[Federal Register Volume 72, Number 30 (Wednesday, February 14, 2007)]
[Rules and Regulations]
[Pages 6936-6958]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: E7-2528]


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COMMODITY FUTURES TRADING COMMISSION

17 CFR Part 38

RIN 3038-AC28


Conflicts of Interest in Self-Regulation and Self-Regulatory 
Organizations (``SROs'')

AGENCY: Commodity Futures Trading Commission.

ACTION: Final rule.

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SUMMARY: The Commission hereby adopts final acceptable practices for 
minimizing conflicts of interest in decision making by designated 
contract markets (``DCMs'' or ``exchanges''),\1\ pursuant to Section 
5(d)(15) (``Core Principle 15'') \2\ of the Commodity Exchange Act 
(``CEA'' or ``Act'').\3\ The final acceptable practices are the first 
issued for Core Principle 15 and are applicable to all DCMs.\4\ They 
focus upon structural conflicts of interest within modern self-
regulation, and offer DCMs a ``safe harbor'' by which they may minimize 
such conflicts and comply with Core Principle 15. To receive safe 
harbor treatment, DCMs must implement the final acceptable practices in 
their entirety, including instituting boards of directors that are at 
least 35% public and establishing oversight of all regulatory functions 
through Regulatory Oversight Committees (``ROCs') consisting 
exclusively of public directors.
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    \1\ The acceptable practices for core principles reside in 
Appendix B to Part 38 of the Commission's Regulations, 17 CFR Part 
38, App. B.
    \2\ Core Principle 15 states: ``CONFLICTS OF INTEREST--The board 
of trade shall establish and enforce rules to minimize conflicts of 
interest in the decision-making process of the contract market and 
establish a process for resolving such conflicts of interest.'' CEA 
Sec.  5(d)(15), 7 U.S.C. 7(d)(15).
    \3\ The Act is codified at 7 U.S.C. 1 et seq. (2000).
    \4\ Any board of trade that is registered with the Securities 
and Exchange Commission (``SEC'') as a national securities exchange, 
is a national securities association registered pursuant to section 
15(A)(a) of the Securities Exchange Act of 1934, or is an 
alternative trading system, and that operates as a designated 
contract market in security futures products under Section 5f of the 
Act and Commission Regulation 41.31, is exempt from the core 
principles enumerated in Section 5 of the Act, and the acceptable 
practices thereunder, including those adopted herein.

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DATES: Effective Date: March 16, 2007.

FOR FURTHER INFORMATION CONTACT: Rachel F. Berdansky, Acting Deputy 
Director for Market Compliance, (202) 418-5429, or Sebastian Pujol 
Schott, Special Counsel (202) 418-5641, Division of Market Oversight, 
Commodity Futures Trading Commission, Three Lafayette Centre, 1155 21st 
Street, Washington, DC 20581.

SUPPLEMENTARY INFORMATION:

Table of Contents

I. Introduction
    A. Overview of the Acceptable Practices
    B. Background
II. Procedural History
III. Public Comments Received and the Commission's Response
    A. Legal Comments
    1. Overview of Commission's Authority to Issue the Acceptable 
Practices
    2. Specific Legal Issues Raised by Commenters
    B. Policy Comments
    1. General Comments
    2. Comments With Respect to the Board Composition Acceptable 
Practice
    3. Comments With Respect to the Public Director Acceptable 
Practice
    4. Comments With Respect to the ROC Acceptable Practice

[[Page 6937]]

    5. Comments With Respect to the Disciplinary Committee 
Acceptable Practice
IV. Specific Requests for Modifications and/or Clarifications that 
the Commission has Determined to Grant or Deny
    A. Phase-in Period for the New Acceptable Practices
    B. Selection of Public Directors
    C. Compensation of Public Directors
    D. Overlapping Public Directors
    E. Jurisdiction of Disciplinary Panels and Definition of 
``Public'' for Persons Serving on Disciplinary Panels
    F. ``No Material Relationship Test''
    G. Elimination of ROCs' Periodic Reporting Requirement
V. Related Matters
VI. Text of Acceptable Practices for Core Principle 15

I. Introduction

A. Overview of the Acceptable Practices

    The final acceptable practices recognize DCMs' unique public-
interest responsibilities as self-regulatory organizations (``SROs'') 
in the U.S. futures industry. They address conflicts of interest that 
exist within DCMs as they operate in an increasingly competitive 
environment and transform from member-owned, not-for-profit entities 
into diverse enterprises with a variety of business models and 
ownership structures. While continuing to meet their regulatory 
responsibilities, DCMs must now compete effectively to generate 
profits, advance their commercial interests, maximize the value of 
their stock, and/or serve multiple membership, ownership, customer, and 
other constituencies. The presence of these potentially conflicting 
demands within a single entity--regulatory authority coupled with 
commercial incentives to misuse such authority--constitutes the new 
structural conflict of interest addressed by the acceptable practices 
adopted herein.
    The Commission has determined that the structural conflicts 
outlined above are appropriately addressed through reforms within DCMs 
themselves, including reforms of DCMs' governing bodies. Accordingly, 
the Commission offers the new acceptable practices for Core Principle 
15 as an appropriate method for minimizing such conflicts. The 
Commission believes that additional public directors on governing 
bodies, greater independence at key levels of decision making, and 
careful insulation of regulatory functions and personnel from 
commercial pressures, are important elements in ensuring vigorous, 
effective, and impartial self-regulation now and in the future. The new 
acceptable practices incorporate and emphasize each of these elements, 
and offer all DCMs clear instruction as to how they may comply with 
Core Principle 15.
    Although DCMs are free to comply with Core Principle 15 by other 
means, the Commission stresses that they all must address structural 
conflicts of interest and adopt substantive measures to protect their 
regulatory decision making from improper commercial considerations. 
DCMs must ensure that regulatory decisions are made on their own 
merits, and that they are not compromised by the commercial interests 
of the DCMs or the interests of their numerous constituencies. 
Likewise, DCMs' regulatory operations and personnel must be insulated 
from improper influence and commercial considerations to ensure 
appropriate regulatory outcomes.
    The new acceptable practices are set forth in four component parts, 
and DCMs must meet all four to receive safe harbor treatment under Core 
Principle 15. Each component part is summarized as follows:
    First, the Board Composition Acceptable Practice calls upon all 
DCMs to minimize conflicts of interest in self-regulation by 
establishing boards of directors that contain at least 35% ``public 
directors'' (as defined by a separate Public Director Acceptable 
Practice discussed below). The Board Composition Acceptable Practice 
further requires that DCMs ensure that any executive committees (or 
similarly empowered bodies) also meet the 35% public director standard. 
This 35% standard in the new acceptable practices represents a 
modification from the 50% public director standard in the proposed 
acceptable practice.\5\
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    \5\ Conflicts of Interest in Self-Regulation and Self-Regulatory 
Organizations (``Proposed Rule''), 71 FR 38740 (July 7, 2006).
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    Second, the Regulatory Oversight Committee Acceptable Practice 
mandates that all DCMs establish Regulatory Oversight Committees, 
composed only of public directors, to oversee core regulatory functions 
and ensure that they remain free of improper influence. The Commission 
notes that ROCs are intended to insulate self-regulatory functions and 
personnel from improper influence. In fulfilling this role, however, 
ROCs are not expected to assume managerial responsibilities, or to 
isolate self-regulatory functions and personnel from others within the 
DCM. ROCs' oversight and insulation should be aided by their DCMs' 
chief regulatory officers (``CROs''). A full description of the 
responsibilities and authority of ROCs may be found in the text of the 
final acceptable practices.
    Third, the Disciplinary Panel Acceptable Practice states that DCM 
disciplinary panels should not be dominated by any group or class of 
DCM members or participants, and must include at least one ``public 
person'' on every panel. Under the Disciplinary Panel Acceptable 
Practice, disciplinary panels must keep thorough minutes of their 
meetings, including a full articulation of the rationale supporting 
their disciplinary decisions.
    Finally, the Public Director Acceptable Practice establishes 
specific definitions of ``public'' for DCM directors and for members of 
disciplinary panels. Public directors are persons who have no 
``material relationship'' with their DCM, i.e., any relationship which 
could reasonably affect their independent judgment or decision making. 
In addition, public directors must meet a series of ``bright-line 
tests'' which identify specific circumstances and relationships which 
the Commission believes are clearly material. For members of 
disciplinary panels, the definition of ``public'' includes the bright-
line tests, but not the materiality criterion.
    The final acceptable practices also include clarifications to the 
acceptable practices originally proposed by the Commission on July 7, 
2006. For example, the final acceptable practices clarify that a DCM's 
public directors may also serve as public directors of its holding 
company under certain circumstances. These clarifications were made in 
response to public comments on the proposed acceptable practices.
    In addition, although the final acceptable practices are effective 
30 days after publication in the Federal Register, the Commission will 
permit currently established DCMs to implement responsive measures over 
a phase-in period of two years or two regularly-scheduled board 
elections, whichever occurs sooner.\6\ Responsive measures include 
implementing the final acceptable practices or otherwise fully 
complying with the requirements of Core Principle 15, including 
requirements to minimize the structural conflicts of interest discussed 
herein. The phase-in period and the modified public director 
requirements for boards and executive committees are the only 
significant changes between the proposed acceptable practices and those 
adopted today.
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    \6\ ``Currently established'' DCMs are those that are already 
designated at the time this release is published in the Federal 
Register.

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[[Page 6938]]

B. Background

    U.S. futures markets are a critical component of the U.S. and world 
economies, providing significant economic benefits to market 
participants and the public at large. They provide an important hedging 
vehicle to individuals and firms in myriad industries, resulting in 
more efficient production, lower costs for consumers, and other 
economic benefits. By offering a competitive marketplace and focal 
point where traders can freely interact based on their assessments of 
supply and demand, futures markets also provide a vital forum for 
discovering prices that are generally considered to be superior to 
administered prices or prices determined privately. For this reason, 
futures markets are widely utilized throughout the global economy. 
Participants in the markets include virtually all economic actors, and 
the prices discovered on a daily basis materially affect a wide range 
of businesses in the agricultural, energy, financial, and other 
sectors.
    For the reasons outlined above, DCMs are not just typical 
commercial enterprises, but are commercial enterprises affected with a 
significant national public interest. Actions that distort prices or 
otherwise undermine the integrity of the futures markets have broad, 
detrimental implications for the economy as a whole and the public in 
general. Congress recognized the importance of futures trading in the 
Act, when it explicitly stated that futures transactions ``are entered 
into regularly in interstate and international commerce and are 
affected with a national public interest * * *.'' \7\ It defined the 
public interest to include ``liquid, fair, and financially secure 
trading facilities.'' \8\ Congress also identified the purposes of the 
Act: ``to deter and prevent price manipulation or any other disruptions 
to market integrity; to ensure the financial integrity of all 
transactions subject to this Act and the avoidance of systemic risk; 
and to protect all market participants from fraudulent or other abusive 
sales practices and misuses of customer assets.'' \9\ To accomplish 
these purposes, Congress established a statutory system of DCM self-
regulation, combined with Commission oversight, to promote 
``responsible innovation and fair competition among boards of trade, 
other markets and market participants.'' \10\ Meeting these statutory 
obligations and purposes requires DCM self-regulation that is as 
vigorous, impartial, and effective as possible.
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    \7\ CEA Sec.  3(a), 7 U.S.C. 5(a).
    \8\ Id.
    \9\ CEA Sec.  3(b), 7 U.S.C. 5(b).
    \10\ Id.
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    All DCMs face unique and potentially conflicting regulatory 
obligations and commercial demands as they work to meet the statutory 
requirements outlined above. On the commercial side, they must attract 
trading to their markets, maximize the value of their stock, generate 
profits, satisfy the financial needs of their numerous stakeholders and 
constituencies, and/or meet the diverse business needs of their market 
participants. At the same time, as self-regulatory organizations, DCMs 
must exercise their authority judiciously, impartially, and in the 
public interest. As essential forums for the execution of futures 
transactions and for price discovery, DCMs must ensure fair and 
financially secure trading facilities. DCMs must also help to ``serve'' 
and ``foster'' the national public interest through self-regulatory 
responsibilities that include ensuring market integrity, financial 
integrity, and the strict protection of market participants.\11\
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    \11\ Id.
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    When DCMs were first entrusted with these extensive regulatory 
responsibilities, they were almost exclusively member-owned, not-for-
profit exchanges facing little competition for customers or in their 
prominent contracts. Although conflicts of interest in self-regulation 
were a concern even then, such conflicts typically centered on 
individual exchange members policing one another. Today's DCMs, 
however, are vibrant commercial enterprises competing globally in an 
industry whose ownership structures, business models, trading 
practices, and products are evolving rapidly. As a result, DCMs now 
face potential conflicts of interest between their critical self-
regulatory responsibilities and their powerful commercial imperatives. 
Specifically, DCMs must: defend and expand their markets against others 
offering similar products or services; generate returns for their 
owners; and provide liquid markets where their members and customers 
may profit. At the same time, they must continue to meet fundamental 
public interest responsibilities through vigorous and impartial self-
regulation. To reconcile these obligations, DCMs must acknowledge and 
guard against conflicts between their regulatory responsibilities and 
their commercial interests, and take measures to prevent improper 
influence upon self-regulation by their numerous constituencies, 
including members, owners, customers, and others.
    As explained in the proposing release, rapid and ongoing changes in 
the futures industry have raised concerns as to whether existing self-
regulatory structures are equipped to manage evolving conflicts of 
interest. Self-regulation's traditional conflict--that members will 
fail to police their peers with sufficient zeal--has been joined by the 
possibility that competing DCMs could abuse their regulatory authority 
to gain competitive advantage or satisfy commercial imperatives. Such 
conflicts of interest must be addressed promptly and proactively to 
prevent them from becoming real abuses, and to ensure continued public 
confidence in the integrity of the U.S. futures markets.
    After three-and-a-half years of careful study, the Commission has 
determined that the conflicts of interest identified above are inherent 
in any system of self-regulation conducted by competing DCMs, many of 
which operate under new ownership structures and business models, and 
all of which are possessed of strong commercial imperatives. The 
Commission has further determined that successfully addressing such 
conflicts, and complying with Core Principle 15, requires appropriate 
responses within DCMs. Only by reconciling the inherent tension between 
their self-regulatory responsibilities and their commercial interests, 
whether via the new acceptable practices or otherwise, can DCMs 
successfully minimize conflicts of interest in their decision-making 
processes and thereby ensure the integrity of self-regulation in the 
U.S. futures industry.
    The new acceptable practices for Core Principle 15 are a direct 
response to the industry changes outlined above. As required by the 
Act, they ``promote responsible innovation and fair competition'' among 
U.S. DCMs, and ensure that self-regulation remains compatible with the 
modern business practices of today's DCMs.\12\ The new acceptable 
practices embody the Commission's firm belief that effective self-
regulation in an increasingly competitive, publicly traded, for-profit 
environment requires independent decision making at key levels of DCMs' 
regulatory governance structures. The Commission further believes that 
the new acceptable practices constitute an ideal solution to emerging 
structural conflicts of interest in self-regulation. Both proactive and 
carefully targeted, the new acceptable practices for Core Principle 15 
advance the public interest and ensure the continued strength and

[[Page 6939]]

integrity of self-regulation in a rapidly evolving industry.
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    \12\ Id.
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    The conflicts of interest described above require careful responses 
by all DCMs. The Commission believes that DCMs can comply with Core 
Principle 15 by minimizing conflicts of interest between their 
regulatory responsibilities and their commercial interests or those of 
their membership, ownership, management, customer, and other 
constituencies. However, whether DCMs choose to comply with Core 
Principle 15 via the acceptable practices adopted herein or by other 
means, the Commission recognizes that necessary measures may take time 
to implement. Accordingly, and at the request of public commenters, the 
Commission is adopting a phase-in period for full compliance with Core 
Principle 15. Within two years of this document's effective date, or 
two regularly-scheduled board elections, whichever occurs first, all 
DCMs must be in full compliance with Core Principle 15, either by 
availing themselves of the new acceptable practices or undertaking 
other effective measures to address the structural conflicts of 
interest identified herein. Commission staff will contact all DCMs in 
six months of the effective date of these final acceptable practices to 
learn of their plans for full compliance. Established DCMs must 
demonstrate substantial compliance with Core Principle 15, and plans 
for full compliance, well before the phase-in period's expiration. New 
candidates for designation as contract markets should be prepared to 
demonstrate compliance with Core Principle 15, or a plan for 
compliance, upon application.

II. Procedural History

    The four acceptable practices for Core Principle 15 adopted today 
are the culmination of a comprehensive review of self-regulation in the 
U.S. futures industry (``SRO Review'' or ``Review'') launched by the 
Commission in May of 2003. Phase I of the Review explored the roles, 
responsibilities, and capabilities of SROs in the context of industry 
changes. Staff examined the designated self-regulatory organization 
system of financial surveillance, the treatment of confidential 
information, the composition of DCM disciplinary committees and panels, 
and other aspects of the self-regulatory process. Phase I of the Review 
also included staff interviews with over 100 persons including 
representatives of DCMs, clearing houses, futures commission merchants 
(``FCMs''), industry associations, and securities-industry entities, as 
well as current and retired industry executives, academics, and 
consultants.
    In June of 2004, the Commission initiated Phase II of the SRO 
Review and broadened its inquiry to explicitly address SRO governance 
and the interplay between DCMs' self-regulatory responsibilities and 
their commercial interests. In June of 2004, the Commission issued a 
Federal Register Request for Comments (``Request'') on the governance 
of futures industry SROs.\13\ The Request sought input on the proper 
composition of DCM boards, optimal regulatory structures, the impact of 
different business and ownership models on self-regulation, the proper 
composition of DCM disciplinary committees and panels, and other 
issues.
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    \13\ Governance of Self-Regulatory Organizations, 69 FR 32326 
(June 9, 2004). Comment letters received are available at: http://www.cftc.gov/foia/comment04/foi04--005_1.htm.
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    In November of 2005, the Commission updated its previous findings 
through a second Federal Register Request for Comments (``Second 
Request'') that focused on the most recent industry developments.\14\ 
The Second Request examined the board-level ROCs recently established 
at some SROs in the futures and securities industries. It also asked 
commenters to consider the impact of New York Stock Exchange (``NYSE'') 
listing standards on publicly traded futures exchanges; whether the 
standards were relevant to self-regulation; and how the standards might 
inform the Commission's own regulations.\15\
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    \14\ Self-Regulation and Self-Regulatory Organizations in the 
Futures Industry, 70 FR 71090 (Nov. 25, 2005). Comment letters 
received are available at http://www.cftc.gov/foia/comments05/foi05--007_1.htm.
    \15\ The NYSE's corporate governance listing standards require 
listed companies to: have a majority of independent directors; meet 
materiality and bright-line tests for independence; convene 
regularly scheduled executive sessions of the board without 
management present; institute nominating/governance, compensation, 
and audit committees consisting exclusively of public directors; 
etc. See NYSE Listed Company Manual, Sec. Sec.  303A:00-14, 
available at: http://www.nyse.com/regulation/listed/1101074746736.html. The NASDAQ Stock Market has adopted corporate 
governance listing standards similar to the NYSE's. See the NASDAQ 
Stock Market Listing Standards and Fees, available at: http://www.nasdaq.com/about/nasdaq_listing_req_fees.pdf. DCMs whose 
parent companies are listed on the NYSE include the CBOT, CME, 
NYBOT, and NYMEX. Although these DCMs themselves are not required to 
comply with the listing standards, they may be in de facto 
compliance if they have chosen to name identical boards of directors 
for both the listed parent and the DCM.
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    Phase II of the SRO Review concluded with a public Commission 
hearing on ``Self-Regulation and Self-Regulatory Organizations in the 
U.S. Futures Industry'' (``Hearing''). The day-long Hearing, held on 
February 15, 2006, included senior executives and compliance officials 
from a wide range of U.S. futures exchanges, representatives of small 
and large FCMs, academics and other outside experts, and an industry 
trade group. The Hearing afforded the Commission an opportunity to 
question panelists on four broad subject areas: (1) Board composition; 
(2) alternative regulatory structures, including ROCs and third-party 
regulatory service providers; (3) transparency and disclosure; and (4) 
disciplinary committees.\16 \
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    \16\ The Hearing Transcript is available at http://www.cftc.gov/files/opa/opapublichearing021506.final.pdf.
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    Finally, in July of 2006, the Commission published the Proposed 
Rule and sought public comment on new acceptable practices for Core 
Principle 15.\17\ The Commission proposed that at least 50% of the 
directors on DCM boards and executive committees (or similarly 
empowered bodies) be public directors. It also proposed that day-to-day 
regulatory operations be overseen and insulated through a CRO reporting 
directly to a board-level ROC consisting exclusively of public 
directors. The proposed acceptable practices also defined ``public 
director'' for persons serving on boards and ROCs, and defined ``public 
person'' for disciplinary panel members. To qualify as a public 
director under the proposal, the director in question would require an 
affirmative determination that he or she had no material relationship 
with the DCM. In addition, public directors and public persons would 
both have been required to meet a series of ``bright-line'' tests. The 
inability to satisfy both the material relationship and bright-line 
test requirements would automatically preclude them from serving as 
public directors or public disciplinary panel members. Finally, the 
proposed acceptable practices called for DCM disciplinary panels that 
were not dominated by any group or class of SRO participants, and that 
included at least one public person.
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    \17\ See supra note 5.
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    The proposal's original 30-day comment period, scheduled to close 
on August 7, 2006, was extended by an additional 30 days, to September 
7, 2006. The Commission received a total of 34 comment letters in 
response to the proposed acceptable practices for Core Principle 15, 
significant aspects of which are discussed below.\18\
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    \18\ Comment letters in response to the Proposed Rules are 
available at: http://www.cftc.gov/foia/comment06/foi06--004_1.htm.

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[[Page 6940]]

III. Public Comments Received and the Commission's Response

    The 34 comment letters received in response to the proposed 
acceptable practices included responses from 10 industry associations 
and trade groups, nine individuals (including directors of exchanges 
writing separately), eight DCMs, six futures commission merchants 
(``FCMs''), one group of DCM public directors, one U.S. Senator, and 
one U.S. Congressman.\19\
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    \19\ The commenters were: Bear Stearns; Citigroup; Morgan 
Stanley; the Chicago Mercantile Exchange (``CME''); the New York 
Mercantile Exchange (``NYMEX''); U.S. Sen. Pat Roberts and 
Congressman Jerry Moran; the National Grain Trade Council; Daniel L. 
Gibson; the National Grain and Feed Association; the New York Board 
of Trade (``NYBOT''); Public Members of the NYBOT; the Chicago Board 
of Trade (``CBOT''); Philip McBride Johnson; the CBOE Futures 
Exchange (``CFE''); Dennis M. Erwin; HedgeStreet; Colby Moss; 
Horizon Milling, LLC; John Legg; the National Futures Association; 
Robert J. Rixey; Michael Braude; Lehman Brothers; the Kansas City 
Board of Trade (``KCBT''); the Futures Industry Association 
(``FIA''); the Florida Citrus Producers Association; the National 
Cotton Council of America; Cargill Juice North America; Nickolas 
Neubauer; the American Cotton Shippers Association; Barry Bell; 
Fimat; J.P. Morgan Futures Inc.; and the Minneapolis Grain Exchange 
(``MGEX'').
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    The Commission thoroughly reviewed and considered all comments 
received. In response to persuasive arguments by various commenters, 
the final acceptable practices include two significant modifications 
from those originally proposed. Specifically, the final acceptable 
practices include: (1) a reduction in the required number of public 
directors on boards and executive committees, from at least 50% public 
to at least 35% public; and (2) a phase-in period to implement the 
acceptable practices, or otherwise come into full compliance with Core 
Principle 15, of two years or two regularly scheduled board elections, 
whichever occurs sooner.
    In addition, in response to comments received, the Commission has 
made several clarifications and non-substantive revisions to the final 
acceptable practices. The Commission has also provided further 
discussion or elaboration in this preamble in order to provide further 
clarification on specific aspects of the acceptable practices, 
consistent with the Commission's original intent.
    Specifically, in the text of the final acceptable practices, the 
Commission has clarified: that a public director may serve on the 
boards of both a DCM and of its parent company; that public directors 
are allowed deferred compensation in excess of $100,000 under certain 
circumstances; and that public persons serving on disciplinary panels 
are subject only to the bright-line tests used to define public 
directors. The Commission has also clarified that the acceptable 
practices do not address the manner in which DCMs select their public 
directors, whether by election, appointment, or other means.
    Some commenters called for greater requirements than in the 
proposed acceptable practices, and others called for less requirements. 
The Commission carefully considered those comments, but decided not to 
make any changes other than those outlined above. As stated previously, 
the Commission believes that adopting the new acceptable practices 
strikes a careful balance between an appropriate approach to minimizing 
conflicts of interest in self-regulation, as required by Core Principle 
15, and the overall flexibility offered by the core principle regime. 
Moreover, the Commission believes that the acceptable practices adopted 
herein are necessary and appropriate to fulfill the purposes of the Act 
and advance the public interest.
    The substantive comments received, and the Commission's responses 
thereto, are presented below. They are organized as follows:

    Legal Comments: comments questioning the Commission's authority 
to issue the proposed acceptable practices, including comments with 
respect to the meaning of Core Principle 15 and its interaction with 
other core principles;
    Policy Comments: comments requesting more or stricter guidance 
than that proposed by the Commission; comments requesting that the 
Commission issue no acceptable practices, or fewer or less detailed 
acceptable practices; and comments questioning the rationale behind 
the proposed acceptable practices, including:
     General comments;
     Comments with respect to board composition;
     Comments with respect to the definition of public 
director;
     Comments with respect to Regulatory Oversight 
Committees;
     Comments with respect to disciplinary committees;
    Comments Requesting Modifications and Clarifications, including:
     Phase-in period for the new acceptable practices;
     Selection of public directors;
     Compensation of public directors;
     Overlapping public directors;
     Jurisdiction of disciplinary panels and definition of 
``public'' for persons serving on disciplinary panels;
     ``No material relationship'' test for public directors;
     elimination of ROCs' periodic reporting requirements.

A. Legal Comments: Public Comments Received and the Commission's 
Response.

1. Overview of the Commission's Authority To Issue the Acceptable 
Practices
    The Commission's issuance of the acceptable practices for Core 
Principle 15 respects the letter and spirit of the Act. The 
Commission's authority to do so is firmly rooted in Core Principle 15's 
mandate to DCMs to minimize conflicts of interest in decision making. 
Core Principle 15 requires DCMs to maintain systems to minimize 
structural conflicts of interest inherent in self-regulation, as well 
as individual conflicts of interest faced by particular persons.\20\ 
The acceptable practices are rationally related to the purposes of Core 
Principle 15.
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    \20\ 71 FR 38740, 38743.
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    The Board Composition Acceptable Practice recognizes that the 
governing board of a DCM is its ultimate decision maker and therefore 
the logical place to begin to address conflicts. Participation by 
public directors in board decision making is a widely accepted and 
effective means to reduce conflicts of interest.\21\ By providing for 
significant public participation on the board, the seat of DCM 
governance and policymaking, the acceptable practice ensures that 
conflicts of interest are minimized at the highest level of decision 
making.
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    \21\ See, e.g., NYSE Listed Company Manual, Sec.  303A 
(commentary).
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    The ROC Acceptable Practice recognizes the importance of insulating 
core regulatory functions from improper influences and pressures 
stemming from a DCM's commercial affairs. It operates to minimize 
conflicts of interest in decisions made in the ordinary course of 
business. Finally, the Disciplinary Panel Acceptable Practice, by 
mandating participation on most disciplinary panels of at least one 
person who meets the bright-line tests for public director, minimizes 
conflicts of interest that may undermine the fundamental fairness 
required of DCM disciplinary proceedings. In sum, these acceptable 
practices represent an effective means to implement Core Principle 15 
and are fully consistent with its mandate that DCMs minimize conflicts 
of interest in all decision making. They therefore lie well within the 
Commission's authority.
    Congress has determined that there is a national public interest in 
risk management and price discovery.\22\ The individual provisions of 
the Act operate

[[Page 6941]]

in furtherance of those interests by instituting and enforcing a system 
of ``effective self-regulation of trading facilities, clearing systems, 
market participants and market professionals under the oversight of the 
Commission.'' \23\ Core Principle 15 must be read in light of those 
public interests and purposes.
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    \22\ CEA Section 3(a), 7 U.S.C. 5(a).
    \23\ CEA Section 3(b), 7 U.S.C. 5(a).
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    The safe harbor created by the new acceptable practices removes the 
guesswork from compliance with Core Principle 15. Congress 
intentionally wrote the core principles to be broad and flexible, and 
to help DCMs and the Commission to adjust to changing circumstances. 
Flexibility, however, may give rise to uncertainty. In order to provide 
DCMs with greater certainty in the context of flexible core principles, 
Congress, in adopting the Commodity Futures Modernization Act 
(``CFMA''),\24\ added Section 5c(a)(1) to the CEA, which specifically 
authorizes the Commission, consistent with the purposes of the CEA, to 
``issue interpretations, or approve interpretations submitted to the 
Commission * * * to describe what would constitute an acceptable 
business practice for Core Principles.'' \25\ As a general rule, the 
Commission believes that issuing acceptable practices and other 
guidance under the core principles is beneficial, given the CFMA's lack 
of legislative history that might otherwise have been a source of 
guidance. Safe harbors, such as those created by the acceptable 
practices being issued today, remove uncertainty while setting high 
standards consistent with the purposes of the CEA and the authority 
granted by Congress to the Commission to issue such acceptable 
practices. Nothing in these acceptable practices, as safe harbors, 
infringes upon the Congressional directive in Section 5c(a)(2) of the 
CEA that acceptable practices not be the ``exclusive means for 
complying'' with core principles, as DCMs remain free to demonstrate 
core principle compliance by other means.\26\
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    \24\ The CFMA is published at Appendix E of Pub. L. 106-554, 114 
Stat. 2763 (2000).
    \25\ 7 U.S.C. 7a-2(a)(1).
    \26\ 7 U.S.C. 7a-2(a)(2).
---------------------------------------------------------------------------

    Pursuant to its duty under the CEA to consider the costs and 
benefits of its action in issuing the acceptable practices, as 
discussed separately below, the Commission believes that the acceptable 
practices will minimize conflicts of interest in DCM decision making 
and promote public confidence in the futures markets. These are 
significant benefits to the futures industry, market participants, and 
the public. While commenters alleged that compliance would be costly, 
none of them provided an estimate of those costs in response to the 
Commission's specific request for quantitative data. The Commission has 
no basis to conclude that compliance would not be a reasonable cost of 
doing business in an industry subject to federal oversight--a cost that 
may be phased in gradually over two years or two election cycles.
    Finally, the Board Composition Acceptable Practice operates without 
impeding the duties owed to shareholders by the directors of a public 
corporation. Demutualized DCMs typically have reorganized themselves as 
subsidiaries of parent holding companies. The acceptable practice 
applies to the board of a DCM itself--not to the parent. Accordingly, 
the Board Composition Acceptable Practice is unquestionably within the 
Commission's authority to issue acceptable practices under the core 
principles applicable to DCMs. The composition of a DCM governing board 
may be identical to that of its parent--that decision is a matter for 
the business judgment of the persons involved. Nevertheless, the boards 
are separate bodies, even if their memberships overlap. DCM directors 
have a fiduciary duty to stockholders, to be sure, but stockholders of 
a DCM own an entity that, as a matter of federal law, is required to 
minimize conflicts of interest under Core Principle 15 and that serves 
a public interest through its business activity. Stockholders are well 
served when the DCMs that they own comply with applicable laws and 
regulations.
    We now turn to the legal issues raised by the commenters with 
respect to the Commission's authority to issue the acceptable 
practices.
2. Specific Legal Issues Raised by Commenters
    FIA, five major FCMs, and one exchange, CFE, filed comments 
generally in favor of the proposed acceptable practices and endorsed 
the Commission's analysis of its authority to issue them. CME, CBOT, 
NYMEX, and other commenters, in opposition, challenged the Commission's 
interpretation of Core Principle 15 and the statutory authority under 
which the proposals were issued.
    As stated above, Core Principle 15 requires DCMs to establish and 
maintain systems that address conflicts of interest inherent in the 
structure of self-regulation, as well as personal conflicts faced by 
individuals. FIA endorsed this analysis, stating that the proposed 
acceptable practices are ``well-grounded'' in the Commission's 
statutory authority and ``rationally related'' to the purposes of Core 
Principle 15.\27\
---------------------------------------------------------------------------

    \27\ FIA Comment Letter (``CL'') 7 at 3-4.
---------------------------------------------------------------------------

    Commenters challenging the Commission's authority to promulgate the 
acceptable practices for Core Principle 15 contend that they: (1) 
Conflict with Core Principle 16; (2) are contrary to the text of the 
statute; (3) are contrary to Congressional intent in enacting the CFMA; 
(4) lack factual support; (5) conflict with guidance for Core Principle 
14; and (6) impermissibly shift the burden to DCMs to demonstrate 
compliance with Core Principle 15. As discussed below, none of these 
contentions is persuasive.
    a. The Acceptable Practices For Core Principle 15 Do Not Conflict 
With Core Principle 16.
    CME challenged Core Principle 15's applicability to the acceptable 
practices, contending that because Core Principle 16 is the only core 
principle that mentions board composition, it is the only source of 
authority the Commission may use for this purpose, and that it is 
limited to mutually-owned DCMs.\28\ Similarly, NYBOT and KCBT contended 
that as member-owned DCMs, they are subject to Core Principle 16's 
requirement to maintain governing boards that ``reflect[ ] market 
participants,'' and should not face any other board composition 
provision.\29\
---------------------------------------------------------------------------

    \28\ CME CL 29 at 4-5. Core Principle 16 states: ``COMPOSITION 
OF BOARDS OF MUTUALLY OWNED CONTRACT MARKETS.--In the case of a 
mutually owned contract market, the board of trade shall ensure that 
the composition of the governing board reflects market 
participants.'' CEA Sec.  5(d)(16), 7 U.S.C. 7(d)(16).
    \29\ NYBOT CL 21 at 4; KCBT CL 8 at 3.
---------------------------------------------------------------------------

    Core Principle 16 requires a mutually owned board of trade to 
ensure that the composition of its governing board reflects market 
participants. Based on its plain language, Core Principle 16 is limited 
to that goal,\30\ and has no bearing on the entirely separate goal of 
Core Principle 15 to ``minimize conflicts of interest in the decision-
making process of the contract market,'' whether or not it is mutually 
owned. Core Principle 16 applies only to mutually owned contract 
markets and directs that their governing boards must fairly represent 
market participants. Core Principle 15 applies to all contract markets, 
no matter how organized, and directs them to minimize conflicts of 
interest. Conflicts may be structural as well as personal. Core 
Principle 15 embraces both and supports the public director membership 
requirement for

[[Page 6942]]

boards of DCMs. Accordingly, Core Principle 16 does not limit the 
Commission's authority to issue acceptable practices to increase public 
director representation on DCM boards in order to minimize conflicts of 
interest under Core Principle 15.
---------------------------------------------------------------------------

    \30\ There is no legislative history concerning Core Principle 
16 other than the statutory language itself.
---------------------------------------------------------------------------

    b. The Acceptable Practices for Core Principle 15 Are Not Contrary 
to the CEA's Text.
    Other opposing comments based on the text of Core Principle 15 
substitute the Commission's straightforward reading of the statute with 
targeted interpretations of individual words and phrases. The 
Commission believes that these comments do not rise to the stature of 
significant questions of statutory interpretation. For instance, 
various commenters contended that Core Principle 15 says ``minimize'' 
conflicts of interest, not ``eliminate'' them, as they argue the 
Commission seeks to do with the Board Composition Acceptable 
Practice.\31\ However, if the Commission had sought to ``eliminate'' 
conflicts of interest, the Commission could have imposed a 100% public 
director requirement. Certainly any less-than-100% public director 
requirement may not eliminate all conflicts of interest.
---------------------------------------------------------------------------

    \31\ See, e.g., KCBT CL 8 at 2 and Roberts & Moran CL 27 at 1-2.
---------------------------------------------------------------------------

    Another such comment stated that Core Principle 15 applies to 
``rules'' and ``process,'' but board composition is contained in DCM 
``bylaws'' (not rules), and a change to board composition is not a 
``process.'' \32\ Contrary to this commenter's restrictive 
interpretation of the term, ``rule'' is defined broadly in Commission 
regulations to include by-laws.\33\ Thus, the mere mention of ``rules'' 
in Core Principle 15 has no bearing on the Commission's authority. In 
addition, Core Principle 15 provides that a DCM shall establish and 
enforce rules to minimize conflicts of interest in the decision-making 
process of the contract market and establish a process for resolving 
such conflicts of interest. The two requirements are not mutually 
exclusive.
---------------------------------------------------------------------------

    \32\ NYMEX CL 28 at 6.
    \33\ See Commission Reg. 40.1(h), 17 CFR 40.1(h).
---------------------------------------------------------------------------

    Another commenter stated that Core Principle 15 provides that a DCM 
shall ``enforce'' rules, and thereby contemplates action against 
individuals rather than the DCM itself.\34\ In fact, Core Principle 15 
states ``establish and enforce'' rules. Use of the conjunctive belies 
any contention that Core Principle 15 was intended to be directed 
solely to individuals.
---------------------------------------------------------------------------

    \34\ NYMEX CL 28 at 6.
---------------------------------------------------------------------------

    Numerous comments of this type were received, none of which 
constitutes a serious challenge to the Commission's legal authority and 
reasonable interpretation of Core Principle 15.
    c. The Acceptable Practices for Core Principle 15 Are Not Contrary 
to Congressional Intent in Enacting the CFMA.
    Several commenters, including NYMEX and CBOT, contended that the 
Board Composition Acceptable Practice is contrary to Congress' intent 
in enacting Core Principle 15 and the CFMA.
    Specifically, CBOT stated that prior to the CFMA's enactment, the 
CEA treated board composition and conflicts of interest in two distinct 
provisions of the statute. In passing the CFMA, Congress omitted the 
board composition provision and kept the conflicts of interest 
provision. CBOT interpreted this as evidence that Congress did not view 
board composition as a mechanism to minimize conflict of interests.\35\ 
We believe that the legal import of silence as a statutory canon of 
construction in these circumstances is a weak indicator of 
Congressional intent.\36\ Moreover, inclusion of public directors on 
company boards is a widely accepted means to reduce conflicts of 
interest.\37\ Congress has in other contexts recognized the utility of 
public directors in controlling conflicts of interest.\38\ Interpreting 
the CFMA as the CBOT advocates would require the Commission to infer 
that Congress was unaware of its own enactments, as well as the 
aforementioned wide acceptance of public directors for reducing 
conflicts, which the Commission is not prepared to do.
---------------------------------------------------------------------------

    \35\ CBOT CL at 5-6.
    \36\ See, e.g., U.S. v. Vonn, 535 U.S. 55, 65 (2002); Pauley v. 
Bethenergy Mines, Inc., 501 U.S. 680, 703 (1991) (internal citation 
omitted).
    \37\ See, e.g., NYSE Corporate Governance Rule 303A 
(commentary).
    \38\ See Section 10(a) of the Investment Company Act of 1940, 7 
U.S.C. 80a-10(a); Burks v. Lasker, 441 U.S. 471, 484 (1979).
---------------------------------------------------------------------------

    Similarly, NYMEX commented that when the CFMA was enacted there was 
a general understanding among DCMs, Commission staff, and legislators 
that Congress did not intend the Commission to establish board 
composition requirements for demutualized DCMs, which would instead be 
subject to corporate governance and NYSE listing standards.\39\ A 
congressional comment letter stated that it does not ``appear'' that 
Congress intended the Commission to address board composition in the 
instance of small mutually-owned DCMs like KCBT.\40\
---------------------------------------------------------------------------

    \39\ NYMEX CL 28 at 5-6.
    \40\ Roberts & Moran CL 27 at 1-2.
---------------------------------------------------------------------------

    No commenter, however, cited any legislative history supporting 
these views, and no rule of statutory or legal interpretation compels 
the Commission to adopt them. The Commission may interpret the CEA 
according to its reasoned discretion and agency expertise given the 
absence of any contrary indication of Congressional intent at the time 
the CFMA was enacted.
    Various commenters also asserted that the proposed acceptable 
practices in general are counter to the spirit of the CFMA, which 
transformed the Commission into an oversight agency.\41\ They contended 
also that the 50% public board member requirement in the proposed Board 
Composition Acceptable Practice is stricter than the former statutory 
requirement that DCM boards have 20% independent directors.\42\ This 
comment would apply equally to the minimum 35% requirement contained in 
the final acceptable practice. These commenters, however, overlook the 
essential fact that the acceptable practices--unlike the pre-CFMA 20% 
rule--are safe harbors, not statutory mandates. Persons taking this 
view appear to want the Commission to do nothing at all--neither issue 
rules nor announce nonbinding acceptable practices that embody high 
standards.
---------------------------------------------------------------------------

    \41\ See, e.g., NYMEX CL 28 at 9-10.
    \42\ See, e.g., CME CL 29 at 12.
---------------------------------------------------------------------------

    One commenter argued that the Commission did not subject DCMs to 
Commission Rule 1.64 (containing the board composition requirement for 
non-member representation) \43\ when it adopted Commission Rule 38.2 
\44\ shortly after the enactment of the CFMA, thus suggesting that the 
Commission's interpretation was that Core Principle 15 did not impose a 
board composition requirement.\45\
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    \43\ 17 CFR 1.64.
    \44\ Commission Rule 38.2 contains an exemption for DCMs from 
all Commission regulations except those specifically enumerated. 17 
CFR 38.2.
    \45\ NYMEX CL 28 at 15.
---------------------------------------------------------------------------

    The Commission did not adopt acceptable practices for all of the 
core principles when it promulgated Commission Rule 38.2. Nor did the 
Commission permanently reserve from exemption all regulations that are 
reflected in core principles. Indeed, in January 2006, the Commission 
added Commission Rule 1.60 to the enumerated list of regulations to 
which DCMs are subject pursuant to Commission Rule 38.2.\46\ 
Accordingly,

[[Page 6943]]

the fact that Commission Rule 1.64 was not specifically exempted when 
Commission Rule 38.2 was promulgated is not a reliable indicator of the 
Commission's interpretation of Core Principle 15. Moreover, not long 
after Commission Rule 38.2 was issued, the Commission began the SRO 
Review to examine governance issues in order to determine whether 
action was warranted. Thus, even if the omission of Commission Rule 
1.64 from the enumerated regulations in Commission Rule 38.2 were 
somehow indicative of a contemporaneous interpretation by the 
Commission of Core Principle 15, a matter that the Commission does not 
concede, the Commission's evolving views--based on the extensive record 
developed during the course of the SRO Review--support its current 
interpretation that Core Principle 15 authorizes it to adopt the Board 
Composition Acceptable Practice.
---------------------------------------------------------------------------

    \46\ See 71 FR 1953 (Jan. 12, 2006).
---------------------------------------------------------------------------

    d. Acceptable Practices Are Justified As A Prophylactic Measure.
    Several commenters contended that the acceptable practices lack 
factual support demonstrating a need for their issuance. They argued 
that the Commission did not point to any specific event or documented 
self-regulatory failure or allegation of such failure in support of the 
acceptable practices.\47\ Several commenters contended that the studies 
cited by the Commission in the proposing release applied only to the 
securities industry, and thus were inapposite to conditions in the 
futures industry.\48\
---------------------------------------------------------------------------

    \47\ See CME CL 29 at 9; NYMEX CL 28 at 11-12; NYBOT CL 22 at 4; 
CBOT CL 21 at 3.
    \48\ See, e.g., NYMEX CL 28 at 11-13; CME CL 29 at 9; NYBOT CL 
22 at 2; Comment of Donald L. Gibson, CL 25 at 1.
---------------------------------------------------------------------------

    These comments are misplaced. Although the Commission did not 
specifically identify futures industry self-regulatory lapses in 
support of the acceptable practices, it identified significant trends 
in the futures industry, including increased competition and changing 
ownership structures, that justify the acceptable practices as a 
prophylactic measure to minimize conflicts in decision making and to 
promote public confidence in the futures markets in the altered, 
demutualized, and more competitive landscape. Commenters pointed to 
nothing in the CEA, nor has the Commission found anything, to suggest 
that Congress intended to restrict the authority of the Commission to 
make ``precautionary or prophylactic responses to perceived risks,'' 
that would render the Commission's action a violation of the CEA.\49\
---------------------------------------------------------------------------

    \49\ Chamber of Commerce v. SEC, 412 F.3d 133, 141 (D.C. Cir. 
2005).
---------------------------------------------------------------------------

    e. Acceptable Practices for Core Principle 15 Do Not Conflict with 
Guidance to Core Principle 14.
    Another issue raised is whether the new acceptable practices for 
Core Principle 15 conflict with guidance issued for Core Principle 
14.\50\ One commenter asserted that guidance to Core Principle 14 
suggests that directors of DCMs should, at a minimum, be market 
participants, contrary to the proposed ``public director'' 
definition.\51\ This contention misreads the guidance for Core 
Principle 14. Minimum standards for directors provided in the guidance 
are derived from the bases for refusal to register persons under CEA 
Section 8a(2),\52\ and from the types of serious disciplinary offenses 
that would disqualify persons from board and committee service under 
Commission Rule 1.63.\53\ Nothing in the Application Guidance for Core 
Principle 14 requires directors to be market participants. Moreover, a 
significant number of DCMs currently have directors on their boards who 
are not market participants.
---------------------------------------------------------------------------

    \50\ Core Principle 14 provides that a ``Board of Trade shall 
establish and enforce appropriate fitness standards for directors 
[and others].'' CEA Sec.  5(d)(14), 7 U.S.C. 7(d)(14).
    \51\ CME CL 29 at 9.
    \52\ 7 U.S.C. 12a(2).
    \53\ 17 CFR 1.63. See 17 CFR Part 38, Appendix B, Core Principle 
14 (``Application Guidance'').
---------------------------------------------------------------------------

    f. Acceptable Practices for Core Principle 15 Do Not Impermissibly 
Shift the Burden to DCMs for Demonstrating Compliance.
    Finally, CME, CBOT, and NYMEX contended that the Board Composition 
Acceptable Practice impermissibly shifts the burden of demonstrating a 
DCM's compliance with Core Principle 15 from the Commission to the DCM 
if a DCM elects not to comply with the acceptable practices.
    There is no burden shifting here. All DCMs are required to 
demonstrate to the Commission how they are complying with the core 
principles. Without such a factual demonstration, the Commission could 
not determine whether a contract market is in compliance with the core 
principles, and thus the Commission could not meet its obligations 
under the CEA.\54\ Compliance with these acceptable practices merely 
eliminates the need for a DCM to demonstrate to the Commission that it 
is complying with certain aspects of Core Principle 15. It follows that 
a contract market that does not comply with the acceptable practices 
must demonstrate to the Commission that it is complying with Core 
Principle 15 by other means, as stated in the release.
---------------------------------------------------------------------------

    \54\ See CEA Sec.  5c(d), 7 U.S.C. 7a-2(d).
---------------------------------------------------------------------------

B. Policy Comments: Public Comments Received and the Commission's 
Response

1. General Comments
    The Commission received a series of general comments, as discussed 
more fully below, both in support of and in opposition to the overall 
direction and findings of the proposed acceptable practices.
    a. The proposed acceptable practices are inflexible; DCMs should be 
free to determine their own methods of core principle compliance.
    Several commenters stated that, consistent with the CFMA, DCMs, and 
not the Commission, should determine the composition of their boards 
and committees, and should have the discretion to establish their own 
definition of ``public director.'' One commenter noted that the concept 
of membership has evolved as markets have become increasingly 
electronic and global, and now encompasses a growing number of new 
types of market participants (which consequently reduces the population 
of potential public directors). Commenters argued that DCMs should be 
permitted to tap these new types of members for service as directors, 
bringing market knowledge and differing perspectives to their boards, 
rather than adding public directors, who, as defined by the Commission, 
will lack experience and expertise. It was further argued that DCMs 
should be permitted to decide for themselves how to constitute their 
boards in order to obtain the necessary knowledge, experience, and 
expertise that will permit them to serve their economic functions and 
the public interest.
    With respect to the other committees and panels addressed in the 
proposal, commenters stated that each DCM should be permitted to 
determine the appropriate size and composition of its executive 
committee, and likewise should be permitted: To determine whether to 
establish an ROC; to determine the extent of an ROC's responsibilities; 
and to determine the most appropriate composition for such committee. 
Commenters also stated that each DCM should be permitted to determine 
the composition and the structure of its disciplinary committees in 
order to ensure that decisions are informed by knowledge and 
experience.
    Numerous commenters opined that the proposals are inflexible, 
arbitrary, or

[[Page 6944]]

overly prescriptive. Among other things, commenters stated that the 
regulatory proposals: could stifle vital day-to-day market functions; 
Could swing the balance too far towards rigid, arbitrary requirements 
when there is no demonstrable need for such action; are contrary to the 
spirit and intent of the CFMA and the market-oriented, principle-based 
structure authorized by that legislation; unnecessarily micromanage the 
operations of DCMs; fail to recognize the changing definition and 
increasing breadth of the concept of DCM membership; inflexibly impose 
uniform requirements upon all DCMs without regard to the nature of a 
particular DCM or the products traded on that DCM; and should be 
presented not as a model for DCMs to adopt, but rather as examples of 
ways for DCMs to meet core principle requirements.
    Commenters also expressed concern that a bright-line test regarding 
the proper number of public directors will become the de facto 
requirement for all DCMs and will severely limit the ability of DCMs to 
undertake other approaches to achieving the general performance 
standard set by the core principles. Some commenters also contended 
that requiring a DCM that does not meet the proposed acceptable 
practices to demonstrate compliance with Core Principle 15 through 
other means impermissibly shifts the burden of proof to DCMs to justify 
departures from the acceptable practices, when the Act gives DCMs 
reasonable discretion in how they comply with the core principles. 
Another commenter noted that since the Commission has proposed absolute 
numerical standards as a means of avoiding conflicts of interest, there 
is no legitimate way to prove compliance by other means.
    b. Safeguards are already in place to protect against conflicts of 
interest at publicly traded, mutually-owned, and other DCMs.
    Numerous commenters opined that the proposals are not necessary 
because there are sufficient safeguards already in place to ensure that 
potential conflicts of interest are adequately identified and 
controlled and that self-regulation remains effective. Several 
commenters argued that small DCMs already have in place adequate 
controls to address potential conflicts of interest, and that the 
Commission conducts an independent review of each DCM's compliance 
department through its rule enforcement review (``RER'') program.\55\ 
Several commenters noted that their board composition standards already 
require public directors (albeit at a level lower than the proposed 50% 
requirement). Those commenters opined that their existing procedures 
for avoiding conflicts and including public participation are 
sufficient and more effective than the proposed 50% public member 
requirement.
---------------------------------------------------------------------------

    \55\ The Commission's Division of Market Oversight conducts 
periodic RERs at all DCMs to assess their compliance with particular 
core principles over a one-year target period. Staff's analyses, 
conclusions, and recommendations regarding any identified deficiency 
are included in a publicly available written report.
---------------------------------------------------------------------------

    Commenters also argued that fear of a possible conflict of interest 
between a demutualized DCM's regulatory responsibilities and the 
demands of a for-profit company is without foundation. These comments 
asserted that demutualization actually encourages rather than 
discourages effective self-regulation because market integrity is key 
to attracting and retaining business. Commenters stated that large, 
publicly traded DCMs already have numerous safeguards in place to 
ensure that they act in the best interest of their shareholders and do 
not act to the detriment of a particular group of shareholders. In 
addition, some commenters opined that corporate governance requirements 
currently applicable to publicly traded DCMs, combined with the 
reasonable exercise of discretion by DCMs pursuant to Core Principle 
1,\56\ provide sufficient assurance that conflicts of interest will be 
kept to a minimum in the decision-making process. One DCM commented 
that the proposed acceptable practices are unnecessary given, inter 
alia, the NYSE and NASDAQ listing standards to which some DCM parent 
companies are subject. In addition, it was observed that when a 
potential conflict does arise, DCMs have developed specific board 
governance procedures to ensure proper disclosure and to remove the 
potential conflict from the decision-making process. One commenter 
stated that the proposals are unnecessary because, if the Commission's 
general concern is that a DCM will adopt rules that will disadvantage 
members who are their competitors, it may address that concern through 
its review of self-certified rules to ensure that such rules comply 
with the Act and regulations.
---------------------------------------------------------------------------

    \56\ Core Principle 1 states: ``IN GENERAL--To maintain the 
designation of a board of trade as a contract market, the board of 
trade shall comply with the core principles specified in this 
subsection. The board of trade shall have reasonable discretion in 
establishing the manner in which it complies with the core 
principles.'' CEA Sec.  5(d)(1), 7 U.S.C. 7(d)(1).
---------------------------------------------------------------------------

    Several commenters argued that the proposals should not be applied 
to mutually-owned DCMs, as none of the factors cited by the Commission 
as justification for the proposed acceptable practices apply to them. 
These commenters further argued that applying the acceptable practices 
to mutually-owned DCMs to the same degree as large publicly traded DCMs 
would be burdensome in terms of cost, administration, and efficiency.
1a. The Commission's Response to the General Comments
    i. Proactive measures are justified to protect the integrity of 
self-regulation in the U.S. futures industry.
    The Commission's response to the comments summarized above is 
three-fold. First, the Commission believes that the argument that there 
are no specific regulatory failures justifying new acceptable practices 
for Core Principle 15 is misplaced. As discussed more fully in the 
cost-benefit analyses in Section V-A, the Commission did identify 
industry changes that it believes create new structural conflicts of 
interest within self-regulation, increase the risk of customer harm, 
could lead to an abuse of self-regulatory authority, and threaten the 
integrity of, and public confidence in, self-regulation in the U.S. 
futures industry. Increased competition, demutualization and other new 
ownership structures, for-profit business models, and other factors are 
highly relevant to the impartiality, vigor, and effectiveness with 
which DCMs exercise their self-regulatory responsibilities. The 
Commission strongly believes that credible threats to effective self-
regulation must be dealt with promptly and proactively, and is 
confident that precautionary and prophylactic methods are fully 
justified and well within its authority.
    Second, the Commission firmly rejects commenters' implicit argument 
that its oversight authority may be exercised only in response to 
crises or failures in self-regulation. To the contrary, the 
Commission's mandate, given by the Congress, is affirmative and 
forward-looking, including promoting ``responsible innovation'' and 
``fair competition'' in the U.S. futures industry.\57\ As catalogued 
throughout the SRO Review, rapid innovation and increasing competition 
are powerful new realities for all DCMs. The Commission's statutory 
obligation is to ensure that these realities evolve as fairly and 
responsibly as possible, and always in a manner that serves the public 
interest. The Commission believes that the new acceptable practices for 
Core Principle 15 serve exactly those purposes by ensuring a strong 
public voice at key levels of SRO

[[Page 6945]]

decision making, particularly as it effects self-regulation.
---------------------------------------------------------------------------

    \57\ CEA Sec.  3(b), 7 U.S.C. 5(b) .
---------------------------------------------------------------------------

    Finally, prior to adopting these acceptable practices, the 
Commission initiated an exhaustive, three-and-one-half year research 
program that resulted in a uniquely informed regulatory process. The 
Commission determined, as have many other regulatory and self-
regulatory bodies, that ``independent'' directors can be of great 
benefit to the deliberations and decisions of corporate boards and 
their committees. The Commission further determined, as have others, 
that DCMs charged with self-regulatory responsibilities are distinct 
from typical corporations, and thereby require careful attention to how 
their independent directors are defined. Finally, the Commission 
determined, as have others, that DCMs' independent directors should be 
of a special type--``public'' directors--and should meet higher 
standards, including non-membership in the DCM. All three decisions 
have ample precedent in exchange governance and self-regulation, both 
in the futures and the securities industries, are based on the 
extensive record amassed during the SRO Review and on the Commission's 
expertise and unique knowledge of the futures industry, and are well-
grounded in the Commission's statutory authority to issue acceptable 
practices for core principle compliance.
    ii. Some comments do not stand up to factual scrutiny.
    Some general comments in opposition to the proposed acceptable 
practices do not stand up to factual scrutiny. For example, DCMs whose 
parent companies are publicly traded and subject to NYSE listing 
standards (50% ``independent'' board of directors and key committees 
that are 100% independent) argued that those standards are sufficient 
to ensure effective self-regulation. The argument fails on two grounds.
    First, by their very terms, the NYSE's listing standards are 
designed for shareholder protection, not the effective self-regulation 
of futures exchanges in the public interest. Second, DCM holding 
companies have determined that DCM members are independent under the 
NYSE's listing standards.\58\ By doing so, they have demonstrated the 
inappropriateness of relying on the listing standards as a means of 
identifying public directors for effective self-regulation. Notably, 
the NYSE itself recognized this same point when reforming its own 
governance and self-regulatory structure, which is substantially more 
demanding than what it requires of its listed companies, or than what 
the Commission's new acceptable practices will require of DCMs.\59\
---------------------------------------------------------------------------

    \58\ See, e.g., CME's Categorical Independence Standards: ``* * 
* the Board of Directors has determined that a director who acts as 
a floor broker, floor trader, employee or officer of a futures 
commission merchant, CME clearing member firm, or other similarly 
situation person that intermediates transactions in or otherwise 
uses CME products and services shall be presumed to be 
``independent,'' if he or she otherwise satisfies all of the above 
categorical standards and the independence standards of the [NYSE] 
and The Nasdaq Stock Market, Inc. * * *'' CME Holdings Inc., 
Definitive Proxy Statement (Form DEF 14A), App. A, (March 10 2006). 
Accord CBOT Holdings Inc., Definite Proxy Statement (Form DEF 14A), 
App. A, (March 29, 2006). Both holding companies are listed on the 
NYSE and subject to its listing standards.
    \59\ NYSE Group's board of directors consists exclusively of 
directors who are independent both of member organizations and 
listed companies. In addition, NYSE Group and NASD recently 
announced plans to consolidate their member firm regulation into a 
single new SRO for all securities broker/dealers. Market regulation 
and listed company compliance will remain with NYSE Regulation, a 
not-for-profit subsidiary of NYSE Group. A majority of NYSE 
Regulation's directors must be independent of member organizations 
and listed companies, and unaffiliated with any other NYSE Group 
board. See http://www.nyse.com/regulation/1089235621148.html.
---------------------------------------------------------------------------

    The related argument that the proposed acceptable practices should 
not be applied to mutually-owned DCMs is also without merit. It ignores 
the futures industry's rapid and continuing evolution. When the SRO 
Review began in 2003, three of the four largest DCMs were member-owned. 
Now, all four are subsidiaries of public companies.\60\ Only two 
member-owned futures exchanges remain in the United States, and one is 
actually structured as a Delaware for-profit stock corporation that has 
paid dividends for nine consecutive years, including $11,000 per share 
in 2006 and $7,000 per share in 2005.\61\ More importantly, all DCMs, 
regardless of ownership structure, operate in an increasingly 
competitive environment where improper influence may be brought to bear 
upon regulatory functions, personnel, and decisions.
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    \60\ CME, CBOT, and NYMEX are wholly-owned subsidiaries of CME 
Holdings Inc., CBOT Holdings Inc., and NYMEX Holdings Inc., 
respectively. NYBOT is a wholly owned subsidiary of 
IntercontinentalExchange Inc. In each case, the DCMs are now 
subsidiaries of for-profit, publicly traded stock corporations 
listed on the NYSE.
    \61\ The two mutually-owned exchanges are the Kansas City Board 
of Trade and the Minneapolis Grain Exchange. However, as noted 
above, KCBT is structured as a for-profit, dividend-paying, stock 
corporation. See http://www.kcbt.com/news_2.asp?id=457 (KCBT press 
release announcing ninth consecutive annual dividend, including 
$11,000 per share in 2006) and http://www.kcbt.com/news_2.asp?id=347 (KCBT press release announcing eighth consecutive 
annual dividend, including $7,000 per share in 2005).
---------------------------------------------------------------------------

    Another misplaced series of comments argued that existing 
Commission processes, such as RERs, provide sufficient safeguards to 
ensure the future integrity of self-regulation. RERs are in fact 
central to the Commission's oversight regime for DCMs, and constitute 
the primary method by which the Commission verifies core principle 
compliance. However, RERs are retrospective in nature (focusing on a 
target period in the past) and cannot guarantee future performance. 
When self-regulatory failures are discovered, they are typically 
corrected via recommendations made by the Commission's Division of 
Market Oversight and implemented by the relevant DCM on a forward-
looking basis. In contrast, the objective of effective self-regulation 
and Commission oversight is to prevent such failures from ever 
occurring. The Commission does not believe that RERs should be a 
substitute for issuing acceptable practices for compliance with a 
particular core principle. The Commission has found that acceptable 
practices improve core principle compliance by providing all DCMs with 
greater clarity regarding the Commission's expectations, and a safe-
harbor upon which they may fully rely. Neither RERs nor any other 
existing Commission process, such as the review of self-certified 
rules, is an adequate substitute for carefully tailored acceptable 
practices.\62\ This is particularly true when the new acceptable 
practices concern a core principle that has no previous acceptable 
practices or respond to a rapidly changing area of the futures 
industry.
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    \62\ The argument that RERs make acceptable practices 
unnecessary is further misplaced as it ignores the beneficial 
interaction between the two oversight tools. For example, acceptable 
practices facilitate core principle compliance and advance the RER 
process by providing both DCMs and Commission staff with information 
as to the areas of concern which must be addressed under a 
particular core principle. The final acceptable practices for Core 
Principle 15 are no exception, as they highlight the type of 
structural conflicts of interest which all DCMs must address.
---------------------------------------------------------------------------

    iii. The Commission may implement detailed acceptable practices as 
safe-harbors for core principle compliance.
    Notwithstanding those comments generally opposed to the proposed 
acceptable practices for Core Principle 15, the Commission continues to 
strongly believe that the recent structural changes in the U.S. futures 
industry require an appropriate response within DCMs to ensure that 
self-regulation remains compatible with competitive, for-profit DCMs. 
Accordingly, the new acceptable practices for Core Principle 15 
establish

[[Page 6946]]

appropriate governance and self-regulatory structures, while preserving 
DCMs' flexibility to adopt alternate measures if necessary.
    Those commenters that opposed the new acceptable practices for 
their ``inflexibility'' misunderstand the nature of the core principle 
regime and the interaction between core principles and acceptable 
practices. The 18 core principles for DCMs establish standards of 
performance and grant DCMs discretion in how to meet those standards. 
However, compliance with the core principles is not static and does not 
exist in a vacuum; instead, core principles are broad precepts whose 
specific application is subject to change as DCMs and the futures 
industry evolve. Furthermore, as discussed in Section III, core 
principle compliance is an affirmative and continuing obligation for 
all DCMs, and it is incumbent upon them to demonstrate compliance to 
the Commission's satisfaction.\63\
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    \63\ See 17 CFR Part 38, App. B, ] 1 (``This appendix provides 
guidance on complying with the core principles, both initially and 
on an ongoing basis to maintain designation under Section 5(d) of 
the Act and this part'' (emphasis added)).
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    The flexibility inherent in the core principles permits each DCM to 
comply in the manner most appropriate to it. At the same time, such 
flexibility provides both the Commission and the futures industry with 
the latitude to grow in their understanding of self-regulation and its 
requirements. One common example is the Commission's approach to the 
safe storage of trade data under Core Principle 10,\64\ which evolved 
following the events of September 11, 2001.\65\ Similarly, the 
Commission's expectations for the management of conflicts of interest 
under Core Principle 15 now include an understanding that in a highly 
competitive futures industry, where almost all DCMs are for-profit and 
many are subsidiaries of publicly traded companies, the conflicts that 
may arise are not purely personal or individual. Simply stated, whether 
or not DCMs choose to implement the new acceptable practices, the 
conflicts of interest which they must address to comply with Core 
Principle 15 now include structural conflicts between their self-
regulatory responsibilities and their commercial interests.
---------------------------------------------------------------------------

    \64\ Core Principle 10 states: ``TRADE INFORMATION--The board of 
trade shall maintain rules and procedures to provide for the 
recording and safe storage of all identifying trade information in a 
manner that enables the contract market to use the information for 
purposes of assisting in the prevention of customer and market 
abuses and providing evidence of any violations of the rules of the 
contract market.'' CEA Sec.  5(d)(10), 7 U.S.C. 7(d)(10).
    \65\ On September 11, 2001, the physical location of three DCMs 
was destroyed, and both the Commission and the industry recognized 
the importance of redundancy capabilities, including safe storage of 
trade information, that are sufficiently distant from primary 
locations.
---------------------------------------------------------------------------

    All acceptable practices, including those for Core Principle 15, 
are designed to assist DCMs by offering ``pre-approved'' roadmaps or 
safe-harbors for core principle compliance. Although it may be a 
preferred method of compliance, no acceptable practice is mandatory. 
Instead, as safe-harbors, acceptable practices provide all DCMs with 
valuable regulatory certainty upon which they may rely, should they 
choose to do so, when seeking initial designation, when subject to 
periodic RERs by the Division of Market Oversight, or at any other time 
in which the Commission requires a DCM to demonstrate core principle 
compliance.\66\
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    \66\ The Commission has explained that ``boards of trade that 
follow the specific practices outlined under [the acceptable 
practices] * * * will meet the applicable core principle.'' 17 CFR 
38, App. B, ] 2.
---------------------------------------------------------------------------

    Because they offer such broad and beneficial safe-harbors, 
acceptable practices are sometimes detailed and exact in their 
requirements. If the Commission effectively ``pre-approves'' a specific 
self-regulatory structure for minimizing conflicts of interests under 
Core Principle 15, as it is doing here, then it must be sufficiently 
specific in describing that structure and all of its components. In the 
alternative, the Commission would be offering not a safe-harbor upon 
which DCMs may fully rely, but only additional guidance, subject to 
varying interpretations, raising many questions, and providing few 
answers and even less certainty. That is not the intent of these 
acceptable practices.
    In addition, the Commission notes that the presence of ``must,'' 
``shall,'' and similar words in the new acceptable practices indicates 
only that these things must be done to receive the benefits of the 
safe-harbor, not that the acceptable practices themselves are required. 
What is now required of all DCMs under Core Principle 15 is to 
demonstrate that they have effectively insulated their self-regulatory 
functions, personnel, and decisions from improper influence and 
commercial considerations, including those stemming from their numerous 
member, customer, owner, and other constituencies. If a DCM chooses not 
to implement the new acceptable practices for Core Principle 15, then 
the Commission will evaluate the DCM's alternative plan, either through 
RERs, the rule submission process, or other means. During any such 
review, the DCM will be required to present and demonstrate what 
procedures, arrangements, and methods it has adopted or will adopt to 
minimize structural conflicts of interest in self-regulation. The DCM 
will further be required to demonstrate that its approach is capable of 
responding effectively to conflicts that may arise in the future.
2. Comments With Respect to the Board Composition Acceptable Practice
    The proposed Board Composition Acceptable Practice calling for at 
least 50% public director representation on DCM boards and executive 
committees drew substantial comment, both for and against. In their 
comment letters, the FIA and five large FCMs strongly supported the 50% 
public director benchmark for DCM boards. The FIA particularly noted 
that the proposal provides DCMs with flexibility as to how they want to 
address the diversity of interest groups in that the proposal does not 
specify any fixed number of board members. The FIA also recommended 
that a subgroup of public directors should serve as a nominating 
committee to select new or re-nominate existing public directors. One 
exchange also generally supported the proposals, commenting that the 
proposed governance standards and ROCs will enhance DCM governance and 
serve to protect market participants and the public interest.
    Many commenters, however, opposed the proposed 50% public director 
composition requirement. Several commenters were concerned that the 
proposal would dilute the voices of trade, commodity, and farmer 
interests in DCM governance, as well as the voices of market users, 
members, shareholders, and other stakeholders in the DCM. Commenters 
were also concerned about the need for experience and expertise on DCM 
boards.\67\
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    \67\ One commenter stated that filling governance positions with 
those totally devoid of any connection to the marketplace would 
necessarily lead to major decisions regarding the operation of 
futures markets being made by those with no expertise in such 
decision making and no vested interest in the long-term best 
interests of those markets. It was suggested that this will result 
in either grossly mismanaged DCMs or the appearance of conflicts of 
interest as public directors defer to the less diverse non-public 
directors and officers.
---------------------------------------------------------------------------

    Several commenters stated that, in order to meet the proposed 50% 
board composition requirement, either the board would have to be made 
unreasonably large, or a DCM would have to reduce the number of 
directors drawn from its commercial interest and other memberships. 
Commenters also contended that it would be difficult to

[[Page 6947]]

attract a sufficient number of qualified public directors.\68\
---------------------------------------------------------------------------

    \68\ One mutually-owned DCM commented that payment of a stipend 
to directors will create additional financial burdens on smaller, 
non-profit DCMs and create the possibility of less qualified 
directors serving on the board. Another commenter noted that public 
directors with no industry experience might be less inclined to 
invest in the self-regulatory functions of the DCM.
---------------------------------------------------------------------------

    Many of the comments regarding executive committee composition 
raised the same points as comments regarding the board composition 
requirement. Such comments included the need for a diversity of 
representation on executive committees, the need for experience and 
expertise, and the difficulty of attracting qualified public directors. 
In addition, several commenters argued that members of an executive 
committee have a special need for expertise due to its unique 
involvement in day-to-day operational and managerial issues.
2a. The Commission's Response to Comments on the Board Composition 
Acceptable Practice
    After carefully reviewing the comments above, the Commission has 
decided to modify the proposed Board Composition Acceptable Practice, 
and reduce the required ratio of public directors on boards and 
executive committees from at least 50% to at least 35%. The Commission 
is confident that the new Board Composition Acceptable Practice, 
together with the other acceptable practices adopted herein, 
effectively accomplishes what Core Principle 15 requires--
``minimiz[ing] conflicts of interest in the decision-making process of 
the contract market''--while simultaneously respecting the legitimate 
needs of efficiency and expertise in that process.
    Both the proposed and final Board Composition Acceptable Practices 
recognize the importance of DCM boards of directors in effective self-
regulation. Boards of directors bear ultimate responsibility for all 
regulatory decisions, and must ensure that DCMs' unique statutory 
obligations are duly considered in their decision making. While 
exchange boards do have fiduciary obligations to their owners, they are 
also required by the Act to ensure effective self-regulation, to 
protect market participants from fraud and abuse, and to compete and 
innovate in a fair and responsible manner. To meet these obligations, 
boards of directors, and any committees to which they delegate 
authority, including executive committees, must make certain that DCMs' 
regulatory responsibilities are not displaced by their commercial 
interests or those of their numerous constituencies.
    The Commission strongly believes that DCMs are best able to meet 
their statutory obligations if their boards and executive committees 
include a sufficient number of public directors.\69\ While determining 
a ``sufficient'' level of public representation is not an exact 
process, the Commission has concluded that the public interest will be 
furthered if the boards and executive committees of all DCMs are at 
least 35% public. Such boards and committees will gain an independent 
perspective that is best provided by directors with no current industry 
ties or other relationships which may pose a conflict of interest. 
These public directors, representing over one-third of their boards, 
will approach their responsibilities without the conflicting demands 
faced by industry insiders. They will be free to consider both the 
needs of the DCM and of its regulatory mission, and may best appreciate 
the manner in which vigorous, impartial, and effective self-regulation 
will serve the interests of the DCM and the public at large. 
Furthermore, boards of directors that are at least 35% public will help 
to promote widespread confidence in the integrity of U.S. futures 
markets and self-regulation. Public participation on such boards will 
enhance the independence and accountability of all self-regulatory 
actions. As regulatory authority flows from the board of directors to 
all decision-makers within a DCM, such independence should permeate 
every level of self-regulation and successfully minimize conflicts of 
interest as required by Core Principle 15.
---------------------------------------------------------------------------

    \69\ As noted previously, some commenters made similar arguments 
with respect to executive committee composition and board 
composition. Those arguments are addressed jointly in this Section. 
Some commenters also argued that executive committees require a 
special degree of expertise due to their unique role in day-to-day 
operational and managerial issues. The Commission notes that this 
argument runs counter to commenters' opposition to the ROC 
Acceptable Practice on the grounds that directors and board 
committees should not take part in day-to-day operational and 
managerial issues. The Commission believes that executive 
committees' unique role stems from their authority to act in place 
of the full board of directors. Regardless of the decision being 
made, if a DCM decides that such decision is best made by a small 
group of directors to whom full board authority has been delegated, 
then the ratio of public directors in that group should be no less 
than the ratio on the full board. Anything less would deprive a key 
level of DCM decision making from the benefits attendant to 
sufficient public representation and independence, and diminish the 
effectiveness of the Board Composition Acceptable Practice.
---------------------------------------------------------------------------

    As stated above, the Commission is confident that boards of 
directors and executive committees that are at least 35% public will 
effectively protect the public interest; at the same time, the 
Commission believes that they are appropriately responsive to the 
comments. Under the new 35% standard, DCMs will have more latitude to 
include a broader diversity of non-public directors, such as commercial 
representatives and other highly experienced industry professionals, 
and to appoint more member directors and other emerging classes of 
trading privilege holders. There will also be sufficient room for 
stockholders and other outside investors, DCM officers, and persons 
representing affiliated entities or business partners.
    The Commission believes that a public director level of at least 
35% will not require DCMs to increase the size of their boards or 
executive committees, nor will they lose the ability to convene boards 
and committees on short notice. Furthermore, at the 35% level, DCMs 
should find it easier to attract a sufficient number of qualified 
public directors to serve on their boards and executive committees, 
thereby substantially reducing any disproportionate burden on smaller 
or start-up DCMs. Finally, while this modification makes ROCs with 100% 
public representation all the more necessary, it also provides ROC 
directors with access to a larger pool of industry expertise from among 
their fellow board members, with whom they may freely consult whenever 
needed.
    At the same time, the Commission has determined that the 35% 
standard adopted in the final Board Composition Acceptable Practice is 
sufficient to ensure strong representation of the public interest in 
DCM decision making. While a DCM may determine that a 50% public 
director standard is more appropriate for its circumstances,\70\ the 
Commission believes that the 35% standard for safe harbor purposes 
under Core Principle 15 will be effective while also responsive to 
reasonable concerns voiced in the public comments.
---------------------------------------------------------------------------

    \70\ Certain DCMs, such as large exchange subsidiaries of 
publicly traded companies, may be better served by a higher ratio of 
public directors, and may be better able to attract them. Although 
the Commissions believes that the 35% standard adopted herein is an 
appropriate minimum standard for all DCMs, the core principle regime 
grants DCMs the flexibility to adopt higher ratios of public 
directors should they wish.
---------------------------------------------------------------------------

    The Commission has concluded that the most effective way to address 
DCM conflicts of interest, while still maintaining the self-regulatory 
model, is to place a sufficient number of public persons on DCM boards 
of directors, executive committees, and other decision-making bodies. 
Ultimately, however, the Commission's objective is

[[Page 6948]]

not to engineer specific board-level decisions, but rather to encourage 
a process that ensures that every decision will be both well-informed 
by inside expertise and well-balanced by the public interest. Following 
implementation of the Board Composition and companion acceptable 
practices, the Commission will carefully monitor DCM decision making, 
and reserves the right to modify the required ratio of public directors 
as necessary.
3. Comments With Respect to the Public Director Acceptable Practice
    Many commenters addressed the proposed acceptable practices' 
definition of ``public'' for DCM directors and members of disciplinary 
panels. With respect to the definition generally, the FIA supported the 
Commission's definition but noted that it had proposed a more stringent 
public director standard of no involvement with the futures or 
derivatives business. Several commenters expressed the general concern 
that the Commission's definition of public would lead to a lack of 
experience and expertise among DCM directors and members of 
disciplinary panels. One commenter contended that the definition was 
not needed for NYSE-listed DCMs as the definition of independence 
contained in the NYSE listing requirements was sufficient to ensure the 
appropriate level of independence in a DCM's decision-making processes.
    With respect to the proposed definition's exclusion of persons 
having a material relationship with the contract market, one commenter 
asked that the Commission clarify that DCM boards may make material 
relationship determinations without any independent nominating 
committee involvement. That commenter also asked that the Commission 
clarify whether it would represent a material relationship with the 
futures exchange for an individual, who otherwise satisfied the 
proposed qualification criteria, to be a lessor member of a DCM 
affiliate with a de minimus equity percentage interest in the DCM 
affiliate. Another commenter questioned whether the material 
relationship test would prevent an otherwise qualified individual from 
becoming a public director if its family farming operation used the 
DCM's contracts as risk management tools.\71\
---------------------------------------------------------------------------

    \71\ The use of a DCM's contracts to hedge risks in commercial 
activities otherwise unrelated to futures trading does not 
automatically constitute a material relationship. However, a board 
of directors should consider all relevant factors carefully when 
making its materiality determination. For example, if the farm 
operator cited above conducted its hedging activities as an exchange 
member, as broadly defined herein, such membership would disqualify 
it and persons affiliated with it from serving as public directors. 
Likewise, if futures trading is a central economic activity for an 
individual or firm, rather than incidental to other commercial 
activity, then the board should consider whether such futures 
trading rises to the level of a material relationship that could 
affect a director's decision making. For example, a director voting 
on a proposed exchange rule that would facilitate or deter a 
particular trading strategy will have a material conflict if their 
personal or firm trading is likely to benefit or be harmed by such 
new rule.
---------------------------------------------------------------------------

    The proposed definition stated that a director will not be 
considered ``public'' if the director is a member of the contract 
market or a person employed by or affiliated with a member. In 
response, one commenter stated that such a restriction would be a 
mistake because it would exclude from the board people with both 
industry knowledge and substantial shareholdings, including persons who 
hold membership but who are retired or lease their membership to 
others, members that are marginally involved in trading, persons who 
are members at other DCMs, and holders of corporate memberships whose 
firms likely conduct business at multiple DCMs. One commenter stated 
that the proposal's definition of member does not take into account the 
various types of membership, some of which may raise greater potential 
for conflicts of interest, while others may raise very little 
potential.
    The proposed definition also stated that a director will not be 
considered ``public'' if the director is an officer or employee of the 
DCM or a director, officer, or employee of its affiliate. In response, 
one commenter argued against the disqualification of an otherwise 
public DCM because he or she is also serving as a director at an 
affiliate of the DCM. Another commenter requested that the Commission 
clarify that a director of a DCM would not be considered non-public 
because he or she was also a director of the DCM's holding company.
    Several comments addressed the proposed definition's determination 
that a director will not be considered ``public'' if the director 
receives more than $100,000 in payments, not including compensation for 
services as a director, from the DCM, any affiliate of the DCM or from 
a member or anyone affiliated with a member. The FIA argued that the 
Commission should adopt a ``no-payment-from-contract-market'' standard, 
noting that payment of up to $100,000 would result in at least some 
allegiance to DCM management. Additionally, the FIA commented that if 
the $100,000 compensation limit is retained, the Commission should 
clarify that it is an overall cap of permissible compensation from 
contract markets and their members. The FIA also opined that receipt of 
more than $100,000 by a potential director's firm (rather than by the 
director) from a DCM member constitutes indirect payment or 
compensation and should not prevent an otherwise qualified director 
from being considered public.
    By contrast, one DCM stated that the public director definition 
should be modified to eliminate the $100,000 compensation provision 
because it is an arbitrary level and may amount to de minimis 
compensation in the context of the person's total compensation.\72\ 
Another exchange requested that the Commission clarify that pensions 
and other forms of deferred compensation for prior services that are 
not contingent on continued service would not automatically disqualify 
a person from serving as a public director.
---------------------------------------------------------------------------

    \72\ This commenter stated that each DCM board should consider 
compensation from the DCM or its members as one factor in 
determining whether the person has a material relationship with the 
DCM.
---------------------------------------------------------------------------

    One commenter addressed the proposed definition's determination 
that a person will be precluded from serving as a public director if 
any of the relationships identified in the definition apply to a member 
of the director's immediate family. That commenter stated that an 
individual should not be prohibited from serving as a public director 
based on the affiliation of an immediate family member with a member 
firm unless the family member is an executive officer of the member 
firm. The same commenter further noted that the exclusion should not 
apply to family members who do not live in the same household as the 
director.
    The proposed definition also included a one-year look back 
provision with respect to the identified disqualifying circumstances. 
With respect to this provision, the FIA commented that a two-year look 
back would be more realistic and effective. In contrast, an exchange 
commented that the proposed one-year look back is more than sufficient 
and noted that that the longer the look back period, the less likely 
that individuals will plan to return to the industry.
3a. The Commission's Response to Comments on the Public Director 
Acceptable Practice
    The Commission carefully considered all of the comments with 
respect to the Public Director Acceptable Practice, and generally found 
that many of the

[[Page 6949]]

discrete requests for clarification regarding the definition of 
``public'' were reasonable. Accordingly, the Commission made 
appropriate responsive modifications to the final Public Director 
Acceptable Practice, as discussed in Section IV below.
    The Commission has determined, however, that a less stringent 
definition of public director, as requested by some, is contrary to the 
acceptable practices' stated objectives: minimizing conflicts of 
interest through independent decision making, encouraging a strong 
regard for the public interest, and insulating regulatory functions via 
public directors and persons who are not conflicted by industry ties. 
Furthermore, the Commission believes that a strict definition of public 
director is especially necessary now that it will apply to 35% of a 
DCM's directors, rather than the 50% originally proposed. More 
importantly, the Commission strongly believes that, rather than being a 
drawback, the most significant contribution made by public directors to 
the DCM decision-making process is precisely their outside, non-
industry perspective. The Commission is confident that a board 
consisting of at least 35% public directors, as defined in the Public 
Director Acceptable Practice, is more than capable of reaching 
intelligent collective decisions, even on technical matters requiring 
detailed knowledge of futures trading, while at the same time 
exercising its regulatory authority in a manner consistent with the 
public interest.
    The Commission rejects the contention that it will be impossible to 
find a sufficient number of qualified public directors to serve on DCM 
boards. Similarly, it rejects the argument that the materiality and 
bright-line tests may result in inexperienced directors with limited 
knowledge of the futures industry. To the contrary, the Commission 
believes that DCMs are fully capable of finding a sufficient number of 
qualified directors to constitute at least 35% public boards. DCMs may 
draw from a large pool of talented candidates with relevant or related 
experience, including retired futures industry insiders; scholars whose 
research focuses on the futures markets and related disciplines; 
officers and executives of many sophisticated corporate entities; 
persons with expertise in the securities industry, which may translate 
well into futures; and other members of the legal, business, and 
regulatory communities.
    The Commission notes that a wide variety of DCMs--large and small, 
mutually-owned and publicly traded, for-profit and not-for-profit--
already have boards of directors that are at least 20% non-member, as 
once required by Commission Regulation 1.64. One securities exchange 
that is the parent company of a DCM has a board that is at least 50% 
non-member,\73\ and the NYSE's board of directors is 100% non-member. 
Accordingly, many exchanges have already demonstrated an ability to 
successfully recruit, retain, and thrive with significant numbers of 
public directors.
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    \73\ The board of directors of the Chicago Board Options 
Exchange, which owns CFE, is 50% public (independent non-member).
---------------------------------------------------------------------------

    It is noteworthy that the three largest-volume DCMs, all of which 
are subsidiaries of publicly traded companies, are already required to 
have boards that are at least 50% ``independent,'' as defined by the 
NYSE. In certain respects, the Commission's definition of ``public 
director'' overlaps with the NYSE's ``independent directors'' 
definition. Thus, these DCMs could potentially select at least some of 
their public directors from among their independent directors who do 
not have current ties to the futures industry. At the same time, the 
argument that the NYSE listing standards render the proposed Public 
Director Acceptable Practices unnecessary is misplaced. Despite the 
similarities between the acceptable practices and the NYSE's definition 
of independent, one overarching difference remains-- the listing 
standards are designed to protect shareholders, through boards of 
directors that are sufficiently independent from management.\74\ In 
contrast, the new acceptable practices for Core Principle 15, while 
recognizing that DCMs are commercial enterprises, serve the national 
public interest in vigorous, impartial, and effective self-regulation.
---------------------------------------------------------------------------

    \74\ The NYSE's commentary to its listing standards emphasizes 
that ``as the concern is independence from management, the Exchange 
does not view ownership of even a significant amount of stock, by 
itself, as a bar to an independence finding.'' NYSE Listed Company 
Manual, Sec.  303A.02 (commentary) (emphasis added).
---------------------------------------------------------------------------

    The Commission agrees with many of the commenters that effective 
self-regulation is in the long-term interest of DCM owners, including 
shareholders. However, it is crucial for all DCMs and their owners to 
understand that DCMs have two responsibilities: a responsibility to 
their ownership and a responsibility to the public interest as defined 
in the Act.\75\ Whereas the NYSE listing standards serve those with a 
direct fiduciary claim upon a company (shareholders (owners)), the new 
acceptable practices serve the public, whose claim upon DCMs is 
entirely independent of ownership, membership, or any other DCM 
affiliation. In short, through the new acceptable practices for Core 
Principle 15, the Commission seeks to ensure adequate representation of 
a public voice that otherwise is not guaranteed any formal standing 
within a DCM, and which receives no effective representation under any 
regulatory regime other than the Commission's.
---------------------------------------------------------------------------

    \75\ CEA Sec.  3(b), 7 U.S.C. 5(b).
---------------------------------------------------------------------------

    Some commenters argued that the proposed Public Director Acceptable 
Practice, and the bright-line tests in particular, do not take into 
account different types of DCM memberships and the different degrees of 
conflict which they may or may not engender. Although different 
commenters focused on different groups of industry participants, their 
underlying argument was the same: that industry participants should be 
permitted to serve as public directors to a lesser or greater extent. 
The Commission's response to this and similar comments summarized above 
is two-fold.
    First, if DCMs value the presence of industry insiders on their 
boards, they may place them among the 65% of directors who are not 
required to be public under the final acceptable practices. The 
Commission has facilitated this option by reducing the required ratio 
of public directors. Second, and as stated previously, the purpose of 
the Public Director Acceptable Practice is to ensure independent 
decision making and strong consideration of the public interest by DCM 
boards of directors. While all directors are required to consider DCMs' 
statutory obligations and public responsibilities, public directors are 
particularly meaningful because they have no fiduciary duty to lessees 
or lessors of trading seats, corporate members, persons who trade small 
amounts, or any other persons affiliated with the futures industry and 
inquired about in the comments. Allowing persons with current industry 
affiliation to serve as public directors would necessarily reintroduce 
into board deliberations and ROC oversight the very conflicts of 
interest that Core Principle 15 and the new acceptable practices seek 
to minimize.
    The Commission also notes that the most significant determination 
to be made under the Public Director Acceptable Practice is the board's 
finding that a potential public director has no material relationship 
with the DCM. The Commission has left this determination to the board's 
discretion, and offers the bright-line tests only as a beginning to the 
board's inquiry. The material relationship test requires a

[[Page 6950]]

DCM's board to make an affirmative, on-the-record finding that a 
director has no material relationship with the DCM, and to disclose the 
basis for that determination. The bright-line tests simply facilitate 
the board's inquiry by noting obviously material relationships, and 
freeing the board to focus on other relationships that may be less 
apparent but that are equally detrimental to impartial representation 
of the public interest. As such, the bright-line tests, like any other 
acceptable practices, must be sufficiently detailed to merit the 
benefits accorded to a safe-harbor. Consistent with this approach, the 
Commission reaffirms the familial relationships excluded under the 
bright-line tests, the one-year look-back provision, and all other 
elements of the proposed Public Director Acceptable Practice, except 
for those specifically treated in Section IV.\76\
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    \76\ In Section IV, the Commission makes clarifications with 
respect to, inter alia, the manner in which DCMs select their public 
directors, the compensation of public directors, and public 
directors serving on both a parent company and a subsidiary DCM 
(``overlapping public directors'').
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4. Comments With Respect to the Regulatory Oversight Committee 
Acceptable Practice
    The proposed Regulatory Oversight Committee Acceptable Practice 
called upon DCMs to establish a board-level ROC, composed solely of 
public directors, to oversee regulatory functions. Many commenters 
focused on the composition of the proposed ROC, voicing many of the 
same concerns they had with respect to the proposed 50% public director 
board requirement. Two DCMs commented that each DCM should be permitted 
to determine whether to establish a ROC, the extent of the ROC's 
responsibilities, and the most appropriate composition thereof. One DCM 
argued that the level of public representation should be the same for 
ROCs and boards.
    A number of commenters expressed concern with the difficulty in 
recruiting qualified public directors (similar to the concerns 
expressed with respect to recruiting qualified directors for the board 
generally) to serve on ROCs, and noted the need for experience, 
expertise, and diversity on any such body. One DCM commented that an 
ROC should be able to include public representatives who are not public 
directors of the exchange, but who are otherwise qualified to be.
    The FIA and a large FCM supported the proposed Regulatory Oversight 
Committee Acceptable Practice. The FCM commented that adoption of the 
proposal will enhance the credibility and effectiveness of DCMs in 
their capacity as self-regulators.
    One DCM commented that while an ROC is an appropriate way to 
reinforce impartiality in DCM self-regulation, it may not be the best 
approach for all DCMs (particularly smaller ones) to charge the 
committee with managerial duties and overseeing daily market regulation 
functions. Another DCM commented that ROCs should not remove DCMs' 
chief regulatory officers from the appropriate direction and input of 
DCM management. Commenters also argued that ROCs' proposed duties could 
conflict with the responsibilities of the chief executive officer, the 
board, and DCM personnel, and could well undercut their authority.
    Many commenters addressed ROCs' stated responsibilities. Several of 
these commenters argued that the level of authority assigned to an 
ROC's public directors is contrary to commonly accepted corporate 
management best practices because management functions are removed from 
management and become directors' responsibilities. A number of 
commenters offered recommendations as to what should be the 
responsibilities of an ROC. One DCM requested that the Commission 
clarify that if an ROC were to have any authority with respect to 
overseeing budgets and the hiring and compensation of regulatory 
officers and staff, that such authority would supplement rather than 
replace these normal management and board responsibilities. It was 
further argued that the Commission should make clear that it is not the 
function of an ROC to plan or conduct trade practice investigations or 
market surveillance or to review the results of particular 
investigations or audits, but rather to serve an oversight role. It 
also was suggested that the Commission should remove language that 
states that an ROC shall supervise the DCM's CRO because it is 
inconsistent with the Commission's stated position that an ROC should 
not serve as a manager. Another DCM commented that ROCs should be 
granted unhindered access to regulatory staff along with the authority 
to ensure that regulatory staff has sufficient resources and that 
nothing interferes with staff's fulfillment of the regulatory program.
    In other comments addressing the proposed responsibilities of ROCs, 
a large FCM and the FIA contended that ROCs (or their chairmen) should 
approve the composition of DCM disciplinary panels. The FIA also 
recommended that ROCs be granted the power to hire, supervise, and 
determine the compensation of DCMs' CROs and set (or recommend to the 
board) DCMs' self-regulatory budgets. Further, in the interest of more 
transparency for DCM rulemakings, the FIA recommended that ROCs should 
consider and approve any new DCM rule or rule change or, if the 
Commission elects not to call for committee approval of all such rules 
and rule changes, than any new DCM rule or rule change that a DCM 
decides to self-certify to the Commission.
4a. The Commission's Response to Comments on the Regulatory Oversight 
Committee Acceptable Practice
    Criticisms of the proposed ROC Acceptable Practice often mirrored 
those leveled against the proposed Board Composition Acceptable 
Practice and the proposed acceptable practices in general. After 
careful consideration, the Commission has determined to implement the 
ROC Acceptable Practice for Core Principle 15 as proposed.\77\
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    \77\ As stated in the proposing release, the Commission 
emphasizes that ROCs are expected to identify aspects of their DCMs' 
regulatory system that work well and those that need improvement, 
and to make any necessary recommendations to their boards for 
changes that will help to ensure vigorous, impartial, and effective 
self-regulation. ROCs should be given the opportunity to review, 
and, if they wish, present formal opinions to management and the 
board on any proposed rule or programmatic changes originating 
outside of the ROCs, but which they or their CROs believe may have a 
significant regulatory impact. DCMs should provide their ROCs and 
CROs with sufficient time to consider such proposals before acting 
on them. ROCs should prepare for their boards and the Commission an 
annual report assessing the effectiveness, sufficiency, and 
independence of the DCM's regulatory program, including any 
proposals to remedy unresolved regulatory deficiencies. ROCs should 
also keep thorough minutes and records of their meetings, 
deliberations, and analyses, and make these available to the 
Commission upon request. In the future, when reviewing DCMs' 
compliance with the core principles, the Commission will examine any 
recommendations made by ROCs to their boards and the boards' 
reactions thereto.
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    The Commission stresses that ROCs are oversight bodies, and that 
the enumerated powers granted to them in the ROC Acceptable Practice 
merely complement normal board functions. ROCs are not intended to 
supplant their boards of directors, nor are they expected to assume 
managerial responsibilities or to perform direct compliance work. Under 
the acceptable practices for Core Principle 15, DCM self-regulation 
remains exactly that--self-regulation, but with a stronger and more 
defined voice for the public responsibilities inherent to all DCMs. 
Properly functioning ROCs should be robust oversight bodies capable of 
firmly representing the interests of vigorous, impartial, and effective 
self-regulation. ROCs should also represent the interests and needs of 
regulatory

[[Page 6951]]

officers and staff; the resource needs of regulatory functions; and the 
independence of regulatory decisions. In this manner, ROCs will 
insulate DCM self-regulatory functions, decisions, and personnel from 
improper influence, both internal and external.
    Many of the comments in opposition to the ROC Acceptable Practice--
for example, that whether to establish ROCs should be left at DCMs' 
discretion and that it will be difficult to find qualified public 
directors--have already been addressed, and the Commission's previous 
responses need only brief summarizing here. The Commission strongly 
believes that new structural conflicts of interest within self-
regulation require an appropriate response within DCMs. The Commission 
further believes that ROCs, consisting exclusively of public directors, 
are a vital element of any such response. With respect to those public 
directors, the Commission is confident that DCMs can recruit a 
sufficient number of qualified persons, as they have done for their 
boards in the past. Finally, the Commission notes that while DCMs must 
respond to conflicts between their regulatory responsibilities and 
their commercial interests; the exact manner in which they do so 
remains at their discretion.
    A second line of comments with respect to the ROC Acceptable 
Practice argued that ROCs should include industry directors, and that 
the ratio of public directors on ROCs should be the same as on boards. 
The Commission believes that these comments ignore the very purpose of 
the ROC Acceptable Practice. As stated previously, the new acceptable 
practices ensure that DCMs' decision-making bodies include an 
appropriate number of persons who are not conflicted by industry ties. 
For ROCs--the overseers of DCMs' regulatory functions--the appropriate 
number is 100% public. The Commission believes that anything less 
invites into regulatory oversight operations precisely those directors 
whose industry affiliations lend themselves to conflicts of interest in 
decision making.
    What constitutes a ``sufficient'' number of public persons for DCM 
decision making depends upon the decision-making body in question and 
its responsibilities. Thus, DCM disciplinary panels are required to be 
diverse and have only one public person because their responsibility--
expert and impartial adjudications--often requires a detailed knowledge 
of futures trading best provided by industry participants. At the same 
time, that expertise is balanced by the impartiality of at least one 
public panelist and a diversity of industry representatives. For boards 
of directors, however, with both regulatory responsibilities and 
commercial interests, the minimum 35% ratio properly recognizes boards' 
dual role as the ultimate regulatory and commercial authorities within 
DCMs. Industry directors on DCMs' boards are fully justified precisely 
because of the numerous commercial decisions that they must make.
    Within this construct, ROC's discrete regulatory responsibilities 
assume added significance. The sole purpose of ROCs is to insulate 
self-regulatory functions, personnel, and decisions from improper 
influence, and to advocate effectively on their behalf. ROCs make no 
direct commercial decisions, and therefore, have no need for industry 
directors as members. The public directors serving on ROCs are a buffer 
between self-regulation and those who could bring improper influence to 
bear upon it. The Commission notes that at least three DCMs--CME, 
NYBOT, and U.S. Futures Exchange--have already established board-level 
committees similar to the ROCs described in the ROC Acceptable 
Practice, and they consist exclusively of public directors. The same is 
true of the securities exchange parent company of one DCM that 
submitted comments.
    Commenters who requested greater industry participation on ROCs 
should recall that ROCs will be subject to the final authority of their 
boards of directors, which may include a sufficient number of industry 
directors. DCM boards, including industry directors, will have ample 
opportunity to consult with and advise ROC public directors, to 
interact with regulatory officers and personnel, and ultimately to 
enact any regulatory policies or decisions that they deem appropriate. 
As stated previously, ROCs are designed to insulate self-regulation, 
not isolate it. At the same time, under the ROC Acceptable Practice, 
ROCs have the absolute right to whatever resources and authority they 
may require to fulfill their responsibilities, including resources 
within their DCMs. More specifically, ROCs have the authority and 
resources necessary to conduct their own inquiries; consult directly 
with their regulatory officers and staffs; interview DCM employees, 
officers, members, and others; review relevant documents; retain 
independent legal counsel, consultants, and other professional service 
providers and industry experts; and otherwise exercise their 
independent analysis and judgment as needed to fulfill their regulatory 
responsibilities.\78\
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    \78\ ROCs should not rely on outside professionals or firms that 
also provide services to the full board, other board committees, or 
other units or management of their DCMs.
---------------------------------------------------------------------------

    The related concern that ROCs will undercut the authority of DCM 
boards of directors is misplaced. ROCs should function as any other 
committee of the board, making recommendations which are afforded great 
weight and deference, and reaching final decisions if such power is 
delegated to it, but ultimately subject to the board's authority. The 
very text of the ROC Acceptable Practice calls for ROCs to ``monitor,'' 
``oversee,'' and ``review,'' none of which implies binding authority or 
a usurpation of the full board of directors. At most, it implies a 
change in workflow.\79\
    Similarly, concerns that ROCs will become managerial bodies or 
interfere with established managerial relationships are equally 
misplaced. To be clear, the Commission expects ROCs to oversee DCMs' 
self-regulatory functions and personnel, not to manage them. ROCs' 
responsibilities, detailed in Section 3 of the final acceptable 
practices, include traditional oversight functions or functions that 
can easily be delegated to a DCM's CRO.\80\ Some

[[Page 6952]]

examples of traditional committee responsibilities that can easily be 
performed by an ROC without undue interference in managerial 
relationships include: recommending rule changes or going on the record 
as opposed to a rule change originating elsewhere within the DCM; 
determining an appropriate regulatory budget in conjunction with the 
CRO and then forwarding that determination for consideration by the 
full board; arriving at employment decisions with respect to senior 
regulatory personnel and then forwarding those determinations for 
consideration by the full board; annual review and reporting on 
regulatory performance to the full board, etc.
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    \79\ For example, whereas the compensation of senior DCM 
executives typically may be recommended to the board by a 
compensation committee, the compensation of the CRO will be 
recommended by the ROC. This provides insulation to the CRO and the 
regulatory personnel beneath him or her, but does not infringe upon 
the board's final decision-making authority. Similarly, a ROC, 
rather than a budget committee, should be the body that formally 
recommends the appropriate level of regulatory expenditures for the 
DCM. Again, the salutary effect is to insulate a crucial self-
regulatory decision, but not to remove it from the ultimate purview 
of the full board of directors. In these and similar instances, the 
Commission will be in a position to evaluate how boards treat ROC 
recommendations, thus adding Commission review as an additional 
level of self-regulatory insulation.
    \80\ The text of the final acceptable practices makes clear that 
ROCs' shall ``supervise the contract market's chief regulatory 
officer, who will report directly to the ROC.'' This two-way 
relationship--delegation of certain responsibilities from the ROC to 
the CRO combined with supervision of the CRO by the ROC--is a key 
element of the insulation and oversight provided by the ROC 
structure. It permits regulatory functions and personnel, including 
the CRO, to continue operating in an efficient manner while 
simultaneously protecting them from any improper influence which 
could otherwise be brought to bear upon them. The ROC Acceptable 
Practice identifies key levers of influence, including authority 
over the conduct of investigations, the size and allocation of the 
regulatory budget, and employment and compensation decisions with 
respect to regulatory personnel, among others, and then places them 
within the insulated ROC/CRO-regulatory personnel relationship. 
While in no way diminishing the ultimate authority of the board of 
directors, this three-part relationship is intended to protect 
regulatory functions and personnel, including the CRO, from improper 
influence in the daily conduct of regulatory activities and broader 
programmatic regulatory decisions.
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    ROCs' most important responsibility will simply be to insulate 
self-regulatory functions and personnel from improper influence. Such 
insulation does not usurp established authority, but rather acts as a 
filter through which it must pass, and be cleansed of any efforts to 
exercise improper influence or drive regulatory decisions according to 
commercial interest. One facet of the insulation provided by an ROC 
clearly is the relationship between it and its CRO, and through him or 
her, all regulatory functions, personnel, and decisions. The Commission 
has endeavored to identify the levers of influence that may be used to 
pressure an individual, or an entire regulatory department, and to 
place ROCs alongside those levers. Matters such as the hiring, 
termination, and compensation of regulatory personnel, and size of 
regulatory budgets, are clearly areas where insulation from improper 
influences may be beneficial. The insulation provided by the ROC 
Acceptable Practice, however, need not interfere with the established 
relationships between management, staff, and others necessary to 
effective self-regulation.
5. Comments With Respect to the Disciplinary Committee Acceptable 
Practice
    Several commenters addressed the proposed Disciplinary Panel 
Acceptable Practice provision that all DCM disciplinary panels include 
at least one public participant and that no panel be dominated by any 
group or class of DCM members. The FIA and large FCMs that commented 
were generally supportive of the proposed Disciplinary Panel Acceptable 
Practice, with the FIA commenting that one public member of a DCM 
disciplinary panel should be a prerequisite for safe harbor relief, but 
that a 50% public independent member standard for such panels would be 
much more in keeping with the spirit of the proposed acceptable 
practices. One large FCM noted that the proposal's composition 
requirement would avoid the perception of conflict and lack of fairness 
and impartiality. Another large FCM commented that it supports the 
proposed provision that would require rules precluding any group or 
class of industry participants from dominating or exercising 
disproportionate influence on disciplinary panels.
    Although two large DCMs commented that it is not necessary for the 
Commission to prescribe diversity on disciplinary panels, most of the 
smaller DCMs that commented in this area were supportive of the 
proposed acceptable practice. One smaller DCM that hires hearing 
officers to determine whether to bring a disciplinary action, however, 
commented that this proposed acceptable practice is not necessary for 
that DCM as it did not have any widespread inadequacies.
    Two commenters addressed what should be the qualifications of the 
public person serving on disciplinary panels; one agreed that having a 
public person on disciplinary panels is a sound proposition, but 
recommended that such person need not be subject to the same qualifying 
criteria as public directors. Another requested that the Commission 
clarify that the proposed board determination and reporting 
requirements with respect to public directors generally are unnecessary 
for public persons serving on disciplinary panels. The same commenter 
also requested clarification that the Disciplinary Panel Acceptable 
Practice's exclusion of decorum or attire cases from the requirement 
that one public person serve on disciplinary panels also applies to 
cases limited to certain recordkeeping matters (e.g., the timely 
submission of accurate records required for clearing or verifying each 
day's transactions or other similar activities).
5a. The Commission's Response to Comments on the Disciplinary Panel 
Acceptable Practice
    After carefully reviewing these comments, the Commission is 
satisfied that the Disciplinary Panel Acceptable Practice should be 
implemented as proposed. The Commission believes that fair disciplinary 
procedures, with minimal conflicts of interest, require disciplinary 
bodies that represent a diversity of perspectives and experiences. The 
presence of at least one public person on disciplinary bodies also 
provides an outside voice and helps to ensure that the public's 
interests are represented and protected. This approach is consistent 
with the Commission's overall objective of ensuring an appropriate 
level of public representation at every level of DCM decision making, 
while simultaneously calibrating the required number of public persons 
to the nature and responsibility of the decision-making body in 
question.
    The Disciplinary Panel Acceptable Practice accomplishes these dual 
objectives of diversity and public representation, while also 
maintaining the expertise necessary to evaluate sometimes complex 
disciplinary matters. The Commission also is comfortable that its RER 
process is well-positioned to evaluate the performance of DCM 
disciplinary committees and panels, such that a substantially higher 
proportion of public representation or other ameliorative steps are not 
required. RERs typically examine all of a DCM's disciplinary cases 
during a target period in detail, including reviews of disciplinary 
committee and panel minutes, investigation reports, settlement offers, 
and sanctions imposed. The Commission also pays careful attention to 
the recommendations of DCM compliance staff, to disciplinary bodies' 
responses to those recommendations, and to the analysis and rationale 
offered by disciplinary bodies in support of their decisions. If 
disciplinary committees and panels are underperforming, the Commission 
will be able to recognize any shortcomings and take appropriate 
measures.
    The work of disciplinary panels requires more specialized knowledge 
of futures trading than almost any other governing arm of a DCM. 
Neither the strategic business decisions made by boards of directors, 
nor the oversight conducted by ROCs, for example, require as much 
technical futures trading expertise as disciplinary panel service. 
Accordingly, the Commission believes that increasing the proportion of 
public representatives on disciplinary panels to 50%, as suggested by 
one commenter, would eliminate too much expertise from the disciplinary 
process and is unwarranted.
    The Commission recognizes that a small number of DCMs may have 
unique disciplinary structures. However, the Commission strongly 
believes that diverse panels, including at least one public person, are 
appropriate for all DCMs. Should an individual DCM choose to comply 
with this element of Core Principle 15 by other means, the Commission 
will examine and monitor it to ensure full core principle compliance.
    Other specific requests for modifications and/or clarifications 
with respect to the Disciplinary Panel

[[Page 6953]]

Acceptable Practice are treated separately in Section IV(E) below.

IV. Specific Requests for Modifications and/or Clarifications That the 
Commission Has Determined To Grant or Deny

    Several commenters made specific requests for modifications and/or 
clarifications that the Commission has determined to grant in some 
instances and deny in others. The specific modifications and/or 
clarifications do not represent changes in the proposed acceptable 
practices, but rather implement the Commission's original intent. They 
are described below.

A. Phase-in Period for the New Acceptable Practices

    Several commenters indicated concern that adoption of the proposed 
acceptable practices, particularly the requirement to restructure the 
board, would be burdensome, time consuming and costly. For instance, 
one large DCM commented that implementation of the acceptable practices 
would necessitate major changes and cause significant disruption for 
DCMs, virtually none of which currently meet the proposed 50% public 
director standard (or the minimum 35% standard adopted in this final 
release). Another large DCM commented that publicly held DCMs 
implementing the acceptable practices would have to amend their 
certificates of incorporation, by-laws, and various public disclosures 
and respond to any shareholder challenge. As a result of the perceived 
time requirement, several commenters requested that, if the proposals 
are adopted, the Commission should provide for an adequate phase-in 
period.
    The Commission hereby grants an appropriate phase-in period. The 
new acceptable practices for Core Principle 15 are effective 30 days 
after publication in the Federal Register. Under the phase-in period 
described below, DCMs may take up to two years or two regularly-
scheduled board elections, whichever occurs first, to fully implement 
the new acceptable practices or otherwise demonstrate full compliance 
with Core Principle 15. The Commission expects that DCMs will begin 
making preparations and taking conforming steps early in the phase-in 
period. Accordingly, six months after publishing these acceptable 
practices in the Federal Register, the Commission will survey all DCMs 
to evaluate their plans for full compliance with Core Principle 15. The 
Commission also will monitor all DCMs throughout the phase-in period to 
evaluate their progress toward full compliance.
    Although DCMs are not required to implement the new acceptable 
practices, the Commission has determined that full compliance with Core 
Principle 15 requires all DCMs to address structural conflicts of 
interest between their regulatory responsibilities and their commercial 
interests or those of their numerous constituencies. Such measures must 
be present throughout DCMs' decision-making processes. DCMs choosing to 
adopt measures other than the final acceptable practices adopted herein 
should consider and address key areas of decision making that are 
subject to conflicts of interest. These may include decisions with 
respect to regulatory budgets, expenditures, and funding; employment, 
compensation, and similar decisions involving regulatory personnel; the 
constitution of disciplinary panels; the promulgation of rules with a 
potential regulatory impact; decision making with respect to the 
investigation, prosecution, and sanctioning of disciplinary offenses; 
and the chain of command in compliance programs (including trade 
practice surveillance, market surveillance, and financial surveillance) 
beyond regulatory officers. The Commission will consider all of these 
factors in evaluating compliance with Core Principle 15.

B. Selection of Public Directors

    With respect to the placement of public directors on boards, one 
DCM commented that the proposing release calls upon DCMs to ``elect'' 
boards composed of at least 50% public members, but that at that 
particular DCM public governors are not elected but are identified and 
appointed by the board itself. Further, election of public members 
might discourage potential candidates because having to stand for 
election creates the potential for elected individuals to be beholden 
to their electing constituency, especially if the position is 
compensated. Another commenter noted that the proposing release 
suggests a role for nominating committees in the selection of public 
directors, and asked for clarification that nominating committees are 
not required to be involved. Conversely, the FIA recommended that a 
subgroup of public directors should serve as a nominating committee to 
select new or re-nominate existing public directors.
    The Commission hereby clarifies that DCMs may select their public 
directors in the manner most appropriate to them. Compliance with the 
new acceptable practices for Core Principle 15 does not require the use 
of nominating committees, the ``election'' of public directors, or the 
selection of public directors by any pre-specified means. DCMs are free 
to select their public directors by any process they choose, as long as 
their public directors meet the requirements set forth in the new 
acceptable practices. In addition, the Commission expects that the 
tenures and terms of public directors will be no less secure than that 
of other directors of the DCM. For example, if other directors can be 
removed only for cause, then that same protection should extend to 
public directors. Similarly, if other directors are selected for two-
year terms, then public directors should be as well, etc.
    The Commission considered FIA's request for a special nominating 
committee for public directors. However, in promulgating these 
acceptable practices, the Commission has been careful to focus on 
outcomes--the insulation of regulatory functions, a pure public voice 
in board deliberations, and fair disciplinary proceedings-while 
providing only as much instruction as necessary to achieve the safe 
harbor.

C. Compensation of Public Directors

    As summarized in Section III above, several commenters requested 
clarifications or amendments with respect to the compensation of public 
directors under the Public Director Acceptable Practice. Section 
(2)(B)(iii) of the proposed acceptable practices specified that a 
public director may not receive more than $100,000 in payments from the 
DCM (or any affiliate of the DCM, or from a member or anyone affiliated 
with a member) other than for services as a director. One commenter 
asked whether deferred compensation for prior services would count 
toward the $100,000 payment limit for public directors. It does not. 
The Commission hereby affirms that public directors may receive 
deferred compensation for prior services in excess of $100,000, and 
that such compensation will not count towards the $100,000 payment 
limit for public directors. To comply with the acceptable practices, 
DCMs must ensure that any such compensation is truly deferred 
compensation for prior services. Thus, the agreement by which the 
public director is being compensated should predate his or her 
selection as a public director. Furthermore, it should in no way be 
conditioned upon the directors' future performance, services, or 
behavior, and in no way be revocable by the compensating party.
    FIA requested clarification that the $100,000 payments cap for 
public directors, for services other than as a

[[Page 6954]]

director, is a cumulative cap on compensation from DCMs and their 
membership. The Commission hereby confirms that FIA's understanding is 
correct. The $100,000 payment cap is an annual, cumulative cap on 
payments to the public director from all ``relevant'' sources (i.e., 
the DCM, any affiliate of the DCM, or any member or affiliate of a 
member of the DCM) combined. As explained previously, the $100,000 cap 
also includes indirect payments made by a DCM, its affiliates, and its 
members or affiliates of its members to the director. In addition, the 
$100,000 payment cap is an annual cap, as summarized above.
    Finally, FIA argued that the Commission should preclude public 
directors from receiving any compensation from the DCM, but that 
compensation received by a director's firm, rather than the director 
itself should not count towards any compensation cap. The Commission 
considered both comments carefully, but determined that neither is 
appropriate. The Public Director Acceptable Practice's compensation 
cap, higher than that requested by FIA, combined with its narrow limits 
on where such compensation may originate, strikes the proper balance 
between an effective but not overly restrictive definition of public 
director.
    The Commission strongly believes that significant compensation paid 
by a DCM or its affiliates to a firm could adversely impact the 
independence of a director affiliated with that firm. In the 
Commission's opinion, any such relationship between a DCM and a 
director, through the director's firm, clearly rises to the level of a 
``material relationship'' that would preclude the director from serving 
as a public director. Accordingly, the Commission hereby clarifies that 
a director affiliated with a firm receiving over $100,000 in 
compensation from the DCM or an affiliate of the DCM may not qualify as 
a public director.

D. Overlapping Public Directors

    At least one commenter requested clarification with respect to 
overlapping public directors at DCMs whose ownership structures include 
a parent-subsidiary relationship. In the proposed acceptable practices, 
Sections (2)(B)(i) and (2)(B)(v), when read together, suggested that 
the same person could not serve as a public director at both the parent 
company and its subsidiary DCM. The question is most likely to arise in 
the context of DCMs that are subsidiaries of publicly traded companies, 
and whose boards of directors overlap in whole or in part with those of 
their public parents.
    The Commission hereby clarifies that overlapping public directors 
are permitted. However, such directors must still meet the Commission's 
definition of public director, as set forth in the Public Director 
Acceptable Practice. In effect, overlapping public directors must carry 
the Commission's definition of ``public'' director from their DCMs to 
the holding companies' boards of directors. Conforming language has 
been added to the final acceptable practices.

E. Jurisdiction of Disciplinary Panels and Definition of ``Public'' for 
Persons Serving on Disciplinary Panels

    One commenter asked the Commission to confirm that DCM disciplinary 
panels considering cases involving the timely submission of accurate 
records required for clearing or verifying each day's transactions need 
not include a public person. The Commission included such language in 
the preamble to the proposed Disciplinary Panel Acceptable Practices, 
but neglected to include it in the text of the acceptable practices 
themselves. The Commission is correcting that oversight and modifying 
the final acceptable practices for Core Principle 15 to make clear that 
disciplinary panels considering cases involving the timely submission 
of accurate records required for clearing or verifying each day's 
transactions need not include a public member.
    The same commenter requested clarification that public members of 
DCM disciplinary panels need only meet the ``bright-line'' tests for 
public directors contained in Section (2)(B)(i-v) and (2)(C) of the 
proposed acceptable practices. That was, in fact, the Commission's 
intent. Public members of disciplinary panels are not subject to the 
broader ``no material relationship'' test of Section (2)(i), nor the 
disclosure requirements of Section (2)(v) in the final acceptable 
practices. The Commission is confident that the new bright-line tests, 
combined with DCMs' existing personal conflicts of interest provisions, 
are sufficient to ensure impartial public representatives on 
disciplinary panels. Furthermore, the Commission also believes that 
requiring DCMs to conduct and disclose a material relationship test for 
disciplinary panel members would constitute an unjustifiable burden at 
this time. Conforming changes have been made in the final acceptable 
practices.

F. ``No Material Relationship Test''

    Section (2)(B)(ii) of the proposed acceptable practices precludes a 
DCM director from being considered public if he or she is a member of 
the DCM, or employed by or affiliated with a member. A director is 
``affiliated with a member'' if he or she is an officer or director of 
the member. The Commission hereby adds an additional element to that 
definition: a DCM director is affiliated with a member if he or she has 
any relationship with the member such that his impartiality could be 
called in question in matters concerning the member.
    The Commission believes that this additional element of 
``affiliated'' is a natural outgrowth of its original proposal. In 
particular, the proposed acceptable practices already precluded a DCM's 
public directors from also serving as employees, officers, or directors 
of a member. Combined with the materiality test in Section (2)(A) of 
the proposed acceptable practices, the Commission's intent to capture a 
broad array of relationships is clear. Properly applied, the proposed 
Public Director Acceptable Practice already excluded from service as 
public directors persons whose relationship with a member firm could 
call their impartiality into question. Whether the relevant 
relationships are employment, or similar to employment--independent 
contracting, legal services, consulting, or other relationships--they 
are precluded by the Public Director Acceptable Practice. Conforming 
language has been added to the final acceptable practices.

G. Elimination of ROCs' Periodic Reporting Requirements

    Finally, the Commission is removing certain language from Section 
3(B)(v) of the proposed acceptable practices. Among other things, this 
section called for ROCs to ``prepare periodic reports for the board of 
directors and an annual report assessing the contract market's self-
regulatory program. * * *'' While the annual reporting obligation 
remains in full effect, the Commission has determined that an explicit 
requirement to prepare periodic reports for the board is unnecessary at 
this time. DCM boards of directors are free to request reports, 
updates, and information from committees whenever they wish, and 
committees are free to provide them even if not requested. Nothing in 
the ROC Acceptable Practice is intended to change that dynamic.

[[Page 6955]]

V. Related Matters

A. Cost-Benefit Analysis

    Section 15(a) of the CEA,\81\ as amended by Section 119 of the 
CFMA, requires the Commission to consider the costs and benefits of its 
action before issuing a new regulation or order under the CEA. By its 
terms, Section 15(a) does not require the Commission to quantify the 
costs and benefits of its action or to determine whether the benefits 
of the action outweigh its costs. Rather, Section 15(a) simply requires 
the Commission to ``consider the costs and benefits'' of the subject 
rule or order.
---------------------------------------------------------------------------

    \81\ 7 U.S.C. 19(a).
---------------------------------------------------------------------------

    Section 15(a) further specifies that the costs and benefits of the 
proposed rule or order shall be evaluated in light of five broad areas 
of market and public concern: (1) Protection of market participants and 
the public; (2) efficiency, competitiveness, and financial integrity of 
futures markets; (3) price discovery; (4) sound risk management 
practices; and (5) other public interest considerations. The Commission 
may, in its discretion, give greater weight to any one of the five 
enumerated areas of concern and may, in its discretion, determine that, 
notwithstanding its costs, a particular rule or order is necessary or 
appropriate to protect the public interest or to effectuate any of the 
provisions or to accomplish any of the purposes of the CEA.\82\
---------------------------------------------------------------------------

    \82\ E.g, Fishermen's Dock Co-op., Inc. v. Brown. 75 F.3d 164 
(4th Cir. Va. 1996); Center for Auto Safety v. Peck, 751 F.2d 1336 
(D.C. Cir. 1985) (agency has discretion to weigh factors in 
undertaking costs-benefits analyses).
---------------------------------------------------------------------------

    In the proposing release, the Commission considered the costs and 
benefits of the acceptable practices, requested comment on the 
application of the criteria contained in Section 15(a) of the CEA, and 
invited commenters to submit any quantifiable data that they might 
have.
    DCM commenters asserted that the costs of compliance outweighed any 
benefit, particularly the costs of amending governing documents in the 
manner required by Delaware corporate law. A number of DCMs and 
individuals contended that the Board Composition Acceptable Practice 
(and the other proposed acceptable practices) is unnecessary and that 
the Commission's cost-benefit analysis is flawed. Commenters asserted 
that the acceptable practices present no or minimal benefit, since the 
Commission failed to demonstrate any problems in the futures industry 
to warrant issuance of any of the acceptable practices.\83\ Several 
commenters distinguished between securities industry reforms, which 
followed public scandals, and the recent absence of such events in the 
futures industry.\84\
---------------------------------------------------------------------------

    \83\ See, e.g., CME CL 29 at 9; NYMEX CL 28 at 10-11; NYBOT CL 
22 at 4; CBOT CL 21 at 3.
    \84\ See, e.g., NYMEX CL 28 at 11-13; CME CL 29 at 9; NYBOT CL 
22 at 2; Comment of Donald L. Gibson, CL 25 at 1.
---------------------------------------------------------------------------

    As noted above, however, the Commission identified significant 
futures industry trends, including increased competition and changing 
ownership structures, which justify the acceptable practices as a 
prophylactic measure to minimize conflicts of interest in DCM decision 
making and to promote public confidence in the futures markets in the 
altered landscape. Minimizing conflicts and promoting public confidence 
in the futures markets are significant benefits for the futures 
industry, market participants, and the national public interest served 
by the futures markets.
    KCBT and NYBOT commented that, as small, non-public DCMs, they do 
not present the types of conflicts the Commission sought to address in 
expanding public participation on DCM governing boards.\85\ 
HedgeStreet, a small electronic DCM, expressed similar views.\86\ The 
Commission sees no rational basis for the proposition that size 
insulates a DCM from conflicts of interest. The potential impact 
arising from an improperly managed conflict may well be less at a 
smaller DCM than at a large one. The magnitude of potential harm is not 
the appropriate standard for taking prophylactic measures. What matters 
is whether the means proposed will impact small DCMs 
disproportionately. Neither KCBT, NYBOT, nor HedgeStreet have 
identified a disproportionate burden. Nor have they shown how their 
status as non-public DCMs immunizes them from conflicts. As the 
Commission made clear in proposing the acceptable practices, DCMs that 
become public, stockholder-owned corporations face an additional, new 
layer of conflict. Conflicts are inherent in other forms of ownership 
as well. Such conflicts may be minimized at all sizes and forms of DCMs 
by an increase in the percentage of public directors.
---------------------------------------------------------------------------

    \85\ KCBT at CL 8 at 2; NYBOT CL at 4. NYBOT has informed the 
Commission of its intent to be acquired by ICE and run as a for-
profit subsidiary. Accordingly, its comment has little relevance to 
its own contemplated future circumstances.
    \86\ See HedgeStreet CL 17.
---------------------------------------------------------------------------

    If any DCM faces a particular burden peculiar to its individual 
circumstances in complying with the acceptable practices, that DCM may, 
as a matter of statute, choose an alternative method of complying with 
Core Principle 15 that is responsive to its circumstances. However, 
such DCM must still demonstrate, to the Commission's satisfaction, that 
its alternative method effectively addresses conflicts of interest in 
decision making under Core Principle 15, including structural conflicts 
of interest.
    DCM commenters asserted that complying with the Board Composition 
Acceptable Practice will be an expensive undertaking requiring 
amendment of corporate charters and other documents, and that the 
Commission gave too little consideration to these costs. For example, 
NYMEX states:

    The process of preparing * * * bylaw changes requires a 
commitment of time both by in-house exchange staff as well as by 
specialized legal advisors. This process can be fairly time-
intensive with regard to review by such professionals of various 
drafts of amendments and other material for shareholders in relation 
to the successive SEC filings. There are the obvious costs generated 
by numerous runs by the applicable print shop specializing in SEC 
filing productions as well as the not inconsiderable costs of 
overnight shipping of the shareholder materials to hundreds if not 
thousands of shareholders of record.\87\ >
---------------------------------------------------------------------------

    \87\ NYMEX CL at 20 n.32.

    Arguments such as these are not persuasive. NYMEX describes a 
process, and asserts that it entails a cost, but fails even to estimate 
that cost, or to place the cost in any kind of context that would allow 
the Commission to judge the level of burden. Other comments alleging 
burdensome costs are similarly flawed. The Commission has no basis to 
conclude that compliance is other than a reasonable cost of doing 
business in an industry subject to federal oversight. Moreover, the 
costs may be phased in over a period of time. In this final release, 
although the acceptable practices will be effective immediately, the 
Commission is adopting a phase-in period of two years or two board 
election cycles, whichever occurs first.
    The DCMs' contentions that any level of compliance is burdensome 
because they already are subject to other governance regimes miss the 
mark. CME, CBOT, and NYMEX essentially contended that the governance 
provisions of the Delaware General Corporation Law under which they are 
organized, and the NYSE Listing Standards, contain sufficient 
provisions to assure sound governance.\88\ The

[[Page 6956]]

member-owned DCMs, NYBOT, KCBT, and their supporters, state that the 
diversity standards of Core Principle 16 provide an adequate bulwark 
against conflicts of interest, and that the membership presence on 
their boards will be diluted if a large contingent of public directors 
is admitted.\89\ These arguments overlook the overarching purpose of 
the Board Composition Acceptable Practice, which is expressly to 
minimize conflicts of interest by addressing the keystone of all 
corporate decision making--the board of directors.
---------------------------------------------------------------------------

    \88\ CME CL 29 at 14; CBOT CL 21 at 6-7; NYMEX CL 28 at 5-6, 15.
    \89\ NYBOT CL 22 at 3-4; KCBT CL 8 at 1-2; for their supporters, 
see, e.g., comment of Michael Braude, CL 10 at 1.
---------------------------------------------------------------------------

    CME stated that the responsibility imposed on public directors to 
act in the public interest actually conflicts with the duty owed to 
shareholders under Delaware corporate law and the NYSE Listing 
Standards.\90\ The Commission's review of corporate law authority 
reveals no such conflict. These proposals are entirely consistent with 
bedrock corporate law principles: as Delaware corporations, they are 
run ``by or under the Board of Directors.'' \91\ Directors act as 
fiduciaries of stockholders, to be sure, but that does not mean the 
performance of their duties is limited to serving the narrow interests 
of stockholders. Those affairs include complying with the various 
statutes to which the corporation is subject. Shareholders are well-
served or ill-served by the quality of the directors' discharge of 
their statutory duties.
---------------------------------------------------------------------------

    \90\ CME CL 29 at 8.
    \91\ Del. Code Ann. tit. 8, Sec.  141(a).
---------------------------------------------------------------------------

    Corporate law experts generally agree that outside directors 
benefit corporate governance generally. ``[M]ost persons in academia 
and business agree that outside directors play an important role in the 
effective functioning of the board.'' \92\ The suggestion of some 
commenters that public directors have an inherent conflict between the 
public interest and their duty to shareholders is misplaced. The 
acceptable practices address DCM governing boards, not the boards of 
parent public holding companies. DCMs--and their governing bodies--are 
vested with a public interest duty under the plain text of the CEA. 
Moreover, the public interest duty applies to nonpublic as well as 
public directors. The Commission is aware of overlapping board 
memberships--i.e., that the members of a DCM governing board may be the 
same individuals as those who serve on the parent board. This is 
entirely permissible. When an individuals sits, deliberates and acts in 
respect of the governance of the registered entity, he or she must do 
so consistently with the public interest mandate of the CEA.
---------------------------------------------------------------------------

    \92\ D. Pease, ``Outside Directors: Their Importance to the 
Corporation and Protection from Liability,'' 12 Del. J. Corp. L. 25, 
31 et seq. (1987) (citing extensive authority and noting the legal 
advantages of outside directors).
---------------------------------------------------------------------------

    A number of commenters who wrote in support of KCBT and NYBOT 
assumed that public directors will lack interest and experience, and 
add little to board deliberations.\93\ These commenters, however, 
offered no empirical evidence to support their speculation. The 
Commission notes that many DCM boards already include public directors 
who have been deemed qualified and competent by the DCMs. As discussed 
previously, the boards of exchanges such as the KCBT, MGEX, NYMEX, 
NYBOT, and CME, are typically 20% or more non-member. Moreover, the 
acceptable practices do not preclude non-member producers, retired and 
former industry persons, academics, and others from being considered 
public directors, which should provide a significant pool of futures 
industry experience from which to draw. DCMs that fear adding public 
directors will expand their boards to an unwieldy size may comply with 
the acceptable practices by phasing in public directors into existing 
seats.
---------------------------------------------------------------------------

    \93\ See, e.g., Comment of Dennis M. Erwin, CL 18 at 1; Comment 
of John Legg, CL 14 at 1; and Comment of Robert J. Rixey, CL 11 at 
1.
---------------------------------------------------------------------------

    One commenter contended that in prior cost-benefit analyses, the 
Commission has addressed each of the five considerations under Section 
15(a) separately, and that this approach would have facilitated public 
comment.\94\ However, the Commission has not always addressed each 
consideration separately in its rulemakings, nor is it required by the 
statute to do so. Section 15(a) requires that costs and benefits be 
evaluated in terms of the five considerations, but the Commission may 
give greater weight to any one of them. The cost-benefit analysis in 
the proposed acceptable practices provided sufficient notice to the 
public regarding the considerations to which the Commission accorded 
the greatest weight. The same commenter asserted that the Commission 
should endeavor to apply the relevant factors separately to each major 
proposal.\95\ Again, however, the statute does not require that the 
Commission apply the factors in this fashion, but allows it to consider 
the costs and benefits in light of the impact of its proposal as a 
whole. Finally, the commenter encouraged the Commission to consider 
regulatory alternatives in its cost-benefit analysis.\96\ As noted 
above, however, the only alternative suggested by the commenters was 
that the Commission do nothing. They suggested no other alternative 
that would address the concerns cited by the Commission in proposing 
the acceptable practices. In the Commission's judgment, these 
acceptable practices serve to protect the public interest in a manner 
that minimizes the costs to the industry while demonstrating compliance 
with Core Principle 15.
---------------------------------------------------------------------------

    \94\ NYMEX CL 32 at 20.
    \95\ Id.
    \96\ Id.
---------------------------------------------------------------------------

    As was discussed in the proposing release, the acceptable practices 
described herein are safe harbors for compliance with Core Principle 
15's conflict of interest provisions. They offer DCMs the opportunity 
to meet the requirements of Core Principle 15 through a regulatory 
governance structure that insulates their regulatory functions from 
their commercial interests. The Board Composition Acceptable Practice 
provides that DCMs implement boards of directors and executive 
committees thereof that are at least 35% public. The ROC Acceptable 
Practice further provides that all DCMs place oversight of core 
regulatory functions in the hands of board-level ROCs composed 
exclusively of ``public'' directors. The Public Director Acceptable 
Practice offers guidance on what constitutes a ``public'' director. In 
addition, the Disciplinary Panel Acceptable Practice suggests minimum 
composition standards for DCM disciplinary committees. As noted above, 
although the acceptable practices will be effective immediately, the 
Commission is allowing a phase-in period for DCMs to implement them.
    The proposed acceptable practices are consistent with legislative 
and regulatory requirements, and voluntarily undertaken changes in 
governance practices in other financial sectors, such as the securities 
markets, and are intended to enhance protection of the public. The 
Commission has endeavored to establish the least intrusive safe harbors 
and regulatory requirements that reasonably can be expected to meet the 
requirements of Core Principle 15 of the CEA. These acceptable 
practices advance the Commission's mandate of assuring the continued 
existence of competitive and efficient markets and to protect the 
public interest in markets free of fraud and abuse. They nevertheless 
may be expected to entail some costs, including, among the most 
foreseeable, those attendant to recruiting and appointing additional 
directors, amending corporate documents, making necessary

[[Page 6957]]

rule changes and certifying them to the Commission, and appointing a 
Chief Regulatory Officer. In light of the reduction of the percentage 
of public board members from 50% in the Board Composition Acceptable 
Practice as proposed to at least 35%, and the phase-in period, the 
Commission believes that these costs will not impose a significant 
burden and can be borne over time. After considering the costs and 
benefits of the acceptable practices, and considering the comments 
received in response to its proposal, the Commission has determined to 
issue the acceptable practices for Core Principle 15 with respect to 
DCMs.

B. Paperwork Reduction Act of 1995

    The acceptable practices contain information collection 
requirements. As required by the Paperwork Reduction Act of 1995 (44 
U.S.C. 3504(h)), the Commission has submitted a copy of this section 
and the acceptable practices to the Office of Management and Budget 
(``OMB'') for its review.
    The revision of collection of information has been reviewed and 
approved by the Office of Management and Budget pursuant to the 
Paperwork Reduction Act, under control number 3038-0052. 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. In the Notice of Proposed Acceptable Practices, the Commission 
estimated the paperwork burden that could be imposed by the acceptable 
practices and solicited comment thereon. 71 FR 38740, 38748 (July 7, 
2006). No specific or sufficiently material comment was received.
    Copies of the information collection submission to OMB are 
available from the Commission Clearance Officer, Three Lafayette 
Centre, 1155 21st Street, NW., Washington DC 20581, (202) 418-5160.

C. Regulatory Flexibility Act

    The Regulatory Flexibility Act, 5 U.S.C. 601 et seq., requires 
federal agencies, in promulgating rules, to consider the impact of 
those rules on small entities. The final acceptable practices affect 
designated contract markets. The Commission has previously determined 
that designated contract markets are not small entities for purposes of 
the Regulatory Flexibility Act.\97\ Accordingly, the Chairman, on 
behalf of the Commission, hereby certifies pursuant to 5 U.S.C. 605(b) 
that the final acceptable practices will not have a significant 
economic impact on a substantial number of small entities.
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    \97\ Policy Statement and Establishment of Definitions of 
``Small Entities'' for Purposes of the Regulatory Flexibility Act, 
47 FR 18618, 18619 (Apr. 30, 1982).
---------------------------------------------------------------------------

VI. Text of Acceptable Practices for Core Principle 15

List of Subjects in 17 CFR Part 38

    Commodity futures, Reporting and recordkeeping requirements.

0
In light of the foregoing, and pursuant to the authority in the Act, 
and in particular, Sections 3, 5, 5c(a) and 8a(5) of the Act, the 
Commission hereby amends part 38 of title 17 of the Code of Federal 
Regulations as follows:

PART 38--DESIGNATED CONTRACT MARKETS

0
1. The authority citation for part 38 is revised to read as follows:

    Authority: 7 U.S.C. 2, 5, 6, 6c, 7, 7a-2 and 12a, as amended by 
Appendix E of Pub. L. 106-554, 114 Stat. 2763A-365.


0
2. In Appendix B to Part 38 amend Core Principle 15 by adding paragraph 
(b) ``Acceptable Practices'' to read as follows:

Appendix B to Part 38--Guidance on, and Acceptable Practices in, 
Compliance With Core Principles.

* * * * *
    Core Principle 15 of section 5(d) of the Act: Conflicts of 
Interest
* * * * *
    (b) Acceptable Practices. All designated contract markets 
(``DCMs'' or ``contract markets'') bear special responsibility to 
regulate effectively, impartially, and with due consideration of the 
public interest, as provided for in Section 3 of the Act. Under Core 
Principle 15, they are also required to minimize conflicts of 
interest in their decision-making processes. To comply with this 
Core Principle, contract markets should be particularly vigilant for 
such conflicts between and among any of their self-regulatory 
responsibilities, their commercial interests, and the several 
interests of their management, members, owners, customers and market 
participants, other industry participants, and other constituencies. 
Acceptable Practices for minimizing conflicts of interest shall 
include the following elements:
    (1) Board Composition for Contract Markets
    (i) At least thirty-five percent of the directors on a contract 
market's board of directors shall be public directors; and
    (ii) The executive committees (or similarly empowered bodies) 
shall be at least thirty-five percent public.
    (2) Public Director
    (i) To qualify as a public director of a contract market, an 
individual must first be found, by the board of directors, on the 
record, to have no material relationship with the contract market. A 
``material relationship'' is one that reasonably could affect the 
independent judgment or decision making of the director.
    (ii) In addition, a director shall not be considered ``public'' 
if any of the following circumstances exist:
    (A) The director is an officer or employee of the contract 
market or a director, officer or employee of its affiliate. In this 
context, ``affiliate'' includes parents or subsidiaries of the 
contract market or entities that share a common parent with the 
contract market;
    (B) The director is a member of the contract market, or a person 
employed by or affiliated with a member. ``Member'' is defined 
according to Section 1a(24) of the Commodity Exchange Act and 
Commission Regulation 1.3(q). In this context, a person is 
``affiliated'' with a member if he or she is an officer or director 
of the member, or if he or she has any other relationship with the 
member such that his or her impartiality could be called into 
question in matters concerning the member;
    (C) The director, or a firm with which the director is 
affiliated, as defined above, receives more than $100,000 in 
combined annual payments from the contract market, any affiliate of 
the contract market, or from a member or any person or entity 
affiliated with a member of the contract market. Compensation for 
services as a director does not count toward the $100,000 payment 
limit, nor does deferred compensation for services prior to becoming 
a director, so long as such compensation is in no way contingent, 
conditioned, or revocable;
    (D) Any of the relationships above apply to a member of the 
director's ``immediate family,'' i.e., spouse, parents, children, 
and siblings.
    (iii) All of the disqualifying circumstances described in 
Subsection (2)(ii) shall be subject to a one-year look back.
    (iv) A contract market's public directors may also serve as 
directors of the contract market's parent company if they otherwise 
meet the definition of public in this Section (2).
    (v) A contract market shall disclose to the Commission which 
members of its board are public directors, and the basis for those 
determinations.
    (3) Regulatory Oversight Committee
    (i) A board of directors of any contract market shall establish 
a Regulatory Oversight Committee (``ROC'') as a standing committee, 
consisting of only public directors as defined in Section (2), to 
assist it in minimizing actual and potential conflicts of interest. 
The ROC shall oversee the contract market's regulatory program on 
behalf of the board. The board shall delegate sufficient authority, 
dedicate sufficient resources, and allow sufficient time for the ROC 
to fulfill its mandate.
    (ii) The ROC shall:
    (A) Monitor the contract market's regulatory program for 
sufficiency, effectiveness, and independence;
    (B) Oversee all facets of the program, including trade practice 
and market surveillance; audits, examinations, and other regulatory 
responsibilities with respect to member firms (including ensuring

[[Page 6958]]

compliance with financial integrity, financial reporting, sales 
practice, recordkeeping, and other requirements); and the conduct of 
investigations;
    (C) Review the size and allocation of the regulatory budget and 
resources; and the number, hiring and termination, and compensation 
of regulatory personnel;
    (D) Supervise the contract market's chief regulatory officer, 
who will report directly to the ROC;
    (E) Prepare an annual report assessing the contract market's 
self-regulatory program for the board of directors and the 
Commission, which sets forth the regulatory program's expenses, 
describes its staffing and structure, catalogues disciplinary 
actions taken during the year, and reviews the performance of 
disciplinary committees and panels;
    (F) Recommend changes that would ensure fair, vigorous, and 
effective regulation; and
    (G) Review regulatory proposals and advise the board as to 
whether and how such changes may impact regulation.
    (4) Disciplinary Panels
    All contract markets shall minimize conflicts of interest in 
their disciplinary processes through disciplinary panel composition 
rules that preclude any group or class of industry participants from 
dominating or exercising disproportionate influence on such panels. 
Contract markets can further minimize conflicts of interest by 
including in all disciplinary panels at least one person who would 
qualify as a public director, as defined in Subsections (2)(ii) and 
(2)(iii) above, except in cases limited to decorum, attire, or the 
timely submission of accurate records required for clearing or 
verifying each day's transactions. If contract market rules provide 
for appeal to the board of directors, or to a committee of the 
board, then that appellate body shall also include at least one 
person who would qualify as a public director as defined in 
Subsections (2)(ii) and (2)(iii) above.
* * * * *

    Issued in Washington, DC, on January 31, 2007 by the Commission.
Eileen A. Donovan,
Acting Secretary of the Commission.
[FR Doc. E7-2528 Filed 2-13-07; 8:45 am]
BILLING CODE 6351-01-P