Conflicts of Interest in Self-Regulation and Self-Regulatory Organizations, 18982-18990 [E9-9508]

Agencies

• Commodity Futures Trading Commission

[Federal Register Volume 74, Number 79 (Monday, April 27, 2009)]
[Rules and Regulations]
[Pages 18982-18990]
From the Federal Register Online via the Government Printing Office [www.gpo.gov]
[FR Doc No: E9-9508]


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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

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

ACTION: Final rule.

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SUMMARY: The Commission hereby adopts its final definition of ``public 
director'' for the acceptable practices to Section 5(d)(15) (``Core 
Principle 15'') of the Commodity Exchange Act (``CEA'' or ``Act'').\1\ 
In addition, the Commission is lifting the stay it had previously 
placed on these acceptable practices. All designated contract markets 
(``DCMs'') must demonstrate full compliance with Core Principle 15, via 
the acceptable practices or otherwise, within one year of this 
document's publication in the Federal Register. The acceptable 
practices and their procedural history

[[Page 18983]]

are summarized below, as is the final definition of public director.
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    \1\ The Act is codified at 7 U.S.C. 1 et seq. (2000). The 
acceptable practices for the DCM core principles reside in Appendix 
B to Part 38 of the Commission's Regulations, 17 CFR Part 38, App. 
B. 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 
Section 5(d)(15). 7 U.S.C. 7(d)(15).

DATES: Effective date: The stay is lifted on paragraph (b) of Core 
Principle 15 in Appendix B to 17 CFR Part 38 effective May 27, 2009. 
The amendments to the acceptable practices in appendix B to part 38 are 
effective May 27, 2009. Compliance date: All DCMs must demonstrate full 
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compliance with Core Principle 15 by April 27, 2010.

FOR FURTHER INFORMATION CONTACT: Rachel F. Berdansky, 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:

I. Background

A. Summary of the Acceptable Practices

    As noted above, the Commission hereby adopts its final definition 
of public director and lifts its stay on the acceptable practices for 
Core Principle 15.\2\ These important acceptable practices consist of 
four interrelated provisions, including three operating provisions 
(sections (1), (3), and (4)) and one which provides necessary 
definitions (section (2)). The operating provisions pertain to DCM 
boards of directors, the insulation and oversight of self-regulatory 
functions through regulatory oversight committees (``ROCs''), and the 
composition of disciplinary panels. More specifically, section (1) 
requires that a DCM's board and any executive committee of the board be 
composed of at least 35% public directors. Section (3) requires that a 
DCM's regulatory programs fall under the authority of a board-level ROC 
consisting exclusively of public directors. Section (4) requires that a 
DCM's disciplinary panels include at least one public person. To fully 
implement the acceptable practices, DCMs must enact all three sections.
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    \2\ As explained in the procedural history below, the Commission 
stayed the entire acceptable practices for Core Principle 15 in 
November of 2007. See Section B (``Procedural History of the 
Acceptable Practices and the Definition of Public Director'').
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    Sections (1), (3), and (4) of the acceptable practices are each 
dependent on the presence of one or more ``public'' persons, either 
public directors serving on the board, public directors serving on the 
ROC, or public members serving on disciplinary panels. Thus, the 
acceptable practices include an important fourth provision--section 
(2)--that defines ``public director'' and also impacts disciplinary 
panel members. The definition of public director includes several 
subsections. The first and most important, subsection (2)(i), is an 
overarching materiality test which requires that a public director 
``have no material relationship with the contract market.'' The 
definition also includes a series of bright-line tests in subsections 
(2)(ii)(A)-(2)(ii)(D), with specific relationships defined as per se 
material. Finally, subsections (2)(iii), (2)(iv) and (2)(v) pertain to 
a one-year look back period, affiliate relationships, and disclosure 
requirement, respectively.\3\
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    \3\ While not required under these acceptable practices, the 
Commission believes that DCMs benefit from endeavoring to recruit 
their public directors from a broad and culturally diverse pool of 
qualified candidates.
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    Given the acceptable practices' long procedural history, outlined 
below, industry participants may benefit from a brief review of their 
underlying rationale, purpose, and importance. Above all, the 
Commission emphasizes its full commitment to Core Principle 15's 
acceptable practices in their entirety. As the Commission noted when it 
adopted them, the acceptable practices ``recognize DCMs' unique public 
interest responsibilities as self-regulatory organizations (``SROs'') 
in the U.S. futures industry.'' \4\ They remind all DCMs that they 
``bear special responsibility to regulate effectively, impartially, and 
with due consideration of the public interest.'' \5\ They also clearly 
enumerate certain conflicts of interest for which DCMs must be alert. 
To comply with Core Principle 15, all DCMs must be ``particularly 
vigilant'' for ``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.'' \6\
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    \4\ 72 FR 6936 at 6937 (February 14, 2007).
    \5\ 17 CFR Part 38, App. B, Core Principle 15 (Acceptable 
Practices).
    \6\ Id.
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    When the Commission adopted the acceptable practices on January 31, 
2007, it noted new structural conflicts of interest in self-regulation 
as for-profit DCMs operate in a competitive, global environment. The 
Commission expressed concern with the presence of potentially 
conflicting demands--regulatory responsibility vs. commercial 
imperatives--within a single for-profit entity. It concluded that such 
conflicts, arising from new business models, new ownership structures, 
and increased competition, could be addressed through ``reforms within 
the DCMs themselves, including reforms of DCMs' governing bodies.'' \7\ 
The acceptable practices reflect both concrete measures that DCMs may 
implement and principles of modern self-regulation based on public 
representation and the insulation of regulatory functions. They embody 
the Commission's settled position 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.'' \8\
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    \7\ 72 FR at 6937.
    \8\ Id.
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    One principle embodied in the acceptable practices is the inclusion 
of public persons on DCM boards, executive committees, and disciplinary 
panels. Subsection (1)(i) of the acceptable practices requires that at 
least 35% of a DCM's directors be public directors, with an identical 
minimum ratio of public directors required for executive committees of 
the board or similarly empowered bodies under subsection (1)(ii). As 
the Commission explained when adopting the acceptable practices, it 
``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. * * * 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.'' \9\ The principle of public representation is 
also present in section (4) of the acceptable practices, which requires 
at least one public person on all disciplinary panels.\10\
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    \9\ 72 FR at 6947.
    \10\ A public person is not required for cases limited to 
decorum, attire, or the timely submission of accurate records 
required for clearing or verifying each day's transactions.
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    A second principle embodied in the acceptable practices is the ROC 
required under subsections (3)(i) and (3)(ii). ROCs are tasked with 
overseeing DCM regulatory programs, including monitoring those programs 
for sufficiency, effectiveness, and independence. Their 
responsibilities also include reviewing the size and allocation of 
DCMs' regulatory budgets and resources; reviewing the number, hiring, 
termination, and compensation of regulatory personnel; and supervising 
DCMs' chief regulatory officers, who should report directly to their 
ROCs. As described by the Commission, ``properly

[[Page 18984]]

functioning ROCs should be robust oversight bodies * * *.'' \11\ They 
should also ``represent the interests and needs of regulatory officers 
and staff; the resource needs of regulatory functions; and the 
independence of regulatory decisions.'' \12\ ROCs should consist 
exclusively of public directors. ``[A]nything less invites into 
regulatory oversight operations precisely those directors whose 
industry affiliations lend themselves to conflicts of interest in 
decision making.'' \13\
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    \11\ 72 FR at 6950.
    \12\ Id. at 6950-6951.
    \13\ Id. at 6951.
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    The three operating provisions described above--board composition, 
disciplinary panel composition, and ROC--are all dependent upon the 
definition of public director in section (2). Now, as that definition 
is finalized and the stay on the acceptable practices is lifted, all 
industry participants should be aware that the Commission's highest 
goal for self-regulation remains unchanged: Self-regulation must be 
vigorous, effective, and impartial. DCMs, in particular, are reminded 
that although they are free to comply with Core Principle 15 by means 
other than the acceptable practices, they must address the specific 
conflicts of interest that the Commission has identified and adopt 
measures that are substantive and responsive.

B. Procedural History of the Acceptable Practices and the Definition of 
Public Director

    On January 31, 2007, the Commission adopted its first acceptable 
practices for Core Principle 15, which requires all DCMs to minimize 
conflicts of interest in their decision making process. The acceptable 
practices focus on conflicts between DCMs' regulatory responsibilities 
and their commercial interests, and they offer all DCMs a safe harbor 
by which they may demonstrate core principle compliance. The acceptable 
practices for Core Principle 15 contain four provisions, including 
three ``operating'' provisions and one provision which primarily 
defines public director. All four provisions were published in the 
Federal Register on February 14, 2007.\14\ Existing DCMs were given a 
two-year phase-in period to implement the acceptable practices or 
otherwise demonstrate full compliance with Core Principle 15.
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    \14\ 72 FR 6936 (February 14, 2007).
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    On March 26, 2007, the Commission published the ``2007 proposed 
amendments,'' which made certain clarifications and other changes to 
the definition of public director.\15\ The proposed amendments did not 
alter the acceptable practices in any other respect. In proposing the 
amendments, the Commission emphasized that they should not be read as a 
diminution of the public representation, conflict-of-interest 
mitigation, and self-regulatory insulation intended by the acceptable 
practices. To that end, all three operating provisions in the 
acceptable practices remained as originally adopted.
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    \15\ 72 FR 14051 (March 26, 2007). In addition to the clarifying 
amendments, the Commission also proposed to correct a technical 
drafting error.
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    The Commission received six comment letters in response to the 2007 
proposed amendments, but after careful consideration determined not to 
act upon them.\16\ Instead, on November 23, 2007, the Commission gave 
notice via the Federal Register that the acceptable practices for Core 
Principle 15 were stayed indefinitely and in their entirety.\17\ 
Likewise, the two-year compliance period for existing DCMs also was 
stayed. With the definition of public director in flux, the Commission 
concluded that a stay was an appropriate measure while it arrived at a 
final definition of public director.
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    \16\ The six comment letters are summarized in 74 FR 3475 
(January 21, 2009).
    \17\ 72 FR 65658 (November 23, 2007).
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    Finally, on January 21, 2009, the Commission proposed and sought 
public comment on the ``2009 amendments,'' which also apply only to the 
definition of public director, and which are adopted herein.\18\ In 
publishing the 2009 amendments, the Commission asserted its continued 
commitment to ``the fundamental philosophy underpinning the acceptable 
practices for Core Principle 15: that potential conflicts of interest 
in self-regulation by for-profit and publicly-traded DCMs * * * can be 
addressed successfully through appropriate measures embedded in DCMs' 
governance structures.'' \19\ The Commission also reaffirmed ``its 
support for public representation on DCM boards of directors and 
disciplinary panels, including the 35% public board standard first 
enunciated in the acceptable practices,'' and its ``strong commitment 
to ROCs, consisting exclusively of public directors, to oversee all 
facets of DCMs' self-regulatory programs and staff.'' \20\ The 2009 
amendments and public comments thereon are summarized below. As stated 
previously, the Commission is adopting the 2009 amendments in their 
entirety.
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    \18\ 74 FR 3475.
    \19\ 74 FR at 3476-3477.
    \20\ Id. at 3477.
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C. Summary of the 2009 Amendments

    The 2009 amendments fall into four broad categories, all of which 
pertain to section (2) of the acceptable practices--the definition of 
public director. First, the Commission has amended subsection (2)(ii) 
to make its vocabulary more consistent with that in subsection (2)(i), 
but without altering its meaning. As originally adopted, the provision 
stated that ``* * * a director shall not be considered public if [the 
bright-line tests are not met].'' Now, subsection (2)(ii) reads ``* * * 
a director shall be considered to have a `material relationship' with 
the contract market if [the bright-line tests are not met].'' Because 
the overarching material relationship test in subsection (2)(i) 
precludes a person with a material relationship from serving as a 
public director, the purpose and effect of the provision remains 
unchanged.
    Second, the Commission has amended subsections (2)(ii)(A) and 
(2)(iv) to save a DCM's public directors from bright-line tests that 
they would have failed if they also served as directors of the DCM's 
affiliates. For this purpose, ``affiliate'' is now defined in 
subsection (2)(ii)(A) to include ``parents or subsidiaries of the 
contract market or entities that share a common parent with the 
contract market'' (``sister companies''). Previously, a DCM's public 
directors could also serve as directors of its parent company, but not 
as directors of its subsidiary or sister companies. With this 
amendment, the latter two relationships no longer suffer automatic 
exclusion.
    Third, the Commission has amended subsection (2)(ii)(B). As 
originally adopted, this subsection precluded DCM members, employees of 
members, and persons affiliated with members from service as public 
directors. ``[A]ffiliated with a member'' was defined as being an 
officer or director of a member, or having ``any other relationship 
with the member such that his or her impartiality could be called into 
question in matters concerning the member.'' Under that original text, 
subsection (2)(ii)(B) effectively inserted another material 
relationship determination in what was an otherwise bright-line test.
    Now, the Commission has streamlined subsection (2)(ii)(B) in three 
ways. First, any material relationship determination made pursuant to 
section (2) takes place under the overarching material relationship 
test of subsection (2)(i), and not under the bright-line tests of 
subsection (2)(ii). Second, subsection

[[Page 18985]]

(2)(ii)(B) sets forth the exact membership relationships that are 
automatically precluded. Finally, the subsection allows a DCM to 
conduct a material relationship analysis to determine whether 
employment by a member should preclude a specific individual from 
serving as a public director.
    Finally, the Commission has amended subsection (2)(ii)(C) and its 
bright-line tests. Here again, the Commission has simplified the 
provision to ensure that the bright-line tests are clearly articulated. 
As originally adopted, subsection (2)(ii)(C) created a $100,000 
combined annual payments test for potential public directors and the 
firms with which they may be affiliated (``payment recipients''). A 
particular payment's relevance to the $100,000 bright-line test depends 
upon the source (``payment provider'') and nature of the payment. In 
this regard, the subsection did not specify which payments should count 
towards the $100,000 annual cap--all payments or only those for certain 
types of services. In addition, the subsection also contained potential 
ambiguity with respect to the universe of potential payment providers 
and payment recipients.
    The first amendment to subsection (2)(ii)(C) defines the nature of 
``payment,'' specifying that it is payment for ``legal, accounting, or 
consulting services.'' The second amendment clarifies that the relevant 
payment recipients include the potential public director and any firm 
in which the director is an officer, partner, or director (``direct'' 
and ``indirect'' compensation, respectively). The third amendment to 
subsection (2)(ii)(C) clarifies that the relevant payment providers 
include the DCM and any parent, sister, or subsidiary company of the 
DCM. Notably, the new payment providers provision no longer captures 
DCM members or persons or entities affiliated with members, although 
such relationships should still be scrutinized carefully under the 
overarching materiality test of subsection (2)(i). Finally, the 
Commission has amended subsection (2)(ii)(C) to take into account 
payments to a public director in excess of $100,000 by sister and 
subsidiary companies of the DCM. This is consistent with the 
Commission's intent, previously articulated, not to automatically 
prohibit overlapping public directors between DCMs and their 
affiliates.

D. The 2009 Amendments and the Material Relationship Test

    As described above, the 2009 amendments touch only on the bright-
line tests for public director. The most important element of the 
definition--the overarching ``material relationship'' test in 
subsection (2)(i)--remains unchanged. As before, ``[t]o 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.'' And, as before, ``[a] material 
relationship is one that reasonably could affect the independent 
judgment or decision making of the director.''
    The practical consequence of the amended bright-line tests is that 
formerly disqualifying bright-line relationships must now be analyzed 
under the material relationship test recited above. However, DCMs 
should be aware that shifting the point of analysis in no way 
diminishes the importance of the relationships under review, nor does 
it mean that a formerly disqualifying relationship is now generally 
permissible. Instead, the amended bright-line tests make it incumbent 
upon DCMs to carefully evaluate the facts to determine whether a 
potential public director's relationships could reasonably affect his 
or her independent judgment or decision making as a director of a DCM. 
The Commission will carefully review those determinations in evaluating 
DCMs' compliance with Core Principle 15.
    Finally, while reemphasizing the importance of the material 
relationship test in the definition of public director, the Commission 
also notes its continued commitment to specific bright-line tests for 
director-DCM relationships that are clearly material. Accordingly, the 
2009 amendments to the bright-line tests retain most of the original 
tests' substantive content. As with the original bright-lines, those 
adopted herein touch on a potential public director's (A) Employment 
relationships with the contract market; (B) direct and indirect 
membership relationships with the contract market; (C) direct and 
indirect compensation relationships with the contract market; and (D) 
familial relationships with the contract market. The one-year look back 
period also remains intact, as does the requirement that a DCM disclose 
to the Commission those members of its board that are public directors 
and the basis for those determinations. Commission staff will also 
closely scrutinize the implementation of the material relationship and 
bright-line tests when conducting future reviews of DCM governance.

E. Public Comments on the 2009 Amendments

    Before summarizing and responding to individual comment letters, 
the Commission wishes to address a recurring theme in the comments made 
by DCMs throughout the development of these bright-line tests for 
public director. DCMs have regularly argued that the tests will exclude 
otherwise desirable candidates from serving on their boards, or that it 
will be too difficult to determine with certainty whether an individual 
qualifies as a public director under the acceptable practices. The 
Commission has been responsive to DCMs' concerns, even proposing 
alternative bright-line tests on two occasions after the acceptable 
practices were adopted. However, after these efforts, some DCMs 
continue to repeat this same criticism, including in their comments on 
the 2009 amendments.
    The Commission is confident that the definition of public director 
adopted herein can be used effectively by all DCMs. Armed with this 
streamlined definition, DCMs should be able to implement the acceptable 
practices fully and easily. Moreover, if for some reason it is unclear 
whether a person qualifies as a public director, a solution is readily 
available: He or she is free to serve as a non-public director. Under 
the acceptable practices, almost two-thirds of a DCM's board is filled 
at its discretion, subject to the fitness requirements of Core 
Principle 14. Thus, if a DCM believes that an individual adds 
exceptional value, it is free to install him or her as a non-public 
director. Furthermore, with respect to the 35% of directors who must be 
public under the acceptable practices, the difficulties alleged by DCMs 
might arise only if they attempt to seat directors who are too close to 
the DCM or to the futures industry, rather than authentically public 
persons.
    The Commission has previously stated that ``the most significant 
contribution made by public directors * * * is precisely their outside, 
non-industry perspective.'' \21\ Directors who are truly unrelated to 
the futures industry and its participants should have little difficulty 
qualifying as public directors, and DCMs should have little difficulty 
in implementing the acceptable practices if they avoid public director 
candidates who are in the professional or personal orbit of the futures 
industry.
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    \21\ 72 FR at 6949.

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[[Page 18986]]

1. Specific Comments Received and the Commission's Response
    The Commission received five comment letters in response to the 
2009 amendments, including comments from ICE Futures U.S., Inc. (``ICE 
Futures''), the Futures Industry Association (``FIA''), CBOE Futures 
Exchange, LLC (``CFE''), CME Group, Inc. (``CME Group''), and the 
Kansas City Board of Trade (``KCBT'').\22\ Commission staff reviewed 
all five letters carefully. Most were generally supportive of the 
proposed amendments, while also suggesting further changes. The five 
letters and the Commission's responses thereto are summarized below.
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    \22\ As explained below, CME Group is the parent company of four 
DCMs: the Chicago Board of Trade, the Chicago Mercantile Exchange, 
the Commodity Exchange, and the New York Mercantile Exchange.
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    a. CBOE Futures Exchange, LLC.
    CFE's comment letter reiterates the exchange's belief that the 
acceptable practices will have a ``positive impact'' with respect to 
futures exchange governance and minimizing conflicts of interest, and 
that they ``will serve to enhance the self-regulatory process.'' \23\ 
The comment letter also summarizes the 2009 amendments and affirms the 
exchange's agreement with most of them. CFE states that it supports 
those amendments that ``clarify (i) The types of payments that would 
disqualify a person from serving as a public director,\24\ (ii) that a 
person who serves as a director of a futures exchange affiliate is not 
disqualified from serving as a public director of the futures exchange 
if the person otherwise qualifies to serve in that capacity, and (iii) 
that receipt of director compensation from a futures exchange affiliate 
does not disqualify the recipient from serving as a public director of 
the futures exchange if the person otherwise qualifies to serve in that 
capacity.'' \25\
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    \23\ CFE comment letter (``CL'') at 1.
    \24\ While ICE Futures and CME Group also support the amendments 
pertaining to payment for services rendered, CFE's support is 
offered in a very specific context, as explained below.
    \25\ CFE CL at 1.
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    While generally supportive of the 2009 amendments, CFE's comment 
letter also raises certain concerns, both from the exchange's 
perspective and from the Commission's. First, CFE declares its 
opposition to an amendment in subsection (2)(ii)(B) removing employees 
of DCM member firms from automatic disqualification. In addition, the 
exchange offers certain interpretations with respect to the potential 
adverse impact of this amendment. Second, CFE states its support for 
the amendments to subsection (2)(ii)(C) (pertaining to a bright-line 
test for payment for services rendered). Here again, CFE offers its own 
interpretation as to what the subsection now permits. The Commission 
believes that both of CFE's comments and interpretations merit further 
discussion. They are treated below, in order.
    CFE disagrees ``with the elimination by the CFTC's proposal of the 
previous disqualification of an employee of a member of a futures 
exchange from serving as a public director of that futures exchange.'' 
\26\ This comment refers to amended subsection (2)(ii)(B), which no 
longer subjects a DCM member's employees to automatic disqualification 
from service as a public director (unless they are officers or 
directors). CFE observes, accurately, that ``the CFTC has stated that 
one of the primary objectives of the Acceptable Practices is to 
insulate the regulatory functions of a futures exchange via public 
directors who are not conflicted by industry ties * * *.'' \27\ The 
exchange argues that ``permitting a member employee to serve as a 
futures exchange public director, and allowing the possibility that all 
35% of the public directors of a futures exchange could be member 
employees, is inconsistent with that goal * * *.'' \28\
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    \26\ Id.
    \27\ CFE CL at 2.
    \28\ Id.
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    The Commission agrees with CFE's overall sentiment, and although it 
stands by the amendments to subsection (2)(ii)(B), it is vital that no 
DCM misinterpret them. The Commission is concerned with any suggestion 
that the acceptable practices now allow a DCM's public directors to 
consist exclusively of members' employees. While the Commission is not 
prejudging any potential relationship that might be presented to it in 
the future, it is difficult to imagine that employees of member firms 
will routinely pass the material relationship test of subsection 
(2)(i).
    DCMs are reminded that all director relationships, including 
employment, remain subject to the acceptable practices' overarching 
material relationship test. They should also be aware that the removal 
of a relationship from the bright-line tests does not mean that such 
relationship is now always permitted. Indeed, in the example offered by 
CFE, the Commission agrees that a board whose public directors are all 
employees of member firms is inconsistent with the intent of the 
acceptable practices. In that regard, the Commission emphasizes the 
language with which it proposed to amend subsection (2)(ii)(B), stating 
``the amendments merely shift the point of analysis from the bright-
lines of subsection (2)(ii) to the overarching material relationship 
test of subsection (2)(i).'' \29\ The Commission further affirmed--and 
this is of special importance with respect to member employees--that it 
``remains concerned about any relationship between potential public 
directors and DCM members that could `affect the independent judgment 
or decision making of the director' '' (emphasis added).\30\ 
Accordingly, no DCM should interpret the removal of member employment 
from the bright-line tests as an invitation to seat a member's employee 
as a public director without careful consideration. Any finding that a 
member's employee qualifies as public will require full disclosure and 
explanation under subsection (2)(v) of the acceptable practices, which 
requires DCMs to disclose to the Commission the basis for any 
determination that a director qualifies as public.
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    \29\ 74 FR at 3478.
    \30\ Id.
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    CFE's second comment and interpretation relates to subsection 
(2)(ii)(C). There, the exchange asserts that the amendments ``make 
clear that a public director of the National Futures Association 
(``NFA'') is not disqualified as serving as a public director of CFE 
because NFA provides regulatory services to CFE * * *.'' \31\ CFE is 
correct that amended subsection (2)(ii)(C) now limits the bright-line 
definition of ``payment'' to payment for legal, accounting, or 
consulting services. Previously, the term was undefined and thus 
potentially broader in scope, to include payment for regulatory 
services to a regulatory service provider (``RSP'') such as NFA.
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    \31\ CFE CL at 1.
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    The Commission cautions, however, that subsection (2)(ii)(C) is 
just one element in a multi-prong test for evaluating whether an 
individual is qualified to serve as a public director. While the 
clarification of subsection (2)(ii)(C) is this instance may leave RSP 
directors outside the scope of one bright-line test, such directors 
remain subject to other elements in the definition of public director. 
Most significant among these is the overarching material relationship 
test of subsection (2)(i). As with other potential relationships, the 
Commission will not prejudge what might be presented to it in the 
future. However, a DCM should move cautiously in any scenario where it 
outsources its regulatory functions to an RSP and seeks to install a 
director of

[[Page 18987]]

its RSP as public director on its board, including its ROC. In this 
context, the DCM should recall that ROC members are charged with 
evaluating the quality of regulatory services provided to the DCM. 
Certain questions naturally arise under these circumstances. Would the 
RSP director be able to evaluate the RSP's performance objectively? 
Would he or she be able to impartially counsel the exchange to seek 
regulatory services elsewhere if the RSP, on whose board he/she also 
sits, was underperforming? Even if the RSP director was only being 
considered for service on the board, and not for the ROC, would his or 
her board actions with respect to the RSP be as objective as those of a 
public director with no RSP ties? Questions such as these must be 
addressed fully in any material relationship analysis.
    b. The Futures Industry Association and the Kansas City Board of 
Trade.
    The FIA's comment letter expresses its support for the 2009 
amendments.\32\ Echoing the Commission's own sentiments, the FIA notes 
that ``it is vitally important that DCMs include a significant number 
of Board Members that are recognized to be independent of the DCM and 
its members.'' \33\ FIA also maintains that ``no one could fairly 
contest the Commission's definition of a public director as someone 
with no material relationship with the DCM,'' and that ``the Commission 
has proposed a workable and effective set of automatically 
disqualifying relationships'' for potential public directors.\34\ FIA's 
positive comments are balanced with the observation that it and others 
might ``quibble'' with the 35% standard for public directors on DCM 
boards, and that it might ``recommend expanding the [bright-line tests] 
in some areas or restricting it in others.'' \35\ Overall, however, FIA 
``urge[s] the Commission to adopt the [2009 amendments] quickly and to 
make its Acceptable Practices effective as soon as practicable.'' \36\
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    \32\ FIA CL at 1.
    \33\ Id.
    \34\ FIA CL at 1 and 2.
    \35\ Id.
    \36\ FIA CL at 2.
---------------------------------------------------------------------------

    KCBT's brief comment letter notes its ``support for the revised 
public director definition published for comment in connection with the 
SRO governance core principle guidelines.'' \37\ The exchange is 
``appreciative of the Commission narrowing the applicability of the 
$100,000 in professional services payments to a public director (or the 
firm such public director represents) by a DCM or its affiliates.'' 
\38\
---------------------------------------------------------------------------

    \37\ KCBT CL at 1.
    \38\ Id.
---------------------------------------------------------------------------

    c. ICE Futures U.S., Inc.
    ICE Futures' comment letter contains both supportive statements and 
suggestions for further modifications to the 2009 amendments. First, 
the exchange ``commend[s] the decision to free a DCM's public directors 
from bright-line tests that would have been failed if the directors 
also served on the board of the DCM's affiliates.'' \39\ This comment, 
which pertains to ``interlocking directorships'' under subsection 
(2)(iv), was echoed by CFE and CME Group.\40\
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    \39\ ICE Futures CL at 2.
    \40\ CME Group states, for example, ``[t]he Commission has 
appropriately recognized that an individual may be a director of 
both a DCM and its parent, subsidiary, or entity that shares a 
common parent with the DCM, and not lose his or her status as a 
public director.'' CME CL at 3.
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    The amendments to subsection (2)(iv) expand the universe of DCM 
affiliates on whose board public directors may serve.\41\ Previously, 
public directors could only serve on the board of a DCM's parent, but 
the 2009 amendments also permit interlocking directorships with a DCM's 
subsidiaries or entities sharing a common parent with the DCM. While 
ICE Futures and others find this amendment helpful, DCMs are reminded 
that as with all other public director relationships, the materiality 
test is still in place. In addition, interlocking public directorships 
are permitted only if the DCM director otherwise meets the definition 
of public director. DCMs should be particularly vigilant for 
circumstances where the interlocking directorship involves an entity 
that could come under the DCM's regulatory authority. An affiliate that 
trades or brokers in the DCM's markets, for example, could pose a 
conflict of interest.
---------------------------------------------------------------------------

    \41\ Subsection (2)(ii)(A) is also relevant, as it defines 
``affiliate'' as used in subsection (2)(iv).
---------------------------------------------------------------------------

    In addition to the comments summarized above, ICE Futures also 
suggests further amendments to the bright-line tests for public 
director. The exchange's concerns center around subsection (2)(ii)(C), 
which, as amended, defines a bright-line test for potential public 
directors based on direct and indirect compensation in excess of 
$100,000 for legal, accounting, and consulting services rendered. ICE 
Futures argues that, ``[b]ecause this prohibition is so broad, and the 
dollar threshold so low, it needlessly sweeps into its net payments 
that would be considered de minimis by the firm being compensated and 
relationships that might not automatically create a conflict of 
interest.'' \42\
---------------------------------------------------------------------------

    \42\ ICE Futures CL at 2.
---------------------------------------------------------------------------

    It should be noted that ICE Futures' comment seems limited to 
indirect compensation to a public director via the firm with which he 
or she is associated; the exchange's apparent preference is that 
indirect compensation not constitute part of the bright-line tests at 
all. It contends that ``[t]he DCM should be entrusted to evaluate all 
the relevant facts and circumstances * * * and determine whether the 
independent judgment of a public director would be compromised by the 
indirect compensation arrangements.'' \43\
---------------------------------------------------------------------------

    \43\ ICE Futures CL at 3.
---------------------------------------------------------------------------

    If indirect compensation is not removed from the bright-line tests, 
then the exchange argues that the Commission should at least 
``significantly increase the dollar threshold for indirect 
compensation.'' \44\ ICE Futures offers the listing standards of the 
New York Stock Exchange (``NYSE'') as an ``instructive'' guide in 
establishing what it considers a more appropriate cut-off on payments 
for services rendered.\45\
---------------------------------------------------------------------------

    \44\ Id.
    \45\ While the Commission understands the attraction of adopting 
a single payment cap based on the more widely used listing standards 
of the NYSE, it does not believe that the listing standards are an 
appropriate guide. The Commission continues to think that the 
listing standards serve a distinct purpose--the protection of 
shareholders through boards of directors that are sufficiently 
independent from management. In contrast, the acceptable practices 
for Core Principle 15, including the bright-line tests for public 
director, seek to protect self-regulation through DCM boards of 
directors and other bodies that include a sufficient number of truly 
public persons.
---------------------------------------------------------------------------

    The Commission understands that the $100,000 threshold in 
subsection (2)(ii)(C) is a significant bright-line test, and that 
others might have chosen to draw the line at a higher dollar value or 
as a percentage of revenues. However, it continues to believe that 
$100,000 in combined annual payments is an appropriate cap in 
compensation for a public director or a firm on which he or she serves 
as an officer, director, or partner. The $100,000 cap applies to 
payments from the DCM or any affiliate of the DCM for legal, 
accounting, or consulting services. As the Commission explained when it 
reduced the ratio of public directors required by the acceptable 
practices from 50% (as originally proposed) to 35% (as adopted), ``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

[[Page 18988]]

proposed.'' \46\ The Commission also reiterates its previous 
observation that a potential public director who fails one or more 
bright-line tests--the $100,000 payment cap, for example--is free to 
serve as a non-public director if the DCM deems it important.
---------------------------------------------------------------------------

    \46\ 72 FR at 6949.
---------------------------------------------------------------------------

    Finally, the Commission reminds DCMs that other relationships 
involving payment for services rendered--even those not specifically 
listed in subsection (2)(ii)(C)--should be scrutinized closely under 
the material relationship test. Such other relationships could include 
payments from other sources (e.g., a DCM member firm rather than the 
DCM itself); payments based on other relationships (e.g., employee 
rather than director or partner); and payments for lesser amounts 
(e.g., $95,000 to a firm where the DCM director serves as partner and 
to which $95,000 represents significant revenue). In short, DCMs must 
continue to consider the payment provider, the payment recipient, and 
the services provided when making materiality determinations under 
subsection (2)(ii)(C). DCMs also must disclose to the Commission which 
members of its board are public directors, and the basis for those 
determinations.\47\ The Commission expects that all potentially 
material relationships will have been examined carefully.
---------------------------------------------------------------------------

    \47\ Subsection (2)(v) of the acceptable practices.
---------------------------------------------------------------------------

    d. CME Group Inc.
    CME Group is the publicly-traded parent company of four DCMs: the 
Chicago Board of Trade (``CBOT''), the Chicago Mercantile Exchange 
(``CME''), the Commodity Exchange (``COMEX''), and the New York 
Mercantile Exchange (``NYMEX''). Its comment letter includes a brief 
history of the acceptable practices for Core Principle 15 and the 
amendments to the bright-line tests for public director. CME Group 
closes its comment letter by stating, ``[i]n sum, we believe that the 
Commission has substantially improved its proposed definition of public 
director, in connection with the non-exclusive safe harbor acceptable 
practices for compliance with Core Principle 15.'' \48\
---------------------------------------------------------------------------

    \48\ CME Group CL at 4.
---------------------------------------------------------------------------

    Like CFE and ICE Futures, CME Group approves of provisions in the 
2009 amendments that allow for interlocking public directors across a 
DCM, its subsidiaries, and entities sharing a common parent with the 
DCM. CME Group also approves of provisions in the amendments that 
eliminate the bright-line test for employees of DCM member firms.\49\ 
Finally, CME Group supports amendments to subsection (2)(ii)(C) with 
respectto direct and indirect payments to directors for services 
rendered. All three amendments have already been discussed above in the 
context of CFE's and ICE Futures' comment letters. As the Commission 
noted there, potential public directors remain subject to the material 
relationship test of subsection (2)(i) in all three circumstances.
---------------------------------------------------------------------------

    \49\ However, as explained previously, employees of DCM members, 
while no longer automatically disqualified from serving as public 
directors, are not automatically permitted to do so either. Instead, 
each one faces a robust and individualized material relationship 
analysis which must be disclosed to the Commission. In this regard, 
the Commission notes that blanket determinations by a DCM that 
particular categories of persons qualify as public directors without 
individual examination is insufficient to satisfy the acceptable 
practices for Core Principle 15.
---------------------------------------------------------------------------

    In addition to the supportive statements summarized above, CME 
Group also requests that the Commission ``consider a further refinement 
[to the bright-line tests] with respect to immediate family members.'' 
\50\ Referring to subsection (2)(ii)(D), it argues ``we do not believe 
that an individual should be considered to have a per se material 
relationship with a DCM merely because his immediate family member is a 
director or an officer of a member.'' \51\ The Commission's response is 
similar to that given ICE Futures' request for a more relaxed bright-
line test for indirect payments for services rendered. Because the 
final acceptable practices require that only 35% of a DCM's directors 
be public, a strict definition of public director is appropriate. In 
this regard, the Commission believes that a close family bond certainly 
could affect the independent judgment or decision making of the 
director and should therefore be precluded automatically. The 
acceptable practices' material relationship test is instructive: the 
Commission is concerned with relationships that ``reasonably could 
affect'' the director; proof of certain effect is not required.
---------------------------------------------------------------------------

    \50\ CME Group CL at 3.
    \51\ Id.
---------------------------------------------------------------------------

    CME Group's comment letter also includes broader legal and policy 
arguments that the Commission has previously addressed at length. 
Nonetheless, they require a brief response here so that no DCM is 
confused as to what is required under Core Principle 15. DCMs should be 
aware that the acceptable practices are voluntary safe harbors which 
they may use to demonstrate compliance with Core Principle 15, and that 
they are free to comply by other means. The Commission will fairly 
evaluate any alternatives presented to it. What DCMs are not free to 
do, however, is to substitute their interpretations of Core Principle 
15 for the Commission's.
    CME Group argues that it ``continues to believe that the board 
composition acceptable practices are not related to Core Principle 15 
and conflict with the clear Congressional intent in the Commodity 
Futures Modernization Act of 2000 (``CFMA'') to impose no composition 
requirements on the boards of publicly owned futures exchanges.'' \52\ 
CME Group's beliefs notwithstanding, the Commission has interpreted its 
statutory authority and acted upon it. CME Group's four regulated DCMs 
are required to comply with Core Principle 15, and all the core 
principles, as they are interpreted by the Commission.
---------------------------------------------------------------------------

    \52\ CME Group CL at 2.
---------------------------------------------------------------------------

    To comply with Core Principle 15, DCMs must specifically address 
the conflicts of interest discussed at length during the development of 
these acceptable practices. The Commission has been clear in its 
requirements, and the preamble to the acceptable practices explains 
them as well. As stated in the acceptable practices, ``[all DCMs] bear 
special responsibility to regulate effectively, impartially, and with 
due consideration of the public interest. * * * Under Core Principle 
15, they are also required to minimize conflicts of interest in their 
decision-making process. To comply with this core principle, [DCMs] 
should be particularly vigilant for such conflicts between and among 
their self-regulatory responsibilities, their commercial interests, and 
the several interests of their management, members, owners, customers 
and market participants, and other constituencies.''
    Within these boundaries, DCMs may demonstrate compliance with Core 
Principle 15 as they deem best. The Commission has repeatedly affirmed 
that the acceptable practices are not mandatory. What is mandatory, 
however, is that all DCMs mitigate conflicts of interest in their 
decision making process, including the conflicts that the Commission 
has identified between their commercial interests and their regulatory 
responsibilities.
    Indeed, CME Group's own comment letter expresses the potential 
conflict of interest between regulatory and commercial decision making. 
Referring to commercial interests, CME Group claims, ``[w]e believe 
that each publicly traded DCM has an obligation to its shareholders to 
follow the listing rules

[[Page 18989]]

of the relevant securities exchange and to nominate for election as 
directors a mix of individuals based on their ability to create value 
for the corporation.'' \53\ While the Commission acknowledges all DCMs' 
commercial interests, it also reminds them of their regulatory 
responsibilities.
---------------------------------------------------------------------------

    \53\ CME Group CL at 2.
---------------------------------------------------------------------------

    In the case of CME Group, the Commission notes that its subsidiary 
DCMs--CBOT, CME, COMEX, and NYMEX--are not traded on national 
securities exchanges or subject to listing standards. While CME Group 
may be required to comply with certain listing rules and to maximize 
shareholder value, its regulated DCMs have additional statutory and 
regulatory obligations. Above all, regardless of their corporate 
structures, all DCMs must regulate effectively, impartially, and with 
due consideration of the national public interest as provided for in 
the Act.
    The Commission is confident that regulatory and commercial 
interests can be reconciled in effective self-regulation. However, 
continued success depends on all DCMs recognizing the potential for 
conflicts; acknowledging the primacy of regulatory interests; and 
implementing effective solutions to protect self-regulatory functions, 
decisions, and personnel from improper commercial influence and 
considerations. As the Commission stated when it adopted the acceptable 
practices for Core Principle 15, and as it continues to believe now:

    [I]t 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. 
Whereas the [listing standards] serve those with a direct fiduciary 
claim upon a company * * * 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.\54\
---------------------------------------------------------------------------

    \54\ 72 FR 6936, 6949.

II. Related Matters

A. Cost-Benefit Analysis

    Section 15(a) of the Act requires the Commission to consider the 
costs and benefits of its actions before issuing a new regulation or 
order under the Act.\55\ By its terms, Section 15(a) requires the 
Commission to ``consider the costs and benefits'' of a subject rule or 
order, without requiring it to quantify the costs and benefits of its 
action or to determine whether the benefits of the action outweigh its 
costs. Section 15(a) requires that the costs and benefits of new 
regulations 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. In conducting its analysis, 
the Commission may, in its discretion, give greater weight to any one 
of the five enumerated areas of concerns and may determine that, 
notwithstanding its costs, a particular rule 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.\56\
---------------------------------------------------------------------------

    \55\ 7 U.S.C. 19(a).
    \56\ E.g., Fishermen's Dock Co-op., Inc. v. Brown, 75 F.3d 164 
(4th Cir. 1996); Center for Auto Safety v. Peck, 751 F.2d 1336 (D.C. 
Cir. 1985) (agency has discretion to weigh factors in undertaking 
cost benefit analyses).
---------------------------------------------------------------------------

    On February 14, 2007, the Commission published final acceptable 
practices for Core Principle 15 that included prophylactic measures 
designed to minimize conflicts of interest in DCMs' decision making 
processes. The final rulemaking thoroughly considered the costs and 
benefits of the acceptable practices and responded to comments relating 
to the costs of adhering to their requirements.
    The 2009 amendments to the definition of public director bring 
further clarity and finality to the acceptable practices for Core 
Principle 15. The Commission believes that the amendments are fully 
consistent with the design and purpose of the acceptable practices as 
originally conceived. Furthermore, through more consistent, 
streamlined, and precise articulations, the amendments will facilitate 
DCMs' implementation of the acceptable practices and thereby advance 
important public interest considerations with respect to conflicts of 
interest in DCM self-regulation. In particular, the acceptable 
practices offer all DCMs a safe harbor for compliance with Core 
Principle 15, which requires them to ``establish and enforce rules to 
minimize conflicts of interest in the decision making process of the 
contract market * * *.'' \57\ The acceptable practices' safe harbor is 
based on the inclusion of public directors on their boards; the 
creation and empowerment of ROCs consisting exclusively of public 
directors; and the presence of public persons on DCM disciplinary 
panels. Thus, each of these provisions depends heavily on a clear and 
settled definition of public director. The Commission believes that the 
2009 amendments will not impose any additional costs upon DCMs. To the 
contrary, they may reduce the costs of compliance through improvements 
in the bright-line tests for public director, such that the tests truly 
operate as bright-lines and the definition of public director is well-
settled.
---------------------------------------------------------------------------

    \57\ 7 U.S.C. 7(d)(15).
---------------------------------------------------------------------------

    After considering the above mentioned factors and issues, the 
Commission has determined to adopt these amendments to the acceptable 
practices for Core Principle 15. The Commission received no comments on 
its Section 15(a) analysis of the amendments and hereby adopts them as 
proposed.

B. 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 2009 amendments affect DCMs, which 
the Commission has previously determined are not small entities for 
purposes of the Regulatory Flexibility Act.\58\ Accordingly, the Acting 
Chairman, on behalf of the Commission, hereby certifies pursuant to 5 
U.S.C. 605(b) that the 2009 amendments will not have a significant 
economic impact on a substantial number of small entities.
---------------------------------------------------------------------------

    \58\ See Policy Statement and Establishment of Definitions of 
``Small Entities'' for Purposes of the Regulatory Flexibility Act, 
47 FR 18618, 18619 (Apr. 30, 1982).
---------------------------------------------------------------------------

C. Paperwork Reduction Act of 1995

    The 2009 amendments to the acceptable practices for Core Principle 
15 will not impose any new recordkeeping or information collection 
requirements, or other collections of information that require approval 
of the Office of Management and Budget, under 44 U.S.C. 3501 et seq. 
Additionally, the Commission received no comments on the accuracy of 
the estimate of additional recordkeeping or information collection 
requirements. Accordingly, the Paperwork Reduction Act does not apply.

III. Text of Amendments

List of Subjects in 17 CFR Part 38

    Commodity futures, Reporting and recordkeeping requirements.

    In light of the foregoing, and pursuant to the authority in the 
Act, and in

[[Page 18990]]

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 continues to read as follows:

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


0
2. The stay is lifted on paragraph (b) of Core Principle 15 in Appendix 
B to 17 CFR Part 38.
0
3. In Appendix B to Part 38 revise paragraphs (b)(2)(ii) through 
(b)(2)(v) of Core Principle 15 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) * * *
    (2) * * *
    (ii) In addition, a director shall be considered to have a 
``material relationship'' with the contract market if any of the 
following circumstances exist:
    (A) The director is an officer or employee of the contract 
market or an 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 an 
officer or director of a member. ``Member'' is defined according to 
Section 1a(24) of the Commodity Exchange Act and Commission 
Regulation 1.3(q);
    (C) The director, or a firm with which the director is an 
officer, director, or partner, receives more than $100,000 in 
combined annual payments from the contract market, or any affiliate 
of the contract market (as defined in Subsection (2)(ii)(A)), for 
legal, accounting, or consulting services. Compensation for services 
as a director of the contract market or as a director of an 
affiliate of the contract market 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 affiliate (as defined in 
Subsection (2)(ii)(A)) if they otherwise meet the definition of 
public director 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.
* * * * *

    Issued in Washington, DC, on April 21, 2009 by the Commission.
David A. Stawick,
Secretary to the Commission.
[FR Doc. E9-9508 Filed 4-24-09; 8:45 am]
BILLING CODE P