[Federal Register Volume 70, Number 226 (Friday, November 25, 2005)]
[Notices]
[Pages 71090-71092]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: E5-6510]


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COMMODITY FUTURES TRADING COMMISSION


Self-Regulation and Self-Regulatory Organizationsin the Futures 
Industry

AGENCY: Commodity Futures Trading Commission (``Commission'').

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

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    \1\ For purposes of this Request, SROs include designated 
contract markets (``DCMs''), derivatives clearing organizations 
(``DCOs''), and registered futures associations.
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SUMMARY: This Request for Comments (``Request'') continues the 
Commission's ongoing review of self-regulation and self-regulatory 
organizations in the U.S. futures industry (``SRO Study''). The Request 
seeks public comment on a range of SRO issues, including governance, 
minimizing conflicts of interest within self-regulation, the 
composition of SROs' boards of directors and disciplinary committees, 
and the impact of increasing competition, changing business models and 
new ownership structures on SROs' self-regulatory responsibilities.\2\ 
Commenters are also asked to consider the impact of securities 
exchanges' listing standards and the unique role of registered futures 
associations (``RFAs'') and other third-party regulatory service 
providers. The questions presented update the Commission's prior fact-
finding on self-regulation, build on industry developments since that 
time, and offer interested parties an additional opportunity to comment 
as the SRO Study nears conclusion. The questions raised in this Request 
will also form the basis of an upcoming Commission roundtable on self-
regulation. The roundtable will provide a forum for industry 
participants to present their views on both the challenges and 
opportunities of self-regulation in a rapidly evolving futures 
industry.
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    \2\ SROs' self-regulatory responsibilities include, among other 
things, market surveillance, trade practice surveillance, and audits 
and examinations of member firms (e.g., ensuring compliance with 
financial integrity, financial reporting, sales practice, and 
recordkeeping requirements). An SRO's specific responsibilities will 
depend upon whether it is a DCM, DCO, or RFA.

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DATES: Responses must be received January 9, 2006.

ADDRESSES: Written responses should be sent to Jean A. Webb, Secretary, 
Commodity Futures Trading Commission, Three Lafayette Center, 1155 21st 
Street, NW., Washington, DC 20581. Responses may also be submitted via 
e-mail at [email protected]. ``Self-Regulation and Self-Regulatory 
Organizations'' must be in the subject field of responses submitted via 
e-mail, and clearly indicated in written submissions. This document is 
also available for comment at http://www.regulations.gov.

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

SUPPLEMENTARY INFORMATION:

I. Introduction

    Since its initiation in May of 2003, the SRO Study has proceeded 
through two phases.\3\ Phase I included staff interviews with over 100 
individuals representing every segment of the futures industry, 
including futures commission merchants (``FCMs''), DCMs, DCOs, and 
industry associations. Staff also interviewed industry executives, 
academics, consultants, and individuals associated with securities-side 
entities. Based on these interviews, the Commission identified several 
issues for further attention and launched Phase II of the SRO Study in 
February of 2004.\4\
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    \3\ The SRO Study was initiated in an address by former 
Commission Chairman James E. Newsome at the Futures Industry 
Association Law and Compliance Luncheon (May 28, 2003), available 
at: http://www.cftc.gov/opa/speeches03/opanewsm-40.htm.
    \4\ As a prelude to Phase II, the Commission encouraged every 
SRO to reexamine its policies, employee training efforts, and day-
to-day practices to confirm that there are safeguards in place to 
prevent the misuse use of confidential information obtained by SROs 
during audits, investigations, or other self-regulatory activities. 
The Commission continues to examine confidentiality of information 
as it moves forward with the SRO Study. See CFTC Progresses with 
Study of Self-Regulation, CFTC Press Release No. 4890-04 (Feb. 6, 
2004), available at: http://www.cftc.gov/opa/press04/opa4890-04.htm.
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    Phase II of the SRO Study has pursued two lines of inquiry. The 
first addresses issues relating to the cooperative regulatory agreement 
by which DCMs and the National Futures Association (``NFA'') coordinate 
compliance examinations of FCMs (``DSRO System''). In April of 2004, 
Commission staff sought public comment on the governance and operation 
of the Joint Audit Committee (``JAC'') and on the effectiveness of JAC 
and NFA examination programs.\5\ Commission staff also sought comment 
on certain proposed amendments to the Joint Audit Agreement. The 
proposed amendments, among other things, add additional parties to the 
JAC, add certain voting eligibility provisions, and memorialize certain 
DSRO assignment procedures. The comments received and the proposed 
amendments to the JAC remain under consideration by Commission staff.
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    \5\ CFTC Seeks Comment on How Self-Regulatory Exams of Futures 
Firms Are Coordinated, CFTC Press Release No. 4910-04 (Apr. 7, 
2004), available at: http://www.cftc.gov/opa/press04/opa4910-04.htm.
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    The second line of inquiry in Phase II of the SRO Study focuses 
primarily on conflicts of interest in self-regulation, and those 
factors that may tend to increase or ameliorate such conflicts. In June 
of 2004, the Commission sought public comment on SRO board composition, 
changing ownership structures and business models among SROs, and the 
organization and oversight of SROs' regulatory departments and 
personnel, among other things.\6\ Simultaneously, the Commission 
distributed to each SRO a questionnaire to help evaluate the governance 
structures, policies, and procedures of the self-regulators under the 
Commission's authority. The comments solicited in 2004 and in the 
earlier interviews generated an array of responses and approaches to 
self-regulation that the Commission is now re-examining in light of 
industry developments and findings since that time.
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    \6\ SRO Governance, 69 FR 32,326 (June 9, 2004) and 69 FR 42,971 
(July 19, 2004) (extending comment period to Sept. 30, 2004).
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    One significant development in self-regulation since the beginning 
of the SRO Study is the creation of exchange ``regulatory oversight 
committees'' (``ROCs''). In each case, the ROCs are board-level 
committees, composed only

[[Page 71091]]

of independent non-member directors, with varying degrees of 
responsibility and authority. Among futures exchanges, both the New 
York Board of Trade (``NYBOT'') and the parent company of the Chicago 
Mercantile Exchange (``CME'') have created advisory ROCs with oversight 
of the exchanges' self-regulatory activities.\7\ Both ROCs remain 
subject to their respective boards of directors. In contrast, the 
Futures Industry Association (``FIA'') has recommended exchange ROCs 
that create a ``functional separation of compliance and business 
staffs,'' including the hiring, firing, and compensation of such 
staff.\8\ The Securities and Exchange Commission (``SEC'') has proposed 
its own version of the ROC for U.S. securities exchanges.\9\ Its 
proposal places ROCs within majority independent non-member boards of 
directors.
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    \7\ NYBOT Rule 3.40, available at: http://www.nybot.com/aboutNYBOT/rulebooks/nybot/download/Ch%203%20Committees.pdf and 
Chicago Mercantile Exchange Holdings, Inc., Charter of the Market 
Regulatory Oversight Committee, available at: http://investor.cme.com/downloads/regulation.pdf.
    \8\ The Governance of Self Regulatory Organizations, FIA Comment 
Letter at 4 and 5 (Sept. 30, 2004), available at: http://www.cftc.gov/files/foia/comment04/foicf0405c009.pdf.
    \9\ Fair Administration and Governance of Self-Regulatory 
Organizations, 69 FR 71126 (Dec. 8, 2004).
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    As the questions below indicate, the Commission is interested in 
commenters' evaluation of the existing and proposed ROCs. Responses 
should address whether ROCs are necessary, how effective they are 
likely to be, and any potential drawbacks. Responses should also 
address what responsibilities and authority should be vested in ROCs, 
how their members should be nominated and elected, and the appropriate 
relationship between boards, ROCs, and SROs' senior regulatory 
officers. Finally, as the Commission considers a range of options to 
help insulate self-regulation from improper influence and commercial 
interests, commenters should address whether such insulation is best 
accomplished through new board composition standards, ROCs, or a 
combination of both.
    Of the issues raised in the SRO Study, exchange disciplinary 
committees and the impact of changing ownership structures and business 
models have generated the most divergent opinions and approaches. Thus, 
although the Commission has previously solicited public comments on 
these matters, they require further exploration in an effort to 
reconcile the divergent views expressed by industry participants, 
outside experts, and others. Through this Request for Comments and the 
upcoming roundtable, the Commission will complete its research and 
prepare to conclude the SRO Study.
    With respect to disciplinary committees, the central question is 
one of composition. The Chicago Board of Trade (``CBOT'') and Kansas 
City Board of Trade (``KCBT''), for example, typically use member-only 
disciplinary committees.\10\ In contrast, other futures exchanges 
include independent persons on their committees, although only as a 
minority of the committee. The FIA recommends a fundamentally different 
approach: Majority-independent disciplinary committees.\11\ The NFA is 
bound by Commission Regulation 1.64(c) which requires, among other 
things, that SRO disciplinary committees include at least one non-
member of the SRO whenever the respondent is a member of the board or 
of a major disciplinary committee, or whenever the conduct alleged 
includes manipulation or attempted manipulation or results in direct 
harm to a non-member.\12\ In the case of DCMs, Regulation 1.64(c) also 
required that a majority of disciplinary committee members represent an 
exchange membership category other than that of the respondent.\13\ 
However, DCMs are now exempt from Regulation 1.64.\14\
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    \10\ See e.g., KCBT Rules 244.00 and 247.00 and CBOT Rules 
540.12, 542.00, and 543.00.
    \11\ See The Governance of Self Regulatory Organizations, FIA 
Comment Letter at 8.
    \12\ 17 CFR 1.64(c).
    \13\ See Sec.  1.64(a)(1) (excluding clearing organizations from 
the requirements of Sec.  1.64).
    \14\ See 17 CFR 38.2.
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    In issuing this Request for Comments, the Commission is 
particularly interested in specific examples of instances where a 
disciplinary committee's composition may have influenced the outcome of 
a disciplinary matter. Interested parties should also comment on the 
appropriate composition of disciplinary committees and the optimal 
number and role of independent committee members.
    The impact on self-regulation of changing ownership structures and 
business models has generated an equally broad array of opinions in the 
SRO Study. Starting with the CME in 2003, exchanges' continuing 
transformation from member-owned, not-for-profit entities to publicly-
traded, for-profit businesses requires careful attention from the 
Commission. With the CBOT's initial public offering (``IPO'') and 
listing completed in October 2005, the two largest U.S. futures 
exchanges, accounting for almost 87% of all futures volume in the U.S., 
are now public, for-profit companies. In addition, the New York 
Mercantile Exchange is preparing to sell a 10% stake in the exchange to 
a private equity group in anticipation of a 2006 IPO. At that time, 
over 97% of U.S. futures trades will be transacted on exchanges whose 
incentives, owners, and demands are different from the not-for-profit, 
member-owned model that has prevailed for over 100 years, and upon 
which member self-regulation is based.
    The Commission is particularly interested in specific examples of 
instances where an SRO's new commercial motives and incentives may have 
altered its self-regulatory behavior. More generally, commenters should 
address whether and how demutualized, for-profit, publicly-traded 
entities might alter their regulatory behavior in an effort to gain 
competitive advantage, reduce costs, satisfy shareholder and earnings 
expectations, or meet other non-regulatory objectives. Such regulatory 
behavior could include over-regulation, under-regulation, or selective 
or discriminatory regulation. Specific examples, either in the SRO or 
DSRO context, are welcome.
    Finally, the Commission wishes to draw interested parties' 
attention to the listing standards of the New York Stock Exchange 
(``NYSE''), which impact both the CME and the CBOT as their parent 
companies are listed on that exchange. Certain governance provisions in 
the listing standards are another new development since the beginning 
of the SRO Study.\15\ In particular, the NYSE now requires that the 
boards of directors of listed companies be majority independent, and 
provides detailed guidelines for determining a director's independence. 
The Commission notes, however, that both the governance and 
independence provisions in the listing standards are directed at 
shareholder protection and broad corporate governance. Although listed 
futures exchanges and their shareholders may benefit from these 
provisions, they may not be relevant to fair, effective, and vigorous 
self-regulation.
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    \15\ Section 303A of the NYSE's Listed Company Manual, which 
includes both the requirement that a majority of listed companies' 
directors be independent and bright-line tests for independence, 
received final approval from the SEC on November 4, 2003, with 
further amendments as late as November 3, 2004. The Listed Company 
Manual is available at: http://www.nyse.com/Frameset.html?displayPage=/lcm/lcm_section.html.
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    The Commission is interested in receiving comments on the 
relationship between SROs' Commission-mandated self-regulatory 
responsibilities and the

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

II. Questions

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

    Issued in Washington, DC, on November 18, 2005, by the 
Commission.
Jean A. Webb,
Secretary of the Commission.
 [FR Doc. E5-6510 Filed 11-23-05; 8:45 am]
BILLING CODE 6351-01-P