executive session;

[[Page 71141]]

rather, it is leaving this decision to the board, to be based on the 
facts and circumstances of the particular exchange or association.
---------------------------------------------------------------------------

    \187\ See ABA Task Force Report, supra note 91, at 63; Breeden 
Report, supra note 134, at 52; and Higgs Report, supra note 91, at 
34.
    \188\ See proposed Rules 6a-5(d)(1) and 15Aa-3(d)(1). The 
proposed governance rules would define ``executive session'' as a 
meeting of independent directors of the board, without the presence 
of either management of the exchange or association or directors who 
are not independent directors. See proposed Rules 6a-5(b)(9) and 
15Aa-3(b)(10).
---------------------------------------------------------------------------

    The proposed governance rules also would require that independent 
directors have the authority to direct and supervise inquiries into any 
matter brought to their attention within the scope of their duties, and 
to obtain advice and assistance from independent legal counsel and 
other advisors, as they determine necessary to carry out their 
duties.\189\ Accordingly, the proposed governance rules would require 
that the exchange or association provide sufficient funding and other 
resources, as determined by the independent directors, to permit the 
independent directors to fulfill their responsibilities and to retain 
independent legal counsel and other advisors.\190\ The Commission 
believes that the proposed governance rules should provide independent 
directors with the ability to serve effectively, including assuring 
that they have adequate resources and funding to perform their duties. 
In addition, authorizing independent directors to utilize independent 
legal counsel and other advisors is important to permit them to have 
access to advice from independent sources before acting on significant 
matters affecting the exchange or association.
---------------------------------------------------------------------------

    \189\ See proposed Rules 6a-5(d)(2) and 15Aa-3(d)(2). See also 
supra note 158 (noting the Business Roundtable Report's support of 
board and committee access to outside advisors).
    \190\ See proposed Rules 6a-5(d)(3) and 15Aa-3(d)(3).
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7. Separation of Chairman of the Board and CEO Positions
    The Commission is not proposing to require that an exchange's or 
association's Chairman of the board be an independent director in all 
circumstances.\191\ However, if the exchange's or association's CEO is 
not also the Chairman, we are proposing that the Chairman must be an 
independent director.\192\
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    \191\ The Commission seeks to mitigate the conflict between an 
SRO's regulatory functions on the one hand, and its business 
operations on the other, among other conflicts. We note in this 
connection that, in light of the distinct statutory scheme and 
historical experience relevant to mutual funds and investment 
advisers, and in the context of different and potentially more 
serious conflicts, involving activities expressly prohibited by 
Congress, the Commission (Commissioners Glassman and Atkins 
dissenting) determined to require an independent chairman. See 
Investment Company Act Release No. 26520 (July 27, 2004), 69 FR 
46377 (August 2, 2004); see also supra note 93. In the context of 
SROs, the Commission may require a different regulatory response. In 
any event, we are soliciting comment on whether this approach is 
appropriate in this context.
    \192\ See proposed Rules 6a-5(m)(1) and 15Aa-3(m)(1).
---------------------------------------------------------------------------

    The proposed rules, including the provisions related to the 
Chairman and CEO, are designed to foster a greater degree of 
independent decision-making by the governing body of an exchange or 
association. However, while recognizing the benefits of independence, 
the Commission understands that some SROs may perceive efficiencies in 
having one person serve as Chairman and CEO, and therefore the 
Commission is not proposing to prohibit this arrangement. In this 
regard, the Commission notes that both the NYSE and BSE currently have 
separate individuals serving as the Chairman and as the CEO of the 
exchange, although the exchanges' governing documents do not expressly 
require this separation.\193\ Nevertheless, in the event that an 
exchange or association elects to have a single individual serve as 
Chairman and CEO, the proposed governance rules would prohibit that 
person--who, as the CEO, would not be ``independent''--from 
participating in any executive sessions of the board and from serving 
on the Nominating, Governance, Compensation, Audit, or Regulatory 
Oversight Committees.\194\
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    \193\ See NYSE Constitution, Article IV, Section 2 and BSE 
Constitution, Article II, Section 1.
    \194\ See proposed Rules 6a-5(m)(2) and (4) and 15Aa-3(m)(2) and 
(4).
---------------------------------------------------------------------------

    The Commission also proposes that if the Chairman and CEO were the 
same individual, the board would be required to designate an 
independent director as a ``lead director'' to preside over executive 
sessions of the board, and the board would be required to publicly 
disclose the lead director's name and a means by which interested 
parties may communicate with the lead director.\195\ This requirement 
should benefit exchanges and associations by providing that an 
independent director would head executive sessions, and thereby 
encourage an open climate of decision-making.
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    \195\ See proposed Rules 6a-5(m)(3) and 15Aa-3(m)(3). With 
regard to SROs, the Commission believes at this time that, in 
combination with the other proposed safeguards, a lead independent 
director would adequately address its concerns. We are soliciting 
comment on these proposals.
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8. Separation of Regulatory and Market Operations
    There is an inherent tension between an exchange's or association's 
role as a regulator and as the operator of a market, and between its 
role as a regulator and as a membership organization.\196\ The 
existence of a shareholder class separate from membership adds yet 
another constituency with interests potentially in conflict with the 
regulatory responsibilities of the SRO. In recent years, some 
exchanges, as well as the NASD, have attempted to address this tension 
by separating, to varying degrees, their regulatory functions from 
their market operations.\197\
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    \196\ In testimony before Congress, the Commission's Chairman 
identified the inherent tension between an SRO's role as a regulator 
and as the operator of a market, and between its role as a regulator 
and as a membership organization, as a possible explanation for why 
self-regulation has not always worked as effectively and fairly as 
it should. See Testimony of William H. Donaldson, Chairman, 
Commission, Concerning Improving the Governance of the NYSE, before 
the Senate Committee on Banking, Housing and Urban Affairs (November 
20, 2003).
    \197\ See supra note 80. Although the NYSE has not separated its 
regulatory functions and market operations into distinct legal 
entities, the NYSE's Regulatory Oversight and Regulatory Budget 
Committee is responsible for, among other things, assuring the 
effectiveness, vigor, and professionalism of the NYSE's regulatory 
program; overseeing the NYSE's Regulation, Enforcement & Listing 
Standards Committee and the Regulatory Quality Review Unit; 
determining the NYSE's regulatory plan, budget and staffing 
proposals annually; and assessing the NYSE's regulatory performance 
and recommending compensation and personnel actions involving senior 
regulatory personnel to the board's Human Resources & Compensation 
Committee for action. See NYSE Constitution, Article IV, Section 
12(a)(4).
---------------------------------------------------------------------------

    As discussed below, the Commission is proposing to require 
exchanges and associations, among other things, to effectively separate 
their regulatory function from their market operations and other 
commercial interests, to use regulatory funds only to fund regulatory 
obligations, and to establish procedures to prevent the dissemination 
of regulatory information other than to persons carrying out the 
exchange's or association's regulations obligations.\198\ The 
Commission believes that these requirements should allow SROs to better 
manage the conflicts of interest inherent in any self-regulatory 
structure. In addition, the Commission believes that these provisions, 
along with other features of the proposed governance rules, would help 
promote greater accountability on the part of exchanges and 
associations with respect to their regulatory programs and strengthen 
their ability to meet their statutory obligations.
---------------------------------------------------------------------------

    \198\ See proposed Rules 6a-5(n) and 15Aa-3(n).
---------------------------------------------------------------------------

    a. Independence of Regulatory Program. The proposed rules would 
require exchanges and associations to establish policies and procedures 
that provide for the independence of their regulatory programs from the 
operation or administration of their trading facilities and other 
businesses.\199\ Specifically, the proposals would require that the 
exchange's or association's regulatory program be

[[Page 71142]]

either: (1) Structurally separated from the exchange's or association's 
market operations and other commercial interests, by means of separate 
legal entities; or (2) functionally separated within the same legal 
entity from the exchange's or association's market operations and other 
commercial interests.\200\ In the Commission's view, such separation 
must be designed to permit the regulatory program to function 
independently from the market operations and other commercial interests 
of the exchange or association. In either case, the proposed governance 
rules would require that the board appoint a Chief Regulatory Officer 
to administer the regulatory program and that the Chief Regulatory 
Officer report directly to the proposed independent Regulatory 
Oversight Committee.\201\
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    \199\ See proposed Rules 6a-5(n)(1) and 15Aa-3(n)(1).
    \200\ See proposed Rules 6a-5(n)(2) and 15Aa-3(n)(2).
    \201\ See proposed Rules 6a-5(n)(3) and 15Aa-3(n)(3). To the 
extent that the Chief Regulatory Officer of the exchange or 
association performs the same responsibilities for any regulatory 
subsidiary, the regulatory subsidiary would not need to appoint a 
Chief Regulatory Officer. See proposed Rules 6a-5(a) and 15Aa-3(a).
---------------------------------------------------------------------------

    The Commission believes that its proposal to require the structural 
or functional separation of the regulatory functions and the market 
operations and other commercial interests of the exchange or 
association, together with the creation of a fully independent 
Regulatory Oversight Committee and the appointment of a Chief 
Regulatory Officer who would administer the regulatory program and 
report directly to the Regulatory Oversight Committee, are designed to 
manage more effectively the inherent conflicts of interest in our self-
regulatory system and bolster the effectiveness of exchanges' and 
associations' regulatory programs. By not mandating a particular 
structure for this separation--focusing on the ends rather than the 
means--the proposed rules would provide exchanges and associations with 
a measure of flexibility in determining how best to achieve the result 
of functional independence of the regulatory program.
    In addition, the proposed requirement that each exchange and 
association appoint a Chief Regulatory Officer is designed to assure 
that all regulatory matters are subject to oversight by a person 
independent of the SRO's commercial interests. Further, the proposal to 
require the Chief Regulatory Officer to report directly to a committee 
composed solely of independent directors is intended to fortify the 
independence of the Chief Regulatory Officer. In the Commission's view, 
these requirements to enhance the independence of the regulatory 
function further the objectives of Sections 6(b)(1) and 15A(b)(2) of 
the Exchange Act,\202\ which require exchanges and associations, 
respectively, to be so organized and have the capacity to carry out the 
purposes of the Exchange Act, and comply, and enforce compliance by 
their members, and persons associated with their members, with the 
Exchange Act and rules thereunder and the rules of the exchange or 
association.
---------------------------------------------------------------------------

    \202\ 15 U.S.C. 78f(b)(1) and 78o-3(b)(2).
---------------------------------------------------------------------------

    b. Use of Regulatory Fees, Fines, and Penalties. The proposed 
governance rules also would require an exchange or association to 
direct monies collected from regulatory fees, fines or penalties 
(``regulatory funds'') exclusively to fund the regulatory operations 
and other programs of the exchange or association related to its 
regulatory responsibilities, and to keep such books and records as are 
necessary to evidence compliance with this requirement.\203\ Consistent 
with the proposed rules, an exchange or association could not use such 
regulatory funds to pay dividends or make distributions to its 
shareholders. The scope of the categories of regulatory funds included 
in this requirement, as well as the limitation on use of such funds, is 
intended to be broad. As discussed in Section IV.C. below, regulatory 
fees would include all member fees, dues and assessments charged and 
collected by an exchange or association that are assessed for the 
purpose of funding the operation of the exchange's or association's 
regulatory program.\204\ Regulatory fines or penalties also would 
include any revenue received from fines or penalties resulting from 
disciplinary or enforcement actions.
---------------------------------------------------------------------------

    \203\ See proposed Rules 6a-5(n)(4) and 15Aa-3(n)(4).
    \204\ See also proposed Exhibit I to revised Form 1 and new Form 
2.
---------------------------------------------------------------------------

    This proposed restriction on the use of regulatory funds is 
intended to preclude an SRO from using its authority to raise 
regulatory funds for the purpose of benefiting its shareholders, or for 
other non-regulatory purposes, such as to fund executive compensation. 
SROs have an obligation to be so organized and have the capacity to be 
able to carry out the purposes of the Exchange Act, and to enforce 
compliance by their members with the Exchange Act and their rules.\205\ 
SRO rules must provide for the equitable allocation of reasonable dues, 
fees, and other charges among its members and issuers and other persons 
using its facilities.\206\ SRO rules also must provide that their 
members and persons associated with their members are appropriately 
disciplined for violations of the Exchange Act or SRO rules.\207\ SROs 
collect various fees, dues and assessments from their members on the 
basis that they need to fund a program to carry out these statutory 
obligations. The Commission believes that these proposed requirements 
to use regulatory funds only to fund regulatory activities would 
further advance the SROs' ability to effectively comply with these 
statutory requirements, by helping to ensure that an SRO's regulatory 
activities are properly funded and that the SRO is not abusing its 
regulatory authority.
---------------------------------------------------------------------------

    \205\ See 15 U.S.C. 78f(b)(1) and 78o-3(b)(2).
    \206\ See 15 U.S.C. 78f(b)(4) and 78o-3(b)(5).
    \207\ See 15 U.S.C. 78f(b)(6) and 78o-3(b)(7).
---------------------------------------------------------------------------

    c. Confidentiality of Regulatory and Trading Information. Proposed 
Rules 6a-5(n)(5)(i)(A) and 15Aa-3(n)(5)(i)(A) would require exchanges 
and associations to establish policies and procedures reasonably 
designed to prevent the dissemination of regulatory information \208\ 
to any person other than those officers, directors, employees, and 
agents of the exchange or association directly involved in carrying out 
the exchange's or association's regulatory obligations under the 
Exchange Act. This means that an exchange's or association's policies 
and procedures would be required to establish that regulatory 
information could only be available to officers and employees that are 
responsible for regulatory functions, directors that are involved in 
regulatory functions, such as an appeal of a disciplinary matter, or 
agents to the extent necessary to perform the regulatory function for 
which they have been hired. In addition, the proposed rules would 
require that an exchange's or association's policies and procedures be 
reasonably designed to prevent the use of regulatory information for 
any purpose other than for carrying out the exchange's or association's 
regulatory obligations.\209\ The Commission also is proposing that an 
exchange's or association's policies and procedures would have to 
require that its officers,

[[Page 71143]]

directors, employees and agents agree to comply with these 
requirements.\210\
---------------------------------------------------------------------------

    \208\ The term ``regulatory information'' is proposed to be 
defined to mean any information collected by an exchange or 
association in the course of performing its regulatory obligations 
under the Exchange Act. See proposed Rules 6a-5(b)(17) and 15Aa-
3(b)(18). Examples of such regulatory information would include, for 
instance, information relating to an on-going disciplinary 
investigation or action against a member, the amount of a fine 
imposed on a member, financial information, or information regarding 
proprietary trading systems gained in the course of examining a 
member.
    \209\ See proposed Rules 6a-5(n)(5)(i)(B) and 15Aa-
3(n)(5)(i)(B).
    \210\ See proposed Rules 6a-5(n)(5)(ii) and 15Aa-3(n)(5)(ii).
---------------------------------------------------------------------------

    In addition, proposed Rules 6a-5(n)(5)(i)(c) and 15Aa-3(n)(5)(i)(c) 
would require exchanges and associations to have policies and 
procedures reasonably designed to maintain the confidentiality of 
information that must be submitted to the exchange or association to 
effect a transaction on or through the exchange, association or a 
facility.\211\ The proposed rules would, however, allow an exchange or 
association to make available such information in an aggregated form, 
if the information is aggregated to such an extent that the recipient 
is unable to identify (such as by reverse engineering) any person whose 
data is included in the aggregate information, or if the person 
consents.\212\ Exchanges' and associations' policies and procedures 
also would have to require exchange and association officers, 
directors, employees and agents to agree to maintain the 
confidentiality of this information consistent with the proposed 
rules.\213\
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    \211\ For example, this information could include the name of 
the member, or the member's customer, submitting the order for 
execution, and the terms of the order.
    \212\ See proposed Rules 6a-5(n)(5)(i)(C) and 15Aa-
3(n)(5)(i)(C).
    \213\ See proposed Rules 6a-5(n)(5)(ii) and 15Aa-3(n)(5)(ii). 
The Commission notes that, of course, nothing in the proposed rules 
would limit in any way the Commission's authority to access SRO 
information or the ability of any SRO and its officers, directors, 
employees, and agents to provide any information to the Commission.
---------------------------------------------------------------------------

    The Commission believes that the requirement that exchanges and 
associations keep regulatory and certain other information 
confidential, and not use information collected in the course of 
performing regulatory obligations for business or other non-regulatory 
purposes would help to assure an independent and effective regulatory 
function and is implicit in the exchange's or association's 
responsibilities under the Exchange Act.\214\ As competitive pressures 
on SROs increase, however, and the tensions between their regulatory 
obligations and commercial interests increase, the Commission believes 
that an explicit prohibition on this conduct may be necessary and 
appropriate.
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    \214\ See Sections 6(b)(8) and 15A(b)(9) of the Exchange Act, 15 
U.S.C. 78f(b)(8) and 78o-3(b)(9).
---------------------------------------------------------------------------

9. Member Voting and Ownership Limitations
    As discussed above in Section II.A., to further the ability of an 
exchange or association to effectively carry out its statutory 
obligations under Sections 6(b) and 15A(b) of the Exchange Act,\215\ 
the Commission is proposing to require an exchange or association to 
limit the ability of its members that are brokers or dealers to own or 
vote a significant interest in the exchange, association or any 
separate facility.\216\
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    \215\ 15 U.S.C. 78f(b) and 78o-3(b).
    \216\ See proposed Rules 6a-5(o) and 15Aa-3(o).
---------------------------------------------------------------------------

    Several exchanges that have converted to shareholder-owned 
structures have limited the ability of any person, including their 
members, to directly or indirectly own or vote more than a certain 
percentage of the interest in the exchange.\217\ Similar limits have 
been approved for separate SRO facilities.\218\ The Commission approved 
these limits on a case-by-case basis under the rule filing process of 
Section 19(b) of the Exchange Act and Rule 19b-4 thereunder.\219\
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    \217\ See, e.g., Securities Exchange Act Release Nos. 49718 and 
49098, supra note 61.
    \218\ See Securities Exchange Act Release Nos. 50170, supra note 
65 and 49067, supra note 59.
    \219\ 15 U.S.C. 78s(b) and 17 CFR 240.19b-4.
---------------------------------------------------------------------------

    For example, in the case of the public offering of Archipelago 
Holdings (the parent company of Arca-Ex, the equities trading facility 
of PCX Equities), the Commission approved a PCX rule prohibiting any 
person and its related persons from directly or indirectly owning more 
than 40% and voting more than 20% of the securities of Archipelago 
Holdings.\220\ If a person wanted to exceed these limits, the rules 
require PCX to file a proposed rule change with the Commission and the 
Commission would need to approve such action. Similarly, in connection 
with the demutualizations of Phlx and PCX, the Commission approved a 
comparable prohibition under the exchanges' rules on any person and its 
related persons directly or indirectly owning more than 40% or voting 
more than 20% of the applicable securities without first receiving 
Commission approval of a proposed rule change.\221\ In each of these 
three instances, the limitations applied not only to members,\222\ but 
to any person owning securities of the applicable SRO or a 
facility.\223\
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    \220\ See Securities Exchange Act Release No. 50170, supra note 
65.
    \221\ See Securities Exchange Act Release Nos. 49718 and 49098, 
supra note 61.
    \222\ In each of these instances, members' ownership interest 
was limited to 20%, with no process for members to exceed that 
limitation.
    \223\ When the Commission approved the demutualization of PCX 
and the operation of BOX as a facility of the BSE, there were 
shareholders that owned more than 20%. In each case, the rules of 
the exchange required the controlling shareholder to consent to the 
Commission's jurisdiction; to provide that the books and records of 
the shareholder shall be deemed to be the books and records of the 
SRO (to the extent they are related to the exchange's or facility's 
activities); to agree and consent (on behalf of its officers and 
directors) that its officers and directors would be deemed to be 
officers and directors of the SRO (to the extent they are related to 
the exchange's or facility's activities); and to agree (on its own 
behalf and that of its officers and directors) to cooperate with the 
Commission and the SRO in the performance of their regulatory 
oversight responsibilities. See Securities Exchange Act Release Nos. 
49718, supra note 61 and 49067, supra note 59. The Commission is not 
at this time proposing such requirements for controlling 
shareholders of an SRO or a facility.
---------------------------------------------------------------------------

    By proposing to require SROs only to limit the ownership and voting 
of their members, the Commission today is proposing a less restrictive 
approach than the rules adopted by the exchanges discussed above. The 
proposal is designed only to address the specific conflict of interest 
that could exist if a member were to own a significant interest in the 
exchange or association of which it was a member or a facility through 
which the member is permitted to effect transactions, by requiring an 
exchange or association to impose ownership and voting limits on 
members that are brokers or dealers.\224\ The Commission believes that 
the conflict with respect to members creates a risk that a member could 
use its controlling interest in its regulator to influence the 
regulatory process to its benefit. Accordingly, because of the risk 
presented by the prospect of member control of its regulator, and the 
significant incentives for a member to attempt to exercise undue 
influence in such a case, the Commission is proposing to require an SRO 
to impose ownership and voting restrictions on members that are brokers 
or dealers.
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    \224\ The definition of ``related person'' also would include 
all members that are natural persons, either because they are 
registered brokers or dealers, or because they are ``related 
persons'' of the broker or dealer with which they are associated. 
See infra Section II.B.9.a.
---------------------------------------------------------------------------

    The Commission recognizes that there is also the potential for any 
person that controls an exchange or association or facility of an 
exchange or association to direct its operation so as to cause the SRO 
to neglect its regulatory obligations under the Exchange Act. In light 
of the substantive governance and other standards being proposed today 
to strengthen the independence of SROs and their regulatory functions, 
the Commission is not at this time proposing to require an exchange or 
association to impose ownership and voting restrictions on persons 
other than members. For the time being, however, the Commission intends 
to maintain its current policies in this area while it considers 
whether to adopt ownership and voting restrictions that apply only to 
members.

[[Page 71144]]

    The proposed rules would apply to all exchanges and associations, 
not just demutualized ones. Although the proliferation of demutualized 
exchanges and shareholder-owned facilities has highlighted the concern 
with member control of an SRO, the Commission believes these concerns 
are equally applicable to SROs that continue to be mutual 
organizations.\225\
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    \225\ The Commission notes that PCX had a limitation on the 
number of seats that any person, associated person, or group of 
associated persons could own. See Securities Exchange Act Release 
No. 46098 (June 20, 2002), 67 FR 43693 (June 28, 2002) (order 
approving PCX rule filing to limit to 15% the number of exchange 
memberships that any person, associated person, or group of 
associated persons could, directly or indirectly, beneficially own 
or control the voting rights of). In connection with the 
demutualization of PCX, PCX replaced the limitation on the number of 
seats that any person, associated person, or group of associated 
persons could own with limitations on the amount of ownership 
interests and voting power that a person and its related persons 
could possess. See Securities Exchange Act Release No. 49718, supra 
note 61.
    The Commission also notes that the CHX has a rule that states 
that the exchange will not approve a transfer or sale of a 
membership if the transferee (or lessor), together with any person 
who directly or indirectly controls, is controlled by, or under 
common control with, the transferee (or lessor), owns or has the 
voting power of 10% or more of the outstanding memberships of the 
exchange, unless the requirement is waived by the exchange's board 
for good cause shown. See CHX Article I, Rule 10.
---------------------------------------------------------------------------

    Specifically, proposed Rules 6a-5(o)(1) and 15Aa-3(o)(1) would 
require the rules of a national securities exchange and a registered 
securities association to prohibit any member that is a broker or 
dealer, alone or together with its related persons, from either:
     Directly or indirectly beneficially owning \226\ any 
interest in the exchange or association, or a facility of the exchange 
or association through which the member is permitted to effect 
transactions, that exceeds 20% of any class of securities or other 
ownership interest of the exchange, association or facility; or
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    \226\ ``Beneficial ownership'' would be defined to have the 
meaning set forth in Rule 13d-3, 17 CFR 240.13d-3. See proposed 
Rules 6a-5(b)(4) and 15Aa-3(b)(5). The concept of beneficial 
ownership in Rule 13d-3 is designed to encompass any person or group 
of persons that may be able to act to influence or control an 
issuer. The Commission is proposing to use the same definition of 
beneficial ownership in this rule because it also would describe 
those persons or groups of persons that may be able to act to 
influence or control an exchange or association. However, to the 
extent any person beneficially owns any security or other ownership 
interest solely because such person is a member of a group within 
the meaning of Section 13(d)(3) of the Exchange Act, such person 
would not be deemed to beneficially own such security or other 
ownership interest for purposes of this section, unless such person 
had the power to direct the vote of such security or other ownership 
interest. See proposed Rules 6a-5(b)(4) and 15Aa-3(b)(5). The 
Commission is proposing to exclude beneficial ownership that results 
solely from being a member of a group to provide more certainty to 
members that would be required to comply with the limitations, in 
light of the impact of exceeding the ownership limit--i.e., that the 
member will be divested of the excess interest. If a person has the 
right to vote the interest, however, it is important to continue to 
include such interest.
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     Voting any interest in such exchange, association or 
facility of the exchange or association through which the member is 
permitted to effect transactions, that exceeds 20% of the voting power 
of any class of securities or other ownership interest of such 
exchange, association or facility.\227\
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    \227\ Specifically, this requirement would prohibit a member 
that is a broker or dealer from directly or indirectly voting, 
causing the voting of, or giving any consent or proxy with respect 
to the voting of, any interest in the exchange, association, or 
facility that exceeds 20% of the voting power of any class of 
securities or other ownership interest of such exchange, 
association, or facility. See proposed Rules 6a-5(o)(1)(ii) and 
15Aa-3(o)(1)(ii).
---------------------------------------------------------------------------

    Thus, a member that is a broker or dealer would not be able to, 
alone or together with its related persons, own more than 20% of the 
exchange or association of which it is a member or a facility through 
which the member is permitted to effect transactions. A member that is 
a broker or dealer, and its related persons, also would not be able to 
vote or cause the voting of more than 20%. The rules of the SRO would 
be required to prohibit both; they would not be able to prohibit only 
one or the other.
    The Commission preliminarily believes that a member ownership and 
voting limit of 20% is an appropriate threshold because it precludes 
situations where a member would have a realistic probability of being 
able to exert undue influence over its SRO, yet refrains from 
interfering in an SRO's organizational processes or the desire by 
members to acquire equity interests in their markets. In some 
Commission rules, a 10% ownership threshold is used to determine 
``control.'' \228\ Accordingly, the Commission considered whether 10% 
would be a more appropriate threshold to propose for member ownership 
and voting limitations, given the concerns regarding the conflict of 
interest if a member were to control its regulator. The Commission 
recognizes, however, that generally the existing standard that 
exchanges have in place with respect to limits on their member's 
ownership in and voting of interests in the exchange or a facility is 
20%, and that members that currently own more than 10% would have to 
divest themselves of any excess interest. The Commission therefore is 
proposing 20% as the ownership and voting threshold. The Commission 
requests specific comment on whether the threshold should be lower than 
20%, given the concern that a member with a lesser interest may be able 
to influence or control the exchange or association.\229\
---------------------------------------------------------------------------

    \228\ See, e.g., Rule 19h-1(f)(2) under the Exchange Act, 17 CFR 
240.19h-1(f)(2) (defining a presumption of ``control'' to include a 
person that directly or indirectly has the right to vote 10% or more 
of the voting securities of a company) and Rule 10A-3(e) under the 
Exchange Act, 17 CFR 240.10A-3(e) (deeming a person not to be in 
control of a specified person if the person is not the beneficial 
owner, directly or indirectly, of more than 10% of any class of 
voting security of the specified person).
    \229\ See infra Section II.C.
---------------------------------------------------------------------------

     a. Members' Interests Aggregated With Their Related Persons. For 
purposes of calculating a member's ownership and voting interests, the 
proposed rules would aggregate a member's ownership and voting 
interests with those of its ``related persons.'' An exchange or 
association has members over which the exchange or association has 
regulatory authority, and these members participate in the governance 
and disciplinary process of the exchange or association. The Commission 
therefore believes that it is important to aggregate the members' 
ownership and voting interests with the interest of any person with 
whom the member may be able to act together to influence or control the 
exchange, association or facility. As such, the proposed rules would 
define ``related person'' to mean, with respect to a member that is a 
broker or dealer: (i) Any affiliate of the member;\230\ (ii) any 
person(s) associated with the member;\231\ (iii) any immediate family 
member of the member, or any immediate family member of the member's 
spouse, who, in each case, has the same home as the member or who is a 
director or officer of the exchange, association or facility or any of 
its parents or subsidiaries; and (iv) any immediate family member of a 
person associated with the member or any

[[Page 71145]]

immediate family member of such person's spouse, who, in each case, has 
the same home as the person associated with the member or who is a 
director or officer of the exchange, association or facility or any of 
its parents or subsidiaries.\232\
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    \230\ ``Affiliate'' would be defined to mean any person that, 
directly or indirectly, controls, is controlled by, or is under 
common control with, the exchange or association. See proposed Rules 
6a-5(b)(1) and 15Aa-3(b)(1). ``Control'' would be defined to mean 
the possession, direct or indirect, of the power to direct or cause 
the direction of the management and policies of a person, whether 
through the ownership of voting securities, by contract, or 
otherwise. Any person that (i) is a director, general partner, or 
officer exercising executive responsibility (or having similar 
status or function); (ii) directly or indirectly has the right to 
vote 25% or more of a class of voting securities or has the power to 
sell or direct the sale of 25% or more of a class of voting 
securities; or (iii) in the case of partnership, has the right to 
receive, upon dissolution, or has contributed, 25% or more of the 
capital, is presumed to control that person. See proposed Rules 6a-
5(b)(7) and 15A-3(b)(8).
    \231\ ``Person associated with a member'' would be defined to 
have the same meaning as in Section 3(a)(21) of the Exchange Act, 15 
U.S.C. 78c(a)(21). See proposed Rules 6a-5(b)(16) and 15Aa-3(b)(17).
    \232\ See proposed Rules 6a-5(b)(19) and 15Aa-3(b)(20).
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    For example, the parent company of a member would be considered a 
``related person'' of the member. A sister affiliated company of the 
member also would be a ``related person'' of the member. The definition 
of ``related person'' also would include all members that are natural 
persons, either because they are registered brokers or dealers, or 
because they are ``related persons'' of the broker or dealer with which 
they are associated.
    It is important to note that the proposed rules would require an 
exchange or association to restrict the indirect ownership and voting 
interests of a member that is a broker or dealer in an exchange, 
association or facility. The Commission believes that it is crucial to 
restrict the indirect ownership and voting interests of these members 
because if the Commission were to require an exchange or association to 
establish requirements only for direct--but not indirect--ownership and 
voting rights, the limitations could be easily circumvented. For 
example, if an exchange only prohibited a member from directly owning 
or voting shares, the member could hold its ownership interests in the 
exchange, association or facility through multiple subsidiaries of a 
holding company, thus easily circumventing the intent of the proposed 
rules. In addition, the ownership and voting limitations would apply to 
ownership and voting of interests in a parent company of the exchange 
or association. For example, if the exchange, association or facility 
was wholly-owned by a holding company, a member (alone or together with 
its related persons) would be prohibited from owning or voting more 
than 20% of the interest in the parent company because that would be an 
indirect ownership or voting interest in the exchange, association or 
facility. The proposed limitations also would apply to a member (either 
alone or together with its related persons) that beneficially owned 
more than 20% of an entity that itself owned more than 20% of an 
exchange, association or facility, if the person (and the entity) had 
the ability to vote or cause the vote, or dispose of, or cause the 
disposition of, the interest in the exchange, association, or facility.
    b. Solicitation of Revocable Proxies. The Commission is proposing 
to make clear in the proposed rules that the 20% voting limitation--
which includes ``causing the vote'' of more than 20% of the interests 
in an exchange, association or facility--would not apply to any 
solicitation or receipt of revocable proxies by a member, if conducted 
pursuant to Regulation 14A under the Exchange Act.\233\ Thus, an 
exchange or association would be required to preserve the ability of a 
member to solicit and receive revocable proxies from other shareholders 
on such issues as alternative nominees for the board of directors, or a 
particular shareholder proposal. The solicitation or receipt of a 
revocable proxy does not transfer voting (or investment) power--i.e. 
beneficial ownership--to the person soliciting or receiving the 
proxy.\234\ Therefore, the act of soliciting or receiving a revocable 
proxy should not undermine the purpose of the voting limitation because 
it would not constitute an agreement or other arrangement between the 
shareholder soliciting the proxy and a shareholder being solicited to 
vote a particular way. In particular, any shareholder so solicited 
would remain free to choose whether or not to grant a proxy, and the 
proxy would remain revocable up until the vote that is the subject of 
the proxy. The Commission notes, however, that if a member and one or 
more persons banded together to solicit proxies, and in addition that 
group agreed to vote a particular way, the agreement to vote would go 
beyond the soliciting or receipt of proxies and be considered to be 
causing the vote, or giving a consent or proxy with respect to voting, 
that would be in violation of the proposed voting limitation, if the 
aggregate amount of ownership or voting interests controlled by the 
group of persons so agreeing exceeded 20%.
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    \233\ See 17 CFR 240.14a-1 through 240.14a-15. See also proposed 
Rules 6a-5(o)(2) and 15Aa-3(o)(2).
    \234\ See Securities Exchange Act Release No. 39538 (January 12, 
1998), 63 FR 2854, at 2858 (Section II.G.) (January 16, 1998).
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    The Commission is concerned, however, that allowing a member to 
solicit an ``open-ended'' proxy--one with no end date and one not for a 
particular purpose or meeting--from one or more shareholders would 
allow a member to obtain the ability to vote more than 20%. As such, 
the proposed rules would require an exchange or association to prohibit 
a member subject to the voting limitation from soliciting a proxy 
pursuant to an exemption contained in Rule 14a-2(b)(2) under the 
Exchange Act \235\ with regard to a person or persons whose interest, 
together with the member and its related person's interests, would 
exceed the 20% voting limit.\236\ The purpose of not allowing 
solicitations by members pursuant to this exemption in excess of the 
voting limitation is to prevent a member from soliciting proxies that 
are not subject to the requirements of Rule 14a-4 under the Exchange 
Act,\237\ which requires, among other things, a form of proxy to 
clearly identify each matter to be acted upon, limits the authority 
that a proxy may confer, and limits the length of time for which a 
proxy is valid.\238\ Thus, disallowing this exemption for members would 
close a potential loophole to the proposed voting limitation.
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    \235\ Rule 14a-2(b)(2) under the Exchange Act, 17 CFR 240.14a-
2(b)(2), exempts from Rules 14a-3 to 14a-6 (other than Rule 14a-
6(g)), 14a-8, and 14a-10 to 14a-15 any solicitation made otherwise 
than on behalf of the registrant where the total number of persons 
solicited is 10 or fewer. See 17 CFR 240.14a-3 through 240.14a-6; 
240.14a-8; and 240.14a-10 through 240.14a-15.
    \236\ See proposed Rules 6a-5(o)(2) and 15Aa-3(o)(2).
    \237\ 17 CFR 240.14a-4.
    \238\ See Rules 14a-4(a)(3), 14a-4(c)-(d), and 14a-4(d)(2)-(3) 
under the Exchange Act, 17 CFR 240.14a-4(a)(3), 14a-4(c)-(d), and 
14a-4(d)(2)-(3).
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    c. Requirement To Divest Ownership Interest and Restrict Voting. 
Proposed Rules 6a-5(o)(3) and 15Aa-3(o)(3) also would require an 
exchange or association to provide in its rules an effective mechanism 
to divest any member and its related persons of any interest owned in 
excess of the 20% limitation discussed above. The Commission believes 
that to be an effective mechanism, the rule would have to require the 
exchange or association to take action to reduce the member's and its 
related persons' ownership interest that exceeded the proposed 
ownership limit. In addition, proposed Rules 6a-5(o)(4) and 15Aa-
3(o)(4) would require the rules of an exchange or association to be 
reasonably designed to not give effect to the portion of a vote by a 
member and its related persons that is in excess of the proposed voting 
limitation.
    The Commission is not proposing to specify how an exchange or 
association would effectuate these requirements. Instead, the 
Commission is proposing to provide exchanges and associations 
flexibility to determine the best approach under relevant state law. 
Any mechanism adopted by an exchange or association, however, would 
need to be sufficient to assure that the exchange or association has a 
viable, enforceable mechanism to divest a member and its related 
persons of any interest owned in excess of, and to not give effect to 
the

[[Page 71146]]

portion of a vote in excess of, the 20% limitation. This mechanism 
would need to impose a requirement, not a choice, on the exchange or 
association to take such action to reduce the member's interest or 
voting power.\239\ For example, an exchange could adopt rules--perhaps 
as part of its organizational documents--to provide that, if a member 
that is a broker or dealer exceeded the 20% ownership limitation, the 
exchange would be required to redeem that number of shares owned in 
excess of the 20% ownership limitation at par value.\240\ Because the 
par value of the shares of stock is likely to be substantially less 
than the fair market value of the shares of stock, such a provision may 
act as a strong disincentive to members to exceed the limit, and cause 
them to more closely monitor their accumulation of ownership or voting 
power in an exchange, association or facility.\241\ This requirement 
would not preclude an exchange or association from having a separate 
mechanism to divest a broker-dealer member whose ownership goes above 
20% solely because of an issuer repurchase of its own shares. For 
example, an SRO could adopt rules that permit a grace period to divest 
shares under such circumstances. An exchange or association also could 
amend its rules to provide that, if a broker-dealer member were to 
vote, or attempt to vote, more than 20%, the exchange or association 
would not honor any portion of the vote in excess of 20%.\242\
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    \239\ The Commission notes that any mechanism would need to be 
valid, binding, and enforceable under state law.
    \240\ See, e.g., Securities Exchange Act Release No. 50170, 
supra note 65. The Commission notes that any redemption mechanism 
that reduces the number of outstanding shares of stock or other 
ownership interest, to be effective, would have to take into account 
such reduction in determining what amount would need to be redeemed 
to bring the member and its related persons below the 20% threshold, 
and to cover a situation where a reduction in the number of 
outstanding shares causes another owner to exceed the 20% threshold.
    \241\ The SRO's procedures also could provide that even a member 
that exceeds the ownership limitation through its own (or its 
related person's) actions would have the ability to sell out its 
excess shares prior to the SRO repurchasing them. The Commission 
emphasizes, however, that this ``grace period'' should be of short 
duration.
    \242\ See, e.g., Securities Exchange Act Release No. 49718, 
supra note 61. The Commission notes that any such rule changes would 
be required to be filed pursuant to Section 19(b) of the Exchange 
Act and would be subject to the Commission's review and approval.
---------------------------------------------------------------------------

    d. Ability To Obtain Information. Finally, proposed Rules 6a-
5(o)(5) and 15Aa-3(o)(5) would require an exchange's or association's 
rules to provide a mechanism for the exchange or association to obtain 
information relating to ownership and voting interests in the exchange, 
association or separate facility from any owner of any interest. The 
Commission believes this requirement would help an exchange or 
association to more closely monitor ownership and voting by its members 
in relation to the proposed 20% limits. For example, an exchange could 
amend its governing documents to require owners to provide information 
relating to their ownership and voting interests to the exchange upon 
request. Alternatively, the exchange could require owners to provide 
such information at specified times, such as monthly or quarterly. In 
addition, this requirement would provide a mechanism for an exchange or 
association to obtain the ownership information that the exchange or 
association would be required to disclose to the Commission pursuant to 
proposed Exhibit Q to revised Form 1 and new Form 2.\243\
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    \243\ See infra Section IV.C.9.
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10. Code of Conduct and Ethics and Governance Guidelines
    The proposed governance rules would require that the rules of each 
exchange and association provide for a code of conduct and ethics for 
directors, officers and employees, and provide that any waiver of the 
code of conduct and ethics must be approved by the board, or the 
appropriate board committee.\244\ The proposed rules also would require 
that the exchange or association prohibit any of its employees or 
officers from being a member of the board of directors of a listed 
issuer or member firm.\245\
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    \244\ See proposed Rules 6a-5(p)(1) and 15Aa-3(p)(1). This 
proposal is consonant with the Business Roundtable Report which 
recommended that, as part of good governance, ``corporations should 
have a code of conduct with effective reporting and enforcement 
mechanisms.'' See Business Roundtable Report, supra note 91, at 10.
    \245\ See proposed Rules 6a-5(p)(2) and 15Aa-3(p)(2).
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    Although the exchange or association could determine the details of 
its own policies, the Commission proposes that the code of conduct and 
ethics, at a minimum, establish policies and procedures regarding: 
conflicts of interest; corporate opportunities; confidentiality; fair 
dealing; protection and proper use of the exchange's or association's 
assets; compliance with laws, rules, and regulations by directors, 
officers and employees; and the reporting of illegal or unethical 
behavior. Formulation and adoption of a code of conduct and ethics 
would present an exchange or association with an opportunity to express 
its values, as well as the standards of behavior that the exchange or 
association wishes to set for itself.\246\ The Commission believes that 
requiring exchanges and associations to adopt a code of conduct and 
ethics should help foster the ethical behavior of directors, officers 
and employees, because these individuals would be informed of the 
standards of conduct expected of them in fulfilling the 
responsibilities of their positions. The Commission further believes 
that the specific provision prohibiting employees or officers of an 
exchange or association from being a board member of a listed issuer or 
member firm is desirable to avoid the inherent conflict of interest of 
such a relationship.
---------------------------------------------------------------------------

    \246\ See Breeden Report, supra note 134.
---------------------------------------------------------------------------

    The proposed governance rules also would require that each exchange 
and association adopt governance guidelines that, at a minimum, 
establish policies regarding: director qualification standards; 
director responsibilities; director access to management and 
independent advisors; director compensation; director orientation and 
continuing education; management succession; and annual performance 
evaluations of the board.\247\ Requiring exchanges and associations to 
adopt governance guidelines should help promote greater awareness of 
the principles that are intended to guide the exchange or association 
in implementing good governance.
---------------------------------------------------------------------------

    \247\ See proposed Rules 6a-5(q) and 15Aa-3(q).
---------------------------------------------------------------------------

    In our view, these proposals would assist exchanges and 
associations in fulfilling the statutory mandate that they be so 
organized and have the capacity to carry out the Exchange Act's 
purposes.\248\
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    \248\ See Sections 6(b)(1) and 15A(b)(2) of the Exchange Act, 15 
U.S.C. 78s(b)(1) and 78o-3(b)(2).
---------------------------------------------------------------------------

11. Exemption Provision
    The proposed governance rules would establish procedures for the 
Commission, upon written request or its own motion, to grant an 
exemption from the rules' provisions, either unconditionally or on 
specified terms and conditions, if the Commission determines that such 
exemption is necessary or appropriate in the public interest and is 
consistent with the protection of investors.\249\ Pursuant to this 
provision, the Commission would consider and act upon appropriate 
requests for relief from the proposed rules' provisions and would 
consider the particular facts and circumstances relevant to each such 
request, the potential ramifications of granting any exemption, and any 
appropriate

[[Page 71147]]

conditions to be imposed as part of the exemption.
---------------------------------------------------------------------------

    \249\ See proposed Rules 6a-5(s) and 15Aa-3(s).
---------------------------------------------------------------------------

12. Implementation
    Because exchanges and associations in all likelihood would have to 
revise their governing documents to comply with the applicable rule, 
each exchange and association would be required to submit to the 
Commission proposed rule changes reflecting new rules or rule 
amendments no later than four months following the date of publication 
of final rules in the Federal Register (``final rules' publication 
date''), and those rules or rule amendments would have to be approved 
by the Commission no later than ten months following the final rules' 
publication date and operative no later than one year following the 
final rules' publication date.\250\ By amending its existing rules, 
each exchange or association could tailor its governance rules to its 
own particular structure, as long as such rules were consistent with 
the Exchange Act and the proposed governance rules, if those rules 
ultimately are adopted by the Commission.
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    \250\ See proposed Rules 6a-5(r) and 15Aa-3(r). As SROs, 
exchanges and associations currently are required by the Exchange 
Act to file with the Commission any proposed new rules or rule 
amendments, accompanied by a concise general statement of the basis 
for, and purpose of, the proposed rule change. Once an exchange or 
association files a proposed rule change, the Commission must 
publish notice of it and provide an opportunity for public comment. 
See Section 19(b)(1) of the Exchange Act, 15 U.S.C. 78s(b)(1), and 
Rule 19b-4 under the Exchange Act, 17 CFR 240.19b-4. The proposed 
rule change may not take effect unless the Commission approves it 
pursuant to Section 19(b)(2) of the Exchange Act, or it is otherwise 
permitted to become effective under Section 19(b)(3)(A) or Section 
19(b)(7) of the Exchange Act. 15 U.S.C. 78s(b)(2), (b)(3)(A) and 
(b)(7).
    The requirements that the exchanges and associations file a 
proposed rule change that complies with the applicable proposed rule 
by a specified date, and that final rules be operative by a 
specified date, are consistent with the Commission's approach when 
it adopted Rule 10A-3 under the Exchange Act. See Rule 10A-3 under 
the Exchange Act, 17 CFR 240.10A-3.
---------------------------------------------------------------------------

C. Request for Comment

    The Commission seeks comments on proposed Rules 6a-5 and 15Aa-3. 
Also, the Commission requests that interested persons respond to the 
following specific questions:
    Question 1. Do the proposed governance rules strike an appropriate 
balance? Are there provisions of the proposed rules that are 
unnecessary or are there other provisions that should be added? Are 
there aspects of the proposed rules that would be difficult for 
exchanges or associations to implement and, if so, why would that be 
the case?
    Question 2. Is it appropriate to extend the proposed rules to 
regulatory subsidiaries?
    Question 3. Is the proposal that the board of each exchange and 
association be composed of a majority of independent directors 
appropriate? Should the proposal require a different threshold, e.g., a 
wholly independent board or independent directors constituting 75% or 
66% of the board?
    Question 4. Is the proposed definition of ``independent director,'' 
i.e., that the director have no material relationship with the exchange 
or association or any affiliate of the exchange or association, or any 
member of the exchange or association or any affiliate of such member, 
appropriate? Is there another definition of independent director that 
would be preferable? Is the proposed definition of ``material 
relationship'' appropriate? Is an annual determination of independence 
appropriate, or should such determination be made more or less 
frequently? Have we provided enough guidance for boards to make the 
required independence determination? If not, what additional guidance 
is needed?
    Question 5. Are the relationship tests set forth in the proposed 
rules that indicate when a director would not be considered independent 
appropriate? Are there aspects of these relationship tests that should 
be modified or clarified and, if so, why would that be the case? Is the 
three-year look-back period appropriate? Should the look-back period be 
longer or shorter? Is the scope of the proposed relationship tests 
appropriate? Are there other relationships that should be expressly 
covered so that the director could not be considered independent, e.g., 
the Chairman of the board of a member firm or listed issuer? Is the 
$60,000 limit on payments received by the director, or an immediate 
family member, from the exchange or association appropriate? Should 
this amount be higher or lower? Is the proposed definition of 
``immediate family member'' appropriate? Is the proposed definition of 
``compensation'' appropriate? Is the 2% of recipient's yearly gross 
revenues or $200,000 limit on payments made to or from an exchange or 
association to an organization in which the director, or an immediate 
family member, is a partner, controlling shareholder or executive 
officer appropriate? Is the exclusion from the 2% gross revenues/
$200,000 payments test for non-discretionary charitable contribution 
matching programs appropriate? Should these percentage and dollar 
amounts be higher or lower? Is the proposed definition of ``control'' 
appropriate? Is it appropriate to include in the relationship tests 
immediate family members and affiliates? Is the limitation on prior or 
current relationships with the exchange's or association's auditor 
appropriate?
    Question 6. Many exchanges define a ``public director'' to include 
a person who has no material relationship with a broker or dealer. The 
proposed rules' definition of independent director would not expressly 
preclude an independent director from being associated with a non-
member broker or dealer or affiliate of a non-member broker or dealer, 
unless such non-member broker or dealer or affiliate has a material 
relationship with the exchange or association. Should the proposed 
definition of independent director preclude a director associated with 
a broker or dealer or any affiliate of such broker or dealer from being 
considered an independent director?
    Question 7. Should an executive officer of an issuer whose 
securities are ``primarily traded'' on an exchange or a facility of an 
association be precluded from being an independent director? Should 
this limitation cover an executive officer of any issuer of securities 
that are traded on the exchange or a facility of an association 
pursuant to unlisted trading privileges without regard to the extent of 
the volume of trading in those securities?
    Question 8. Is the proposed requirement to remedy non-compliance 
with the majority independence requirement by the earlier of the next 
annual meeting or one year from the date of non-compliance appropriate? 
Is another time frame more appropriate?
    Question 9. Is the proposed definition of ``Standing Committee'' 
appropriate? Should we require fewer or additional Standing Committees? 
If so, what should be eliminated or added? Is the proposed requirement 
that each Standing Committee be composed entirely of independent 
directors appropriate? Are there circumstances when this requirement 
would not be necessary? Are the duties of each of the Standing 
Committees, as proposed to be set forth in their charters, appropriate 
or are there duties that should be added or deleted? If so, what should 
be added or deleted? Are the requirements that the Standing Committees 
be composed solely of independent directors and report directly to the 
board likely to foster a greater degree of independent decision-making 
by the exchange's or association's governing body? If not, what would 
accomplish this goal? Should each Standing Committee be required to 
conduct an annual performance evaluation?

[[Page 71148]]

    Question 10. Some SROs currently require that members of their 
audit committee be financially literate and/or that at least one member 
have accounting related financial management expertise. See, e.g., PCX 
Rule 3.3(d) and the NYSE Audit Committee Charter. Also, Section 407 of 
the Sarbanes-Oxley Act and Item 401 under Regulation S-K require that 
listed companies disclose whether or not the Audit Committee contains 
at least one financial expert. Should the proposed governance rules 
contain a similar requirement for exchanges' and associations' Audit 
Committees? Are the proposed responsibilities of the Audit Committee 
appropriate? Should the proposed rules require the Audit Committee to 
prepare and publicly disclose an annual report? Are there other 
responsibilities that should be added? If so, which? Should any of the 
proposed Audit Committee responsibilities be eliminated? If so, which?
    Question 11. Are the provisions relating to the fair representation 
requirement appropriate? Is the requirement that at least 20% of the 
directors be selected by members and that members be given the 
opportunity to select candidates who compose at least 20% of the total 
number of directors appropriate? Should the 20% threshold be higher or 
lower?
    Question 12. Given the proposed fair representation requirement 
that at least 20% of directors be selected by members, could this 
factor impair the independence of those directors selected by members?
    Question 13. Is the provision pertaining to the petition process 
appropriate? Is the requirement limiting to 10% the percentage of 
members necessary to put forth an alternative member candidate or 
candidates appropriate? Should the 10% threshold be higher or lower? 
Should the percentage limitation differ depending on whether members 
petition to nominate a single candidate or more than one candidate? Are 
there other ways to obtain the fair representation of members through a 
petition process rather than by imposing a limitation on the percentage 
of members necessary to put forth an alternative candidate?
    Question 14. Are the other provisions relating to the proposed fair 
representation requirement appropriate? Specifically, is the proposed 
requirement that at least 20% of the members of any committee, 
subcommittee, or panel that is subject to the jurisdiction of the 
Regulatory Oversight Committee and that is responsible for disciplinary 
matters be composed of members of the exchange or association, 
appropriate? Is the proposed requirement that at least 20% of the 
members of any committee, subcommittee, or panel that is subject to the 
jurisdiction of a Standing Committee and that is responsible for 
providing advice with respect to trading rules or disciplinary rules be 
members of the exchange or association appropriate? Is the proposed 
minimum threshold adequate member representation to achieve the goal of 
fair representation? Should the proposed threshold be higher or lower 
than 20%?
    Question 15. Is it appropriate to require that when the board 
considers any matter that is recommended by or otherwise is within the 
authority or jurisdiction of a Standing Committee, a majority of the 
directors who vote on the matter must be independent directors? Are 
there circumstances when this provision would be unnecessary?
    Question 16. Is it appropriate to require that if any committee has 
the authority to act on behalf of the board, it must be composed of a 
majority of independent directors and that the board may not delegate 
to any committee not consisting solely of independent directors the 
authority to act on matters that otherwise are within the jurisdiction 
of a Standing Committee?
    Question 17. Should the proposed rules give greater guidance on the 
matters that should be considered with respect to the annual 
performance self-evaluations and annual performance evaluation of the 
governance of the exchange or association by the Standing Committees?
    Question 18. Is there a reason to deny SROs the flexibility of 
having a non-executive Chairman who is not an independent director? Do 
other provisions of the proposed governance rules make it unnecessary 
to require the Chairman to be an independent director if two 
individuals serve as Chairman and CEO? Should the proposed governance 
rules instead require that if the Chairman is not an independent 
director and two individuals serve as Chairman and CEO, a lead director 
should preside over executive sessions and over any Standing Committee 
meetings?
    Question 19. Should the proposed governance rules require a 
complete separation of the positions of Chairman and CEO? Is the 
provision requiring the exchange or association to appoint a lead 
director to preside over executive sessions when a single individual 
serves as Chairman and CEO sufficient? Is it appropriate to require 
that the Chairman be prohibited from serving on a Standing Committee, 
unless the Chairman is an independent director?
    Question 20. Are the provisions relating to the separation of 
regulatory functions from any market operations and other commercial 
interests of the exchange or association appropriate? Should the 
proposed governance rules require the regulatory function and market 
operations and other commercial interests of an exchange or association 
to be conducted in separate legal entities? What would be the 
consequences of any such requirement? Would such a requirement mitigate 
conflicts of interest? If so, how? Are there other requirements 
relating to the independence of the regulatory function that should be 
implemented?
    Question 21. Is the proposal requiring each exchange and 
association to have a Chief Regulatory Officer appropriate? Are there 
other duties that a Chief Regulatory Officer should be required to 
perform? Are there other provisions that should be imposed to require 
his or her independence?
    Question 22. Should the proposed governance rules be applied to 
other SROs, such as clearing agencies? Why?
    Question 23. Is the requirement that officers and directors of an 
exchange or association not be subject to a statutory disqualification, 
as defined in Section 3(a)(39) of the Exchange Act, appropriate? Is 
there some other definition of statutory disqualification that is more 
appropriate? Should the definition be broader or narrower?
    Question 24. Is the requirement that an exchange or association 
explicitly mandate that each director, in discharging his or her 
obligations as a director, reasonably consider all requirements 
applicable to the exchange or association under the Exchange Act broad 
enough?
    Question 25. Should the proposed rules require that the exchange or 
association provide sufficient funding and other resources to permit 
the independent directors and the Standing Committees to retain 
independent legal counsel and other advisors in order to fulfill their 
responsibilities?
    Question 26. Is the requirement that an exchange or association 
apply funds received from regulatory fees, fines or penalties only to 
fund programs and operations directly related to such exchange's or 
association's regulatory responsibilities appropriate? Is the scope of 
which funds would be included in the requirement clear? Is it broad 
enough, or are there other sources of remuneration that should be 
included? For instance, should issuer fees be considered regulatory 
fees?

[[Page 71149]]

Should the Commission define the term ``regulatory fees''?
    Question 27. Should regulatory fees, fines, or penalties be allowed 
to be used to fund non-regulatory activities? If so, should there be 
any restrictions on activities for which such funds could be used?
    Question 28. Instead of requiring exchanges and associations to use 
regulatory funds only to fund regulation, should the Commission permit 
an exchange or association to use regulatory funds for purposes other 
than to fund regulation if the exchange's or association's Regulatory 
Oversight Committee approves the use of the funds and the exchange or 
association submits to the Commission, pursuant to section 19(b)(2) and 
Rule 19b-4, both its stated policy, practice, or interpretation 
regarding committee approval and each proposed use of regulatory funds 
for other than regulatory purposes?
    Question 29. Should the Commission enumerate in the proposed rules 
certain types of regulatory fees, fines or penalties that would fall 
within the prohibition? If so, what items should be included?
    Question 30. Is the proposed requirement that an exchange or 
association implement policies and procedures to maintain the 
confidentiality of regulatory and certain other information 
appropriate?
    Question 31. Is there any other type of information other than 
regulatory information and information required to be submitted to 
effectuate a transaction that an exchange or association should be 
required to keep confidential? Should such information include 
information gained in the course of applications for listing on the 
exchange?
    Question 32. Should an exchange or association be allowed to 
disseminate such information (other than regulatory information), 
including order and trade data, in an aggregated form, as proposed? If 
so, are there any restrictions, in addition to those proposed, that 
should be required so that the information is truly aggregated?
    Question 33. Is the proposed definition of ``regulatory 
information'' appropriate? Is it too broad? Or, should the prohibition 
on use of regulatory information for other than a regulatory purpose 
include information other than information gained in the course of 
carrying out regulatory obligations? If so, what information?
    Question 34. Would the proposed limitations on disseminating 
regulatory information and information required to be submitted to 
effectuate a transaction restrict an exchange or association from being 
able to disseminate information that currently is disseminated by 
exchanges or associations? If so, how so?
    Question 35. Should an exchange or association be allowed to 
disseminate order and trade data, or regulatory information, which is 
otherwise made public by a person other than the exchange, association, 
or an officer, director, employee, or agent of the exchange or 
association?
    Question 36. Do commenters believe that it is necessary to have any 
ownership and voting limits?
    Question 37. Should the proposed ownership and voting limitations 
in relation to interests in an exchange, association or a facility of 
an exchange or association apply to all other persons, besides members 
that are brokers or dealers? What specific concerns exist that imposing 
ownership and voting limits on other persons, not just members that are 
brokers or dealers, would serve to mitigate? If the Commission were to 
impose restrictions on other persons, should the limit be the same as 
for members that are brokers or dealers--20%--or should it be higher or 
lower? Upon which other persons should these restrictions be imposed?
    Question 38. Should the Commission require that SROs impose 
ownership and voting limits on persons that are not statutory 
``members'' but that own one or more memberships, or ``seats,'' in an 
exchange, but are not registered brokers or dealers and do not trade on 
or through the facilities of the exchange, but lease the trading right 
to a broker-dealer? If so, should it depend upon whether the person 
retains the voting rights associated with such membership?
    Question 39. If the Commission were to impose ownership and voting 
restrictions on all persons, should the SRO and the Commission be able 
to permit persons to exceed the limit? If so, should the Commission 
impose requirements on any person that was permitted to exceed the 
limit? If so, what types of requirements? Should the person be required 
to agree to provide the Commission access to its books and records, and 
agree to cooperate with the Commission and the relevant SRO in the 
performance of their regulatory oversight responsibilities? Are there 
any other requirements that should be imposed?
    Question 40. Is a 20% ownership and voting threshold the 
appropriate level? Are these thresholds too high? For instance, should 
the Commission prohibit ownership and voting over 10% (the level used 
in the definition of ``associate'' in Rule 12b-2)? Or 5% (the reporting 
threshold for Regulation 13D)? Or should these thresholds be higher 
than 20%?
    Question 41. The Commission is proposing to limit a member's 
beneficial ownership in an SRO or facility of an SRO. The beneficiaries 
of an irrevocable trust are not generally deemed to beneficially own 
the securities in the trust, because the voting and investment power 
over those securities is typically held exclusively by a third party 
trustee. Should the Commission explicitly prohibit members from owning 
securities subject to the proposed prohibition through such an 
irrevocable trust? Are there any other forms of ownership that the 
Commission should require an SRO to prohibit, other than beneficial 
ownership?
    Question 42. The Commission is proposing ownership and voting 
limits on members' ownership, and voting of interests, both in 
``traditional'' mutually-owned SROs and in demutualized SROs. Is this 
appropriate? Should the Commission not limit ownership of seats, or 
memberships, in a mutually-owned SRO? If so, why should the Commission 
treat these SROs differently than demutualized SROs?
    Question 43. Is there any special consideration that should be 
taken into account with respect to requiring a mutually-owned SRO to 
impose ownership and voting limits on its members' ownership in or 
voting of interests in the SRO and its facilities? For instance, if a 
member is entitled to only one vote even if it owns more than one seat 
or membership, would a limit on ownership be necessary? If so, how 
should such a limit be structured?
    Question 44. Are there practical implementation issues that would 
be faced by exchanges and associations in devising rules to divest 
members that are brokers or dealers and their related persons of any 
interest in excess of that proposed to be permitted? What about rules 
reasonably designed to not give effect to the portion of a vote by a 
member that is a broker or dealer that is in excess of the proposed 
limits? If so, how could these issues be addressed?
    Question 45. Are the proposed requirements that an exchange and 
association impose ownership and voting limits on its members that are 
brokers or dealers consistent with state law under which the SROs are 
governed? If not, please explain why that is the case.
    Question 46. Should the Commission prohibit direct, but not 
indirect, ownership and voting over the proposed limits? Could a limit 
on direct ownership and voting--without a limit on indirect--easily be 
circumvented?

[[Page 71150]]

    Question 47. The ownership and voting limitations as proposed would 
apply to ownership in or voting of interests in any facility of an 
exchange or association. Is this appropriate, or is it too broad? If 
too broad, what types of facilities should be included within the scope 
of the member ownership and voting limitations? How would the 
Commission achieve its goals by narrowing the ownership and voting 
limitations?
    Question 48. The Commission requests comment on whether any broker-
dealer members and their ``related persons'' currently own more than 
20% of the interest in an exchange, association or a facility of an 
exchange or association. If so, the Commission requests comment on the 
length of time that an exchange or association should be given to allow 
such members to divest themselves of such interest.
    Question 49. As proposed, a broker-dealer member of an exchange or 
association would be prohibited from owning and voting more than 20% of 
the securities of an exchange, association, or facility, which could 
include agreements not to vote. The Commission has not proposed any 
requirements on what would constitute a quorum for purposes of a 
shareholder vote, in part because broker-dealer members and other 
persons would be able to vote all the shares of stock they are entitled 
to own (i.e., members can own and vote up to 20%), so there would not 
be a percentage of stock that is owned but not voted. The Commission 
recognizes, however, that a broker-dealer member theoretically could 
accumulate undetected ownership in violation of the 20% limit. If the 
member's interest was large enough, the member could, by not being 
present at a shareholder vote, keep a quorum from being present at a 
shareholder meeting. The Commission requests comment on whether it is 
necessary to require the exchange or association to amend its rules to 
prohibit such a scenario.
    Question 50. Are the proposed definitions of ``affiliated,'' 
``affiliated issuer,'' and ``affiliated security'' appropriate? Should 
the definitions be broader? Should they be narrower?
    Question 51. Is the proposed definition of ``related persons'' too 
narrow? Or too broad? Is there any other relationship that should be 
included within the definition that is not? For instance, should the 
Commission include ownership that is acquired solely by being a member 
of a group?
    Question 52. Is the proposed part of the definition of ``related 
person'' that includes any person associated with a member too broad? 
For example, should it be limited to those associated persons that 
possess, directly or indirectly, the power to direct or cause the 
direction of management and policies of the member, whether through the 
ownership of voting securities, by contract, or otherwise?
    Question 53. The proposed ownership and voting limits would apply 
to members that are natural persons directly, if they are broker-
dealers, or indirectly, through the member's associated broker or 
dealer. Should the Commission require that an SRO impose the ownership 
and voting limits directly on all members, or would it be sufficient to 
capture natural persons that are not brokers or dealers as ``related 
persons'' of their associated broker-dealer?
    Question 54. Is the proposed definition of ``beneficial ownership'' 
appropriate for purposes of the proposed ownership limitation? Is it 
too narrow? Or is it too broad? What other definition would be 
appropriate? Should the Commission instead only require information to 
be filed with respect to record ownership rather than beneficial 
ownership? If so, how would that impact securities positions of a 
customer of the member for which the member holds in street name?
    Question 55. How difficult would it be for an SRO to monitor 
ownership by broker-dealer members and their related persons under the 
proposed definition of related person? Would the proposed rule (Rule 
17a-27) that would require broker-dealer members to report to the 
Commission and the relevant SRO ownership by the member and its related 
persons in excess of 5% help the SRO monitor the ownership and voting 
limits? To what extent would the proposed requirement that an SRO adopt 
rules permitting it to request information from its owners help SROs 
obtain the information they need?
    Question 56. Should the Commission require exchanges and 
associations to allow members subject to the ownership and voting 
limits to solicit and receive revocable proxies under Regulation 14A of 
the Exchange Act, as the Commission has proposed? Or, would doing so 
undermine the purpose of the 20% voting limitation? Or, is not allowing 
``open-ended proxies'' sufficient to mitigate any concern that the act 
of soliciting and receiving proxies would in and of itself provide a 
member the opportunity to exceed the 20% threshold? If so, would 
disallowing the exemption contained in Rule 14a-2(b)(2) under the 
Exchange Act be sufficient? Are there other situations that should be 
explicitly excluded from the proposed limitation?
    Question 57. Should the Commission specify the manner in which an 
SRO must assure that if a member that is a broker or dealer violated 
the ownership and voting limits the exchange or association has an 
effective mechanism to divest a member and its related persons of any 
interest owned in excess of, or to not give effect to the portion of a 
vote in excess of, the 20% limitation? If so, what should the 
requirement be?
    Question 58. Should the Commission require an exchange or 
association to have an independent party tabulate any shareholder vote, 
to help ensure compliance by the exchange or association and its 
broker-dealer members with the proposed voting limit? How should the 
Commission define ``independent party'' in this context?
    Question 59. Are there other issues that an exchange's or 
association's code of conduct and ethics and governance guidelines 
should be required to address in addition to those identified in 
proposed Rules 6a-5(p) and (q) and 15Aa-3(p) and (q)?
    Question 60. Are the proposed dates by which the exchange or 
association must file a rule change proposing the governance standards 
and by which the proposed rule change must be adopted by the Commission 
and operative by the SRO appropriate?

III. Proposed Regulation AL--National Securities Exchanges and 
Registered Securities Associations Listing Affiliated Securities

A. Background and Need for Proposed Regulation AL

    As discussed above, competition among markets has increased 
dramatically over the past few years, and several SROs have 
demutualized or entered into arrangements with separate trading 
facilities.\251\ As a demutualized entity, an SRO may become a publicly 
traded company and choose to list its securities on its own market. In 
addition, a facility of an SRO that has a separate legal existence and 
that is publicly traded currently may choose to list on its affiliated 
SRO. The owner of one facility of an SRO already has completed an 
initial public offering, and another SRO has filed a registration 
statement under the Securities Act with regard to its intended initial 
public offering.\252\ The listing of securities issued by an SRO, the 
facility of an SRO, or an affiliate of either on the SRO would create a 
new conflict of interest

[[Page 71151]]

with the SRO's statutory obligations as a regulator.
---------------------------------------------------------------------------

    \251\ See supra Section I.B.4. and note 61.
    \252\ See supra note 65.
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    In particular, such ``self-listing'' raises questions as to an 
SRO's ability to independently and effectively enforce its own or the 
Commission's rules against itself or an affiliated entity, and thus 
comply with its statutory obligations under the Exchange Act.\253\ For 
instance, the SRO might be reluctant to vigorously monitor for 
compliance with its initial and continued listing rules by the 
securities of an affiliated issuer or its own securities, and may be 
tempted to allow its own securities, or the securities of an affiliate, 
to be listed (and continue to be listed) on its market even if the 
security is not in full compliance with the SRO's listing rules. In 
addition, self-listing may exacerbate conflicts with the SRO overseeing 
competitors that also may be listed on, and thus regulated by, the SRO. 
For example, an SRO might choose to more strictly construe and apply 
its listing rules to the securities of a competitor that is listed on, 
or that seeks to list on, the SRO than it would for its own or an 
affiliate's securities. Or, an SRO might be reluctant to allow 
additional time for the securities of an unaffiliated issuer to regain 
compliance with a listing rule, or may allow more time for its own 
securities that are self-listed.
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    \253\ See Sections 6(b) and 15A(b) of the Exchange Act, 15 
U.S.C. 78f(b) and 78o-3(b).
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    Trading of its own securities or the securities of an affiliated 
issuer on the SRO also raises similar potential conflict concerns, in 
that the SRO might choose to selectively enforce (or not enforce) its 
trading rules with respect to trading in its own stock or that of an 
affiliate so as to benefit itself. For example, the SRO may determine 
to look the other way with respect to improper trading in an affiliated 
security that creates the appearance of increased volume, such as 
through wash sales, or trading that artificially inflates or sustains 
the price of the stock, such as marking the close. In addition, the SRO 
may improperly pressure the specialist to stabilize the price of the 
stock. The SRO also may improperly discourage legal short sales or 
other types of legitimate trading practices that the SRO believed may 
negatively impact the value of the stock.
    To date, the Commission has approved, through the rule filing 
process of Section 19(b) of the Exchange Act,\254\ heightened reporting 
requirements in a particular instance in which an SRO ``self-listed'' 
securities issued by an affiliate.\255\ Specifically, in anticipation 
of the listing of Archipelago Holdings (the parent company of Arca-Ex) 
on PCX, PCX amended its rules to require it to periodically report to 
the Commission regarding its oversight of the listing on PCX and 
trading on Arca-Ex of Archipelago Holdings' stock. PCX also amended its 
rules to require an annual independent audit of Archipelago Holdings' 
compliance with PCX's listing standards, a copy of which the exchange 
must provide to the Commission.\256\ The Commission approved PCX's 
proposed rule change as consistent with the Exchange Act, stating that 
it would help protect against concern that PCX would not effectively 
enforce its rules with respect to the listing and trading of securities 
of an affiliate of the exchange or any entity that operates or owns a 
facility of the exchange.\257\
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    \254\ 15 U.S.C. 78s(b).
    \255\ See Securities Exchange Act Release No. 50171 (August 9, 
2004), 69 FR 50427 (August 16, 2004) (approving SR-PCX-2004-76, 
which places additional reporting requirements on the exchange if 
any affiliate of the exchange or any entity that operates and/or 
owns a trading system or facility of the exchange lists any security 
on the exchange). The Commission notes that the NASD did not impose 
additional requirements when the securities of Nasdaq, a facility of 
the NASD, began trading in the OTC Bulletin Board, a service 
operated by the NASD.
    \256\ See id.
    \257\ See id.
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    SROs currently have listing rules that would permit them to list 
and trade their own or ``affiliated'' securities without any additional 
requirements such as those adopted by PCX. Because of the conflict of 
interest raised by self-listing, which could result in an SRO being 
less vigilant in its obligations to enforce the securities laws and its 
own rules, the Commission is proposing additional requirements when an 
SRO lists and trades its own, or an affiliate's, securities. Proposed 
Regulation AL is designed to provide further assurance that SROs will 
carry out their regulatory responsibilities under the Exchange Act with 
respect to surveillance of affiliated securities and to provide the 
Commission a greater ability to monitor SROs' efforts in this regard. 
The Commission believes that the proposed rule would establish 
safeguards that would better ensure that the listing and trading of an 
affiliated security on an SRO complies with applicable rules of the SRO 
and the Commission. In addition, the Commission believes that the 
proposed rules would serve to mitigate the inherent conflict of 
interest between the SRO's responsibility to vigorously oversee the 
listing and trading of an affiliated security on its market and its own 
commercial and economic interests by providing the Commission with 
enhanced information and increased ability to monitor the SRO's 
surveillance of the affiliated security.

B. Description of Proposed Regulation AL

1. Definition of Affiliated Security
    Proposed Regulation AL would define the term ``affiliated 
security'' \258\ to mean any security issued by an affiliated issuer, 
except any option exempt from the Securities Act pursuant to Rule 238 
under the Securities Act \259\ and any security futures product exempt 
from the Securities Act under Section 3(a)(14) of the Securities 
Act.\260\ The term ``affiliated issuer'' would be defined to mean: (i) 
With respect to a national securities exchange, the national securities 
exchange, an SRO trading facility of the national securities exchange, 
an affiliate of the national securities exchange, or an affiliate of an 
SRO trading facility of the national securities exchange, and (ii) with 
respect to a registered securities association, the registered 
securities association, an SRO trading facility of the registered 
securities association, an affiliate of the registered securities 
association, or an affiliate of an SRO trading facility of the 
registered securities association.\261\ The term ``SRO

[[Page 71152]]

trading facility'' would be defined to mean any facility of a national 
securities exchange or registered securities association that executes 
orders in securities \262\ and would capture Nasdaq's SuperMontage 
system, Arca-Ex and the NYSE floor. It would not, however, include the 
NASD's Alternative Display Facility (``ADF'') because the ADF does not 
execute orders. Thus, Nasdaq would be considered an affiliated issuer 
of the NASD because it would be an SRO trading facility of the NASD, 
and Archipelago Holdings would be an affiliated issuer of PCX because 
it would be an affiliate of an SRO trading facility of PCX.\263\ The 
proposed definitions of affiliated security, affiliated issuer, and SRO 
trading facility are intended to include the securities of any entity 
whose interests may be so closely aligned with the SRO's interests that 
the same concerns are raised about the ability of the SRO to oversee 
such security's listing and trading as are raised by the listing and 
trading of the SRO's own securities.
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    \258\ See proposed Rule 800(a)(4).
    \259\ 17 CFR 230.238.
    \260\ 15 U.S.C. 77c(a)(14). See proposed Rule 800(a)(4). 
Standardized options and security futures products are issued and 
guaranteed by a clearing agency. Currently, all standardized options 
and security futures products are issued by the Options Clearing 
Corporation (``OCC''). The Commission proposes to exempt 
standardized options and security futures products from the 
definition of ``affiliated security'' because the value of these 
instruments is not related to the value of its issuer--i.e., the 
OCC. Instead, their value is based on the value of the security 
underlying the option or security futures product. Accordingly, the 
Commission does not believe the same conflicts exist when an SRO 
lists and trades standardized options and security futures products 
issued by an affiliate as when an SRO lists and trades other 
securities issued by an affiliate.
    \261\ See proposed Rule 800(a)(3). ``Affiliate'' would be 
defined to mean, with respect to any person, any other person that 
directly or indirectly controls, is controlled by, or is under 
common control with, the person. See proposed Rule 800(a)(2). 
``Control'' would be defined to mean the possession, direct or 
indirect, of the power to direct or cause the direction of the 
management and policies of a person, whether through ownership of 
voting securities, by contract, or otherwise. A person is presumed 
to control another person if the person (i) is a director, general 
partner or officer exercising executive responsibility (or having 
similar status or functions); (ii) directly or indirectly has the 
right to vote 25% or more of a class of voting securities or has the 
power to sell or direct the sale of 25% or more of a class of voting 
securities; or (iii) in the case of a partnership, has the right to 
receive, upon dissolution, or has contributed, 25% or more of the 
capital. See proposed Rule 800(a)(5). The Commission proposes to 
define the term ``affiliate'' consistent with its existing 
definitions of such terms under the securities laws, including Rules 
12b-2 and 10A-3 under the Exchange Act and Rule 144 under the 
Securities Act, and to define ``control'' consistent with its 
existing definitions of such terms under the securities laws, 
including Form 1, Form BD and Rule 300 of Regulation ATS. These 
definitions are intended to include any person that would have the 
potential ability to influence the operation of the person 
specified.
    \262\ See proposed Rule 800(a)(6). The term ``facility'' would 
have the meaning in Section 3(a)(2) of the Exchange Act and proposed 
Rule 15Aa-3 under the Exchange Act. See proposed Rule 800(a)(7).
    \263\ Securities issued by Nasdaq currently trade on the OTC 
Bulletin Board pursuant to rules of the NASD, and would be covered 
by proposed Regulation AL. If securities issued by Nasdaq were to 
trade on Nasdaq, they also would be covered as they would be 
approved for trading on, and would trade pursuant to the rules of, 
the NASD.
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2. Initial Listing
    Proposed Regulation AL would prohibit a national securities 
exchange or registered securities association from approving for 
listing an affiliated security unless such exchange's or association's 
Regulatory Oversight Committee certified that such security satisfies 
the exchange's or association's rules for listing.\264\ This 
requirement is intended to provide for review by an independent body of 
a listing process that contains a conflict of interest so as to help 
ensure that the exchange or association effectively carries out its 
obligations under Section 6 or 15A of the Exchange Act,\265\ as 
applicable. The Commission notes that only an exchange or association, 
as an SRO, is permitted to establish listing rules. For instance, the 
listing rules for securities traded on Nasdaq are rules of the NASD. 
Accordingly, the NASD, not Nasdaq, would be required to comply with 
proposed Regulation AL.
---------------------------------------------------------------------------

    \264\ See proposed Rule 800(b)(1).
    \265\ 15 U.S.C. 78f and 78o-3.
---------------------------------------------------------------------------

3. Continued Listing and Trading
    In addition, if an affiliated security is listed on, approved for 
trading on, or trades pursuant to the rules of, an exchange or 
association, proposed Regulation AL would impose specific reporting and 
notice obligations on the exchange or association. The proposal would 
require the exchange or association to file a quarterly report with the 
Commission summarizing its monitoring of the affiliated security's 
compliance with its listing rules.\266\ This proposed requirement could 
require an exchange or association to evaluate an affiliated security's 
compliance with applicable listing rules more frequently than other 
securities listed on the exchange or association to comply with the 
quarterly filing requirement.\267\ The Commission believes that 
requiring this report to be filed quarterly would help ensure that the 
SRO monitors and reports its monitoring of compliance by the affiliated 
security with listing rules on a frequent enough basis so as to bring 
to light possible concerns, without being unduly burdensome. Pursuant 
to the proposed rule, the exchange would be required to provide in the 
report factual information regarding the affiliated security's 
compliance with each applicable rule, both for quantitative listing 
standards (e.g. market capitalization) and qualitative standards (e.g. 
that the majority of the board of directors be independent).
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    \266\ See proposed Rule 800(b)(2)(i)(A). The exchange or 
association would be required to file the report not more than 30 
calendar days after the end of each calendar quarter.
    \267\ The Commission understands, however, that most, if not 
all, SROs review compliance with listing rules on at least a 
quarterly basis.
---------------------------------------------------------------------------

    In addition, the exchange or association would be required to 
include in the quarterly report a summary of its surveillance of the 
trading of affiliated securities by its members.\268\ Each SRO may 
employ different tools and methods in carrying out its statutory 
obligations under the Exchange Act to monitor trading in its market by 
its members. The Commission therefore is not proposing to delineate 
each item or type of factual information that must be included in the 
summary of surveillance of trading. The Commission believes, however, 
that this report should include factual information regarding 
surveillance alerts, exception reports, complaints and regulatory 
referrals, including the steps taken by the SRO with respect to 
problems identified in surveillance alerts, exception reports or 
complaints, in relation to trading in the affiliated security.
---------------------------------------------------------------------------

    \268\ See proposed Rule 800(b)(2)(i)(B).
---------------------------------------------------------------------------

    Finally, the Commission proposes to require the exchange's or 
association's Regulatory Oversight Committee to approve the report 
before it is filed with the Commission.\269\ This requirement is 
intended to provide an independent level of review of the report prior 
to submission, and would ensure that the Regulatory Oversight Committee 
is made aware of potential concerns regarding the listing and trading 
of an affiliated security.
---------------------------------------------------------------------------

    \269\ See proposed Rule 800(c)(i).
---------------------------------------------------------------------------

    In addition to the quarterly report described above, the exchange 
or association would be required to file with the Commission annually a 
report prepared by a third party analyzing compliance by the affiliated 
security with applicable listing rules of the exchange or 
association.\270\ This requirement is intended to provide a second 
level of review by an entity other than the SRO of an affiliated 
security's compliance with the SRO's listing rules. The exchange or 
association also would be required to provide its Regulatory Oversight 
Committee a copy of this report within five business days of its 
receipt so that this committee is made aware of any potential concerns 
regarding affiliated securities' compliance with SRO listing 
rules.\271\ This report would be required to be filed within 60 
calendar days of the end of the exchange's or association's fiscal 
year.\272\ The Commission has proposed that a copy of this report be 
provided to the Commission within 60 days of the end of the exchange's 
or association's fiscal year to coincide with the proposed requirement 
for annually updating Form 1 and new Form 2.\273\
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    \270\ See proposed Rule 800(b)(2)(ii).
    \271\ See proposed Rule 800(c)(ii).
    \272\ See proposed Rule 800(b)(2)(ii).
    \273\ See proposed Rules 6a-2(b) and 15Aa-2(b).
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    Pursuant to its existing rules, an exchange or association would 
review an affiliated security's compliance with applicable listing 
rules. If the exchange or association were to believe that the 
affiliated security is not in compliance with any applicable listing 
rule, the proposal would require the SRO to notify the affiliated 
issuer promptly.\274\ This proposed requirement likely would require 
exchanges and associations to

[[Page 71153]]

amend their current rules setting forth the process for reviewing 
continued listing to require prompt notification to affiliated issuers 
of any alleged non-compliance found during routine reviews.
---------------------------------------------------------------------------

    \274\ See proposed Rule 800(b)(2)(iii).
---------------------------------------------------------------------------

    The proposal also would require the exchange or association, within 
five business days of providing such notice to the affiliated issuer, 
to file a report with the Commission identifying the date the SRO 
alleged that the affiliated security was not in compliance, the listing 
rule at issue, the action the exchange or association proposes to take 
with respect to the affiliated security, and any other material 
information conveyed to the affiliated issuer in the notice of non-
compliance (a ``non-compliance report'').\275\ The exchange's or 
association's Regulatory Oversight Committee would be required to 
approve this non-compliance report prior to filing with the 
Commission.\276\ Finally, the exchange or association also would be 
required to provide the Commission and the exchange's or association's 
Regulatory Oversight Committee with a copy of any response received 
from the affiliated issuer regarding its alleged noncompliance within 
five business days of receipt of the response.\277\
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    \275\ See proposed Rule 800(b)(2)(iv).
    \276\ See proposed Rule 800(c)(i).
    \277\ See proposed Rule 800(b)(2)(v) and (c)(ii).
---------------------------------------------------------------------------

    The Commission believes that requiring the exchange or association 
to provide to the Commission a non-compliance report and a copy of any 
response from an affected affiliated issuer within five business days 
of receipt would provide the Commission with timely information but 
still provide sufficient time for the exchange or association to 
prepare and file the report and to file the response. The Commission 
believes that requiring the Regulatory Oversight Committee to approve 
the non-compliance report before it is filed with the Commission, and 
requiring the Regulatory Oversight Committee to receive a copy of any 
response from the affiliated issuer, would make this committee aware of 
any compliance concerns regarding an affiliated security in a timely 
manner.
    Pursuant to proposed Rule 800(e)(i), each report required to be 
filed under proposed Regulation AL would constitute a ``report'' within 
the meaning of Sections 17(a), 18(a), and 32(a) of the Exchange Act, 
and any other applicable provisions of the Exchange Act.\278\ In 
addition, each report or response required to be filed pursuant to 
Regulation AL would be considered filed upon receipt by the Division of 
Market Regulation at the Commission's principal office in Washington, 
DC.\279\
---------------------------------------------------------------------------

    \278\ 15 U.S.C. 78q(a), 78r(a), and 78ff(a). Section 17(a) of 
the Exchange Act imposes recordkeeping requirements on national 
securities exchanges and registered securities associations; Section 
18(a) of the Exchange Act imposes liability for false or misleading 
statements with respect to a material fact in applications, reports, 
or documents filed pursuant to the Exchange Act or any rule or 
regulation thereunder; and Section 32(a) of the Exchange Act 
provides for penalties against any person that willfully violates 
any provision of, or that willfully and knowingly makes, or causes 
to be made, any false or misleading statements with respect to a 
material fact in any application, report, or document required to be 
filed under the Exchange Act or any rule or regulation thereunder.
    \279\ See proposed Rule 800(e)(ii).
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4. Parity in Application of Listing and Trading Rules
    Proposed Regulation AL also would require that, except as otherwise 
required by proposed Regulation AL, (i) any action taken by the 
exchange or association with regard to the listing of an affiliated 
security, including the time period granted to the affiliated issuer to 
come into compliance with any listing standard, be in compliance with 
the existing rules of the exchange or association and (ii) the exchange 
or association must not apply the same listing rules to affiliated 
securities in a manner materially different than the treatment afforded 
to other securities listed on the exchange or association.\280\ This 
requirement would not preclude an exchange or association from amending 
its rules to apply stricter initial and continued listing standards to 
affiliated securities.\281\ Additionally, any action taken by the 
exchange or association with respect to the trading of an affiliated 
security by the exchange's or association's members must be in 
compliance with the rules of the exchange or association and with 
federal securities laws, and must not be materially different than 
action taken with respect to the trading of other securities traded on 
the exchange or association.\282\ These requirements are intended to 
help ensure that an exchange or association does not give preferential 
treatment to affiliated securities.
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    \280\ See proposed Rule 800(d)(i) and (ii).
    \281\ Of course, any such amendment would have to be filed with 
the Commission pursuant to Section 19(b) of the Exchange Act and the 
rules thereunder. 15 U.S.C. 78(s) and 17 CFR 240.19b-4.
    \282\ See proposed Rule 800(d)(iii).
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5. Exemption Provision
    Proposed Rule 800(f) would establish procedures for the Commission 
to grant an exemption, upon written request or on its own motion, from 
the provisions of proposed Regulation AL, either unconditionally or on 
specified terms and conditions, if the Commission determines that such 
exemption is necessary or appropriate in the public interest and is 
consistent with the protection of investors. Pursuant to this 
provision, the Commission would consider and act upon appropriate 
requests for relief from the rule's provisions and consider the 
particular facts and circumstances relevant to each such request, the 
potential ramifications of granting any exemption, and any appropriate 
conditions to be imposed as part of the exemption.

C. Request for Comment

    The Commission seeks general comments on all aspects of proposed 
Regulation AL as described above. In addition, the Commission requests 
that interested persons respond to the following specific questions:
    Question 61. Proposed Regulation AL would place reporting and 
notice obligations on an exchange or association with respect to an 
affiliated security listed on, approved for trading on, or traded 
pursuant to the rules of, the exchange or association. As noted above, 
this would include the trading of securities issued by Nasdaq on the 
OTC Bulletin Board or Nasdaq, as well as the trading of an exchange's 
securities on the exchange or a facility of the exchange. Is the scope 
of the proposed rule broad enough? Is it too broad?
    Question 62. How frequently should an SRO be required to file 
reports summarizing its monitoring of the affiliated security's 
compliance with the SRO's listing rules and surveillance of the trading 
of the affiliated securities by such SRO's members? Is quarterly 
reporting appropriate, or should it be more often? Or less frequent? Is 
this proposed reporting requirement appropriate at all?
    Question 63. Should the Commission specify in the proposed rule the 
type of information an SRO should include in the quarterly report 
summarizing the SRO's surveillance of trading of affiliated securities 
by exchange members? For instance, should the Commission explicitly 
require the SRO to provide factual information on all exception 
reports, surveillance alerts, complaints, or regulatory referrals 
related to trading in the affiliated security? Is there any other 
particular information that should be specified?
    Question 64. Under the proposal, an SRO has 60 calendar days after 
the end of its fiscal year to file with the Commission a report 
prepared by a third party analyzing compliance by the affiliated 
security with the SRO's listing rules. If an SRO found that an 
affiliated

[[Page 71154]]

security were not in compliance with any applicable listing rule of the 
SRO, the SRO would be required to file a report notifying the 
Commission within five business days of notifying the affiliated issuer 
of its noncompliance. In addition, the SRO would be required to provide 
the Commission with a copy any response from the affiliated issuer 
within five business days of receipt. Finally, the SRO would be 
required to provide its Regulatory Oversight Committee with a copy of 
the annual report and the response from an affiliated issuer within 
five business days. Are these time periods appropriate? Should they be 
shorter? Should they be longer?
    Question 65. Should the third party preparing the annual report 
regarding compliance by the affiliated security with applicable listing 
rules of the SRO be required to be independent of the SRO? If so, how 
should independence be defined? Or should the SRO be allowed to have 
its regular auditor conduct the analysis and prepare the report, as 
proposed?
    Question 66. Should the Commission require a third party to 
periodically audit an SRO's surveillance of trading in the affiliated 
security as well as compliance with listing rules? If so, should the 
Commission require that entity to be independent of the exchange or 
association? If so, how should independence be defined? If so, what 
type of entity would be qualified to undertake this analysis? What 
would be the cost to the SRO of hiring a third-party to conduct the 
audit?
    Question 67. Should the Commission itself have primary 
responsibility for assessing compliance by the affiliated security with 
the exchange's or association's listing rules? If so, should the 
Commission determine initial compliance, as well as continued 
compliance? If both, how often should the Commission conduct a review?
    Question 68. Are the definitions of ``affiliated issuer,'' 
``affiliated security'' and ``SRO trading facility'' appropriate? Are 
they broad enough? For instance, should any entity be included that is 
not included within the proposed definition of ``affiliated issuer?'' 
Are they too broad?
    Question 69. Should the definition of ``affiliated security'' 
include options and security futures products? If so, why?
    Question 70. Should the Commission exclude from the definition of 
``affiliated security'' any security issued by an investment company 
that tracks an index, such as an ETF? If so, why?
    Question 71. Is the proposed definition of ``control'' appropriate? 
Should it be broader? Or more narrow?
    Question 72. Should the Commission impose additional requirements 
beyond those proposed here on SROs that wish to list or trade an 
affiliated security? Or should the Commission prohibit outright the 
listing and trading on the SRO of an affiliated security? What impact 
would doing so have on competition, if the issuer was forced to list 
the security on a competing market?
    Question 73. Should ``self listing'' be allowed only if the 
securities also are listed on another market and such other market has 
made an independent initial listing determination? If so, should the 
self-listing SRO be required to abide by the actions of the other 
market with regard to continuing compliance with listing rules and 
decisions to delist? Would the listing rules of the two markets need to 
be comparable?
    Question 74. Should the Commission require an SRO that lists or 
trades an affiliated security to contract with another SRO to monitor 
an affiliated security's compliance with the affiliated SRO's listing 
rules, and to monitor trading in the affiliated security by the 
affiliated SRO's members?
    Question 75. Are there other requirements that the Commission 
should impose to address the conflicts of interest?

IV. Disclosure by SROs

A. Overview of Proposed Amendments to Registration Forms for Exchanges 
and Associations

    The Commission proposes to amend the procedures for the 
registration of exchanges and associations and the filing of amendments 
and supplements to the registration application. These proposals are 
intended to bring greater transparency to the governance structure of 
SROs and to their regulatory programs and processes, and to provide the 
mechanism for more timely disclosure of the specified information. The 
enhanced disclosure requirements are designed to assure that users of 
exchange or association facilities, investors, and others have access 
to current and relevant information about SROs, including their 
administration, regulatory programs and ownership structure. Moreover, 
improving the transparency of SROs would enable their members, market 
participants, investors and regulators to more readily monitor the 
effectiveness and performance of SROs and promote greater 
accountability by SROs with respect to their Exchange Act obligations.
    In addition, the proposals should assist the Commission in its 
oversight of exchanges and associations and help make its oversight 
programs more effective by requiring better and more frequent 
disclosure of important SRO information, particularly with respect to 
the governance of SROs, their regulatory programs and expenditures on 
those programs, and the ownership of SROs and their facilities. Along 
with proposed Rule 17a-26 under the Exchange Act,\283\ which would 
require SROs to provide the Commission with periodic information about 
specific aspects of their regulatory programs, the proposals to improve 
SRO transparency should help the Commission better identify and respond 
to regulatory issues and concerns promptly and effectively.
---------------------------------------------------------------------------

    \283\ See infra Section V.
---------------------------------------------------------------------------

    Further, the proposals would provide for greater uniformity in the 
regulatory treatment of exchanges and associations by mandating similar 
disclosure for both exchanges and associations. Under the current 
disclosure framework, exchanges are required to provide more detailed 
information on Form 1 than associations are required to submit on 
applicable registration forms. In the Commission's view, there does not 
appear to be a sound reason today for maintaining differing disclosure 
requirements. National securities exchanges and registered securities 
associations are charged with nearly identical obligations under the 
Exchange Act.\284\ Among other requirements, both exchanges and 
associations must be so organized and have the capacity to carry out 
the purposes of the Exchange Act and comply with, and enforce their 
members' compliance with, the federal securities laws and rules 
thereunder and SRO rules.\285\ The proposal therefore seeks to more 
closely align the regulatory disclosure framework for exchanges and 
associations.
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    \284\ See supra Section I.A.
    \285\ Sections 6, 15A, and 19 of the Exchange Act, 15 U.S.C. 
78f, 78o-3, and 78s, among others, establish a statutory scheme with 
respect to the responsibilities imposed on and Commission oversight 
of SROs. The statutory scheme vests SROs that are national 
securities exchanges and registered securities associations with 
nearly identical responsibilities and imposes upon the Commission 
virtually the same oversight requirements with respect to such 
exchanges and associations.
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B. Description of Registration Processes

1. Registration as a National Securities Exchange or Exemption From 
Such Registration Based on Limited Volume
    Section 6(a) of the Exchange Act \286\ generally provides that an 
exchange may be registered as a national securities exchange by filing 
with the Commission an application for

[[Page 71155]]

registration in such form as the Commission, by rule, may prescribe. 
The application must contain the rules of the exchange and such other 
information and documents as the Commission, by rule, may prescribe as 
necessary or appropriate in the public interest or for the protection 
of investors.\287\
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    \286\ 15 U.S.C. 78f(a).
    \287\ Id.
---------------------------------------------------------------------------

    Currently, under Rule 6a-1 under the Exchange Act, an exchange 
applying for registration as a national securities exchange, or for an 
exemption from such registration based on limited volume, is required 
to file its application with the Commission on Form 1.\288\ Form 1 
requires applicants to provide general identifying information (e.g., 
name, address, telephone, and legal status), as well as more specific 
information, as set forth in exhibits attached to the Form.\289\ In 
addition, Rules 6a-1 and 6a-2 under the Exchange Act \290\ set forth 
the application procedures and timing requirements for registration as 
a national securities exchange, or for an exemption from registration 
as an exchange based on limited volume, and the procedures and timing 
requirements for amending the application.\291\
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    \288\ See Rule 6a-1 under the Exchange Act, 17 CFR 240.6a-1, and 
Form 1, 17 CFR 249.1.
    \289\ Currently, Form 1 requires the following material to be 
included as exhibits: (1) a copy of the constitution, articles of 
incorporation or association, and by-laws (Exhibit A); (2) a copy of 
all written rulings, settled practices having the effect of rules, 
and interpretations of any governing board or committee of the 
exchange (Exhibit B); (3) information regarding all affiliates and 
subsidiaries (Exhibit C); (4) unconsolidated financial statements 
for each subsidiary or affiliate of the exchange for the latest 
fiscal year (Exhibit D); (5) a description of the manner of 
operation of the electronic trading system to be used to effect 
transactions on the exchange (Exhibit E); (6) complete set of 
applications for membership, participation or subscription to the 
exchange or for a person associated with a member, participant, or 
subscriber of the exchange (Exhibit F); (7) financial statements, 
reports or questionnaires required of members, participants, 
subscribers, or other users (Exhibit G); (8) listing applications, 
any agreements required to be executed in connection with listing 
and a schedule of listing fees (Exhibit H); (9) audited consolidated 
financial statements for the last fiscal years of the exchange 
prepared in accordance with, or reconciled to, United States 
generally accepted accounting principles (Exhibit I); (10) 
information with respect to officers, governors, members of all 
standing committees, or persons performing similar functions, who 
presently hold or have held their offices or positions during the 
previous year (Exhibit J); (11) information with respect to persons 
with 5% direct ownership for non-member owned exchanged (Exhibit K); 
(12) description of the exchange's criteria for membership (Exhibit 
L); (13) information with respect to any members, participants, 
subscribers or other users and the information pertaining thereto 
(Exhibit M); and (14) a schedule of securities listed on the 
exchange, securities admitted to unlisted trading privileges, 
securities admitted to trading on the exchange which are exempt from 
registration under Section 12(a) of the Exchange Act, 15 U.S.C. 78l, 
and other securities traded on the exchange (Exhibit N).
    \290\ 17 CFR 240.6a-1 and 240.6a-2.
    \291\ See infra Section IV.D. for a description of the 
requirements of Rule 6a-2 under the Exchange Act.
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2. Registration as a Registered Securities Association or Affiliated 
Securities Association
    Section 15A of the Exchange Act \292\ generally provides that an 
association of brokers and dealers may be registered as a registered 
securities association or as an affiliated securities association \293\ 
by filing with the Commission an application for registration in such 
form as the Commission, by rule, may prescribe. The application must 
contain the rules of the association and such other information and 
documents as the Commission, by rule, may prescribe as necessary or 
appropriate in the public interest or for the protection of 
investors.\294\
---------------------------------------------------------------------------

    \292\ 15 U.S.C. 78o-3.
    \293\ Section 15A(d) of the Exchange Act, 15 U.S.C. 78o-3(d), 
generally provides that an association shall not be registered as an 
affiliated securities association unless it appears to the 
Commission that: (1) such association will be affiliated with an 
association registered as a registered securities association and 
(2) such association and its rules satisfy the requirements of 
Section 15A(b)(2)-(10) and (12). To date, no entity has registered 
with the Commission as an affiliated securities association.
    \294\ Section 15A(a) of the Exchange Act, 15 U.S.C. 78o-3(a).
---------------------------------------------------------------------------

    Rules 15Aa-1 and 15Aj-1 under the Exchange Act \295\ set forth the 
application process and timing requirements for registration as a 
registered securities association or an affiliated securities 
association, and the process for amending or supplementing such 
application. Rule 15Aa-1 under the Exchange Act requires an association 
applying for registration as a registered securities association or an 
affiliated securities association to file its application for 
registration on Form X-15AA-1.\296\ Currently, Form X-15AA-1 requires 
an applicant to provide general organizational information (e.g., name 
and addresses of applicant and information about the applicant's 
officers, directors, and committee chairs and members). An applicant 
also is required to identify its rules that pertain to (1) admission to 
association membership; (2) fair representation of membership; (3) dues 
and expenses; (4) business conduct; (5) protection of members; (6) 
disciplining of members; (7) affiliated associations; (8) dealings with 
nonmembers; and (9) enforcement of association rules. An applicant is 
required to provide additional information to the Commission as set 
forth in Exhibits A, B, and C to Form X-15AA-1.\297\ Rule 15Aj-1 
currently requires a registered securities association or affiliated 
securities association to update its registration statement promptly 
after the discovery of any inaccuracy in the statement or in any 
amendment or supplement thereto, either on Form X-15AJ-1 or on Form X-
15AJ-2, depending on the circumstances.\298\
---------------------------------------------------------------------------

    \295\ 17 CFR 240.15Aa-1 and 240.15Aj-1.
    \296\ See Rule 15Aa-1 under the Exchange Act, 17 CFR 240.15Aa-1, 
and Form X-15AA-1, 17 CFR 249.801.
    \297\ The exhibits to Form X-15AA-1, 17 CFR 249.801, require the 
following information: (1) copies of the association's constitution, 
charter, articles of incorporation or association, with all 
amendments thereto, and of its existing by-laws and of any rules or 
instruments corresponding to the foregoing (Exhibit A); (2) a 
balance sheet of the association together with an income and expense 
statement (Exhibit B); and (3) an alphabetical list of all members 
of the association and the member's principal place of business 
(Exhibit C).
    \298\ 17 CFR 240.15Aj-1. See infra Section IV.D. for a 
description of Rule 15Aj-1 under the Exchange Act.
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C. Proposed Revisions to Form 1 and New Form 2

    We propose to harmonize the procedures for application as a 
national securities exchange and as a registered securities association 
and for the submission of amendments to such applications. Under the 
proposals, an applicant for registration as a national securities 
exchange or for an exemption from exchange registration based on 
limited volume,\299\ would be required to file revised Form 1, and an 
applicant for registration as a registered securities association or an 
affiliated securities association would be required to file new Form 
2.\300\ The revised Form 1 and new Form 2 also would be used by an 
exchange or association, respectively, for submitting all amendments. 
Because new Form 2 would serve as the form for both initial 
registration of registered securities associations and for all 
amendments, the Commission proposes to repeal Forms X-15AJ-1 and X-
15AJ-2. In addition, the proposals would require exchanges and 
associations to disclose more detailed information than currently is 
required about their governance, regulatory functions, and ownership in 
the registration

[[Page 71156]]

application and subsequent amendments thereto.
---------------------------------------------------------------------------

    \299\ See Section 5 of the Exchange Act, 15 U.S.C. 78e.
    \300\ For clarity, we use the term ``revised Form 1'' to refer 
to the Form 1, as proposed to be amended by this rulemaking. 
Currently, securities associations are required to register on Form 
X-15AA-1 and to file amendments and supplements on Forms X-15-AJ-1 
and X-15-AJ-2. The Commission proposes to redesignate Form X-15AA-1 
as Form 2 and to amend Form 2 consistent with the proposals 
contained in this release. For clarity, we refer to the registration 
form for registered securities associations, as proposed to be 
amended, as ``new Form 2.''
---------------------------------------------------------------------------

    The Commission also proposes to amend Rules 6a-2, 15Aa-1, and 15Aj-
1 under the Exchange Act (and to redesignate Rule 15Aj-1 as Rule 15Aa-
2), as discussed below.\301\ Among other things, the proposed changes 
to these rules would require exchanges and associations to submit any 
amendments to revised Form 1 or new Form 2 on a more timely basis. 
Further, the proposals would mandate the posting of amendments to 
revised Form 1 and new Form 2 on the Internet Web site of the exchange 
or association.\302\
---------------------------------------------------------------------------

    \301\ See infra Sections IV.D. through IV.F., inclusive.
    \302\ The proposals would not require the posting of an 
applicant's initial Form 1 or Form 2 on the applicant's Web site, 
because the Commission generally files the initial application on 
its own Web site when it publishes the applicant's proposed rules 
for public comment.
---------------------------------------------------------------------------

    The following subsections will set forth the scope of the proposed 
disclosures required by revised Form 1 and Form 2; describe those 
Exhibits to revised Form 1 and new Form 2 that would require enhanced 
disclosures; and discuss the current Exhibits to Form 1 that the 
Commission proposed to retain in revised Form 1 (in the same or 
substantially the same for mat) and to incorporate into new Form 2.
1. Scope of Disclosures Required by Revised Form 1 and New Form 2
    We propose to require more detailed information, and, in some 
cases, new information from exchanges and associations on revised Form 
1 and new Form 2. These disclosures would supplement the Commission's 
proposals to impose new substantive standards with respect to SRO 
governance, administration and ownership, and SRO reporting 
requirements.\303\
---------------------------------------------------------------------------

    \303\ See supra Section II., relating to proposed new Rules 6a-5 
and 15Aa-3 under the Exchange Act, and Section V., relating to 
proposed new Rule 17a-26.
---------------------------------------------------------------------------

    Further, the revisions to the registration forms for exchanges and 
associations also are intended to update and modernize the forms by 
taking into account new ways in which SROs are organized. Thus, the 
requirements of revised Form 1 and new Form 2 would be applicable to 
exchanges and associations, respectively, and also any ``facility'\304\ 
(including an ``SRO trading facility'') \305\ of an exchange or 
association that is a separate legal entity, and any ``regulatory 
subsidiary'' \306\ of an exchange or association.\307\ By expressly 
referring to a facility and regulatory subsidiary, the forms are 
intended to elicit complete information about the exchange or 
association. In our view, the trend in recent years of SROs to delegate 
to separate legal entities functions arising out of their obligations 
under the Exchange Act necessitates enhanced disclosure about those 
regulatory subsidiaries that perform the duties on behalf of an SRO. 
Moreover, an SRO trading facility may be contained in a separate entity 
and may be owned or operated by the SRO or another entity.\308\ The 
Commission notes that even if an SRO enters into an agreement or 
arrangement to delegate certain self-regulatory duties to a subsidiary, 
the SRO itself, and not the regulatory subsidiary, retains the ultimate 
responsibility and primary liability under the Exchange Act for self-
regulatory failures. The SRO's obligations under the Exchange Act 
extend to the operation and administration of any regulatory 
subsidiary.
---------------------------------------------------------------------------

    \304\ For purposes of revised Form 1, the term ``facility'' 
would have the same meaning as in Section 3(a)(2) of the Exchange 
Act, 15 U.S.C. 78c(a)(2). For purposes of new Form 2, the term 
``facility'' would have the same meaning as in proposed Rule 15Aa-
3(b)(11). See proposed Instructions to revised Form 1 and new Form 
2.
    \305\ The term ``SRO trading facility'' would mean any facility 
of a national securities exchange or registered securities 
association that executes orders in securities. See proposed 
Instructions to revised Form 1 and new Form 2.
    \306\ The term ``regulatory subsidiary'' would be defined as any 
person that, directly or indirectly, is controlled by the exchange 
or association and provides, whether pursuant to contract, agreement 
or rule, regulatory services to or on behalf of the exchange or 
association. See proposed Instructions to revised Form 1 and new 
Form 2. For example, several SROs have delegated to one or more 
subsidiaries the responsibility to carry out certain functions 
arising out of the SRO's obligations under the Exchange Act. 
Examples include BOXR, which is a wholly-owned options regulatory 
subsidiary of the BSE, and PCX Equities, a wholly-owned subsidiary 
of PCX. See, e.g., Securities Exchange Act Release Nos. 49065, supra 
note 80 and 44983, supra note 49.
    \307\ Therefore, the exchange or association must file as part 
of revised Form 1 or new Form 2 the information specified in various 
Exhibits with respect to any facility that is a separate legal 
entity and any regulatory subsidiary of the exchange or association. 
These Exhibits are Exhibits A, B, C, D, E, F, G, H, and I, which are 
discussed below.
    \308\ See supra note 64 and accompanying text.
---------------------------------------------------------------------------

    Therefore, revised Form 1 and new Form 2 expressly would require 
exchanges and associations to provide information about any facility 
and regulatory subsidiary in various Exhibits. This disclosure should 
more fully inform market participants and the public of the structure 
and governance of exchanges and associations in today's market 
environment and thus should help promote investor confidence in the 
administration of U.S. securities markets.
2. Composition, Structure, and Responsibilities of the Board
    Proposed Exhibit C of revised Form 1 and new Form 2 would require 
each exchange and association, respectively, to describe the 
composition, structure, and responsibilities of its board.\309\ This 
description would include a list of all directors who presently hold or 
have held their positions during the previous year, indicating each 
director's name, title, dates of commencement and termination of term 
or position, and type of business in which the director is primarily 
engaged. This information currently is required by Exhibit J to Form 1 
and would be incorporated into revised Form 1 and new Form 2.
---------------------------------------------------------------------------

    \309\ For a discussion of proposed Exhibits A and B to revised 
Form 1 and new Form 2, see Section IV.C.13.
---------------------------------------------------------------------------

    The Forms also would require the identification of any board member 
who is an independent director and the basis for the affirmative 
determination that such board member is independent. The determination 
of whether a director is an ``independent director'' would be made 
according to the criteria set forth in proposed new Rules 6a-5(b)(12) 
and 15Aa-3(b)(13).\310\ Exchanges and associations also would be 
required to provide a description of any affiliations or relationships 
that reasonably could affect the director's judgment or decision-making 
as a director, i.e., whether the director has a material relationship 
\311\ that would render the director ineligible to be considered an 
``independent'' director. The Commission notes that the proposed 
disclosures are intended to bolster the requirements of proposed Rules 
6a-5 and 15Aa-3 under the Exchange Act.\312\ The Commission further 
believes that such disclosures would aid market participants, 
investors, and the Commission in determining whether exchanges and 
associations are complying with the proposed requirement that their 
boards be composed of a majority of independent directors and in 
ascertaining any affiliations and relationships that would preclude 
directors from being considered independent.
---------------------------------------------------------------------------

    \310\ See Section II.B.2.a.
    \311\ See supra note 106 and accompanying text for the 
definition of ``material relationship.''
    \312\ See proposed Rules 6a-5 and 15Aa-3.
---------------------------------------------------------------------------

    In addition, if the board's Chairman and CEO are the same person, 
the exchange or association would be required to indicate the director 
that is designated as the lead independent director. These disclosure 
items would correspond with the requirement in proposed Rules 6a-
5(m)(3) and 15Aa-

[[Page 71157]]

3(m)(3) that if a single individual serves as both Chairman and CEO, 
the board must designate an independent director as a lead director to 
preside over executive sessions of the board.\313\
---------------------------------------------------------------------------

    \313\ See supra Section II.B.7.
---------------------------------------------------------------------------

    Exhibit C also would require a discussion of the authority of the 
board, including any powers of the board to delegate its authority to 
management or any executive board or committee. Further, the exchange 
or association would have to describe the lines of authority between 
the Chairman and CEO (or between any lead independent director and the 
CEO, when the CEO is the Chairman). The Commission believes that such 
disclosure should provide market participants, investors, and the 
Commission with a better understanding of the administration of the 
exchange or association.
    Finally, Exhibit C of revised Form 1 and new Form 2 would obligate 
the exchange or association to state the method for interested persons 
to communicate their concerns regarding any matter within the authority 
or jurisdiction of a Standing Committee directly to the independent 
directors. These disclosure items would correspond with the requirement 
in proposed Rules 6a-5(c)(9) and 15Aa-3(c)(9) that the board establish 
a method for interested persons to communicate their concerns regarding 
any matter within the authority or jurisdiction of a Standing Committee 
directly to the independent directors.\314\ The proposed disclosure 
also would aid in implementing proposed Rules 6a-5(m)(3) and 15Aa-
3(m)(3), which would require that the board publicly disclose the lead 
director's name and a means by which interested parties may communicate 
with the lead director.\315\ The Commission believes that requiring the 
disclosure of such processes would make more evident to market 
participants, investors, and the public the opportunity to communicate 
with independent directors and increase their understanding of the 
governance and administration of exchanges and associations.\316\
---------------------------------------------------------------------------

    \314\ See supra Section II.B.2.b.
    \315\ See supra Section II.B.7.
    \316\ See Sections 6(b)(1) and 15A(b)(2) of the Exchange Act, 15 
U.S.C. 78f(b)(1) and 78o-3(b)(2).
---------------------------------------------------------------------------

3. Composition, Structure, and Responsibilities of Committees and 
Executive Boards
    Proposed Exhibit E of revised Form 1 and new Form 2 would require a 
description of the structure, composition, and responsibilities of any 
executive board or committee of the exchange or association (including 
board, non-board, and mixed board/non-board committees and executive 
board committees).\317\ The description would include a list of members 
of any executive board and each committee, with identifying information 
that includes each member's name, title, dates of term of office or 
position, and primary business, which is information currently required 
by Form 1 and would be incorporated into revised Form 1 and new Form 2. 
Exhibit E also would require disclosure of any affiliations or 
relationships that reasonably could affect the committee member's 
independent judgment or decision-making. Further, this Exhibit to the 
Forms would require the submission of a chart illustrating the complete 
governance structure of the exchange or association and any facility or 
regulatory subsidiary of the applicant.
---------------------------------------------------------------------------

    \317\ For example, the NYSE maintains a Board of Executives 
composed of representatives of members, significant investors, and 
listed companies. See NYSE Constitution, Article V, Section 2.
---------------------------------------------------------------------------

    The Commission believes that requiring greater information about 
the governance structure of exchanges and associations would aid market 
participants, investors, and the public with greater insight into the 
manner in which the exchange or association is organized. Moreover, 
requiring identifying information about executive board directors and 
members of the committees of an exchange or association should aid 
market participants, investors, and the Commission in determining 
whether the executive board and committee members of exchanges and 
associations have any affiliations or relationships that could 
influence their judgment. Further, the Commission believes that 
requiring disclosure of the SRO's complete governance structure in a 
chart would present important information in a clear format and thus 
assist investors and market participants in their understanding of the 
SRO's organization from a governance perspective.
    In addition, the exchange or association would be required to 
provide a copy of the written charter of each Standing Committee of the 
exchange's or association's board. Under proposed Rules 6a-5 and 15Aa-
3, each Standing Committee must have a written charter that sets forth 
the Committee's purpose and responsibilities. In our view, requiring 
the disclosure of Standing Committee charters would prove useful to 
market participants, investors, and the public, because they could gain 
an understanding of the duties of key committees of exchanges and 
associations. The Commission further notes that this requirement would 
supplement the provisions of proposed Rules 6a-5 and 15Aa-3, which 
would require the Standing Committees of the boards of exchanges and 
associations to have written charters.\318\
---------------------------------------------------------------------------

    \318\ See supra Section II.B.3. For purposes of proposed Rules 
6a-5 and 15Aa-3, the term ``Standing Committees' means the following 
committees of the board: Nominating Committee, Governance Committee, 
Compensation Committee, Audit Committee, and Regulatory Oversight 
Committee, or their equivalent.
---------------------------------------------------------------------------

    In the Commission's view, the disclosure requirements of Exhibit E 
would further the Exchange Act's requirements for registration that 
exchanges and associations be so organized and have the capacity to 
carry out their statutory obligations.\319\
---------------------------------------------------------------------------

    \319\ See 15 U.S.C. 78f (b) and 78o-3(b).
---------------------------------------------------------------------------

4. Governance
    a. Governance Guidelines. Exchanges and associations would have to 
provide as part of proposed Exhibit F to revised Form 1 and new Form 2 
a copy of their governance guidelines and the governance guidelines of 
any regulatory subsidiary. We believe that requiring exchanges and 
associations to disclose their governance guidelines would further 
heighten SRO awareness of the need for good governance and help foster 
SROs' compliance with their obligations under Sections 6 and 15A of the 
Exchange Act.\320\ Increased transparency also would aid market 
participants, investors and the public by providing them with greater 
knowledge of the governance guidelines of exchanges and associations. 
Further, the proposed disclosures would supplement the provisions under 
proposed Rules 6a-5(q) and 15Aa-3(q), which would require exchanges and 
associations, respectively, to adopt governance guidelines and would 
set forth the minimum criteria that the governance guidelines would 
address.\321\
---------------------------------------------------------------------------

    \320\ 15 U.S.C. 78f and 78o-3.
    \321\ See supra Section II.B.10.
---------------------------------------------------------------------------

    b. Code of Conduct and Ethics. Proposed Exhibit F to revised Form 1 
and new Form 2 would require exchanges and associations to file a copy 
of the code of conduct and ethics for directors, officers, and 
employees of the exchange or association. In addition, the exchange and 
association would be required to disclose any waivers of the code of 
conduct and ethics for directors, officers, or employees. The 
Commission believes that requiring disclosure of exchanges' and 
associations' codes of conduct and ethics should provide

[[Page 71158]]

market participants, investors, and the public with useful information 
about the ethical standards that these SROs have set for their 
directors, officers, and employees. In addition, disclosure of waivers 
of the code of conduct and ethics should give market participants, 
investors, the public, as well as regulators, the opportunity to 
evaluate the board's performance with respect to adherence to the code 
of conduct and ethics and the circumstances under which it has 
determined to grant waivers. Further, the proposal would complement the 
requirements of proposed Rules 6a-5(p) and 15Aa-3(p), which would 
require exchanges and associations to adopt a code of conduct and 
ethics for directors, officers, and employees, and also would require 
the board or appropriate board committee to approve any waiver of the 
code of conduct and ethics.\322\
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    \322\ See supra Section II.B.10.
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5. Organizational Charts
    Proposed Exhibit G to revised Form 1 and new Form 2 would require 
exchanges and associations to submit a chart or charts illustrating 
fully the internal organizational structure of the exchange and 
association (and of any facility or regulatory subsidiary). The charts 
would need to indicate the internal divisions or departments, the 
responsibilities of each such division or department, and the reporting 
structure of each division or department, including its oversight by 
board committees or their equivalent. The charts should be sufficiently 
detailed to permit the Commission and the public to gain a complete 
understanding of the manner in which the exchange or association is 
structured and, along with the proposed governance chart requirement of 
Exhibit E, should be able to provide the Commission and the public with 
an overview of the SRO's organizational and governance structure. The 
Commission believes that disclosure of these organizational charts 
would be an important means by which to provide market participants, 
investors, and regulators with a better understanding of the governance 
structure of exchanges and associations.
6. Regulatory Program
    Proposed Exhibit H to revised Form 1 and new Form 2 would require 
exchanges and associations to describe fully their regulatory programs. 
The description would include information such as member firm 
regulation, market surveillance, enforcement, listing qualifications, 
arbitration, rulemaking and interpretation, as well as the process for 
assessment and development of regulatory policy. Exchanges and 
associations would be required to submit a copy of any delegation plan 
or other contract or agreement relating to regulatory services that are 
provided to the exchange or association by a regulatory subsidiary of 
the exchange or association, another SRO, or a regulatory subsidiary of 
another SRO. The Commission believes that such enhanced transparency 
from an exchange or association would better inform market participants 
and investors about the exchange's or association's regulatory program. 
Moreover, such disclosure would aid the Commission in its oversight and 
evaluation of the exchange's and association's compliance with Exchange 
Act provisions.
    Further, Exhibit H would require a description of the independence 
of the regulatory program from the market operations or other 
commercial interests of the exchange or association. The proposed 
disclosure is intended to provide transparency in connection with 
substantive requirements set forth in proposed new Rules 6a-5(n) and 
15Aa-3(n), which would require exchanges and associations to establish 
standards and procedures to provide for the independence of their 
regulatory programs from their market operations or other commercial 
interests.\323\
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    \323\ See supra Section II.B.8.
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    In addition, each exchange and association would be required to 
discuss fully any new material regulatory issues that have arisen or 
any material events that have taken place in the past year, including 
any technology or trading issues, that relate to or otherwise may 
affect the exchange's or association's regulatory responsibilities or 
the operation of its regulatory program. The Commission believes that 
the discussion of such issues or events would be focused on those 
issues and events that would be considered by the exchange or 
association to be material to an assessment of the overall 
effectiveness of the regulatory program. Exhibit H would require 
exchanges and associations to discuss the effect these material issues 
or events may have on the mission, strategy, and future operations of 
the exchange's or association's regulatory program. Exchanges and 
associations also would be required to discuss generally any material 
changes that are planned for their regulatory programs. The Commission 
expects that the discussion would center on those changes that would 
impact the exchange's or association's regulatory program and its 
ability to fulfill its regulatory obligations under the Exchange Act.
    The Commission believes that mandating enhanced disclosure 
regarding exchanges' and associations' regulatory programs would 
substantially facilitate the ability of the Commission and the public 
to assess the strengths and vulnerabilities of these programs. The 
Commission further believes that requiring exchanges and associations 
to provide details concerning their regulatory programs would enable 
regulators to conduct more effective oversight of these SROs' 
compliance with their obligations under the Exchange Act. In addition, 
requiring disclosure of an exchange's or association's regulatory 
program and its self-analysis of regulatory issues could help an 
exchange or association to focus on its capability to meet its 
statutory obligations under the Exchange Act \324\ and to pursue 
necessary changes and improvements in its regulatory program.
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    \324\ See, e.g., 15 U.S.C. 78f, 78o-3, and 78s.
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7. Audited Financial Statements and Other Financial Information
    Proposed Exhibit I to revised Form 1 would retain the current 
requirement that exchanges include audited financial statements for the 
applicant's latest fiscal year, which are prepared in accordance with 
(or in the case of a foreign applicant, reconciled with) U.S. generally 
accepted accounting principles.\325\ We are proposing to incorporate 
this requirement in new Form 2.\326\ In the Commission's view, the 
financial statement requirements currently imposed on exchanges should 
be applied to associations as well because, under the statutory 
framework, the obligations of exchanges and associations are nearly 
parallel. In addition, the exchange or association would be required to 
file audited financial statements for any facility of an exchange or 
association that is a separate legal entity and for any regulatory 
subsidiary.
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    \325\ This requirement is part of Exhibit I to current Form 1.
    \326\ Exhibit B to current Form X-15AA-1 requires a securities 
association to provide a balance sheet within 30 days of the filing 
of the Form, together with an income and expense statement. The 
Commission believes that the proposed financial disclosure 
requirements set forth in proposed Exhibit I to revised Form 1 and 
new Form 2 would provide a more comprehensive view of the finances 
of an association and better aid the public and the Commission in 
their understanding of how the association would meet its 
obligations under Sections 15A and 19 of the Exchange Act. 15 U.S.C. 
78o-3 and 78s. Therefore, Exhibit B to current Form X-15AA-1 would 
not be retained in new Form 2.
---------------------------------------------------------------------------

    Moreover, Exhibit I to these Forms would specify that the audited 
financial statements would need to be prepared

[[Page 71159]]

by a registered public accounting firm.\327\ This requirement mirrors a 
standard recently imposed on reporting issuers, and conforms to 
existing Form 1 by retaining the requirement that exchanges include 
audited financial statements for the applicant's latest fiscal 
year.\328\ The Commission believes that disclosure of audited financial 
statements would permit market participants, investors, and the 
Commission to better understand the financial resources and decisions 
of exchanges and associations, so as to determine whether they continue 
to comply with their obligations under the Exchange Act.\329\
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    \327\ The term ``registered public accounting firm'' would have 
the same meaning as under Section 2(a)(12) of the Sarbanes-Oxley Act 
of 2002, 15 U.S.C. 7201(a)(12). Currently, Exhibit I to Form 1 
contains the requirement that audited financial statements for an 
exchange be covered by a report prepared by an independent public 
accountant.
    \328\ See infra Section IV.C.13.d. for a discussion of Exhibit J 
to revised Form 1 relating to financial statements of affiliates.
    \329\ For example, Sections 6(b)(4) and 15A(b)(5) of the 
Exchange Act require that the rules of exchanges and associations 
provide for the equitable allocation of reasonable dues, fees, and 
other charges among its members and issuers and other persons using 
its facilities. 15 U.S.C. 78f(b)(4) and 78o-3(b)(5).
---------------------------------------------------------------------------

    Exhibit I to revised Form 1 and new Form 2 also would require 
exchanges and associations to provide more detailed financial 
information as a means to supplement the financial information SROs 
currently are required to provide. Under the proposal, the following 
categories of financial information would be required for the current 
fiscal year, and would need to be compared to the same figures for the 
prior fiscal year and estimated figures for the next fiscal year.
    a. Budget and Revenues Devoted to Regulatory Activities. We propose 
to require exchanges and associations to disclose their regulatory 
expenses as a proportion of their total budget, and separately as a 
proportion of their total annual revenues. Pursuant to this provision, 
exchanges and associations would be required to disclose the aggregate 
amounts that they expend on regulatory activities, as well as the 
amounts that they expend on certain subcategories of regulatory 
activities, including supervisory activities (e.g., routine 
examinations and oversight of member activity conducted in the regular 
course of business), surveillance activities (e.g., manual and 
automated surveillance to ensure compliance with rules, such as trading 
rules and financial responsibility rules), and disciplinary activities 
(e.g., enforcement activities). We propose to require the disclosure of 
this financial data, in part, to allow the Commission and the public to 
assess more fully the adequacy of the resources devoted by exchanges 
and associations to their regulatory programs and how these financial 
determinations affect their capacity to be able to carry out the 
purposes of the Exchange Act.\330\
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    \330\ See Sections 6(b)(1) and 15A(b)(2) of the Exchange Act, 15 
U.S.C. 78f(b)(1) and 78o-3(b)(2).
---------------------------------------------------------------------------

    b. Revenues and Expenses. Proposed Exhibit I to revised Form 1 and 
new Form 2 would require exchanges and associations to disclose the 
dollar amount of their revenues and expenses of their regulatory 
programs, with detailed itemization within the following broad 
categories: revenues; direct expenses; and allocated expenses. 
Exchanges and associations should provide this information for each 
area of their regulatory programs, such as surveillance, supervision, 
and discipline, and provide aggregate data for all program areas. The 
Commission believes that these uniform categories would provide useful 
information to market participants, investors, and the Commission by 
relaying an overview of the finances of exchanges and associations that 
are related to regulatory programs.
    Each itemized category of revenue or expense should be accompanied 
by a description that permits an objective assessment of the nature of 
the revenues or expenses included within each category, annotated as 
appropriate. Proper descriptions of the itemized categories are 
especially important given the variation currently among the exchanges 
and the NASD in the way they report their itemized financial 
information. For example, an exchange or association should specify the 
underlying components or otherwise provide a description of the nature 
of an item labeled ``member technology fees'' to allow a complete 
understanding of the scope of that item.
    Each of the three broad categories (revenues, direct expenses, and 
allocated costs) should be subdivided and itemized as specified in 
Exhibit I, and at a minimum, would have to include the items specified 
in Exhibit I to revised Form 1 and new Form 2. With respect to 
revenues, the Commission proposes to require exchanges and associations 
to provide general information on the main categories of revenues that 
are reported by exchanges and associations. To the extent that an 
exchange or association does not report a category of revenue that 
would be required by the Exhibit, the exchange or association should 
note this fact.
    In particular, Exhibit I would require exchanges and associations 
to disclose revenues by fee categories, including regulatory fees, 
transaction and transaction services fees, and market information fees. 
The Commission notes that the category of ``regulatory fees'' would 
include all fees charged and earned by an exchange or association, 
including all member dues and assessments, that are assessed for the 
purpose of funding the operation of the exchange's or association's 
regulatory program. Exchanges and associations would be required to 
itemize, by category, all such regulatory fees. Disclosure of this 
information should allow market participants, investors, and the 
Commission to better assess the adequacy of the funding sources 
supporting an exchange's or association's regulatory program.
    In addition, Exhibit I would require exchanges and associations to 
disclose other member dues and assessments not used for the purpose of 
funding regulation, as well as their transaction fees, transaction 
services fees, trading privileges fees, and similar fees. As with the 
regulatory fees, these member dues, transaction fees, and trading fees 
would need to be itemized by category. Exhibit I also would require 
exchanges and associations to disclose their revenues earned from 
market information fees, including market data fees, itemized by 
product. The proposed disclosure of this information would provide 
market participants, the public, and the Commission with an 
understanding of the other primary sources of revenue for exchanges and 
associations and, in particular, would permit the assessment of the 
relative adequacy of an exchange's or association's expenditures on its 
regulatory program as a proportion of its overall revenues.
    Exhibit I also would require the disclosure of other categories of 
revenue, along with a general catch-all category. In particular, 
exchanges and associations would need to detail their revenues from 
fines and penalties resulting from disciplinary and enforcement 
actions, fees paid by issuers, including listing fees and issuer 
services, and investments of the exchange or association, including 
dividend and interest income. With respect to the ``other revenues'' 
catch-all category, an exchange or association would be required to 
itemize and footnote the amount disclosed to allow market participants, 
investors, and the Commission to obtain an understanding of the nature 
of the categories that comprise the ``other revenues'' category. The 
disclosure of these additional categories of revenue would allow market 
participants, investors, users of the SRO's facilities, the public and 
the

[[Page 71160]]

Commission to obtain a more complete understanding of an exchange's or 
association's total annual revenues, thereby permitting them to assess 
the adequacy of the exchange or association's resources devoted to 
fulfilling self-regulatory responsibilities.
    Exhibit I would require exchanges and associations to disclose 
direct and allocated expenses that are incurred in connection with 
their regulatory activities. Direct expenses refer to the amounts an 
exchange or association spends on its regulatory department or unit as 
well as amounts expended in the performance of its regulatory 
activities, while allocated expenses refer to the portion of expenses 
incurred by non-regulatory personnel and systems which are attributed 
by the exchange or association, in whole or in part, to the performance 
of regulatory activities. The disclosure of this information would 
allow market participants, investors, users of the SRO's facilities, 
and the Commission to ascertain expenditures by an exchange or 
association on regulatory activities and compare those expenditures 
with the exchange's or association's revenues generally. The Commission 
stresses, however, that the amount spent by an exchange or association 
on its regulatory programs is not, by itself, an indication of the 
quality of the exchange's or association's regulatory program. Rather, 
an exchange's or association's expenditures relating to its regulatory 
program is only one factor that the Commission considers in assessing 
the overall adequacy of the SRO's regulatory program.
    With respect to direct expenses, an exchange or association would 
be required to disclose the expenses it incurs in connection with its 
supervision of members, surveillance activities, and disciplinary 
activities. Specifically, Exhibit I would require exchanges and 
associations to disclose the aggregate personnel costs for their 
regulatory employees, including compensation and benefits, as well as 
provide compensation schedules for the Chief Regulatory Officer and all 
other senior regulatory personnel.\331\ The Commission expects that 
these compensation schedules would include all forms of compensation 
including base compensation, bonuses, and benefits. In addition, 
exchanges and associations would be required to disclose expenses 
associated with training programs relating to the regulatory function 
of the exchange or association. Market participants, investors, users 
of the SRO's facilities, and the Commission could use this information 
to assess the level of compensation that is part of the SRO's 
regulatory budget, as well as the resources devoted to training the 
exchange's or association's regulatory personnel.
---------------------------------------------------------------------------

    \331\ The exhibit would not require exchanges and association to 
identify their senior regulatory personnel by name in the 
compensation schedule, though identification according to position 
would be necessary to complete the schedule.
---------------------------------------------------------------------------

    In addition, exchanges and associations would be required to 
disclose certain expenses that they incur in connection with regulatory 
services, including all expenses in connection with routine and for-
cause examinations, investigations, and enforcement actions, with each 
category reported separately. As the Commission proposes that the 
expense categories to be disclosed in Exhibit I would be mutually 
exclusive, for clarity's sake, the Commission believes that this 
category should include expenses incurred that are not already reported 
under another category, such as personnel expenses. The reporting of 
this information would allow market participants, investors, users of 
the SRO's facilities, and the Commission to assess the adequacy of 
resources devoted by an exchange or association to its examination, 
investigatory and disciplinary regulatory activity. Similarly, Exhibit 
I would require the disclosure of information technology expenses, 
broken down by categories including data center costs, systems hardware 
and software, systems consultant fees, and electronic surveillance 
systems. The information technology expenses to be disclosed under this 
provision would include automated surveillance and information 
technology support provided to regulatory personnel. To the extent an 
exchange or association has entered into a contract or agreement with a 
regulatory subsidiary or another SRO to provide regulatory services to 
or on behalf of the exchange or association, the Commission believes 
that the costs associated with the contract or agreement should be 
disclosed separately. Finally, with respect to direct expenses, Exhibit 
I would require an exchange or association to disclose its occupancy 
and other overhead expenses, all professional services, such as 
independent auditors or attorneys, any depreciation and amortization, 
and any other expenses itemized as appropriate.
    For allocated regulatory expenses incurred by non-regulatory 
departments that directly involve or relate to an exchange's or 
association's regulatory function, the Commission proposes to require 
exchanges and associations to disclose several basic categories in 
sufficient detail to allow market participants, investors, users of the 
SRO's facilities, and the Commission to assess the nature and extent of 
regulatory activities performed by non-regulatory personnel or groups. 
Specifically, Exhibit I would require exchanges and associations to 
disclose personnel expenses, based on a stated percentage of employee 
hours devoted to regulation-related activities, as well as information 
technology expenses, occupancy and other overhead expenses, and other 
allocated costs including, but not limited to, legal fees related to 
regulatory activities and expenses of regulatory and business conduct 
committees.
    Exchanges and associations also would be required to provide an 
itemization of their non-regulatory expenditures, including, but not 
limited to, personnel expenses, program expenses, systems and other 
technology expenses, consultants and advisors, and overhead. The 
disclosure of non-regulatory expenditures would provide market 
participants, investors, users of the SRO's facilities, and the 
Commission with a frame of reference against which they could consider 
an exchange's or association's regulatory expenditures as a portion of 
the exchange's or association's other expenses when using the 
information to assess the exchange's or association's regulatory 
expenditures devoted to fulfilling its self-regulatory 
responsibilities.
    The purpose of the proposed financial disclosure requirements 
relating to an exchange's or association's regulatory program is to 
provide enhanced transparency of the regulatory and non-regulatory 
revenues and expenses of exchanges and associations. Accordingly, 
market participants, investors, users of the SRO's facilities, and the 
public generally, as well as the Commission, would be able to better 
assess, among other things, the adequacy of resources devoted by an SRO 
to its regulatory program and the way in which the exchange or 
association has utilized those resources. The assessment would be 
useful to the Commission and others in determining whether the exchange 
or association is meeting its obligations under Sections 6, 15A, and 19 
of the Exchange Act, among other statutory provisions, and the rules 
thereunder and enforcing compliance by its members with the Exchange 
Act and rules thereunder and the SRO's own rules. \332\ The proposed 
disclosures relating to regulatory revenue, in

[[Page 71161]]

particular those relating to regulatory fees, fines and penalties, and 
to regulatory expenses, should help the Commission review an exchange's 
or association's compliance with the requirements in proposed Rules 6a-
5(n)(4) and 15Aa-3(n)(4) that an exchange or association use monies 
received from regulatory fees, fines, or penalties only to fund the 
regulatory operations of the exchange or association.
---------------------------------------------------------------------------

    \332\ 15 U.S.C. 78f, 78o-3, and 78s.
---------------------------------------------------------------------------

    c. Other Financial Disclosures. The Commission also proposes to 
require disclosure of a number of additional items relating to the 
financial condition of an exchange or association (and any separate 
facility or regulatory subsidiaries). In many cases, these disclosures 
are modeled on those disclosure requirements applicable to reporting 
issuers. The Commission believes that similar transparency with respect 
to exchanges and associations would provide market participants, 
investors, members of the public, and the Commission with greater 
knowledge to permit an assessment of how specified financially-related 
matters could impact an exchange's or association's performance of its 
statutory obligations to oversee its members and facilities. \333\
---------------------------------------------------------------------------

    \333\ See, e.g., Sections 6(b)(1), 6(b)(5), 15A(b)(2) and 
15A(b)(6) of the Exchange Act, 15 U.S.C. 78f(b)(1), 78f(b)(5), 78o-
3(b)(2) and 78o-3(b)(6).
---------------------------------------------------------------------------

    First, proposed Exhibit I would require a discussion of information 
necessary to an understanding of the financial condition of the 
exchange or association and any material changes in its financial 
condition. \334\ Exchanges and associations also would be required to 
disclose all charitable contributions of the applicant (whether made 
directly or indirectly) in excess of $1,000 to a charity in which an 
executive officer or director of the applicant, or any of their 
immediate family members, is an executive officer or director of the 
charity. This proposed requirement would enable market participants, 
users of the exchange's or association's facilities, the public, and 
the Commission to be apprised of larger charitable donations where 
there is a nexus between officers and directors of the exchange or 
association, and officers and directors of the charitable organization.
---------------------------------------------------------------------------

    \334\ This requirement is similar to disclosure requirements 
imposed on registered companies pursuant to Item 303 of Regulation 
S-K, 17 CFR 229.303; however, the Commission has tailored the 
proposed requirement to the operations of exchanges and 
associations. The Commission believes that requiring similar 
disclosure about an exchange's or association's financial condition 
would help the Commission and the public to determine whether the 
SRO has the capacity to be able to carry out the purposes of the 
Exchange Act. See Sections 6(b)(1) and 15A(b)(2) of the Exchange 
Act, 15 U.S.C. 78f(b)(1) and 78o-3(b)(2).
---------------------------------------------------------------------------

    Further, under Exhibit I, the exchange or association would have to 
incorporate a discussion of any unusual or infrequent events or 
transactions or any significant economic changes that have had a 
material effect on the financial condition of the exchange or 
association, and any known demands, commitments, events or 
uncertainties that would result in or are reasonably likely to result 
in a material change in financial condition. \335\ The discussion 
should focus on events and uncertainties known to management that would 
cause reported financial information not to be necessarily indicative 
of future financial condition.
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    \335\ See id.
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    The Commission also would require a description of any significant 
business development involving the exchange or association, including a 
reorganization, merger or consolidation, acquisition or disposition of 
significant assets, or any other material change in business or 
operations. \336\
---------------------------------------------------------------------------

    \336\ See id.
---------------------------------------------------------------------------

    In addition, proposed Exhibit I would require exchanges and 
associations to describe all material contracts and all material 
related party transactions. In this context, material contracts and 
related party transactions would be those to which the exchange or 
association, and any facility or regulatory subsidiary is a party; any 
director, nominee for director, officer, member, lessee, or any 
immediate family member \337\ of any of the foregoing persons is also a 
party; and either the amount involved exceeds $60,000 or it is not a 
contract made in the ordinary course of business of the exchange or 
association and any facility or regulatory subsidiary. The Commission 
notes that these proposals regarding material contracts and related 
party transactions, and the $60,000 minimum amount triggering 
disclosure, is consistent with the requirement for listed companies in 
Item 404 of Regulation S-K. \338\ The Commission believes that similar 
required disclosures for exchanges and associations should help the 
Commission and the public in assessing an exchange's or association's 
compliance with the proposed requirements in Rules 6a-5 and 15Aa-3 that 
the board of an exchange or association be composed of a majority of 
independent directors.\339\ Such disclosures should aid the Commission 
and the public in the determination of whether a director is 
independent.
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    \337\ The term ``immediate family member'' would mean a person's 
spouse, parents, children, and siblings, whether by blood, marriage, 
or adoption, or anyone residing in such person's home. See proposed 
Instructions to revised Form 1 and new Form 2.
    \338\ See Item 404(a) of Regulation S-K, 17 CFR 229.404(a). See 
also NASD Rule 4350(h) (defining ``related party transactions'' as 
transactions required to be disclosed pursuant to Regulation S-K).
    \339\ See proposed Rules 6a-5(c)(i) and 15Aa-3(c)(i).
---------------------------------------------------------------------------

    Further, Exhibit I would require a description of the material 
commitments of the exchange or association for expenditures as of the 
end of the latest fiscal period, and indicate the general purpose of 
such commitments and the anticipated source of funds needed to fulfill 
such commitments.\340\
---------------------------------------------------------------------------

    \340\ See supra note 334.
---------------------------------------------------------------------------

    Finally, Exhibit I would require the submission of a table 
detailing the compensation of the exchange's or association's top five 
most highly compensated executives, disclosed in a manner consistent 
with the table required of reporting companies.\341\ The mandated 
disclosure would include all compensation (including perquisites) and 
would be presented in a table comparable to that required of public 
companies. In addition, Exhibit I would require a description of the 
material terms of the employment agreements of the five most highly 
compensated executives of the applicant and would require the exchange 
or association to provide a description of the compensation provided to 
members of its board. In the Commission's view, the information 
presented in the compensation table regarding the SRO's five most 
highly compensated executives, the description of the material terms of 
their employment contracts, and the description of the compensation 
provided to members of the SRO's board of directors would prove useful 
to the Commission and the public in determining whether the 
compensation accorded to directors and executives appears reasonable or 
presents conflicts of interest that may impact the SRO's capacity to 
carry out the purposes of the Exchange Act and rules thereunder and the 
SRO's own rules.
---------------------------------------------------------------------------

    \341\ See Item 402 of Regulation S-K, 17 CFR 229.402.
---------------------------------------------------------------------------

    The Commission believes that all of the financial and other related 
disclosures proposed to be disclosed as part of proposed Exhibit I 
should assist the Commission and the public in assessing the vigor of 
the regulatory programs of exchanges and associations. As SROs, 
exchanges and associations have been accorded a public trust to oversee 
their members and, when they

[[Page 71162]]

operate markets, remove impediments to and perfect the mechanism of a 
free and open market and a national market system and protect investors 
and the public interest, among other requirements.\342\ Requiring 
greater disclosure of financial and other information about the 
regulatory programs of exchanges and associations should enable market 
participants, investors, and the Commission to more easily ascertain 
how well SROs abide by their statutory responsibilities. For these 
reasons, the Commission has determined to propose these enhanced 
disclosures of financial and other related information by exchanges and 
associations.
---------------------------------------------------------------------------

    \342\ See Sections 6(b)(1), 6(b)(5), 15A(b)(2) and 15A(b)(6) of 
the Exchange Act, 15 U.S.C. 78f(b)(1), 78f(b)(5), 78o-3(b)(2) and 
78o-3(b)(6).
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8. Relationship Between SROs, Facilities, and Their Affiliates
    Proposed Exhibit P to revised Form 1 and new Form 2 would require 
exchanges and associations to provide an organizational chart showing 
the relationship between and among the exchange or association, any 
facility of the exchange or association, and any affiliate of the 
exchange, association, or facility of the exchange or association.\343\ 
Exhibit P to revised Form 1 and new Form 2 also would require 
disclosure about the nature and organizational structure of the 
exchange, association, any facility, and any affiliate, including legal 
name, form of organization, and ownership structure.\344\
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    \343\ See supra note 230 for the proposed definition of the 
terms ``affiliate'' and ``control.''
    \344\ See Items 1, 2 and 3 of proposed Exhibit P to revised Form 
1 and new Form 2.
---------------------------------------------------------------------------

    Exchanges and associations would be required to further disclose 
whether the exchange, association, facility or affiliate is a reporting 
issuer under Sections 12 of the Exchange Act,\345\ and whether it is 
registered with the Commission as a broker or dealer, investment 
adviser, or otherwise.\346\ Information also would be required 
concerning whether and how any facility or affiliate possesses the 
power, directly or indirectly, to direct or cause the direction of the 
management and policies of the exchange or association, whether through 
ownership of voting securities, by contract, or otherwise.\347\ In 
addition, Exhibit P would require that exchanges and associations 
provide a description concerning the ability of any facility or 
affiliate to exert any influence over the exchange's or association's 
regulatory responsibilities.\348\
---------------------------------------------------------------------------

    \345\ 15 U.S.C. 78l.
    \346\ See Items 4 and 5 of proposed Exhibit P to revised Form 1 
and new Form 2.
    \347\ See Item 6 of proposed Exhibit P to revised Form 1 and new 
Form 2.
    \348\ See Item 7 of proposed Exhibit P to revised Form 1 and new 
Form 2.
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    In view of the trend toward demutualization of SROs, and the 
increased competitive pressures under which all SROs operate, the 
Commission believes that the disclosures required in Exhibit P should 
provide relevant information to the public and the Commission about the 
relationships among exchanges, associations, their facilities and their 
respective affiliates, so that the public and Commission might better 
evaluate how exchanges and associations fulfill their statutory 
responsibilities under Sections 6 and 15A of the Exchange Act.\349\ In 
today's rapidly evolving marketplace, the disclosures proposed to be 
required in Exhibit P should provide greater transparency regarding the 
relationships among SROs, their facilities, and their affiliates, and 
whether those entities have the ability to control the SRO, thus 
enabling members, market participants, investors, and the Commission to 
more readily monitor the effectiveness and performance of SROs and 
promote greater accountability by SROs with respect to their Exchange 
Act obligations to comply with, and enforce compliance by their members 
with, their rules and the federal securities laws.
---------------------------------------------------------------------------

    \349\ 15 U.S.C. 78f and 78o-3.
---------------------------------------------------------------------------

9. Ownership
    Proposed Exhibit Q to revised Form 1 and new Form 2 would require 
that exchanges and associations provide enhanced disclosures describing 
any class or series of outstanding securities or other ownership 
interest of the exchange, association, or a facility of the exchange or 
association (each would be defined as a ``Disclosure Entity''), and 
information on persons owning more than 5% of such class of securities 
or other ownership interest and the nature and extent of such 
ownership.\350\ The 5% reporting threshold and the information proposed 
to be required to be disclosed about such ownership is modeled on the 
beneficial ownership reporting requirements of the Williams Act, 
embodied in Sections 13(d) and 13(g) of the Exchange Act and the rules 
and regulations thereunder.\351\ These Exchange Act provisions are 
intended to provide information to the issuer and the marketplace about 
accumulations of securities that may have the potential to change or 
influence control of an issuer.\352\ Similarly, the intent of the 
proposed disclosure requirements in proposed Exhibit Q to revised Form 
1 and new Form 2 is to provide the Commission, members of an exchange 
or association, persons who trade on the facilities of an exchange or 
association, investors, and the SRO itself, more detailed information 
about which persons or certain groups of persons potentially could 
control or influence the SRO.
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    \350\ Currently, Exhibit K to Form 1 requires certain 
disclosures from exchanges that have one or more owners, 
shareholders, or partners that are also not members of the exchange, 
including general information about persons owning 5% or more of the 
ownership interest in the exchange. Proposed Exhibit Q to revised 
Form 1 and new Form 2 is intended to solicit more detailed and 
relevant disclosure about significant owners from all exchanges and 
associations.
    \351\ 15 U.S.C. 78m(d) and (g).
    \352\ See Securities Exchange Act Release Nos. 37403 (July 3, 
1996), 61 FR 36521 (July 11, 1996) and 26598 (March 6, 1989), 54 FR 
10552 (March 14, 1989).
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    To begin, proposed Item 1 of Exhibit Q would require exchanges and 
associations to provide a description of each class or series of 
outstanding securities or other ownership interest (including debt) of 
each Disclosure Entity that includes: (1) The title of the class of 
securities or other ownership interest; (2) the total number of 
securities or other ownership interests issued and outstanding; (3) any 
restrictions on ownership, voting, transfers, or other disposition of 
such securities or other ownership interest; (4) if the securities are 
publicly traded, the market(s) where they trade; and (5) any other 
material information relating to ownership of the Disclosure 
Entity.\353\
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    \353\ See Item 1 of proposed Exhibit Q to revised Form 1 and new 
Form 2.
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    Further, pursuant to proposed Item 2 of Exhibit Q, exchanges and 
associations would be required to provide certain information with 
regard to any person (alone or together with its Related Persons \354\) 
that directly or indirectly beneficially owns more than 5% of any class 
of securities or other ownership interest in a Disclosure Entity (``5% 
Owner'').\355\ Background details would

[[Page 71163]]

be required to be provided about any such person, including their name, 
address, place of organization (for corporations), principal business 
or occupation, and whether the person is an officer or director of the 
Disclosure Entity.\356\
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    \354\ The term ``Related Persons'' is proposed to be defined in 
the Instructions to revised Form 1 and new Form 2 to mean (1) with 
respect to any member of the exchange or association that is a 
broker or dealer, any related person as defined in Rules 6a-5 or 
15Aa-3 under the Exchange Act; or (2) with respect to any other 
person: (a) Any affiliate of such person and (b) in the case of a 
person that is a natural person, any immediate family member of such 
person, or any immediate family member of such person's spouse, who, 
in each case, has the same home as such person or who is a director 
or officer of the Disclosure Entity or any of its parents or 
subsidiaries. See also supra Section II.B.9.
    \355\ Proposed Item 6 of Exhibit Q to revised Form 1 and new 
Form 2 would require that for each Disclosure Entity that is a 
partnership, the exchange or association provide a list of all 
general partners and those limited and special partners that have 
the right to receive upon dissolution, or have contributed, more 
than 5% of the partnership's capital.
    The term ``beneficially owns'' is proposed to be defined to have 
the same meaning, with respect to any security or other ownership 
interest, as set forth in Rule 13d-3 under the Exchange Act, as if 
(and whether or not) such security or other onwership interest were 
a voting equity security registered under Section 12 of the Exchange 
Act; provided thatto the extent any person beneficially owns any 
security or other ownership interest solely because such person is a 
member of a group within the meaning of Section 13(d)(3) of the 
Exchange Act, such person shall not be deemed to beneficially own 
such security or other ownership interest for purposes of Form 1 or 
Form 2, unless such person has the power to direct the vote of such 
security or other ownership interest. See proposed Instructions to 
revised Form 1 and new Form 2 and supra note 226.
    \356\ See Items 2.a. and 2.b. of proposed Exhibit Q to revised 
Form 1 and new Form 2.
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    Furthermore, for each person that is a 5% Owner, proposed Item 2.c. 
of Exhibit Q would require the exchange or association to state the 
aggregate number and percentage of shares of a class of securities or 
ownership interest of such security that are beneficially owned.\357\ 
In addition, the exchange or association would be required to indicate 
the aggregate number of shares or ownership interest as to which there 
is sole power to vote or to direct the vote, shared power to vote or to 
direct the vote, sole power to dispose or to direct the disposition, or 
shared power to dispose or to direct the disposition.\358\ If any other 
person is known to have the right to receive or the power to direct the 
receipt of dividends from, or the proceeds from the sale of, such 
securities or other ownership interest, a statement to that effect 
would need to be included, and if such interest related to more than 5% 
of the class, such person would need to be identified.\359\ Pursuant to 
proposed Item 3 of Exhibit Q, the exchange or association would be 
required to separately identify each Related Person whose ownership in 
the Disclosure Entity is included in the calculation of beneficial 
ownership required to be disclosed pursuant to proposed Item 2 of 
Exhibit Q, and provide the same ownership information as for the 
original person as would be required by proposed Item 2.c. of Exhibit 
Q. The exchange or association also would be required to disclose if 
the Related Person is an officer or director of the Disclosure 
Entity.\360\
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    \357\ For purposes of making this percentage determination, a 
class of securities would be deemed to consist of the amount of the 
outstanding securities of such class, exclusive of any securities 
held by or for the Disclosure Entity (the issuer), or a subsidiary 
of the Disclosure Entity. See Item 4 of Exhibit Q to revised Form 1 
and new Form 2.
    \358\ See Items 2.c.i. of proposed Exhibit Q to revised Form 1 
and new Form 2.
    \359\ See Items 2.c.ii. of proposed Exhibit Q to revised Form 1 
and new Form 2. A listing of the shareholders of an investment 
company registered under the Investment Company Act of 1940 or the 
beneficiaries of an employee benefit plan, pension fund or endowment 
fund would not be required.
    \360\ See Item 3.c. of proposed Exhibit Q to revised Form 1 and 
new Form 2.
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    The Commission notes that the proposed disclosure relating to 
ownership in an exchange, association, or a facility of an exchange or 
association would cover both direct and indirect ownership. Thus, if 
the exchange or facility were owned by a holding company, the exchange 
or association would be required to provide ownership information with 
regard to any person, alone or together with its related persons, that 
owned more than 5% of the holding company. The Commission emphasizes 
that the exchange's or association's responsibility to provide any 
disclosure pursuant to proposed Exhibit Q to revised Form 1 or new Form 
2 would be independent of the obligation of any person to file with the 
Commission, and provide to the issuer, a Schedule 13D or 13G. 
Therefore, an exchange or association would be required to undertake 
its own due diligence to obtain and provide to the Commission the 
information that would be required by proposed Items 2 and 3 of Exhibit 
Q.
    An exchange or association also would be required to state whether 
and how the 5% Owner, alone or with any Related Persons, possesses the 
power, directly or indirectly, to direct or cause the direction of the 
management or policies of the Disclosure Entity, whether through 
ownership of voting securities, by contract, or otherwise (i.e., 
whether they have ``control'').\361\ Finally, exchanges and 
associations would be required to describe any contracts, arrangements, 
understandings or relationships (legal or otherwise) among the persons 
and Related Persons identified in Exhibit Q, and between such persons 
and any other person, with respect to any securities or other ownership 
interest of the Disclosure Entity, including but not limited to 
transfer or voting of any of the securities or other ownership 
interest, finder's fees, joint ventures, loan or option arrangements, 
put or calls, guarantees of profits, division of profits or loss, or 
the giving or withholding of proxies, and to name the persons with whom 
such contracts, arrangements, understandings or relationships have been 
entered into.\362\ The description also would be required to include 
such information for any of the securities or other ownership interest 
that are pledged or otherwise subject to a contingency the occurrence 
of which would give another person voting power or investment power 
over such securities or other ownership interest. However, disclosure 
of standard default and similar provisions contained in loan agreements 
would not be necessary.\363\
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    \361\ See Item 5 of proposed Exhibit Q to revised Form 1 and new 
Form 2.
    \362\ See Item 7 of proposed Exhibit Q of revised Form 1 and new 
Form 2.
    \363\ See id.
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    In order to more easily obtain this information, proposed Rules 6a-
5(o)(5) and 15Aa-3(o)(5) would require the rules of an exchange or 
association to provide a mechanism for the exchange or association to 
obtain information from any owner of the exchange, association, or a 
facility of the exchange or association relating to such owner's 
ownership in and voting of such interest.\364\ The Commission requests 
comment on the ability of an exchange or association to obtain the 
information regarding its owners and its owners' related persons 
necessary to calculate and report beneficial ownership interest in 
compliance with the proposed requirements of proposed Exhibit Q to 
revised Form 1 and new Form 2.
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    \364\ See proposed Rules 6a-5(o)(5) and 15Aa-3(o)(5) and 
discussion in Section II.B.9.
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    The Commission believes that each item of information proposed to 
be disclosed pursuant to Exhibit Q would be pertinent to providing a 
complete picture of which person or group of persons may control a 
significant stake in an SRO. The Commission believes that these 
disclosures proposed to be required by Exhibit Q relating to ownership 
of the exchange, association or a facility would provide the 
Commission, as well as members and users of the exchange or association 
(or the facilities of the exchange or association), with up-to-date 
information regarding a change or potential change in control of an 
exchange or association. In addition, requiring an SRO to gather and 
publicly disclose this information should provide greater 
accountability by the SRO with respect to the performance of its 
regulatory obligations and further its ability to operate in compliance 
with the requirements of Sections 6(b)(1) and 15A(b)(2) of the Exchange 
Act \365\ that it be so organized and have the capacity

[[Page 71164]]

to be able to carry out the purposes of the Exchange Act and to comply 
with, and enforce compliance by its members and persons associated with 
members with, the Exchange Act and rules thereunder and with the rules 
of the exchange, and the requirements of Sections 6(b)(8) and 15A(b)(9) 
of the Exchange Act \366\ that the rules of the exchange not impose any 
burden on competition not necessary or appropriate in furtherance of 
the purposes of the Exchange Act. Requiring the disclosure of this 
information also will allow the Commission and the public to more 
readily monitor the SROs' performance of their obligations. In 
addition, the Commission expects that the disclosure of information 
concerning persons owning more than 5% of an exchange, an association 
or a facility of an exchange or association should help the Commission 
more effectively oversee and regulate SROs and their facilities, 
especially if the SRO or facility is owned and controlled by persons 
who are not regulated by the Commission.
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    \365\ 15 U.S.C. 78f(b)(1) and 78o-3(b)(2).
    \366\ 15 U.S.C. 78f(b)(8) and 78o-3(b)(9).
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10. Listing and Trading of Affiliated Securities
    Proposed Exhibit T of revised Form 1 and new Form 2 would require 
that exchanges and associations provide information with respect to 
securities listed and traded on the SRO or its facilities.\367\ Among 
other disclosures, an exchange or association would be required to 
provide an explanation of the process for monitoring initial and 
ongoing compliance with the listing rules of the exchange or 
association of a security issued by the SRO, or a trading facility, or 
an affiliate of the SRO or trading facility, if such security were 
listed on the exchange or association. In addition, the exchange or 
association would have to explain the process for monitoring trading of 
the security by the members of the exchange or association, as well as 
the process for enforcing the exchange's or association's listing 
rules, trading rules, and the federal securities laws with respect to 
the listing and trading of the securities.\368\ The Commission believes 
that, given the conflicts inherent in ``self-listing,'' \369\ enhanced 
public transparency concerning the ``self-listing'' of an exchange or 
association (or listing by an SRO facility or affiliate of the 
exchange, association, or facility) should result in a greater degree 
of accountability by the SRO with respect to monitoring the listing by 
and trading of the ``affiliated'' security on the SRO or a facility of 
the SRO in compliance with its statutory obligations under Sections 
6(b)(1) and 15A(b)(2) of the Exchange Act.\370\ In addition, providing 
this information to the Commission should further the Commission's 
ability to monitor the SRO's regulation of such listing and trading of 
the affiliated security.
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    \367\ See infra Section IV.C.13.l. for a discussion of current 
Form 1 requirements regarding securities listed and traded on an 
exchange or association, and their facilities, which would be 
retained in revised Form 1 and added to new Form 2.
    \368\ See proposed Item 5 of Exhibit T to revised Form 1 and new 
Form 2. See also discussion of proposed Regulation AL in Section 
III.
    \369\ See supra Section III.
    \370\ 15 U.S.C. 78f(b)(1) and 78o-3(b)(2).
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11. Location of Books and Records
    Proposed Exhibit U to revised Form 1 and new Form 2 would require 
exchanges and associations to provide the name and address of the 
location where their books and records are maintained. The Commission 
believes that requiring exchanges and associations to provide details 
concerning the location of their books and records should enable the 
Commission to conduct more effective and efficient oversight of these 
SROs. The proposed disclosure also is intended to reinforce a proposed 
change to Rule 17a-1 under the Exchange Act \371\ that would require, 
for the existing five-year record retention period, exchanges and 
associations (and registered clearing agencies and the Municipal 
Securities Rulemaking Board) to maintain their books and records in the 
United States. This requirement is intended to assure that such books 
and records may be made easily available for inspection and examination 
by the Commission pursuant to Section 17 of the Exchange Act,\372\ 
particularly in an instance where an exchange or association is owned 
by a person or entity located outside the U.S.
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    \371\ See Rule 6a-2(d) under the Exchange Act, 17 CFR 240.17a-1.
    \372\ 15 U.S.C. 78q.
---------------------------------------------------------------------------

12. Miscellaneous Matters Specific to New Form 2
    Currently, applicants for registration as an affiliated securities 
association must provide the name of the registered securities 
association that the applicant association seeks affiliation with, and 
an estimation of the annual dollar volume of transactions effected by 
members of the applicant association.\373\ The Commission believes that 
this information, which is specifically asked of applicants for 
affiliated securities association status, should be included on new 
Form 2,\374\ because such identifying information is useful to the 
Commission in its determination of whether the association satisfies 
the requirements set forth in Section 15A(d) of the Exchange Act.\375\
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    \373\ Currently, this information is required by Items 29 and 30 
of Form X-15AA-1.
    \374\ This item would be included on the execution page of new 
Form 2.
    \375\ 15 U.S.C. 78o-3(d).
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    In addition, applicants for registration as a registered securities 
association or an affiliated securities association are now asked to 
identify the rule or rules of the association that deal with 
membership; fair representation of members; dues and expenses; business 
conduct and protection of members; disciplining of members; and 
affiliated associations.\376\ Because new Form 2 would require 
applicants to provide the Commission with a copy of the association's 
rules, the Commission believes that separately requesting that 
applicants identify their rules by category would be unnecessary. 
Therefore, the Commission proposes to omit these inquiries from new 
Form 2.
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    \376\ Currently, this information is required by Items 7 through 
28, inclusive, of Form X-15AA-1.
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13. Current Disclosures To Be Retained in Revised Form 1 and Added to 
New Form 2
    The Commission is proposing to retain in revised Form 1 and add to 
new Form 2 several exhibits that currently are required by Form 1 and 
Form X-15AA-1. In addition, the Commission proposes to incorporate in 
new Form 2 several disclosures currently required by Form 1. The 
Commission believes that the information proposed to be disclosed in 
these exhibits should aid the Commission in its evaluation of an 
application for registration as an exchange (or for an exemption from 
exchange registration based on limited volume) or association. In 
addition, the information to be disclosed in these exhibits would be 
relevant to the Commission and to the public in their evaluation of 
whether the exchange or association has rules that comply with Sections 
6(b)(5) and 15A(b)(6) of the Exchange Act.\377\ The disclosures should 
also guide the Commission (and the exchange or association) in 
determining whether the exchange or association meets the statutory 
standards for initial and continued registration as a national 
securities exchange or registered securities association.\378\
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    \377\ See Sections 6(b)(5) and 15A(b)(6) of the Exchange Act, 15 
U.S.C. 78f(b)(5) and 78o-3(b)(6).
    \378\ See Sections 6(b) and 15A(b) of the Exchange Act, 15 
U.S.C. 78f(b) and 78o-3(b).
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    Further, the Commission in several instances proposes to align the

[[Page 71165]]

regulatory treatment of exchanges and associations by mandating similar 
disclosure for both exchanges and associations. Under the current 
disclosure framework, exchanges are required to provide more detailed 
information on Form 1 than associations are required to submit on 
applicable registration forms. The Commission does not believe that in 
today's environment the registration procedures for exchanges and 
associations under the Exchange Act should maintain differing 
disclosure requirements. National securities exchanges and registered 
securities associations are charged with nearly identical obligations 
under the Exchange Act.\379\ In addition, we are proposing to enhance 
the transparency of governance, administration, regulation, and 
ownership for both exchanges and associations. This is an opportune 
time to review all aspects of the registration procedures and forms for 
exchanges and associations and propose appropriate revisions. In our 
view, the proposed inclusion in new Form 2 of certain Exhibits 
currently contained in Form 1 would align more closely the regulatory 
disclosure framework for exchanges and associations. Moreover, the 
Commission believes that the incorporation of current Form 1 
requirements into new Form 2 would further the statutory goal of 
assuring that to be registered, and remain registered, an exchange and 
an association must be so organized and have the capacity to comply 
with, and enforce compliance by members with, the provisions of the 
Exchange Act, the rules thereunder, and the rules of the exchange or 
association.\380\
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    \379\ See supra note 285.
    \380\ See Sections 6(b)(1) and 15A(b)(2) of the Exchange Act, 15 
U.S.C. 78g(b)(1) and 78o-3(b)(2).
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    a. Constitution, Articles of Incorporation, By-Laws, and Rules. 
Exhibit A of current Form 1 and current Form X-15AA-1 both require that 
exchanges and associations provide to the Commission copies of their 
constitution or articles of incorporation or association, with all 
subsequent amendments, and of their existing by-laws or corresponding 
rules or instruments. This disclosure item would be retained as Exhibit 
A of revised Form 1 and new Form 2.
    b. Rulings and Interpretations. Exhibit B of current Form 1 
requires exchanges to provide a copy of all written rulings, settled 
practices having the effect of rules, and interpretations of the board 
or any committee of the exchange in respect of any provisions of the 
constitution, by-laws, rules, or trading practices of the exchange 
which were not otherwise provided as part of Exhibit A. This required 
disclosure item would be retained in revised Form 1, and added to new 
Form 2, as Exhibit B.
    c. Officers. Form 1 currently requires the disclosure of the 
officers of the exchange or association who presently hold their 
offices or positions, or have held them during the previous year, with 
identifying information that includes each officer's name, title, dates 
of commencement and termination of term of office, and type of 
business.\381\ The Commission believes that mandating associations and 
exchanges to disclose this information should better inform market 
participants, investors, and regulators about exchange and association 
officers. Therefore, this required disclosure would be retained in 
revised Form 1 and added to new Form 2, as Exhibit D.
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    \381\ Currently, this information is required by Exhibit J to 
Form 1.
---------------------------------------------------------------------------

    d. Financial Statements of Affiliates. Form 1 currently requires 
exchanges to provide to the Commission unconsolidated financial 
statements for each subsidiary or affiliate for the latest fiscal 
year.\382\ Such financial statements must consist, at a minimum, of a 
balance sheet and an income statement with such footnotes and other 
disclosure as are necessary to avoid rendering the financial statements 
misleading.\383\ We believe that the financial statements of affiliates 
would be relevant to the Commission and to market participants and the 
public generally with respect to associations, as well as exchanges. 
Therefore, this required disclosure would be retained in revised Form 
1, and added to new Form 2, as Exhibit J.\384\ The required financial 
statements under proposed Exhibit J would consist of, at a minimum, a 
balance sheet and an income statement of cash flows, with such 
footnotes and other disclosure as are necessary to avoid rendering the 
financial statements misleading. The Commission proposes to clarify 
that the financial statement would include an income statement of cash 
flows, would clarify that separate financial statements are required 
for each affiliate, and would delete the reference to ``subsidiary'', 
in each case to conform to current accounting terminology.\385\
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    \382\ Currently, this information is required by Exhibit D to 
Form 1.
    \383\ If any affiliate or subsidiary is required by another 
Commission rule to submit annual financial statements, a statement 
to that effect, with a citation to the other Commission rule, may be 
provided along with a copy of the financial statements prepared 
pursuant to such other Commission rule.
    \384\ The Commission notes that by proposing to require 
disclosure only of an affiliate of an exchange or association, there 
is no intent to propose a substantive change to the current 
requirement. The Commission believes that the definition of 
``affiliate'' set forth in the Instructions to revised Form 1 and 
new Form 2 would include a ``subsidiary,'' and by proposing to 
eliminate the term ``subsidiary'' from proposed Exhibit J, the 
Commission seeks solely to clarify the requirement.
    \385\ See Regulation S-X, 17 CFR Part 210.
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    e. General Information Relating to Affiliates and SRO Trading 
Facilities. Form 1 currently requires exchanges to provide to the 
Commission information regarding any of their affiliates, subsidiaries 
and any electronic trading system to be used to effect transactions on 
the exchange.\386\ The exchange is required to disclose identifying 
information about the organization of each such entity, such as name, 
address, form of organization, and state under which it is organized. 
The exchange also must describe the nature and extent of any 
affiliation, and the nature of the business or functions performed by 
the affiliate, subsidiary, or electronic trading system, including 
responsibilities with respect to the operation of an electronic trading 
system. In addition, the exchange must provide to the Commission a copy 
of the organizational documents of each such entity, including its 
constitution or articles of incorporation and by-laws, as well as a 
list of officers, governors, and members of standing committees. 
Finally, the exchange must indicate if such entity ceased to be 
associated with the exchange during the previous year. The exchange 
must provide a brief statement of the reasons for termination of the 
association with the entity.
    We believe that knowledge of identifying and organizational 
information with respect to affiliates and any unaffiliated entity that 
operates an SRO trading facility would be useful to the Commission and 
to the public. This would be the case with respect to associations as 
well as exchanges. Therefore this disclosure item would be retained in 
revised Form 1, and added to new Form 2, as proposed Exhibit K.\387\
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    \386\ Currently, this information is required by Exhibit C to 
Form 1.
    \387\ The Commission notes that by proposing to require 
disclosure only of an affiliate of an exchange or association, there 
is no intent to propose a substantive change to the current 
requirement. The Commission believes that the definition of 
``affiliate'' set forth in the Instructions to revised Form 1 and 
new Form 2 would include a ``subsidiary,'' and by eliminating the 
term ``subsidiary'' from proposed Exhibit K, the Commission, seeks 
solely to clarify the requirement.
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    f. Operation of SRO Trading Facilities. Under current Form 1 
requirements, exchanges must describe the manner of operation of any 
electronic trading system to be used to effect transactions

[[Page 71166]]

on the exchange.\388\ The description must include the means of access, 
procedures governing entry and display of quotations and orders, 
procedures governing the execution, reporting, clearance, and 
settlement of transactions, proposed fees, and procedures for ensuring 
compliance with usage guidelines. The exchange must also disclose the 
hours of operation of the electronic trading system, and the date on 
which the exchange intends to commence operation of the electronic 
trading system. If the exchange proposes to hold funds or securities on 
a regular basis, the exchange must provide a description of the 
controls that will be implemented to ensure safety of those funds or 
securities. Finally, the exchange is required to attach a copy of the 
users' manual. The Commission believes that market participants, 
investors, and regulators would benefit from the disclosure of 
information about SRO trading facilities of associations, including 
electronic trading systems, in addition to SRO trading facilities of 
exchanges. This required disclosure would be retained in revised Form 
1, and added to new Form 2, as proposed Exhibit L.
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    \388\ Currently, this information is required by Exhibit E to 
Form 1.
---------------------------------------------------------------------------

    g. Membership Forms Form 1 currently requires exchanges to provide 
a complete set of all forms pertaining to application for membership, 
participation or subscription to the exchange, application for approval 
as a person associated with a member, participant, or subscriber, and 
any other similar materials.\389\ The current Forms for associations 
requires the filing of a list of members, but does not require the 
filing with the Commission of the forms for membership. In our view, 
the information required to be disclosed with respect to membership 
would be beneficial in the context of associations, in addition to 
exchanges. Therefore this required disclosure item would be retained in 
revised Form 1, and added to new Form 2, as proposed Exhibit M.
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    \389\ Currently, this information is required by Exhibit F to 
Form 1.
---------------------------------------------------------------------------

    h. Financial Responsibility and Minimum Capital Requirements of 
Members. Pursuant to Form 1, exchanges must provide a complete set of 
all forms of financial statements, reports or questionnaires required 
of members, participants, subscribers, or any other users relating to 
financial responsibility or minimum capital requirements for such 
members, participants, or any users.\390\ We believe that the 
information regarding member financial responsibility and minimum 
capital requirements, if any, would be relevant information to be 
disclosed by associations as well. Therefore, this disclosure item 
would be retained in revised Form 1, and added to new Form 2, as 
proposed Exhibit N.
---------------------------------------------------------------------------

    \390\ Currently, this information is required by Exhibit G to 
Form 1. The exchange also must provide a table of contents of the 
forms included in the exhibit.
---------------------------------------------------------------------------

    i. Listing Applications. Form 1 currently requires exchanges to 
provide the Commission with a complete set of documents comprising its 
listing applications, including any agreements required to be executed 
in connection with listing, and a schedule of listing fees.\391\ If the 
exchange does not list securities, the exchange must provide a brief 
description of the criteria used to determine what securities may be 
traded on the exchange. The Commission believes that information about 
listing and trading of securities on facilities of an association also 
would be useful to the Commission and to the public generally. In this 
way, the Commission and the public would have access to the current 
listing applications used by issuers, along with other materials 
related to the listing of securities. We therefore propose to retain 
the required disclosure in revised Form 1, and add it to new Form 2, as 
proposed Exhibit O.
---------------------------------------------------------------------------

    \391\ Currently, this information is required by Exhibit H to 
Form 1.
---------------------------------------------------------------------------

    j. Criteria for Membership. Form 1 currently requires exchanges to 
provide a description of the criteria for membership, the conditions 
under which members may be subject to suspension or termination with 
regard to access to the exchange, and any procedures that will be 
involved in the suspension or termination of a member.\392\ In 
contrast, Form X-15AA-1 simply requires associations to state which of 
its rules deal with admissions to membership, restrictions on 
membership, and appeals procedures for brokers or dealers that have 
been denied membership.\393\ The Commission believes that the 
information about membership criteria is relevant to the Commission and 
to the public generally as a means to be informed about membership 
eligibility requirements and the conditions under which those members 
can have their access to the SRO's facilities suspended or terminated. 
We propose that this required disclosure, in the format required by 
current Form 1, be retained in revised Form 1, and added to new Form 2, 
as proposed Exhibit R.
---------------------------------------------------------------------------

    \392\ Currently, this information is required by Exhibit L to 
Form 1.
    \393\ See Form X-15AA-1.
---------------------------------------------------------------------------

    k. List of Members. Form 1 currently requires exchanges to provide 
a list of all members, participants, subscribers or other users.\394\ 
Exchanges must also note the name of the entity with which an 
individual is associated and relationship to the entity, the type of 
activities primarily engaged \395\ in by the member, participant, 
subscriber, or other user (e.g., floor broker, specialist, odd lot 
dealer, other market maker, proprietary trade, non-broker dealer, 
inactive or other functions), and the class of membership, 
participation or subscription or other access. Form X-15AA-1 simply 
requires associations to provide a list of all of its members and the 
principal place of business for each of them.\396\ The Commission 
believes that the broader Form 1 disclosure requirements should be 
applied to associations, as well, including information about members, 
participants, subscribers or other users of association facilities, if 
any. Thus, we propose that this disclosure be retained in revised Form 
1, and added to new Form 2, as proposed Exhibit S.
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    \394\ Currently, this information is required by Exhibit M to 
Form 1.
    \395\ Current Exhibit M to Form 1 states that a person shall be 
``primarily engaged'' in an activity or function when that activity 
or function is the one in which that person is engaged for the 
majority of their time.
    \396\ Currently, this information is required by Exhibit C to 
Form X-15AA-1.
---------------------------------------------------------------------------

    l. Securities Listed and Traded. Under current Form 1 requirements, 
exchanges must provide a schedule of listed securities (including name 
of issuer and description of the security); securities admitted to 
unlisted trading privileges (including name of issuer and description 
of the security); securities admitted to trading on the exchange which 
are exempt from registration under Section 12(a) of the Exchange Act 
\397\ (including the name of the issuer, a description of the security, 
and the statutory exemption claimed); and other securities traded on 
the exchange (including name of issuer and description of the 
security).\398\ The Commission believes that information with respect 
to securities listed and traded on the facilities of an association, if 
any, would be helpful to the Commission and to market participants in 
ascertaining the securities that are listed and traded on an SRO's 
facilities. We therefore propose that this required disclosure be 
retained in revised Form

[[Page 71167]]

1, and added to new Form 2, as Exhibit T.
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    \397\ 15 U.S.C. 78 l.
    \398\ Currently, this information is required by Exhibit N to 
Form 1.
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D. Timing and Format of Revised Form 1 and New Form 2

    In conjunction with its proposals to revise Form 1 and adopt new 
Form 2, the Commission also proposes to revise the rules governing the 
timing and format of the required disclosures by exchanges and 
associations. Currently, Rule 6a-2(a) under the Exchange Act \399\ 
requires a national securities exchange, or an exchange exempted from 
such registration based on limited volume, to file with the Commission 
an amendment to its Form 1 within 10 days after any action is taken 
that renders inaccurate, or that causes to be incomplete: (1) 
Information filed on the Execution Page of Form 1 (or any amendment 
thereto); or (2) information filed as part of certain exhibits \400\ to 
Form 1. In addition, Rule 6a-2(b) under the Exchange Act \401\ requires 
an exchange to file an annual amendment to its Form 1 to update certain 
exhibits,\402\ while Rule 6a-2(c) under the Exchange Act \403\ requires 
an exchange to file an amendment to its Form 1 every three years to 
update certain other exhibits.\404\ Finally, Rule 6a-2 provides 
exchanges with several alternatives that they may utilize in lieu of 
the annual filing requirement for Exhibits K, M, and N and the three-
year filing requirement for Exhibits A, B, C, and J.\405\ In lieu of 
paper filing of Exhibits A, B, C, J, K, M, and N, exchanges have the 
following options (``paper filing alternatives''):
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    \399\ 17 CFR 240.6a-2(a).
    \400\ Currently, these exhibits are Exhibits C, F, G, H, J, K 
and M to Form 1. See supra note 289 for a brief description of the 
subject matter of the exhibits to current Form 1.
    \401\ 17 CFR 240.6a-2(b).
    \402\ Currently, these exhibits are Exhibits D, I, K, M, and N 
to Form 1. See supra note 289 for a brief description of the subject 
matter of the exhibits to current Form 1.
    \403\ 17 CFR 240.6a-2(c).
    \404\ Currently, these exhibits are Exhibits A, B, C, and J to 
Form 1. See supra note 289 for a brief description of the subject 
matter of the exhibits to current Form 1.
    \405\ See supra note 289 for a description of the information 
required by Exhibits A, B, C, J, K, M, and N.
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    (1) If the exchange publishes, or cooperates in the publication of 
the information required by these exhibits, on an annual or more 
frequent basis, the exchange may identify the publication in which such 
information is available, the name, address, and telephone number of 
the person from whom such publication may be obtained, and the price of 
such publication, so long as it certifies to the accuracy of the 
information as of its publication date;
    (2) If the exchange keeps the information required by these 
exhibits up-to-date, and makes it available to the Commission and the 
public upon request, the exchange may certify that the information is 
kept up-to-date and available to the Commission and public upon 
request; or
    (3) If the information required by these exhibits is available 
continuously on an Internet Web site controlled by the exchange, the 
exchange may indicate the location where such information may be found 
and certify that the information available at such location is accurate 
as of its date.\406\
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    \406\ 17 CFR 240.6a-2(d).
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    Rule 15Aj-1 under the Exchange Act \407\ is the companion rule for 
a registered securities association or an affiliated securities 
association and contains filing requirements similar to the provisions 
of Rule 6a-2. Rule 15Aj-1 currently requires an association to update 
its Form X-15AA-1 \408\ promptly after the discovery of any inaccuracy 
in the registration statement or in any amendment or supplement 
thereto.\409\ Rule 15Aj-1 also requires an association to file a 
current supplement on Form X-15AJ-1 \410\ following any change which 
renders the information contained or incorporated in the registration 
statement or any amendment thereto no longer accurate.\411\ In 
addition, an association is required to file a consolidated supplement 
to its registration statement on Form X-15AJ-2 \412\ annually and a 
complete Exhibit A of the Form X-15AJ-2 every three years.\413\ 
Finally, an association must file with the Commission a supplement 
setting forth its balance sheet following the close of each fiscal 
year.\414\ As is the case for exchanges under Rule 6a-2, with respect 
to certain filings required under current Rule 15Aj-1, an association 
may, in lieu of filing in paper form, identify the publication in which 
such information is available, the name, address, and telephone number 
of the person from whom such information may be obtained, and the price 
of the publication, as long as it certifies that the information is 
accurate.\415\
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    \407\ 17 CFR 240.15Aj-1.
    \408\ 17 CFR 249.801. Rule 15Aa-1 under the Exchange Act 
requires the initial filing of the Form X-15AA-1 for registration as 
a registered securities association or an affiliated securities 
association. See 17 CFR 240.15Aa-1.
    \409\ 17 CFR 240.15Aj-1(a).
    \410\ 17 CFR 259.802.
    \411\ 17 CFR 240.15Aj-1(b).
    \412\ 17 CFR 259.803.
    \413\ 17 240.15Aj-1(c)(i)-(ii).
    \414\ 17 CFR 240.15Aj-1(c)(2).
    \415\ 17 CFR 240.15Aj-1(c)(1)(i)-(ii). This alternative to paper 
filing is available for annual supplements and the filing of a 
complete Exhibit A to current Form X-15AJ-2, which is required every 
three years.
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    For clarity, the Commission proposes to redesignate Rule 15Aj-1 as 
Rule 15Aa-2 so that it will be located with Rule 15Aa-1, the rule for 
registration as a registered securities association or affiliated 
securities association. The Commission also proposes to revise Rule 6a-
2 and the redesignated Rule 15Aa-2 to enhance the frequency of 
disclosures by exchanges and associations, to harmonize filing and 
format requirements for exchanges and associations, and to streamline 
the disclosure process.\416\
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    \416\ Whereas proposed Rule 6a-2 resembles the current Rule 6a-
2, proposed redesignated Rule 15Aa-2 would completely replace the 
text of the current Rule 15Aj-1 as a result of an effort to conform 
Rule 15Aa-2 more closely to Rule 6a-2 and thereby harmonize the 
procedural and timing requirements for the filing of the revised 
Form 1 and new Form 2 and any amendments.
---------------------------------------------------------------------------

    The proposed amendments to Rule 6a-2 would require a national 
securities exchange or an exchange exempted from such registration 
based on limited volume, to file an amendment to revise its Form 1 
within 10 calendar days after any material event takes place that 
renders inaccurate, or that causes to be incomplete:
    (i) Any information filed on the Execution Page of revised Form 1, 
or an amendment thereto;
    (ii) Any information filed as part of proposed Exhibits C (board), 
D (officers), E (executive board and committees), H (regulatory 
program), I (financial statements and information), J (financial 
information about subsidiaries and affiliates), K (general information 
about subsidiaries, affiliates, and SRO trading facilities), M 
(membership forms), N (financial responsibility requirements), O 
(listing applications), P (relationship among the exchange or 
association, any facility of the exchange or association, and any 
affiliate of either), S (list of members and participants), or U 
(location of books and records), and as part of Item 3 of Exhibit F 
(waivers of code of conduct and ethics) or Items 1, 5, 6 and 7 of 
Exhibit Q (certain information about ownership in a Disclosure Entity) 
to revised Form 1, or any amendments thereto; or
    (iii) Any information filed as part of Items 2 and 3 of proposed 
Exhibit Q, or any amendment thereto, except that such information would 
not be required to be filed with respect to any ownership change that 
is less than 1% from the ownership interest last reported on Form 1, or 
any amendment thereto.\417\
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    \417\ See proposed Rule 6a-2(a).

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[[Page 71168]]

    The Commission is proposing to retain the 10-day filing deadline 
requirement from the current Form 1, because the Commission believes 
that 10 days is a sufficient time period in which to file a Form 1 
amendment.
    The proposed amendments to redesignated Rule 15Aa-2 similarly would 
require a registered securities association or an affiliated securities 
association to file an amendment to revise new Form 2 \418\ within 10 
calendar days after any material event takes place that renders 
inaccurate, or that causes to be incomplete: (i) Any information filed 
on the Execution Page of new Form 2, or an amendment thereto; (ii) any 
information filed as part of proposed Exhibits C (board), D (officers), 
E (executive board and committees), H (regulatory program), I 
(financial statements and information), J (financial information about 
subsidiaries and affiliates), K (general information about 
subsidiaries, affiliates, and SRO trading facilities), M (membership 
forms), N (financial responsibility requirements), O (listing 
applications), P (relationship among the exchange or association, any 
facility of the exchange or association, and any affiliates of either), 
S (list of members and participants), or U (location of books and 
records), and as part of Item 3 of Exhibit F (waivers of code of 
conduct and ethics) or Items 1, 5, 6 and 7 of Exhibit Q (certain 
information about ownership in a Disclosure Entity) to the new Form 2, 
or any amendment thereto; or (iii) any information filed as part of 
Items 2 and 3 of proposed Exhibit Q, or any amendment thereto, except 
that such information would not be required to be filed with respect to 
any ownership change that is less than 1% from the ownership interest 
last reported on Form 1 or Form 2, or any amendment thereto.\419\
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    \418\ As part of the Commission's effort to simplify and 
streamline the disclosure process for registered securities 
associations and affiliated securities associations, new Form 2 
would be used for all applications and amendments and would replace 
current Forms X-15AA-1, X-15AJ-1 and X-15AJ-2. See supra Section 
IV.F.
    \419\ See proposed Rule 15Aa-2(a).
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    The 10-day filing deadline requirement for filing an amendment to 
revised Form 1 is based on the current Form 1 filing deadline. The 
Commission believes that the filing requirements for exchanges and 
association should be uniform. As with the requirement for exchanges, 
the Commission believes that 10 days is a sufficient time period in 
which to file a Form 2 amendment.
    Under proposed Rules 6a-2(b) and 15Aa-2(b), an exchange or 
association would be required to file an annual amendment to update the 
proposed revised Form 1 or new Form 2, as applicable, in its entirety, 
within 60 days of the end of its fiscal year. With respect to this 
annual amendment, the information would be required to be up-to-date as 
of the end of the latest fiscal year of the exchange or 
association.\420\ The Commission believes that a 60-day filing deadline 
would give exchanges and associations sufficient time in which to file 
an annual amendment to Forms 1 and 2, while at the same time rendering 
the information contained in the annual amendment still timely and 
relevant.
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    \420\ See proposed Rules 6a-2(b) and 15Aa-2(b).
---------------------------------------------------------------------------

    The Commission believes that the proposed amendments to Rules 6a-2 
and 15Aa-2 would enhance investor confidence in the integrity of the 
markets by requiring exchanges and associations to provide more 
consistent and up-to-date disclosures about significant changes in 
their governance, administration, regulatory programs, and ownership. 
Furthermore, by standardizing the requirements for exchanges and 
associations and by replacing the current forms for associations with 
new Form 2, the Commission believes the proposed rules should simplify 
and streamline the disclosure process and provide more uniform 
treatment for exchanges and associations. The Commission does not 
believe that the registration procedures for exchanges and associations 
under the Exchange Act should maintain differing disclosure 
requirements, as national securities exchanges and registered 
securities associations are charged with nearly identical obligations 
under the Exchange Act.\421\
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    \421\ See supra Section I.A.
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    The Commission also is proposing changes to the current 
requirements with respect to the format in which registration 
applications and their amendments are submitted, with the aim of making 
such information more readily accessible to both the Commission and the 
public. Currently, exchanges and associations submit their registration 
forms and amendments to the Commission, through its Division of Market 
Regulation, in paper format. As noted above, there are paper filing 
alternatives to the filing of exhibits to existing Form 1 and Forms X-
15AJ-1 and X-15AJ-2.
    Under proposed Rules 6a-2(c) and 15Aa-2(c), a national securities 
exchange, an exchange exempted from such registration based on limited 
volume, a registered securities association, or an affiliated 
securities association would be required to file the initial proposed 
revised Form 1 or new Form 2, and all subsequent amendments thereto 
(with a few exceptions),\422\ in paper format with the Commission.\423\ 
However, in addition to the paper filing, the Commission also proposes 
to require that each exchange and association continuously post its 
most recent annually amended registration form and any subsequent 
updating amendments on a publicly accessible Web site controlled by the 
exchange or association. In the Commission's view, a publicly 
accessible Internet Web site is one that does not require a password in 
order to access information contained in Form 1 or Form 2.
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    \422\ The proposed rules provide an exception to the paper 
filing requirement for annual amendments to proposed Exhibits A, B, 
M, N, S, and T to revised Form 1 and new Form 2, and Items 1-7 of 
proposed Exhibit L to revised Form 1 and new Form 2. With respect to 
these Exhibits, an exchange or association, in lieu of filing such 
information in paper format, would only be required to identify the 
Internet web site it controls where such information is available 
continuously and to certify to the accuracy of such information as 
of its date. See proposed Rules 6a-2(d) and 15Aa-2(d).
    \423\ The Commission is not proposing at this time to require 
that exchanges and associations file revised Form 1 and new Form 2 
electronically. In the future, the Commission may consider the 
feasibility of requiring electronic filing of revised Form 1 and new 
Form 2. See, e.g., Securities Exchange Act Release No. 50486 
(October 4, 2004), 69 FR 60287 (October 8, 2004) (adopting rules 
requiring SRO proposed rule changes under Section 19(b) of the 
Exchange Act, 15 U.S.C. 78s(b), to be filed electronically with the 
Commission).
---------------------------------------------------------------------------

    In addition, Rules 6a-2(c) and 15Aa-2(c) would require the exchange 
or association to indicate, in any amendments filed with the 
Commission, the location of the Internet Web site where the most recent 
Form 1 or Form 2 and any subsequent updating amendments may be found, 
and to certify that the information available at such location is 
accurate as of its date. The Commission believes that posting the most 
recent version of Form 1 or Form 2 on an Internet Web site would 
significantly increase transparency with regard to each exchange and 
association, and would assist the Commission, market participants, and 
the public in their understanding and awareness of significant aspects 
of these SROs.
    Finally, the Commission proposes to add to Rules 6a-2 and 15Aa-2 a 
process for the Commission, upon written application or its own motion, 
to grant an exemption from the Form 1 or Form 2 filing requirements, 
either unconditionally or on specified terms and conditions, if the 
Commission determines that such exemption is necessary or appropriate 
in the public interest and is consistent with the protection of 
investors.\424\ Currently,

[[Page 71169]]

Rule 6a-2 contains a provision providing procedures for the Commission, 
upon certain conditions, to exempt an exchange from filing an amendment 
required by the rule for any affiliate or subsidiary listed in Exhibit 
C to current Form 1. The Commission, however, proposes to include 
procedures for broader exemptive relief under Rules 6a-2 and 15Aa-2, 
particularly in light of the additional disclosure requirements that 
are proposed.
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    \424\ See proposed Rules 6a-2(e) and 15Aa-2(e).
---------------------------------------------------------------------------

E. Proposed Changes to Rule 15Aa-1

    Rule 15Aa-1 under the Exchange Act requires that an application for 
registration as a registered or an affiliated securities association 
shall be made on Form X-15AA-1.\425\ Because the Commission is 
proposing to revise Form X-15AA-1 and redesignate it as new Form 2, the 
Commission is also proposing corresponding changes to Rule 15Aa-1. The 
amendment to Rule 15Aa-1 would clarify that an application for 
registration as a registered or an affiliated securities association 
shall be made on new Form 2.
---------------------------------------------------------------------------

    \425\ 17 CFR 240.15Aa-1.
---------------------------------------------------------------------------

F. Proposed Repeal of Forms X-15AJ-1 and X-15AJ-2

    Currently, a registered securities association is required to file 
amendments or supplements to correct any statement that the association 
discovers is inaccurate or that is no longer accurate on Form X-15AJ-
1.\426\ An association also is required to file an annual consolidated 
supplement to its registration statement, and an amendment every three 
years with the Commission on Form X-15AJ-2.\427\ Under the proposals, a 
registered securities association would be required to file all 
amendments to its registration application on new Form 2, rather than 
on Forms X-15AJ-1 or X-15AJ-2. Therefore, the Commission is proposing 
to repeal Forms X-15AJ-1 and X-15AJ-2. The Commission believes that the 
repeal of these forms should make the process of registration as a 
registered securities association or affiliated securities association, 
as well as the process of filing amendments to new Form 2, more 
efficient to the extent that associations could use one form for both 
purposes.
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    \426\ 17 CFR 259.802. See Rule 15Aj-1(a) and (b), 17 CFR 
240.15Aj-1(a) and (b).
    \427\ 17 CFR 259.803. See Rule 15Aj-1(c), 17 CFR 240.15Aj-1(c).
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G. Request for Comment

    The Commission seeks comments on the proposed changes to the forms 
for registration as a national securities exchange (or exemption from 
registration as a limited volume exchange) and as a registered 
securities association (or affiliated securities association), in 
addition to the companion rules governing the filing of the 
registration forms and amendments to those forms, as described above. 
In addition, the Commission requests that interested persons respond to 
the following specific questions:
    Question 76. Are the requested disclosure items contained in 
revised Form 1 and new Form 2 appropriate? Are there other disclosure 
items that should be added or are there proposed items that should be 
deleted?
    Question 77. Is the proposed definition of ``control'' in the 
proposed Instructions to revised Form 1 and new Form 2 appropriate?
    Question 78. Is the proposed definition of ``disclosure entity'' in 
the proposed Instructions to revised Form 1 and new Form 2 appropriate?
    Question 79. Is the proposed definition of ``immediate family 
member'' in the proposed Instructions to revised Form 1 and new Form 2 
appropriate?
    Question 80. Is the proposed definition of ``regulatory 
subsidiary'' in the proposed Instructions to revised Form 1 and new 
Form 2 appropriate?
    Question 81. Is the proposed definition of ``SRO trading facility'' 
in the proposed Instructions to revised Form 1 and new Form 2 
appropriate?
    Question 82. Currently, national securities exchanges are required 
to provide more detailed disclosure to the Commission than are 
registered securities associations. The Commission's proposal aims to 
harmonize the filing requirements for exchanges and associations. 
Should registered securities associations be required to disclose the 
same items as national securities exchanges? Are any of the proposed 
disclosure items unnecessary for registered securities associations? 
Are there items that have not been proposed that should be added for 
registered securities associations? Is there any other information 
currently required by Form X-15AA-1 that should be retained in new Form 
2?
    Question 83. Are there features of the proposed disclosure 
requirements that should be applied to other SROs, such as registered 
clearing agencies and the Municipal Securities Rulemaking Board?
    Question 84. Are the disclosure items contained in proposed Exhibit 
A (constitution, bylaws, rules) to revised Form 1 and new Form 2 
appropriate? Are there other disclosure items that should be added or 
are there proposed items that should be deleted?
    Question 85. Are the disclosure items contained in proposed Exhibit 
B (written rulings and interpretations) to revised Form 1 and new Form 
2 appropriate? Are there other disclosure items that should be added or 
are there proposed items that should be deleted?
    Question 86. Are the disclosure items contained in proposed Exhibit 
C (board) to revised Form 1 and new Form 2 appropriate? Are there other 
disclosure items that should be added or are there proposed items that 
should be deleted? Is it useful to require the disclosure of 
information relating to affiliations or relationships that reasonably 
could affect the director's independent judgment or decision-making for 
all directors?
    Question 87. Are the disclosure items contained in proposed Exhibit 
D (officers) to revised Form 1 and new Form 2 appropriate? Are there 
other disclosure items that should be added or are there proposed items 
that should be deleted?
    Question 88. Are the disclosure items contained in proposed Exhibit 
E (executive board and committees) to revised Form 1 and new Form 2 
appropriate? Are there other disclosure items that should be added or 
are there proposed items that should be deleted? Is it useful to 
require disclosure of information relating to affiliations or 
relationships that reasonably could affect each executive board or 
committee member's independent judgment or decision-making? Is it 
useful to require the filing of the charters of each Standing 
Committee?
    Question 89. Are the disclosure items contained in proposed Exhibit 
F (governance guidelines and codes of conduct) to revised Form 1 and 
new Form 2 appropriate? Are there other disclosure items that should be 
added or are there proposed items that should be deleted? Is it useful 
to require the disclosure of governance guidelines and codes of conduct 
and any waiver of the code of conduct?
    Question 90. Are the disclosure items contained in proposed Exhibit 
G (organization charts) to revised Form 1 and new Form 2 appropriate? 
Would the organization charts be helpful? Should the Commission require 
a minimum level of detail that exchanges and associations should 
provide in the charts? Are there other disclosure items that should be 
added to this Exhibit?
    Question 91. Are the disclosure items contained in proposed Exhibit 
H (regulatory program) to revised Form 1 and new Form 2 appropriate? 
Are there other disclosure items that should be

[[Page 71170]]

added or are there proposed items that should be deleted? Is it useful 
for SROs to disclose information about their regulatory programs, 
including the independence of the regulatory program from market 
operations and other commercial interests, any significant planned 
changes, and any significant issues and events and their effect on the 
regulatory program? Should SROs be required to submit copies of their 
delegations plans or other agreements pertaining to regulatory services 
provided by another SRO or its regulatory subsidiary, or the regulatory 
subsidiary of the applicant?
    Question 92. Are the categories of financial disclosures contained 
in proposed Exhibit I (regulatory program financial and other 
information) appropriate? Are there any categories that need to be 
clarified, added, or deleted?
    Question 93. Are the items in proposed Exhibit I pertaining to 
percentage of total budget and percentage of total revenues devoted to 
regulatory activities appropriate? Are there other items that should be 
included?
    Question 94. Are the categories of revenues and expenditures and 
allocated costs in proposed Exhibit I that must be disclosed with 
respect to the regulatory program appropriate? Are there specific 
categories that should be added, deleted, or clarified? Do the 
specified items capture sufficiently the categories of revenue and 
expenses that exchanges and associations currently utilize? Would it be 
easy or difficult for SROs to provide the requested information?
    Question 95. Should disclosure of a discussion of unusual events or 
significant economic changes that have had a material effect on the 
SRO's financial condition be required?
    Question 96. Should disclosure of significant business developments 
involving the SRO be required?
    Question 97. Should disclosure of material contracts and material 
related party transactions be required? Is the $60,000 threshold amount 
for material contracts and related party transactions, as set forth in 
proposed Exhibit I, appropriate? Should the threshold amount be set 
higher or lower?
    Question 98. Should disclosure of material commitments for 
expenditures as of the end of the latest fiscal period and the purpose 
of those commitments and their anticipated source of funds be required?
    Question 99. Should disclosure of charitable contributions in 
excess of $1,000, whether made directly or indirectly, under specified 
circumstances be required? Should the disclosure threshold be $1,000 or 
a higher or lower amount? Should all charitable contributions be 
disclosed? Are there other kinds of contributions that should be 
disclosed?
    Question 100. Should disclosure of a table detailing the 
compensation of the five most highly compensated executives of the 
exchange or association, using Item 402(b) of Regulation S-K, be 
required?
    Question 101. Should proposed Exhibit I require the disclosure of 
an annual report of the exchange's or association's Audit Committee?
    Question 102. Are the disclosure items contained in proposed 
Exhibit J (subsidiary financial statements) to revised Form 1 and new 
Form 2 appropriate? Are there other disclosure items that should be 
added or are there proposed items that should be deleted?
    Question 103. Are the disclosure items contained in proposed 
Exhibit K (SRO trading facility) to revised Form 1 and new Form 2 
appropriate? Are there other disclosure items that should be added or 
are there proposed items that should be deleted?
    Question 104. Are the disclosure items contained in proposed 
Exhibit L (SRO trading facility) to revised Form 1 and new Form 2 
appropriate? Are there other disclosure items that should be added or 
are there proposed items that should be deleted?
    Question 105. Are the disclosure items contained in proposed 
Exhibit M (membership forms) to revised Form 1 and new Form 2 
appropriate? Are there other disclosure items that should be added or 
are there proposed items that should be deleted?
    Question 106. Are the disclosure items contained in proposed 
Exhibit N (members' financial forms) to revised Form 1 and new Form 2 
appropriate? Are there other disclosure items that should be added or 
are there proposed items that should be deleted?
    Question 107. Are the disclosure items contained in proposed 
Exhibit O (listing forms) to revised Form 1 and new Form 2 appropriate? 
Are there other disclosure items that should be added or are there 
proposed items that should be deleted?
    Question 108. Is the information proposed to be required in 
proposed Exhibit P (organizational charts) relating to the relationship 
between an exchange, an association, a facility of an exchange or 
association, and their respective affiliates, and whether and how the 
facility or affiliate has the power to influence or control the 
management, policies and regulatory responsibilities of the exchange or 
association, appropriate? Should the Commission require the exchange or 
association to provide any other information?
    Question 109. Are the disclosure requirements contained in proposed 
Exhibit Q (ownership of an exchange or association or facility of an 
exchange or association) appropriate? Should the Commission require an 
exchange or association to disclose any additional information relating 
to such ownership?
    Question 110. Should the Commission require the exchange or 
association to disclose direct and indirect ownership in any entity 
other than the exchange, association, or a facility of the exchange or 
association? If so, what other category of entity?
    Question 111. In relation to the proposed ownership disclosure in 
proposed Exhibit Q, is the proposed definition of ``related persons'' 
appropriate? Should it be broader? Narrower?
    Question 112. Will the exchange or association be able to obtain 
the information necessary to determine whether any person, alone or 
together with its related persons, exceeds the 5% reporting threshold? 
The Commission has proposed to require an exchange or association to 
have rules that would provide a mechanism for the exchange or 
association to obtain information from its owners or the owners of its 
facility regarding such ownership. Would this help? How difficult would 
it be for an exchange or association to implement such rules for owners 
that are not members, such as by amending its certificate of 
incorporation? Alternatively, should the Commission require an exchange 
or association to disclose ownership information only to the extent it 
is reasonably available to them, if they have made reasonable efforts 
to obtain such information and were unable to do so?
    Question 113. Are the disclosure items contained in proposed 
Exhibit R (membership criteria) to revised Form 1 and new Form 2 
appropriate? Are there other disclosure items that should be added or 
are there proposed items that should be deleted?
    Question 114. Are the disclosure items contained in proposed 
Exhibit S (list of members) to revised Form 1 and new Form 2 
appropriate? Are there other disclosure items that should be added or 
are there proposed items that should be deleted?
    Question 115. Are the disclosure items contained in proposed 
Exhibit T (schedule of securities listed or admitted to trading) to 
revised Form 1 and new Form 2 appropriate? Are there other disclosure 
items that should be

[[Page 71171]]

added or are there proposed items that should be deleted?
    Question 116. Is the requested disclosure item contained in 
proposed Exhibit U (location of books and records) of revised Form 1 
and new Form 2 appropriate?
    Question 117. Is the proposed change to Rule 17a-1 to require, for 
the existing five-year record retention period, an exchange or 
association (and other SROs) to maintain its books and records in the 
United States appropriate?
    Question 118. In proposed Exhibit J to revised Form 1 and new Form 
2, exchanges and associations would be required to provide separate 
annual financial statements for each affiliate. In proposed Exhibit K, 
exchanges and associations would be required to provide specified 
organizational information concerning each affiliate and for any 
unaffiliated entity that operates an SRO trading facility, including 
copies of organizational documents and lists of officers, governors, 
and Standing Committee members. Substantively, these requirements 
mirror those currently applicable to exchanges in Exhibits C and D of 
current Form 1. Given the trend toward SRO demutualization, and the 
prospect that an SRO could become part of a large conglomerate, should 
the SRO affiliates with respect to which information is required in 
proposed Exhibits J and K be narrowed (e.g. to those affiliates that 
are in the chain of control with the exchange or association, or to 
affiliates that are in the securities business)? If so, what specific 
information should be excluded with respect to these affiliates (e.g., 
separate financial statements, copies of organizational documents)?
    Question 119. Should the disclosure requirement contained in 
current Exhibit B to Form X-15AA-1 be retained in new Form 2 
appropriate? Are there other disclosure items from Form X-15Aa-1 that 
should be added to revised Form 1?
    Question 120. Are the revisions to proposed Rules 6a-2 and 15Aj-1 
(to be redesignated as Rule 15Aa-2) appropriate? Is the 10-day filing 
deadline for periodic updates appropriate? Is it too long? Is it too 
short? Is the 60-day filing deadline for annual updates appropriate? Is 
it too long? Is it too short?
    Question 121. The Commission has proposed to permit exchanges and 
associations, in complying with the requirement of filing amendments to 
revised Form 1 and new Form 2, to make proposed Exhibits A, B, M, N, S, 
or T or Items 1-7 of proposed Exhibit L available continuously on a Web 
site controlled by the exchange or association, instead of filing the 
information in the Exhibits in paper form. Should this Web site posting 
alternative be available for the filing other proposed Exhibits to 
revised Form 1 and new Form 2?
    Question 122. Should there be more alternatives to paper filing, 
e.g., simply relying on posting on the exchange's or association's 
Internet website?
    Question 123. Should revised Form 1 and new Form 2 be integrated 
into a single form to be used both exchanges and associations?
    Question 124. Should the Commission consider electronic filing of 
revised Form 1 and new Form 2, such as on EDGAR?

V. Periodic Reporting Obligations of Exchanges and Associations

A. Background and Need for Proposed Rule 17a-26

    A critical component of the self-regulatory system is the 
Commission's authority to inspect and examine each SRO to ascertain 
whether it is properly complying with and enforcing federal statutory 
and regulatory provisions, as well as the SRO's own rules.\428\ Among 
the mechanisms utilized by the Commission in its oversight efforts are 
cyclical inspections of SROs that concentrate on particular facets of 
their regulatory programs and targeted inspections of SROs that are 
conducted in response to particular developments. The periodic nature 
of the Commission's inspections of SROs, coupled with the inherent 
limitations on the Commission's ability to detect violations in a 
system based on self-regulation, creates a risk that the Commission 
could be unaware that an exchange or association may not be responding 
promptly and adequately to new regulatory issues, or may not be fully 
and promptly addressing the findings and recommendations of the 
Commission's staff's prior inspection. In addition, an issue uncovered 
during the course of an inspection of an exchange or association can 
foreshadow similar issues across several SROs in a particular 
regulatory program area. The Commission believes that its ability to 
identify such system-wide issues, given the time necessary for its 
staff to prepare for and conduct on-site inspections of one or more 
SROs, could be enhanced by its receiving regulatory program information 
from the SROs on a regular basis.
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    \428\ The Commission has the authority to require exchanges and 
associations to make, keep, and file with the Commission any 
records, and make and disseminate any reports, that the Commission, 
by rule, prescribes as necessary or appropriate in the public 
interest, for the protection of investors, or otherwise in 
furtherance of the purposes of the Exchange Act. See Section 
17(a)(1) of the Exchange Act, 15 U.S.C. 78q(a)(1).
    In addition, all records of exchanges and associations are 
subject to such reasonable, periodic, special, or other examinations 
by representatives of the Commission as the Commission deems 
necessary or appropriate in the public interest, for the protection 
of investors, or otherwise in furtherance of the purposes of the 
Exchange Act. See Section 17(b)(1) of the Exchange Act, 15 U.S.C. 
78q(b)(1).
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    Accordingly, the Commission proposes to adopt new Rule 17a-26 under 
the Exchange Act to establish a system of quarterly and annual 
reporting by national securities exchanges and registered securities 
associations with respect to key aspects of their regulatory programs. 
Along with the proposals to strengthen the public disclosure 
requirements applicable to exchanges and associations,\429\ proposed 
Rule 17a-26 is intended to enhance the Commission's ability to monitor 
exchanges' and associations' compliance with their regulatory 
responsibilities.
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    \429\ See supra Section IV.
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    The proposed rule would elicit specific information about 
exchanges' and associations' regulatory programs, including their 
surveillance and disciplinary operations. By requiring exchanges and 
associations to file with the Commission the information specified in 
proposed Rule 17a-26 on a periodic basis, the Commission believes that 
it should be able to better target its on-site inspection resources and 
monitor more closely SROs' responses to critical issues affecting the 
securities markets, particularly during the period between Commission 
inspections of the exchange or association. Additionally, proposed Rule 
17a-26 should assist the Commission in its efforts to stay abreast of 
new developments and challenges affecting SROs' self-regulatory 
obligations and to monitor SROs' performance of their statutory 
obligation to comply with, and enforce compliance with, the federal 
securities laws and the rules and regulations thereunder, in addition 
to the SROs' own rules. We believe that the information to be provided 
by SROs would be valuable to the Commission because it would highlight 
potential problem areas and, in turn, could aid the Commission in 
crafting an appropriate response. Accordingly, the information filed 
pursuant to the proposed rule could enhance the Commission's ability to 
oversee the SROs, their members, and the entities under their 
jurisdiction.
    Furthermore, proposed Rule 17a-26 should improve compliance 
practices by SROs. In particular, the proposed rule

[[Page 71172]]

would compel exchanges and associations to review, on a quarterly and 
annual basis, the operation and performance of their regulatory 
programs. In gathering the necessary information and preparing the 
required reports under the proposed rule, exchanges and associations 
would have the opportunity to review and assess the information that 
they compile and file with the Commission. The preparation of the 
reports required by proposed Rule 17a-26 should be particularly useful 
to the SRO's proposed Chief Regulatory Officer and the members of its 
proposed Regulatory Oversight Committee to inform them about the 
operations of the SRO's regulatory program. The reporting requirements 
should help exchanges and associations to identify potential weaknesses 
in their compliance practices and surveillance programs, and help 
facilitate their ability to quickly revise and, as necessary, 
strengthen their regulatory programs. Finally, by helping to bolster 
the effectiveness of self-regulation, proposed Rule 17a-26 should 
benefit not only the SROs and their members, but also users of their 
facilities and other market participants, as well as the investing 
public.

B. Scope and Timing of Reports Required by Proposed Rule 17a-26

    Proposed Rule 17a-26 would require every exchange and association 
subject to the proposed rule \430\ to file quarterly and annual reports 
with the Commission that contain specified information about their 
regulatory programs.\431\ The information required by the proposed rule 
would concern the regulatory programs of an exchange or association 
(which would include any regulatory subsidiary)\432\ and would 
encompass any surveillance, examination, and disciplinary programs. In 
the event that an exchange or association has entered into a 
contractual relationship with another SRO pursuant to which that SRO 
provides regulatory services to or on behalf of the exchange or 
association, the information required by the proposed rule also would 
need to account for the regulatory services provided on behalf of the 
exchange or association.
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    \430\ Proposed Rule 17a-26 would not apply to a national 
securities exchange registered pursuant to Section 6(g)(1) of the 
Exchange Act, 15 U.S.C. 78f(g)(1), or to a national securities 
association registered pursuant to Section 15A(k)(1) of the Exchange 
Act, 15 U.S.C. 78o-3(k)(1). Because the Commission does not have 
primary responsibility for the regulation of entities under those 
provisions, including security futures product exchanges and limited 
purpose national securities associations, the Commission is 
proposing to exempt such exchanges and associations from Rule 17a-
26. See supra note 77 (discussing the division of regulatory 
responsibility between the Commission and the CFTC).
    \431\ See proposed Rule 17a-26(a)(1) (regarding quarterly and 
annual reports) and (d) (regarding interim changes). Although 
proposed Rule 17a-26 would not expressly require exchanges or 
associations to maintain the records necessary to prepare the 
required reports, Rule 17a-1 under the Exchange Act, 17 CFR. 240-
17a-1, would do so. Rule 17a-1(b) requires every exchange and 
association, among others, to keep and preserve all documents made 
or received by it in the course of its business for a period of not 
less than five years, the first two in an easily accessible place, 
subject to the destruction and disposition provisions of Rule 17a-6 
under the Exchange Act, 17 CFR 240.17a-6.
    \432\ See proposed Rule 17a-26(j)(5) for a definition of the 
term ``regulatory subsidiary.''
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1. Quarterly Reports
    Every national securities exchange and registered securities 
association subject to the proposed rule would be required to file with 
the Commission the reports specified in paragraph (b)(2) of proposed 
Rule 17a-26 on a quarterly basis, within 20 business days after the end 
of each calendar quarter.\433\ The Commission believes that the 
requirement to file the quarterly reports within 20 business days after 
a quarter's end would accommodate the Commission's interest in 
receiving the reports as promptly as possible, while granting an 
exchange or association a sufficient amount of time to prepare and 
finalize the reports containing the information that it compiles during 
the course of the quarter. The scope of the information proposed to be 
required in the quarterly reports is discussed below.\434\
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    \433\ See proposed Rule 17a-26(a)(1).
    \434\ See infra Section V.D.
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2. Annual Reports
    Under proposed Rule 17a-26, every national securities exchange and 
registered securities association subject to the proposed rule also 
would be required to prepare an annual report covering the following 
categories of information: (1) An aggregated year-end cumulative 
summary of the information specified in the first seven items of the 
quarterly report provisions of the proposed rule,\435\ (2) additional 
information on the SRO's regulatory program that is not required to be 
set forth in the quarterly reports, and (3) the annual report of an 
independent third party designed to assess whether the operations of 
any electronic SRO trading facility of the exchange or association 
comply with the rules governing such facility.\436\ Together, these 
three categories, discussed below, would compose the annual 
report.\437\ The proposed rule would specify that the annual report 
would have to be filed with the Commission within 60 calendar days 
after the calendar year end.\438\ The Commission believes that the 
proposed requirement to file the annual report within 60 calendar days 
after the year's end satisfies the Commission's interest in receiving 
the reports as promptly as possible, while granting an exchange or 
association a sufficient amount of time to prepare the report. The 
scope of the information proposed to be required in the annual report 
in addition to the aggregated quarterly information is discussed 
below.\439\
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    \435\ See proposed Rule 17a-26(b)(2)(i)-(vii). Given the 
proposed electronic nature of the quarterly reports, the Commission 
would expect that it would be a relatively simple task for an SRO to 
aggregate the quarterly information and incorporate the data into 
the annual report. The Commission believes that the aggregation of 
this material in the annual report would facilitate its review by 
the SRO's management and governing board, including the Chief 
Regulatory Officer and the Regulatory Oversight Committee.
    \436\ See proposed Rule 17a-26(b)(3).
    \437\ Accordingly, at the end of a calendar year, the exchange 
or association would file the quarterly report for the fourth 
quarter within 20 business days after the end of the calendar year 
(which represents the end of the fourth quarter), and the annual 
report within 60 days after the calendar year end.
    \438\ See proposed Rule 17a-26(a)(1).
    \439\ See infra Sections V.E. and V.F.
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C. Format of Reports

    Proposed Rule 17a-26 would require all quarterly and annual 
reports, as well as all audits of electronic SRO trading 
facilities,\440\ to be submitted electronically in a uniform, readily-
accessible, and useable format.\441\ To that end, the proposed rule 
would require every exchange and association subject to the proposed 
rule to establish procedures for the preparation of the quarterly and 
annual reports in a uniform, readily accessible, and usable electronic 
format, as well as to review those procedures from time to time to 
evaluate their efficacy, and to revise the procedures as 
necessary.\442\ The reports should be in a user-friendly format, with 
an emphasis on readable layouts, ability to manipulate and search the 
data (including cutting, pasting, and exporting text), and a common,

[[Page 71173]]

compatible, and accessible program language. The proposed rule would 
not mandate a technology-specific format or a particular template for 
presenting the data, but it does contemplate that an exchange or 
association would select a commonly-acceptable standard that would 
emphasize presentation of the data in a simple layout with the ability 
to access and manipulate the data provided.
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    \440\ See proposed Rule 17a-26(a)(2).
    \441\ See proposed Rule 17a-26(b)(1)(ii). The term ``uniform'' 
in this context means that there should be uniformity in 
presentation of the data on the SRO's part for both quarterly and 
annual reports. See also Securities Act Release No. 8497 (September 
27, 2004), 69 FR 59111 (October 1, 2004) (concept release regarding 
enhancing Commission filings through the use of tagged data). Data 
tagging uses standard definitions to translate text-based 
information into files that can be retrieved, searched, and analyzed 
through automated means.
    \442\ See proposed Rule 17a-26(b)(1)(ii).
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    In proposing to require the exchanges and associations to establish 
procedures for preparing the data for quarterly and annual reports in 
an electronic format, the Commission hopes to minimize the costs 
incurred by exchanges and associations to generate the reports, and to 
foster a mutually acceptable format for the reports in a manner that 
facilitates historical comparisons and data tracking by each SRO and by 
the Commission. The Commission requests comment below on the nature of 
the proposed electronic format, as well as possible alternatives for a 
common format for all exchanges and associations that would be user-
friendly and compatible with existing SRO and Commission computer 
systems. The Commission also seeks comment below concerning whether it 
should explore the feasibility of the filing of proposed quarterly and 
annual reports through a secure Web-based system.\443\
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    \443\ See Securities Act Release No. 50486, supra note 423.
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D. Quarterly Reporting of Regulatory Information

    The categories of information specified below would compose the 
quarterly report required by the proposed rule. The program areas 
covered by these categories are designed to address the primary 
operations and main features of an exchange's or association's 
regulatory program, and constitute those areas for which the Commission 
has an interest in receiving information on a regular basis.
1. Information on the SRO's Surveillance Program
    Proposed Rule 17a-26 would require exchanges and associations to 
report quarterly on the results of their surveillance programs, both 
manual and automated, during the reporting period.\444\ This reported 
information would include, but would not be limited to, information on 
the number of exception reports and alerts generated, sorted by 
applicable rule or category.\445\ An exchange or association also would 
be required to indicate the number of exception reports and alerts that 
were reviewed by the exchange or association and the number of 
exception reports and alerts that were referred for further 
investigation or for an enforcement proceeding.
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    \444\ See proposed Rule 17a-26(b)(2)(i). Automated surveillance 
programs refer generally to computer-based programs that monitor 
activity for compliance with the SRO's rules and the federal 
securities laws and regulations, and generate alerts and reports 
upon the occurrence of any conduct that does not comply with 
designated parameters. Manual surveillance programs refer generally 
to non-computer-based regulatory review of activity.
    \445\ Exception reports and alerts are produced in connection 
with the operation of an SRO's manual and automated surveillance 
programs and generally highlight unusual activity that may be 
indicative of violations of the SRO's trading rules or the federal 
securities laws and regulations.
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    The Commission believes that this information, as with the other 
categories of information required by the proposed rule, should better 
enable it to stay informed of novel and recurring issues that could 
present a challenge to an SRO's regulatory programs, as well as 
facilitate the Commission's ability to respond in a timely manner, as 
appropriate. The required information also should raise awareness of 
surveillance issues at the SROs, and allow the Commission and the SROs 
to take action when necessary to implement a coordinated response to 
any systemic concerns. Finally, the regular submission of this 
information should help focus the Commission's inspection resources on 
those matters that need urgent attention and encourage further 
cooperation between the Commission and each SRO in seeking solutions to 
regulatory challenges.
    With respect to an exchange's or association's efforts to monitor 
for compliance with financial and operational requirements of its 
broker-dealer members, proposed Rule 17a-26 would require exchanges and 
associations to maintain records of and report information regarding 
all members that had net capital computation errors exceeding 10% of 
excess net capital, including an objective description of any action 
taken by the exchange or association in response to such 
deficiency.\446\ An exchange or association also would be required to 
provide a list of members that were late in filing their FOCUS reports 
as well as a separate list of members that filed amended FOCUS reports, 
and provide an objective description of any response taken by the 
exchange or association in response to either of these situations.\447\ 
The Commission believes that this information should allow it to better 
monitor the effectiveness of an exchange's or association's 
surveillance for compliance with net capital and FOCUS reporting 
obligations, and should permit the Commission to respond on a 
contemporaneous basis to circumstances that may warrant further 
attention.
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    \446\ See proposed Rule 17a-26(b)(2)(ii).
    \447\ See id. The Financial and Operational Combined Uniform 
Single Report (``FOCUS report'') is filed by a broker or dealer on 
Form X-17A-5 pursuant to Rule 17a-5(a), 17 CFR 240.17a-5(a). The 
FOCUS report is the basic financial and operations report required 
of brokers and dealers that are subject to minimum net capital 
requirements under Rule 15c3-1 of the Exchange Act, 17 CFR 240.15c3-
15. An amended FOCUS report generally is filed when a broker or 
dealer becomes aware of a material inaccuracy in its previous 
filing.
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    Rather than identify the member firms by name, however, the 
proposed rule would require the lists to be prepared using a unique 
identifier specific to each member firm reported. Various provisions 
throughout the proposed rule, including the provision regarding 
compliance with financial and operational requirements, would require 
an exchange or association to assign each member firm (or its 
associated persons) a unique identifier for the purpose of reporting 
the information required by the proposed rule.\448\ Although the 
exchange or association would not be required to include the identity 
of the member firm or its associated persons in the regularly-filed 
reports, a unique identifier would need to be used in a consistent 
manner in each quarterly and annual report in order to allow the 
Commission to spot trends involving a particular firm or individual. 
The protection afforded by a system of unique identifiers is intended 
to maintain the anonymity, with respect to the Commission, in 
information filed regularly with the Commission of the member firms or 
individuals subject to an investigation or regulatory action by an SRO. 
Commission staff could contact the SRO to follow-up if it saw a 
recurring pattern of a particular unique identifier being captured on 
the required reports.
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    \448\ For example, Firm ABC could be identified according to the 
unique identifier ``MF123.'' Subsequent references to this member in 
the same or any subsequent reports would need to refer to the member 
as ``MF123.'' The unique identifier should be used consistently 
throughout a particular report, including across each category of 
information, as well as consistently in all reports over time.
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2. Information on Complaints Received
    Proposed Rule 17a-26 would require an exchange or association to 
report quarterly on all complaints it received during the reporting 
period that relate to the exchange's or association's regulatory 
programs.\449\ An exchange or association would have to include 
objective summaries of the substance of

[[Page 71174]]

each complaint received. The summaries would be grouped by the subject 
matter of the complaint, and would use a unique identifier specific to 
the member and any associated persons involved.\450\ Similar to the 
requirements for financial and operational reporting, discussed above, 
the provision requiring information on complaints received would 
require an exchange or association to assign each member a unique 
identifier for the purpose of reporting the information required by the 
proposed rule.\451\
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    \449\ See proposed Rule 17a-26(b)(2)(iii).
    \450\ See supra note 448 and accompanying text.
    \451\ See supra note 448 and accompanying text. To refer to an 
associated person of Firm ABC, an exchange or association could use 
a suffix system as follows: ``MF123-1.'' The unique identifier 
should be used consistently throughout a particular report, 
including across each category of information, as well as 
consistently in all reports over time.
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    The summary also would need to include the type of source of the 
complaint (e.g., ``member'' or ``public''), the date the complaint was 
received by the exchange or association, and the disposition of the 
matter, including an objective description of any action taken or 
response by the exchange or association and the date of any such 
response. By requiring SROs to file with the Commission information on 
complaints they receive, the Commission should be able to better 
monitor potential problem areas and take steps designed to ensure that 
the exchanges and associations are taking appropriate, timely action in 
response to complaints. In addition, the requirement to compile and 
summarize information on complaints should help to focus an SRO's 
attention on the complaints it receives and should facilitate its 
ability to assess any trends with respect to, and track the resolution 
of, such complaints.
3. Investigations, Examinations, and Enforcement Actions
    The Commission proposes to require exchanges and associations to 
report on all investigations, examinations, and enforcement cases 
opened, closed, and pending during the reporting period. With respect 
to investigations, proposed Rule 17a-26 would require exchanges and 
associations to provide a summary of, including a count of the 
aggregate numbers of, open, closed, and pending investigations, as well 
as provide an objective summary of the facts and circumstances of each 
investigation.\452\ The summary information would include, but would 
not be limited to, the member firm and any associated person(s) under 
review using a unique identifier specific to the member and any 
associated person(s); \453\ a factual description of any alleged rule 
violations; a general identification of the type of source that led to 
the investigation (e.g., ``member complaint'' or ``automated 
surveillance alert''); a factual description of the matter under 
investigation (i.e., without subjective commentary, explanation, or 
elaboration by the exchange or association) and the relevant security 
symbol or type of security involved; the date of the occurrence of the 
matter under investigation and the date the alleged violation was 
reported or detected; the date the exchange or association opened the 
investigation; and the length of time the investigation has been open. 
For closed investigations, the summary also would include the date the 
investigation was closed; the length of time the investigation was 
open; and an objective description of the recommendations and 
disposition of the investigation. In addition, the proposed rule would 
require a summary of the number of investigations conducted during the 
reporting period as well as the average elapsed time, in days, for 
investigations closed during the reporting period.\454\ This 
information should allow the Commission to better monitor the 
operations and effectiveness of the SROs' investigation programs, as 
well as spot trends with respect to potentially violative conduct by 
member firms and their associated persons.
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    \452\ See proposed Rule 17a-26(b)(2)(iv).
    \453\ See supra note 448 and accompanying text. The unique 
identifier should be used consistently throughout a particular 
report, including across each category of information, as well as 
consistently in all reports over time.
    \454\ See proposed Rule 17a-26(b)(2)(iv).
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    With respect to examinations, proposed Rule 17a-26 would require 
exchanges and associations to provide a summary of, including a count 
of the aggregate numbers of, open, closed, and pending examinations, as 
well as provide an objective summary of the facts and circumstances of 
each investigation.\455\ The summary information would include, but 
would not be limited to, the following: a list of the member firms 
examined, using a unique identifier specific to the member firm;\456\ 
the member's examination cycle (i.e., the frequency with which the 
member is generally examined, such as a one-year or two-year cycle); 
whether the examination was a routine cycle examination or whether it 
was for-cause and an objective description of any reasons for a cause 
examination; whether the examination was of a new member of the 
exchange or association and, if so, the date the new member registered 
under the Exchange Act and the date the examination of the new member 
commenced; an objective description of the scope and subject matter of 
the examination and the areas and items reviewed during the 
examination; the date the examination was opened and, as applicable, 
closed; the length of time the examination has been or was open; an 
objective description of any potential violations (i.e., the rules 
allegedly violated); and a factual description of the recommendations 
and disposition of the examination.\457\ In addition, we propose to 
require exchanges and associations to provide data on the number of 
examinations conducted during the reporting period and the average 
elapsed time, in days, for all examinations that have been completed 
during the reporting period.\458\ As with the information proposed to 
be filed with the Commission regarding investigations, the Commission 
believes that its receipt of this information should permit it to 
better monitor each SRO's reasons for opening, and progress in 
conducting, examinations, and to discern trends across SROs.
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    \455\ See proposed Rule 17a-26(b)(2)(v).
    \456\ See supra note 448 and accompanying text. The unique 
identifier should be used consistently throughout a particular 
report, including across each category of information, as well as 
consistently in all reports over time.
    \457\ See proposed Rule 17a-26(b)(2)(v).
    \458\ See id.
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    Finally, with respect to enforcement cases, the Commission proposes 
to require exchanges and associations to provide a summary of, 
including a count of the aggregate numbers of, open, closed, and 
pending enforcement cases, as well as provide a factual summary of the 
facts and circumstances of each case.\459\ The summaries would include 
a list of all enforcement cases, grouped by subject matter, and provide 
factual case information, including, but not limited to, the member 
firm and any associated person(s) under review, identified according to 
a unique identifier specific to the member firm and associated person; 
\460\ the type of source that led to opening the case (e.g., tip, 
referral from another regulator, complaint, etc.); a factual 
description of any alleged violations and the relevant security symbol 
or specific type of security involved; the date of occurrence of any 
alleged violations and the date they were reported or detected; the 
date the enforcement case was opened; and the number of days the

[[Page 71175]]

case has been open.\461\ For cases closed during the reporting period, 
the exchange or association also would be required to provide the date 
the case was closed; the number of days the case had remained opened; 
and an objective description of the disposition of the case, including 
whether the case was settled and the sanctions imposed, if any, 
including any fines and penalties.\462\ In addition, the report would 
include a summary of the number of enforcement cases conducted during 
the reporting period and the average elapsed time for all enforcement 
cases closed during the reporting period.\463\ The Commission believes 
that the required information on enforcement cases could assist it in 
monitoring, on a regular basis, each exchange's and association's 
vigilance with respect to, as well as its resolution of, enforcement 
matters. In addition, this information should assist the Commission in 
its efforts to monitor developing enforcement issues that potentially 
could impact SROs generally, as well as focus an SRO's attention on 
trends in its enforcement program.
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    \459\ See proposed Rule 17a-26(b)(2)(vi).
    \460\ See supra note 448 and accompanying text. The unique 
identifier should be used consistently throughout a particular 
report, including across each category of information, as well as 
consistently in all reports over time.
    \461\ See proposed Rule 17a-26(b)(2)(vi).
    \462\ See id.
    \463\ The Commission anticipates that the provision of 
enforcement information under proposed Rule 17a-26 also would assist 
in the Commission's initiative to receive information pursuant to 
Rule 19d-1 under the Exchange Act, 17 CFR 240.19d-1, in electronic 
format.
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    In the Commission's view, the proposed requirement to compile and 
summarize information on investigations, examinations, and enforcement 
actions should help to focus an SRO's attention on these regulatory 
activities and should facilitate the ability of its management, 
including its Chief Regulatory Officer and its Regulatory Oversight 
Committee, to monitor the SRO's vigilance in pursuing and completing 
investigations, examinations, and enforcement activity.
4. Information on Listings Programs
    Under proposed Rule 17a-26, exchanges and associations would be 
required to provide quarterly information on their listings 
programs.\464\ Each exchange or association would be required to 
provide information including a list of all securities that were newly 
listed and delisted during the reporting period; a list of all issuers 
to whom the exchange or association, or a facility thereof, sent during 
the reporting period a notice alleging that such issuer does not 
satisfy a rule or standard for continued listing on the exchange or 
association, or a facility thereof, and, in the case of an exchange, a 
notice that the exchange has submitted an application under Exchange 
Act Rule 12d2-2 (17 CFR 240.12d2-2) to the Commission to delist a class 
of the issuer's securities, and, in the case of an association, a 
notice that the association has taken all necessary steps under its 
rules to delist the security from its facility; a list of all issuers, 
using unique identifiers,\465\ alleged to not satisfy a rule or 
standard for continued listing and any action taken with respect to any 
listed issuer that allegedly failed to satisfy any rule or standard for 
continued listing; and a list of any issuers, using unique identifiers, 
that are alleged to have failed to file timely quarterly or annual 
reports.\466\ Further, the proposed rule would require exchanges and 
associations to set forth the rule or standard for continued listing 
that the issuer is alleged to have failed to satisfy and the date when 
the issuer was alleged to have failed to satisfy such rule or standard 
for continued listing. The summary also would need to discuss the 
status of any compliance plan agreed upon between the issuer and the 
exchange or association, including any alleged failure on the part of 
the issuer to satisfy any of the provisions of such compliance 
plan.\467\ For listed options, the exchange or association would be 
required to provide information on any options classes or series that 
did not satisfy the applicable listing standards or rules when trading 
commenced.\468\ The Commission believes that this information should 
permit it to better monitor, among other things, listing and delisting 
trends and, in particular, the SROs' handling of delisting proceedings.
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    \464\ See proposed Rule 17a-26(b)(2)(vii). With respect to the 
proposed requirement to provide information on listing programs, for 
an exchange or association that has an affiliate that lists and 
trades securities, the exchange or association would be responsible 
for assuring that its affiliate provides it with the required 
information on its listings program, and the exchange or association 
would be responsible for including such information in its quarterly 
report.
    \465\ See supra note 448 and accompanying text. The unique 
identifier should be used consistently throughout a particular 
report, including across each category of information, as well as 
consistently in all reports over time.
    \466\ See proposed Rule 17a-26(b)(2)(vii).
    \467\ See id.
    \468\ See id.
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5. Copies of Board and Committee Meeting Agenda
    Proposed Rule 17a-26 would require every exchange and association 
to provide, as part of their quarterly reports, the final agenda from 
any meeting of the board of directors or executive committee of the 
exchange or association, or any meeting of any committee of the board 
of directors or executive committee, that occurs during the reporting 
period.\469\ An exchange or association would not be required to 
resubmit this information as part of its annual report.\470\ The 
Commission believes that the quarterly filing of this information would 
assist it in its efforts to keep abreast of regulatory matters 
considered by an exchange's or association's board and its committees 
and would help to focus the Commission's inspection efforts.
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    \469\ See proposed Rule 17a-26(b)(2)(viii).
    \470\ See proposed Rule 17a-26(b)(3).
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E. Annual Reporting of Regulatory Information

    In addition to filing quarterly reports for each calendar quarter, 
proposed Rule 17a-26(b)(3) also would require an exchange or 
association to file an annual report with the Commission.\471\ The 
annual report would contain a cumulative year-end summary of the first 
seven categories of information filed as part of the quarterly 
reports,\472\ as well as an audit of any electronic SRO trading 
facility and a summary of several additional categories of regulatory 
information, and would be due within 60 calendar days after the year's 
end.\473\ The additional categories of annual regulatory information 
are discussed below.
---------------------------------------------------------------------------

    \471\ See id.
    \472\ See proposed Rule 17a-26(b)(2)(i)-(vii).
    \473\ See proposed Rule 17a-26(a)(1).
---------------------------------------------------------------------------

1. Cumulative Summary of Quarterly Information
    The annual report required by proposed Rule 17a-26(b)(3) would need 
to contain an aggregated year-end cumulative summary of the information 
specified in the first seven items of the quarterly report provisions 
of the proposed rule.\474\ Accordingly, the annual report would need to 
include a compilation of the following quarterly information: (1) The 
results of the surveillance programs; (2) the results of the 
surveillance programs for financial and operations requirements; (3) 
the summary of complaints relating to the exchange's or association's 
regulatory program; (4) the summary of investigations; (5) the summary 
of examinations; (6) the summary of enforcement cases; and (7) the 
summary of listings information. Exchanges and associations would not 
be required to re-file copies of their board and committee agenda. The 
Commission believes that the compilation and

[[Page 71176]]

aggregation of the quarterly report information into the annual report 
should facilitate review of the annual report by the exchange's or 
association's management and board, including the proposed Chief 
Regulatory Officer and the proposed Regulatory Oversight Committee. 
Given the electronic nature of the quarterly reports, the Commission 
expects that an exchange or association should be able to compile the 
data easily. The Commission solicits comment, below, on this provision, 
including the attendant burden of aggregating the quarterly information 
into the annual report.
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    \474\ See proposed Rule 17a-26(b)(2)(i)-(vii).
---------------------------------------------------------------------------

2. Processes for Carrying Out Regulatory Responsibilities
    Proposed Rule 17a-26 would require exchanges and associations to 
report on their internal policies and procedures for carrying out their 
regulatory responsibilities on an annual basis.\475\ Under this 
provision, the Commission proposes to require each exchange and 
association to describe in detail its overall program of surveillance 
for member compliance with all applicable rules, laws, and regulations. 
The purpose of this requirement, among other things, is for the SRO to 
report on its designated examining authority responsibilities, as well 
as on its manual and automated surveillance programs, including the 
processes for ensuring compliance by its members with the SRO's rules, 
as well as the federal securities laws and regulations. By requiring 
exchanges and associations to prepare and submit this information 
yearly, the Commission should be better apprised of each exchange's or 
association's regulatory programs and processes and how they contribute 
to the SRO's fulfillment of its statutory and regulatory obligations. 
In addition, by preparing this report, exchanges and associations 
should have a better opportunity to focus on the effectiveness of their 
regulatory programs and to ascertain whether revisions to those 
programs are necessary. The Commission notes that the annual report is 
intended to provide a greater depth of information than would be 
provided in Exhibit H of revised Form 1 and new Form 2 \476\ with 
respect to the exchange's or association's regulatory programs. The 
annual report also would need to highlight and summarize any new, 
revised, or terminated surveillance programs and discuss the reasons 
for such change.\477\
---------------------------------------------------------------------------

    \475\ See proposed Rule 17a-26(b)(3)(i).
    \476\ See supra Section IV.C.6. (discussing proposed Exhibit H 
to revised Form 1 and new Form 2).
    \477\ Paragraph (d)(1) of proposed Rule 17a-26 would require 
exchanges and associations to file with the Commission a supplement 
in the event that the exchange or association implements, revises, 
or discontinues any manual or automated surveillance programs in the 
period between quarterly reports. The annual report should highlight 
and summarize any material reported pursuant to the interim changes 
provision, which is discussed in Section V.H. below.
---------------------------------------------------------------------------

    Each exchange and association would be required to identify the 
staff responsible for carrying out the SRO's regulatory and supervisory 
responsibilities by providing an organization chart detailing the 
various regulatory groups or divisions according to their areas of 
responsibility, and noting the names of staff and supervisors in each 
group or division.\478\ This information is intended to provide the 
Commission with information about the organizational structure, and the 
lines of authority and areas of responsibility, with respect to the 
SRO's regulatory program.
---------------------------------------------------------------------------

    \478\ See proposed Rule 17a-26(b)(3)(i).
---------------------------------------------------------------------------

3. Evaluation of the Regulatory Program
    To complement the information provided by exchanges and 
associations pursuant to proposed Exhibit H of revised Form 1 and new 
Form 2, which would require exchanges and associations to describe 
generally their regulatory program and publicly disclose this 
information,\479\ proposed Rule 17a-26 would require exchanges and 
associations to file with the Commission an evaluation of the 
effectiveness of their regulatory programs in effect during the 
reporting period.\480\ An exchange or association would provide a 
discussion of the particular strengths and weaknesses of its regulatory 
program, as well as a discussion of any planned revisions to the 
regulatory program in response to any weaknesses, including those 
weaknesses uncovered during the process of preparing the quarterly and 
annual reports. In this regard, exchanges and associations would need 
to provide candid discussions of the overall operation and 
effectiveness of their regulatory programs, and would need to highlight 
the areas in which their programs should be improved. The Commission 
believes that this information should allow it to better monitor the 
operations of an SRO's regulatory program, with a particular emphasis 
on potential challenges to and weaknesses in an SRO's regulatory 
program. In addition, by preparing this information, SROs would be 
required to assess regularly the adequacy of their self-regulatory 
procedures and systems, and their ability to monitor properly the 
activity on their markets. The Commission also would expect this 
requirement to encourage closer cooperation between the Commission and 
the SROs in seeking solutions to regulatory challenges that SROs 
encounter.
---------------------------------------------------------------------------

    \479\ See supra Section IV.C.6. (discussing proposed Exhibit H 
to revised Form 1 and new Form 2).
    \480\ See proposed Rule 17a-26(b)(3)(ii).
---------------------------------------------------------------------------

4. Internal Controls
    Under the proposed rule, an exchange or association would have to 
provide in the annual report a discussion of the internal controls 
implemented by the exchange or association that are designed to detect, 
prevent, and control any conflicts of interest between its market and 
other business interests and its self-regulatory responsibilities, and 
to assure that the exchange or association appropriately carries out 
its self-regulatory responsibilities.\481\ The discussion would need to 
address the controls that assure the exchange or association adequately 
supervises its members, surveils for misconduct, and otherwise carries 
out its self-regulatory responsibilities even when the market 
operations and other commercial interests of the exchange or 
association create conflicting incentives.\482\ The discussion also 
would need to address the controls that the exchange or association has 
in place that assures it carries out its self-regulatory obligations 
under the Exchange Act.\483\ This provision is intended to assure that 
the exchange or association has the mechanisms in place to effectively 
control conflicts of interest arising from its business functions. The 
Commission expects exchanges and associations to remain acutely 
sensitive to the conflicts of interest that may arise between their 
commercial interests, including their facilities for the trading of 
securities, and their regulatory responsibilities. The periodic 
submission of information on the internal controls that address these 
conflicts should allow the Commission to better assess an SRO's ability 
to effectively carry out its regulatory obligations in the face of 
commercial pressures. Requiring an SRO to discuss its internal controls 
in the annual report also should help focus the SRO's attention on its 
internal controls and the operation of those controls.
---------------------------------------------------------------------------

    \481\ See proposed Rule 17a-26(b)(3)(iii).
    \482\ See id.
    \483\ See id.

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[[Page 71177]]

5. Employment Arrangements With Regulatory Personnel
    Proposed Rule 17a-26 would require exchanges and associations to 
discuss the employment arrangements in effect between the exchange or 
association and its Chief Regulatory Officer and other senior 
regulatory program personnel.\484\ The exchange or association would 
need to provide information on all aspects of its employment 
arrangements with its Chief Regulatory Officer and other senior 
regulatory program personnel, including salary and bonus levels and 
benefits and other cash and non-cash compensation paid to these 
individuals. This information would aid the Commission in its 
understanding and knowledge of the compensation arrangements for the 
most senior personnel at an exchange or association who are charged 
with carrying out the SRO's regulatory responsibilities.
---------------------------------------------------------------------------

    \484\ See proposed Rule 17a-26(b)(3)(iv) and supra note 167 for 
a discussion of the term ``senior regulatory personnel.''
---------------------------------------------------------------------------

6. Copies of Standing Committee Evaluations
    Proposed Rule 17a-26 would require an exchange or association to 
file with the Commission copies of the most recent annual performance 
self-evaluation, as would be required by proposed Rules 6a-5 and 15Aa-
3, of each Standing Committee of the board of a national securities 
exchange or registered securities association, as well as the proposed 
annual governance performance evaluation prepared by each exchange's or 
association's Governance Committee.\485\ This information would allow 
the Commission to review each Standing Committee's assessment of its 
fulfillment of the responsibilities set forth in the committee's 
charter and an assessment of the overall governance of the exchange or 
association by its Governance Committee. The proposed responsibilities 
of the Standing Committees, as set forth in proposed Rules 6a-5 and 
15Aa-3, generally are related to the self-regulatory functions of an 
exchange or association.
---------------------------------------------------------------------------

    \485\ See proposed Rule 17a-26(b)(3)(v). See supra Section 
II.B.3. for a discussion of proposed Rules 6a-5(f)(5), (g)(3), 
(h)(3), (i)(3), and (j)(6) and 15Aa-3, (f)(5), (g)(3), (h)(3), 
(i)(3), and (j)(6).
---------------------------------------------------------------------------

7. Compliance With Regulatory Plans
    Under the proposed rule, exchanges and associations would be 
required to provide annual information on their efforts to comply with 
any recommendations resulting from any inspection or examination 
conducted by Commission staff.\486\ Requiring exchanges and 
associations to provide periodic information on the status of their 
compliance with inspection recommendations should allow the Commission 
to respond more effectively to identified concerns and to monitor the 
implementation of recommended changes to an exchange's or association's 
regulatory program. Additionally, the proposed requirement should 
further encourage regular communication between exchanges and 
associations and the Commission's staff as a means to assist these SROs 
in tailoring and adjusting the implementation of the recommendations.
---------------------------------------------------------------------------

    \486\ See Rule 17a-26(b)(3)(vi).
---------------------------------------------------------------------------

F. Audit Report of Electronic SRO Trading Facilities

    Proposed Rule 17a-26 would require every exchange and association 
subject to the proposed rule that owns, operates, or sponsors an 
electronic SRO trading facility to file with the Commission, on an 
annual basis as part of the annual report, an audit report of an 
independent third party that assesses whether the operations of the 
electronic SRO trading facility comply with the rules governing the 
facility.\487\ The purpose of the proposed requirement is to determine 
whether the facility's design and implementation is consistent with the 
exchange's or association's rules relating to such system that have 
been filed with and approved by the Commission.
---------------------------------------------------------------------------

    \487\ See proposed Rule 17a-26(a)(2).
---------------------------------------------------------------------------

    For purposes of the proposed rule, an electronic SRO trading 
facility would be defined as a facility of an exchange or association 
that executes orders in securities on an electronic basis.\488\ An 
independent third party would include a party not affiliated with the 
exchange or association that is qualified to render an opinion on such 
matters. We are not mandating the category of persons or entities that 
are qualified to perform such an audit and prepare the audit report 
with respect to an electronic SRO trading facility so that SROs would 
have flexibility in retaining an appropriate party to conduct their 
electronic SRO trading facility audit and prepare the audit report. At 
a minimum, however, the independent third party must have the 
capability to assess whether the system's design and implementation 
complies with the rules governing the facility. The Commission believes 
that the proposed requirement is a reasonable means to determine 
whether the systems aspects of electronic SRO trading facilities align 
with the rules that govern those facilities (e.g., trading rules), 
particularly as electronic SRO trading facilities and their associated 
rules have become more complex over the years. This provision of the 
proposed rule is intended to evaluate the integrity of electronic SRO 
trading facilities with respect to compliance with applicable 
regulatory requirements and surveillance procedures.
---------------------------------------------------------------------------

    \488\ See proposed Rule 17a-26(j)(3).
---------------------------------------------------------------------------

G. Certifications

    All quarterly and annual reports filed with the Commission pursuant 
to proposed Rule 17a-26 would be required to be accompanied by a signed 
certification executed on behalf of the exchange or association by the 
CEO or an equivalent officer, representing that the information 
contained in the report is current, true, and complete as of the date 
filed with the Commission.\489\ Any supplemental filing submitted 
pursuant to proposed Rule 17a-26(d) also would need to be accompanied 
by a certification.\490\ The Commission intends for the certification 
requirement to reinforce to exchanges and associations the importance 
of informing and updating the Commission on the operation of their 
regulatory programs and to remain mindful of their obligations as self-
regulatory organizations.
---------------------------------------------------------------------------

    \489\ See proposed Rule 17a-26(c).
    \490\ See id.
---------------------------------------------------------------------------

H. Interim Changes

    Proposed Rule 17a-26 would specify that any material changes to or 
material developments that effect an exchange's or association's 
regulatory program must be reported to the Commission in a supplemental 
filing within 10 business days after the occurrence of such event or 
change, along with a discussion of the event or change and the reasons 
for any change.\491\ Examples of material changes that would require an 
exchange or association to file a supplement would include changes to 
the parameters of an exchange's or association's surveillance programs 
and any new, revised, or discontinued manual or automated surveillance 
programs that occurred since the filing of the previous quarterly 
report.\492\ An exchange or association also would be required to 
report a material change to the organization or staffing of its 
regulatory or supervisory department or unit within 10 business days of 
such change.\493\ The Commission believes that a 10 business day 
requirement

[[Page 71178]]

strikes an appropriate balance between allowing the Commission to have 
prompt notice of material changes and giving an SRO adequate time to 
prepare and file a supplement with the Commission.
---------------------------------------------------------------------------

    \491\ See proposed Rule 17a-26(d)(1).
    \492\ See Id.
    \493\ See proposed Rule 17a-26(d)(2).
---------------------------------------------------------------------------

I. Confidentiality of Reports

    An exchange or association could request confidential treatment of 
any report or other information that the exchange or association 
provides to the Commission pursuant to proposed Rule 17a-26. \494\ The 
Commission would accord confidential treatment to the information to 
the extent permitted by law, including the Freedom of Information Act 
(``FOIA''). \495\ An exchange or association would follow the 
procedures set forth in Rule 24b-2 under the Exchange Act to request 
confidential treatment of information filed pursuant to proposed Rule 
17a-26.\496\ With respect to the basis for requesting confidential 
treatment under FOIA, there are two exemptions that likely would be 
relevant to a Commission determination whether to grant confidential 
treatment for information filed with the Commission under proposed Rule 
17a-26. First, FOIA Exemption 8 provides an exemption for matters that 
are ``contained in or related to examination, operating, or condition 
reports prepared by, on behalf of, or for the use of an agency 
responsible for the regulation or supervision of financial 
institutions.'' \497\ Similarly, Commission Rule 80(b)(8), implementing 
FOIA Exemption 8, states that the Commission generally will not publish 
or make available to any person matters that are ``[c]ontained in, or 
related to, any examination, operating, or condition report prepared 
by, on behalf of, or for the use of, the Commission, any other Federal, 
state, local, or foreign governmental authority or foreign securities 
authority, or any securities industry self-regulatory organization, 
responsible for the regulation or supervision of financial 
institutions.'' \498\ The information required by proposed Rule 17a-26 
is material that would be submitted by SROs to their primary regulator 
in connection with and to facilitate the Commission's periodic 
inspections of exchanges and associations, and would supplement the 
Commission's examination and inspection program.\499\
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    \494\ See proposed Rule 17a-26(e).
    \495\ See 5 U.S.C. 552.
    \496\ See 17 CFR 240.24b-2.
    \497\ 5 U.S.C. 552(b)(8).
    \498\ 17 CFR 200.80(b)(8).
    \499\ See Section 17(b)(1) of the Exchange Act, 15 U.S.C. 
78q(b)(1) (providing that all records of exchanges and associations 
are subject to such reasonable, periodic, special, or other 
examinations by representatives of the Commission as the Commission 
deems necessary or appropriate in the public interest, for the 
protection of investors, or otherwise in furtherance of the purposes 
of the Exchange Act).
---------------------------------------------------------------------------

    Second, FOIA Exemption 4 provides an exemption for ``trade secrets 
and commercial or financial information obtained from a person and 
privileged or confidential.'' \500\ Commission Rule 80(b)(4)(iii), 
which implements FOIA Exemption 4, provides that this exemption is 
available for ``information contained in reports, summaries, analyses * 
* * arising out of, in anticipation of or in connection with an 
examination or inspection of the books and records of any person or any 
other investigation.'' \501\ The information to be filed with the 
Commission pursuant to the proposed rule concerns regulatory and 
supervisory processes of SROs, and may contain trade secrets and 
commercial information, such as information involving the proprietary 
design of an exchange's or association's surveillance systems.
---------------------------------------------------------------------------

    \500\ 5 U.S.C. 552(b)(4).
    \501\ 17 CFR 200.80(b)(4)(iii).
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J. Compliance Date

    The first quarterly report required by proposed Rule 17a-26 would 
be due for the first full quarterly reporting period commencing six 
months after the publication of any final rule in the Federal 
Register.\502\ The Commission believes that this implementation period 
would allow exchanges and associations sufficient time to begin 
tracking, to the extent they are not currently doing so, all categories 
of information required by the proposed rule, as well as to develop an 
electronic format for filing the proposed reports.
---------------------------------------------------------------------------

    \502\ See proposed Rule 17a-26(f).
---------------------------------------------------------------------------

K. Exemptions and Extensions of Time for Filing Reports

    Under Rule 17a-26 as proposed, the Commission would consider 
granting an extension of time for the filing of any reports or 
materials required by the proposed rule, upon the written request of an 
exchange or association or upon its own motion, if it determines that 
such extension is necessary or appropriate in the public interest and 
is consistent with the protection of investors.\503\ In addition, upon 
the written request of the exchange or association or on its own 
motion, the Commission would consider granting an exemption from any of 
the proposed rule's requirements, either unconditionally or on 
specified terms and conditions, if it determines that such exemption is 
necessary or appropriate in the public interest and is consistent with 
the protection of investors.\504\ The proposed rule also would exempt 
from its reporting requirements all notice-registered exchanges and 
limited purpose securities associations.\505\
---------------------------------------------------------------------------

    \503\ See proposed Rule 17a-26(g).
    \504\ See proposed Rule 17a-26(h)(1).
    \505\ See proposed Rule 17a-26(h)(2). See also 15 U.S.C. 78f(g) 
(notice-registered exchanges) and 78o-3(k)(1) (limited purpose 
securities associations).
---------------------------------------------------------------------------

L. Filing of Reports

    Each report required by Proposed Rule 17a-26 shall constitute a 
``report'' within the meaning of the Exchange Act, including the books 
and records provision of Sections 17(a) and the liability provisions of 
Sections 18(a) and 32(a). \506\ In proposing this provision of the 
proposed rule, the Commission intends to specify that the reports 
submitted pursuant to proposed Rule 17a-26 would be subject to the 
general books and requirements of the Exchange Act and would be subject 
to the Exchange Act's provisions governing liability for misleading 
statements in reports filed with the Commission.
---------------------------------------------------------------------------

    \506\ See proposed Rule 17a-26(i). See also 15 U.S.C. 78q(a) 
(Section 17(a) under the Exchange Act requiring the maintenance of 
certain books and records); 78r(a) (Section 18(a) under the Exchange 
Act providing for liability for misleading statements); and 78ff(a) 
(Section 32(a) under the Exchange Act providing for penalties for 
willful violations and false and misleading statements).
---------------------------------------------------------------------------

M. Request for Comment

    The Commission invites interested persons to submit written 
comments on proposed Rule 17a-26. The Commission specifically requests 
comments on the following aspects of the proposed rule:
    Question 125. Is the proposed rule sufficiently clear regarding the 
information that is proposed to be required to be filed in the 
quarterly and annual reports? Are there any categories of information 
that should be added or deleted?
    Question 126. Are there provisions of the proposed rule that would 
be difficult for an exchange or association to satisfy and, if so, how 
could the provision in question be better tailored to assist in 
compliance?
    Question 127. Are the time frames for providing quarterly reports, 
i.e., within 20 business days after the calendar quarter end, and 
annual reports, i.e., within 60 days after the year end, appropriate? 
Should they be shorter, e.g., 10 business days after the end of the 
calendar quarter end for the

[[Page 71179]]

quarterly report, or longer, e.g., 75 or 90 days after the year's end 
for the annual report?
    Question 128. Should the quarterly and annual reports required by 
the proposed rule be based on the SRO's fiscal year, rather than on a 
calendar year basis? Are there reporting requirements in the proposed 
rule that should be filed on a fiscal year basis?
    Question 129. Should the Commission require a fourth quarter report 
to be filed 20 business days after the calendar year end, given the 
requirement to file an annual report 60 days after the year end and the 
fact that the annual report would contain, in an aggregated form, 
information from the fourth quarter? If the Commission decides to 
require filing of only the first three quarterly reports, how could the 
information for the fourth quarter be separated in the annual report? 
Should it be separated in the annual report?
    Question 130. Are there issues presented by requiring the report of 
an annual independent audit to assess the operations of an exchange's 
or association's electronic SRO trading facility for compliance with 
all applicable SRO rules and with the federal securities laws and 
regulations? Are there other ways for the Commission to achieve the 
same result, i.e., to determine that the operation of any electronic 
SRO trading facility is conducted in accordance with all applicable 
statutory provisions and rules? Does the proposal provide sufficient 
time for the independent audit report to be prepared and incorporated 
into the annual report? If not, what time period would be sufficient? 
Should the audits be required more or less often? Should the Commission 
establish specific criteria to determine the entities qualified to 
conduct such an audit and prepare a report? Should the audit be 
required to be conducted by an independent auditor? Would independent 
public auditor be capable of conducting such audits? How much would 
such an audit cost?
    Question 131. Are any issues presented by the Commission's proposed 
requirement that exchanges and associations establish procedures for 
the preparation of the quarterly and annual reports in a uniform, 
readily accessible, and usable electronic format? Should the Commission 
mandate the use of a particular format? Should the Commission require 
exchanges and associations to work together to develop a plan for 
filing the required reports in a standard electronic format? What role 
should the Commission play in such a process?
    Question 132. If the Commission were to adopt a technological 
standard for the format of the electronic quarterly and annual reports, 
what standard would be appropriate? The Commission's primary concern in 
considering a technological standard is to minimize costs to the 
exchanges and associations, allow for easy manipulation and use of the 
data submitted, and not unduly restrict the development and adoption of 
new technological standards and formats. What standard or method would 
best serve to accomplish these goals? To what extent should the 
electronic reports be in a Microsoft Excel-type format versus a XML 
``data tagging'' language format? If data tagging is the better 
approach, would XML, or a variation thereof, be an appropriate 
standard? To what extent does the appropriate electronic format depend 
upon the type and amount of data that would be required under the 
proposed rule?
    Question 133. Should the Commission specify a method by which 
exchanges and associations file the proposed information, such as CD-
ROM? Should the Commission explore the creation of a secure Web-based 
system for the filing of the required reports?
    Question 134. Would the requirement that the annual report contain 
an aggregation of the quarterly information for a given year be a 
relatively simple task, given the electronic nature of the reports? 
Would the inclusion of aggregated quarterly data in the annual report 
be helpful to an SRO's management, including its Chief Regulatory 
Officer and the Regulatory Oversight Committee, in reviewing the 
operation of the SRO's regulatory program on an annual basis? What 
arguments are there against requiring the annual report to contain the 
aggregated quarterly data?
    Question 135. Are there any items that should be added or deleted 
with respect to the results of surveillance programs, both manual and 
automated, and the results of surveillance for financial and 
operational requirements? Should the Commission require more or less 
detail on some or all of the items? Are there any alternatives to 
unique identifiers that could better accomplish the goals of tracking 
the information over time without including the identity of the member? 
Are there any issues presented by requiring the unique identifiers to 
be constant over time?
    Question 136. Are there any items that should be added or deleted 
in connection with the summaries of complaints, investigations, 
examinations, and enforcement cases? Should the Commission require more 
or less detail on any of the subcategories mentioned under any of those 
items? Should the Commission require information on other categories of 
complaints? Are there any alternatives to unique identifiers that could 
better accomplish the goals of tracking the information over time 
without including the identity of the member and associated person 
under review? Are there any issues presented by requiring the unique 
identifiers to be constant over time?
    Question 137. Is the provision requiring reporting of listings 
activity, including reporting of securities that were delisted or 
otherwise reprimanded for failure to satisfy listing standards, 
appropriate? Should the listings information in the proposed quarterly 
reports be expanded to include information on SRO delisting decisions 
that were appealed during the reporting period? Should the summary 
contain additional information on compliance plans? Is there any other 
information that should be added or deleted from this provision?
    Question 138. Is the provision requiring an exchange or association 
to file with the Commission, as part of the quarterly report, copies of 
agenda for board and committee meetings appropriate? Should the 
Commission require the filing of the complete minutes for board and 
committee meetings, or, as an alternative, some specified portion of 
the minutes? If a specified portion were required, what should that 
portion include? Should the provision extend to subject matter 
committees that are not composed of directors and are not part of the 
official board committee structure?
    Question 139. Is the requirement that the annual report contain a 
discussion of the internal policies and procedures an exchange or 
association uses to carry out its regulatory responsibilities 
appropriate? Are there any items under this category that should be 
deleted or added?
    Question 140. Is the requirement that the annual report contain an 
organizational chart of the regulatory department appropriate? Should 
the Commission require more or less detail to be reported on this 
chart? Should the Commission require contact information and employee 
titles to be reported in the chart? Should the Commission limit or 
expand the categories of staff that need to be specifically identified 
in the chart?
    Question 141. Is the provision requiring the SRO to evaluate the 
effectiveness of its regulatory program, including strengths and 
weaknesses, appropriate? Are there other

[[Page 71180]]

requirements that should be included in or deleted from this provision?
    Question 142. Is the requirement that the annual report contain a 
discussion of the internal controls regarding conflicts of interest 
appropriate? Are there items that should be added or deleted from this 
provision?
    Question 143. Is the requirement that the annual report discuss the 
employment arrangements with the Chief Regulatory Officer appropriate? 
Is requiring a discussion of employment arrangements with senior 
regulatory program personnel appropriate? Should the Commission limit 
the coverage of this provision to the five most highly compensated 
regulatory personnel? If so, is five the appropriate number or should 
the number be higher or lower?
    Question 144. Is the requirement that the annual report contain a 
copy of the annual performance self-evaluation prepared by a national 
securities exchange's or registered securities association's standing 
committees, including its Nominating, Compensation, Audit, and 
Regulatory Oversight Committees, appropriate? Is the requirement to 
provide a copy of the annual performance evaluation prepared by the 
Governance Committee appropriate?
    Question 145. Is the requirement to discuss efforts to comply with 
any recommendations or plan resulting from a Commission inspection or 
examination appropriate?
    Question 146. Is the certification requirement appropriate? Is the 
chief executive officer the appropriate official to certify the 
quarterly and annual reports on behalf of the exchange or association? 
In light of the provision of proposed Rules 6a-5 and 15Aa-3, which 
would require exchanges and associations to establish a Chief 
Regulatory Officer, would it be more appropriate for the Chief 
Regulatory Officer to certify the required reports, or for both 
officers to certify?
    Question 147. Under the Commission's current rules, if an SRO 
wanted to request confidential treatment for information filed pursuant 
to proposed Rule 17a-26, the SRO would need to submit a request for 
confidential treatment pursuant to Rule 24b-2, and follow that Rule's 
procedures. As discussed above, each SRO subject to proposed Rule 17a-
26 would be required to submit quarterly and annual reports. In light 
of the regularity of filing of the proposed reports, should the 
Commission adopt a confidential treatment request procedure like Rule 
83? If the Commission adopts a procedure like Rule 83, are there ways 
that the Rule 83 procedure should be tailored in the context of Rule 
17a-26? If so, how?
    Question 148. Are the provisions relating to the reporting of 
interim changes to the regulatory program and regulatory department or 
unit appropriate? Are there any other interim changes or developments, 
in addition to the changes to surveillance programs and changes to the 
exchange's or association's regulatory department cited in the rule, 
that should specifically be mentioned as triggering an obligation to 
file a supplement with the Commission?
    Question 149. Are the defined terms appropriate and sufficiently 
clear? Is the definition of the term ``electronic SRO trading 
facility'' and ``regulatory subsidiary'' appropriate? Should the 
Commission add to, delete, or modify any of the defined terms in the 
proposed rule?

VI. Proposed Rule 17a-27

A. Background and Need for Proposed Rule 17a-27

    Proposed Rule 17a-27 would require a member of a national 
securities exchange or registered securities association that is a 
broker or dealer to provide notice to the Commission and the exchange 
or association of which it is a member when it acquires more than a 5% 
ownership interest in such exchange, association or in a facility of 
such exchange or association through which it is permitted to effect 
transactions. The proposed rule is designed to facilitate the ability 
of the Commission and each exchange and association to monitor the 
accumulation of significant ownership interests by members, so as to 
help ensure that exchanges and associations effectively perform their 
regulatory obligations to oversee the operations of their members and 
trading in their own markets, and to further the ability of the 
Commission to carry out its regulatory oversight of exchange and 
associations. This reporting requirement also is designed to complement 
proposed Rules 6a-5(o) and 15Aa-3(o), which would require exchanges and 
associations to have rules that prohibit their members that are brokers 
or dealers from owning and voting more than 20% of the exchange or 
association or a facility of the exchange or association, and proposed 
Items 2 and 3 of Exhibit Q to revised Form 1 and new Form 2, which 
would require an exchange or association to provide to the Commission 
information on all persons that own more than 5% of the exchange or a 
facility of the exchange or association.\507\
---------------------------------------------------------------------------

    \507\ See supra Sections II.B.9. and IV.C.9. for a detailed 
discussion of these proposed rules.
---------------------------------------------------------------------------

B. Description of Proposed Rule 17a-27

1. Brokers and Dealers Subject to the Rule
    Proposed Rule 17a-27 would require any member \508\ of an exchange 
or association that is a broker or dealer to file a statement with the 
Commission if such member, alone or together with its related persons, 
acquires, directly or indirectly, beneficial ownership \509\ of more 
than 5% of any class of securities or other ownership interest in a 
disclosure entity.\510\ For purposes of proposed Rule 17a-27, the term 
``disclosure entity'' would be defined to mean, with respect to a 
member, an exchange or association of which it is a member, or a 
facility of an exchange or association through which it is permitted to 
effect transactions.\511\ The term ``related persons'' would be defined 
in proposed Rule 17a-27(a)(13) to cover the same relationships as the 
term ``related persons'' in proposed Rules 6a-5 and 15Aa-3.\512\ As 
discussed above in Section II, the Commission believes it is important 
to capture all

[[Page 71181]]

potential relationships of a member with another person that could lead 
to the member having the ability to influence or control an exchange or 
association.\513\
---------------------------------------------------------------------------

    \508\ ``Member'' would be defined to have the meaning in Section 
3(a)(3) of the Exchange Act, 15 U.S.C. 78c(a)(3). See proposed Rule 
17a-27(a)(9).
    \509\ ``Beneficial ownership'' would be defined to have the 
meaning in Rule 13d-3 under the Exchange Act, 17 CFR 240.13d-3, as 
if (and whether or not) such security or other ownership interest 
were a voting equity security registered under Section 12 of the 
Act; provided that, to the extent any person beneficially owns any 
security or other ownership interest solely because such person is a 
member of a group within the meaning of Section 13(d)(3) of the 
Exchange Act, such person would not be deemed to beneficially own 
such security or other ownership interest for purposes of this 
section, unless such person had the power to direct the vote of such 
security or other ownership interest. See proposed Rule 17a-27(a)(3) 
and supra note 226.
    \510\ See proposed Rule 17a-27(b)(1). Proposed Rule 17a-27(c) 
also would require the member to provide a copy of the statement to 
the exchange or association, as applicable.
    \511\ See proposed Rule 17a-27(a)(6). The term ``disclosure 
entity'' would exclude exchanges registered under Section 6(g) of 
the Exchange Act, 15 U.S.C. 78f(g), and national securities 
associations registered under Section 15A(k) of the Exchange Act, 15 
U.S.C. 78o-3(k). Because the Commission does not have primary 
responsibility for regulating these exchanges and associations, 
members of such exchanges and associations would not be subject to 
proposed Rule 17a-27. See supra note 77.
    \512\ See proposed Rules 6a-5(b)(19) and 15Aa-3(b)(20). 
``Person'' would be defined to have the meaning in Section 3(a)(9) 
of the Exchange Act, 15 U.S.C. 78c(a)(9). See proposed Rule 17a-
27(a)(11). Members can be natural persons. If a member is a natural 
person, and a broker or dealer, it would be subject to the proposed 
Rule. If the member is not a broker or dealer, the member's 
affiliated broker or dealer (which would be subject to the rule) 
would be required to aggregate the member's interest with its own 
interest.
    \513\ See supra Section II.B.9. for a discussion of the proposed 
definition of related persons.
---------------------------------------------------------------------------

2. Information Required To Be Filed
    Any statement required to be filed by a member pursuant to proposed 
Rule 17a-27 would be required to include the following information: 
\514\
---------------------------------------------------------------------------

    \514\ See proposed Rule 17a-27(b)(2).
---------------------------------------------------------------------------

     The title of the class of securities or other ownership 
interests for which the member is required to file the statement, and 
the identity and form of organization of the disclosure entity; \515\ 
and
---------------------------------------------------------------------------

    \515\ See proposed Rule 17a-27(b)(2)(i).
---------------------------------------------------------------------------

     Such member's contact information, principal occupation 
(if the member is a natural person), and principal business (if the 
member is not a natural person).\516\
---------------------------------------------------------------------------

    \516\ See proposed Rule 17a-27(b)(2)(ii) and (iii).
---------------------------------------------------------------------------

    The member would be required to provide general information 
regarding the ownership interest that is the subject of the filing, 
including: (i) The total number of securities or other ownership 
interests of the disclosure entity issued and outstanding in each class 
or series; (ii) if the securities are publicly traded, the market(s) 
where they trade; (iii) any restrictions on ownership voting, 
transfers, or other disposition of such securities or other ownership 
interest of the disclosure entity; and (iv) any other material 
provisions relating to ownership of the disclosure entity.\517\ In 
addition, the member would be required to state whether the disclosure 
entity is a reporting issuer under Section 12 of the Exchange Act.\518\
---------------------------------------------------------------------------

    \517\ See proposed Rule 17a-27(b)(2)(iv).
    \518\ 15 U.S.C. 78l. See proposed Rule 17a-27(b)(2)(v).
---------------------------------------------------------------------------

    The member also would be required to state the aggregate number and 
percentage of shares of a class of securities or other ownership 
interest of the disclosure entity that are beneficially owned by the 
member.\519\ In addition, the member would be required to indicate the 
aggregate number of shares or other ownership interest as to which the 
member has sole power to vote or to direct the vote, shared power to 
vote or to direct the vote, sole power to dispose or to direct the 
disposition, or shared power to dispose or to direct the 
disposition.\520\ Also, if any other person is known to have the right 
to receive or the power to direct the receipt of dividends from, or the 
proceeds from the sale of, such securities or other ownership interest, 
the member would be required to include a statement to that effect and, 
if such interest relates to more than 5% of the securities or ownership 
interest, to identify such person.\521\ Further, the member would be 
required to separately identify each related person whose ownership in 
a disclosure entity is included in the calculation of beneficial 
ownership required to be disclosed by the member, and provide the same 
ownership information for the related person as for the member.\522\ As 
noted above in Section IV, these requirements are modeled on the 
information required to be included in Schedule 13D or 13G under the 
Exchange Act.\523\ The Commission believes these requirements are 
appropriate because the intent of proposed Rule 17a-27--to provide the 
Commission with up-to-date information on the ability of members to 
control or influence the exchange--is similar to the purpose of the 
disclosure requirements of Sections 13(d) and 13(g) of the Exchange Act 
and the rules thereunder.\524\
---------------------------------------------------------------------------

    \519\ See proposed Rule 17a-27(b)(2)(vi)(A). For purposes of 
making this percentage determination, a class of securities means 
the outstanding securities of such class, exclusive of any 
securities of such class held by or for the account of the 
disclosure entity (the issuer), or a subsidiary of the disclosure 
entity. See proposed Rule 17a-27(a)(4).
    \520\ See proposed Rule 17a-27(b)(2)(vi)(B).
    \521\ See proposed Rule 17a-27(b)(2)(vi)(C). A listing of the 
shareholders of an investment company registered under the 
Investment Company Act of 1940 or the beneficiaries of an employee 
benefit plan, pension fund or endowment fund would not be required.
    \522\ See proposed Rule 17a-27(b)(2)(vii) and supra notes 519-
521 and accompanying text.
    \523\ See supra Section IV.C.9.
    \524\ 15 U.S.C. 78m(d) and (g).
---------------------------------------------------------------------------

    The member also would be required to describe the power or ability 
of the member and its related persons to direct or cause the direction 
of the management and policies of the disclosure entity and any ability 
to exercise any influence or control over the regulatory 
responsibilities of the exchange or association.\525\ In addition, the 
member would be required to describe any contracts, arrangements, 
understandings or relationships (legal or otherwise) among the member 
and its related persons and between such persons and any other person 
with respect to any securities or other ownership interest of the 
disclosure entity, including but not limited to the transfer or voting 
of any of the securities or ownership interest, finder's fees, joint 
ventures, loan or option arrangements, put or calls, guarantees of 
profits, division of profits or loss, or the giving or withholding of 
proxies. Such disclosure also would be required with respect to any of 
the securities or other ownership interests that are pledged or 
otherwise subject to a contingency the occurrence of which would give 
another person voting power or investment power over such securities or 
interest, except the statement would not need to disclose any standard 
default or similar provisions contained in loan agreements. The member 
would be required to provide the names of the other parties to these 
contracts, arrangements, understanding or relationships.\526\
---------------------------------------------------------------------------

    \525\ See proposed Rules 17a-27(b)(2)(viii) and 17a-
27(b)(2)(ix).
    \526\ See proposed Rule 17a-27(b)(2)(x).
---------------------------------------------------------------------------

    Each statement filed by a member pursuant to this proposed rule 
would constitute a ``report'' within the meaning of Sections 17(a), 
18(a), and 32(a) of the Exchange Act, and any other applicable 
provisions of the Exchange Act.\527\ In addition, each statement 
required to be filed by a member pursuant to proposed Rule 17a-27 would 
be considered filed upon receipt by the Division of Market Regulation 
at the Commission's principal office in Washington, D.C.\528\
---------------------------------------------------------------------------

    \527\ 15 U.S.C. 78q(a), 78r(a), and 78ff(a). See proposed Rule 
17a-27(e)(i).
    \528\ See proposed Rule 17a-27(e)(ii).
---------------------------------------------------------------------------

    The disclosure requirements of proposed Rule 17a-27 are designed to 
provide information on members' significant interests in their 
regulators or a facility thereof. The Commission believes that this 
information would further the ability of the exchange or association to 
carry out its regulatory responsibilities with respect to its members, 
and for the Commission to perform its statutory oversight of the 
exchange or association, by helping to reduce the potential for 
conflict between a member and its regulator.
3. Timing of Filing
    A member would be required to make its initial filing of a 
statement under Rule 17a-27 within 10 calendar days of when it, 
together with its related persons, beneficially owns more than 5% of 
any class of securities or other ownership interest, as set forth in 
paragraph (b)(1) of the proposed rule.\529\ In addition, a member would 
be required to file an amendment to the statement within ten calendar 
days of any change in the information required to be provided. However, 
a member would not be required to amend its statement if there is an 
increase or decrease of less than 1% of the ownership interest last 
reported on the statement or any amendment thereto.\530\

[[Page 71182]]

The Commission believes the 10 day time period is reasonable in that it 
provides for timely disclosure by the member while still providing 
sufficient time to make and prepare the filing.
---------------------------------------------------------------------------

    \529\ See proposed Rule 17a-27(b)(3).
    \530\ See proposed Rule 17a-27(b)(4).
---------------------------------------------------------------------------

4. Filings With the Exchange or Association
    A member also would be required to provide a copy of the statement 
and all amendments to the applicable exchange or association,\531\ and 
the exchange or association would be required to post a copy of the 
statement on its publicly-accessible Web site within 10 calendar days 
of receipt.\532\
---------------------------------------------------------------------------

    \531\ See proposed Rule 17a-27(c).
    \532\ See proposed Rule 17a-27(d).
---------------------------------------------------------------------------

5. Exemptions
    Finally, paragraph (f) of proposed Rule 17a-27 would provide a 
process for the Commission, upon written request or its own motion, to 
grant an exemption from the provisions of the proposed rule, either 
unconditionally or on specified terms and conditions, if the Commission 
determines that such exemption is necessary or appropriate in the 
public interest and is consistent with the protection of investors. 
Pursuant to this provision, the Commission would consider and act upon 
appropriate requests for relief from the rule's provisions and consider 
the particular facts and circumstances relevant to each such request, 
the potential ramifications of granting any exemption, and any 
appropriate conditions to be imposed as part of the exemption.

C. Request for Comment

    The Commission seeks general comments on all aspects of proposed 
Rule 17a-27 as described above. In addition, the Commission requests 
that interested persons respond to the following specific questions:
    Question 150. Would the information the Commission proposes to 
require members to provide to the Commission and the applicable SRO 
further SROs' ability to carry out their regulatory obligations? Would 
the information be useful to investors?
    Question 151. Is the definition of beneficial ownership 
appropriate? Is it too narrow? Or is it too broad?
    Question 152. Is the proposed definition of ``related persons'' too 
narrow? Too broad? Is there any other relationship that should be 
included?
    Question 153. Should any person associated with a member be 
included in the proposed definition of ``related person,'' or should 
only those associated persons that possess, directly or indirectly, the 
power to direct or cause the direction of management and policies of 
the member, whether through the ownership of voting securities, by 
contract, or otherwise be included within the definition of ``related 
person''?
    Question 154. Are the categories of information that would be 
required on the statement pursuant to proposed Rule 17a-27 appropriate? 
Are there other categories that should be included, or some that should 
be deleted?
    Question 155. Should the Commission require members to provide any 
information in addition to what is proposed? If so, what additional 
information should be required?
    Question 156. Is 10 days sufficient time for members to make the 
initial filing, or do commenters think that less time is necessary? Or 
is more than 10 days needed?
    Question 157. Is 10 days sufficient time for members to update 
information previously filed, or do commenters think that less time is 
necessary? Or is more than 10 days needed?
    Question 158. Is the proposed exclusion of members' ownership in 
notice registered national securities exchanges and limited purpose 
national securities associations from the scope of proposed Rule 17a-27 
appropriate? If not, why should they be included?
    Question 159. The proposal would only require members that are 
broker-dealers to file statements under Rule 17a-27; it would not 
require members that are natural persons and not registered as broker-
dealers to file such statements. The Commission asks for comment on 
whether all members should be subject directly to the proposed 
reporting requirement.
    Question 160. Should the Commission require that members provide 
the required information in a particular form? For instance, should the 
Commission create a standardized form to be used to file the reports 
required by proposed Rule 17a-27? If so, please provide detail as to 
the structure of such a form.
    Question 161. Should the Commission apply the proposed rule to 
those persons that are not statutory ``members'' but that own one or 
more memberships, or ``seats,'' in an exchange, but are not registered 
brokers or dealers and do not trade on or through the facilities of the 
exchange, but lease the trading right to a broker-dealer? If so, should 
it depend upon whether the person retains the voting rights associated 
with such membership?
    Question 162. Will members have access to, or the ability to obtain 
for each item, information that would be required to be filed pursuant 
to proposed Rule 17a-27? In particular, would a member be able to 
obtain the information required by paragraph (b)(2)(iv) on the total 
number of securities or other ownership interest issued and outstanding 
of a disclosure entity? Is there any information a member would not be 
able to easily obtain?

VII. Implementation

    The Commission is proposing to implement the proposed rules and 
rule amendments and proposed revisions to forms as follows:
    Proposed Rules 6a-5 and 15Aa-3 would require SROs to file proposed 
rule changes that comply with the applicable proposed rule's 
requirements no later than four months following the date of 
publication in the Federal Register of any governance rules adopted by 
the Commission, and would require that SROs have final rules approved 
by the Commission no later than ten months following such publication 
date. The SROs' rule changes would have to be operative no later than 
one year following the publication date of any governance rules adopted 
by the Commission.
    Regulation AL would be operative one year following the date of 
publication in the Federal Register of the adoption of proposed 
Regulation AL.
    Revised Form 1 and new Form 2 would become effective 30 days 
following the date of publication in the Federal Register of the 
adoption of the proposed amendments to these forms in the case of those 
applicants whose registration forms have not yet been approved by the 
Commission as of such publication date. The proposed amendments to 
Rules 6a-2 and 15Aa-2 also would become effective 30 days following the 
date of publication in the Federal Register of the adoption of these 
proposed amendments in the case of those applicants whose registration 
forms have not yet been approved by the Commission.
    Pursuant to proposed paragraph (g) of Rule 6a-2 and proposed 
paragraph (f) to Rule 15Aa-2, any exchange or association that is 
registered with the Commission as of the publication date of the 
adoption of proposed amendments to these Commission rules would be 
required to file a complete new statement together with all exhibits no 
later than six months following such publication date. Until such 
filing, currently-registered exchanges and associations could continue 
to rely on the requirements of the current registration forms and the 
related rules.

[[Page 71183]]

    The amendment to Rule 17a-1 would become effective 30 days 
following the date of publication in the Federal Register of the 
adoption of proposed amendments to Rule 17a-1.
    Under proposed Rule 17a-26, the first quarterly report would be due 
for the first full quarterly reporting period commencing six months 
following the date of publication in the Federal Register of the 
adoption of proposed Rule 17a-26.
    Finally, proposed Rule 17a-27 would become effective 60 days 
following the date of publication in the Federal Register of the 
adoption of proposed Rule 17a-27.
    We request comment on these proposed implementation dates and 
whether they would provide sufficient time for SROs to comply with the 
proposed new rules and rule amendments and the proposed revisions to 
the forms. We request comment on whether more or less time is necessary 
for exchanges and associations to review their governance and 
regulatory structures in light of the proposed governance rules and 
whether the proposed implementation schedule would provide sufficient 
time for the SROs to prepare proposed rule changes, prepare for 
necessary governance changes, and conform to the requirements relating 
to the independence of the regulatory programs from market operations 
and other commercial interests.
    We also seek comment on the feasibility of existing exchanges and 
associations preparing a complete new registration statement within the 
proposed six month time frame. We further recognize that many of the 
proposals are interrelated and thus some requirements cannot be 
complied with until all rule and form revisions are fully implemented, 
e.g., certain revised Form 1 and new Form 2 Exhibits relate to items 
proposed in the governance rules. Accordingly, we request commenters' 
views on an implementation schedule that would achieve the Commission's 
goal of having any final rules become operative as soon as feasible, 
yet provide exchanges and associations with sufficient time to comply 
with any new requirements.

VIII. General Request for Comment

    The Commission seeks comment on proposed Exchange Act Rules 3b-19, 
6a-5, 15Aa-3, 17a-26, and 17a-27; proposed amendments to current 
Exchange Act Rules 6a-2, 15Aa-1, 15Aa-2 (redesignated Rule 15Aj-1), and 
17a-1; proposed Regulation AL; proposed amendments to Form 1 and to 
Form 2 (redesignated Form X-15AA-1); and the proposed removal of Forms 
X-15AJ-1 and X-15AJ-2.
    We ask commenters to address whether the proposed rules are 
appropriately tailored to achieve the goal of furthering sound 
governance as well as the other applicable provisions of the Exchange 
Act by requiring SROs' boards to be composed of a majority of 
independent directors and Standing Committees to be fully independent 
and by mandating the independence of the SROs' regulatory functions 
from their market operations and other commercial interests. We also 
request comments on the need to, and appropriateness of, requiring 
exchanges and associations to limit the ability of their members that 
are brokers or dealers from owning or voting a significant stake in the 
exchange or association (or facility thereof), to reduce conflicts of 
interest and the potential for a member to influence or control its 
regulator in a manner detrimental to its competitors or in a manner 
favorable to such member. In addition, we seek commenters' views 
regarding the proposal to enhance the transparency of SROs' governance 
and ownership structures and regulatory activities and its potential 
impact on users of the SROs' trading facilities, other market 
participants, and the public generally. Further, we seek comment on the 
proposed disclosure items of revised Form 1 and new Form 2, and the 
timing and form of amendments to proposed Rules 6a-2, 15Aa-1, and 15Aa-
2. We specifically request comment on the ability of an exchange or 
association to obtain the ownership information necessary to comply 
with the ownership disclosure requirements of revised Form 1 and new 
Form 2.
    We ask commenters to address Rule 17a-26, including whether there 
are items of information that should be added or deleted in the 
quarterly and annual reports to the Commission. We also specifically 
request comment on the effectiveness of proposed Regulation AL to 
enhance an exchange's or association's monitoring of listing and 
trading of affiliated securities and thus to reduce the potential 
conflicts inherent in such oversight, and whether proposed Regulation 
AL would provide adequate guidance for preparing and filing the 
required quarterly and annual reports. We also seek comment on the 
usefulness of the disclosures required by proposed Rule 17a-27. We 
request comment on whether proposed Rule 17a-27 is too broad or narrow 
in its reach and whether the Commission should prescribe a form for 
providing such disclosures. We also seek comment on the various 
proposed definitions and the proposed numerical criteria and threshold 
values that are contained in the proposed rules. We seek comments on 
the proposals as a whole, including their interaction with each other, 
and whether they would achieve their intended goals.
    Commenters should, when possible, provide us with empirical data to 
support their views. Commenters suggesting alternative approaches 
should provide comprehensive proposals, including any conditions or 
limitations that they believe should apply. The Commission also invites 
commenters to provide views and data concerning the costs and benefits 
associated with the proposed new rules and amendments to existing rules 
and forms.

International Commenters

    The Commission shares the goal of the international regulatory 
community in seeking greater convergence of robust standards for 
oversight of the securities markets, and recognizes that the proposals 
described above would impact foreign exchanges seeking to conduct 
business directly in the U.S. market. Accordingly, we are interested in 
obtaining comment from foreign exchanges and market participants about 
these proposals. We are interested in general comments, and, 
specifically, the extent to which any of the proposals would cause 
conflicts with foreign law. In assessing the comments, the Commission 
will be mindful of the importance of its investor protection mandate 
and the need for a level playing field.
    We specifically request comment on the following topics:
    Question 163. With regard to the Governance Standards Proposal, are 
there any direct conflicts of law in your jurisdiction? Has your 
jurisdiction had recent experience with the issues raised by this 
proposal? If so, please describe the approach taken in your 
jurisdiction.
    Question 164. With regard to the Transparency Proposal, are there 
any direct conflicts of law in your jurisdiction? Has your jurisdiction 
had recent experience with the issues raised by this proposal? Please 
describe the types of reporting requirements to which exchanges in your 
jurisdiction are subject.
    Question 165. With regard to the SRO Reporting Proposal, are there 
any direct conflicts of law in your jurisdiction, in particular with 
regard to privacy laws? Has your jurisdiction had recent experience 
with the issues raised by this proposal? If so, please describe the 
approach taken in your jurisdiction.

[[Page 71184]]

    Question 166. With regard to the SRO Ownership Proposal, are there 
any direct conflicts of law in your jurisdiction? Has your jurisdiction 
had recent experience with the issues raised by this proposal? If so, 
please describe the approach taken in your jurisdiction.

IX. Paperwork Reduction Act Analysis

A. Proposed Rule 3b-19

    The proposed amendments to Rule 3b-19 under the Exchange Act do not 
impose recordkeeping or information collection requirements, or other 
collections of information that require approval of the Office of 
Management and Budget (``OMB'') under 44 U.S.C. 3501, et seq. 
Accordingly, the Paperwork Reduction Act does not apply.

B. Proposed Amendments to Rule 6a-2, Revised Form 1, Rule 15Aa-2, and 
New Form 2

    Proposed Rule 6a-2, revised Form 1, proposed Rule 15Aa-2, and new 
Form 2 contain ``collection of information'' requirements within the 
meaning of the Paperwork Reduction Act of 1995 (``PRA'').\533\ The 
Commission has submitted them to the OMB for review in accordance with 
44 U.S.C. 3507(d) and 5 CFR 1320.11. The title for the collection of 
information with respect to exchanges is ``Form 1 and Rules 6a-1 and 
6a-2: Form of Application and Amendments.'' The collection of 
information contains a currently approved collection of information 
under OMB control number 3235-0017. The title for the new collection of 
information with respect to associations is ``Form 2 and Rules 15Aa-1 
and 15Aa-2: Form of Application and Amendments.'' OMB has not yet 
assigned a control number for the new collection of information 
contained in proposed Rules 15Aa-1 and 15Aa-2 and new Form 2. An agency 
may not conduct or sponsor, and a person is not required to respond to, 
a collection of information unless it displays a currently valid 
control number.\534\
1. Summary of Collections of Information
    The Commission proposes to require that an applicant for 
registration as a national securities exchange, or an exemption from 
exchange registration based on limited volume, file Form 1, as proposed 
to be revised. An applicant for registration as a securities 
association or an affiliated securities association would be required 
to file Form 2 (formerly Form X-15AA-1), as proposed to be 
revised.\535\ Proposed Rule 6a-2 would require national securities 
exchanges to submit annual amendments and certain interim updating 
amendments to their registration application on the revised Form 1. 
Proposed Rule 15Aa-2 would require registered associations to submit 
annual amendments and certain interim updating amendments to their 
registration application on the new Form 2. The Commission also 
proposes to repeal Forms X-15AJ-1 and X-15AJ-2, which are now used by 
associations to file amendments to Form X-15AA-1.
    The proposals would require an exchange or association to disclose 
more detailed information about its governance, regulatory functions, 
and ownership in its registration form and amendments thereto. The 
current Form 1 Exhibits that would be incorporated in revised Form 1 
and new Form 2 require the following information:
     Copies of the applicant's constitution or articles of 
incorporation, by-laws, and rules (Exhibit A);
     Written rulings, settled practices and interpretations of 
the applicant (Exhibit B);
     Information about officers (current Exhibit J, proposed 
Exhibit D);
     Audited financial statements (Exhibit I);
     Separate financial statements for each affiliate of the 
applicant (current Exhibit D, proposed Exhibit J);
     General information about the applicant's affiliates and 
any unaffiliated entity that operates an SRO trading facility (current 
Exhibit C, proposed Exhibit K);
---------------------------------------------------------------------------

    \533\ 44 U.S.C. 3501, et seq.
    \534\ 44 U.S.C. 3512.
    \535\ The Commission also proposes to amend Rule 15Aa-1 under 
the Exchange Act, 17 CFR 240.15Aa-1, to state that associations 
would file an initial application for registration on new Form 2. 
This is a technical change that would not impose recordkeeping or 
information collection requirements, or other collections of 
information within the meaning of the PRA.
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     A description of the manner of operation of any SRO 
trading facility used to effect transactions on the applicant (current 
Exhibit E, proposed Exhibit L);
     A complete set of all forms pertaining to application for 
membership, participation or subscription to the applicant, application 
for approval as a person associated with a member, participant, or 
subscriber, and any other similar materials (current Exhibit F, 
proposed Exhibit M);
     A complete set of all forms of financial statements, 
reports or questionnaires required of members, participants, 
subscribers, or any other users relating to financial responsibility or 
minimum capital requirements (current Exhibit G, proposed Exhibit N);
     A complete set of documents comprising listing 
applications (current Exhibit H, proposed Exhibit O);
     A description of the criteria for membership, conditions 
leading to suspension or termination of membership, and any procedures 
for suspension or termination (current Exhibit L, proposed Exhibit R); 
and
     A list of all members, participants, subscribers or other 
users and general information about such person (current Exhibit M, 
proposed Exhibit S).
    The proposed additional Exhibits to the revised Form 1 and new Form 
2 would require enhanced disclosures of exchanges and associations, as 
follows:
     A description of the composition, structure, and 
responsibilities of the applicant's board of directors and information 
about its Chairman and/or Chief Executive Officer (Exhibit C);
     A description of the structure, composition and 
responsibilities of any executive board and committee of the applicant 
and a complete governance chart of the applicant (Exhibit E);
     Copies of the applicant's governance guidelines and code 
of conduct and ethics (and a disclosure of any waivers of the code) 
(Exhibit F);
     An organizational chart illustrating the internal 
governance structure of the applicant and indicating each department or 
division and their respective responsibilities (Exhibit G);
     A description of the applicant's regulatory program, 
including its independence from the other functions of the applicant, 
any significant planned changes in the applicant's regulatory program, 
and any significant regulatory issues or events that may affect the 
applicant's regulatory program and a copy of any delegation plans or 
other contracts relating to regulatory services to be provided to the 
applicant (Exhibit H);
     A detailed description of the applicant's financial 
activities, including an itemization of the applicant's revenues and 
expenses derived from the applicant's regulatory activities, an 
itemization of non-regulatory expenses, a discussion of information 
necessary to an understanding of the financial condition of the 
applicant and any material changes in its financial condition, a 
discussion of any unusual or infrequent events or transactions or any 
significant economic changes that have had a material effect on the 
financial condition of the applicant and any known demands, 
commitments, events or uncertainties that would result in or are 
reasonably likely to result in a

[[Page 71185]]

material change in financial condition, a description of any 
significant business development involving the applicant, a description 
of all material contracts and all material related party transactions, 
a description of material commitments by the applicant for expenditures 
as of the end of the latest fiscal period, certain charitable 
contributions of the applicant in excess of $1,000, a table detailing 
the compensation (and the material terms of the employment agreements) 
of the five most highly compensated executives of the applicant, and a 
description of the compensation provided to directors (Exhibit I);
     An organizational chart of the relationship between the 
applicant, any facility of the applicant, and any affiliate of the 
applicant or a facility of the applicant, and information about the 
nature and ownership structure of those entities (Exhibit P);
     Enhanced disclosures of the ownership interest of any 
applicant or facility (``disclosure entity''), and information on any 
person and its ``Related Persons'' that directly or indirectly 
beneficially owns more than 5% of any class of securities or other 
ownership interest in a disclosure entity (Exhibit Q);
     The location of where the applicant's books and records 
are maintained (Exhibit U); and
     A schedule of listed securities and securities admitted to 
unlisted trading privileges, including information about the ``self-
listing'' of the applicant, an SRO trading facility of the applicant, 
or any affiliate of the applicant or of an SRO trading facility of the 
applicant (current Exhibit N, proposed Exhibit T).
    The proposals further would require exchanges and associations to 
submit any amendments to revised Form 1 or new Form 2 on a basis more 
frequent than is currently required. Proposed Rules 6a-2 and 15Aa-2 
under the Exchange Act would require a national securities exchange, an 
exchange exempted from such registration as a national securities 
exchange based on limited volume, a national securities association, or 
an affiliated securities association to file an amendment to the 
revised Form 1 or new Form 2 (as applicable) within 10 calendar days 
after any material event takes place that renders inaccurate, or that 
causes to be incomplete: (i) Any information filed on the Execution 
Page of proposed Form 1 or new Form 2, or an amendment thereto; (ii) 
any information filed as part of proposed Exhibits C, D, E, H, I, J, K, 
M, N, O, P, S or U and as part of Item 3 of Exhibit F or Items 1, 5, 6, 
and 7 of Exhibit Q to the proposed Form 1 or new Form 2, or any 
amendments thereto; \536\ and (iii) information filed as part of Items 
2 or 3 of Exhibit Q, or any amendment thereto, except that such 
information is not required to be filed with respect to any person 
whose ownership change is less than 1% from the ownership interest last 
reported on the revised Form 1 or new Form 2, or any amendment 
thereto.\537\
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    \536\ See proposed Rules 6a-2(a)(1)-(2) and 15Aa-2(a)(1)-(2). 
The referenced Exhibits would solicit the following information: (1) 
Information regarding the composition, structure, and 
responsibilities of the Board (Exhibit C); (2) information with 
respect to the officers (Exhibit D); (3) information regarding the 
structure, composition, and responsibilities of the executive board 
and each committee (Exhibit E); (4) information regarding the 
regulatory program (Exhibit H); (5) audited financial statements 
(Exhibit I); (6) separate financial statements, including a balance 
sheet and an income statement and statement of cash flows (Exhibit 
J); (7) information regarding each affiliate of the applicant and 
any unaffiliated entity that operates an SRO trading facility 
(Exhibit K); (8) the forms pertaining to the application for 
membership, participation, or subscription (Exhibit M); (9) the 
forms of financial statements, reports, or questionnaires required 
of members, participants, subscribers, or any other users relating 
to financial responsibility or minimum capital requirements (Exhibit 
N); (10) documents comprising the applicant's listing applications, 
including any agreements required to be executed in connection with 
listing and a schedule of listing fees (Exhibit O); (11) information 
on exchanges, associations, their facilities, and their respective 
affiliates (Exhibit P); (12) list of members, participants, 
subscribers, or other users and general information about each 
(Exhibit S); (13) location of books and records (Exhibit U); (14) 
disclosure of any waivers of the code of conduct and ethics for 
directors or officers (Item 3 of Exhibit F); or (15) information 
about each class or series of outstanding securities or other 
ownership interest of an exchange, association, or facility of 
either; whether and how each person and Related Person possess the 
power to influence the management or policies of the exchange, 
association or facility; if a Disclosure Entity is a partnership, a 
list of partners that have the right to or have contributed more 
than 5% of the partnership's capital; and contracts, arrangements, 
understandings or relationships between such persons, and between 
such persons and any other person with respect to any securities or 
other ownership interest of the Disclosure Entity (Items 1, 5, 6, 
and 7 of Exhibit Q).
    \537\ See proposed Rules 6a-2(a)(3) and 15Aa-2(a)(3). Items 2 
and 3 of Exhibit Q would require the following information: (1) 
General information about any person who alone or together with its 
Related Persons, directly or indirectly beneficially owns more than 
5% of any class of securities or other ownership interest in a 
Disclosure Entity (Item 2 of Exhibit Q); and (2) information 
regarding each Related Person identified above whose ownership in a 
Disclosure Entity is included in the calculation of beneficial 
ownership and the number and percentage of shares of ownership 
interest of such security that are beneficially owned (Item 3 of 
Exhibit Q). See proposed Exhibit Q of revised Form 1 and new Form 2.
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    An exchange or association also would be required to file an annual 
amendment to update revised Form 1 or new Form 2 (as applicable) in its 
entirety within 60 days of the end of its fiscal year. With respect to 
this annual amendment, each Exhibit would be required to be up to date 
as of the end of the latest fiscal year of the exchange or 
association.\538\ An exchange or association also would be required to 
post continuously any amendments required to be filed under proposed 
Rules 6a-2(a)-(b) and 15Aa-2(a)-(b) on a publicly accessible Internet 
Web site, simultaneous with the filing of such information in paper 
form with the Commission.\539\
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    \538\ See proposed Rules 6a-2(b) and 15Aa-2(b).
    \539\ See proposed Rules 6a-2(c) and 15Aa-2(c). Pursuant to Rule 
6a-2(d), however, an exchange would not be required to file 
amendments under paragraphs (a) or (b) of proposed Rule 6a-2 with 
respect to Exhibits A, B, M, N, S, or T or Items 1-7 of Exhibit L in 
paper form, as long as the exchange or association makes such 
information continuously available on an Internet Web site under its 
control, indicates the location of the Web site where such 
information could be found, and certifies that the information 
available at such location is accurate as of its date.
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    In addition, exchanges and associations that are registered with 
the Commission as of the date of publication in the Federal Register of 
adoption of the proposed amendments to the forms would be subject to a 
one-time requirement to file a complete revised Form 1 or new Form 2, 
as applicable, no later than six months following such publication 
date.
2. Proposed Use of Information
    The purpose of the collections of information in proposed Rules 6a-
2 and 15Aa-2, revised Form 1, and new Form 2 is to keep the Commission, 
market participants, and the public informed of the governance and 
ownership structure and regulatory program of each applicant and 
harmonize the procedures for application as a national securities 
exchange and as a registered securities association and for the 
submission of amendment to such applications. The information required 
to be disclosed should enable the Commission, market participants, and 
the public to gain a greater awareness of key features of the 
exchange's or association's governance and ownership structure and its 
regulatory programs. The disclosure items on the revenues and 
expenditures of the SRO's regulatory programs should be particularly 
useful to the Commission, market participants, and the public.\540\ 
Further, the information collected should significantly enhance the 
transparency of each applicant's organizational and ownership structure 
and regulatory programs and assist the Commission in monitoring each 
applicant's compliance with the governance requirements contained in 
proposed Rules 6a-5 and 15Aa-3 under the Exchange Act.
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    \540\ See Sections 6(b)(1) and 15A(b)(2) of the Exchange Act, 15 
U.S.C. 78f(b)(1) and 78o-3(b)(2).

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[[Page 71186]]

3. Respondents
    The collection of information in Rule 6a-1, proposed Rule 6a-2, and 
revised Form 1 would apply to every registered national securities 
exchange and every exchange exempt from registration as a national 
securities exchange based on limited volume. Currently, there are nine 
registered securities exchanges.\541\ The collection of information in 
Rule 15Aa-1, proposed Rules 15Aa-2, and new Form 2 would apply to every 
national securities association and every affiliated securities 
association. Currently, there is one national securities 
association.\542\
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    \541\ These nine registered national securities exchanges are 
the Amex, BSE, CHX, CBOE, ISE, NSX, NYSE, PCX, and the Phlx. The 
collection of information does not apply to national securities 
exchanges registered under Section 6(g) of the Exchange Act and 
limited purpose securities associations registered under Section 
15(k) of the Exchange Act. Currently, Virt-X Exchange Limited 
(``Virt-X'') is operating under an exemption from registration as a 
national securities exchange based on limited volume. However, the 
Commission exempted Virt-X from Rules 6a-1, 6a-2 and 6a-3 under the 
Exchange Act. See Securities Exchange Act Release No. 41199 (March 
22, 1999), 64 FR 14953 (March 29, 1999). Therefore, the Commission 
has determined not to include Virt-X as a respondent to the 
collection of information.
    \542\ The national securities association is the NASD. There 
currently are no registered affiliated securities associations.
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4. Reporting and Recordkeeping Burden
    Based on the information available to the Commission at this time, 
the Commission estimates that an applicant for registration as a 
national securities exchange, a securities association, or an 
affiliated securities association, or for an exemption from 
registration as a national securities exchange based on limited volume 
would incur an average burden of 157 hours to obtain information 
necessary to, and to prepare, each initial Form 1 or Form 2 
application, respectively. The Commission estimates that the additional 
information required in Form 1, as proposed to be revised, would impose 
an additional paperwork burden of 110 hours on an applicant, for a 
total recordkeeping and reporting burden of 157 hours per 
applicant.\543\ Proposed Form 2 would be a completely new form, and 
therefore does not have an existing ``collection of information'' 
burden within the meaning of the PRA.\544\ However, because new Form 2 
would impose the same paperwork burden on association applicants that 
revised Form 1 would impose on exchange applicants, the Commission 
estimates that the paperwork burden for Form 2 also would be 157 hours 
per applicant. Those exchanges and associations that are registered 
with the Commission as of the publication date of adoption of the 
proposed revisions to the forms would be subject to a one-time 
requirement to file a complete new registration statement on Form 1 or 
Form 2, as applicable, within six months following such publication 
date, and thus they also would have an initial paperwork burden of 157 
hours each. The Commission estimates that any registered exchange or 
association, whose fiscal year ends after the date by which the one-
time complete new registration statement on revised Form 1 or new Form 
2, as applicable, would be required to be filed, but within the same 
calendar year that such one-time filing is required, would incur an 
additional reporting and recordkeeping burden of 20 hours for the first 
year to prepare an annual amendment to the revised Form 1 or new Form 
2, as applicable.
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    \543\ The current average burden of 47 hours for filing an 
initial application for registration on Form 1 is based on the 
Paperwork Reduction Act update as of Spring 2004.
    \544\ Current Rule 15Aa-1 under the Exchange Act, which 
prescribes Form X-15AA-1 as the initial registration application for 
associations, also does not have a pre-existing paperwork burden.
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    In addition, the Commission estimates that an applicant will incur 
a yearly burden of 40 hours to comply with the requirement in proposed 
Rules 6a-2 and 15Aa-2 to file annual and periodic amendments to revised 
Form 1 or new Form 2. This figure represents a 15 hour increase from 
the current Form 1 average burden due to the estimated additional 
burden of the annual reporting requirements.\545\
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    \545\ The current average burden of 25 hours for filing annual 
and periodic updates on Form 1 is based on the PRA update for Form 1 
as of Spring 2004.
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    Proposed Rules 6a-2 and 15Aa-2 also would require exchanges and 
associations to post their amendments on a publicly accessible Internet 
Web site. The Commission notes that exchanges and associations 
currently are required to maintain a publicly accessible Web site.\546\ 
The Commission estimates that an exchange or association would incur a 
paperwork burden of 4 hours to post its amendment on a publicly 
available Web site,\547\ and that the exchange or association would 
post an average of two amendments per year, for a total burden of 8 
hours annually per exchange or association. The Commission requests 
comment on its estimate of the average number of amendments an SRO 
would file per year, as well as on its estimate of how long it would 
take an exchange or association to post an amendment on its Web site. 
The Commission also requests comment as to whether an SRO would incur 
any start-up costs in preparation for compliance with this Internet 
posting requirement under proposed Rules 6a-2 and 15Aa-2.
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    \546\ See Rules 19b-4(l) and (m) under the Exchange Act, 17 CFR 
240.19b-4(l) and (m) (requiring SROs to post all proposed rule 
changes, as well as current versions of their rules, on their Web 
sites).
    \547\ The basis for the Commission's belief is the time 
estimated for posting by SROs on their Web sites of their proposed 
rule changes and current and complete versions of their rules. See 
Exchange Act Release No. 50486, supra note 423.
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    An applicant also would incur costs in the mailing of paper filings 
and copies to the Commission. The Commission estimates that the costs 
of mailing an initial application on revised Form 1 or new Form 2 would 
be $673.33.\548\ The costs of filing a complete registration form on 
revised Form 1 or new Form 2 no later than six months following the 
final rules publication date is also estimated by the Commission to be 
$673.33.\549\ The Commission estimates that the costs of mailing an 
amendment to revised Form 1 or new Form 2 would be $365.86.\550\
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    \548\ The Commission estimates that an initial application and 
copies would weigh approximately 180 lbs and would be mailed via 
courier/shipping service.
    \549\ Id.
    \550\ The Commission estimates that an amendment and copies 
would weigh approximately 60 lbs and would be mailed via courier/
shipping service.
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    The Commission estimates that total reporting and recordkeeping 
burden for an exchange that submits an initial registration or 
exemption application on the revised Form 1 would be 157 hours and 
$673.33 per applicant.\551\ For exchanges that are already registered 
with the Commission, the estimated reporting and recordkeeping burden 
for filing a complete revised Form 1 and any requisite updating 
amendments for the first year in which the final rules' are published 
would be 177 hours and approximately $1,039 per exchange. Thus, the 
Commission estimates that the total recordkeeping and reporting burden 
for all nine registered exchanges for the first year in which the final 
rules are published would be 1,593 hours and approximately $9,351. 
After the year in which an exchange initially files the revised Form 1, 
the Commission estimates that such exchange would bear an annual 
reporting and recordkeeping burden of 48 hours and $731.72, and that 
all exchanges would bear a total annual reporting and recordkeeping 
burden of 432 hours and approximately $6,585.
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    \551\ This total includes the burden of preparing and submitting 
the initial registration form, but does not include any initial 
start-up burden for creating a website (this is a burden on which 
the Commission is soliciting comments).
---------------------------------------------------------------------------

    The Commission estimates that total reporting and recordkeeping 
burden for

[[Page 71187]]

an association that submits an initial registration application on the 
new Form 2 would be 157 hours and $673.33 per applicant.\552\ For 
associations that are already registered with the Commission, the 
estimated reporting and recordkeeping burden for filing a complete new 
Form 2 and any requisite updating amendments for the first year in 
which the final rules are published would be 177 hours and 
approximately $1,039 per association. Thus, the Commission estimates 
that the total recordkeeping and reporting burden for the one 
registered association for the first year in which the final rules are 
published would be 177 hours and approximately $1,039. After the year 
in which an association initially files the new Form 2, the Commission 
estimates that such association would bear an annual reporting and 
recordkeeping burden of 48 hours and $731.72.
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    \552\ This total includes the burden of preparing and submitting 
the initial registration form, but does not include any initial 
start-up burden for preparation for compliance with the Internet 
posting requirement (this is a burden on which the Commission is 
soliciting comments).
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5. Collections of Information are Mandatory
    These collections of information would be mandatory. The 
collections of information filed with the Commission on revised Form 1 
and new Form 2 with the Commission would be available to the public.
6. Record Retention Period
    Exchanges and associations would be required to retain any 
collections of information required by revised Form 1 and new Form 2, 
respectively, in accordance with, and for the periods specified in, 
Exchange Act Rule 17a-1.\553\
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    \553\ 17 CFR 240.17a-1.
---------------------------------------------------------------------------

C. Proposed Rules 6a-5 and 15Aa-3

    Proposed Rules 6a-5 and 15Aa-3 contain ``collection of 
information'' requirements within the meaning of the PRA.\554\ The 
Commission has submitted them to the OMB for review in accordance with 
44 U.S.C. 3507(d) and 5 CFR 1320.11. The title of the new collection of 
information under proposed Rules 6a-5 and 15Aa-3 under the Exchange Act 
is ``Rules 6a-5 and 15Aa-3: Fair Administration and Governance of 
National Securities Exchanges and Registered Securities Associations.'' 
OMB has not yet assigned a control number for the new collection of 
information contained in proposed Rules 6a-5 and 15Aa-3 under the 
Exchange Act. An agency may not conduct or sponsor, and a person is not 
required to respond to, a collection of information unless it displays 
a currently valid control number.\555\
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    \554\ 44 U.S.C. 3501 et seq.
    \555\ See 44 U.S.C. 3512.
---------------------------------------------------------------------------

1. Summary of Collection of Information
    Proposed Rules 6a-5 and 15Aa-3 under the Exchange Act would require 
national securities exchanges and registered securities associations to 
comply with, and have rules that comply with, the proposed rules' 
requirements, which are designed to facilitate the fair administration 
and governance of exchanges and associations. Various provisions of the 
proposed rules' also would apply to any ``regulatory subsidiary'' of 
the exchange or association.\556\
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    \556\ Pursuant to proposed Rules 6a-5(b)(18) and 15Aa-3(b)(19), 
``regulatory subsidiary'' would mean any person that, directly or 
indirectly, is controlled by the national securities exchange or 
registered securities association, as applicable, and that provides, 
whether pursuant to contract, agreement or rule, regulatory services 
to or on behalf of the national securities exchange or registered 
securities association, as applicable. Several SROs have delegated 
to one or more subsidiaries the responsibility to carry out certain 
functions arising out of the SRO's obligations under the Exchange 
Act. See supra notes 78-81 and accompanying text.
---------------------------------------------------------------------------

    In particular, proposed Rules 6a-5(c)(2) and 15Aa-3(c)(2) under the 
Exchange Act would require the board of each SRO to affirmatively 
determine that each independent director has no material relationship 
with the national securities exchange or registered securities 
association, or any affiliate of the national securities exchange or 
registered securities association.\557\ The board must make this 
determination upon the director's nomination or appointment to the 
board and thereafter no less frequently than annually and as often as 
necessary in light of the director's circumstances.\558\ In order to 
allow the board to obtain the information necessary to make such 
determination, proposed Rules 6a-5(c)(3) and 15Aa-3(c)(3) would require 
a national securities exchange or registered securities association to 
establish policies and procedures to require each director, on his or 
her own initiative and upon request of the exchange or association, to 
inform the exchange or association of the existence of any relationship 
or interest that may reasonably be considered to bear on whether such 
director is an independent director. If the exchange or association 
were to request to receive this information from such directors, that 
would be a collection of information.
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    \557\ See proposed Rules 6a-5(c)(2) and 15Aa-3(c)(2).
    \558\ See id.
---------------------------------------------------------------------------

    In addition, proposed Rules 6a-5(o)(5) and 15Aa-3(o)(5) under the 
Exchange Act would require a national securities exchange or registered 
securities association to have an effective mechanism for obtaining 
information from any owner of any interest in such exchange or 
association or any facility of such exchange or association relating to 
such ownership interest. If the exchange or association were to request 
to receive such information from such owners, that would be a 
collection of information.
    Proposed Rules 6a-5(n)(4)(ii) and 15Aa-3(n)(4)(ii) under the 
Exchange Act would require national securities exchanges and registered 
securities associations to make and keep books and records necessary to 
evidence their compliance with proposed Rules 6a-5(n)(4)(i) and 15Aa-
3(n)(4)(i).\559\ However, the Commission believes that any reporting 
and recordkeeping burden that would be imposed by proposed Rules 6a-
5(n)(4)(ii) and 15Aa-3(n)(4)(ii) would fall under the paperwork burden 
for Rule 17a-1 under the Exchange Act, which requires exchanges and 
associations to keep a copy of all documents and other such records as 
shall be made or received by them in the course of their business as 
such and in the conduct of their self-regulatory activities for a 
period of not less than five years.\560\ The Commission preliminarily 
believes that exchanges already maintain records relating to the 
collection and use of regulatory fees, fines or penalties pursuant to 
Rule 17a-1 as part of their usual and customary activities and 
therefore such collection would not result in a burden under the 
PRA.\561\ The Commission requests comment on whether exchanges already 
maintain these records.
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    \559\ Proposed Rules 6a-5(n)(4)(i) and 15Aa-3(n)(4)(i) would 
prohibit an exchange or association, respectively, from applying 
regulatory fees, fines or penalties to fund anything other than 
programs and operations directly related to their regulatory 
responsibilities. See discussion supra at II.B.8.b.
    \560\ 17 CFR 240.17a-1.
    \561\ See 5 CFR 1320.3(b)(2).
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    With the exception of proposed Rules 6a-5(c)(3) and (o)(5) and 
15Aa-3(c)(3) and (o)(5), the Commission believes that any other 
collection of information, within the meaning of the PRA, that would be 
imposed by proposed Rules 6a-5 and 15Aa-3 would be covered pursuant to 
the approved collection of information for Exchange Act Rule 19b-
4.\562\ In this regard, the Commission notes that exchanges and 
associations likely would need to amend their rules (including their or 
their regulatory

[[Page 71188]]

subsidiary's or facility's constitutions, charters, bylaws, rules or 
other governing documents) to comply with proposed Rules 6a-5 and 15Aa-
3. Pursuant to Exchange Act Rule 19b-4, any such amendments would need 
to be filed with the Commission as proposed rule changes. The 
Commission notes that provisions of the proposed governance standards 
that would result in paperwork burdens for exchanges and associations, 
including with respect to any regulatory subsidiaries, would encompass: 
(i) A written charter for each Standing Committee; \563\ (ii) a code of 
conduct and ethics and governance guidelines; \564\ (iii) annual 
performance evaluations of each Standing Committee; \565\ (iv) policies 
and procedures to require each director to inform the exchange or 
association of the existence of any relationship or interest that may 
reasonably be considered to bear on whether such director is an 
independent director; \566\ (v) provisions relating to the fair 
representation of members; \567\ (vi) policies and procedures for the 
separation of regulatory and market functions; \568\ (vii) policies and 
procedures with respect to the dissemination of regulatory information 
and confidential information; \569\ and (viii) rules that limit 
ownership and voting by members.\570\ However, this collection of 
information would be collected pursuant to Exchange Act Rule 19b-4 and 
therefore would not be a new collection of information for proposed 
Rules 6a-5 and 15Aa-3.
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    \562\ 17 CFR 240.19b-4.
    \563\ See proposed Rules 6a-5(f)(2), (g)(2), (h)(2), (i)(2), and 
(j)(2) and 15Aa-3(f)(2), (g)(2), (h)(2), (i)(2), and (j)(2). The 
Standing Committees are the Nominating Committee, Governance 
Committee, Compensation Committee, Audit Committee, and Regulatory 
Oversight Committee. See proposed Rules 6a-5(b)(21) and 15Aa-
3(b)(22).
    \564\ See proposed Rules 6a-5(p) and (q) and 15Aa-3(p) and (q).
    \565\ See proposed Rules 6a-5(f)(5), (g)(3), (h)(3), (i)(3) and 
(j)(6) and 15Aa-3(f)(5), (g)(3), (h)(3), (i)(3) and (j)(6).
    \566\ See proposed Rules 6a-5(c)(3) and 15Aa-3(c)(3).
    \567\ See proposed Rules 6a-5(c)(4), (c)(7) and (f)(3) and 15Aa-
3(c)(4), (c)(7) and (f)(3).
    \568\ See proposed Rules 6a-5(n)(1) and 15Aa-3(n)(1).
    \569\ See proposed Rules 6a-5(n)(5) and 15Aa-3(n)(5).
    \570\ See proposed Rules 6a-5(o) and 15Aa-3(o).
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2. Proposed Use of Information
    The purpose of the collection of information in proposed Rules 6a-
5(c)(3) and 15Aa-3(c)(3) is to enable national securities exchanges and 
registered securities associations to monitor the independence of their 
directors. This collection of information would provide exchanges and 
associations with a mechanism to determine whether they are in 
compliance with the requirement that their board be composed of a 
majority of independent directors,\571\ as well as allow the board to 
affirmatively determine that a director has no material relationship 
with the exchange or association or any affiliate of the exchange or 
association.\572\
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    \571\ See proposed Rules 6a-5(c)(1) and 15Aa-3(c)(1).
    \572\ See proposed Rules 6a-5(c)(2) and 15Aa-3(c)(2).
---------------------------------------------------------------------------

    The purpose of the collection of information in proposed Rules 6a-
5(o)(5) and 15Aa-3(o)(5) is to enable national securities exchanges and 
registered securities associations to monitor ownership of the 
exchange, association, or facility thereof, and analyze their capacity 
to meet their statutory responsibilities under Sections 6, 15A, 17, and 
19 of the Exchange Act.\573\ In this manner, investor confidence in the 
integrity of the marketplace would be enhanced.
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    \573\ 15 U.S.C. 78f, 78o-3, 78q, and 78s.
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    Further, the collection of information may aid the exchange or 
association in complying with the disclosure requirements pertaining to 
director independence and ownership that are contained in revised Form 
1 and new Form 2.
3. Respondents
    The proposed collection of information in proposed Rules 6a-5(c)(3) 
and 15Aa-3(c)(3) would apply to nine national securities exchanges, one 
registered securities association and each director of a national 
securities exchange or registered securities association. The proposed 
collection of information in proposed Rules 6a-5(o)(5) and 15Aa-3(o)(5) 
would apply to nine national securities exchanges, one registered 
securities association and the owners of voting and ownership interests 
in each national securities exchange, national securities association, 
or facility of a national securities exchange or national securities 
association.
4. Reporting and Recordkeeping Burden
    The Commission is unable to estimate precisely how many responses 
per year would be generated by proposed Rules 6a-5(c)(3) and 15Aa-
3(c)(3), because any collection of information by an exchange or 
association from its directors would differ depending upon the number 
of directors on the exchange's or association's board, and also would 
depend on how often the board is required to request such information 
based on a director's circumstances. The Commission preliminarily 
estimates, however, that each exchange or association would request 
information approximately 2 times per year from approximately 17 
directors, and that each request for information and response from each 
director would require approximately 1 hour to prepare and $0.37 to 
send,\574\ for a total annual reporting and recordkeeping burden of 2 
hours and $0.74 per director and 34 hours and $12.58 per exchange or 
association, for a total annual reporting and recordkeeping burden of 
680 hours and approximately $252. The Commission specifically requests 
comment on these estimates.
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    \574\ The Commission assumes that each request and response will 
weigh one ounce and will be mailed via first class mail at a rate of 
$0.37 per ounce.
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    The Commission is unable to estimate precisely how many responses 
per year would be generated by proposed Rules 6a-5(o)(5) and 15Aa-
3(o)(5) under the Exchange Act, because any collection of information 
by an exchange or association from an owner of the exchange or 
association, or a facility of the exchange or association, would differ 
depending upon the number of shareholders or other owners of the 
exchange, association or facility. The Commission preliminarily 
estimates, however, that each exchange or association would request 
information approximately 2 times per year from approximately 500 
owners and that it would cost each exchange or association $1.29 \575\ 
to mail the request to each owner, resulting in a total annual cost of 
$1,290 to each exchange or association and $12,900 annually for all 
exchanges and associations. The Commission also estimates that the 
initial preparation and sending of the request for information would 
require approximately 4 hours, the preparation and sending of each 
subsequent request would require 2 hours, and reviewing the responses 
to each of the 2 annual requests for information would require 5 hours, 
for a total initial annual reporting and recordkeeping burden of 16 
hours for each exchange or association and an annual burden of 14 hours 
thereafter, and a total initial annual burden for all exchanges and 
associations of 160 hours and an annual burden of 140 hours thereafter. 
The Commission preliminarily estimates that each owner would require 1 
hour

[[Page 71189]]

to prepare and $1.29 \576\ to send to the exchange or association his 
or her response to the request, for a total annual reporting and 
recordkeeping burden of 2 hours and $2.58 for each owner and a total 
annual burden for all owners of 10,000 hours and $12,900. The 
Commission requests comment on these estimates.
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    \575\ The Commission assumes that the request will weigh five 
ounces and will be mailed via first class mail at a rate of $0.37 
for the first ounce and $0.23 for each additional ounce, for a total 
of $1.29.
    \576\ The Commission assumes that each response will weigh five 
ounces and will be mailed via first class mail at a rate of $0.37 
for the first ounce and $0.23 for each additional ounce, for a total 
of $1.29.
---------------------------------------------------------------------------

    Thus, the Commission estimates that the total annual reporting and 
recordkeeping burden for proposed Rules 6a5-3 and 15Aa-3 would be 
10,840 hours and approximately $26,052. The Commission requests comment 
on this estimate.
5. Collection of Information is Mandatory
    The collection of information under proposed Rules 6a-5(c)(3) and 
(o)(5) and 15Aa-3(c)(3) and (o)(5) would be mandatory. The collection 
of information under proposed Rules 6a-5(c)(3) and 15Aa-3(c)(3) would 
be required from directors of the exchange or association upon the 
request of the exchange or association. The collection of information 
under proposed Rules 6a-5(o)(5) and 15Aa-3(o)(5) would be required from 
owners of an exchange or association, or a facility of the exchange or 
association, upon the request of the exchange or association. The 
ownership information would be made public if such information were 
required to be disclosed by the exchange or association pursuant to the 
proposed changes to revised Form 1 and new Form 2, which would require 
exchanges and associations to report certain information with regard to 
any person that, alone or together with its related persons, directly 
or indirectly beneficially owns more than 5% of any class of securities 
or other ownership interest in the exchange, association, or any 
facility of the exchange or association.\577\
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    \577\ See supra Sections IV.C.2. and IV.C.9. for a discussion of 
Exhibits C and Q in revised Form 1 and new Form 2.
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6. Record Retention Period
    Exchanges and associations would be required to retain any 
collection of information required under proposed Rules 6a-5(c)(3) and 
(o)(5) and 15Aa-3(c)(3) and (o)(5), as applicable, in accordance with, 
and for the periods specified in, Exchange Act Rule 17a-1.\578\
---------------------------------------------------------------------------

    \578\ 17 CFR 240.17a-1.
---------------------------------------------------------------------------

D. Proposed Regulation AL

    Proposed Regulation AL contains ``collection of information'' 
requirements within the meaning of the PRA.\579\ The Commission has 
submitted them to the OMB for review in accordance with 44 U.S.C. 
3507(d) and 5 CFR 1320.11. The title of the new collection of 
information under proposed Regulation AL under the Exchange Act is 
``Regulation AL.'' OMB has not yet assigned a control number to the new 
collection of information contained in proposed Regulation AL under the 
Exchange Act. An agency may not conduct or sponsor, and a person is not 
required to respond to, a collection of information unless it displays 
a currently valid control number.\580\
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    \579\ 44 U.S.C. 3501, et seq.
    \580\ 44 U.S.C. 3512.
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1. Summary of Collection of Information
    Pursuant to proposed Rule 800(b)(2)(i), if an affiliated security 
is listed on, approved for trading on, or trades pursuant to the rules 
of, a national securities exchange or registered securities 
association, the exchange or association would be required to file 
quarterly reports with the Commission summarizing such exchange's or 
association's (1) monitoring of the affiliated security's compliance 
with the exchange's or association's listing rules, including an 
explanation of such affiliated security's compliance with each 
applicable rule, and (2) surveillance of the trading of the affiliated 
securities by its members.\581\
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    \581\ Such report must be approved by the exchange's or 
association's Regulatory Oversight Committee. See proposed Rule 
800(c)(i).
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    Pursuant to proposed Rule 800(b)(2)(ii), if an affiliated security 
is listed on, approved for trading on, or trades pursuant to the rules 
of, a national securities exchange or registered securities 
association, the exchange or association would be required to file 
annually with the Commission a report prepared by a third party 
analyzing compliance by the affiliated security with the exchange's or 
association's listing rules.\582\ Moreover, proposed Rule 
800(b)(2)(iii)-(v) would require, in the event that the exchange or 
association alleges that the affiliated security is not in compliance 
with any applicable listing rule of the exchange or association, the 
exchange or association to: (1) Promptly notify the affiliated issuer; 
(2) file a report with the Commission within five days of providing 
such notice to the affiliated issuer, identifying the date on which the 
exchange or association alleged that the affiliated security was not in 
compliance, the action the exchange or association proposes to take, 
the applicable listing rule, and any other material information 
conveyed to the affiliated issuer; \583\ and (3) provide the Commission 
with a copy of any response from the affiliated issuer regarding its 
alleged non-compliance.
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    \582\ Such report must be filed no later than 60 calendar days 
following the end of the exchange's or association's fiscal year. 
See proposed Rule 800(b)(2)(ii).
    \583\ Such report must be approved by the exchange's or 
association's Regulatory Oversight Committee. See proposed Rule 
800(c)(i).
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2. Proposed Use of Information
    The purpose of the collection of information in proposed Regulation 
AL is to provide further assurance that SROs carry out their regulatory 
responsibilities under the Act with respect to surveillance of 
affiliated securities, and provide the Commission greater ability to 
monitor the efforts of SROs.
3. Respondents
    If an affiliated security is listed on, approved for trading on, or 
trades pursuant to the rules of, an exchange or association, the 
exchange or association would be required to comply with proposed 
Regulation AL. The Commission estimates that eight registered national 
securities exchanges and one registered securities association would 
potentially be subject to proposed Regulation AL.\584\
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    \584\ ISE, which does not have rules to list or trade any 
securities other than standardized options (which the Commission has 
proposed to exempt from the definition of ``affiliated security''), 
would not be subject to proposed Regulation AL. In addition, because 
the Commission has proposed to exempt security futures products from 
the definition of ``affiliated security,'' the two national 
securities exchanges registered pursuant to Section 6(g) of the 
Exchange Act and the limited purpose national securities association 
registered pursuant to Section 15A(k) of the Exchange Act would not 
be required to comply with proposed Regulation AL.
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4. Reporting and Recordkeeping Burden
    Although it is difficult to predict how often an exchange or 
association would list or trade an affiliated security that would 
trigger the requirements of proposed Regulation AL, for purposes of 
this Paperwork Reduction Act analysis the Commission estimates one such 
occurrence for each exchange and association.\585\ The Commission 
specifically requests comment on this estimate.
---------------------------------------------------------------------------

    \585\ The Commission notes that currently one exchange and one 
association would be subject to proposed Regulation AL with respect 
to one affiliated security each.
---------------------------------------------------------------------------

    With regard to the requirement of proposed Rule 800(b)(2)(i) that 
would require an exchange or association to

[[Page 71190]]

file quarterly reports with the Commission summarizing its monitoring 
of the listing and trading of the affiliated security on its 
facilities, the Commission understands that the exchanges and 
associations already have in place systems to monitor the compliance of 
listed securities with their listing rules and to monitor the trading 
of such securities through their facilities. The Commission 
preliminarily does not believe that exchanges or associations would 
need to make significant changes to these systems to comply with 
proposed Regulation AL, and that the cost of the monitoring and 
surveying pursuant to proposed Rule 800(b)(2)(i) would be incremental 
and insubstantial. The Commission recognizes, however, that exchanges 
and associations may need to conduct a review of an affiliated 
security's compliance with its listing standards more frequently to 
meet the quarterly reporting requirements, if the exchange or 
association does not currently conduct such review at least quarterly. 
The Commission preliminarily believes that exchanges and associations 
currently review for compliance on a quarterly basis, but assumes for 
purposes of estimating the burden of these proposed requirements that 
each SRO would perform two additional reviews per year and that an 
exchange or association would incur an additional burden of 8 hours per 
review, resulting in a total annual reporting and recordkeeping burden 
of 144 hours. The Commission requests comment on this estimate and 
whether SROs would need to perform any additional reviews to comply 
with the proposed requirements.
    In addition, the Commission estimates that each of the eight 
registered national securities exchanges and the one registered 
securities association would spend $1.29 \586\ to send each report to 
the Commission, 17 hours preparing and filing the initial quarterly 
report and 12 hours for each quarterly report thereafter to comply with 
the proposed rule, for a total of $5.16 and 53 hours per exchange or 
association for the first year and $5.16 and 48 hours per exchange or 
association for subsequent years, resulting in an initial total annual 
reporting and recordkeeping burden of $46.44 and 477 hours and a total 
annual burden of $46.44 and 432 hours thereafter. The Commission 
specifically solicits comment on these estimates and whether SROs would 
be required to modify their systems to comply with this proposed 
quarterly reporting requirement.
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    \586\ The Commission assumes that each report will weigh five 
ounces and will be mailed via first class mail at a rate of $0.37 
for the first ounce and $0.23 for each additional ounce, for a total 
of $1.29.
---------------------------------------------------------------------------

    With regard to the requirement that an exchange or association file 
annually with the Commission a report prepared by a third party 
analyzing compliance by an affiliated security with the exchange's or 
association's listing rules, the Commission estimates that each 
exchange or association would spend approximately 5 hours interacting 
with the third party with respect to their preparation of the report, 4 
hours reviewing each report received from the third party, and $1.29 
\587\ to send each report to the Commission, for a total of $1.29 and 9 
hours per exchange or association per year, for a total annual 
reporting and record keeping burden of $11.61 and 81 hours for all 
exchange and associations. The Commission estimates that it would take 
each third party approximately 22 hours to prepare and file each annual 
report, for a total annual cost per exchange or association of 
$6,600,\588\ resulting in a total annual cost burden of approximately 
$59,400.
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    \587\ The Commission assumes that each report will weigh five 
ounces and will be mailed via first class mail at a rate of $0.37 
for the first ounce and $0.23 for each additional ounce, for a total 
of $1.29.
    \588\ The estimate assumes that the report will be prepared by 
outside legal counsel for the exchange or association at an 
estimated cost of $300 per hour, based on an hourly estimate for 
outside legal services obtained from industry sources. The 
Commission requests comment on this estimate, and on what type of 
entity the SRO may hire to prepare this report.
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    With regard to the requirement in proposed Rule 800(b)(2)(iii) that 
an exchange or association promptly notify an affiliated issuer of 
alleged non-compliance with listing rules, the Commission believes that 
exchanges and associations currently have rules for the provision of 
notice to listed companies that fail to continue to meet certain 
listing requirements. Therefore, the Commission believes that any 
additional paperwork burden on the exchange or association created by 
this proposed requirement would be incremental and insubstantial. The 
Commission recognizes, however, that exchanges and associations may 
incur additional costs if they were required to notify an affiliated 
issuer more often than pursuant to their existing rules. The Commission 
does not know precisely how frequently notification would be required 
under the proposed rule, but estimates that each exchange or 
association would spend approximately 2 hours and $1.29 \589\ to 
prepare and send each notification. The Commission requests comment on 
this estimate and whether exchanges' and associations' existing rules 
would require them to provide the notice to affiliated issuers that 
would be required by the proposed rule, and if so, whether their rules 
would require the notice to be required more often than pursuant to 
their existing rules.
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    \589\ The Commission assumes that each notice will weigh five 
ounces and will be mailed via first class mail at a rate of $0.37 
for the first ounce and $0.23 for each additional ounce, for a total 
of $1.29.
---------------------------------------------------------------------------

    Pursuant to proposed Rule 800(b)(2)(iv), if an affiliated security 
was alleged not to be in compliance with an exchange's or association's 
listing rules, the exchange or association would have to file a report 
with the Commission identifying the date the exchange or association 
alleged that the affiliated security was not in compliance, the action 
the exchange or association proposes to take, the applicable listing 
rule, and any other material information conveyed to the affiliated 
issuer. The Commission does not know how many responses would be 
generated by this requirement because it is unknown whether, or how 
often, an exchange or association would allege that an affiliated 
security fails to comply with the exchange's or association's listing 
rules, but estimates that a national securities exchange or registered 
securities association would spend approximately 5 hours per report and 
$1.29 \590\ to send each report to the Commission to comply with the 
proposed rule. Assuming that each exchange and association had one 
affiliated security, and assuming that the exchange or association 
alleged that the affiliated security failed to comply with the 
exchange's or association's listing rules at least once per year, that 
would result in an annual total burden of 45 hours and $11.61.\591\ For 
the same reason, the Commission does not know how many responses the 
exchange or association would receive from an affiliated issuer to whom 
it gave notice of non-compliance for which the exchange or association 
would need to file a copy with the Commission pursuant to proposed Rule 
800(b)(2)(v). The Commission, however, estimates that an exchange or 
association would spend approximately 2 hours and $1.29 \592\ per 
response to comply with the proposed requirement to file a copy

[[Page 71191]]

of the response with the Commission. Assuming that each affiliated 
issuer responded once, that would result in a total annual burden of 2 
hours per respondent, or 18 total hours. Thus, based on information 
available to the Commission at this time, the estimated total initial 
annual burden for proposed Regulation AL for all respondents would be 
783 hours and approximately $59,504 and 738 hours and approximately 
$59,504 thereafter. The Commission requests comment on the estimates 
included in this analysis.
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    \590\ The Commission assumes that each report will weigh five 
ounces and will be mailed via first class mail at a rate of $0.37 
for the first ounce and $0.23 for each additional ounce, for a total 
of $1.29.
    \591\ The Commission believes this likely overestimates the 
burden because it would assume that each affiliated security fell 
out of compliance each year. The Commission requests comment on this 
estimate.
    \592\ The Commission assumes that each response will weigh five 
ounces and will be mailed via first class mail at a rate of $0.37 
for the first ounce and $0.23 for each additional ounce, for a total 
of $1.29.
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5. Collection of Information Is Mandatory
    The collection of information would be mandatory if an affiliated 
security is listed on, approved for trading on, or trades pursuant to 
the rules of, an exchange or association. The collection of information 
filed pursuant to proposed Regulation AL with the Commission would be 
available to the public unless the exchange or association requested, 
and the Commission granted, confidential treatment pursuant to existing 
Commission rules and statutory authority.
6. Record Retention Period
    Exchanges and associations would be required to retain any 
collection of information required under proposed Regulation AL in 
accordance with, and for the periods specified in, Exchange Act Rule 
17a-1.\593\
---------------------------------------------------------------------------

    \593\ 17 CFR 240.17a-1.
---------------------------------------------------------------------------

E. Proposed Amendments to Rule 17a-1

    The proposed amendments to Rule 17a-1 under the Exchange Act do not 
impose any new recordkeeping or information collection requirements, or 
other collections of information that require approval of OMB under 44 
U.S.C. 3501, et seq. Accordingly the PRA does not apply.

F. Proposed Rule 17a-26

    Proposed Rule 17a-26 contains ``collection of information'' 
requirements within the meaning of the PRA.\594\ The Commission has 
submitted them to the OMB for review in accordance with 44 U.S.C. 
3507(d) and 5 CFR 1320.11. The title of the new collection of 
information under proposed Rule 17a-26 under the Exchange Act is ``Rule 
17a-26: Regulatory Reports of National Securities Exchanges and 
Registered Securities Associations.'' OMB has not yet assigned a 
control number for the new collection of information contained in 
proposed Rule 17a-26 under the Exchange Act. An agency may not conduct 
or sponsor, and a person is not required to respond to, a collection of 
information unless it displays a currently valid control number.\595\
---------------------------------------------------------------------------

    \594\ 44 U.S.C. 3501, et seq.
    \595\ 44 U.S.C. 3512.
---------------------------------------------------------------------------

1. Summary of Collection of Information
    Proposed Rule 17a-26 under the Exchange Act would require national 
securities exchanges and registered securities associations to file 
with the Commission quarterly and annual reports, in electronic format, 
that provide details on the operation of their self-regulatory 
programs. In the proposed quarterly reports, exchanges and associations 
would be required to file with the Commission information on specified 
matters regarding their regulatory programs, including results of their 
surveillance programs; summaries of complaints relating to the 
operation of their regulatory programs; summaries of all 
investigations, examinations, and enforcement cases active during the 
reporting period; summaries of listings activity; and copies of the 
agenda of any board or board committee meeting that occurred during the 
quarter. In the proposed annual reports, exchanges and associations 
would be required to file with the Commission a year-end aggregation of 
the information submitted pursuant to the proposed quarterly reporting 
requirement, except for the board and board committee agenda; a 
discussion of their regulatory processes; an organizational staffing 
chart; an evaluation of the effectiveness of their regulatory programs; 
a discussion of their internal controls; a summary of employment 
arrangements with the Chief Regulatory Officer and senior regulatory 
personnel; copies of the most recent annual performance evaluation of 
the Standing Committees of the board (i.e., Nominations, Compensation, 
Audit, and Regulatory Oversight Committees) and of the most recent 
annual performance evaluation of the Governance Committee; a discussion 
of efforts to comply with any recommendations or plan resulting from 
any inspection or examination conducted by Commission staff; and a 
report of a third-party audit of any electronic SRO trading facility 
owned, operated, or sponsored by the exchange or association. Exchanges 
and associations would be required to submit supplemental filings to 
report interim changes to their regulatory programs. The proposed rule 
also would direct each exchange and association to establish procedures 
for the preparation of the quarterly and annual reports in a uniform, 
readily accessible, and usable electronic format.
2. Proposed Use of Information
    The purpose of the collection of information in proposed Rule 17a-
26 is to enhance the Commission's ability to monitor compliance by 
national securities exchanges and registered securities associations 
with their regulatory responsibilities and to support the Commission's 
program of examinations of self-regulatory organizations. The 
information collected should help to keep the Commission informed of 
new developments and challenges affecting the regulatory programs of 
exchanges and associations, and should assist the Commission in more 
closely monitoring the exchanges' and associations' responses to 
critical regulatory issues affecting them. The collection of the 
information also should aid the Commission in better targeting its 
inspection resources.
3. Respondents
    The proposed collection of information in proposed Rule 17a-26 
would apply to every national securities exchange and every registered 
securities association, other than a national securities exchange 
registered pursuant to Section 6(g) of the Exchange Act \596\ and a 
limited purpose national securities association registered pursuant to 
Section 15A(k)(l) of the Exchange Act,\597\ which at this time includes 
nine registered national securities exchanges and one registered 
securities association.
---------------------------------------------------------------------------

    \596\ 15 U.S.C. 78f(g).
    \597\ 15 U.S.C. 78o-3(k)(l).
---------------------------------------------------------------------------

4. Reporting and Recordkeeping Burden
    The Commission believes that national securities exchanges and 
registered securities associations currently collect and retain much of 
the data that would be necessary to prepare the quarterly and annual 
reports that would be required by the proposed rule in connection with 
the execution of their self-regulatory responsibilities. To comply with 
the proposed rule, however, exchanges and associations would incur an 
additional burden in assembling the information into quarterly and 
annual reports and filing those reports with the Commission. The 
Commission expects that requiring the collection of information to be 
submitted in electronic format should lessen the burden on exchanges 
and associations, as well as reduce the burdens of printing, 
transmission, and

[[Page 71192]]

record retention that are typically incurred with hardcopy reports.
    Based on information available to the Commission at this time, the 
Commission estimates that each national securities exchange and 
registered securities association would incur an average burden of 40 
hours to prepare each quarterly report and 35 hours to prepare each 
annual report, for an annual burden of 195 hours per respondent. 
Accounting for nine national securities exchanges and one registered 
securities association, the total burden to comply with the quarterly 
and annual reporting requirements in proposed new Rule 17a-26 is 
therefore estimated to be 1,950 hours per year. The Commission is 
unable to estimate with certainty the number of interim updates an 
exchange or association would need to file, since the need for any such 
updates would depend on each exchange's or association's particular 
circumstances. Nevertheless, for purposes of this burden analysis, the 
Commission estimates that an exchange or association would incur a 
burden of 4 hours to prepare each interim updating amendment, which 
would likely be required, on average, 5 times per year for a total of 
20 hours per respondent and 200 hours total for the nine exchanges and 
one association. The Commission requests comment on the accuracy of 
these estimates. The total burden resulting from the proposed rule's 
quarterly and annual reporting provisions is estimated to be 2,150 
hours and $60 \598\ to prepare and file with the Commission each report 
and interim supplement.
---------------------------------------------------------------------------

    \598\ The Commission estimates that an average filing will weigh 
two ounces, accounting for a diskette and accompanying letter, and 
will be mailed via first class mail at a rate of $0.37 for the first 
ounce and $0.23 for the additional ounce, for a total of $0.60 per 
filing. At four quarterly reports, one annual report, and an 
estimated five interim supplements, the Commission expects that each 
exchange or association would incur a cost of $6 to comply with the 
proposed rule. The Commission solicits comments on the accuracy of 
this estimate.
---------------------------------------------------------------------------

    For those exchanges or associations that own, operate, or sponsor 
an electronic SRO trading facility, the proposed rule would require 
such exchange or association to file annually with the Commission, as 
part of its annual report, an audit report prepared by an independent 
third party with respect to the electronic SRO trading facility or 
facilities of the exchange or association. The Commission estimates 
that nine national securities exchanges and one registered securities 
association would be required to obtain an annual audit, and each such 
exchange or association owning, operating, or sponsoring at least one 
such facility would spend approximately 15 hours interacting with the 
third party with respect to their conduct of the audit and preparation 
of the audit report and 20 hours reviewing each audit report received 
from the third party, for a total of 35 hours per exchange or 
association per year, for a total annual reporting and recordkeeping 
burden of 350 hours. With respect to the third-party auditor, the 
Commission estimates that it would take each third party 100 hours to 
conduct the audit of any such facility or facilities and prepare the 
audit report for each exchange or association that owns, operates, or 
sponsors at least one electronic SRO trading facility, for a total 
annual cost per exchange or association of $15,000,\599\ resulting in a 
total annual burden cost of $150,000.
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    \599\ The estimate assumes that the report will be prepared for 
the exchange or association by an independent accounting firm or 
similar entity at an estimated cost of $150 per hour, based on an 
hourly estimate for auditing services obtained from industry 
sources. The Commission requests comment on this estimate, and on 
what type of entity an exchange or association may hire to prepare 
this report.
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    With respect to the burden imposed on exchanges and associations in 
connection with establishing procedures for the preparation of the 
reports required by the proposed rule in a uniform, readily accessible, 
and usable electronic format, based on information available to the 
Commission, the Commission estimates that each exchange or association 
would spend approximately 35 hours during the initial year of the 
proposed rule's effectiveness to comply with this requirement. 
Accounting for nine national securities exchanges and one registered 
securities association, the total burden per year to comply with the 
provision in proposed Rule 17a-26 regarding the uniform format for the 
quarterly and annual reports is estimated to be 350 hours.
    Thus, based on information available to the Commission at this 
time, the estimated total reporting and recordkeeping burden for 
proposed Rule 17a-26 is 2,850 hours and $150,060. The Commission 
requests comment on the accuracy of these estimates.
5. Collection of Information Is Mandatory
    The collection of information in proposed Rule 17a-26 under the 
Exchange Act would be mandatory. An exchange or association could 
request confidential treatment of any report or other information that 
the exchange or association provides to the Commission pursuant to 
proposed Rule 17a-26. The Commission would accord confidential 
treatment to the information to the extent permitted by law.
6. Record Retention Period
    Exchanges and associations would be required to retain any 
collection of information required under proposed Rule 17a-26 in 
accordance with, and for the periods specified in, Exchange Act Rule 
17a-1.\600\
---------------------------------------------------------------------------

    \600\ 17 CFR 240.17a-1.
---------------------------------------------------------------------------

G. Proposed Rule 17a-27

    Proposed Rule 17a-27 under the Exchange Act contains ``collection 
of information'' requirements within the meaning of the PRA.\601\ The 
Commission has submitted them to the OMB for review in accordance with 
44 U.S.C. 3507(d) and 5 CFR 1320.11. The title of the new collection of 
information under proposed Rule 17a-27 under the Exchange Act is ``Rule 
17a-27: Ownership of a National Securities Exchange, Registered 
Securities Association, Facility of a National Securities Exchange, or 
Registered Securities Association.'' OMB has not yet assigned a control 
number for the new collection of information contained in proposed Rule 
17a-27 under the Exchange Act. An agency may not conduct or sponsor, 
and a person is not required to respond to, a collection of information 
unless it displays a currently valid control number.\602\
---------------------------------------------------------------------------

    \601\ 44 U.S.C. 3501, et seq.
    \602\ 44 U.S.C. 3512.
---------------------------------------------------------------------------

1. Summary of Collection of Information
    Proposed Rule 17a-27(b) under the Exchange Act would require any 
member of a national securities exchange or registered securities 
association that is a broker or dealer to file a statement with the 
Commission if such member, alone or together with its related persons, 
directly or indirectly beneficially owns more than 5% of any class of 
securities or other ownership interest of an exchange or association of 
which it is a member or any facility of an exchange or association 
through which the member is permitted to effect transactions.\603\ The 
member would be required to include in the statement certain 
information about the member and its related persons, information about 
the securities or other ownership interest that is the subject of the 
filing, detailed information about the member and its related persons' 
holdings, and a description of the ability of the member

[[Page 71193]]

and its related persons to control the exchange or association.\604\
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    \603\ A member would be required to file the initial statement 
within ten calendar days of becoming subject to the requirements of 
proposed Rule 17a-27(b). See proposed Rule 17a-27(b)(3).
    \604\ See supra discussion in Section VI.B.
---------------------------------------------------------------------------

    Pursuant to proposed Rule 17a-27(b)(4), a member would be required 
to file a periodic amendment to the statement within ten calendar days 
of any change in the information required to be provided on the 
statement, except in the event of an increase or decrease of less than 
1% of ownership of a class of securities or other ownership interest 
last reported on the statement, or any amendment thereto. Proposed Rule 
17a-27(c) under the Exchange Act would require any member that is 
required to file the statement required pursuant to proposed Rule 17a-
27(b)(1) or any amendment required pursuant to proposed Rule 17a-
27(b)(4) to provide a copy of such statement or amendment to the 
exchange or association for which ownership information is being 
reported, or, if the relevant entity is a facility, to the applicable 
exchange or association.
    Finally, proposed Rule 17a-27(d) under the Exchange Act would 
require an exchange or association that receives a copy of the report 
from a member to post the statement or amendment on a publicly-
accessible Web site controlled by the exchange or association.
2. Proposed Use of Information
    The purpose of the collection of information in proposed Rule 17a-
27 is to enable the Commission and each exchange or association to 
monitor the accumulation of significant ownership interests in SROs by 
members, so as to further the ability of the SRO to perform its 
statutory obligations under the Exchange Act and the Commission's 
ability to perform its oversight responsibilities. Proposed Rule 17a-27 
also would provide the Commission and each exchange or association with 
information relevant to monitor compliance with proposed Rules 6a-5(o) 
and 15Aa-3(o), which would require exchanges and associations to 
implement rules to prohibit their broker-dealer members from owning or 
voting more than 20% of the exchange, association, or a facility of the 
exchange or association, and an effective mechanism to divest any 
member and its related persons of any interest owned in excess of the 
20% limitation.
3. Respondents
    The requirements in proposed Rule 17a-27(b) to file a statement and 
updates with the Commission and in proposed Rule 17a-27(c) to provide a 
copy of the statement and any amendment to the applicable exchange or 
association would apply to the members of the nine registered national 
securities exchanges and the one registered securities association that 
are brokers or dealers and that beneficially own more than 5% of any 
class of securities or other ownership interest in the exchange or 
association, or a facility of the exchange or association through which 
such member is permitted to effect transactions. The Commission 
estimates that there are approximately 6,800 registered brokers and 
dealers \605\ that would be subject to this requirement.\606\ The 
requirement of proposed Rule 17a-27(d) that an exchange or association 
post a copy of any statement received from a member on an Internet Web 
site would apply to each of the nine registered exchanges and the one 
registered association.\607\
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    \605\ Based on information available to the Commission at this 
time, there are approximately 6,800 registered brokers and dealers. 
Approximately 6,553 brokers and dealers filed FOCUS reports pursuant 
to 17 CFR 240.17a-5 (Exchange Act Rule 17a-5) at the end of 2003.
    \606\ Each registered broker or dealer must be either a member 
of an exchange or an association, and every member of an exchange or 
association is required to be a registered broker or dealer. See 
Section 15(b)(8) of the Exchange Act (15 U.S.C. 78o(b)(8)), Section 
15A(g)(1) of the Exchange Act (15 U.S.C. 78o-3(g)(1)) and Section 
6(b)(2) of the Exchange Act (15 U.S.C. 78f(b)(2)). The Commission 
believes, however, that using the number of registered brokers and 
dealers overestimates the number of members that would exceed the 5% 
ownership threshold and thus trigger the reporting requirements of 
proposed Rule 17a-27, given the amount of ownership it would take to 
trigger the requirement. The Commission requests comment on this 
estimate.
    \607\ The proposed rule would not apply to ownership in 
exchanges registered pursuant to Section 6(g) of the Exchange Act or 
limited purpose national securities associations registered pursuant 
to Section 15A(k)(l) of the Exchange Act. See proposed Rule 17a-
27(a)(6).
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4. Reporting and Recordkeeping Burden
    Because the amount of a member's interest in an exchange, 
association or facility could fluctuate, and because 5% is a fairly 
high threshold, the Commission is not able to determine with certainty 
how many broker-dealer members would be required to file a statement 
pursuant to proposed Rule 17a-27(b).\608\ For purpose of this paperwork 
burden analysis, however, the Commission assumes that 100 of the 6,800 
members that are brokers or dealers would file a statement with respect 
to ownership in one exchange or facility, and estimates that each of 
those members would amend such statement once per year.\609\
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    \608\ The Commission notes that although certain ownership 
information currently is reported to the Commission pursuant to 
Regulation 13D with respect to issuers registered pursuant to 
Section 12 of the Exchange Act, and Exhibit K to Form 1, which 
requires information with respect to each shareholder of an exchange 
that directly owns 5% or more of a class of a voting security of 
such exchange, information relating to members' interests in 
exchanges and associations and facilities generally is not currently 
required to be reported to the Commission.
    \609\ Based on the Commission's knowledge of exchanges that have 
demutualized and facilities of exchanges that the Commission has 
approved, the Commission estimates that the number of members that 
are brokers or dealers and that currently own more than 5% of an 
exchange, association or facility is less than 20, but has 
conservatively assumed 100 members would trigger the requirements of 
the proposed Rule. Furthermore, the Commission notes that the 
capital requirements necessary to enable a member to own more than 
5% would be considerably high, and therefore limit the number of 
members likely to trigger the requirements. The Commission believes 
that this estimate overestimates the number of members that are 
brokers or dealers and that would own more than 5% of an exchange, 
association or facility, thus triggering the filing requirement of 
proposed Rule 17a-27. The Commission requests comment on this 
estimate, and a process for more accurately estimating the number of 
respondents.
---------------------------------------------------------------------------

    Based on information available to the Commission at this time, the 
Commission believes that, given the nature of their business, most 
members that would be subject to proposed Rule 17a-27 likely already 
have in place systems and procedures for tracking their ownership of 
securities, and that the new burden of tracking the ownership interests 
in an exchange, association or a facility necessary to prepare the 
statement required by proposed Rule 17a-27 would not be a substantial 
additional burden.\610\ The Commission recognizes, however, that the 
scope of the reporting requirement may exceed the scope of ownership 
for which a member currently keeps records, since a member would need 
to aggregate its ownership interest with those of its related persons.
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    \610\ For example, to comply with Regulation 13D under the 
Exchange Act, 17 CFR 240.13d-1 through 13d-7, members must be able 
to track and report on Schedule 13D or Schedule 13G, 17 CFR 240.13d-
1(a) and (b), as applicable, their beneficial ownership of any 
issuer specified in Exchange Act Rule 13d-1, 17 CFR 240.13d-1, if 
such beneficial ownership exceeds 5%. The Commission also believes 
it likely, given the nature of their business, that members keep 
records of their ownership in entities not covered by the 
requirements of Regulation 13D under the Act, particularly with 
respect to ownership in any exchange or association of which they 
are a member or any facility through which they effect transactions. 
The Commission requests comment on this belief.
---------------------------------------------------------------------------

    The Commission therefore estimates that proposed Rule 17a-27(b) 
would require approximately 35 hours per statement to prepare and file 
the initial statement,\611\ that proposed Rule 17a-27(c) would require 
approximately 2

[[Page 71194]]

hours and $1.29 \612\ to prepare and send the copy of the statement or 
any amendment to the exchange or association, and that each amendment 
required by proposed Rule 17a-27(b)(4) would require 10 hours per 
amendment to prepare and file the amendment, for a total initial annual 
burden of 47 hours per respondent and 12 hours annually thereafter. 
Thus, based on information available to the Commission at this time, 
the Commission estimates the total initial annual burden imposed by 
proposed Rule 17a-27 on all members would be 4,700 hours and $258, and 
the annual burden thereafter would be 1,200 hours and $258. The 
Commission requests comment on the accuracy of these estimates.
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    \611\ The Commission believes that this estimate may 
overestimate the amount of time required for members to prepare the 
statement, and requests comment on this estimate.
    \612\ The Commission assumes that the statement will weigh five 
ounces and will be mailed via first class mail at a rate of $0.37 
for the first ounce and $0.23 for each additional ounce, for a total 
of $1.29.
---------------------------------------------------------------------------

    If a national securities exchange or registered securities 
association receives a copy of a statement from a member pursuant to 
proposed Rule 17a-27(c), the exchange or association must post the 
statement on its Internet Web site pursuant to proposed Rule 17a-27(d). 
The Commission staff preliminarily estimates that 4 hours is the amount 
of time that would be required to post the statement on an exchange's 
or association's Web site.\613\ The Commission staff estimates that the 
total annual burden for posting statements would be 400 hours. The 
Commission requests comment on its estimate of how long it would take 
an exchange or association to post a statement on its Web site.
---------------------------------------------------------------------------

    \613\ See supra note 547 and accompanying text.
---------------------------------------------------------------------------

    Thus, the Commission estimates that the total initial annual 
reporting and recordkeeping burden for proposed Rule 17a-27 is 5,100 
hours and $258, and 1,600 and $258 annually thereafter. The Commission 
requests comment on these estimates.
5. Collection of Information Is Mandatory
    The collection of information under proposed Rule 17a-27 would be 
mandatory if a member that is a broker or dealer exceeds the ownership 
threshold. The collection of information required pursuant to proposed 
Rule 17a-27 would be provided by members to the Commission, as well as 
to the relevant exchange or association, and the exchange or 
association would be required by proposed Rule 17a-27(d) to post the 
information on its publicly available Web site.
6. Record Retention Period
    Members would be required to retain any collection of information 
required under proposed Rule 17a-27 in accordance with, and for the 
periods specified in, Exchange Act Rules 17a-3 and 17a-4.\614\ 
Exchanges and associations would be required to retain any collection 
of information required under proposed Rules 17a-27(c) and (d) in 
accordance with, and for the periods specified in, Exchange Act Rule 
17a-1.\615\
---------------------------------------------------------------------------

    \614\ 17 CFR 240.17a-3 and 17a-4.
    \615\ 17 CFR 240.17a-1.
---------------------------------------------------------------------------

H. Request for Comment

    Pursuant to 44 U.S.C. 3506(c)(2)(B), the Commission solicits 
comments to: (i) Evaluate whether the proposed collections of 
information are necessary for the proper performance of the functions 
of the Commission, including whether the information would have 
practical utility; (ii) evaluate the accuracy of the Commission's 
estimates of the burden of the proposed collections of information and 
provide the Commission with data on proposed Rules 6a-2, 6a-5, 15Aa-1, 
15Aa-2, 15Aa-3, 17a-26, 17a-27, Regulation AL, and revised Form 1 and 
new Form 2; (iii) enhance the quality, utility, and clarity of the 
information to be collected; and (iv) minimize the burden of the 
collections of information on those required to respond, including 
through the use of electronic or automated collection techniques or 
other forms of information technology.
    Persons wishing to submit comments on the collection of information 
requirements should direct them to the following persons: (1) Desk 
Officer for the Securities and Exchange Commission, Office of 
Information and Regulatory Affairs, Office of Management and Budget, 
Washington, DC 20503; and (2) Jonathan G. Katz, Secretary, Securities 
and Exchange Commission, 450 Fifth Street, NW., Washington, DC 20549-
0609, with reference to File No. S7-39-04. Requests for materials 
submitted to OMB by the Commission with regard to this collection of 
information should be in writing, refer to File No. S7-39-04, and be 
submitted to the Securities and Exchange Commission, Records 
Management, Office of Filings and Information Services, 450 Fifth 
Street, NW., Washington, DC 20549-0609. As OMB is required to make a 
decision concerning the collections of information between 30 and 60 
days after publication of this release in the Federal Register, a 
comment to OMB is best assured of receiving full consideration if OMB 
receives it within 30 days of publication of this release.

X. Consideration of Costs and Benefits

    The system of regulation of our nation's securities markets and 
market participants is grounded on the principle of self-regulation. 
Recent developments, including allegations of governance failures on 
the part of SROs, enforcement actions and examinations involving SROs 
and their members, increasing competitive pressures faced by SROs, and 
the growing trend of SROs to reorganize from mutual organizations to 
shareholder-owned entities, have prompted the Commission to review 
aspects of the SROs' governance and the transparency of their 
governance and regulatory processes. At the same time, the Commission 
has determined to review its regulation and oversight of SROs and to 
consider whether changes are necessary in light of recent developments 
involving SROs.\616\
---------------------------------------------------------------------------

    \616\ See supra Section I.B. for a discussion of recent 
developments involving SROs.
---------------------------------------------------------------------------

    Accordingly, the Commission is proposing to adopt new rules and 
amend existing rules and forms under the Exchange Act to strengthen SRO 
governance and the Commission's regulation and oversight of SROs. The 
proposals relate to the governance, administration, transparency, and 
ownership of SROs that are national securities exchanges and registered 
securities associations, and the periodic reporting of information by 
these SROs with respect to their regulatory programs. The proposals 
also relate to the listing and trading by SROs of their own or an 
affiliate's securities.
    The Commission is sensitive to the costs and benefits that may 
result from the proposed rules and amendments, and has identified below 
certain costs and benefits associated with the proposals. The 
Commission encourages commenters to identify, discuss, analyze, and 
supply relevant data, including empirical data, regarding costs or 
benefits that may be associated with the proposals. The Commission 
preliminarily believes that the benefits of the proposed rulemaking to 
investors, users of the SROs' facilities, and other market 
participants, as well as the SROs, justify the costs.

A. Costs and Benefits of Proposed Rules 6a-5 and 15Aa-3

    The Commission is proposing new Rules 6a-5 and 15Aa-3 under the 
Exchange Act that would set forth minimum standards of governance to be 
adopted and implemented by exchanges and associations, respectively. 
The

[[Page 71195]]

proposed governance rules are intended to strengthen the governance of 
exchanges and associations, promote a greater degree of objectivity and 
impartiality in important SRO processes, foster a greater degree of 
independence of the regulatory programs of exchanges and associations, 
and address the conflicts that can arise when a mutual organization 
(such as an exchange) converts to another form of ownership.\617\
---------------------------------------------------------------------------

    \617\ See supra Section II.B. for a discussion of proposed Rules 
6a-5 and 15Aa-3.
---------------------------------------------------------------------------

    Proposed Rules 6a-5 and 15Aa-3 would require an exchange's or 
association's governing board to be composed of a majority of 
independent directors, with key board committees to be composed solely 
of independent directors (``Standing Committees''). For a director to 
be considered independent, the board of the exchange or association 
would be required to affirmatively determine that the director has no 
material relationship with the exchange or association or any affiliate 
of the exchange or association. The board would be required to make 
this determination upon the director's nomination or appointment to the 
board and thereafter no less frequently than annually and as often as 
necessary in light of the director's circumstances. Further, the 
exchange or association would be required to establish policies and 
procedures to require each director, on his or her own initiative and 
upon request of the exchange or association, to inform the exchange or 
association of the existence of any relationship or interest that may 
reasonably be considered to bear on whether such director is an 
independent director. Each Standing Committee would be required to 
conduct an annual self-evaluation of its performance, except that the 
Governance Committee would be required to conduct an annual evaluation 
of the governance of the exchange or association as a whole. Exchanges 
and associations would be required to provide sufficient funding and 
other resources to each Standing Committee, as determined by each 
Standing Committee, to permit it to fulfill its responsibilities and 
retain independent counsel and advisors. Additionally, the independent 
directors of the exchange's or association's board would be required to 
meet regularly in executive session, without the presence of 
management. When the board considered any matter that is recommended by 
or otherwise is within the authority or jurisdiction of any Standing 
Committee, a majority of the directors who vote on the matter would be 
required to be independent.
    Under proposed Rules 6a-5 and 15Aa-3, each exchange and association 
would be required to separate its regulatory function from its market 
operations and other commercial interests, whether through functional 
or structural separation. Exchanges and associations also would be 
required to prevent the dissemination of regulatory and certain other 
information and to apply regulatory fees, fines, and penalties toward 
the funding of regulatory operations. In addition, the proposed 
governance rules would require exchanges and associations to impose on 
their members that are brokers or dealers ownership and voting 
limitations on their interest in the exchange, the association, or a 
facility of the exchange or association. Finally, the proposed 
governance rules would require that exchanges and associations adopt 
both a code of conduct and ethics for directors, officers and employees 
and governance guidelines.
    To further strengthen the governance of exchanges and associations, 
the proposed rules also would apply to any person that, directly or 
indirectly, is controlled by the exchange or association and that 
provides, whether pursuant to contract, agreement or rule, regulatory 
services to or on behalf of the exchange or association (i.e., a 
regulatory subsidiary), because they are an integral part of the SRO 
structure and carry out certain regulatory duties on behalf of the 
exchange or association. Thus, the Commission proposes to require these 
regulatory subsidiaries to be subject to the same governance standards 
applicable to the SRO itself.
    The proposals contemplate that each exchange and association would 
file with the Commission proposed rule changes pursuant to Section 
19(b) of the Exchange Act to amend their existing charters, bylaws, or 
rules to comply with the proposed rules.
1. Benefits
    As discussed below, the Commission believes that exchanges and 
associations, as well as their members, users of their facilities, 
institutional and retail investors, shareholders or other owners of 
those exchanges that have demutualized, and the public generally, are 
likely to benefit significantly from the proposed governance rules.
    The proposed rules are designed to enhance the independence and 
effectiveness of the boards of exchanges and associations, as well as 
their regulatory subsidiaries, by requiring those boards to be composed 
of a majority of independent directors. By mandating a structure that 
would require a majority of the board to be independent, the governance 
of these entities should be less susceptible to competing internal 
interests. The independent directors would constitute a majority of the 
SRO's board and thus should help foster a greater degree of independent 
decision-making by the exchange's and association's governing bodies. 
Further, a board whose independent directors constitute at least a 
majority of the board should help strengthen the hand of the 
independent directors when dealing with management. In the Commission's 
view, requiring SRO boards to have a majority of independent directors 
should help reduce conflicts of interest that otherwise might arise 
when persons with a nexus to the SRO are involved in key decisions. A 
board constituting a majority of independent directors also should help 
further the SRO's ability to meet its obligations under the Exchange 
Act, because those directors would not have relationships with the SRO, 
its members, or listed issuers that otherwise would impair 
disinterested viewpoints or judgments. Further, the requirement that 
each exchange and association establish policies and procedures to 
require each director on his or her own initiative or upon request of 
the exchange or association, to inform the exchange or association of 
the existence of any relationship or interest that may reasonably be 
considered to bear on whether such director is an independent director 
would aid the board in affirmatively determining whether such director 
could be considered independent. In addition, such requirement would 
provide the exchange or association with a mechanism by which to 
determine whether such exchange or association is in compliance with 
the majority independent board requirement. While meeting in executive 
session, free from the presence of management, the independent 
directors would be afforded the opportunity to discuss important 
matters regarding the exchange or association in a frank and open 
manner.
    The proposed governance rules also would require that exchanges and 
associations, as well as their regulatory subsidiaries, administer a 
fair process that provides members with the opportunity to select at 
least 20% of the total number of directors.\618\ The Nominating 
Committee would be required to nominate at least one director who is 
representative of issuers and at least one director who is

[[Page 71196]]

representative of investors and who, in each case, is not associated 
with a member or broker or dealer.\619\ These proposals balance the 
Commission's goal of greater board independence with the right of 
members to participate in the governance of the exchange or association 
by providing members with a practical voice in exchange or association 
affairs, without jeopardizing the overall independence of the board.
---------------------------------------------------------------------------

    \618\ See proposed Rule 6a-5(f)(3) and 15Aa-3(f)(3).
    \619\ See proposed Rules 6a-5(f)(4) and 15Aa-3(f)(4).
---------------------------------------------------------------------------

    Standing Committees composed solely of independent directors should 
result in a greater degree of objective decision-making with respect to 
the exchange's or association's core responsibilities. The Standing 
Committees' annual evaluation process should assist the exchange or 
association in identifying potential strengths and deficiencies in the 
governance, administration, regulatory programs and financial matters 
of the exchange or association and any regulatory subsidiary. Further, 
requiring exchanges and associations to provide sufficient funding and 
other resources to permit the independent directors and the Standing 
Committees to fulfill their responsibilities and to retain independent 
legal counsel and other advisors should provide independent directors 
with the ability to serve effectively.
    Although the proposed governance rules do not require that an 
exchange's or association's Chairman be an independent director, the 
rules would require that if the exchange's or association's CEO is not 
also the Chairman, the Chairman must be an independent director.\620\ 
Further, in the event an exchange or association elected to have a 
single individual serve as Chairman and CEO, the proposed governance 
rules would prohibit that person--who, as the CEO would not be 
``independent''--from participating in any executive sessions of the 
board and from serving on any Standing Committee.\621\ If a single 
individual served as both Chairman and CEO, the board would be required 
to designate an independent director as a lead director to preside over 
executive sessions of the board, and the board would be required to 
publicly disclose such lead director's name and a means by which 
interested parties may communicate with the lead director.\622\ These 
provisions should further a greater degree of independent decision-
making by the governing body of an exchange or association.
---------------------------------------------------------------------------

    \620\ See proposed Rules 6a-5(m)(1) and 15Aa-3(m)(1).
    \621\ See proposed Rules 6a-5(m)(2) and (4) and 15Aa-3(m)(2) and 
(4).
    \622\ See proposed Rules 6a-5(m)(3) and 15Aa-3(m)(3). See supra 
Section II.B.7. for a discussion of these proposed rules.
---------------------------------------------------------------------------

    The proposed rules would require exchanges and associations to 
explicitly mandate that each director, in discharging his or her 
responsibilities as a member of the board, reasonably consider all 
requirements applicable to the exchange or association under the 
Exchange Act.\623\ The Commission believes that this requirement would 
benefit investors, members, and other users of the facilities of the 
exchange or association by helping to ensure that directors of 
exchanges and associations fully recognize that the exchange or 
association has certain obligations under the Exchange Act, and that 
the directors act in accordance with those obligations. In particular, 
explicitly requiring directors to take into account the exchange's or 
association's obligations under the Exchange Act should help promote 
greater awareness and accountability on the part of directors about the 
responsibilities of the exchange or association, thus furthering the 
objectives of the Exchange Act.
---------------------------------------------------------------------------

    \623\ See proposed Rules 6a-5(l)(2) and 15Aa-3(l)(2). See supra 
Section II.B.5. for a discussion of this proposed requirement.
---------------------------------------------------------------------------

    Moreover, the Commission believes that the proposals to separate 
the regulatory operations of an exchange or association, and any 
regulatory subsidiary, from its market operations and other commercial 
interests,\624\ to require regulatory funds to be applied only to fund 
programs and operations directly related to the exchange's or 
association's regulatory responsibilities,\625\ and to require an 
exchange or association to establish procedures to prevent the 
dissemination of regulatory information other than to persons carrying 
out the exchange's or association's regulatory obligations,\626\ should 
allow SROs to better manage the conflicts of interest inherent in the 
self-regulatory structure between the SRO's regulatory responsibilities 
and its market operations.\627\ These provisions of the proposed 
governance rules would help promote greater accountability on the part 
of exchanges and associations with respect to their regulatory programs 
and strengthen their ability to meet their statutory obligations.
---------------------------------------------------------------------------

    \624\ See proposed Rules 6a-5(n)(1) and 15Aa-3(n)(1).
    \625\ See proposed Rules 6a-5(n)(4) and 15Aa-3(n)(4).
    \626\ See proposed Rules 6a-5(n)(5) and 15Aa-3(n)(5).
    \627\ See supra Section II.B.8. for a discussion of these 
proposed rules.
---------------------------------------------------------------------------

    In particular, the proposal to require an exchange or association 
to use funds collected from regulatory fees, fines or penalties only to 
fund programs and operations directly related to the exchange's or 
association's regulatory responsibilities is designed to diminish the 
potential for an exchange or association to use its authority to raise 
regulatory funds for the purpose of benefiting its shareholders, or for 
other non-regulatory purposes, such as to fund executive compensation. 
The Commission believes that the proposed requirements to use 
regulatory funds only to fund regulatory activities would further 
advance the SROs' ability to effectively comply with statutory 
requirements, by helping to ensure that an SRO's regulatory activities 
are properly funded and the SRO is not abusing its regulatory 
authority.
    The proposed rules also would require an exchange or association to 
establish policies and procedures reasonably designed to maintain the 
confidentiality of information required to be submitted to effectuate a 
transaction on or through the facilities of an exchange or 
association.\628\ The proposed rules also would require that an 
exchange's or association's policies and procedures to be designed to 
reasonably prevent the dissemination of information collected from its 
members in the course of performing its regulatory obligations under 
the Exchange Act (``regulatory information'') to any person that is not 
an officer, director, employee, or agent of the exchange or association 
directly involved in carrying out the exchange's or association's 
regulatory obligations under the Exchange Act, and would prohibit an 
exchange or association from using regulatory information other than 
for regulatory purposes.\629\ By helping to ensure that regulatory 
information is only used for regulatory purposes, the Commission 
believes that these proposed requirements would benefit investors and 
the public by helping to maintain the independence of an exchange's or 
association's self-regulatory function, thus furthering the ability of 
the exchange or association to carry out its regulatory 
responsibilities in compliance with the Exchange Act. In addition, 
because the proposed rules

[[Page 71197]]

would help to assure members that any information they provide to the 
exchange or association for regulatory purposes would not be used for 
competitive or other non-regulatory purposes, it would facilitate the 
provision of information to the exchange or association that would help 
the exchange or association carry out its regulatory obligations under 
the Exchange Act.
---------------------------------------------------------------------------

    \628\ See proposed Rule 6a-5(n)(5)(i)(C) and 15Aa-3(n)(5)(i)(C). 
This requirement would not apply if such information is aggregated 
to such an extent that no person whose information is included in 
the aggregated information can be identified, or unless the person 
has consented to the dissemination and use of its information by the 
exchange.
    \629\ See proposed Rules 6a-5(n)(5)(A) and (B) and 15Aa-
3(n)(5)(A) and (B). See supra Section II.B.8.c. for a discussion of 
this proposed requirement.
---------------------------------------------------------------------------

    The proposed governance rules also would require the rules of an 
exchange or association to prohibit any member that is a broker or 
dealer, either alone or together with its ``related persons,'' from 
directly or indirectly beneficially owning and voting any interest in 
the exchange, the association, or a facility of an exchange or 
association through which the member is permitted to effect 
transactions, that exceeds 20% of any class of securities or other 
ownership interest of the exchange, association, or facility.\630\ This 
proposed requirement would serve to mitigate the conflict of interest 
that could occur if a broker-dealer were to control a significant 
interest in its regulator. For example, an ownership and voting limit 
would reduce the ability of a member to influence the regulatory 
operation of the exchange or association for its benefit (such as by 
directing the exchange to refrain from diligently surveilling the 
member's conduct or from punishing conduct that violates the rules of 
the exchange or the federal securities laws). In addition, imposing 
such a limitation would make it more difficult for a member to direct 
or affect the business of an exchange or association to enhance its own 
commercial interests. Thus, the Commission believes that requiring 
exchanges and associations to impose ownership and voting limits on 
members could benefit investors and the public by reducing the risk 
that a member could use its controlling interest in its regulator to 
influence the regulatory process to its benefit.
---------------------------------------------------------------------------

    \630\ See supra Section II.B.9. for a discussion of proposed 
Rules 6a-5(o) and 15Aa-3(o).
---------------------------------------------------------------------------

    The Commission believes that it is important that there be 
sufficient independence within the self-regulatory process to 
adequately check undue interference or influence from the persons or 
entities being regulated. These proposed rules, individually and as a 
whole, would help insulate the regulatory activities of an exchange or 
association from the conflicts of interest that may otherwise arise by 
virtue of its market operations. The independence of the regulatory 
process would be further strengthened through the appointment of a 
Chief Regulatory Officer who would administer the regulatory program 
and who would report directly to the independent Regulatory Oversight 
Committee.
    The Commission believes that requiring exchanges and associations 
to adopt a code of conduct and ethics should help foster the ethical 
behavior of directors, officers and employees, because these 
individuals would be informed of the standards of conduct expected of 
them in fulfilling the responsibilities of their positions. Similarly, 
requiring exchanges and associations to adopt governance guidelines 
should help promote greater awareness of the governance principles that 
are intended to guide the exchange or association in implementing good 
governance.
2. Costs
    The Commission anticipates that proposed Rules 6a-5 and 15Aa-3 
would impose costs on exchanges and associations. Moreover, because the 
proposed governance rules also would apply to regulatory subsidiaries 
of the exchange or association, exchanges and associations would incur 
additional costs related to compliance by these entities with the 
proposed rules. Exchanges and associations not currently in compliance 
with the proposed governance rules would need to spend time and incur 
costs in modifying their internal processes and operations, as well as 
taking necessary steps to amend their rules, including their charters 
and bylaws, to comply with any new standards. Changes also would need 
to be made to the internal processes and operations, and rules, 
including charters and bylaws, of any regulatory subsidiaries or 
facility of the exchange or association to the extent the exchange or 
association would be required to apply the rules to those entities. 
Exchanges and associations would have to file with the Commission under 
Section 19(b) of the Exchange Act \631\ proposed rule changes that 
would contain new rules or rule amendments that comply with the 
proposed governance rules. Modifying internal processes, drafting new 
charter, bylaw, and rule provisions, and preparing proposed rule 
changes to file with the Commission would impose costs on exchanges and 
associations, although some, if not all, SROs most likely would rely on 
in-house legal staff to perform these tasks. The Commission seeks 
comment on these costs.
---------------------------------------------------------------------------

    \631\ 15 U.S.C. 78s(b)(1).
---------------------------------------------------------------------------

    Exchanges and associations that do not already have a board 
composed of a majority of independent directors would incur additional 
costs in modifying the composition of their boards. An exchange or 
association could comply with the majority independent board 
requirement by decreasing the size of its board and allowing some non-
independent directors to resign; maintaining the current size of its 
board and replacing some non-independent directors with independent 
directors; or by increasing the size of its board and electing 
additional independent directors. In any event, unless an exchange or 
association currently complies with the proposed standards, it would 
incur costs in adding new directors or replacing existing directors. If 
an exchange or association elects to add independent directors to 
comply with the proposed requirement for a majority independent board, 
it could incur costs in finding qualified candidates that fit the 
proposed independence criteria. An exchange or association also could 
incur costs associated with preparing, as well as administering and 
reviewing, questionnaires to be completed by a director to determine 
whether such director could be considered independent. As discussed 
above in Section IX, the Commission estimates that each exchange or 
association would annually spend 34 hours and $12.58 if it were to 
request information from its directors regarding their independence, 
resulting in a total annual reporting and recordkeeping burden of 
approximately 340 hours and approximately $126 for all exchanges and 
associations.
    Exchanges and associations that do not already have an independent 
Chairman, in the event that the Chairman and CEO are two individuals, 
could incur additional costs in hiring and compensating a new Chairman. 
An exchange or association could elect to name a current independent 
member of the board as Chairman; however, such a move would still 
likely impose compensation costs, in addition to costs incurred in 
changing leadership. Also, when modifying the composition of their 
boards, exchanges and associations could incur additional costs 
associated with preparing, mailing and processing proxy or information 
statements that would be necessary to hold a meeting to elect new 
directors. The Commission seeks comment on these costs.
    In addition, exchanges and associations could have additional costs 
in adjusting to new board practices and providing independent directors 
with the necessary funding and resources to

[[Page 71198]]

carry out their duties.\632\ For example, the proposed rules would 
require that independent directors meet regularly in executive 
session.\633\ In addition, independent directors would be permitted to 
hire and obtain advice and assistance from independent legal counsel 
and other advisors as they determine necessary to carry out their 
duties.\634\ The Commission seeks comment on these costs.
---------------------------------------------------------------------------

    \632\ See proposed Rules 6a-5(d)(3) and 15Aa-3(d)(3).
    \633\ See proposed Rules 6a-5(d)(1) and 15Aa-3(d)(1).
    \634\ See proposed Rules 6a-5(d)(2) and 15Aa-3(d)(2).
---------------------------------------------------------------------------

    The proposed governance rules also would require exchanges and 
associations to administer a fair process that provides members with 
the opportunity to select at least 20% of the total number of 
directors.\635\ Further, the Nominating Committee would be required to 
nominate at least one director who is representative of issuers and at 
least one director who is representative of investors and who, in each 
case, is not associated with a member or broker or dealer.\636\ These 
proposed provisions are intended to codify in rules the fair 
representation requirements set forth in the Exchange Act.\637\ Some 
SROs currently may be in compliance with these proposed requirements 
because they are commensurate with statutory standards that SROs 
currently must satisfy. However, the Commission requests comment 
concerning whether exchanges and associations would incur additional 
costs to comply with the specific requirements set forth in the 
proposed rules.
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    \635\ See proposed Rules 6a-5(c)(4) and (f)(3) and 15Aa-3(c)(4) 
and (f)(3).
    \636\ See proposed Rule 6a-5(f)(4) and 15Aa-3(f)(4).
    \637\ See 15 U.S.C. 78f(b)(3) and 15 U.S.C. 78o-3(b)(4).
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    The proposed governance rules would require that each Standing 
Committee be composed entirely of independent directors; \638\ that 
each Standing Committee perform an annual self-evaluation, except that 
the Governance Committee would perform an annual evaluation of the 
governance of the exchange or association as a whole; \639\ and that 
each Standing Committee be provided sufficient funding and other 
resources, as determined by each Standing Committee, to permit it to 
retain independent legal counsel and other advisors.\640\ The exchange 
or association could incur costs to organize board functions along the 
lines of the proposed Standing Committees. As noted above, an exchange 
or association could incur costs to add independent directors to its 
board, but there should not be any costs incurred as a result of 
appointing those independent directors to serve on Standing Committees. 
Similarly, the Commission does not believe that costs would be incurred 
in connection with the annual performance evaluation by each Standing 
Committee, unless such Standing Committee had to hire new employees or 
outside advisors to perform the evaluation. However, to the extent that 
the proposal causes an increase in the duties of board committee 
members, and a corresponding increase in the amount of time that 
directors spend fulfilling their committee obligations, exchanges and 
associations could find that there are additional costs in compensating 
directors for their duties. The Commission requests comment on the 
likelihood of this scenario. Further, to the extent that current 
funding is not sufficient to permit the independent directors to retain 
independent legal counsel and other advisors, an exchange or 
association could incur additional costs in providing such funding. The 
Commission seeks comment on these costs.
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    \638\ See proposed Rules 6a-5(f)(1), (g)(1), (h)(1), (i)(1) and 
(j)(1) and 15Aa-3(f)(1), (g)(1), (h)(1), (i)(1) and (j)(1).
    \639\ See proposed Rules 6a-5(f)(5), (g)(3), (h)(3), (i)(3) and 
(j)(6) and 15Aa-3(f)(5), (g)(3), (h)(3), (i)(3) and (j)(6).
    \640\ See proposed Rules 6a-5(e)(3) and 15Aa-3(e)(3).
---------------------------------------------------------------------------

    The proposed governance rules would require exchanges and 
associations to establish policies and procedures to assure the 
independence of their regulatory program from the operation or 
administration of any market operations and other commercial 
interests.\641\ To this end, the proposed governance rules would 
require that the exchange's or association's regulatory program either 
be structurally separated from its market operations and other 
commercial interests or functionally separated but contained within the 
same entity.\642\ In either case, the proposed governance rules would 
require that the board appoint a Chief Regulatory Officer to administer 
the regulatory program and that the Chief Regulatory Officer report 
directly to the independent Regulatory Oversight Committee.\643\ The 
Commission seeks comment on these costs.
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    \641\ See proposed Rules 6a-5(n)(1) and 15Aa-3(n)(1).
    \642\ See proposed Rules 6a-5(n)(2) and 15Aa-3(n)(2).
    \643\ See proposed Rules 6a-5(n)(3) and 15Aa-3(n)(3).
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    An exchange or association that undertakes a structural separation 
of its regulatory program from its market operations and other 
commercial interests through the creation of a new separate legal 
entity would incur costs associated with the formation or incorporation 
of such new entity, as well as costs associated with hiring and 
compensating individuals to manage such new entity. An exchange or 
association that undertakes to functionally separate its regulatory 
program from its market operations and other commercial interests also 
would incur additional costs associated with analyzing the exchange's 
or association's current regulatory practices and modifying such 
practices to comply with the proposed governance rules. Unless an 
exchange or association currently employs a Chief Regulatory Officer, 
the Commission expects that exchanges and associations would incur 
costs associated with hiring and compensating a Chief Regulatory 
Officer. The Commission seeks comment on these costs.
    The Commission recognizes that an exchange or association could 
incur costs to establish policies and procedures necessary to segregate 
regulatory funds and to keep books and records necessary to demonstrate 
compliance with the proposed requirement to use regulatory funds only 
to fund programs and operations directly related to the exchange's or 
association's regulatory responsibilities.\644\ The Commission 
preliminarily believes that those funds should be readily identifiable, 
and that exchanges and associations likely already segregate certain 
funds derived from regulatory fees, fines and penalties. To the extent 
that exchanges and associations do not already segregate regulatory 
funds, they would have to modify their existing financial controls to 
assure that they operate in compliance with the proposed requirement. 
The Commission seeks comment on whether exchanges and associations 
currently segregate regulatory funds, or can easily identify such 
funds, and the costs that would be incurred to make modifications. The 
Commission also seeks comment on whether exchanges and associations 
would have to put in place new financial controls, or whether the 
existing financial controls of an exchange or association are 
sufficient to assure that it operates in compliance with the proposed 
rules.
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    \644\ See supra Section II.B.8.b. for a discussion of proposed 
Rules 6a-5(n)(4) and 15Aa-3(n)(4).

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[[Page 71199]]

    The Commission also recognizes that an exchange or association 
could incur costs to establish the policies and procedures reasonably 
designed to prevent the dissemination of regulatory information to any 
person not directly involved in carrying out the exchange's or 
association's regulatory obligations under the Exchange Act, and to 
keep certain other transaction-related information confidential, unless 
made available in aggregated form.\645\ As part of their existing 
policies to comply with their obligations under the Exchange Act, the 
Commission believes that exchanges and associations already have 
policies and procedures designed to safeguard and restrict the use and 
dissemination of such information. Therefore, the Commission 
preliminarily believes that exchanges and associations would not need 
to expend substantial resources to modify their internal processes to 
comply with the proposed requirements. The Commission requests comment 
from exchanges and associations as to whether the measures they employ, 
if any, to safeguard and restrict the use and dissemination of 
confidential information currently comply with the proposed 
requirements, or whether exchanges and associations will need to modify 
their internal processes. An exchange or association also could incur 
costs in taking action necessary to assure that its officers, 
directors, employees and agents agree to comply with the proposed 
requirements (as required by the proposed rules),\646\ and to educate 
new, as well as existing, employees about these requirements. The 
Commission seeks comment on the extent of these identified costs.
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    \645\ See supra Section II.B.8.c. for a discussion of proposed 
Rules 6a-5(n)(5) and 15Aa-3(n)(5).
    \646\ See proposed Rules 6a-5(o)(5) and 15Aa-3(o)(5).
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    While the Commission believes that members of the boards of 
exchanges and associations already consider the Exchange Act 
responsibilities of the exchange or association in the course of 
performing their duties, the Commission recognizes that an exchange or 
association would incur costs necessary to amend its rules to 
explicitly require its directors to reasonably consider its Exchange 
Act responsibilities when discharging their responsibilities as members 
of the board.\647\ The exchange or association also would incur costs 
necessary to inform its current board members of the rule and their 
obligations, and to inform new board members. The Commission seeks 
comment on these costs.
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    \647\ See supra Section II.B.5. for a discussion of proposed 
Rules 6a-5(l)(2) and 15Aa-3(l)(2).
---------------------------------------------------------------------------

    The Commission recognizes that exchanges and associations (and 
their facilities) likely would incur costs associated with establishing 
and enforcing rules to effectuate the proposed ownership and voting 
limits on members that are brokers or dealers. These costs could 
include exchange or association staff resources and legal fees related 
to drafting, preparing, and filing proposed rule changes with the 
Commission. The costs also would include staff resources, legal and 
filing fees related to filing corporate governing documents with the 
exchange's, association's or facility's state of incorporation. The 
Commission also recognizes that an exchange or association might need 
to obtain the approval of its members or shareholders, or of the owners 
of its facility, to implement such rules, which could require the 
exchange or association to prepare a proxy statement. The costs that 
would be required to obtain the necessary approval of any required 
change would depend on the number of such persons, the ownership 
concentration of the exchange, association or facility, and such 
persons' receptiveness to the proposed rules. In addition, corporate 
law might require the exchange or facility to notify its shareholders 
or owners of any ownership or voting restrictions by either sending a 
notice or by inserting a legend on the stock or ownership certificates. 
The Commission seeks comment on these costs.
    The Commission also recognizes that exchanges and associations 
would incur ongoing costs associated with obtaining ownership 
information and monitoring the ownership interests of members for 
compliance with the proposed ownership and voting limits. Facilities 
also could incur these costs to the extent the exchange or association 
requires the facility's help to obtain and monitor ownership by members 
and their related persons in the facility. As stated above in Section 
IX., the Commission estimates that an exchange or association would 
spend approximately 14 hours and $1,290 annually if it determined to 
request ownership information from owners of voting and ownership 
interests. Thus, the Commission estimates that all exchanges and 
associations annually would spend a total of approximately 140 hours 
and $12,900 if they requested such ownership information. The 
Commission requests comment on this estimate. In addition, an exchange 
or association, as well as a facility, could incur costs of enforcing 
the ownership and voting limits. For example, an exchange could incur 
costs involved with redeeming shares held in excess of the proposed 
limits if the exchange chooses to provide that any such excess shares 
would be purchased by the exchange. An exchange, association or 
facility also could incur costs associated with monitoring votes cast 
at any shareholder meeting to determine that no member and its related 
persons subject to the voting limits exceeded those limits.
    Any member and its related persons that owns in excess of the 
proposed limit of any class of securities or other ownership interest 
of the exchange, association, or facility could incur costs involved 
with divesting the portion of its ownership interest that exceeds the 
limit. As stated above in Section IX., the Commission preliminarily 
believes that only two members that are brokers or dealers currently 
own greater than 20% of a demutualized exchange or facility.\648\ The 
Commission specifically requests comment on this issue, and whether any 
other broker-dealer members (alone or together with their related 
persons) currently own more than 20% of an SRO or a facility of an SRO. 
The Commission also recognizes that implementation of the proposed 
ownership and voting restrictions on members that are brokers or 
dealers potentially could reduce the value of the ownership interests 
in the exchange, association, or facility, to the extent that the 
proposed requirements adversely affect the free transferability of the 
securities, which would impact the owner of the securities, as well as 
the exchange, association, or facility. The Commission seeks comment on 
these costs.
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    \648\ At the time that the Commission approved BOX as a trading 
facility of BSE, Interactive Brokers Group LLC (a registered broker-
dealer) owned more than a 20% interest in BOX. See Securities 
Exchange Act Release No. 49067, supra note 59. Also, at the time the 
Commission approved a PCX rule filing relating to the IPO of 
Archipelago Holdings, one member of PCX held both an equity trading 
permit issued by PCX Equities and more than a 20% interest in 
Archipelago Holdings. See Securities Exchange Act Release No. 50170, 
supra note 65.
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    Finally, the proposed governance rules would require each exchange 
and association to adopt a code of conduct and ethics for directors, 
officers and employees, as well as governance guidelines that include 
specified provisions.\649\ Some exchanges or associations could already 
have codes and guidelines that comply with the proposed governance 
rules, in which

[[Page 71200]]

case, little or no costs would be incurred. However, other exchanges or 
associations may be required to utilize in-house staff or hire legal 
counsel to draft such codes or guidelines. The Commission requests 
comment on the extent to which exchanges and associations already have 
codes and guidelines that comply with the proposed rules.
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    \649\ See supra Section II.B.10. for a discussion of the 
proposed code of conduct and ethics and governance guidelines.
---------------------------------------------------------------------------

3. Request for Comment
    The Commission generally requests comment as to whether the 
operation of proposed Rules 6a-5 and 15Aa-3 would result in the 
potential costs discussed above, and how to quantify these potential 
costs. In addition, the Commission requests data to quantify the costs 
and benefits described above. The Commission seeks estimates of these 
costs and benefits, as well as any costs and benefits not already 
defined, which may result from the adoption of these proposed new 
rules.

B. Costs and Benefits of Proposed Regulation AL

    As discussed above, the listing of securities issued by an SRO, the 
facility of an SRO, or an affiliate of either (``affiliated 
securities'') on the SRO raises questions as to the SRO's ability to 
independently and effectively enforce its rules against itself.\650\ 
For instance, the SRO might be reluctant to vigorously monitor for 
compliance with its initial and continued listing rules by the 
securities of an affiliated issuer or its own securities, and may be 
tempted to allow its own securities, or the securities of an affiliate, 
to be listed (and continue to be listed) on its market even if the 
security is not in full compliance with the SRO's listing rules. The 
trading of securities of an SRO or the securities of an affiliated 
issuer on the SRO also raises similar potential conflict concerns, in 
that the SRO might choose to selectively enforce (or not enforce) its 
trading rules with respect to trading in its own stock or that of an 
affiliate so as to benefit itself. For example, the SRO may determine 
to look the other way with respect to improper trading in an affiliated 
security that creates the appearance of increased volume, such as 
through wash sales, or trading that artificially inflates or sustains 
the price of the stock, such as marking the close.
---------------------------------------------------------------------------

    \650\ See supra Section III. for a discussion of proposed 
Regulation AL.
---------------------------------------------------------------------------

    Proposed Regulation AL would prohibit an exchange or association 
from approving for listing an affiliated security unless such 
exchange's or association's Regulatory Oversight Committee (composed of 
independent directors) certified that such security satisfies the 
exchange's or association's rules for listing.\651\ Proposed Regulation 
AL also would impose reporting and notice requirements on an exchange 
or association with respect to an affiliated security.\652\ 
Specifically, an exchange or association would have to file quarterly 
reports with the Commission regarding its monitoring of the listing and 
trading of an affiliated security on its market; on an annual basis 
provide the Commission a copy of a report prepared by a third party 
analyzing compliance by the affiliated security with the exchange's or 
association's listing rules; promptly notify an affiliated issuer of 
alleged non-compliance with a listing rule; provide the Commission with 
a report detailing such alleged non-compliance; and provide the 
Commission with a copy of any response from the affiliated issuer.\653\ 
The exchange's or association's Regulatory Oversight Committee would 
have to approve the quarterly reports and the report detailing non-
compliance.
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    \651\ See proposed Rule 800(b)(1).
    \652\ See proposed Rule 800(b)(2)
    \653\ See id.
---------------------------------------------------------------------------

1. Benefits
    The Commission believes that requiring an exchange's or 
association's Regulatory Oversight Committee to have a role in 
monitoring compliance with the exchange's or association's rules with 
regard to an affiliated security would reduce the potential for 
conflict between an exchange's or association's self-regulatory 
responsibility to vigorously oversee the listing and trading of the 
affiliated security on its market, and its own commercial or economic 
interests. In particular, requiring the Regulatory Oversight 
Committee--a fully independent committee--to certify that an initial 
listing of an affiliated security satisfies the listing rules would 
bring a level of independence to the process. Also, requiring the 
Regulatory Oversight Committee to approve the quarterly reports and 
reports detailing non-compliance prior to filing with the Commission 
would serve to bring independent oversight to the ongoing monitoring 
process, and provide the Regulatory Oversight Committee with timely 
notice of potential concerns. In addition, the Commission believes that 
requiring a third party to analyze compliance with listing rules would 
serve to add an additional layer of impartiality to the oversight 
process. Regulation AL also would require the exchange or association 
to apply its listing rules to affiliated securities in a manner that is 
not materially different than the treatment afforded to other 
securities listed on the exchange or association, and that any action 
taken by the exchange or association with respect to listing and 
trading of an affiliated security be in compliance with the rules of 
the exchange or association. The Commission believes that these steps 
would help to address the potential conflict of interest, which would 
benefit investors and the market generally by helping to prevent fraud 
and manipulation and by helping to ensure that the exchange or 
association does not give preferential treatment to affiliated 
securities.
2. Costs
    Each exchange or association already should have in place 
established policies and procedures for monitoring the listing and 
trading of securities on or through its facilities.\654\ The Commission 
believes that the monitoring of the listing and trading of an 
affiliated security should fall within these existing procedures, thus 
minimizing costs necessary to monitor the listing and trading of an 
affiliated security's compliance with proposed Regulation AL.
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    \654\ The Commission notes that an exchange or association only 
would incur costs necessary to comply with proposed Regulation AL if 
it approved for listing an affiliated security that is to be traded 
on or through its facilities.
---------------------------------------------------------------------------

    The Commission recognizes that each exchange or association that 
lists an affiliated security could incur costs associated with a more 
frequent review for compliance with listing rules if the exchange or 
association does not perform such review at least once a quarter. As 
stated above in Section IX., the Commission estimates that an exchange 
or association that does not review for compliance on a quarterly basis 
would incur an additional reporting and recordkeeping burden of 8 hours 
per review, and further estimates that two additional reviews per year 
would be required. The Commission's preliminary belief, however, is 
that each exchange and association already performs some level of 
review for compliance with its listing rules on at least a quarterly 
basis. The Commission requests comment on this issue.
    In addition, the exchange or association could incur costs 
associated with requiring the Regulatory Oversight Committee to certify 
the initial listing of the affiliated security, and to approve each 
quarterly and any non-compliance reports, because the Committee would 
need time to review the listing rules and reports. An exchange or 
association also would incur in-house legal, compliance

[[Page 71201]]

and administrative costs related to preparing and filing quarterly 
reports with the Commission and, if an exchange or association were to 
allege that an affiliated security was not in compliance with listing 
rules, with preparing and filing a report with the Commission detailing 
such alleged non-compliance.\655\ As discussed above in Section IX., 
the Commission estimates that each exchange or association would spend 
approximately 17 hours preparing and filing the initial quarterly 
report and 12 hours for each quarterly report thereafter, for a total 
of 53 hours per exchange or association for the first year and 48 hours 
per exchange or association thereafter. Additionally, the Commission 
estimates that each exchange or association would spend approximately 5 
hours to prepare and file a non-compliance report, 2 hours to notify an 
issuer of alleged non-compliance, 2 hours to comply with the proposed 
requirement to file a copy with the Commission of a response to any 
issuer that notifies the exchange or association of alleged non-
compliance and $1.29 \656\ each time the exchange or association 
notifies an issuer of alleged non-compliance, files a report with the 
Commission, sends notice of non-compliance to an issuer or files a copy 
with the Commission of any notice of non-compliance. The Commission is 
not able to estimate how many non-compliance reports would need to be 
filed, how many times an exchange or association would need to notify 
an issuer of non-compliance, and how many times an exchange or 
association would need to file a copy with the Commission of any 
response to any issuer that notifies the exchange or association of its 
non-compliance, but estimates that one occurrence of each such event 
per exchange or association would occur each year. Accordingly, the 
Commission estimates that each exchange or association would spend 9 
hours per year and $3.87, for a total of 81 hours and approximately $35 
for all exchanges and associations.
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    \655\ The exchange or association may also incur outside legal 
costs, to the extent they choose to outsource the preparation of 
these reports. The Commission does not believe it likely that an 
exchange or association would outsource the preparation of these 
reports, but requests comment on the issue.
    \656\ The Commission assumes that each report and notification 
will weigh five ounces and will be mailed via first class mail at a 
rate of $0.37 for the first ounce and $0.23 for each additional 
ounce, for a total of $1.29.
---------------------------------------------------------------------------

    In addition, the exchange or association would incur the costs of 
hiring a third party to analyze and prepare a report regarding the 
affiliated security's compliance with the exchange's or association's 
listing rules on an annual basis.\657\ The Commission also estimates 
that an exchange or association would spend approximately 9 hours 
reviewing and participating in the preparation of such third party 
reports. As discussed above in Section IX., the Commission 
preliminarily estimates that it would take a third party approximately 
22 hours to prepare and file each report, for a total annual cost per 
exchange or association of approximately $6,612, or $59,508 annually 
for all exchanges and associations.
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    \657\ The Commission believes that most, if not all, exchange 
and association listing rules include fairly objective quantitative 
(e.g. market capitalization) and qualitative (e.g. that the majority 
of the board be independent) listing standards. For example, see 
Sections 1 and 3 of the NYSE Listed Company Manual and Rules 4300, 
et seq., of the NASD Manual.
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3. Request for Comment
    The Commission seeks comment on any additional benefits of proposed 
Regulation AL. The Commission also generally requests comment as to 
whether the operation of the proposed rule would result in the 
potential costs discussed above, and how to quantify these potential 
costs. The Commission also seeks comment on any additional anticipated 
costs and benefits of the proposed rule, including specifics of the 
dollar amount of such cost or benefit impact.

C. Costs and Benefits of Proposed Rule 6a-2 and Revised Form 1, and 
Rule 15Aa-2 and New Form 2

    The Commission proposes to amend the procedures for application as 
a national securities exchange (or exchange exempt from registration 
based on limited volume) or registered securities association (or 
affiliated securities association), and for the submission of 
amendments to such applications. In addition, the proposals would 
harmonize the disclosure requirements for exchanges and associations.
    Under the proposals, an applicant for registration as a national 
securities exchange or an exchange exempt from registration pursuant to 
Section 5 of the Exchange Act,\658\ or as a registered securities 
association or an affiliated securities association, would be required 
to submit a registration statement and provide disclosure to the 
Commission on revised Form 1 (for exchanges) or new Form 2 (for 
associations).\659\ Any exchange or association that is registered with 
the Commission as of the publication date of adoption of any proposed 
amendments to the forms would be required to file a complete 
registration statement on revised Form 1 or new Form 2, as applicable, 
within six months following such publication date. Exchanges and 
associations also would use revised Form 1 and new Form 2, 
respectively, to submit amendments. An exchange or association further 
would be required to comply with proposed amendments to Rule 6a-2 \660\ 
and revised Form 1, and proposed Rule 15Aa-2 and new Form 2, on behalf 
of any facility that is a separate legal entity \661\ or any regulatory 
subsidiary of the exchange or association with respect to the filing of 
specified Exhibits.\662\ The term ``regulatory subsidiary'' would mean 
any person that, directly or indirectly, is controlled by the exchange 
or association and that provides, whether pursuant to contract, 
agreement or rule, regulatory services to or on behalf of the exchange 
or association.\663\
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    \658\ 15 U.S.C. 78e.
    \659\ Currently, securities associations are required to 
register on Form X-15AA-1 and to file amendments and supplements on 
Forms X-15AJ-1 and X-15AJ-2. The Commission proposes to redesignate 
Form X-15AA-1 as Form 2 and to amend Form 2 in a manner consistent 
with the proposals contained in this release. For clarity, we refer 
to the registration form for exchanges, as proposed to be amended, 
as ``revised Form 1'' and the registration form for securities 
associations, as proposed to be redesignated and amended, as ``new 
Form 2.''
    \660\ 17 CFR 240.6a-2.
    \661\ The term ``facility'' when used with respect to an 
exchange would have the same meaning as in Section 3(a)(2) of the 
Exchange Act. 15 U.S.C. 78c(a)(2). The term ``facility'' when used 
with respect to an association is defined in proposed Rule 15Aa-
3(b)(11).
    \662\ The proposed Exhibits to revised Form 1 and new Form 2 for 
which an exchange or association would need to include information 
with respect to a facility or regulatory subsidiary are Exhibits A 
(governance documents and rules), B (written rulings, 
interpretations), C (composition, structure and responsibilities of 
the board), D (list of officers), E (information about executive 
board and committees), F (governance guidelines, code of conduct and 
ethics (and waivers), G (internal organizational charts), H 
(regulatory program), and I (financial information).
    \663\ See proposed Instructions to revised Form 1 and new Form 
2.
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    The Commission's proposals would require the disclosure of greater 
information about exchanges and associations, particularly with respect 
to their governance and organizational structure, their regulatory 
programs, and significant ownership of the exchange or association or 
facility of the exchange or association.\664\ Under the Commission's 
proposals, certain Exhibits to the current Form 1 (exchanges) would be 
revised to require more detailed disclosures; comparable disclosures 
would be required pursuant to Form 2 (associations). These revised 
Exhibits

[[Page 71202]]

would pertain to information about the officers of exchanges and 
associations; \665\ a description of the structure, composition, and 
responsibilities of any executive board and each committee; \666\ 
financial information, including an itemization of revenues and 
expenses; \667\ the ownership interest of any exchange, association, or 
facility of an exchange or association, and information on persons 
owning more than 5% of such ownership interest; \668\ and information 
about securities listed or traded on the SRO or on any SRO trading 
facility.\669\ In addition, the Commission is proposing to add several 
new Exhibits to the current Form 1 and to incorporate those Exhibits in 
new Form 2. These Exhibits would pertain to the composition, structure, 
and responsibilities of the board; \670\ the governance guidelines, 
code of conduct and ethics (and waivers thereof),\671\ and the method 
established by the exchange or association for interested parties to 
communicate their concerns regarding any matter within the authority or 
jurisdiction of a Standing Committee directly to independent directors; 
\672\ the organizational structure of the exchange or association; 
\673\ the regulatory program of the exchange or association; \674\ the 
relationship between and among the exchange (or association), any 
facility of an exchange (or association), and any affiliate of the 
exchange (or association) or facility of the exchange (or association); 
\675\ and the location of the exchange's or association's books and 
records.\676\
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    \664\ See supra Section IV.
    \665\ See proposed Exhibit D to revised Form 1 and new Form 2.
    \666\ See proposed Exhibit E to revised Form 1 and new Form 2.s
    \667\ See proposed Exhibit I to revised Form 1 and new Form 2.
    \668\ See proposed Exhibit Q to revised Form 1 and new Form 2.
    \669\ See proposed Exhibit T to revised Form 1 and new Form 2. 
The term ``SRO trading facility'' would mean any facility of a 
national securities exchange or registered securities association 
that executes orders in securities. See proposed Instructions to 
revised Form 1 and new Form 2.
    \670\ See proposed Exhibit C to revised Form 1 and new Form 2.
    \671\ See proposed Exhibit F to revised Form 1 and new Form 2.
    \672\ See proposed Exhibit C to revised Form 1 and new Form 2.
    \673\ See proposed Exhibit G to revised Form 1 and new Form 2.
    \674\ See proposed Exhibit H to revised Form 1 and new Form 2.
    \675\ See proposed Exhibit P to revised Form 1 and new Form 2.
    \676\ See proposed Exhibit U to revised Form 1 and new Form 2.
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    One of the most significant proposed features is the requirement 
that exchanges and associations provide more in-depth disclosures about 
their regulatory programs and a breakdown of the revenues and expenses 
associated with those programs. Exchanges and associations would need 
to provide a description of their regulatory programs (and those of any 
regulatory subsidiary). The description would include information 
concerning member firm regulation, market surveillance, enforcement, 
listing qualifications, arbitrations, rulemaking and interpretation, 
and the process for assessment and development of regulatory policy. 
Exchanges and associations would be required to provide a copy of any 
delegation plan or other contract or agreement relating to regulatory 
services that are provided or will be provided to the exchange or 
association by another SRO, a regulatory subsidiary, or a regulatory 
subsidiary of another SRO. Exchanges and associations also would be 
required to describe fully the method established by the board for 
interested parties to communicate their concerns regarding any matter 
within the authority or jurisdiction of a Standing Committee directly 
to independent directors.\677\
---------------------------------------------------------------------------

    \677\ See proposed Exhibit C to revised Form 1 and new Form 2.
---------------------------------------------------------------------------

    Further, revised Form 1 and new Form 2 would require the exchange 
or association to provide a description of the structural or functional 
independence of the regulatory program from the market operations and 
other commercial interests of the exchange or association, and to 
discuss fully any significant regulatory issues that have arisen or any 
significant events that have taken place in the past year and the 
effect these significant issues or events may have on the mission, 
strategy, and future operations of the exchange's or association's 
regulatory program.\678\
---------------------------------------------------------------------------

    \678\ See proposed Exhibit H to revised Form 1 and new Form 2.
---------------------------------------------------------------------------

    In addition, the proposals would require exchanges and associations 
to disclose their regulatory expenses as a proportion of their total 
budget, and separately as a proportion of their total annual revenues. 
Pursuant to this provision, exchanges and associations would be 
required to disclose the aggregate amounts that they expend on 
regulatory activities, as well as the amounts that they expend on 
certain subcategories of regulatory activities, including supervisory 
activities (e.g., routine examinations and oversight of member activity 
conducted in the regular course of business), surveillance activities 
(e.g., manual and automated surveillance to ensure compliance with 
rules, such as trading rules and financial responsibility rules), and 
disciplinary activities (e.g., enforcement activities). Revised Form 1 
and new Form 2 also would require exchanges and associations to 
disclose the dollar amount of their revenues and expenses of their 
regulatory programs, with detailed itemization within the following 
broad categories: revenues; direct expenses; and allocated expenses. 
Exchanges and associations would provide this information for each area 
of their regulatory programs, such as surveillance, supervision, and 
discipline, and provide aggregate data for all program areas.\679\
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    \679\ See proposed Exhibit I to revised Form 1 and new Form 2.
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    Further, the proposals would require exchanges and associations to 
amend Form 1 and Form 2 closer in time to the occurrence of an event 
that requires amendment.\680\ The Commission also is proposing to 
require that each exchange and association prepare annually an updated 
Form 1 or Form 2, as applicable,\681\ and continuously post its most 
recent form and any subsequent amendments on a publicly accessible 
Internet Web site controlled by the exchange or association.\682\ The 
proposed amendments would give exchanges and associations the option of 
complying with the annual filing requirements for specified Exhibits by 
posting the required information on an Internet Web site and certifying 
that the posted information is accurate.\683\
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    \680\ See proposed Rules 6a-2(a) and 15Aa-2(a).
    \681\ See proposed Rules 6a-2(b) and 15Aa-2(b).
    \682\ See proposed Rules 6a-2(c) and 15Aa-2(c).
    \683\ See proposed Rules 6a-2(d) and 15Aa-2(d).
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1. Benefits
    By requiring that national securities exchanges (and exchanges 
exempted from registration based on limited volume) and registered 
securities associations (and affiliated securities association) to 
provide equivalent information on revised Form 1 (exchanges) and new 
Form 2 (associations), the Commission expects that the proposals would 
benefit an exchange's or association's members, users of their 
facilities, institutional and retail investors, and the shareholders or 
other owners of the exchange or association, as well as the Commission, 
by providing them with access to more frequent and more detailed 
information about aspects of exchanges' and associations' governance 
and organizational structures, their regulatory programs, and their 
significant owners. Further, the proposals are intended to align the

[[Page 71203]]

regulatory disclosure framework for exchanges and associations by 
mandating comparable disclosure requirements for both types of SROs, 
particularly as they are charged with nearly identical obligations 
under the Exchange Act.\684\ The Commission also believes that 
disclosure of information with respect to the facility or regulatory 
subsidiary of an exchange or association would provide benefits to 
investors, market participants, and others by providing a more accurate 
and complete overview of the structure and governance of an SRO.
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    \684\ See Sections 6 and 15A of the Exchange Act, 15 U.S.C. 78f 
and 78o-3.
---------------------------------------------------------------------------

    In the Commission's view, the proposed amendments to Rule 6a-2 and 
new Rule 15Aa-2, along with revised Form 1 and new Form 2, should bring 
a much greater degree of transparency to the administration, 
organization, governance, and ownership of exchanges and associations 
than currently exists. The Commission and the public would have access 
to more detailed information about the board members, officers, and 
committee members of exchanges and associations; the structure, 
composition, and responsibilities of the board, executive board, and 
each committee; financial information, including an itemization of 
revenues and expenses; the ownership interest of any exchange, 
association, or facility of an exchange or association, and information 
on persons owning more than 5% of such ownership interest; and 
information about securities listed or traded on the SRO or on any SRO 
trading facility. In addition, the Commission and the public would be 
able to obtain information about the governance guidelines, waiver of 
the code of conduct and ethics, and method by which interested parties 
may communicate concerns to independent directors with respect to a 
Standing Committee; the organizational structure of the exchange or 
association; the regulatory program of the exchange or association; the 
relationship between and among the SRO, its facilities, and any 
affiliate of the SRO or a facility of the SRO; and the location of the 
exchange's or association's books and records.
    These enhanced disclosure requirements would enable a wide range of 
individuals and entities, including members of exchanges and 
associations, users of their facilities, institutional and retail 
investors, other market participants, shareholders and other owners of 
demutualized exchanges or facilities and the public generally, as well 
as regulators, to have access to important information about exchanges 
and associations. Such specific, detailed disclosure requirements would 
further the goal of providing market participants, investors, and the 
public generally with disclosures by SROs that present a greater degree 
of clarity and transparency. As SROs, exchanges and associations are 
accorded a public trust to oversee their markets and members and to 
protect investors and the public interest. The proposed disclosure 
requirements are intended to shed more light on those aspects of an SRO 
that are central to its carrying out its obligations under the Exchange 
Act.\685\ Thus, the proposed disclosure requirements should enhance 
investors' confidence in the fairness and integrity of the securities 
markets by requiring exchanges and associations to provide specific 
disclosures about their governance and administration.
---------------------------------------------------------------------------

    \685\ See Sections 6(b) and 15A(b) of the Exchange Act, 15 
U.S.C. 78f(b) and 78o-3(b).
---------------------------------------------------------------------------

    The proposed disclosure requirements also should benefit exchanges 
and associations because they would require these SROs to periodically 
focus on their governance structures and regulatory programs, as well 
to identify their significant owners, when they prepare the annual 
updates to Forms 1 and 2. Moreover, the proposals would provide the 
Commission with access to a stream of important information about 
exchanges and associations that could be used for oversight purposes. 
For instance, requiring an SRO to report on persons that own more than 
5% of the SRO or its facilities would serve to focus the SRO's 
attention on persons who accumulate significant interests. SROs could 
use this information to assess the ability of those persons to affect 
the operation of the SRO and its performance of its regulatory 
responsibilities. Providing detailed information regarding significant 
owners of the SRO or its facilities to the Commission, investors, 
members, and users of an SRO's facilities should help ensure greater 
accountability on the part of the exchange to monitor for undue 
influence or control of its regulatory and commercial operations, as 
well as further the ability of the Commission to carry out its 
oversight responsibilities over the SRO.
    The Commission believes that requiring those exchanges and 
associations that are registered with the Commission as of the date of 
publication in the Federal Register of adoption of any proposed 
amendments to the forms to file a complete registration statement on 
revised Form 1 or new Form 2 within six months following such 
publication date would establish a baseline for all registered 
exchanges and associations and would facilitate bringing such exchanges 
and associations into the disclosure process as proposed to be revised. 
In addition, the Commission's proposal to require more frequent updates 
of amendments to revised Form 1 and new Form 2, and to post recent 
versions of the forms on a publicly accessible Internet Web site in 
lieu of paper filing, should benefit investors, market participants, 
and the Commission. The proposed amendments should enhance investor 
confidence in the integrity of the markets by requiring exchanges and 
associations to provide more regular and up-to-date disclosures about 
significant changes in their governance, regulation, administration, 
and significant ownership. The Commission expects that posting the most 
recent version of completed Form 1 or Form 2 on an Internet Web site 
would make such information more readily accessible to both the 
Commission and the public, thereby enhancing the transparency of each 
exchange and association. Web site disclosure should assist market 
participants and the public in their understanding and awareness of 
significant aspects of these SROs. Moreover, SRO members, market 
participants, investors and regulators would be able to more easily 
monitor the effectiveness and performance of SROs, thus helping to 
promote greater accountability by SROs with their Exchange Act 
obligations.
    Finally, the Commission believes that the proposed elimination of 
Forms X-15AJ-1 and X-15AJ-2 and the proposed use of Form 2 as both the 
application for initial registration as a registered securities 
association or affiliated securities association, and the form for 
submitting amendments to the initial application, would provide for 
more uniform disclosure requirements for exchanges and associations 
than the existing regulatory scheme. The Commission believes that more 
closely aligning the disclosure requirements for exchanges and 
associations would benefit the Commission and the public, particularly 
in light of the fact that the Exchange Act imposes comparable 
requirements on these SROs. The Commission requests comment on the 
benefits of its proposals to increase disclosure on revised Form 1 and 
new Form 2.
2. Costs
    The Commission anticipates that the additional disclosure 
requirements contained in the proposals, and the proposed requirements 
for more

[[Page 71204]]

frequent filing, would impose costs on exchanges and associations in 
terms of additional staff time dedicated to recordkeeping, the 
obtaining and compilation of data, annual preparation and internal 
review of revised Form 1 and new Form 2, respectively, and periodic 
amendments to the applicable form. However, much of the required 
information should be readily available to the boards of exchanges and 
associations and management of these SROs, particularly with respect to 
matters relating to governance structure. The Commission anticipates, 
however, that an exchange or association would incur greater costs in 
the first year or two after adoption of the proposals than in 
subsequent years. This is in part because the exchange or association 
would incur costs as it becomes familiar with the new requirements and 
sets up the mechanisms and internal procedures to collect and provide 
the information required by the forms' Exhibits, particularly the 
information relating to ownership of the exchange, association or a 
facility of either. Once these systems have been established, the 
Commission anticipates that the cost to maintain them would be 
relatively low. Under the proposed implementation schedule, the 
requirement that exchanges and associations that are registered with 
the Commission as of the publication date of adoption of any proposed 
amendments to the forms submit an initial complete revised Form 1 or 
new Form 2 from within six months following such publication date also 
would impose a higher initial cost on such exchanges and associations 
in the first year after the adoption of the proposals. A registered 
exchange or association, whose fiscal year ends after the final date by 
which such initial complete revised Form 1 or new Form 2, as 
applicable, must be submitted before the end of the calendar year in 
which such initial complete form is submitted, would incur higher costs 
in that first year because it also would be required to file an annual 
amendment in the same year as it submits the initial complete revised 
Form 1 or new Form 2, as applicable. The Commission believes that this 
is a necessary and justified cost, however, in order to bring currently 
registered exchanges and associations into the disclosure process, as 
proposed to be revised.
    As discussed above in Section IX, Commission staff believes that 
exchanges and associations would incur some costs in gathering the 
documentation to comply with the proposed rule and form amendments. The 
Commission believes the initial paperwork burdens for an exchange or 
association filing an initial registration statement is estimated to be 
157 hours per applicant. The yearly ongoing paperwork burdens for an 
exchange or association that has been approved for registration is 
estimated to be 48 hours per SRO.
    The Commission also believes that those exchanges and associations 
that are registered with the Commission as of the publication date of 
adoption of any proposed amendments to the forms, and thus would need 
to file a complete registration on revised Form 1 or new Form 2 no 
later than six months following such publication date would incur a 
paperwork burden of 157 hours per exchange or association for the 
complete revised Form 1 or new Form 2, plus an additional 20 hours if 
an annual amendment is required within the same calendar year. The 
yearly ongoing paperwork burden for each such exchange or association 
would be 48 hours. As a result, these exchanges and associations could 
have to file a completed registration form twice within a twelve month 
period. An exchange or association also would incur costs in the 
mailing of paper filings and copies to the Commission. The Commission 
estimates that the costs of mailing an initial application on revised 
Form 1 or new Form 2 would be $673.33 per exchange or association.\686\ 
The costs of filing a complete registration statement on revised Form 1 
or new Form 2 no later than six months following the final rules' 
publication date is also estimated by the Commission to be $673.33 per 
exchange or association.\687\ The Commission estimates that the costs 
of mailing an amendment to revised Form 1 or new Form 2 would be 
$365.86 per exchange or association.\688\ We request comment on the 
costs associated with this implementation proposal.
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    \686\ The Commission estimates that an initial application and 
copies would weigh approximately 180 lbs, and would be mailed via 
courier/shipping service.
    \687\ See supra note 686.
    \688\ The Commission estimates that an amendment and copies 
would weigh approximately 60 lbs, and would be mailed via courier/
shipping service.
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    As discussed in Section IX., for PRA purposes, the Commission 
estimates that total reporting and recordkeeping burden for an exchange 
that submits an initial registration or exemption application on the 
revised Form 1 would be 157 hours and $673.33 per applicant.\689\ For 
exchanges that are already registered with the Commission, the 
estimated reporting and recordkeeping burden for filing a complete 
revised Form 1 and any requisite updating amendments for the first year 
in which the final rules' are published would be 177 hours and 
approximately $1,039 per exchange. Thus, the Commission estimates that 
the total recordkeeping and reporting burden for all nine registered 
exchanges for the first year in which the final rules' are published 
would be 1,593 hours and approximately $9,351. After the year in which 
an exchange initially files the revised Form 1, the Commission 
estimates that such exchange would bear an annual reporting and 
recordkeeping burden of 48 hours and $731.72, and that all exchanges 
would bear a total annual reporting and recordkeeping burden of 432 
hours and approximately $6,585.
---------------------------------------------------------------------------

    \689\ This total includes the burden of preparing and submitting 
the initial registration form, but does not include any initial 
start-up burden for creating a website (this is a burden on which 
the Commission is soliciting comments).
---------------------------------------------------------------------------

    The Commission estimates that total reporting and recordkeeping 
burden for an association that submits an initial registration 
application on the new Form 2 would be 157 hours and $673.33 per 
applicant.\690\ For associations that are already registered with the 
Commission, the estimated reporting and recordkeeping burden for filing 
a complete new Form 2 and any requisite updating amendments for the 
first year in which the final rules' are published would be 177 hours 
and approximately $1,039 per association. Thus, the Commission 
estimates that the total recordkeeping and reporting burden for the one 
registered association for the first year in which the final rules' are 
published would be 177 hours and approximately $1,039. After the year 
in which an association initially files the new Form 2, the Commission 
estimates that such association would bear an annual reporting and 
recordkeeping burden of 48 hours and $731.72.
---------------------------------------------------------------------------

    \690\ This total includes the burden of preparing and submitting 
the initial registration form, but does not include any initial 
start-up burden for creating a website (this is a burden on which 
the Commission is soliciting comments).
---------------------------------------------------------------------------

    Revised Form 1 and new Form 2 would require that exchanges and 
associations provide copies of certain documents to the Commission. For 
example, exchanges and associations would be required to provide a copy 
of the constitution and other governing documents, and a copy of all 
written rulings and interpretations.\691\ Exchanges and associations 
also would be required to provide a copy of the written charter for 
each Standing

[[Page 71205]]

Committee.\692\ In addition, exchanges and association would be 
required to submit a copy of the governance guidelines, code of conduct 
and ethics,\693\ and copy of the procedures for interested persons to 
communicate concerns regarding matters within the jurisdiction or 
authority of a Standing Committee to independent directors.\694\ Copies 
of delegation plans or other agreement relating to regulatory services 
provided to the exchange or association,\695\ membership 
applications,\696\ forms of financial statements, reports or 
questionnaires relating to financial responsibility or minimum capital 
requirements,\697\ and listing applications \698\ also would be 
required to be provided on revised Form 1 and new Form 2. The 
Commission believes that exchanges and associations already maintain 
these documents, and should only incur mailing costs, as discussed 
earlier.\699\ The Commission, however, requests comment on whether 
exchanges and associations currently retain such documents.
---------------------------------------------------------------------------

    \691\ See proposed Exhibits A and B of revised Form 1 and new 
Form 2.
    \692\ See proposed Exhibit E of revised Form 1 and new Form 2.
    \693\ See proposed Exhibit F of revised Form 1 and new Form 2.
    \694\ See proposed Exhibit C of revised Form 1 and new Form 2.
    \695\ See proposed Exhibit H of revised Form 1 and new Form 2.
    \696\ See proposed Exhibit M of revised Form 1 and new Form 2.
    \697\ See proposed Exhibit N of revised Form 1 and new Form 2.
    \698\ See proposed Exhibit O of revised Form 1 and new Form 2.
    \699\ Moreover, as discussed below, the costs of filing some of 
the exhibits should be further reduced for exchanges and 
associations that choose to comply by posting specified Exhibits on 
an Internet Web site. See proposed Rules 6a-2(d) and 15Aa-2(d).
---------------------------------------------------------------------------

    However, other Exhibits to Forms 1 and 2 would require the exchange 
or association, respectively, to provide charts detailing aspects of 
its governance structure and internal organizational structure, as well 
as the relationship among the exchange, association, its facilities, 
and any affiliates.\700\ If the exchange or association currently does 
not prepare such charts, it would incur costs in preparing these 
charts. The exchange or association also must provide a table 
indicating the compensation of the five most highly compensated 
executives.\701\ The Commission does not expect that exchanges and 
associations would incur significant costs in preparing such charts or 
tables as this information is readily available to them. The Commission 
requests comment on the costs associated with the preparation of charts 
or tables in compliance with revised Form 1 and new Form 2.
---------------------------------------------------------------------------

    \700\ See proposed Exhibits E, G, and P of revised Form 1 and 
new Form 2.
    \701\ See proposed Exhibit I of revised Form 1 and new Form 2.
---------------------------------------------------------------------------

    Exchanges and associations also would be required to provide more 
detailed information regarding their regulatory programs, including 
revenues and expenditures related to those regulatory programs.\702\ 
Exhibit H to revised Form 1 and new Form 2 would require exchanges and 
associations to provide a description of all of their regulatory 
programs. Further, Exhibit H would require a description of the 
structural independence of the regulatory program from market operation 
and other commercial interests of the exchange or association. 
Exchanges and associations would be required to discuss any significant 
changes that are planned for their regulatory programs. In addition, 
each exchange and association would be required to discuss fully any 
significant regulatory issues that have arisen or any significant 
events that have taken place in the past year, that relate to or 
otherwise may affect the exchange's or association's regulatory 
responsibilities or the operation of its regulatory program. Exhibit H 
also would require exchanges and associations to discuss the effect 
that these significant issues or events may have on the mission, 
strategy, and future operations of the exchange's or association's 
regulatory program.\703\ An exchange or association would be likely to 
incur costs with regard to the description and discussion of the 
specified aspects of regulatory program that is necessary for 
compliance with proposed Exhibit H to revised Form 1 and new Form 2. 
The Commission requests comment on the costs of compliance with this 
proposal. The Commission further requests comment on whether the SRO 
would be likely to incur costs related to hiring and compensating 
outside counsel or consultants to aid in completing the description and 
discussion of specific aspects of the exchange's or association's 
regulatory program.
---------------------------------------------------------------------------

    \702\ See proposed Exhibits H and I of revised Form 1 and new 
Form 2.
    \703\ See proposed Exhibit H to revised Form 1 and new Form 2.
---------------------------------------------------------------------------

    Revised Form 1 and new Form 2 would require exchanges and 
associations to submit audited financial statements. This requirement 
is contained in the current Form 1 and the Commission believes that 
there should not be significant new costs associated with providing 
audited financial statements. The Commission requests comment on the 
costs associated with the preparation and filing of audited financial 
statements in accordance with revised Form 1 and new Form 2.
    Exchanges and associations would be required to disclose their 
regulatory expenses as a proportion of their total budget, and 
separately as a proportion of their total annual revenues. Pursuant to 
proposed Exhibit I to revised Form 1 and new Form 2, exchanges and 
associations would be required to disclose the aggregate amounts that 
they expend on regulatory activities, as well as the amounts that they 
expend on certain subcategories of regulatory activities, including 
supervisory activities, surveillance activities, and disciplinary 
activities. Revised Form 1 and new Form 2 also would require exchanges 
and associations to disclose the dollar amount of their revenues and 
expenses for each area (e.g., surveillance, supervision, and 
discipline) of their regulatory programs, with detailed itemization 
within the following broad categories: revenues; direct expenses; and 
allocated expenses.\704\ The Commission believes that the SROs 
currently track and maintain records of this financial information and 
that the costs of compliance with revised Form 1 and new Form 2 
therefore would not be substantial. The Commission requests comment on 
the costs of compiling information about their regulatory revenues and 
expenses.
---------------------------------------------------------------------------

    \704\ See proposed Exhibit I to revised Form 1 and new Form 2.
---------------------------------------------------------------------------

    Exchanges and associations also would be required to provide an 
itemization of their non-regulatory expenditures, including, but not 
limited to, personnel expenses, program expenses, systems and other 
technology expenses, consultants and advisors, and overhead.\705\ The 
Commission believes that the SROs currently track and maintain records 
of this financial information and that the costs of compliance with 
revised Form 1 and new Form 2 therefore would not be substantial. The 
Commission requests comment on the costs of compiling information about 
their non-regulatory expenditures.
---------------------------------------------------------------------------

    \705\ See proposed Exhibit I to revised Form 1 and new Form 2.
---------------------------------------------------------------------------

    Exchanges and associations also would be required to disclose all 
charitable contributions of the exchange or association (whether made 
directly or indirectly) in excess of $1,000 to a charity in which an 
executive officer or director of the applicant, or any of their 
immediate family members, is an executive officer or director of the

[[Page 71206]]

charity.\706\ Exchange and associations would incur costs in obtaining 
this financial information. The Commission requests comment on the 
costs of compiling information about charitable contributions of the 
exchange or association. The Commission further requests comment on 
whether SROs currently obtain information about charitable 
contributions from officers, directors, and their immediate family 
members. Commenters also are asked to comment on the ease by which an 
SRO could obtain information regarding charitable contributions 
required to be disclosed on revised Form 1 and new Form 2.
---------------------------------------------------------------------------

    \706\ See id.
---------------------------------------------------------------------------

    Further, under proposed Exhibit I, the exchange or association 
would have to incorporate a discussion of any unusual or infrequent 
events or transactions or any significant economic changes that have 
had a material effect on the financial condition of the exchange or 
association, and any known demands, commitments, events or 
uncertainties that would result in or are reasonably likely to result 
in a material change in financial condition. Proposed Exhibit I also 
would require a description of any significant business development 
involving the exchange or association, including a reorganization, 
merger or consolidation, acquisition or disposition of significant 
assets, or any other material change in business or operations.\707\ An 
exchange or association is likely to incur costs with regard to the 
staff and board analysis and internal discussion of such events and 
changes that is necessary for compliance with proposed Exhibit I to 
revised Form 1 and new Form 2. The Commission requests comment on the 
costs of compliance with this proposal. The Commission further requests 
comment on whether the SRO would be likely to incur costs related to 
hiring and compensating outside counsel or consultants to aid in 
completing the requirements of proposed Exhibit I.
---------------------------------------------------------------------------

    \707\ See id.
---------------------------------------------------------------------------

    In addition, proposed Exhibit I would require exchanges and 
associations to describe all material contracts and all material 
related party transactions. Further, Exhibit I would require a 
description of the material commitments of the exchange or association 
for expenditures as of the end of the latest fiscal period, and 
indicate the general purpose of such commitments and the anticipated 
source of funds needed to fulfill such commitments.\708\ SROs would 
incur costs to track and maintain records of this financial 
information. The Commission requests comment on the costs of compiling 
information about their material contracts and material related party 
transactions. The Commission further requests comment on whether SROs 
currently maintain records of their material contracts and related 
party transactions, and, if not, the ease of with which an SRO could 
obtain such information.
---------------------------------------------------------------------------

    \708\ See id.
---------------------------------------------------------------------------

    Finally, proposed Exhibit I would require a description of the 
material terms of the employment agreements of the five most highly 
compensated executives of the exchange or association and would require 
the exchange or association to provide a description of the 
compensation provided to members of its board.\709\ The Commission 
believes that the SROs currently track and maintain records of their 
compensation agreements with executives and that the costs of 
compliance would therefore not be substantial. The Commission requests 
comment on the costs of compiling information about employment 
agreements with the five most highly compensated executives of the 
exchange or association.
---------------------------------------------------------------------------

    \709\ See id.
---------------------------------------------------------------------------

    Overall, the Commission requests comment as to the types of records 
exchanges and associations presently maintain with respect to their 
budgets, revenues, and expenses, and, in particular, the revenues and 
expenses associated with their regulatory programs. Further, the 
Commission recognizes that exchanges and associations, would incur 
costs in the first year or two in setting up the format for disclosing 
revenues and expenditures according to the categories set forth in 
proposed Exhibit I to Forms 1 and 2, and in becoming familiar with the 
format. The Commission seeks comment on the costs that would be 
incurred by an exchange or association in preparing the proposed 
financial data contained in proposed Exhibit I according to the 
categories set forth therein.
    Proposed Exhibit Q to revised Form 1 and new Form 2 would require 
the exchange or association to disclose detailed information regarding 
direct and indirect significant (more than 5%) owners of the exchange 
or association or a facility thereof. Although an exchange or 
association may already collect or have access to some of this 
information, it is likely that it would incur costs associated with 
putting in place a process to obtain more detailed information, both in 
terms of the type of ownership information (e.g., number of shares, 
contracts relating to ownership) and the scope of persons whose 
ownership interest must be aggregated together (e.g., a person's 
interest must be aggregated with any of its ``related persons'' `` its 
affiliates, associated persons, and immediate family members). 
Facilities of the exchange or association also may incur costs 
associated with obtaining and providing ownership information to the 
exchange or association. The Commission believes that these costs would 
likely be more in the first year or two as the exchange, association or 
facility becomes familiar with the process, but recognizes that there 
would be ongoing costs to continually obtain this information. The 
Commission requests comment on the accuracy of this view and on the 
specific costs of obtaining and providing such detailed ownership 
information pursuant to revised Form 1 and new Form 2. The Commission 
further requests comment on the ease or difficulty an SRO would 
encounter to obtain all the information required to be disclosed by 
proposed Exhibit Q, including information regarding related persons. In 
addition, commenters are requested to provide information on costs 
associated with monitoring ownership on an on-going basis, including 
whether exchanges and associations would have to file a proposed rule 
change with the Commission to make changes to their rules to allow them 
to request this information from their or a facility's owners.
    The Commission proposes to more closely align the disclosure 
requirements for exchanges and associations. Currently, associations 
are not required to provide the same kind of information as exchanges. 
As a result of the proposed revisions that would require associations 
to disclose information in a format that is comparable to the one 
currently used by exchanges, associations likely would incur greater 
costs to comply with the disclosure requirements of new Form 2 than 
exchanges would face in complying with revised Form 1. The Commission 
requests comment on the costs of requiring more uniform registration 
forms for exchanges and associations.
    With limited exceptions,\710\ revised Form 1 or new Form 2, and all 
subsequent amendments thereto, would be required to be filed in paper 
format with the Commission, as well as posted on a publicly accessible 
Internet Web site controlled by the exchange or association. The 
exchanges registered

[[Page 71207]]

under Section 6(a) of the Exchange Act and the only association 
registered under Section 15A(a) of the Exchange Act, the NASD, all 
currently maintain publicly accessible Internet Web sites.\711\ 
Therefore, each exchange and association should incur minimal costs in 
updating their Internet Web sites to meet the proposed requirements. 
The Commission seeks comment on these costs.
---------------------------------------------------------------------------

    \710\ See proposed Rules 6a-2(d) and 15Aa-2(d).
    \711\ See supra note 546 and accompanying text.
---------------------------------------------------------------------------

    The Commission recognizes that certain exhibits require information 
that changes frequently; in addition, the paper involved to prepare 
those Exhibits could be voluminous. For that reason, the proposed rules 
provide that with respect to Exhibits A, B, M, N, S, or T, or Items 1-7 
of Exhibit L,\712\ of revised Form 1 and new Form 2, an exchange or 
association, in lieu of filing such information on paper, would be 
required only to identify the Internet Web site it controls where such 
information is available continuously and to certify to the accuracy of 
such information as of the date of filing. The Commission, in the 
future, may consider the feasibility of eliminating the paper filing 
requirement and permitting the forms and exhibits to be posted on an 
Internet Web site controlled by the SRO, filed electronically with the 
Commission or through some other means. The Commission seeks comment on 
these costs.
---------------------------------------------------------------------------

    \712\ These proposed Exhibits to revised Form 1 and new Form 2 
would require disclosure of: governance documents and rules (Exhibit 
A); written rulings and interpretations (Exhibit B); membership 
forms (Exhibit M); documents relating of financial responsibility or 
minimum capital requirements (Exhibit N); list of members and other 
users (Exhibit S); securities listed and traded (Exhibit T); and 
certain information regarding the manner of operation of an SRO 
trading facility (Items 1-7 of Exhibit L).
---------------------------------------------------------------------------

3. Request for Comment
    The Commission requests data to quantify the costs and benefits 
associated with its proposals to improve SRO transparency and provide 
for uniform regulatory treatment of exchanges and associations. The 
Commission seeks estimates of these costs and benefits, as well as any 
costs and benefits not already defined, which may result from the 
adoption of these proposed amendments to Rule 6a-2, new Rule 15Aa-1, 
revised Form 1, and new Form 2, along with the proposed repeal of Forms 
X-15AJ-1 and X-15AJ-2. Commenters are requested to provide empirical 
data and other factual support for their views to the extent possible.

D. Costs and Benefits of Proposed Amendments to Rule 17a-1

    The proposed change to Rule 17a-1 would require national securities 
exchanges, national securities associations, registered clearing 
agencies and the Municipal Securities Rulemaking Board to keep in the 
United States at least one copy of all documents required to be kept by 
Section 17(a) \713\ of the Exchange Act and Rule 17a-1 thereunder.\714\
---------------------------------------------------------------------------

    \713\ 15 U.S.C. 78q(a).
    \714\ 17 CFR 240.17a-1. See supra Section IV.C.11 for a 
discussion of the proposed change to Rule 17a-1.
---------------------------------------------------------------------------

1. Benefits
    While the Commission believes that in practice SROs subject to Rule 
17a-2 currently keep copies of all documents in the United States, the 
Commission is concerned that, given the globalization of the securities 
markets and the trend of SROs to demutualize, there is a greater 
potential that an SRO may be owned by a non-U.S. entity. By proposing 
to require that at least one copy of each document is kept in the 
United States, such documents should be more readily accessible for 
inspection and examination by the Commission pursuant to Section 17 of 
the Exchange Act,\715\ thus increasing the efficiency and effectiveness 
of Commission examinations and aiding the Commission's ability carry 
out its oversight responsibilities. The Commission seeks comment on any 
additional benefits of the proposed changes to Rule 17a-1.
---------------------------------------------------------------------------

    \715\ 15 U.S.C. 78q.
---------------------------------------------------------------------------

2. Costs
    The Commission preliminarily believes that the proposed changes to 
Rule 17a-1 would impose minimal costs, if any, on national securities 
exchanges, national securities associations, registered clearing 
agencies and the Municipal Securities Rulemaking Board. The Commission 
believes that the proposed changes to Rule 17a-1 would reflect the 
current practice of these entities to keep at least one copy of their 
documents in the United States. To the extent one of these entities 
currently keeps its documents outside the United States, the Commission 
preliminarily believes that any storage and staff costs incurred in 
keeping the documents in the United States would be at least partially 
off-set by the reduction in storage and staff costs of keeping the 
documents outside of the United States. The Commission recognizes, 
however, that such SRO may incur costs to maintain duplicate sets of 
books and records.
3. Request for Comment
    The Commission seeks comment on whether there are any additional 
costs of the proposed change to Rule 17a-1, including specifics of the 
dollar amount of such cost impact, and whether any national securities 
exchanges, national securities associations, registered clearing 
agencies or the Municipal Securities Rulemaking Board currently keeps 
documents solely outside of the United States. The Commission also 
requests comment on any additional benefits associated with the 
proposed change to Rule 17a-1.

E. Costs and Benefits of Proposed Rule 17a-26

    The Commission proposes to adopt new Rule 17a-26 under the Exchange 
Act, which would require every national securities exchange and 
registered securities association, other than a national securities 
exchange registered pursuant to Section 6(g) of the Exchange Act \716\ 
and a limited purpose national securities association registered 
pursuant to Section 15A(k)(l) of the Exchange Act,\717\ to file with 
the Commission, on a quarterly and annual basis, reports that contain 
the information specified by the rule. The reports would be submitted 
electronically. Proposed Rule 17a-26 would require exchanges and 
associations to establish procedures for the preparation of the 
required reports in a uniform, readily accessible, and usable 
electronic format.
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    \716\ 15 U.S.C. 78f(g).
    \717\ 15 U.S.C. 78o-3(k)(l).
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    The quarterly reports would include information with respect to an 
exchange's or association's surveillance program; complaints received; 
investigations, examinations, and enforcement cases; and listings 
information; as well as copies of final agenda from any board or board 
committee meeting that took place during the quarter.\718\ The annual 
report would contain: (1) An aggregated year-end cumulative summary of 
specified categories of information regarding the SRO's regulatory 
program in the quarterly reports; (2) additional updated information on 
all items that are required to be part of the annual report, including 
a discussion of regulatory program procedures, the effectiveness of the 
regulatory program, internal controls addressing conflicts of interest, 
employment arrangements with senior regulatory personnel, efforts to 
comply

[[Page 71208]]

with undertakings made to the Commission, and copies of the proposed 
Standing Committee self-evaluations and the annual governance 
performance evaluation prepared by the Governance Committee; and (3) an 
independent audit of any electronic SRO trading facility.\719\ Finally, 
exchanges and associations would be required to file a supplement under 
certain circumstances in order to provide information concerning 
material changes or material events that affect the SRO's regulatory 
program.\720\
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    \718\ See proposed Rule 17a-26(b)(2).
    \719\ See proposed Rule 17a-26(a)(2) and (b)(3). The term 
``electronic SRO trading facility'' would be defined as a facility 
of an exchange or association that executes orders in securities on 
an electronic basis. See proposed Rule 17a-26 (j)(3).
    \720\ See proposed Rule 17a-26(d)(1).
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1. Benefits
    Proposed new Rule 17a-26 is intended to enhance the Commission's 
ability to monitor national securities exchanges' and registered 
securities associations' compliance with their self-regulatory 
responsibilities, particularly during the period between inspections by 
the Commission. The reports filed by these SROs would enable the 
Commission to monitor, on a routine basis, key aspects of the 
exchanges' and associations' regulatory programs; assess the SROs' 
responses to critical issues affecting them; and better target the 
Commission's inspection resources. Moreover, analysis of information 
provided in the reports should aid the Commission and SROs in the 
regulation and evaluation of other regulated entities, such as brokers 
and dealers. By utilizing the information in the reports, the 
Commission and SROs would better be able to target their resources to 
adopt rules to deter violative behavior, or to remove regulation that 
may be unnecessary.
    The Commission also would be able to use the reports to identify 
compliance trends within and among the exchanges and associations, 
including trends in exception reports and enforcement activities. The 
quarterly and annual reports would allow the Commission to monitor for 
developments, both within a given exchange or association and among the 
various exchanges and associations, upon which the Commission may be 
required to act. Thus, proposed Rule 17a-26 would assist the Commission 
in its efforts to stay abreast of new developments and challenges 
affecting exchanges and associations, their regulatory programs, their 
members and investors, and would permit the Commission and its staff to 
better identify, on a more contemporaneous basis, issues that warrant 
further investigation or immediate attention. The proposed rule also 
would assist the Commission by allowing it to utilize its inspection 
staff and resources more effectively.
    The Commission also believes that proposed Rule 17a-26 would 
provide benefits to exchanges and associations. The proposed rule 
should have a positive effect on exchange and association compliance 
practices. For example, the requirement that exchanges and associations 
obtain an annual audit of the operations of any of their electronic SRO 
trading facilities would help assure that such facilities are operated 
in compliance with all applicable legal and regulatory requirements. 
Given the technological and operational complexity of many electronic 
SRO trading facilities, the annual audit could help to ensure the 
integrity of these systems in practice with respect to their proper 
functioning and regulatory compliance. The Commission would be able to 
use such information in monitoring SRO compliance with Exchange Act 
rules and regulations, and SROs could be encouraged to take action on 
their own initiative to address any regulatory concerns raised by such 
audit.
    In addition, the proposed rule would require exchanges and 
associations to review, on at least a quarterly basis, the operation 
and performance of their regulatory programs. In summarizing material 
and preparing the reports required under the proposed rule, exchanges 
and associations would benefit by the opportunity to review on a 
quarterly basis the strengths and weaknesses of their regulatory 
programs. Exchanges and associations could use the reports to track 
surveillance and enforcement trends within their regulatory programs, 
as well as monitor trends in complaints received regarding the 
operation of their regulatory programs. The Commission expects that the 
reporting requirements should help exchanges and associations identify 
potential weaknesses in their compliance practices and surveillance 
programs, allowing them to update and strengthen their regulatory 
programs as needed.
    The Commission also expects that proposed Rule 17a-26 would 
encourage exchanges and associations to stress the importance of an 
active, top-quality compliance program, including thorough and diligent 
surveillance and enforcement, to their members and to their listed 
issuers, as well as to the senior management of the exchange or 
association. The annual and quarterly reports also would be a useful 
tool to allow the board of the exchange or association, as well as 
management, to monitor the operation of the exchange's or association's 
regulatory program over time. Finally, knowledge that SROs are 
submitting reports on a periodic basis to the Commission on their 
regulatory programs should contribute to an increased confidence by 
investors, issuers, and other market participants in the market as a 
whole.
2. Costs
    Proposed Rule 17a-26 would require national securities exchanges 
and registered securities associations to file quarterly and annual 
reports with the Commission. As discussed above in Section IX., the 
Commission believes that exchanges and associations would incur costs 
to comply with the proposed rule. In particular, based on information 
available to the Commission at this time, the Commission estimates that 
each national securities exchange and registered securities association 
would incur an average burden of 40 hours to prepare each quarterly 
report and 35 hours to prepare each annual report required by the 
proposed rule, for an annual burden of 195 hours per respondent. 
Accounting for nine national securities exchanges and one registered 
securities association, the total burden to comply with the quarterly 
and annual reporting requirements in proposed new Rule 17a-26 is 
therefore estimated to be 1,950 hours per year. Further, for purposes 
of this release, the Commission estimates that an exchange or 
association would incur a burden of 4 hours to prepare each interim 
updating amendment, which would likely be required, on average, 5 times 
per year for a total of 20 hours per respondent and 200 hours total for 
the nine exchanges and one association. Accordingly, as discussed above 
in Section IX., the total burden resulting from the proposed rule's 
quarterly and annual reporting provisions would be 2,150 hours and $60 
\721\ to prepare and file with the Commission each report and interim 
supplement.
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    \721\ The Commission estimates that an average filing will weigh 
two ounces, accounting for a diskette and accompanying letter, and 
will be mailed via first class mail at a rate of $0.37 for the first 
ounce and $0.23 for the additional ounce, for a total of $0.60 per 
filing. At four quarterly reports, one annual report, and an 
estimated five interim supplements, the Commission expects that each 
exchange or association would incur a cost of $6 to comply with the 
proposed rule. The Commission solicits comments on the accuracy of 
this estimate.
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    The Commission notes that some exchanges and associations could 
need to hire additional staff to comply with the requirements of the 
proposed rule. Whether an exchange or association

[[Page 71209]]

would need to hire additional staff to gather information and prepare 
the required reports would depend on the thoroughness and effectiveness 
of an exchange's or association's current recordkeeping systems and 
practices, the level and extent of regulatory activity subject to 
quarterly reporting (e.g., an exchange that experiences unusually heavy 
enforcement activity or has highly active listings activity could incur 
a greater reporting burden), and the current workloads of existing 
staff. The Commission expects that most exchanges and associations, in 
fulfilling their self-regulatory and recordkeeping requirements, are 
currently collecting most, if not all, of the information required to 
be reported under the proposed rule. Based on conversations with two of 
the larger SROs, the Commission understands that much of the 
information required by the proposed rule, in particular with respect 
to the quarterly reports, currently is maintained by those SROs. 
Specifically, the information that would be required to appear in the 
quarterly reports, including the results of surveillance programs; 
information on complaints received; information on investigations and 
examinations; information on enforcement cases; information on new 
listings, delistings, and alleged failures to satisfy listing 
standards; and board and board committee agenda, generally is retained 
by those SROs in varying formats. Accordingly, the primary cost to 
those SROs with respect to the information they currently retain would 
be in assembling that information into an electronic report for 
submission to the Commission. Thus, a primary burden on an exchange or 
association would be to prepare a consolidated electronic report 
containing all of the information proposed to be required, to the 
extent that it is not doing so already as part of its routine business 
practices. The Commission seeks comment on these costs. The Commission 
also requests comment on the extent to which exchanges and associations 
currently maintain this information in electronic format.
    The required annual reports would require exchanges and 
associations to aggregate information contained in the quarterly 
reports to be submitted as part of the annual report; however, the 
Commission expects that those costs would not be substantial. Given the 
proposed electronic nature of the quarterly reports, the Commission 
would expect that it would not be a costly or complicated task for an 
SRO to aggregate the quarterly information and incorporate the data 
into the proposed annual report. The Commission requests comment on the 
costs of compiling the data and preparing the proposed annual report. 
Exchanges and associations should comment on whether such reports would 
be prepared in-house or by outside counsel or advisors. Comment is also 
requested on whether exchanges and associations would expect to 
purchase software or hardware to aid in the preparation of the proposed 
annual reports.
    The Commission believes that exchanges and associations would incur 
costs related to the proposed requirement to include in the annual 
report an audit of any electronic SRO trading facility, which must be 
prepared by an independent third party. The purpose of this audit is to 
assess whether the operations of the electronic SRO trading facility 
comply with the rules governing the facility. Because the exchange or 
association would need to hire an independent third party to conduct 
this annual audit, it would incur ongoing yearly costs to comply with 
this requirement. As discussed above in Section IX., the Commission 
estimates that nine national securities exchanges and one registered 
securities association would be required to obtain and submit as part 
of the annual report, an annual audit of any electronic SRO trading 
facility, and each such exchange or association owning, operating, or 
sponsoring at least one such facility would spend approximately 15 
hours interacting with the third party with respect to their conduct of 
the audit and preparation of the audit report and 20 hours reviewing 
each audit report received from the third party, for a total of 35 
hours per exchange or association per year, for a total annual 
reporting and recordkeeping burden of 350 hours. With respect to the 
third-party auditor, the Commission estimates that it would take each 
third party 100 hours to conduct the audit and prepare the audit report 
for each exchange or association that owns, operates, or sponsors at 
least one electronic SRO trading facility, for a total annual cost per 
exchange or association of $15,000,\722\ resulting in a total annual 
burden cost of $150,000. The Commission requests comment on the 
expected costs of hiring an independent third-party to conduct the 
proposed annual audit. Exchanges and associations should comment as to 
whether they currently use the services of an independent third party 
to audit their operations and what type of business the third party is 
primarily engaged in (e.g., legal, consultant, financial). The 
Commission notes, however, that certain other annual report 
requirements, such as the discussion of internal controls and the 
discussion of the processes for carrying out regulatory 
responsibilities, should not impose significant costs on exchanges and 
associations.
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    \722\ The estimate assumes that the report will be prepared by 
an independent accounting firm or similar entity for the exchange or 
association at an estimated cost of $150 per hour, based on an 
hourly estimate for auditing services obtained from industry 
sources. The Commission requests comment on this estimate, and on 
what type of entity an exchange or association may hire to prepare 
this report.
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    Further, the Commission believes that exchanges and associations 
would incur initial start-up costs as part of the proposed rule. 
Exchanges and associations would be required to establish procedures 
for a uniform, readily accessible, electronic format for the required 
data. While these SROs would incur start-up costs in establishing these 
procedures, the Commission does not believe that these start-up costs 
would be significant. As stated above in Section IX., the Commission 
estimates that each exchange or association would spend approximately 
35 hours during the initial year of the proposed rule's effectiveness 
to establish procedures for the preparation of the reports required by 
the proposed rule in a uniform, readily accessible, and usable 
electronic format. Accounting for nine national securities exchanges 
and one registered securities association, the total burden per year to 
comply with the provision in proposed Rule 17a-26 regarding the uniform 
format for the quarterly and annual reports is estimated to be 350 
hours. The Commission seeks comment on these costs.
3. Request for Comment
    The Commission requests data to quantify the costs and benefits of 
proposed Rule 17a-26. The Commission seeks estimates of these costs and 
benefits, as well as any costs and benefits not discussed above, that 
may result from the adoption of this proposed rule. Commenters are 
requested to provide empirical data and other factual support for their 
views to the extent possible. The Commission specifically requests 
comment on the costs and benefits associated with the Commission's 
proposal to require periodic regulatory reports from exchanges and 
associations, including both start-up costs and annual ongoing 
compliance costs. The Commission also specifically requests comment on 
the costs and benefits of obtaining the report of an independent third 
party relating to the annual review of the

[[Page 71210]]

operations of an electronic SRO trading facility.

F. Costs and Benefits of Proposed Rule 17a-27

    Proposed Rule 17a-27 would require any member of an exchange or 
association that is a broker or dealer to provide a report to the 
Commission and the exchange or association of which it is a member when 
it, alone or together with its related persons, acquires, directly or 
indirectly, more than 5% of any class of securities or other ownership 
interest of such exchange, association, or of a facility of such 
exchange or association through which it is permitted to effect 
transactions.\723\
---------------------------------------------------------------------------

    \723\ See supra Section VI. for a discussion of the proposed 
rule.
---------------------------------------------------------------------------

1. Benefits
    As discussed above, a member of an exchange or association that is 
a broker or dealer and that owns a significant interest in such 
exchange, association, or a facility thereof potentially could control 
or influence the regulatory process and market operations of the 
exchange or association to its benefit. Requiring such members to 
furnish a statement to the Commission, and a copy of the statement to 
the SRO, describing their ownership interests in an exchange, 
association or facility, along with information regarding the member's 
ability to influence the management of the exchange or association, 
would help guard against any potential abuses of influence or control 
of the SRO's regulatory authority by alerting the Commission and the 
applicable exchange or association to accumulations of significant 
ownership interests by its members that are brokers or dealers. 
Providing information to the Commission on accumulations of interest by 
these members would facilitate the SRO's ability to effectively perform 
its regulatory obligations, and the Commission's ability to effectively 
carry out its statutory oversight responsibilities with respect to the 
exchange or association, by allowing the Commission and the applicable 
exchange or association to more easily monitor for accumulations of 
significant interests, to monitor the effects of such ownership, and to 
monitor the ability of a person or group of related persons to 
influence the operation of the exchange, association, or facility.
    Moreover, providing copies of the statement to the applicable 
exchange or association for which ownership information is provided 
would facilitate the exchange's or association's ability to monitor 
whether the ownership interests of its members that are brokers or 
dealers are in compliance with the proposed limits on broker-dealer 
members' ownership in and voting of interests in the SRO or its 
facilities. In addition, proposed Rule 17a-27 would assist exchanges 
and associations in complying with the proposed requirement of Exhibit 
Q to revised Form 1 and new Form 2 that would require exchanges and 
associations to provide disclosure to the Commission regarding any 
person that owns more than 5% of the exchange, association, or a 
facility thereof.
2. Costs
    The Commission recognizes that the proposed rule would impose costs 
on members that are brokers or dealers to track, calculate, and report 
ownership of more than 5% in an exchange or association of which it is 
a member or of a facility of an exchange or association through which 
it is permitted to effect transactions. The Commission preliminarily 
believes that, given the nature of their business, most members that 
are brokers or dealers currently have in place systems to track their 
ownership (and that of their affiliates) of securities, even for 
securities for which there is no reporting requirement under Sections 
13(d) or 13(g) of the Exchange Act, but specifically requests comment 
on this issue.\724\ The proposed rule likely would, however, require 
these members to make modifications to their systems and procedures to 
obtain additional ownership information for ``related persons'' for 
which they might not already obtain such information. For instance, the 
definition of ``related person'' includes immediate family members of 
the member (if such member is a natural person) and of a person 
associated with a member.\725\ The Commission notes that if the 
exchange, association, or facility is a public reporting company under 
Section 12 of the Exchange Act,\726\ members of the exchange or 
facility are required under Regulation 13D under the Exchange Act \727\ 
to monitor their ownership interests in such entity and to file a 
Schedule 13D or 13G if they exceed the 5% reporting threshold.\728\ 
However, because the scope of the reporting requirement of proposed 
Rule 17a-27 is broader than what is required by Schedule 13D and 13G, 
members may incur additional costs to comply with the proposed rule. In 
addition, for exchanges, associations or facilities that are not public 
reporting companies under Section 12 of the Exchange Act,\729\ the 
member likely would incur greater costs to comply with proposed Rule 
17a-27 because such members currently are not required to monitor their 
ownership interests in those entities. The Commission requests comment 
on the costs associated with obtaining and calculating ownership 
information under the proposed rule.
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    \724\ For example, members may monitor their ownership interests 
to prevent and monitor conflicts of interests and for supervision 
and compliance purposes.
    \725\ The Commission preliminarily believes that most, if not 
all, members require their associated persons to report their 
securities transactions and holdings to the member. See, e.g., NASD 
Rule 3050. Thus, the member could incorporate this information into 
its system for tracking ownership as would be required by proposed 
Rule 17a-27.
    \726\ 15 U.S.C. 78l.
    \727\ 17 CFR 240.13d-1 through 13d-7.
    \728\ 17 CFR 240.13d-101 or 240.13d-102.
    \729\ 15 U.S.C. 78l.
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    A member of an exchange or association that is a broker or dealer 
and that exceeds the reporting threshold also would incur costs to 
prepare and file the statement required by proposed Rule 17a-27. Such 
members would incur in-house legal, compliance and administrative costs 
associated with preparing and filing the initial report and periodic 
amendments in the event of an increase or decrease of more than 1% of 
the ownership interest last reported. The members also may incur 
outside legal costs associated with preparing these reports; although 
the Commission preliminarily believes that preparation of the report 
likely would not be outsourced, the Commission requests comment on this 
issue. As discussed above in Section IX., the Commission estimates that 
a member would spend approximately 35 hours to prepare and file the 
initial report, 2 hours and $1.29 to prepare and send a copy of the 
report or any amendment to the exchange or association and 10 hours to 
prepare and file any amendment, resulting in a total initial annual 
burden for all members of 4,700 hours and $258, and 1,200 hours and 
$258 annually thereafter. Additionally, the Commission estimates that 
each exchange or association would spend 4 hours to post a member's 
report on its Web site, resulting in a total annual burden of 400 hours 
for all exchanges and associations.
3. Request for Comment
    The Commission requests comment on whether there are any additional 
costs of the proposed Rule 17a-27. The Commission also requests comment 
on quantifying the amount of time and the dollar amount of the costs 
discussed above and any additional costs, including the costs 
associated with

[[Page 71211]]

tracking and reporting ownership interests pursuant to the proposed 
rule. The Commission also seeks comment on any additional benefits of 
the proposed Rule 17a-27.

XI. Consideration of Burden on Competition, and Promotion of 
Efficiency, Competition, and Capital Formation

    Section 3(f) of the Exchange Act requires the Commission, whenever 
it engages in rulemaking or in the review of a rule of an SRO, and it 
is required to consider or determine whether an action is necessary or 
appropriate in the public interest, to consider, in addition to the 
protection of investors, whether the action will promote efficiency, 
competition, and capital formation.\730\ Section 23(a)(2) of the 
Exchange Act \731\ requires the Commission, in adopting rules under the 
Exchange Act, to consider the impact that any such rules would have on 
competition. Section 23(a)(2) also prohibits the Commission from 
adopting any rule that would impose a burden on competition not 
necessary or appropriate in furtherance of the purposes of the Exchange 
Act.\732\
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    \730\ 15 U.S.C. 78c(f).
    \731\ 15 U.S.C. 78w(a).
    \732\ 15 U.S.C. 78w(a)(2).
---------------------------------------------------------------------------

    The Commission has considered the proposed rules in light of these 
standards and preliminarily believes that they will not impose a burden 
on competition not necessary or appropriate in furtherance of the 
purposes of the Exchange Act. In addition, the Commission believes that 
the proposed governance rules should have a beneficial impact on 
efficiency, competition, and capital formation. In particular, proposed 
Exchange Act Rules 6a-5 and 15Aa-3 are designed to strengthen the 
independence of SROs' governance and regulatory processes by enhancing 
the independence and effectiveness of exchange and association boards 
and those board committees. Moreover, the independence of exchanges' 
and associations' regulatory programs should be strengthened by the 
proposal to require the separation of their regulatory programs from 
their market operations and other commercial interests, as well as by 
the prohibition on using regulatory funds for non-regulatory purposes 
and the prohibition on using regulatory information for competitive 
purposes. Further, the proposed limitations on ownership and voting 
should help prevent members of an exchange or association that are 
brokers or dealers from being able to influence the operation of the 
exchange or association and the performance of its regulatory function 
in a manner detrimental to its competitors or in a manner favorable to 
such person or its affiliates. Overall, these requirements would help 
prevent an exchange or association from disregarding the regulatory 
process, and should help bolster investors' confidence in the entities 
that oversee and operate our nation's securities markets. Similarly, 
the Commission believes that the disclosure requirements under proposed 
Exchange Act Rules 6a-2, 15Aa-1, 15Aa-2 and the related Forms 1 and 2 
are appropriately tailored to provide the Commission and the public 
with important information about an exchange's or association's 
governance practices and regulatory programs. To the extent that the 
proposed rules would affect efficiency, competition, and capital 
formation, we believe that any effect would be positive because these 
proposals should help improve the transparency of exchanges and 
associations and thus increase investor confidence in the 
administration and operation of the securities markets.
    The Commission believes that the reporting requirements of proposed 
new Exchange Act Rule 17a-26 would not impose any unnecessary or 
inappropriate burden on competition because they would enhance the 
Commission's ability to monitor exchanges' and associations' compliance 
with their regulatory responsibilities, particularly during the period 
between inspections by Commission staff. Further, proposed Rule 17a-26 
should enable the Commission to deploy its inspection resources more 
efficiently and to monitor more effectively these SROs' responses to 
critical issues affecting their markets. In addition, the Commission 
believes that, to the extent that there is any impact on efficiency, 
competition, and capital formation as a result of proposed Rule 17a-26, 
the result would be a positive one. The proposal is designed to require 
exchanges and associations to provide quarterly and annual information 
about key features of their regulatory programs, which in turn should 
heighten these SROs' attention to their regulatory responsibilities 
under the Exchange Act as they prepare the required quarterly and 
annual reports.
    The proposed amendments to Rule 17a-1 and proposed new Rule 17a-27 
should bolster investor confidence in the markets by helping to ensure 
that the Commission is able to carry out its oversight responsibilities 
over national securities exchanges and registered securities 
associations. In addition, proposed Regulation AL, by requiring notice 
and heightened reporting by an exchange or association to the 
Commission with respect to the exchange's or association's oversight of 
the listing and trading of the securities of an affiliated issuer, 
should help bolster investor confidence that the exchange or 
association is fairly and effectively carrying out its regulatory 
obligations with respect to the listing and trading of the affiliated 
security.
    By promoting investor confidence in the fairness and integrity of 
our markets, and in the entities that oversee and operate our 
securities markets, investors may be more willing to effect 
transactions in those markets, which in turn would help to increase 
liquidity and to foster the capital formation process. The Commission 
requests comment on whether the proposed rules are expected to affect 
efficiency, competition, and capital formation.

XII. Consideration of Impact on the Economy

    For purposes of the Small Business Regulatory Enforcement Fairness 
Act of 1996, or ``SBREFA,'' \733\ the Commission must advise the Office 
of Management and Budget as to whether proposed Exchange Act Rules 3b-
19, 6a-5, 15Aa-3, 17a-26, 17a-27, or Regulation AL; the proposed 
amendments to Form 1 under the Exchange Act, redesignated Form 2 under 
the Exchange Act, Exchange Act Rules 6a-2, 15Aa-1 and 17a-1, or 
redesignated Exchange Act Rule 15Aa-2; or the removal of Forms X-15AJ-1 
and X-15AJ-2 under the Exchange Act constitute a ``major'' rule. Under 
SBREFA, a rule is considered ``major'' where, if adopted, it results or 
is likely to result in:
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    \733\ Pub. L. 104-121, Title II, 110 Stat. 857 (1996) (codified 
in various sections of 5 U.S.C., 15 U.S.C., and as a note to 5 
U.S.C. 601).
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     An annual effect on the economy of $100 million or more 
(either in the form of an increase or a decrease);
     A major increase in costs or prices for consumers or 
individual industries; or
     A significant adverse effect on competition, investment, 
or innovation.
    If a rule is ``major,'' its effectiveness will generally be delayed 
for 60 days pending Congressional review. We request comment on the 
potential impact of the proposed Exchange Act rules on the economy on 
an annual basis. Commenters are requested to provide empirical data and 
other factual support for their views to the extent possible.

[[Page 71212]]

XIII. Regulatory Flexibility Act Certification

    Section 3(a) of the Regulatory Flexibility Act (``RFA'') \734\ 
requires the Commission to undertake an Initial Regulatory Flexibility 
Analysis (``IRFA'') of the proposed rules and amendments on small 
entities unless the Commission certifies that the proposed rules and 
amendments, if adopted, would not have a significant economic impact on 
a substantial number of small entities.\735\ The Commission hereby 
certifies, pursuant to 5 U.S.C. 605(b), that the proposed Rules 3b-19, 
6a-5, 15Aa-2, 15Aa-3, 17a-26, and 17a-27, proposed Regulation AL, 
revised Rules 6a-2, 15Aa-1, 17a-1, and revised Form 1 and new Form 2, 
if adopted, would not have a significant economic impact on a 
substantial number of small entities. Proposed Rules 3b-19, 6a-5, 15Aa-
2, 15Aa-3, and 17a-26, proposed Regulation AL, Section (d) of proposed 
Rule 17a-27, revised Rules 6a-2, 15Aa-1, 17a-1, and revised Form 1 and 
new Form 2 would apply only to national securities exchanges, exchanges 
exempted from such registration based on limited volume, registered 
securities associations, or affiliated securities associations. Neither 
national securities exchanges, exchanges exempted from such 
registration based on limited volume, registered securities 
associations, nor affiliated securities associations, are considered 
``small entities'' within the meaning of the Regulatory Flexibility 
Act.\736\ Accordingly, the Commission does not believe that proposed 
Rules 6a-5, 15Aa-2, 15Aa-3, and 17a-26, proposed Regulation AL, revised 
Rules 6a-2, 15Aa-1, 17a-1, and revised Form 1 and new Form 2 would have 
a significant economic impact on a substantial number of small 
entities.
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    \734\ 5 U.S.C. 603(a).
    \735\ 5 U.S.C. 605(b).
    \736\ 5 U.S.C. 603.
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    Proposed Rules 17a-27(b) and (c) would apply to any member of an 
exchange or association that is a broker or dealer. The Commission 
preliminarily believes that proposed Rules 17a-27(b) and (c) would not 
have a significant economic impact on a substantial number of small 
entities. Proposed Rules 17a-27(b) and (c) would apply to any member of 
a national securities exchange or registered securities association 
that is a broker or dealer and that, alone or together with its 
``related persons,'' \737\ directly or indirectly beneficially owns 
more than 5% of any class of securities or other ownership interest of 
such exchange or association, or a facility of an exchange or 
association. The Commission estimates there are approximately 6,800 
members of an exchange or association that are registered brokers or 
dealers, \738\ of which approximately 906 are considered small 
entities. \739\ Although the Commission does not have sufficient data 
to determine how many members that are brokers or dealers and are small 
entities have or would have, alone or together with their related 
persons, ownership interests that would trigger the requirements of 
proposed Rule 17a-27, the Commission believes it is unlikely that any 
member that is a broker or dealer and is a small entity would trigger 
the 5% threshold, given the $500,000 capital limit a broker or dealer 
must not exceed to be considered a small entity. \740\ Based upon 
information available to the Commission at this time, the Commission 
estimates that there are less than 20 brokers or dealers that would 
trigger the requirements of proposed Rules 17a-27(b) and (c), and that 
these brokers or dealers would not be considered small entities. The 
Commission requests comment on this estimate. Furthermore, because of 
the cost of acquiring 5% or more of the securities of or other 
ownership interest in an exchange, association or facility thereof, the 
Commission believes it is unlikely that any broker or dealer that is a 
small entity would acquire such a substantial interest. \741\ Even if 
such a broker or dealer did acquire an interest in excess of 5%, \742\ 
the Commission does not believe that a substantial number would do so, 
given the limited number of exchanges, associations and facilities, and 
the relatively high price of acquiring such an interest. Consequently, 
the Commission does not believe that a substantial number of small 
entities would be required to prepare and file reports with the 
Commission pursuant to proposed Rule 17a-27. In addition, if a small 
broker or dealer did have to file a report with the Commission because 
it exceeded the 5% threshold, the Commission does not believe that the 
preparation and filing of that report would have a significant economic 
impact on the broker or dealer. \743\
---------------------------------------------------------------------------

    \737\ Pursuant to proposed Rule 17a-27(a)(13), the term 
``related person'' would be defined to mean, with respect to any 
member that is a broker or dealer: (i) Any affiliate of the member; 
(ii) any person associated with the member; (iii) any immediate 
family member of such member, or any immediate family member of the 
member's spouse, who, in each case, has the same home as the member 
or who is a director or officer of the disclosure entity or any of 
its parents or subsidiaries; and (iv) any immediate family member of 
the person associated with the member, or any immediate family 
member of that person's spouse, who, in each case, has the same home 
as the person associated with the member or who is a director or 
officer of the disclosure entity or any of its parents or 
subsidiaries. Pursuant to proposed Rule 17a-27(a)(6), the term 
``disclosure entity'' would be defined to mean, with respect to any 
member: (i) A national securities exchange of which it is a member, 
other than an exchange registered pursuant to Section 6(g) of the 
Exchange Act; (ii) a registered securities association of which it 
is a member, other than a limited purpose national securities 
association registered pursuant to Section 15A(K)(l) of the Exchange 
Act; and (iii) a facility of such national securities exchange or 
registered securities association through which it is permitted to 
effect transactions.
    \738\ See id.
    \739\ Based on the data in reports filed pursuant to Exchange 
Act Rule 17a-5, the Commission has determined that 906 of the 6,553 
filers are ``small entities.'' Paragraph (c) of Rule 0-10 of the Act 
states that the term ``small business,'' when referring to a broker 
or dealer, means a broker or dealer that: (i) Had total capital (net 
worth plus subordinated liabilities) of less than $500,000 on the 
date in the prior fiscal year as of which its audited financial 
statements were prepared pursuant to 17 CFR 240.17a-5(d) or, if not 
required to file such statements, a broker or dealer that had total 
capital (net worth plus subordinated liabilities) of less than 
$500,000 on the last business day of the preceding fiscal year (or 
in the time that it has been in business, if shorter); and (ii) is 
not affiliated with any person (other than a natural person) that is 
not a small business or small organization as defined in Rule 0-10.
    \740\ 17 CFR 240.0-10(c)(1). See supra note 739.
    \741\ For example, there were 46,310,865 outstanding shares of 
common stock of Archipelago Holdings, Inc. as of August 12, 2004 
(see Archipelago Holdings, Inc.'s prospectus dated August 12, 2004, 
filed with the Commission on August 12, 2004). Based on the closing 
price of $17.46 per share for Archipelago Holdings, Inc.'s common 
stock on November 3, 2004, 5% of the common stock of Archipelago 
Holdings, Inc. would be valued at approximately $43,886,461 
(assuming the number of outstanding shares has not increased or 
decreased). There are 1,366 ``seats'' on the NYSE. These seats 
represent an ownership interest in the NYSE. Based on the last 
reported sale price of a NYSE seat on October 29, 2004 of $1,035,000 
(see NYSE's Web site, www.nyse.com), a 5% ownership interest in the 
NYSE would be valued at approximately $70,690,500. Similarly, there 
are over 200 seats on the BSE. Assuming 200 seats and based on the 
last reported sale price of $5,000 on April 6, 2004 (see BSE's Web 
site, ``www.bostonstock.com''), a 5% ownership interest in the BSE 
would be valued at approximately $50,000. The Commission believes it 
unlikely that an entity with total capital of less than $500,000 
would be the holder of an ownership interest of such value or, if it 
did hold such interest, would not be affiliated with an entity 
(other than a natural person) that is not a small entity.
    \742\ For example, the Commission believes that the possibility 
of a small broker or dealer acquiring a 5% interest in the BSE would 
be greater than the possibility of a small broker or dealer 
acquiring a 5% interest in the NYSE.
    \743\ The Commission notes that, if any small entities are 
required to prepare and file reports pursuant to proposed Rule 17a-
27, the Commission estimates that the rule would require: (i) 
approximately 35 hours per statement to prepare and file the initial 
statement pursuant to proposed Rule 17a-27(b), including the time 
required for a member to modify its system for monitoring ownership 
for purposes of preparing the statement; (ii) approximately 2 hours 
and $1.29 to prepare and send the copy of the statement or any 
amendment to the applicable exchange or association pursuant to 
proposed Rule 17a-27(c); and (iii) that each amendment required by 
proposed Rule 17a-27(b)(4) would require 10 hours per amendment. See 
supra Section IX.G.4. for further discussion of the Commission's 
estimates of the reporting and recordkeeping burden for proposed 
Rule 17a-27.

---------------------------------------------------------------------------

[[Page 71213]]

    Even if a small broker or dealer did not trigger the 5% ownership 
threshold, it may feel the need to monitor ownership levels. The 
Commission believes that any system or other changes a small broker or 
dealer would need to make to monitor ownership interest would not cause 
a significant economic impact. The Commission believes that given the 
nature of their business, most members that are brokers or dealers, 
including those that are small entities, would have in place the 
necessary systems and procedures for tracking their ownership of 
securities, both for ownership of entities subject to reporting under 
Section 13(d) of the Exchange Act and for other entities as well. The 
Commission preliminarily believes that members could monitor their and 
their related persons' ownership interests in exchanges, associations 
and facilities pursuant to these existing systems. The Commission does 
recognize, however, that members may need to update their systems to 
meet the scope of the reporting parameters of the proposed rule (for 
instance, to include all ``related persons''), but preliminarily does 
not believe that these changes would create a significant economic 
impact. In addition, a broker or dealer that is considered a small 
entity likely would have fewer ``related persons'' for which to track 
ownership. Therefore, the Commission does not believe that proposed 
Rule 17a-27 would have a ``significant economic impact'' on a 
substantial number of small entities.
    The Commission encourages written comments regarding this 
certification. The Commission requests that commentators describe the 
nature of any impact on small entities and provide empirical data to 
support the extent of the impact. In particular, the Commission 
requests comments on (a) the number of small entities that would be 
affected by proposed Rule 17a-27; (b) the nature of any impact the by 
proposed Rule 17a-27 would have on small entities and empirical data 
supporting the extent of the impact; and (c) how to quantify the number 
of small entities that would be affected by or how to quantify the 
impact of by proposed Rule 17a-27. Commentators are asked to describe 
the nature of any impact and provide empirical data supporting the 
extent of the impact. Persons wishing to submit written comments should 
refer to the instructions for submitting comments in the front of this 
release.

XIV. Statutory Authority and Text of Proposed Rules

    Pursuant to the Exchange Act, 15 U.S.C. 78a et seq., and 
particularly, Sections 3, 6, 11A, 15A, 17, 19, 23(a) and 36(a) thereof, 
the Commission is proposing to (1) adopt Sec. Sec.  240.3b-19, 240.6a-
5, 240.15Aa-3, 240.17a-26, 240.17a-27 and Regulation AL under the 
Exchange Act; (2) amend Form 1 and Sec. Sec.  240.6a-2, 240.15Aa-1 and 
240.17a-1 under the Exchange Act; (3) redesignate Sec.  240.15Aj-1 
under the Exchange Act as Sec.  240.15Aa-2 and amend newly redesignated 
Sec.  240.15Aa-2; (4) redesignate Form X-15AA-1 as Form 2 and amend 
newly redesignated Form 2; and (5) remove Forms X-15AJ-1 and X-15AJ-2.

List of Subjects in 17 CFR Parts 240, 242 and 249

    Brokers, Reporting and recordkeeping requirements, Securities.

    For the reasons stated in the preamble, the Commission is proposing 
to amend Title 17, Chapter II of the Code of the Federal Regulations as 
follows:

PART 240--GENERAL RULES AND REGULATIONS, SECURITIES EXCHANGE ACT OF 
1934

    1. The general authority citation for part 240 is revised to read 
as follows:

    Authority: 15 U.S.C. 77c, 77d, 77g, 77j, 77s, 77z-2, 77z-3, 
77eee, 77ggg, 77nnn, 77sss, 77ttt, 78c, 78d, 78e, 78f, 78g, 78i, 
78j, 78j-1, 78k, 78k-1, 78l, 78m, 78n, 78o, 78o-3, 78p, 78q, 78s, 
78u-5, 78w, 78x, 78ll, 78mm, 79q, 79t, 80a-20, 80a-23, 80a-29, 80a-
37, 80b-3, 80b-4, 80b-11, and 7201 et seq.; and 18 U.S.C. 1350, 
unless otherwise noted.
* * * * *
    1. Section 240.3b-19 is added to read as follows:


Sec.  240.3b-19  Definition of rules of an exchange and rules of an 
association.

    (a) Definitions. The terms rules of an exchange and rules of an 
association shall include the constitution, articles of incorporation, 
bylaws, and rules, or instruments corresponding to the foregoing, of a 
regulatory subsidiary of an exchange or of an association of brokers 
and dealers.
    (b) Exemptions. Upon written request or on its own motion, the 
Commission may grant an exemption from the provisions of this section, 
either unconditionally or on specified terms and conditions, if the 
Commission determines that such exemption is necessary or appropriate 
in the public interest and is consistent with the protection of 
investors.
    3. Section 240.6a-2 is amended by:
    a. Revising paragraphs (a)(2) and paragraphs (b) through (e), and
    b. Adding paragraph (a)(3) and new paragraph (g).
    The revisions and additions read as follows:


Sec.  240.6a-2  Amendments to application.

    (a) * * *
    (2) Information filed as part of Exhibits C, D, E, H, I, J, K, M, 
N, O, P, S, or U and as part of Item 3 of Exhibit F or Items 1, 5, 6, 
and 7 of Exhibit Q, or any amendments thereto; or
    (3) Information filed as part of Items 2 or 3 of Exhibit Q, or any 
amendment thereto, except that such information is not required to be 
filed with respect to any ownership change that is less than one 
percent from the ownership interest last reported on Form 1 (17 CFR 
249.1), or any amendment thereto.
    (b) Within 60 days of the end of its fiscal year, a national 
securities exchange or an exchange exempted from such registration 
based on limited volume, must submit an amendment to its Form 1 that 
updates the Form 1 in its entirety. Each Exhibit to the amended Form 1 
shall be up to date as of the end of the latest fiscal year of the 
exchange.
    (c) Except as set forth in paragraph (d) of this section, a 
national securities exchange or an exchange exempted from such 
registration based on limited volume, must continuously post any 
amendments required to be filed under paragraphs (a) and (b) of this 
section on a publicly-accessible Internet web site controlled by the 
exchange, simultaneous with the filing of such information in paper 
form with the Commission. Only the most recent annual amendment filed 
under paragraph (b) of this section and any subsequent updates filed 
under paragraph (a) of this section are required to be posted on such 
Internet Web site. In its filing with the Commission, such exchange 
shall:
    (1) Indicate the location of the Internet Web site where such 
information may be found; and
    (2) Certify that the information available at such location is 
accurate as of its date.
    (d)(1) If the information required to be filed under paragraphs (a) 
or (b) of this section for Exhibits A, B, M, N, S, or T or Items 1-7 of 
Exhibit L is available continuously on an Internet Web site controlled 
by an exchange, in lieu of filing such information in paper form

[[Page 71214]]

with the Commission, such exchange may:
    (i) Indicate the location of the Internet Web site where such 
information may be found; and
    (ii) Certify that the information available at such location is 
accurate as of its date.
    (2) Only the most recent annual amendment required under paragraph 
(b) of this section and any subsequent updates required under paragraph 
(a) of this section must be continuously posted on an Internet Web site 
controlled by an exchange under paragraph (d)(1) of this section.
    (e) Upon written request or on its own motion, the Commission may 
grant an exemption from any of the requirements of this section, either 
unconditionally or on specified terms and conditions, if the Commission 
determines that such exemption is necessary or appropriate in the 
public interest and is consistent with the protection of investors.
* * * * *
    (g) A national securities exchange shall file as an amendment to 
Form 1 a complete new statement together with all exhibits which are 
prescribed to be filed in connection with Form 1 no later than [six 
months following the date of publication of final rules in the Federal 
Register].
* * * * *
    4. Section 240.6a-5 is added to read as follows:


Sec.  240.6a-5  Fair administration and governance of national 
securities exchanges.

    (a) General. Each national securities exchange must comply with, 
and have rules that comply with, the provisions of this section, and 
must have the capacity to carry out the purposes of this section. If 
the national securities exchange has a regulatory subsidiary, the 
provisions of paragraphs (c), (d), (e), (f), (g), (h), (i), (j), (k), 
(l), (m), (n), (p) and (q) of this section shall apply to such 
regulatory subsidiary in the same manner as the national securities 
exchange; provided, however, that to the extent that a Standing 
Committee of the national securities exchange is authorized to carry 
out responsibilities on behalf of the regulatory subsidiary, as set 
forth in its written charter, the regulatory subsidiary shall not be 
required to have a Standing Committee that performs the same 
responsibilities and to the extent that the Chief Regulatory Officer of 
the national securities exchange performs the same responsibilities for 
the regulatory subsidiary as he or she does for the national securities 
exchange, the regulatory subsidiary shall not be required to appoint a 
Chief Regulatory Officer. When used in paragraphs (c), (d), (e), (f), 
(g), (h), (i), (j), (k), (l), (m), (n), (p) and (q) of this section, 
the terms ``exchange'' shall also mean the regulatory subsidiary of the 
exchange; ``Board'' shall also mean the Board of the regulatory 
subsidiary; ``director'' or ``directors'' shall also mean the directors 
or directors of the regulatory subsidiary; ``independent director'' or 
``independent directors'' shall also mean the independent director or 
independent directors of the regulatory subsidiary; ``executive 
session'' shall also mean executive session of the Board of the 
regulatory subsidiary; and ``Standing Committee'' or ``Standing 
Committees'' shall also mean the Standing Committee or Standing 
Committees of the Board of the regulatory subsidiary.
    (b) Definitions. For purposes of this section, the following 
definitions shall apply:
    (1) The term affiliate means any person that, directly or 
indirectly, controls, is controlled by, or is under common control 
with, the national securities exchange.
    (2) The term affiliated issuer means the national securities 
exchange, an SRO trading facility of the national securities exchange, 
an affiliate of the national securities exchange, or an affiliate of an 
SRO trading facility of the national securities exchange.
    (3) The term affiliated security means any security issued by an 
affiliated issuer, except that it shall not include any option exempt 
from the Securities Act of 1933 under Sec.  230.238 of this chapter and 
any security futures product exempt from the Securities Act of 1933 
under section 3(a)(14) of the Securities Act of 1933 (15 U.S.C. 
77c(a)(14)).
    (4) The terms beneficial ownership, beneficially owns or any 
derivative thereof shall have the same meaning, with respect to any 
security or other ownership interest, as set forth in Sec.  240.13d-3, 
as if (and whether or not) such security or other ownership interest 
were a voting equity security registered under section 12 of the Act 
(15 U.S.C. 78l); provided that to the extent any person beneficially 
owns any security or other ownership interest solely because such 
person is a member of a group within the meaning of section 13(d)(3) of 
the Act (15 U.S.C. 78m(d)(3)), such person shall not be deemed to 
beneficially own such security or other ownership interest for purposes 
of this section, unless such person has the power to direct the vote of 
such security or other ownership interest.
    (5) The term Board means the Board of Directors or Board of 
Governors of the national securities exchange, or any equivalent body.
    (6) The term compensation means any form of compensation and any 
material perquisites awarded, or that are to be awarded, whether or not 
set forth in any written documents, to any executive officer of the 
national securities exchange, including, without limitation, salary, 
bonus, pension, deferred compensation, compensation awarded pursuant to 
any incentive plan or equity-based plan, or any other plan, contract, 
authorization or arrangement pursuant to which cash or securities may 
be received.
    (7) The term control means the possession, direct or indirect, of 
the power to direct or cause the direction of the management and 
policies of a person, whether through the ownership of voting 
securities, by contract, or otherwise. A person is presumed to control 
another person if the person:
    (i) Is a director, general partner or officer exercising executive 
responsibility (or having similar status or functions);
    (ii) Directly or indirectly has the right to vote 25 percent or 
more of a class of voting securities or has the power to sell or direct 
the sale of 25 percent or more of a class of voting securities; or
    (iii) In the case of a partnership, has the right to receive, upon 
dissolution, or has contributed, 25 percent or more of the capital.
    (8) The term director means any member of the Board.
    (9) The term executive session means a meeting of the independent 
directors of the Board, without the presence of management of the 
national securities exchange or the directors who are not independent 
directors.
    (10) The term facility has the same meaning as set forth in section 
3(a)(2) of the Act (15 U.S.C. 78c(a)(2)).
    (11) The term immediate family member means a person's spouse, 
parents, children, and siblings, whether by blood, marriage or 
adoption, or anyone residing in such person's home.
    (12) The term independent director means a director who has no 
material relationship with the national securities exchange or any 
affiliate of the national securities exchange, any member of the 
national securities exchange or any affiliate of such member, or any 
issuer of securities that are listed or traded on the national 
securities exchange or a facility of the national securities exchange. 
A director is not independent if any of the following circumstances 
exists:

[[Page 71215]]

    (i) The director, or an immediate family member, is employed by or 
otherwise has a material relationship with the national securities 
exchange or any affiliate of the national securities exchange, or 
within the past three years was employed by or otherwise had a material 
relationship with the national securities exchange or any affiliate of 
the national securities exchange.
    (ii) The director is a member or is employed by or affiliated with 
a member or any affiliate of a member or, within the past three years 
was a member or was employed by or affiliated with a member or any 
affiliate of a member, or the director has an immediate family member 
that is, or within the past three years was, an executive officer of a 
member or any affiliate of a member.
    (iii) The director, or an immediate family member, has received 
during any twelve month period within the past three years more than 
$60,000 in payments from the national securities exchange or any 
affiliate of the national securities exchange or from a member or any 
affiliate of a member, other than the following:
    (A) Compensation for Board or Board committee service;
    (B) Compensation to an immediate family member who is not an 
executive officer of the national securities exchange or any affiliate 
of the national securities exchange or of a member or any affiliate of 
a member; and
    (C) Pension and other forms of deferred compensation for prior 
service, provided such compensation is not contingent in any way on 
continued service.
    (iv) The director, or an immediate family member, is a partner in, 
or controlling shareholder or executive officer of any organization to 
which the national securities exchange or any affiliate of the national 
securities exchange made, or from which the national securities 
exchange or any affiliate of the national securities exchange received, 
payments for property or services in the current or any of the past 
three full fiscal years that exceed two percent of the recipient's 
consolidated gross revenues for that year, or $200,000, whichever is 
more, other than the following:
    (A) Payments arising solely from investments in the securities of 
the national securities exchange or any facility or affiliate of the 
national securities exchange; or
    (B) Payments under non-discretionary charitable contribution 
matching programs.
    (v) The director, or an immediate family member, is, or within the 
past three years was, an executive officer of an issuer of securities 
listed or primarily traded on the national securities exchange or a 
facility of the national securities exchange.
    (vi) The director, or an immediate family member, is, or within the 
past three years was, employed as an executive officer of another 
entity where any of the national securities exchange's executive 
officers serves on that entity's compensation committee.
    (vii) The director, or an immediate family member, is a current 
partner of the outside auditor of the national securities exchange or 
any affiliate of the national securities exchange, or was a partner or 
employee of the outside auditor of the national securities exchange or 
any affiliate of the national securities exchange who worked on the 
national securities exchange's or any affiliate's audit, at any time 
within the past three years.
    (viii) In the case of a director that is a member of the Audit 
Committee, such director (other than in his or her capacity as a member 
of the Audit Committee, the Board, or any other Board committee), 
accepts, directly or indirectly, any consulting, advisory, or other 
compensatory fee from the national securities exchange, any affiliate 
of the national securities exchange, any member, or any affiliate of a 
member, other than fixed amounts of pension and other forms of deferred 
compensation for prior service, provided such compensation is not 
contingent in any way on continued service.
    (13) The term material relationship means a relationship, whether 
compensatory or otherwise, that reasonably could affect the independent 
judgment or decision-making of the director.
    (14) The term member has the same meaning as set forth in section 
3(a)(3)(A) of the Act (15 U.S.C. 78c(a)(3)(A)).
    (15) The term person has the same meaning as set forth in section 
3(a)(9) of the Act (15 U.S.C. 78c(a)(9)).
    (16) The term person associated with a member has the same meaning 
as set forth in section 3(a)(21) of the Act (15 U.S.C. 78c(a)(21)).
    (17) The term regulatory information means any information 
collected by a national securities exchange in the course of performing 
its regulatory obligations under the Act.
    (18) The term regulatory subsidiary means any person that, directly 
or indirectly, is controlled by the national securities exchange and 
that provides, whether pursuant to contract, agreement or rule, 
regulatory services to or on behalf of the national securities 
exchange.
    (19) The term related person means, with respect to any member that 
is a broker or dealer:
    (i) Any affiliate of the member;
    (ii) Any person associated with the member;
    (iii) Any immediate family member of the member, or any immediate 
family member of the member's spouse, who, in each case, has the same 
home as the member or who is a director or officer of the national 
securities exchange or facility or any of its parents or subsidiaries; 
and
    (iv) Any immediate family member of a person associated with the 
member, or any immediate family member of such person's spouse, who, in 
each case, has the same home as the person associated with the member 
or who is a director or officer of the national securities exchange or 
facility or any of its parents or subsidiaries.
    (20) The term SRO trading facility means any facility of a national 
securities exchange that executes orders in securities.
    (21) The term Standing Committees means the following committees of 
the Board: Nominating Committee, Governance Committee, Compensation 
Committee, Audit Committee, and Regulatory Oversight Committee, or 
their equivalent.
    (c) Board. (1) The Board of each national securities exchange must 
be composed of a majority of independent directors.
    (2) No director may qualify as an independent director unless the 
Board affirmatively determines that the director has no material 
relationship with the national securities exchange or any affiliate of 
the national securities exchange. The Board must make this 
determination upon the director's nomination or appointment to the 
Board and thereafter no less frequently than annually and as often as 
necessary in light of the director's circumstances.
    (3) The national securities exchange must establish policies and 
procedures to require each director, on his or her own initiative and 
upon request of the national securities exchange, to inform the 
national securities exchange of the existence of any relationship or 
interest that may reasonably be considered to bear on whether such 
director is an independent director.
    (4) At least 20 percent of the total number of directors must be 
selected by members.
    (5) At least one director must be representative of issuers and at 
least one director must be representative of investors, and, in each 
case, such

[[Page 71216]]

director must not be associated with a member or broker or dealer.
    (6) When the Board considers any matter that is recommended by or 
otherwise is within the authority or jurisdiction of a Standing 
Committee, a majority of the directors who vote on the matter must be 
independent directors.
    (7) The national securities exchange must adopt rules establishing 
a fair process for members to nominate an alternative candidate or 
candidates to the Board by petition and the percentage of members that 
is necessary to put forth such alternative candidate or candidates. The 
percentage of members that is necessary to put forth an alternative 
candidate or candidates must not exceed 10 percent of the total numbers 
of members.
    (8) If the national securities exchange fails to comply with the 
requirement that the Board be composed of a majority of independent 
directors because there is a vacancy on the Board or a director ceases 
to be independent, it must comply with this requirement by the earlier 
of its next annual meeting or one year from the date of the occurrence 
of the event that caused the failure to comply with this requirement.
    (9) The national securities exchange must establish procedures for 
interested persons to communicate their concerns regarding any matter 
within the authority or jurisdiction of a Standing Committee directly 
to the independent directors.
    (d) Executive session. (1) Independent directors of the national 
securities exchange must meet regularly in executive session.
    (2) The independent directors must have the authority to direct and 
supervise inquiries into any matter brought to their attention within 
the scope of their duties and to obtain advice and assistance from 
independent legal counsel and other advisors as they determine 
necessary to carry out their duties.
    (3) The national securities exchange must provide sufficient 
funding and other resources, as determined by the independent 
directors, to permit the independent directors to fulfill their 
responsibilities and to retain independent legal counsel and other 
advisors.
    (e) Standing Committees of the Board. (1) The national securities 
exchange, at a minimum, must have the following Standing Committees of 
the Board, or their equivalent: Nominating Committee, Governance 
Committee, Compensation Committee, Audit Committee, and Regulatory 
Oversight Committee. Each of these Standing Committees must report to 
the Board.
    (2) Each Standing Committee must have the authority to direct and 
supervise inquiries into any matter brought to its attention within the 
scope of its duties, and to obtain advice and assistance from 
independent legal counsel and other advisors as it deems necessary to 
carry out its duties.
    (3) The national securities exchange must provide sufficient 
funding and other resources, as determined by each Standing Committee, 
to permit the Standing Committees to fulfill their responsibilities and 
to retain independent legal counsel and other advisors.
    (f) Nominating Committee. (1) The Nominating Committee must be 
composed solely of independent directors.
    (2) The Nominating Committee must have a written charter that 
addresses the Nominating Committee's purpose and responsibilities, 
which, at a minimum, must be to identify individuals qualified to 
become Board members, consistent with criteria approved by the Board 
and administer a process for the nomination of individuals to the 
Board.
    (3) The Nominating Committee must administer a fair process that 
provides members with the opportunity to select at least 20 percent of 
the total number of directors. The Nominating Committee must also 
administer the process established by the exchange under paragraph 
(c)(7) of this section for the nomination of an alternative candidate 
or candidates by members through petition.
    (4) The Nominating Committee must nominate at least one director 
who is representative of issuers and at least one director who is 
representative of investors and who, in each case, is not associated 
with a member or broker or dealer.
    (5) The Nominating Committee must conduct an annual performance 
self-evaluation.
    (g) Governance Committee. (1) The Governance Committee must be 
composed solely of independent directors.
    (2) The Governance Committee must have a written charter that 
addresses the Committee's purpose and responsibilities, which, at a 
minimum, must be to develop and recommend to the Board a set of 
governance principles applicable to the national securities exchange 
and to oversee the evaluation of the Board and management.
    (3) The Governance Committee must conduct an annual performance 
evaluation of the governance of the national securities exchange, 
including the effectiveness of the Board and its committees.
    (h) Compensation Committee. (1) The Compensation Committee must be 
composed solely of independent directors.
    (2) The Compensation Committee must have a written charter that 
addresses the Compensation Committee's purpose and responsibilities, 
which, at a minimum, must be to have direct responsibility to review 
and approve corporate goals and objectives relevant to the compensation 
of the executive officers of the national securities exchange; evaluate 
the performance of the executive officers in light of those goals and 
objectives; and consider and approve recommendations with respect to 
the compensation level of the executive officers, based on this 
evaluation.
    (3) The Compensation Committee must conduct an annual performance 
self-evaluation.
    (i) Audit Committee. (1) The Audit Committee must be composed 
solely of independent directors.
    (2) The Audit Committee must have a written charter that addresses 
the Audit Committee's purpose and responsibilities, which, at a 
minimum, must be to assist the Board in oversight of the integrity of 
the national securities exchange's financial statements; the national 
securities exchange's compliance with related legal and regulatory 
requirements; and the qualifications and independence of the national 
securities exchange's auditor, including direct responsibility for the 
hiring, firing, and compensation of the auditor; overseeing the 
auditor's engagement; meeting regularly in executive session with the 
auditor; reviewing the auditor's reports with respect to the national 
securities exchange's internal controls; pre-approving all audit and 
non-audit services performed by the auditor; determining the budget and 
staffing of the national securities exchange's internal audit 
department; and establishing procedures for the receipt of complaints 
regarding accounting, internal accounting controls, or auditing matters 
of the national securities exchange and the confidential submission by 
employees of the national securities exchange of concerns regarding 
questionable accounting or auditing matters.
    (3) The Audit Committee must conduct an annual performance self-
evaluation.
    (j) Regulatory Oversight Committee. (1) The Regulatory Oversight 
Committee must be composed solely of independent directors.

[[Page 71217]]

    (2) The Regulatory Oversight Committee must have a written charter 
that addresses the Regulatory Oversight Committee's purpose and 
responsibilities, which, at a minimum, must be to assure the adequacy 
and effectiveness of the regulatory program of the national securities 
exchange; assess the exchange's regulatory performance; determine the 
regulatory plan, programs, budget, and staffing for the regulatory 
functions of the exchange; assess the performance of, and recommend 
compensation and personnel actions involving, the Chief Regulatory 
Officer and other senior regulatory personnel to the Compensation 
Committee; monitor and review regularly with the Chief Regulatory 
Officer matters relating to the exchange's surveillance, examination, 
and enforcement units; assure that the exchange's disciplinary and 
arbitration proceedings are conducted in accordance with the exchange's 
rules and policies and any other applicable laws or rules, including 
those of the Commission; prior to the exchange's approval of an 
affiliated security for listing, certify that such security meets the 
exchange's rules for listing; and approve reports filed with the 
Commission as required by Regulation AL (Sec.  242.800 of this 
chapter).
    (3) At least 20 percent of the members of any committee, 
subcommittee, or panel that is responsible for conducting hearings, 
rendering decisions, and imposing sanctions with respect to 
disciplinary matters must be members of the national securities 
exchange.
    (4) Any committee, subcommittee, or panel that is responsible for 
conducting hearings, rendering decisions, and imposing sanctions with 
respect to disciplinary matters must be subject to the jurisdiction of 
the Regulatory Oversight Committee.
    (5) The Regulatory Oversight Committee must oversee the preparation 
of the national securities exchange's annual regulatory report, as 
required by Sec.  240.17a-26.
    (6) The Regulatory Oversight Committee must conduct an annual 
performance self-evaluation.
    (k) Other committees of the Board. (1) The national securities 
exchange may establish such other committees of the Board as it deems 
appropriate. However, if such committee has the authority to act on 
behalf of the Board, the committee must be composed of a majority of 
independent directors. The national securities exchange may not 
delegate to any committee not consisting solely of independent 
directors the authority to act on matters that otherwise are within the 
jurisdiction of a Standing Committee.
    (2) At least 20 percent of the members of any committee must be 
members of the national securities exchange if such committee:
    (i) Is not a Standing Committee, or is a committee, subcommittee, 
or panel that is subject to the jurisdiction of a Standing Committee; 
and
    (ii) Is responsible for providing advice with respect to trading 
rules or disciplinary rules.
    (l) Other requirements applicable to directors and officers. The 
rules of the national securities exchange must provide that:
    (1) Any person subject to a statutory disqualification as defined 
in section 3(a)(39) of the Act (15 U.S.C. 78c(a)(39)) shall not be an 
officer or director of the exchange.
    (2) Each director, in discharging his or her responsibilities as a 
member of the Board, must reasonably consider all requirements 
applicable to such exchange under the Act.
    (m) Separation of positions of Chairman of the Board and Chief 
Executive Officer.
    (1) If the Chief Executive Officer of the national securities 
exchange is not also the Chairman of the Board, the Chairman of the 
Board must be an independent director.
    (2) The Chief Executive Officer must not participate in any 
executive sessions of the Board.
    (3) If a single individual serves as both Chairman of the Board of 
the national securities exchange and the Chief Executive Officer, the 
Board must designate an independent director as a lead director to 
preside over executive sessions of the Board. The Board must publicly 
disclose such lead director's name and a means by which interested 
parties may communicate with the lead director.
    (4) The Chairman of the Board of the national securities exchange 
must not serve on the Nominating, Governance, Compensation, Audit, or 
Regulatory Oversight Committees, unless the Chairman of the Board is an 
independent director.
    (n) Separation of regulatory and market operations. (1) The 
national securities exchange must establish policies and procedures to 
assure the independence of its regulatory program from its market 
operations or other commercial interests.
    (2) The national securities exchange's regulatory program must be:
    (i) Structurally separated from the market operations and other 
commercial interests of the exchange, by means of separate legal 
entities; or
    (ii) Functionally separated within the same legal entity from the 
market operations and other commercial interests of the exchange.
    (3) The Board must appoint a Chief Regulatory Officer to administer 
the regulatory program of the national securities exchange. The Chief 
Regulatory Officer must report directly to the Regulatory Oversight 
Committee.
    (4)(i) Any funds received by the national securities exchange from 
regulatory fees, fines, or penalties must be applied only to fund 
programs and operations directly related to such exchange's regulatory 
responsibilities; and
    (ii) The national securities exchange must make and keep books and 
records necessary to demonstrate compliance with the requirement in 
paragraph (n)(4)(i) of this section.
    (5)(i) A national securities exchange must establish policies and 
procedures reasonably designed to:
    (A) Prevent the dissemination of regulatory information to any 
person other than an officer, director, employee, or agent of the 
exchange directly involved in carrying out the exchange's regulatory 
obligations under the Act;
    (B) Prevent the use of regulatory information for any purpose other 
than carrying out the exchange's regulatory obligations under the Act; 
and
    (C) Maintain the confidentiality of any information required to be 
submitted to effectuate a transaction on or through such exchange or 
its facilities, unless such information is aggregated to such an extent 
that no person whose information is included in the aggregated 
information can be identified, or unless the person has consented to 
the dissemination and use of its information by the exchange.
    (ii) An exchange's policies and procedures must require its 
officers, directors, employees, and agents to agree to comply with the 
requirements of paragraph (n)(5)(i) of this section.
    (o) Limits on member ownership and voting. (1) The rules of a 
national securities exchange must prohibit any member of such exchange 
that is a broker or dealer, alone or together with its related persons, 
from either:
    (i) Beneficially owning, directly or indirectly, any interest in 
the national securities exchange or a facility of such exchange through 
which the member is permitted to effect transactions that exceeds 20 
percent of any class of securities or other ownership interest of such 
national securities exchange or facility; or
    (ii) Directly or indirectly voting, causing the voting of, or 
giving any

[[Page 71218]]

consent or proxy with respect to the voting of, any interest in the 
national securities exchange or a facility of such exchange through 
which the member is permitted to effect transactions that exceeds 20 
percent of the voting power of any class of securities or other 
ownership interest of such national securities exchange or facility.
    (2) The prohibition in paragraph (o)(1)(ii) shall not apply to any 
solicitation or receipt of a revocable proxy by any member that is a 
broker or dealer or its related persons from other shareholders of the 
national securities exchange or facility that is conducted pursuant to, 
and in accordance with, Regulation 14A under the Act (15 U.S.C. 78n), 
except that a member and its related persons may not conduct a 
solicitation or receive a proxy pursuant to Sec.  240.14a-2(b)(2) with 
regard to or from a person or persons whose interest in the national 
securities exchange or facility, together with the member's and its 
related person's aggregate interest, would exceed the voting limitation 
in paragraph (o)(1) of this section.
    (3) The rules of the national securities exchange must provide an 
effective mechanism to divest any member that is a broker or dealer and 
its related persons of any interest owned in excess of the ownership 
limitation in paragraph (o)(1) of this section.
    (4) The rules of the national securities exchange must be 
reasonably designed to not give effect to the portion of a vote by a 
member that is a broker or dealer and its related persons that is in 
excess of the voting limitation in paragraph (o)(1) of this section.
    (5) The rules of the national securities exchange must provide an 
effective mechanism for the national securities exchange to obtain 
information relating to ownership and voting interests in the national 
securities exchange or any facility of the national securities exchange 
from any owner of any interest.
    (p) Code of conduct and ethics. (1) The rules of the national 
securities exchange must provide:
    (i) For a code of conduct and ethics for directors, officers and 
employees that, at a minimum, establishes policies and procedures 
regarding: conflicts of interest; corporate opportunities; 
confidentiality; fair dealing; protection and proper use of the 
exchange's assets; compliance with laws, rules, and regulations by 
directors, officers and employees; and the reporting of illegal or 
unethical behavior; and
    (ii) That any waiver of the code of conduct and ethics established 
under paragraph (p)(1)(i) of this section must be approved by the 
Board.
    (2) The rules of the national securities exchange must prohibit any 
of its employees or officers from being a member of the board of 
directors of a listed issuer or member firm.
    (q) Governance guidelines. The national securities exchange must 
adopt rules implementing governance guidelines that, at a minimum, 
establish policies regarding: director qualification standards; 
director responsibilities; director access to management and 
independent advisors; director compensation; director orientation and 
continuing education; management succession; and annual performance 
evaluations of the Board.
    (r) Implementation. (1) The rules of each national securities 
exchange must be designed to meet the requirements of this section and 
must be operative no later than [one year following the date of 
publication of final rules in the Federal Register].
    (2) Each national securities exchange must submit to the Commission 
a proposed rule change that complies with this section no later than 
[four months following the date of publication of final rules in the 
Federal Register].
    (3) Each national securities exchange must have final rules that 
comply with this section approved by the Commission no later than [ten 
months following the date of publication of final rules in the Federal 
Register].
    (s) Exemptions. (1) A national securities exchange registered 
pursuant to section 6(g)(1) of the Act (15 U.S.C. 78f(g)(1)) is exempt 
from the requirements of this section.
    (2) Upon written request or on its own motion, the Commission may 
grant an exemption from any provision of this section, either 
unconditionally or on specified terms and conditions, if the Commission 
determines that such exemption is necessary or appropriate in the 
public interest and is consistent with the protection of investors.


Sec.  240.15Aa-1  [Amended]

    5. Section 240.15Aa-1 is amended by revising the reference to 
``Form X-15AA-1'' to read ``Form 2''.


Sec.  240.15Aj-1  [Removed]

    6. Section 240.15Aj-1 is removed.
    7. Section 240.15Aa-2 is added to read as follows:


Sec.  240.15Aa-2.  Amendments to application.

    (a) A registered securities association or an affiliated securities 
association shall file an amendment to Form 2, which shall set forth 
the nature and effective date of the action taken, and shall provide 
any new information and correct any information rendered inaccurate on 
Form 2, within 10 calendar days after any material event takes place 
that renders inaccurate, or that causes to be incomplete, any of the 
following:
    (1) Information filed on the Execution Page of Form 2, or amendment 
thereto;
    (2) Information filed as part of Exhibits C, D, E, H, I, J, K, M, 
N, O, P, S, or U and as part of Item 3 of Exhibit F or Items 1, 5, 6, 
and 7 of Exhibit Q, or any amendments thereto; or
    (3) Information filed as part of Items 2 or 3 of Exhibit Q, or any 
amendment thereto, except that such information is not required to be 
filed with respect to any ownership change that is less than one 
percent from the ownership interest last reported on Form 2, or any 
amendment thereto.
    (b) Within 60 days of the end of its fiscal year, a registered 
securities association or an affiliated securities association must 
submit an amendment to its Form 2 that updates the Form 2 in its 
entirety. Each Exhibit to the amended Form 2 shall be up to date as of 
the end of the latest fiscal year of the association.
    (c) Except as set forth in paragraph (d) of this section, a 
registered securities association or an affiliated securities 
association must continuously post any amendments required to be filed 
under paragraphs (a) and (b) of this section on a publicly-accessible 
Internet web site controlled by the association, simultaneous with the 
filing of such information in paper form with the Commission. Only the 
most recent annual amendment filed under paragraph (b) of this section 
and any subsequent updates filed under paragraphs (a) of this section 
are required to be posted on such Internet web site. In its filing with 
the Commission, such association shall:
    (1) Indicate the location of the Internet web site where such 
information may be found; and
    (2) Certify that the information available at such location is 
accurate as of its date.
    (d)(1) If the information required to be filed under paragraphs (a) 
or (b) of this section for Exhibits A, B, M, N, S, or T or Items 1-7 of 
Exhibit L is available continuously on an Internet web site controlled 
by an association, in lieu of filing such information in paper form 
with the Commission, such association may:
    (i) Indicate the location of the Internet web site where such 
information may be found; and
    (ii) Certify that the information available at such location is 
accurate as of its date.

[[Page 71219]]

    (2) Only the most recent annual amendment required under paragraph 
(b) of this section and any subsequent updates required under paragraph 
(a) of this section must be continuously posted on an Internet web site 
controlled by an association under paragraph (d)(1) of this section.
    (e) Upon written request or on its own motion, the Commission may 
grant an exemption from any of the requirements of this section, either 
unconditionally or on specified terms and conditions, if the Commission 
determines that such exemption is necessary or appropriate in the 
public interest and is consistent with the protection of investors.
    (f) A registered securities association or an affiliated securities 
association shall file as an amendment to Form 2 a complete new 
statement together will all exhibits which are prescribed to be filed 
in connection with Form 2 no later than [six months following the date 
of publication of final rules in the Federal Register].
    8. Section 240.15Aa-3 is added to read as follows:


Sec.  240.15Aa-3  Fair administration and governance of registered 
securities associations.

    (a) General. Each association must comply with, and have rules that 
comply with, the provisions of this section, and must have the capacity 
to carry out the purposes of this section. If the association has a 
regulatory subsidiary, the provisions of paragraphs (c), (d), (e), (f), 
(g), (h), (i), (j), (k), (l), (m), (n), (p) and (q) of this section 
shall apply to such regulatory subsidiary in the same manner as the 
association; provided, however, that to the extent that a Standing 
Committee of the association is authorized to carry out 
responsibilities on behalf of the regulatory subsidiary, as set forth 
in its written charter, the regulatory subsidiary shall not be required 
to have a Standing Committee that performs the same responsibilities 
and to the extent that the Chief Regulatory Officer of the association 
performs the same responsibilities for the regulatory subsidiary as he 
or she does for the association, the regulatory subsidiary shall not be 
required to appoint a Chief Regulatory Officer. When used in paragraphs 
(c), (d), (e), (f), (g), (h), (i), (j), (k), (l), (m), (n), (p) and (q) 
of this section, the terms ``association'' shall also mean the 
regulatory subsidiary of the association; ``Board'' shall also mean the 
Board of the regulatory subsidiary; ``director'' or ``directors'' shall 
also mean the directors or directors of the regulatory subsidiary; 
``independent director'' or ``independent directors'' shall also mean 
the independent director or independent directors of the regulatory 
subsidiary; ``executive session'' shall also mean executive session of 
the Board of the regulatory subsidiary; and ``Standing Committee'' or 
``Standing Committees'' shall also mean the Standing Committee or 
Standing Committees of the Board of the regulatory subsidiary.
    (b) Definitions. For purposes of this section, the following 
definitions shall apply:
    (1) The term affiliate means any person that, directly or 
indirectly, controls, is controlled by, or is under common control 
with, the association.
    (2) The term affiliated issuer means the association, an SRO 
trading facility of the association, an affiliate of the association, 
or an affiliate of an SRO trading facility of the association.
    (3) The term affiliated security means any security issued by an 
affiliated issuer, except that it shall not include any option exempt 
from the Securities Act of 1933 under Sec.  230.238 of this chapter and 
any security futures product exempt from the Securities Act of 1933 
under section 3(a)(14) of the Securities Act of 1933 (15 U.S.C. 
77c(a)(14)).
    (4) The term association means any association registered under 
section 15A of the Act (15 U.S.C. 78o-3).
    (5) The terms beneficial ownership, beneficially owns or any 
derivative thereof shall have the same meaning, with respect to any 
security or other ownership interest, as set forth in Sec.  240.13d-3, 
as if (and whether or not) such security or other ownership interest 
were a voting equity security registered under section 12 of the Act 
(15 U.S.C. 78l); provided that to the extent any person beneficially 
owns any security or other ownership interest solely because such 
person is a member of a group within the meaning of section 13(d)(3) of 
the Act (15 U.S.C. 78m(d)(3)), such person shall not be deemed to 
beneficially own such security or other ownership interest for purposes 
of this section, unless such person has the power to direct the vote of 
such security or other ownership interest.
    (6) The term Board means the Board of Directors or Board of 
Governors of the association, or any equivalent body.
    (7) The term compensation means any form of compensation and any 
material perquisites awarded, or that are to be awarded, whether or not 
set forth in any written documents, to any executive officer of the 
association, including, without limitation, salary, bonus, pension, 
deferred compensation, compensation awarded pursuant to any incentive 
plan or equity-based plan, or any other plan, contract, authorization 
or arrangement pursuant to which cash or securities may be received.
    (8) The term control means the possession, direct or indirect, of 
the power to direct or cause the direction of the management and 
policies of a person, whether through the ownership of voting 
securities, by contract, or otherwise. A person is presumed to control 
another person if the person:
    (i) Is a director, general partner or officer exercising executive 
responsibility (or having similar status or functions);
    (ii) Directly or indirectly has the right to vote 25 percent or 
more of a class of voting securities or has the power to sell or direct 
the sale of 25 percent or more of a class of voting securities; or
    (iii) In the case of a partnership, has the right to receive, upon 
dissolution, or has contributed, 25 percent or more of the capital.
    (9) The term director means any member of the Board.
    (10) The term executive session means a meeting of the independent 
directors of the Board, without the presence of management of the 
association or the directors who are not independent directors.
    (11) The term facility when used with respect to an association 
includes its premises, tangible or intangible property whether on the 
premises or not, any right to the use of such premises or property or 
any service thereof for the purpose of effecting or reporting a 
transaction (including, among other things, any system of communication 
to or from the association, by ticker or otherwise, maintained by or 
with the consent of the association), and any right of the association 
to the use of any property or service.
    (12) The term immediate family member means a person's spouse, 
parents, children, and siblings, whether by blood, marriage or 
adoption, or anyone residing in such person's home.
    (13) The term independent director means a director who has no 
material relationship with the association or any affiliate of the 
association, any member of the association or any affiliate of such 
member, or any issuer of securities that are listed or traded on a 
facility of the association. A director is not independent if any of 
the following circumstances exists:
    (i) The director, or an immediate family member, is employed by or 
otherwise has a material relationship with the association or any 
affiliate of the association, or within the past three years was 
employed by or otherwise had a material relationship with the

[[Page 71220]]

association or any affiliate of the association.
    (ii) The director is a member or is employed by or affiliated with 
a member or any affiliate of a member or, within the past three years 
was a member or was employed by or affiliated with a member or any 
affiliate of a member, or the director has an immediate family member 
that is, or within the past three years was, an executive officer of a 
member or any affiliate of a member.
    (iii) The director, or an immediate family member, has received 
during any twelve month period within the past three years more than 
$60,000 in payments from the association or any affiliate of the 
association or from a member or any affiliate of a member, other than 
the following:
    (A) Compensation for Board or Board committee service;
    (B) Compensation to an immediate family member who is not an 
executive officer of the association or any affiliate of the 
association or of a member or any affiliate of a member; and
    (C) Pension and other forms of deferred compensation for prior 
service, provided such compensation is not contingent in any way on 
continued service.
    (iv) The director, or an immediate family member, is a partner in, 
or controlling shareholder or executive officer of any organization to 
which the association or any affiliate of the association made, or from 
which the association or any affiliate of the association received, 
payments for property or services in the current or any of the past 
three full fiscal years that exceed two percent of the recipient's 
consolidated gross revenues for that year, or $200,000, whichever is 
more, other than the following:
    (A) Payments arising solely from investments in the securities of 
the association or any facility or affiliate of the association; or
    (B) Payments under non-discretionary charitable contribution 
matching programs.
    (v) The director, or an immediate family member, is, or within the 
past three years was, an executive officer of an issuer of securities 
listed or primarily traded on a facility of the association.
    (vi) The director, or an immediate family member, is, or within the 
past three years was, employed as an executive officer of another 
entity where any of the association's executive officers serves on that 
entity's compensation committee.
    (vii) The director, or an immediate family member, is a current 
partner of the outside auditor of the association or any affiliate of 
the association, or was a partner or employee of the outside auditor of 
the association or any affiliate of the association who worked on the 
association's or any affiliate's audit, at any time within the past 
three years.
    (viii) In the case of a director that is a member of the Audit 
Committee, such director (other than in his or her capacity as a member 
of the Audit Committee, the Board, or any other Board committee), 
accepts, directly or indirectly, any consulting, advisory, or other 
compensatory fee from the association, any affiliate of the 
association, any member, or any affiliate of a member, other than fixed 
amounts of pension and other forms of deferred compensation for prior 
service, provided such compensation is not contingent in any way on 
continued service.
    (14) The term material relationship means a relationship, whether 
compensatory or otherwise, that reasonably could affect the independent 
judgment or decision-making of the director.
    (15) The term member has the same meaning as set forth in section 
3(a)(3)(B) of the Act (15 U.S.C. 78c(a)(3)(B)).
    (16) The term person has the same meaning as set forth in section 
3(a)(9) of the Act (15 U.S.C. 78c(a)(9)).
    (17) The term person associated with a member has the same meaning 
as set forth in section 3(a)(21) of the Act (15 U.S.C. 78c(a)(21)).
    (18) The term regulatory information means any information 
collected by an association in the course of performing its regulatory 
obligations under the Act.
    (19) The term regulatory subsidiary means any person that, directly 
or indirectly, is controlled by the association and that provides, 
whether pursuant to contract, agreement or rule, regulatory services to 
or on behalf of the association.
    (20) The term related person means, with respect to any member:
    (i) Any affiliate of the member;
    (ii) Any person associated with the member;
    (iii) Any immediate family member of the member, or any immediate 
family member of the member's spouse, who, in each case, has the same 
home as the member or who is a director or officer of the association 
or facility or any of its parents or subsidiaries; and
    (iv) Any immediate family member of a person associated with the 
member, or any immediate family member of such person's spouse, who, in 
each case, has the same home as the person associated with the member 
or who is a director or officer of the association or facility or any 
of its parents or subsidiaries.
    (21) The term SRO trading facility means any facility of an 
association that executes orders in securities.
    (22) The term Standing Committees means the following committees of 
the Board: Nominating Committee, Governance Committee, Compensation 
Committee, Audit Committee, and Regulatory Oversight Committee, or 
their equivalent.
    (c) Board. (1) The Board of each association must be composed of a 
majority of independent directors.
    (2) No director may qualify as an independent director unless the 
Board affirmatively determines that the director has no material 
relationship with the association or any affiliate of the association. 
The Board must make this determination upon the director's nomination 
or appointment to the Board and thereafter no less frequently than 
annually and as often as necessary in light of the director's 
circumstances.
    (3) The association must establish policies and procedures to 
require each director, on his or her own initiative and upon request of 
the association, to inform the association of the existence of any 
relationship or interest that may reasonably be considered to bear on 
whether such director is an independent director.
    (4) At least 20 percent of the total number of directors must be 
selected by members.
    (5) At least one director must be representative of issuers and at 
least one director must be representative of investors, and, in each 
case, such director must not be associated with a member or broker or 
dealer.
    (6) When the Board considers any matter that is recommended by or 
otherwise is within the authority or jurisdiction of a Standing 
Committee, a majority of the directors who vote on the matter must be 
independent directors.
    (7) The association must adopt rules establishing a fair process 
for members to nominate an alternative candidate or candidates to the 
Board by petition and the percentage of members that is necessary to 
put forth such alternative candidate or candidates. The percentage of 
members that is necessary to put forth an alternative candidate or 
candidates must not exceed 10 percent of the total numbers of members.
    (8) If the association fails to comply with the requirement that 
the Board be composed of a majority of independent directors because 
there is a vacancy on the Board or a director ceases to be independent, 
it must comply with this requirement by the earlier of its next annual 
meeting or one year from the date of the occurrence of the event that

[[Page 71221]]

caused the failure to comply with this requirement.
    (9) The association must establish procedures for interested 
persons to communicate their concerns regarding any matter within the 
authority or jurisdiction of a Standing Committee directly to the 
independent directors.
    (d) Executive session. (1) Independent directors of the association 
must meet regularly in executive session.
    (2) The independent directors must have the authority to direct and 
supervise inquiries into any matter brought to their attention within 
the scope of their duties and to obtain advice and assistance from 
independent legal counsel and other advisors as they determine 
necessary to carry out their duties.
    (3) The association must provide sufficient funding and other 
resources, as determined by the independent directors, to permit the 
independent directors to fulfill their responsibilities and to retain 
independent legal counsel and other advisors.
    (e) Standing Committees of the Board. (1) The association, at a 
minimum, must have the following Standing Committees of the Board, or 
their equivalent: Nominating Committee, Governance Committee, 
Compensation Committee, Audit Committee, and Regulatory Oversight 
Committee. Each of these Standing Committees must report to the Board.
    (2) Each Standing Committee must have the authority to direct and 
supervise inquiries into any matter brought to its attention within the 
scope of its duties, and to obtain advice and assistance from 
independent legal counsel and other advisors as it deems necessary to 
carry out its duties.
    (3) The association must provide sufficient funding and other 
resources, as determined by each Standing Committee, to permit the 
Standing Committees to fulfill their responsibilities and to retain 
independent legal counsel and other advisors.
    (f) Nominating Committee. (1) The Nominating Committee must be 
composed solely of independent directors.
    (2) The Nominating Committee must have a written charter that 
addresses the Nominating Committee's purpose and responsibilities, 
which, at a minimum, must be to identify individuals qualified to 
become Board members, consistent with criteria approved by the Board 
and administer a process for the nomination of individuals to the 
Board.
    (3) The Nominating Committee must administer a fair process that 
provides members with the opportunity to select at least 20 percent of 
the total number of directors. The Nominating Committee must also 
administer the process established by the association under paragraph 
(c)(7) of this section for the nomination of an alternative candidate 
or candidates by members through petition.
    (4) The Nominating Committee must nominate at least one director 
who is representative of issuers and at least one director who is 
representative of investors and who, in each case, is not associated 
with a member or broker or dealer.
    (5) The Nominating Committee must conduct an annual performance 
self-evaluation.
    (g) Governance Committee. (1) The Governance Committee must be 
composed solely of independent directors.
    (2) The Governance Committee must have a written charter that 
addresses the Committee's purpose and responsibilities, which, at a 
minimum, must be to develop and recommend to the Board a set of 
governance principles applicable to the association and to oversee the 
evaluation of the Board and management.
    (3) The Governance Committee must conduct an annual performance 
evaluation of the governance of the association, including the 
effectiveness of the Board and its committees.
    (h) Compensation Committee. (1) The Compensation Committee must be 
composed solely of independent directors.
    (2) The Compensation Committee must have a written charter that 
addresses the Compensation Committee's purpose and responsibilities, 
which, at a minimum, must be to have direct responsibility to review 
and approve corporate goals and objectives relevant to the compensation 
of the executive officers of the association; evaluate the performance 
of the executive officers in light of those goals and objectives; and 
consider and approve recommendations with respect to the compensation 
level of the executive officers, based on this evaluation.
    (3) The Compensation Committee must conduct an annual performance 
self-evaluation.
    (i) Audit Committee. (1) The Audit Committee must be composed 
solely of independent directors.
    (2) The Audit Committee must have a written charter that addresses 
the Audit Committee's purpose and responsibilities, which, at a 
minimum, must be to assist the Board in oversight of the integrity of 
the association's financial statements; the association's compliance 
with related legal and regulatory requirements; and the qualifications 
and independence of the association's auditor, including direct 
responsibility for the hiring, firing, and compensation of the auditor; 
overseeing the auditor's engagement; meeting regularly in executive 
session with the auditor; reviewing the auditor's reports with respect 
to the association's internal controls; pre-approving all audit and 
non-audit services performed by the auditor; determining the budget and 
staffing of the association's internal audit department; and 
establishing procedures for the receipt of complaints regarding 
accounting, internal accounting controls, or auditing matters of the 
association and the confidential submission by employees of the 
association of concerns regarding questionable accounting or auditing 
matters.
    (3) The Audit Committee must conduct an annual performance self-
evaluation.
    (j) Regulatory Oversight Committee. (1) The Regulatory Oversight 
Committee must be composed solely of independent directors.
    (2) The Regulatory Oversight Committee must have a written charter 
that addresses the Regulatory Oversight Committee's purpose and 
responsibilities, which, at a minimum, must be to assure the adequacy 
and effectiveness of the regulatory program of the association; assess 
the association's regulatory performance; determine the regulatory 
plan, programs, budget, and staffing for the regulatory functions of 
the association; assess the performance of, and recommend compensation 
and personnel actions involving, the Chief Regulatory Officer and other 
senior regulatory personnel to the Compensation Committee; monitor and 
review regularly with the Chief Regulatory Officer matters relating to 
the association's surveillance, examination, and enforcement units; 
assure that the association's disciplinary and arbitration proceedings 
are conducted in accordance with the association's rules and policies 
and any other applicable laws or rules, including those of the 
Commission; prior to the association's approval of an affiliated 
security for listing, certify that such security meets the 
association's rules for listing; and approve reports filed with the 
Commission as required by Regulation AL (Sec.  242.800 of this 
chapter).
    (3) At least 20 percent of the members of any committee, 
subcommittee, or panel that is responsible for conducting hearings, 
rendering decisions, and

[[Page 71222]]

imposing sanctions with respect to disciplinary matters must be members 
of the association.
    (4) Any committee, subcommittee, or panel that is responsible for 
conducting hearings, rendering decisions, and imposing sanctions with 
respect to disciplinary matters must be subject to the jurisdiction of 
the Regulatory Oversight Committee.
    (5) The Regulatory Oversight Committee must oversee the preparation 
of the association's annual regulatory report, as required by Sec.  
240.17a-26.
    (6) The Regulatory Oversight Committee must conduct an annual 
performance self-evaluation.
    (k) Other committees of the Board. (1) The association may 
establish such other committees of the Board as it deems appropriate. 
However, if such committee has the authority to act on behalf of the 
Board, the committee must be composed of a majority of independent 
directors. The association may not delegate to any committee not 
consisting solely of independent directors the authority to act on 
matters that otherwise are within the jurisdiction of a Standing 
Committee.
    (2) At least 20 percent of the members of any committee must be 
members of the association if such committee:
    (i) Is not a Standing Committee, or is a committee, subcommittee, 
or panel that is subject to the jurisdiction of a Standing Committee; 
and
    (ii) Is responsible for providing advice with respect to trading 
rules or disciplinary rules.
    (l) Other requirements applicable to directors and officers. The 
rules of the association must provide that:
    (1) Any person subject to a statutory disqualification as defined 
in section 3(a)(39) of the Act (15 U.S.C. 78c(a)(39)) shall not be an 
officer or director of the association.
    (2) Each director, in discharging his or her responsibilities as a 
member of the Board, must reasonably consider all requirements 
applicable to such association under the Act.
    (m) Separation of positions of Chairman of the Board and Chief 
Executive Officer. (1) If the Chief Executive Officer of the 
association is not also the Chairman of the Board, the Chairman of the 
Board must be an independent director.
    (2) The Chief Executive Officer must not participate in any 
executive sessions of the Board.
    (3) If a single individual serves as both Chairman of the Board of 
the association and the Chief Executive Officer, the Board must 
designate an independent director as a lead director to preside over 
executive sessions of the Board. The Board must publicly disclose such 
lead director's name and a means by which interested parties may 
communicate with the lead director.
    (4) The Chairman of the Board of the association must not serve on 
the Nominating, Governance, Compensation, Audit, or Regulatory 
Oversight Committees, unless the Chairman of the Board is an 
independent director.
    (n) Separation of regulatory and market operations. (1) The 
association must establish policies and procedures to assure the 
independence of its regulatory program from its market operations or 
other commercial interests.
    (2) The association's regulatory program must be:
    (i) Structurally separated from the market operations and other 
commercial interests of the association, by means of separate legal 
entities; or
    (ii) Functionally separated within the same legal entity from the 
market operations and other commercial interests of the association.
    (3) The Board must appoint a Chief Regulatory Officer to administer 
the regulatory program of the association. The Chief Regulatory Officer 
must report directly to the Regulatory Oversight Committee.
    (4)(i) Any funds received by the association from regulatory fees, 
fines, or penalties must be applied only to fund programs and 
operations directly related to such association's regulatory 
responsibilities; and
    (ii) The association must make and keep books and records necessary 
to demonstrate compliance with the requirement in paragraph (n)(4)(i) 
of this section.
    (5)(i) An association must establish policies and procedures 
reasonably designed to:
    (A) Prevent the dissemination of regulatory information to any 
person other than an officer, director, employee, or agent of the 
association directly involved in carrying out the association's 
regulatory obligations under the Act;
    (B) Prevent the use of regulatory information for any purpose other 
than carrying out the association's regulatory obligations under the 
Act; and
    (C) Maintain the confidentiality of any information required to be 
submitted to effectuate a transaction on or through such association or 
its facilities, unless such information is aggregated to such an extent 
that no person whose information is included in the aggregated 
information can be identified, or unless the person has consented to 
the dissemination and use of its information by the association.
    (ii) An association's policies and procedures must require its 
officers, directors, employees, and agents to agree to comply with the 
requirements of paragraph (n)(5)(i) of this section.
    (o) Limits on member ownership and voting. (1) The rules of an 
association must prohibit any member of such association, alone or 
together with its related persons, from either:
    (i) Beneficially owning, directly or indirectly, any interest in 
the association or a facility of such association through which the 
member is permitted to effect transactions that exceeds 20 percent of 
any class of securities or other ownership interest of such association 
or facility; or
    (ii) Directly or indirectly voting, causing the voting of, or 
giving any consent or proxy with respect to the voting of, any interest 
in the association or a facility of such association through which the 
member is permitted to effect transactions that exceeds 20 percent of 
the voting power of any class of securities or other ownership interest 
of such association or facility.
    (2) The prohibition in paragraph (o)(1)(ii) shall not apply to any 
solicitation or receipt of a revocable proxy by any member or its 
related persons from other shareholders of the association or facility 
that is conducted pursuant to, and in accordance with, Regulation 14A 
under the Act (15 U.S.C. 78n), except that a member and its related 
persons may not conduct a solicitation or receive a proxy pursuant to 
Sec.  240.14a-2(b)(2) with regard to or from a person or persons whose 
interest in the association or facility, together with the member's and 
its related person's aggregate interest, would exceed the voting 
limitation in paragraph (o)(1) of this section.
    (3) The rules of the association must provide an effective 
mechanism to divest any member and its related persons of any interest 
owned in excess of the ownership limitation in paragraph (o)(1) of this 
section.
    (4) The rules of the association must be reasonably designed to not 
give effect to the portion of a vote by a member and its related 
persons that is in excess of the voting limitation in paragraph (o)(1) 
of this section.
    (5) The rules of the association must provide an effective 
mechanism for the association to obtain information relating to 
ownership and voting interests in the association or any facility of 
the association from any owner of any interest.

[[Page 71223]]

    (p) Code of conduct and ethics. (1) The rules of the association 
must provide:
    (i) For a code of conduct and ethics for directors, officers and 
employees that, at a minimum, establishes policies and procedures 
regarding: conflicts of interest; corporate opportunities; 
confidentiality; fair dealing; protection and proper use of the 
association's assets; compliance with laws, rules, and regulations by 
directors, officers and employees; and the reporting of illegal or 
unethical behavior; and
    (ii) That any waiver of the code of conduct and ethics established 
under paragraph (p)(1)(i) of this section must be approved by the 
Board.
    (2) The rules of the association must prohibit any of its employees 
or officers from being a member of the board of directors of a listed 
issuer or member firm.
    (q) Governance guidelines. The association must adopt rules 
implementing governance guidelines that, at a minimum, establish 
policies regarding: director qualification standards; director 
responsibilities; director access to management and independent 
advisors; director compensation; director orientation and continuing 
education; management succession; and annual performance evaluations of 
the Board.
    (r) Implementation. (1) The rules of each association must be 
designed to meet the requirements of this section and must be operative 
no later than [one year following the date of publication of final 
rules in the Federal Register].
    (2) Each association must submit to the Commission a proposed rule 
change that complies with this section no later than [four months 
following the date of publication of final rules in the Federal 
Register].
    (3) Each association must have final rules that comply with this 
section approved by the Commission no later than [ten months following 
the date of publication of final rules in the Federal Register].
    (s) Exemptions. (1) A limited purpose national securities 
association registered pursuant to section 15A(k)(1) of the Act (15 
U.S.C. 78o-3(k)(1)), is exempt from the requirements of this section.
    (2) Upon written request or on its own motion, the Commission may 
grant an exemption from any provision of this section, either 
unconditionally or on specified terms and conditions, if the Commission 
determines that such exemption is necessary or appropriate in the 
public interest and is consistent with the protection of investors.
    9. Section 240.17a-1 is amended by revising paragraph (b) to read 
as follows:


Sec.  240.17a-1  Recordkeeping rule for national securities exchanges, 
national securities associations, registered clearing agencies and the 
Municipal Securities Rulemaking Board.

* * * * *
    (b) Every national securities exchange, national securities 
association, registered clearing agency and the Municipal Securities 
Rulemaking Board shall keep all such documents for a period of not less 
than five years at a place within the United States, the first two in 
an easily accessible place, subject to the destruction and disposition 
provisions in Sec.  240.17a-6.
* * * * *
    10. Section 240.17a-26 is added to read as follows:


Sec.  240.17a-26  Regulatory reports of national securities exchanges 
and registered securities associations.

    (a)(1) Quarterly and annual reports. Every national securities 
exchange and every registered securities association must file with the 
Commission reports, in electronic format, prepared by the exchange or 
association containing the information required by paragraph (b) of 
this section. Unless otherwise noted, the information specified in 
paragraph (b)(2) of this section must be filed on a quarterly basis 
within 20 business days after the end of each calendar quarter. In 
addition, an annual report containing the information specified in 
paragraphs (a)(2), (b)(2)(i) through (b)(2)(vii), and (b)(3) of this 
section must be filed on an annual basis within 60 calendar days after 
the year end.
    (2) Electronic SRO trading facilities. Every national securities 
exchange and registered securities association that owns, operates, or 
sponsors an electronic SRO trading facility must file, as part of the 
annual report, a report of an independent audit designed to assess 
whether the operations of any electronic SRO trading facility of the 
exchange or association comply with the rules governing such facility. 
The report must be prepared by a third party not affiliated with the 
exchange or association that is qualified to render an opinion on such 
matters.
    (b)(1)(i) Scope. The quarterly and annual reports required by 
paragraph (a) of this section must include the information specified in 
paragraphs (b)(2) and (b)(3) of this section, relating to the 
regulatory program of the national securities exchange or registered 
securities association and any affiliate, including any surveillance, 
examination, and disciplinary programs. In the event that the exchange 
or association has entered into a contract or agreement with a 
regulatory subsidiary or with another self-regulatory organization 
pursuant to which such regulatory subsidiary or other self-regulatory 
organization provides regulatory services to or on behalf of the 
exchange or association, the information required by paragraph (b) of 
this section must include the information relating to the regulatory 
subsidiary's or other self-regulatory organization's activities on 
behalf of the exchange or association. In addition, the quarterly and 
annual reports must contain information, including surveillance 
reporting, both for those members for which the exchange or association 
is the designated examining authority and for any other members that 
use any facility of the exchange or association.
    (ii) Uniform format. Every national securities exchange and 
registered securities association subject to this section shall 
establish procedures for the preparation of the quarterly and annual 
reports required by this section in a uniform, readily accessible, and 
usable electronic format, review the reporting procedures from time to 
time to evaluate their efficacy, and revise the procedures as 
necessary.
    (2) Quarterly reports. The following information must be filed with 
the Commission by every national securities exchange and registered 
securities association on a quarterly basis:
    (i) Results of the surveillance programs, both manual and 
automated, during the reporting period, including, but not limited to: 
The number of exception reports and alerts generated, sorted by 
applicable rule or category; the number of exception reports and alerts 
reviewed by the exchange or association; and the number of exception 
reports and alerts closed or referred for further investigation or for 
enforcement proceedings;
    (ii) Results of surveillance programs relating to financial and 
operational requirements of members and other entities over which the 
exchange or association exercises examining authority during the 
reporting period, including, but not limited to: A list of member firms 
with net capital computation errors exceeding ten percent of excess net 
capital, using a unique identifier specific to the member firm to 
identify such member firm, and a factual description of any action 
taken by the exchange or association in response thereto; a list of 
member firms that filed late reports on Form X-17A-5 under Sec.  
240.17a-5(a), using a unique identifier specific to the member firm to 
identify such member firm, and a factual description of any action 
taken by the exchange or association in

[[Page 71224]]

response thereto; and a list of member firms that filed amendments to 
their reports on Form X-17A-5 under Sec.  240.17a-5(a), using a unique 
identifier specific to the member firm to identify such member firm, 
and a factual description of any action taken by the exchange or 
association in response thereto;
    (iii) A summary of all complaints relating to the exchange's or 
association's regulatory program received during the reporting period 
from any source, grouped by subject matter and using a unique 
identifier specific to the member and any associated person(s) 
involved; and including the date the complaint was received; the type 
of source from which the complaint originated; and a factual 
description of any response or action taken by the exchange or 
association in response to the complaint, including any disposition of 
the matter and the date of any response;
    (iv) A summary of all investigations opened, closed, and pending 
during the reporting period including the aggregate number of 
investigations for each such category, and a summary of the facts of 
each investigation including, but not limited to: The member firm and 
any associated person(s) under review using a unique identifier 
specific to the member firm and associated person(s) under review; a 
factual description of any alleged violations; the type of source that 
led to the investigation; a factual description of the matter under 
investigation and the relevant security symbol or specific type of 
security involved; the date of the occurrence of the matter under 
investigation and the date it was reported or detected; the date the 
investigation was opened and, as applicable, closed; the length of time 
the investigation has been or was open; and, if applicable, a factual 
description of the recommendations and disposition of the 
investigation. In addition, the report should include a summary of the 
number of investigations conducted during the reporting period and the 
average elapsed time, in days, for all investigations closed during the 
reporting period;
    (v) A summary of all examinations opened, closed, and pending 
during the reporting period including the aggregate number of 
examinations for each such category, and a summary of the facts of each 
examination including, but not limited to: A list of the members 
examined during the reporting period using a unique identifier specific 
to the member firm; the frequency with which each such member is 
examined; the type of examination, including whether the examination 
was a cycle or for-cause examination and a factual description of any 
reasons for a cause examination; whether the examination was of a new 
member and, if so, the date the member was registered under the Act and 
the date the examination of the new member commenced; a factual 
description of the scope and subject matter of such examination; the 
date the examination was opened and, as applicable, closed; the length 
of time the examination has been or was open; whether the examination 
included an on-site branch examination; a factual description of any 
potential violations; and, if applicable, a factual description of the 
recommendations and disposition of the examination. In addition, the 
report should include a summary of the number of examinations conducted 
during the reporting period and the average elapsed time, in days, for 
all examinations closed during the reporting period;
    (vi) A summary of all enforcement cases opened, closed, and pending 
during the reporting period including the aggregate number of 
enforcement cases in each category, grouped by subject matter, and a 
summary of the facts of each case including, but not limited to: The 
member firm and any associated person(s) under review using a unique 
identifier specific to the member firm and associated person(s) under 
review; the type of source that led to the case; a factual description 
of any alleged violations and, as applicable, the relevant security 
symbol or specific type of security involved; the date of the 
occurrence of any alleged violations and the date they were reported or 
detected; the date the enforcement case was opened and, as applicable, 
closed; the length of time the case has been or was open; and, if 
applicable, a factual description of the disposition of the case, 
including whether the case was settled and any sanctions imposed. In 
addition, the report should include a summary of the number of 
enforcement cases conducted during the reporting period and the average 
elapsed time, in days, for all enforcement cases closed during the 
reporting period;
    (vii) A summary of listings information during the reporting 
period, including, but not limited to: A list of all securities that 
were newly listed or were delisted during the reporting period, 
including the name, symbol, and issuer; a list of all issuers to whom 
the exchange or association, or a facility thereof, sent during the 
reporting period a notice alleging that such issuer does not satisfy a 
rule or standard for continued listing on the exchange or association, 
or a facility thereof, and, in the case of an exchange, a notice that 
the exchange has submitted an application under Sec.  240.12d-2 to the 
Commission to delist a class of the issuer's securities, or, in the 
case of an association, a notice that the association has taken all 
necessary steps under it rules to delist the security from its 
facility; a list of all issuers, using unique identifiers, alleged to 
not satisfy a rule or standard for continued listing and any action 
taken with respect to any listed issuer that allegedly failed to 
satisfy any rule or standard for continued listing; and a list of any 
issuers, using unique identifiers, that are alleged to have failed to 
file timely quarterly or annual reports. The summary must set forth the 
rule or standard for continued listing that the issuer is alleged to 
have failed to satisfy and the date when the issuer was alleged to have 
failed to satisfy any rule or standard for continued listing; and the 
status of any compliance plan for the issuer, including any alleged 
failure by the issuer to satisfy the requirements of the compliance 
plan. In addition, for listed options, the report should include a list 
and a factual description of the circumstances surrounding options 
classes or series that were improperly listed; and
    (viii) Copies of the final agenda of any meeting of the board and 
of any executive board of the exchange or association, or of any 
committee of the board or executive board, that occurred during the 
reporting period.
    (3) Annual report. In addition to a year-end cumulative 
presentation of the information specified in paragraph (b)(2)(i) 
through (b)(2)(vii), and the information specified in paragraph (a)(2), 
the following information must be filed with the Commission by every 
national securities exchange and registered securities association as 
part of the annual report:
    (i) A complete discussion of the internal policies and procedures 
for carrying out the regulatory responsibilities of the exchange or 
association, including a discussion of the overall program of 
surveillance and enforcement and any new, revised, or terminated 
surveillance programs along with a discussion of the reasons for any 
change. In addition, the exchange or association must submit as part of 
the annual report a chart indicating by group or section the regulatory 
activities performed by such group or section, the number of staff 
involved in each group or section, the names of the staff responsible 
for such regulatory activities, and the names of the supervisors of 
each group or section;
    (ii) An evaluation of the effectiveness of the exchange's or 
association's

[[Page 71225]]

regulatory programs in effect during the reporting period, including a 
discussion of the overall operation and effectiveness of the regulatory 
program; the particular strengths and weaknesses of the regulatory 
program; areas in which the regulatory program needs to be improved; 
and any planned revisions to the regulatory program in response to any 
weaknesses, including those weaknesses uncovered during the process of 
preparing the annual and quarterly reports required by this section;
    (iii) A complete discussion of the internal controls implemented by 
the exchange or association that are designed to detect, prevent, and 
control for any conflicts of interest between the market operations and 
other commercial interests of the exchange or association and its self-
regulatory responsibilities, and to assure that the exchange or 
association appropriately carries out its self-regulatory 
responsibilities;
    (iv) A complete discussion of the exchange's or association's 
employment arrangements with its Chief Regulatory Officer and other 
senior regulatory program personnel;
    (v) Copies of the most recent annual performance self-evaluation of 
each standing committee of the board of a national securities exchange 
or registered securities association, as well as the annual governance 
performance evaluation prepared by each exchange's or association's 
Governance Committee, as set forth in Sec.  240.6a-5 and Sec.  
240.15Aa-3; and
    (vi) A complete discussion of the exchange or association's efforts 
to comply with any recommendations or plan resulting from any 
inspection or examination conducted by the Commission's staff.
    (c) Certifications. The reports provided for in paragraph (a) of 
this section, as well as any supplement provided for in paragraph (d) 
of this section, must be accompanied by a certification, executed by an 
exchange's or association's chief executive officer on behalf of, and 
with the authority of, the exchange or association, representing that 
the information contained in the respective report or amendment is 
current, true, and complete as of the date filed with the Commission.
    (d)(1) Interim changes to the regulatory program. Any material 
change to the regulatory program of a national securities exchange or 
registered securities association, or any material developments that 
affect such regulatory program, including any changes to the parameters 
used in surveilling for and enforcing compliance with the federal 
securities laws and rules and regulations thereunder and the exchange's 
or association's rules, including any new, revised, or terminated 
surveillance and enforcement programs that occurred since the filing of 
the prior quarterly report required by this section, must be reported 
in a supplemental filing with the Commission within ten business days 
of such change, along with a discussion of the reasons for such change.
    (2) Interim changes to the regulatory department or unit. Any 
material change to the organization or staffing of any regulatory or 
supervisory department or unit must be reported in a supplemental 
filing with the Commission within ten business days of such change, 
along with a discussion of the reasons for such change.
    (e) Confidentiality. All information submitted pursuant to this 
section will be accorded confidential treatment to the extent permitted 
by law.
    (f) Compliance date. Every national securities exchange and 
national securities association must comply with this section beginning 
with the first full quarterly reporting period commencing [six months 
from the date of publication of the final rule in the Federal 
Register].
    (g) Extensions. Upon written request or on its own motion, the 
Commission may grant an extension of time for filing any reports or 
materials required by this section, if the Commission determines that 
such extension is necessary or appropriate in the public interest and 
is consistent with the protection of investors.
    (h)(1) Exemptions. Upon written request or on its own motion, the 
Commission may grant an exemption from any of the requirements of this 
section, either unconditionally or on specified terms and conditions, 
if the Commission determines that such exemption is necessary or 
appropriate in the public interest and is consistent with the 
protection of investors.
    (2) A national securities exchange registered pursuant to section 
6(g) of the Act (15 U.S.C. 78f(g)), and a limited purpose national 
securities association registered pursuant to section 15A(k)(1) of the 
Act (15 U.S.C. 78o-3(k)(1)) are exempt from the requirements of this 
section.
    (i) Each report filed pursuant to this section shall constitute a 
``report'' within the meaning of sections 17(a), 18(a), and 32(a) of 
the Act (15 U.S.C. 78q(a), 78r(a), and 78ff(a)), and any other 
applicable provisions of the Act.
    (j) Definitions. For purposes of this section,
    (1) The term Act means the Securities Exchange Act of 1934.
    (2) The term board means the Board of Directors or Board of 
Governors of a national securities exchange or registered securities 
association, or any equivalent body.
    (3) The term electronic SRO trading facility means a facility of an 
exchange or association that executes orders in securities on an 
electronic basis.
    (4) The term facility has the same meaning as set forth in section 
3(a)(2) of the Act (15 U.S.C. 78c(a)(2)), or Sec.  240.15Aa-3, as 
applicable.
    (5) The term regulatory subsidiary means any person that, directly 
or indirectly, is controlled by the national securities exchange or 
registered securities association and that provides, whether pursuant 
to contract, agreement or rule, regulatory services to or on behalf of 
the national securities exchange or registered securities association.
    (6) The term standing committee has the same meaning as defined in 
Sec.  240.6a-5(b)(21) for a national securities exchange and in Sec.  
240.15Aa-3(b)(22) for a registered securities association.
    11. Section 240.17a-27 is added to read as follows:


Sec.  240.17a-27  Ownership of a national securities exchange, 
registered securities association, or facility of a national securities 
exchange or registered securities association.

    (a) Definitions. (1) The term Act means the Securities Exchange Act 
of 1934.
    (2) The term affiliate means, with respect to any person, any other 
person that directly or indirectly controls, is controlled by, or is 
under common control with, the person.
    (3) The terms beneficial ownership, beneficially owns or any 
derivative thereof shall have the same meaning, with respect to any 
security or other ownership interest, as set forth in Sec.  240.13d-3, 
as if (and whether or not) such security or other ownership interest 
were a voting equity security registered under section 12 of the Act 
(15 U.S.C. 78l); provided that to the extent any person beneficially 
owns any security or other ownership interest solely because such 
person is a member of a group within the meaning of section 13(d)(3) of 
the Act (15 U.S.C. 78m(d)(3)), such person shall not be deemed to 
beneficially own such security or other ownership interest for purposes 
of this section, unless such person has the power to direct the vote of 
such security or other ownership interest.
    (4) The term class of securities of a disclosure entity means the 
outstanding

[[Page 71226]]

securities of such class, exclusive of any securities of such class 
held by or for the account of the disclosure entity or a subsidiary of 
the disclosure entity.
    (5) The term control means the possession, direct or indirect, of 
the power to direct or cause the direction of the management and 
policies of a person, whether through the ownership of voting 
securities, by contract, or otherwise. A person is presumed to control 
another person if the person:
    (i) Is a director, general partner or officer exercising executive 
responsibility (or having similar status or functions);
    (ii) Directly or indirectly has the right to vote 25 percent or 
more of a class of voting securities or has the power to sell or direct 
the sale of 25 percent or more of a class of voting securities; or
    (iii) In the case of a partnership, has the right to receive, upon 
dissolution, or has contributed, 25 percent or more of the capital.
    (6) The term disclosure entity means, with respect to a member,
    (i) A national securities exchange of which it is a member, other 
than an exchange registered pursuant to section 6(g) of the Act (15 
U.S.C. 78f(g));
    (ii) A registered securities association of which it is a member, 
other than a limited purpose national securities association registered 
pursuant to section 15A(k)(1) of the Act (15 U.S.C. 78o-3(k)(1)); and
    (iii) A facility of such national securities exchange or registered 
securities association through which it is permitted to effect 
transactions.
    (7) The term facility shall have the meaning in section 3(a)(2) of 
the Act (15 U.S.C. 78c(a)(2)) or Sec.  240.15Aa-3, as applicable.
    (8) The term immediate family member means a person's spouse, 
parents, children, and siblings, whether by blood, marriage, or 
adoption, or anyone residing in such person's home.
    (9) The term member shall have the meaning set forth in section 
3(a)(3) of the Act (15 U.S.C. 78c(a)(3)).
    (10) The term national securities exchange means any exchange 
registered pursuant to section 6 of the Act (15 U.S.C. 78g).
    (11) The term person shall have the meaning in section 3(a)(9) of 
the Act (15 U.S.C. 78c(a)(9)).
    (12) The term registered securities association means any 
association of brokers and dealers registered pursuant to section 15A 
of the Act (15 U.S.C. 78o-3).
    (13) The term related person means, with respect to any member that 
is a broker or dealer:
    (i) Any affiliate of the member;
    (ii) Any person associated with the member;
    (iii) Any immediate family member of such member, or any immediate 
family member of the member's spouse, who, in each case, has the same 
home as the member or who is a director or officer of the disclosure 
entity or any of its parents or subsidiaries; and
    (iv) Any immediate family member of a person associated with the 
member, or any immediate family member of that person's spouse, who, in 
each case, has the same home as the person associated with the member 
or who is a director or officer of the disclosure entity or any of its 
parents or subsidiaries.
    (14) The term share means a share of stock in a corporation or unit 
of interest in an unincorporated person.
    (b)(1) Filing requirement. A member of a national securities 
exchange or registered securities association that is a broker or 
dealer must file with the Commission a statement containing the 
information required by paragraph (b)(2) of this section if such 
member, directly or indirectly, alone or together with its related 
persons, beneficially owns more than five percent of any class of 
securities or other ownership interest in a disclosure entity.
    (2) Required information. A statement that a member is required to 
file under paragraph (b)(1) of this section must include the following:
    (i) The title of the class of securities or other ownership 
interest for which the member is required to file this statement, and 
the identity and form of organization (e.g. LLC) of the disclosure 
entity;
    (ii) If the member is a corporation, general partnership, limited 
partnership, syndicate or other group of persons, its name, the state 
or other place of its organization, its principal business, the address 
of its principal business, and the address of its principal office;
    (iii) If the member is a natural person, his or her name, residence 
or business address, present principal occupation or employment, and 
the name, principal business and address of any corporation or other 
organization in which such employment is conducted;
    (iv) A description of the securities or other ownership interest 
that are the subject of the filing, including:
    (A) The total number of securities or other ownership interests 
issued and outstanding in each class or series;
    (B) If the securities are publicly traded, the market(s) where they 
trade;
    (C) Any restrictions on ownership, voting, transfers, or other 
disposition of such securities or other ownership interest; and
    (D) Any other material provisions relating to ownership of the 
disclosure entity;
    (v) Whether such disclosure entity is a reporting issuer under 
section 12 of the Act (15 U.S.C. 78l);
    (vi)(A) The aggregate number and percentage of shares of a class of 
securities or other ownership interest in such disclosure entity that 
are beneficially owned by the member;
    (B) The aggregate number of shares or ownership interest as to 
which the member:
    (1) Has the sole power to vote or to direct the vote;
    (2) Has shared power to vote or to direct the vote;
    (3) Has sole power to dispose or to direct the disposition;
    (4) Has shared power to dispose or to direct the disposition; and
    (C) If any other person is known to have the right to receive or 
the power to direct the receipt of dividends from, or the proceeds from 
the sale of, such securities or other ownership interest, a statement 
to that effect should be included in response to this section and, if 
such interest relates to more than five percent of the securities or 
other ownership interest, such person should be identified; provided 
that, a listing of the shareholders of an investment company registered 
under the Investment Company Act of 1940 or the beneficiaries of an 
employee benefit plan, pension fund or endowment fund is not required.
    (vii) Separately identify each related person whose ownership in a 
disclosure entity is included in the calculation of beneficial 
ownership required to be disclosed by the member pursuant to this 
paragraph (b) and state the aggregate number and percentage of shares 
of a class of securities or other ownership interest in such disclosure 
entity that are beneficially owned by the related person. For each 
related person identified provide the following information:
    (A) Indicate the aggregate number of shares or ownership interest 
as to which the related person:
    (1) Has the sole power to vote or to direct the vote;
    (2) Has shared power to vote or to direct the vote;
    (3) Has sole power to dispose or to direct the disposition;
    (4) Has shared power to dispose or to direct the disposition; and
    (B) If any other person is known to have the right to receive or 
the power to direct the receipt of dividend from, or the proceeds from 
the sale of, such securities or other ownership interest, a statement 
to that effect should be

[[Page 71227]]

included in response to this provision and, if such interest relates to 
more than five percent of the securities or other ownership interest, 
such person should be identified; provided that, a listing of the 
shareholders of an investment company registered under the Investment 
Company Act of 1940 or the beneficiaries of an employee benefit plan, 
pension fund or endowment fund is not required;
    (viii) For each member and its related persons, indicate whether 
and how such member, alone or together with its related persons, 
possesses the power, directly or indirectly, to direct or cause the 
direction of the management and policies of the disclosure entity, 
whether through ownership of voting securities, by contract, or 
otherwise;
    (ix) Specifically describe the ability of each member and its 
related persons, through governance provisions or otherwise, to 
exercise any influence or control over the regulatory responsibilities 
of the exchange or association; and
    (x) A description of any contracts, arrangements, understandings or 
relationships (legal or otherwise) among the member and its related 
persons and between such persons and any other person with respect to 
any securities or other ownership interest of the disclosure entity, 
including but not limited to transfer or voting of any of the 
securities or other ownership interest, finder's fees, joint ventures, 
loan or option arrangements, put or calls, guarantees of profits, 
division of profits or loss, or the giving or withholding of proxies. 
Name the persons with whom such contracts, arrangements, understandings 
or relationships have been entered into. Include such information for 
any of the securities or other ownership interest that are pledged or 
otherwise subject to a contingency the occurrence of which would give 
another person voting power or investment power over such securities or 
interest except that disclosure of standard default and similar 
provisions contained in loan agreements need not be included.
    (3) Timing of initial filing. A member must file a statement 
containing the information specified in paragraph (b)(2) of this 
section within 10 calendar days after becoming subject to such filing 
requirement under paragraph (b)(1) of this section.
    (4) Periodic update. A member must file an amendment to the 
statement required pursuant to paragraph (b)(1) of this section within 
ten calendar days of any change in the information specified under 
paragraph (b)(2) of this section, except in the event of an increase or 
decrease of less than 1 percent of ownership of a class of securities 
or other ownership interest last reported on the statement filed 
pursuant to paragraph (b)(1) of this section, or any amendment thereto.
    (c) Copy to exchange or association. The member shall provide a 
copy of the statement required by paragraph (b)(1) and amendment 
required by paragraph (b)(4) of this section to the disclosure entity 
if the disclosure entity is a national securities exchange or 
registered securities association, or to the applicable national 
securities exchange or registered securities association, if the 
disclosure entity is a facility.
    (d) SRO posting requirements. A national securities exchange or 
registered securities association must continuously post any statement 
received from a member pursuant to paragraph (c) of this section on a 
publicly-accessible Web site controlled by the exchange or association 
within ten calendar days of receipt of such statement.
    (e) Other provisions. (1) Each statement filed pursuant to this 
section shall constitute a ``report'' within the meaning of sections 
17(a), 18(a), and 32(a) of the Act (15 U.S.C. 78q(a), 78r(a), and 
78ff(a)), and any other applicable provisions of the Act.
    (2) Each statement filed pursuant to this section shall be 
considered filed upon receipt by the Division of Market Regulation at 
the Commission's principal office in Washington, DC.
    (f) Exemptions. Upon written request or on its own motion, the 
Commission may grant an exemption from the provisions of this section, 
either unconditionally or on specified terms and conditions, if the 
Commission determines that such exemption is necessary or appropriate 
in the public interest and is consistent with the protection of 
investors.

PART 242--REGULATIONS M, ATS, AC, NMS, AL, B and SHO AND CUSTOMER 
MARGIN REQUIREMENTS FOR SECURITY FUTURES

    12. The authority citation for part 242 continues to read as 
follows:

    Authority: 15 U.S.C. 77g, 77q(a), 77s(a), 78b, 78c, 78g(c)(2), 
78i(a), 78j, 78k-1(c), 78l, 78m, 78n, 78o(b), 78o(c), 78o(g), 
78q(a), 78q(b), 78q(h), 78w(a), 78dd-1, 78mm, 80a-23, 80a-29, and 
80a-37.

    13. The part heading for part 242 is revised as set forth above.
    14. Part 242 is amended by adding an undesignated center heading 
and Sec.  242.800, to read as follows:

Regulation AL--National Securities Exchanges and Registered Securities 
Associations Listing and Trading Affiliated Securities


Sec.  242.800  Regulation AL; National securities exchanges and 
registered securities associations listing and trading affiliated 
securities.

    (a) Definitions. For purposes of this section:
    (1) The term Act means the Securities Exchange Act of 1934.
    (2) The term affiliate means, with respect to any person, any other 
person that directly or indirectly controls, is controlled by, or is 
under common control with, the person.
    (3) The term affiliated issuer means:
    (i) With respect to a national securities exchange, the national 
securities exchange, an SRO trading facility of the national securities 
exchange, an affiliate of the national securities exchange, or an 
affiliate of an SRO trading facility of the national securities 
exchange, and
    (ii) With respect to a registered securities association, the 
registered securities association, an SRO trading facility of the 
registered securities association, an affiliate of the registered 
securities association, or an affiliate of an SRO trading facility of 
the registered securities association.
    (4) The term affiliated security means any security issued by an 
affiliated issuer, except that it shall not include any option exempt 
from the Securities Act of 1933 under Sec.  230.238 of this chapter and 
any security futures product exempt from the Securities Act of 1933 
under section 3(a)(14) of the Securities Act of 1933 (15 U.S.C. 
77c(a)(14)).
    (5) The term control means the possession, direct or indirect, of 
the power to direct or cause the direction of the management or 
policies of a person, whether through ownership of voting securities, 
by contract, or otherwise. A person is presumed to control another 
person if the person:
    (i) Is a director, general partner or officer exercising executive 
responsibility (or having similar status or functions);
    (ii) Directly or indirectly has the right to vote 25 percent or 
more of a class of voting securities or has the power to sell or direct 
the sale of 25 percent or more of a class of voting securities; or
    (iii) In the case of a partnership, has the right to receive, upon 
dissolution, or has contributed, 25 percent or more of the capital.
    (6) The term SRO trading facility means any facility of a national 
securities exchange or registered

[[Page 71228]]

securities association that executes orders in securities.
    (7) The term facility shall have the meaning in section 3(a)(2) of 
the Act (15 U.S.C. 78c(a)(2)) and Sec.  240.15Aa-3 of this chapter.
    (8) The term member shall have the meaning in section 3(a)(3) of 
the Act (15 U.S.C. 78c(a)(3)).
    (9) The term regulatory oversight committee means a committee of 
the national securities exchange or registered securities association 
as required by Sec.  240.6a-5(j) or Sec.  240.15Aa-3(j) of this 
chapter.
    (b) Listing and trading of affiliated securities. (1) A national 
securities exchange or registered securities association may not 
approve for listing an affiliated security unless such exchange's or 
association's regulatory oversight committee certifies that such 
security satisfies the exchange's or association's rules for listing.
    (2) If an affiliated security is listed on, approved for trading 
on, or trades pursuant to the rules of, a national securities exchange 
or registered securities association, the exchange or association must:
    (i) File with the Commission not more than 30 calendar days after 
the end of each calendar quarter a report that:
    (A) Summarizes such exchange's or association's monitoring of the 
affiliated security's compliance with exchange's or association's 
listing rules, including a statement regarding such affiliated 
security's compliance with each applicable rule; and
    (B) Summarizes such exchange's or association's surveillance of the 
trading of the affiliated security by the exchange's or association's 
members;
    (ii) File with the Commission not more than 60 calendar days after 
the end of such exchange's or association's fiscal year a report 
prepared by a third party analyzing compliance by the affiliated 
security with the exchange's or association's listing rules;
    (iii) Notify the affiliated issuer promptly if the exchange or 
association alleges that the affiliated security is not in compliance 
with any applicable listing rule of the exchange or association;
    (iv) Within five business days of notifying an affiliated issuer 
under paragraph (b)(2)(iii) of this section, file a report with the 
Commission that identifies the date the exchange or association alleged 
that the affiliated security was not in compliance, the listing rule(s) 
with which the exchange or association alleged such affiliated security 
failed to comply, the action the exchange or association proposes to 
take with respect to such affiliated security, and any other material 
information conveyed to the affiliated issuer; and
    (v) Provide the Commission with a copy of any response from the 
affiliated issuer regarding the exchange's or association's allegation 
that its affiliated security failed to comply with exchange or 
association rules within five business days of receipt of such 
response.
    (c) Regulatory Oversight Committee approval. (1) The exchange's or 
association's regulatory oversight committee must approve the reports 
required to be filed pursuant to paragraphs (b)(2)(i) and (b)(2)(iv) of 
this section prior to filing with the Commission.
    (2) Within five business days of receipt, the exchange or 
association must provide to the exchange's or association's regulatory 
oversight committee a copy of the report prepared by a third party 
pursuant to paragraph (b)(2)(ii) of this section and any response 
received from an affiliated issuer that is provided to the Commission 
pursuant to paragraph (b)(2)(v) of this section.
    (d) Application of rules. Except as otherwise required by this 
section:
    (1) Any action taken by the national securities exchange or 
registered securities association with regard to the listing of an 
affiliated security must be in compliance with the rules of the 
exchange or association;
    (2) The exchange or association must not apply the same listing 
rules to affiliated securities in a manner that is materially different 
than the treatment afforded to other securities listed on the exchange 
or association; and
    (3) Any action taken by the exchange or association with regard to 
trading of an affiliated security by the exchange's or association's 
members must be in compliance with the rules of the exchange or 
association and with the federal securities laws, and must not be 
materially different than action taken with respect to the trading of 
other securities traded on the exchange or association.
    (e) Other provisions. (1) Each report filed pursuant to paragraphs 
(b)(2)(i), (b)(2)(ii), and (b)(2)(iv) of this section shall constitute 
a ``report'' within the meaning of sections 17(a), 18(a), and 32(a) of 
the Act (15 U.S.C. 78q(a), 78r(a), and 78ff(a)), and any other 
applicable provisions of the Act.
    (2) Each report or response filed pursuant to this section shall be 
considered filed upon receipt by the Division of Market Regulation at 
the Commission's principal office in Washington, DC.
    (f) Exemptions. Upon written request or on its own motion, the 
Commission may grant an exemption from the provisions of this section, 
either unconditionally or on specified terms and conditions, if the 
Commission determines that such exemption is necessary or appropriate 
in the public interest and is consistent with the protection of 
investors.

PART 249--FORMS, SECURITIES EXCHANGE ACT OF 1934

    15. The authority citation for part 249 continues to read in part 
as follows:

    Authority: 5 U.S.C. 78a et seq. and 7201 et seq.; and 18 U.S.C. 
1350, unless otherwise noted.
* * * * *
    16. Form 1 (referenced in Sec.  249.1) is revised to read as 
follows:

    Note: The text of Form 1 does not and this amendment will not 
appear in the Code of Federal Regulations.

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    17. Section 249.2 and Form 2 (referenced in Sec.  249.2) are added 
to read as follows:


Sec.  249.2  Form 2, for application for, and amendments to 
applications for, registration as a registered securities association 
or affiliated securities association.

    The form shall be used for application for, and amendments to 
applications for, registration as a registered securities association 
or affiliated securities association.


    Note: The text of Form 2 does not and this amendment will not 
appear in the Code of Federal Regulations.


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Sec. Sec.  249.801, 249.802, and 249.803  [Removed]

    18. Sections 249.801, 249.802, and 249.803 are removed.

    Dated: November 18, 2004.

    By the Commission.
Margaret H. McFarland,
Deputy Secretary.
[FR Doc. 04-26153 Filed 12-7-04; 8:45 am]
BILLING CODE 8010-01-P