Requirements for Designated Contract Markets and Swap Execution Facilities Regarding Governance and the Mitigation of Conflicts of Interest Impacting Market Regulation Functions, 19646-19726 [2024-04938]
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Federal Register / Vol. 89, No. 54 / Tuesday, March 19, 2024 / Proposed Rules
COMMODITY FUTURES TRADING
COMMISSION
17 CFR Parts 37 and 38
RIN 3038–AF29
Requirements for Designated Contract
Markets and Swap Execution Facilities
Regarding Governance and the
Mitigation of Conflicts of Interest
Impacting Market Regulation
Functions
Commodity Futures Trading
Commission.
ACTION: Notice of proposed rulemaking.
AGENCY:
The Commodity Futures
Trading Commission (‘‘Commission’’ or
‘‘CFTC’’) is proposing new rules and
amendments to its existing regulations
for designated contract markets
(‘‘DCMs’’) and swap execution facilities
(‘‘SEFs’’) that would establish
governance and fitness requirements
with respect to market regulation
functions, as well as related conflict of
interest standards. The proposed new
rules and amendments include
minimum fitness standards,
requirements for identifying, managing,
and resolving conflicts of interest, and
structural governance requirements to
ensure that SEF and DCM governing
bodies adequately incorporate an
independent perspective. The proposal
also address requirements relating to the
following: composition requirements for
board of directors and disciplinary
panels; limitations on the use and
disclosure by employees and certain
others of material non-public
information; requirements relating to
Chief Regulatory Officers, Chief
Compliance Officers, and Regulatory
Oversight Committees; and notification
of certain changes in the ownership or
corporate or organizational structure of
a SEF or DCM.
DATES: Comments must be received on
or before April 22, 2024.
ADDRESSES: You may submit comments,
identified by ‘‘Requirements for
Designated Contract Markets and Swap
Execution Facilities Regarding
Governance and the Mitigation of
Conflicts of Interest’’ and RIN 3038–
AF29, by any of the following methods:
• CFTC Comments Portal: https://
comments.cftc.gov. Select the ‘‘Submit
Comments’’ link for this rulemaking and
follow the instructions on the Public
Comment Form.
• Mail: Send to Christopher
Kirkpatrick, Secretary of the
Commission, Commodity Futures
Trading Commission, Three Lafayette
Centre, 1155 21st Street NW,
Washington, DC 20581.
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SUMMARY:
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• Hand Delivery/Courier: Follow the
same instructions as for Mail, above.
Please submit your comments using
only one of these methods. Submissions
through the CFTC Comments Portal are
encouraged.
All comments must be submitted in
English, or if not, accompanied by an
English translation. Comments will be
posted as received to https://
comments.cftc.gov. You should submit
only information that you wish to make
available publicly. If you wish the
Commission to consider information
that you believe is exempt from
disclosure under the Freedom of
Information Act (‘‘FOIA’’), a petition for
confidential treatment of the exempt
information may be submitted according
to the procedures established in § 145.9
of the Commission’s regulations.1
The Commission reserves the right,
but shall have no obligation, to review,
pre-screen, filter, redact, refuse, or
remove any or all of your submission
from https://www.comments.cftc.gov
that it may deem to be inappropriate for
publication, such as obscene language.
All submissions that have been redacted
or removed that contain comments on
the merits of the rulemaking will be
retained in the public comment file and
will be considered as required under the
Administrative Procedure Act and other
applicable laws, and may be accessible
under FOIA.
FOR FURTHER INFORMATION CONTACT:
Rachel Berdansky, Deputy Director,
rberdansky@cftc.gov, 202–418–5429;
Swati Shah, Associate Director, sshah@
cftc.gov, 202–418–5042; Marilee
Dahlman, Special Counsel, mdahlman@
cftc.gov, 202–418–5264; Jennifer L.
Tveiten-Rifman, Special Counsel,
jtveitenrifman@cftc.gov, 312–802–3848;
Lillian Cardona, lcardona@cftc.gov,
Assistant Chief Counsel, 202–418–5012.
SUPPLEMENTARY INFORMATION:
Table of Contents
I. Introduction
II. Background
a. Statutory Requirements for SEFs and
DCMs
b. Proposed and Final Rules Addressing
SEF and DCM Governance and Conflicts
of Interest
1. 2001 Regulatory Framework
2. 2007 Final Release, Conflicts of Interest
Acceptable Practices for DCMs
3. 2009 Final Release, Definition of Public
Director
4. 2010 Conflicts of Interest Rule Proposal
5. 2011 Governance and Conflicts of
Interest NPRM
6. 2012 Part 38 Final Rule
7. 2013 Part 37 Final Rule
8. 2021 Part 37 Amendments—CCO Duties
and Annual Compliance Report
1 17
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c. Industry Changes and Impact on
Regulatory Developments
d. Conflicts of Interest Relating to Market
Regulation Functions
1. Market Regulation Functions
2. Questions for Comment
3. Conflicts of Interest Between Market
Regulation Functions and Commercial
Interests
III. Proposed Governance Fitness
Requirements
a. Overview
b. Minimum Fitness Standards—Proposed
§§ 37.207 and 38.801
1. Existing Regulatory Framework
2. Proposed Rules
3. Questions for Comment
IV. Proposed Substantive Requirements for
Identifying, Managing and Resolving
Actual and Potential Conflicts of Interest
a. General Requirements for Conflicts of
Interest and Definitions—Proposed
§§ 37.1201 and 38.851
1. Existing Regulatory Framework and
Definitions
2. Proposed Rules
b. Conflicts of Interest in DecisionMaking—Proposed §§ 37.1202 and
38.852
1. Background
2. Existing Regulatory Framework
3. Proposed Rules
4. Questions for Comment
c. Limitations on the Use and Disclosure of
Material Non-Public Information—
Proposed §§ 37.1203 and 38.853
1. Background
2. Existing Regulatory Framework
3. Proposed Rules
4. Questions for Comment
V. Proposed Structural Governance
Requirements for Identifying, Managing
and Resolving Actual and Potential
Conflicts of Interest
a. Composition and Related Requirements
for Board of Directors—Proposed
§§ 37.1204 and 38.854
1. Background
2. Existing Regulatory Framework
3. Proposed Rules
4. Questions for Comment
b. Public Director Definition—Proposed
§§ 37.1201(b)(12) and 38.851(b)(12)
1. Background
2. Existing Regulatory Framework
3. Proposed Rules
4. Questions for Comment
c. Nominating Committee and Diverse
Representation—Proposed §§ 37.1205
and 38.855
1. Background
2. Existing Regulatory Framework
3. Proposed Rules
4. Questions for Comment
d. Regulatory Oversight Committee—
Proposed §§ 37.1206 and 38.857
1. Background
2. Existing Regulatory Framework
3. Proposed Rules
4. Questions for Comment
e. Disciplinary Panel Composition—
Proposed §§ 37.1207 and 38.858
1. Background
2. Existing Regulatory Framework
3. Proposed Rules
4. Questions for Comment
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f. DCM Chief Regulatory Officer—Proposed
§ 38.856
1. Background
2. Existing Regulatory Framework
3. Proposed Rules
4. Questions for Comment
g. Staffing and Investigations—Proposed
Changes to §§ 38.155, 38.158, and 37.203
1. Background
2. Existing Regulatory Framework
3. Proposed Rules
4. Questions for Comment
h. SEF Chief Compliance Officer—
Proposed Changes to § 37.1501
1. Background
2. Existing Regulatory Framework
3. Proposed Rules
4. Questions for Comment
VI. Conforming Changes
a. Commission Regulations §§ 37.2, 38.2,
and Part 1
b. Transfer of Equity Interest—Commission
Regulations §§ 37.5(c) and 38.5(c)
1. Background
2. Existing Regulatory Framework
3. Proposed Rules
4. Questions for Comment
VII. Effective and Compliance Dates
VIII. Related Matters
a. Cost-Benefit Considerations
1. Introduction
2. Baseline
3. Proposed Rules
4. Question for Comment
b. Regulatory Flexibility Act
c. Paperwork Reduction Act
d. Antitrust Considerations
IX. Proposed Rule Text
I. Introduction
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The Commission proposes to establish
governance fitness regulations related to
market regulation functions,2 and
related conflict of interest requirements,
for swap execution facilities (‘‘SEFs’’)
and designated contract markets
(‘‘DCMs’’). Although SEFs and DCMs
have similar obligations with respect to
market regulation functions, they are
subject to different obligations with
respect to governance fitness standards
and mitigating conflicts of interest. SEFs
and DCMs are required to minimize and
resolve conflicts of interest pursuant to
2 As discussed further below, the Commission is
proposing to define ‘‘market regulation functions’’
to include the SEF functions required by SEF Core
Principles 2 (Compliance with Rules), 4
(Monitoring of Trading and Trade Processing), and
6 (Position Limits or Accountability), the DCM
functions required by DCM Core Principles 2
(Compliance with Rules), 4 (Prevention of Market
Disruption), 5 (Position Limitations or
Accountability), 10 (Trade Information), 12
(Protection of Markets and Market Participants),
and 13 (Disciplinary Procedures), and regulations
thereunder. These responsibilities include, but are
not limited to, the responsibilities of SEFs and
DCMs to conduct trade practice surveillance,
market surveillance, real-time market monitoring,
audit trail enforcement, investigations of possible
SEF or DCM rule violations, and disciplinary
actions. See proposed §§ 37.1201(b)(9) and
38.851(b)(9).
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identical statutory core principles.3
However, SEF and DCM regulatory
requirements addressing governance
fitness standards currently differ. With
respect to governance fitness standards,
DCMs are subject to specific statutory
core principles addressing governance,4
while SEFs do not have parallel core
principle requirements. Additionally,
SEFs and DCMs currently have different
regulatory obligations with respect to
governance fitness standards.5 Further,
while both SEFs and DCMs are subject
to equity transfer requirements,6 the
applicable regulatory provisions
currently have different notification
thresholds and obligations.
In this proposal, the Commission is
drawing on staff experience in
conducting its routine oversight of SEF
and DCM ‘‘market regulation
functions,’’ which include
responsibilities related to trade practice
surveillance, market surveillance, realtime market monitoring, audit trail data
and recordkeeping enforcement,
investigations of possible SEF or DCM
rule violations, and disciplinary actions.
Commission staff conducts oversight of
these market regulation functions in a
number of ways, including rule
enforcement reviews,7 SEF regulatory
consultations and registration
application reviews, DCM designation
application reviews, and regular
engagement with SEFs and DCMs.8
Through its oversight, Commission
staff has identified areas where it
preliminarily believes that SEF and
DCM regulations should be enacted, in
lieu of existing guidance and acceptable
practices, to further support the
statutory objective of ensuring that
conflicts of interest are appropriately
mitigated. The Commission is proposing
enhanced substantive requirements for
3 See SEF Core Principle 12, Commodity
Exchange Act (‘‘CEA’’) section 5h(f), 7 U.S.C. 7b–
3(f), and DCM Core Principle 16, CEA section 5(d),
7 U.S.C. 7(d).
4 See DCM Core Principles 15 and 17, CEA
section 5(d)(15), 7 U.S.C. 7(d)(15), and CEA section
5(d)(17), 7 U.S.C. 7(d)(17), respectively.
5 As discussed below, SEFs, but not DCMs, are
required to comply with requirements under part 1
of the Commission’s regulations addressing the
sharing of nonpublic information, service on the
board or committees by persons with disciplinary
histories, board composition, and voting by board
or committee members where there may be a
conflict of interest.
6 Commission regulation § 37.5(c) (SEFs) and
Commission regulation § 38.5(c) (DCMs).
7 See Rule Enforcement Reviews of Designated
Contract Markets, https://www.cftc.gov/
IndustryOversight/TradingOrganizations/DCMs/
dcmruleenf.html.
8 As explained below, this proposal is not
addressing SEF and DCM obligations relating to
core principles that specifically address the
financial integrity of transactions under SEF Core
Principle 7 and DCM Core Principle 11.
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identifying, managing, and resolving
conflicts of interest related to a SEF’s or
DCM’s market regulation functions, and
structural governance requirements to
ensure that SEF and DCM governing
bodies adequately incorporate an
independent perspective. The
Commission is also proposing
additional amendments to address
governance standards as they relate to
the performance of the market
regulation function. The Commission is
further proposing enhanced notification
requirements with respect to changes in
the ownership or corporate or
organizational structure of a SEF or
DCM.
More specifically, the Commission
proposes: (1) new rules to implement
DCM Core Principle 15 (Governance
Fitness Standards) that are consistent
with the existing guidance on
compliance with DCM Core Principle
15; 9 (2) new rules to implement DCM
Core Principle 16 (Conflicts of Interest)
that are consistent with the existing
guidance on, and acceptable practices
in, compliance with DCM Core
Principle 16; 10 (3) new rules to
implement SEF Core Principle 2
(Compliance With Rules) that are
consistent with the DCM Core Principle
15 Guidance; 11 (4) new rules to
implement SEF Core Principle 12
(Conflicts of Interest) that are consistent
with the DCM Core Principle 16
Guidance and Acceptable Practices; (5)
new rules under part 37 of the
Commission’s regulations for SEFs and
part 38 of the Commission’s regulations
for DCMs that are consistent with
existing conflicts of interest and
governance requirements under
Commission regulations §§ 1.59 and
1.63; 12 (6) new rules for DCM Chief
Regulatory Officers (‘‘CROs’’); (7)
amendments to certain requirements
relating to SEF Chief Compliance
Officers (‘‘CCOs’’); and (8) new rules for
SEFs and DCMs relating to the
establishment and operation of a
Regulatory Oversight Committee
(‘‘ROC’’). The Commission also is
proposing to remove the guidance on
9 Part 38, Appendix B, Core Principle 15
Guidance.
10 Part 38, Appendix B, Core Principle 16
Acceptable Practices.
11 As discussed further below, SEF Core Principle
2 requires SEFs to establish rules governing the
operations of the facility. To effectuate this
requirement, the Commission preliminarily believes
it is necessary to establish governance fitness
standards for the individuals responsible for
directing the operations of the SEF. See Section
III(a) herein.
12 The Commission is also proposing conforming
amendments to remove SEFs and DCMs from the
scope of these part 1 requirements. See Section V(a)
herein.
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compliance with DCM Core Principle
15, as well as the guidance on, and
acceptable practices in, compliance
with DCM Core Principle 16.
The Commission also proposes
amendments to existing rules in part 37
and part 38 of its regulations regarding
the notification of a transfer of equity
interest in a SEF or DCM. The proposal
would harmonize and enhance the rules
for SEFs and DCMs, and would also
harmonize these SEF and DCM rules
with the corollary rules for derivatives
clearing organizations (‘‘DCOs’’) under
part 39 of the Commission’s
regulations.13 The proposal would
further confirm the Commission’s
authority to obtain information
concerning continued regulatory
compliance in the event of changes in
the ownership or corporate or
organizational structure of a SEF or
DCM.
Finally, the Commission is proposing
certain technical and conforming
changes to SEF and DCM rules relating
to disciplinary panels, staffing, and
investigations.14
In developing the rules proposed in
this NPRM, the Commission has
consulted with the Securities and
Exchange Commission (‘‘SEC’’),
pursuant to section 712(a)(1) of the
Dodd-Frank Act.15
II. Background
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a. Statutory Requirements for SEFs and
DCMs
Section 5h 16 of the CEA sets forth
requirements for SEFs. CEA section
5h(f)(1)(A) provides that in order to be
registered, and to maintain registration,
with the Commission, a SEF must
comply with (1) 15 core principles, and
(2) any requirement that the
Commission may impose by rule or
regulation pursuant to section 8a(5) of
the CEA.17 Unless otherwise determined
by the Commission by rule or
regulation, a SEF has reasonable
discretion to establish the manner in
13 See, e.g., part 39 of the Commission’s
regulations, adopted pursuant to Derivatives
Clearing Organization General Provisions and Core
Principles, 76 FR 39333 (Nov. 8, 2011).
14 See Section V(e)–(g) herein.
15 15 U.S.C. 8302 (Providing that before
commencing any rulemaking or issuing an order
regarding swaps, swap dealers, major swap
participants, swap data repositories, derivative
clearing organizations with regard to swaps,
persons associated with a swap dealer or major
swap participant, eligible contract participants, or
swap execution facilities pursuant to the applicable
subtitle, the CFTC must consult and coordinate to
the extent possible with the SEC and the prudential
regulators for the purposes of assuring regulatory
consistency and comparability, to the extent
possible).
16 7 U.S.C. 7b–3.
17 7 U.S.C. 7b–3(f).
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which it complies with a particular core
principle. As of January 2024, there
were 21 registered SEFs.
Similarly, Section 5 of the CEA sets
forth requirements for DCMs. CEA
section 5(d)(1)(A) requires that to be
designated, and to maintain designation,
by the Commission, a DCM must
comply with (1) 23 core principles, and
(2) any requirement that the
Commission may impose by rule or
regulation pursuant to section 8a(5) of
the CEA.18 Unless otherwise determined
by the Commission by rule or
regulation, a DCM has reasonable
discretion to establish the manner in
which it complies with a particular core
principle.19 As of January 2024, there
were 17 registered DCMs.
Both SEFs and DCMs are subject to a
respective core principle addressing
conflicts of interest. Pursuant to SEF
Core Principle 12 and DCM Core
Principle 16, both SEFs and DCMs must
establish and enforce rules to minimize
conflicts of interest in their decisionmaking processes, and must establish a
process for resolving such conflicts.20
SEFs are also subject to a Chief
Compliance Officer core principle. SEF
Core Principle 15 requires SEFs to
designate an individual to serve as a
CCO, sets forth CCO duties,21 including
a duty to resolve conflicts of interest,22
and requires CCOs to prepare and
submit an annual report to the
Commission describing the SEF’s
compliance with the CEA and the SEF’s
policies and procedures, including the
SEF’s code of ethics and conflicts of
interest policies.23 There is no
equivalent statutory core principle for
DCMs.24
DCMs are additionally subject to three
core principles addressing
governance.25 DCM Core Principle 15
requires a DCM to establish and enforce
appropriate fitness standards for
members of its board of directors,
disciplinary committee members,
members of the DCM, persons with
direct access to the DCM, and any party
affiliated with of any of the foregoing
persons. DCM Core Principle 17
establishes that a DCM’s governance
arrangements ‘‘shall be designed to
permit consideration of the views of
market participants.’’ 26 DCM Core
Principle 22 requires publicly-traded
DCMs to endeavor to recruit individuals
to serve on the board of directors and
other decision-making bodies of the
DCM from among, and to have the
composition of these bodies reflect, a
broad and culturally diverse pool of
qualified candidates.27 While there are
no SEF core principles directly
addressing governance, the Commission
believes a SEF cannot effectively
manage its SEF Core Principle 2
obligations without effective
governance.
18 CEA section 8a(5), 7 U.S.C. 12a(5), authorizes
the Commission to make and promulgate such rules
and regulations as, in the judgment of the
Commission, are reasonably necessary to effectuate
any of the provisions or to accomplish any of the
purposes of the CEA. The CEA contains a finding
that the transactions subject to the CEA are affected
with a ‘‘national public interest by providing a
means for managing and assuming price risks,
discovering prices, or disseminating pricing
information through trading in liquid, fair and
financially secure trading facilities,’’ and among the
CEA’s purposes are to serve the aforementioned
public interests through a system of ‘‘effective selfregulation of trading facilities.’’ See CEA section 3.
19 CEA section 5(d)(1)(B), 7 U.S.C. 7(d)(1)(B).
20 CEA sections 5(d)(16), 5h(f)(12). DCM Core
Principle 16 and SEF Core Principle 12 are
substantively identical in the statute.
21 The duties include to report directly to the
board or senior officer of the SEF; review
compliance with the core principles; resolve
conflicts of interest in consultation with the board,
a body performing a function similar to that of a
board, or the senior officer of the facility; be
responsible for establishing and administering the
SEF’s self-regulatory policies and procedures;
ensure compliance with the CEA and rules and
regulations issued thereunder; and establish a
procedure for remedying noncompliance issues
found during compliance office reviews, look backs,
internal or external audit findings, self-reported
errors, or validated complaints. See CEA section
5h(f)(15)(B), 7 U.S.C. 7b–3(f)(15)(B).
22 The CCO must fulfill this duty in consultation
with the board of directors, a body performing a
function similar to that of a board, or the senior
officer of the SEF. CEA section 5h(f)(15)(B)(iii), 7
U.S.C. 7b–3(f)(15)(B)(iii).
b. Proposed and Final Rules Addressing
SEF and DCM Governance and Conflicts
of Interest
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Since 2001, the Commission has
proposed and adopted guidance and
acceptable practices addressing conflicts
23 CEA section 5h(f)(15)(D), 7 U.S.C. 7b–
3(f)(15)(D).
24 The Core Principle 16 Acceptable Practices
specify that DCMs should have a Regulatory
Oversight Committee that, among other things,
supervises the DCM’s chief regulatory officer, who
will report directly to the Regulatory Oversight
Committee. See section V(f)(3) herein for a
discussion of the difference between a chief
regulatory officer and a chief compliance officer.
25 Related governance requirements for SEFs exist
in part 1 of the Commission’s regulations.
Commission regulation § 1.69(b) requires SEFs to
adopt rules requiring any member of the board of
directors, disciplinary committee or oversight panel
to abstain from deliberating and voting on any
matter involving a conflict of interest. Commission
regulation § 1.69 applies to ‘‘self-regulatory
organizations’’ (‘‘SRO’’), as defined in Commission
regulation § 1.3, which includes SEFs and DCMs.
However, pursuant to Commission regulation
§ 38.2, DCMs are exempt from the requirements of
Commission regulation § 1.69.
26 Commission regulation § 38.900, DCM Core
Principle 17, Composition of Governing Boards of
Contract Markets.
27 This proposal is not addressing the
requirements identified in DCM Core Principles 17
and 22.
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of interest and governance standards for
SEFs and DCMs.
1. 2001 Regulatory Framework
On August 10, 2001, the Commission
adopted a regulatory framework (‘‘2001
Regulatory Framework’’) implementing
the Commodity Futures Modernization
Act of 2000 (‘‘CFMA’’), effective October
9, 2001.28 The CFMA required the
Commission to implement a framework
of flexible core principles in lieu of
detailed regulatory prescriptions.
Section 110 of the CFMA, codified in
section 5(d)(1) of the CEA, stated that a
DCM shall have reasonable discretion in
establishing the manner in which it
complies with the core principles.
The CFMA contained core principles,
that among other things, related to
governance fitness standards and
conflicts of interest. DCM Core Principle
14 (Governance Fitness Standards) 29
provided that boards of trade shall
establish and enforce appropriate fitness
standards for directors, members of any
disciplinary committee, members of the
contract market, and any other persons
with direct access to the facility
(including any parties affiliated with
any of the persons described in this
paragraph).30 DCM Core Principle 15
(Conflicts of Interest) 31 provided that
boards of trade shall establish and
enforce rules to minimize conflicts of
interest in the decision-making process
of the contract market and shall
establish a process for resolving such
conflicts of interest.32
The 2001 Regulatory Framework
implemented guidance for DCM Core
Principles 14 (Governance Fitness
Standards) and 15 (Conflicts of Interest).
Guidance provides contextual
information regarding the core
principles, including important
concerns which the Commission
believes should be taken into account in
complying with specific core
principles.33 The guidance for a core
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28 A
New Regulatory Framework for Trading
Facilities, Intermediaries and Clearing
Organizations, 66 FR 42256 (Aug. 10, 2001) (‘‘2001
Regulatory Framework’’).
29 In 2001, DCM Core Principle 14 addressed
governance fitness standards. In the Dodd-Frank
Act, the DCM conflicts of interest core principle
was renumbered to be Core Principle 15. See DoddFrank Act, section 735(b); 7 U.S.C. 7(d)(15).
30 See CFMA section 110, codified at CEA section
5(d)(14).
31 In 2001, DCM Core Principle 15 addressed
conflicts of interest. In the Dodd-Frank Act, the
DCM conflicts of interest core principle was
renumbered to be Core Principle 16. See DoddFrank Act, section 735(b); 7 U.S.C. 7(d)(16).
32 See CFMA section 110, codified at CEA section
5(d)(15).
33 The 2001 Regulatory Framework described the
guidance contained therein as ‘‘application
guidance,’’ but the concept is substantively similar
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principle is illustrative only of the types
of matters a DCM may address, and is
not intended to be used as a mandatory
checklist.34
The guidance for DCM Core Principle
14 states that minimum fitness
standards for ‘‘persons who have
member voting privileges, governing
obligations or responsibilities, or who
exercise disciplinary authority,’’ and
‘‘natural persons who directly or
indirectly have greater than a ten
percent ownership interest in a
designated contract’’ should include
those bases for refusal to register a
person under section 8a(2) of the CEA.35
Additionally, the guidance states that
persons who have governing obligations
or responsibilities, or who exercise
disciplinary authority, should not have
a significant history of serious
disciplinary offenses, such as those that
would be disqualifying under
Commission regulation § 1.63.36 The
guidance further states that fitness
standards should include providing the
Commission with fitness information for
such persons, whether registration
information, certification to the fitness
of such persons, an affidavit of such
persons’ fitness by the contract market’s
counsel or other information
substantiating the fitness of such
persons.37 Finally, the guidance
provides that if a contract market
provides certification of the fitness of
such a person, the Commission believes
that such certification should be based
on verified information that the person
is fit to be in his or her position.38
The guidance for DCM Core Principle
15 (Conflicts of Interest) provides that
the means to address conflicts of
interest in a DCM should include
methods to ascertain the presence of
conflicts of interest and to make
decisions in the event of such a
conflict.39 The guidance also states that
a DCM should provide appropriate
to the ‘‘guidance’’ in part 38, Appendix B, sec. 1.
See 2001 Regulatory Framework, 66 FR 42256 at
42278.
34 Part 38, Appendix B, sec 1.
35 See 2001 Regulatory Framework, 66 FR 42256
at 42283.
36 Id. The DCM Core Principle 14 Guidance states
that members with trading privileges but having no
or only minimal equity in the DCM and nonmember market participants who are not
intermediated ‘‘and do not have these privileges,
obligations, or responsibilities or disciplinary
authority’’ could satisfy minimum fitness standards
by meeting the standards that they must meet to
qualify as a ‘‘market participant.’’
37 2001 Regulatory Framework, 66 FR 42256 at
42283.
38 Id.
39 Id. In 2001, DCM Core Principle 15 addressed
conflicts of interest. In the Dodd-Frank Act, the
DCM conflicts of interest core principle was
renumbered to be Core Principle 16. See DoddFrank Act, section 735(b); 7 U.S.C. 7(d)(16).
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19649
limitations on the use or disclosure of
material non-public information gained
through the performance of official
duties by board members, committee
members, and contract market
employees, or gained through an
ownership interest in the contract
market.
In the 2001 Regulatory Framework,
the Commission adopted Commission
regulation § 38.2, which exempted
‘‘agreements, contracts, or transactions’’
traded on a DCM, as well as the
‘‘contract market’’ itself, and the
‘‘contract market’s operator’’ from all
Commission regulations for such
activity, except for the requirements of
part 38 and §§thnsp;1.3, 1.12(e), 1.31,
1.38, 1.52, 1.59(d), 1.63(c), 1.67, 33.10,
part 9, parts 15 through 21, part 40, and
part 190.40 The Commission did so in
the context of the CFMA, which
provided DCMs with a framework of
flexible core principles in lieu of
detailed regulatory prescriptions.41
2. 2007 Final Release, Conflicts of
Interest Acceptable Practices for DCMs
On February 14, 2007, the
Commission adopted ‘‘acceptable
practices’’ 42 as a way for DCMs to
demonstrate compliance with the
conflicts of interest core principle
(‘‘2007 Final Release’’).43 Acceptable
practices are more detailed examples of
how DCMs may satisfy particular
requirements of the core principles.44
Similar to guidance, acceptable
practices are for illustrative purposes
only and do not establish a mandatory
or exclusive means of compliance with
a core principle. Acceptable practices,
however, are intended to assist DCMs by
outlining specific practices for core
principle compliance. As the
Commission has stated, acceptable
practices provide examples of how
DCMs may satisfy particular
requirements of the core principles; they
do not, however, establish mandatory
40 See 2001 Regulatory Framework, 66 FR 42256
at 42277. See also id. at 42257.
41 See Section II(b)(6) herein for a description of
a revised version of Commission regulation 38.2.
42 See Section II(b)(1) herein for a description of
acceptable practices, and how acceptable practices
compare to guidance.
43 Conflicts of Interest in Self-Regulation and SelfRegulatory Organizations, 72 FR 6936 (Feb, 14,
2007) (‘‘2007 Final Release’’).
44 See 2001 Regulatory Framework, 66 FR 42256
at 42279; Part 38, Appendix B, sec 2. Acceptable
practices were adopted in the 2001 Regulatory
Framework for core principles other than those
relating to governance fitness standards and
conflicts of interest. For example, acceptable
practices were adopted for DCM Core Principles 2,
3, 4, 5, 6, 9, 10, 13, and 17. See 2001 Regulatory
Framework, 66 FR 42256 at 42279–83.
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means of compliance.45 Acceptable
practices apply only to compliance with
specific aspects of a core principle, and
do not protect the DCM with respect to
charges of violations of other sections of
the CEA or other aspects of the core
principle.46
The DCM Core Principle 16
acceptable practices have several key
provisions. First, the acceptable
practices provided that DCM boards of
directors, and any executive committees
or similarly empowered bodies, be
comprised of at least 35 percent ‘‘public
directors.’’ Second, the acceptable
practices also established a definition of
who would constitute a ‘‘public
director’’ for purposes of the acceptable
practices. Third, the acceptable
practices provided that a DCM establish
a ROC comprised exclusively of public
directors, which would have among its
duties to supervise the contract market’s
CRO, who will report directly to the
ROC.47 The Commission explained that
properly functioning ROCs should be
robust oversight bodies capable of
firmly representing the interests of
vigorous, impartial, and effective selfregulation. ROCs should also represent
the interests and needs of regulatory
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.48
The Commission also underscored the
importance of a DCM’s ROC being
composed of 100 percent public
directors, particularly given the industry
shift toward demutualization.49 The
Commission stated that it strongly
believed that new structural conflicts of
interest within self-regulation require an
appropriate response within DCMs. The
Commission further stated that it
believed that ROCs, consisting
45 Core Principles and Other Requirements for
Designated Contract Markets, 77 FR 36612 at 36614
n.13 (June 19, 2012); 7 U.S.C. 7(d)(1) (amended
2010).
46 Id.
47 Id. at 6951 n.80.
48 Id. at 6950–51.
49 By 2007, the futures industry had been shifting
away from mutually owned exchanges, starting in
2000 with the rule amendment approvals for CME
and NYMEX to move from not-for-profit
corporations to for-profit corporations. See
Commission Release #4407–00 (June 16, 2000)
https://www.cftc.gov/sites/default/files/opa/
press00/opa4407-00.htm and Commission Release
#4427–00 (July 28, 2000) https://www.cftc.gov/sites/
default/files/opa/press00/opa4427-00.htm,
respectively. The Commission also approved a
demutualization plan for the Chicago Board of
Trade (CBOT) on April 18, 2005. See Certified Rule
Submissions, https://www.cftc.gov/
IndustryOversight/IndustryFilings/
deaapprovalofrulestable.html.
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exclusively of public directors, are a
vital element of any such response. The
Commission observed that 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.50
Fourth, the acceptable practices
specified that DCM disciplinary panels
should not be dominated by any group
or class of DCM members or
participants, and provided that at least
one person who would qualify as a
public director be included on the
panel.
The Commission provided existing
DCMs with a phase-in period of the
lesser of two years or two regularly
scheduled elections of the board of
directors to demonstrate full compliance
with the conflicts of interest core
principle for DCMs.51 Then, on March
26, 2007, the Commission proposed
certain amendments to the ‘‘public
director’’ definition.52 With the ‘‘public
director’’ definition in flux, the
Commission stayed the phase-in period
for existing DCMs to demonstrate full
compliance with the conflicts of interest
core principle.53
3. 2009 Final Release, Definition of
Public Director
On April 27, 2009, the Commission
adopted final amendments to the
acceptable practices for complying with
the conflicts of interest core principle
for DCMs (‘‘2009 Final Release).54 The
amendments established a final
definition of who constitutes a ‘‘public
director’’ for purposes of the acceptable
practices and the stay for demonstrating
full compliance with the conflicts of
interest core principle was lifted.55 In
adopting the amendments, the
Commission stated that ‘‘self-regulation
must be vigorous, effective, and
impartial.’’ 56
The most important component of the
‘‘public director’’ definition is an
overarching materiality test, which
provides that a public director must
have no material relationship with the
DCM. Certain circumstances are
specified under which a director would
50 See
2007 Final Release, 72 FR 6936 at 6951.
id.
52 Conflicts of Interest in Self-Regulation and SelfRegulatory Organizations, 72 FR 14051 (March 26,
2007).
53 Id. at 65659.
54 Conflicts of Interest in Self-Regulation and SelfRegulatory Organizations, 74 FR 18982 (Apr. 27,
2009) (‘‘2009 Final Release’’).
55 Id. at 18983.
56 Id. at 18984.
51 See
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be deemed to have a material
relationship. A director would be
deemed to have a material relationship
by virtue of: (1) being an officer or
employee of the DCM, or an officer or
employee of an affiliate of the DCM; (2)
being a member, or an officer or director
of a member, of the DCM; or (3)
receiving more than $100,000 in annual
payments from the DCM or an affiliate
of the DCM for legal, accounting, or
consulting services. The director would
also have a material relationship if a
family member had any of the
aforementioned relationships. Whether
a director or family member had any
such relationship would be subject to a
one-year look-back period.
4. 2010 Conflicts of Interest Rule
Proposal
On October 18, 2010, the Commission
issued a rule proposal (the ‘‘Mitigation
of Conflicts of Interest NPRM’’), which
proposed prophylactic measures aimed
to mitigate conflicts of interest in the
operation of a SEF or DCM.57 After
identifying certain potential conflicts of
interest, the Commission made rule
proposals for SEFs and DCMs
concerning (1) governance, and (2)
ownership of voting equity and the
exercise of voting rights. With respect to
governance, the Commission proposed,
as rules, enhanced versions of the
acceptable practices that had previously
been adopted for the DCM core
principle on conflicts of interest.58
Specifically, the Commission proposed
to require that each SEF or DCM have:
• a board of directors with at least 35
percent, but no less than two, public
directors;
• a nominating committee with at
least 51 percent public directors, and
with a public director as chair;
• one or more disciplinary panels,
with a public participant as chair;
• a ROC with all public directors; and
• a membership or participation
committee, with 35 percent public
directors.
The Commission also proposed, as
rules, certain limitations with respect to
the ownership of voting equity in the
SEF or DCM and the exercise of voting
rights. These proposals limited SEF
participants or DCM members (and
related persons) to: (1) beneficially
57 Requirements for Derivatives Clearing
Organizations, Designated Contract Markets, and
Swap Execution Facilities Regarding the Mitigation
of Conflicts of Interest, 75 FR 63732 (Oct. 18, 2010).
58 Id. at 63733. See also 2009 Final Release, 74
FR 18982 (which defined ‘‘public director’’); 2007
Final Release, 72 FR 6936 (Feb. 14, 2007) (which
adopted final acceptable practices for the DCM core
principle on conflicts of interest); 71 FR 38740 (July
7, 2006) (which proposed acceptable practices for
such DCM core principle).
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owning no more than 20 percent of any
class of voting equity in the SEF or
DCM; and (2) exercising (whether
directly or indirectly) no more than 20
percent of the voting power of any class
of equity interest in the SEF or DCM.
The Commission never adopted the
proposed rules as final rules.59
5. 2011 Governance and Conflicts of
Interest NPRM
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On January 6, 2011, the Commission
issued a post-Dodd-Frank Act rule
proposal (the ‘‘2011 Governance and
Conflicts of Interest NPRM’’) to establish
the manner in which DCMs, SEFs and
DCOs must comply with their respective
core principle obligations with regard to
conflicts of interest.60 The rule proposal
aimed to mitigate conflicts of interest
through requirements regarding
reporting, transparency in decisionmaking, and limitations on the use or
disclosure of non-public information,
among other things.61 The 2011
Governance and Conflicts of Interest
NPRM also proposed rules to establish
the manner in which DCMs and DCOs
must comply with their respective core
principle obligations with regard to
governance fitness standards 62 and the
composition of governing bodies,63 and
proposed rules to establish the manner
in which publicly traded DCMs must
comply with their core principle
obligation with regard to the diversity of
their board of directors.64 The
Commission never adopted the 2011
Governance and Conflicts of Interest
NPRM as final rules.65
59 The proposal was withdrawn on the Fall 2020
Unified Agenda and Regulatory Plan. The
withdrawal entry is available at: https://
www.reginfo.gov/public/do/
eAgendaViewRule?pubId=202010&RIN=3038AD37.
60 Governance Requirements for Derivatives
Clearing Organizations, Designated Contract
Markets, and Swap Execution Facilities; Additional
Requirements Regarding the Mitigation of Conflicts
of Interest, 76 FR 722 (January 6, 2011).
61 Id.
62 See section 5(d)(15) of the CEA, 7 U.S.C.
7(d)(15) (DCM core principle on governance fitness
standards), as redesignated by section 735 of the
Dodd-Frank Act.
63 See section 5(d)(17) of the CEA, 7 U.S.C.
7(d)(17) (DCM core principle on composition of
governing boards), as added by section 735 of the
Dodd-Frank Act.
64 See section 5(d)(22) of the CEA, 7 U.S.C.
7(d)(22) (DCM core principle on diversity of board
of directors), as added by section 735 of the DoddFrank Act.
65 The proposal was withdrawn on the Fall 2019
Unified Agenda and Regulatory Plan. The
withdrawal entry that appeared in the Fall 2019
Agenda is available at: https://www.reginfo.gov/
public/do/eAgendaViewRule?pubId=
201910&RIN=3038-AD36.
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6. 2012 Part 38 Final Rule
The Dodd-Frank Act overhauled or
reversed key aspects of the regulatory
framework under the CFMA, but
retained the core principles framework.
Importantly, however, the Dodd-Frank
Act specifically empowered the
Commission to determine by rule or
regulation, the manner in which a DCM
may comply with core principles.
Section 735 of the Dodd-Frank Act
amended section 5 of the CEA to
include the proviso that ‘‘[u]nless
otherwise determined by the
Commission by rule or regulation . . .’’
boards of trade shall have reasonable
discretion in establishing the manner in
which they comply with the core
principles.66 On June 19, 2012, the
Commission adopted a rulemaking to
implement the Dodd-Frank Act’s
amendments to section 5 of the CEA
pertaining to the designation and
operation of contract markets (the ‘‘2012
Part 38 Final Rule’’).67 Similar to the
Commission’s approach in this rule
proposal, the Commission’s
implementation of the new provisions
under the Dodd-Frank Act substituted
rules in lieu of guidance and acceptable
practices for several of the DCM core
principles.68
In the 2012 Part 38 Final Rule, the
Commission adopted rules establishing
the manner in which a DCM must
comply with several of the DCM core
principles. The Commission also
adopted revised guidance and
acceptable practices for certain of the
DCM core principles. The Commission
chose to maintain the existing
guidance 69 on compliance with the
DCM core principle on governance
fitness standards, and to maintain the
existing guidance on,70 and acceptable
practices in, compliance with the DCM
conflicts of interest core principle.71
This included the acceptable practice
that the DCM’s ROC supervise the
66 See
CEA section 5(d)(1)(B) (emphasis added).
Principles and Other Requirements for
Designated Contract Markets, 77 FR 36612 (June 19,
2012) (the ‘‘2012 Part 38 Final Rule’’).
68 In 2007, DCM Core Principle 15 addressed
conflicts of interest. In the Dodd-Frank Act, the
DCM conflicts of interest core principle was
renumbered to be Core Principle 16. See DoddFrank Act, section 735(b); 7 U.S.C. 7(d)(16).
69 See section II(b)(1) herein for a description of
the guidance adopted in 2001 relating to
governance fitness standards.
70 See section II(b)(1) herein for a description of
the guidance adopted in 2001 relating to conflicts
of interest.
71 2012 Part 38 Final Rule, 77 FR 36612 at 36655–
56. The Commission added Commission regulation
§ 38.851 to permit DCMs to continue to rely on the
conflicts of interest guidance in Appendix B to part
38. See section II(b)(2)–(3) herein for a description
of acceptable practices adopted in 2007 and 2009
relating to conflicts of interest.
67 Core
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19651
DCM’s CRO, who reports directly to the
ROC. While the Commission did not
adopt rules to establish this as an
affirmative requirement for all DCMs,
the Commission stated in the adopting
release that current industry practice is
for DCMs to designate an individual as
chief regulatory officer, and it will be
difficult for a DCM to meet the
compliance staff and resources
requirements of § 38.155 without a chief
regulatory officer or similar individual
to supervise its regulatory program,
including any services rendered to the
DCM by a regulatory service provider.72
In the 2012 Part 38 Final Rule, the
Commission contemplated that rules
implementing the DCM conflicts of
interest core principle might be adopted
in the future.73
In the 2012 Part 38 Final Rule, the
Commission also adopted equity
transfer notification requirements for
DCMs. Pursuant to § 38.5(c), DCMs must
notify the Commission when they enter
into a transaction involving the transfer
of 10 percent or more of the equity
interest in the DCM.74 DCMs must
notify the Commission of such a transfer
at the earliest possible time, but in no
event later than the open of business 10
business days following the date upon
which the DCM enters into a firm
obligation to transfer the equity
interest.75 In particular, the Commission
explained that while DCMs may take up
to 10 business days to submit a
notification, the DCM must provide
Commission staff with sufficient time,
prior to consummating the equity
interest transfer, to review and consider
the implications of the change in
ownership, including whether the
change in ownership will adversely
impact the operations of the DCM or the
DCM’s ability to comply with the core
principles and the Commission’s
regulations thereunder.76
In addition to Commission regulation
§ 38.5(c)’s equity interest transfer
requirements, the Commission adopted
regulations requiring DCMs to submit
certain information to the Commission.
72 2012
Part 38 Final Rule, 77 FR 36612 at 36628.
Commission explained that until such time
as it may adopt the substantive rules implementing
Core Principle 16, the Commission was maintaining
the current guidance and acceptable practices under
part 38 applicable to Conflicts of Interest (formerly
Core Principle 15). Accordingly, the existing
Guidance and Acceptable Practices from Appendix
B of part 38 applicable to Core Principle 16 were
codified in the revised Appendix B adopted in the
final rulemaking. The Commission noted that at
such time as it may adopt the final rules
implementing Core Principle 16, Appendix B
would be amended accordingly. 2012 Part 38 Final
Rule, 77 FR 36612 at 36656.
74 See Commission regulation § 38.5(c).
75 See id.
76 2012 Part 38 Final Rule, 77 FR 36612 at 36619.
73 The
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Pursuant to Commission regulation
§ 38.5(a), upon request, a DCM must file
with the Commission information
related to its business as a DCM,
including information relating to data
entry and trade details, in the form and
manner and within the time specified
by the Commission in its request.77
The Commission notes that in the
2012 Part 38 Final Rule, pursuant to
§ 38.5(d), the Commission delegated
‘‘the authority set forth in paragraph (b)
of this section’’ (demonstration of
compliance) to the Director of the
Division of Market Oversight.78 This
differs from the corresponding
regulation for SEFs.79 Existing
Commission regulation § 37.5(d)
provides that the Commission delegates
‘‘the authority set forth in this section’’
to the Director of the Division of Market
Oversight, which is a broader delegation
compared to the Part 38 regulation. In
particular, the delegation provision in
§ 37.5(d) includes the authority to
request information pursuant to both
regulations §§ 37.5(a) (requests for
information) and (b) (demonstration of
compliance).80 The delegation provision
in § 38.5(d) does not apply to § 38.5(a)
(requests for information).
Finally, in the 2012 Part 38 Final
Rule, the Commission adopted a revised
version of § 38.2 that specified ‘‘the
Commission regulations from which
DCMs will be exempt’’ as opposed to
listing the regulations that DCMs were
obligated to comply with.81 The
Commission made this change to add
clarity and to eliminate the need for the
Commission to continually update
§ 38.2 when new regulations with which
DCMs must comply are codified.82 The
Commission exempted DCMs from
certain provisions within part 1 of the
Commission’s regulations that address
conflicts of interest and governance for
self-regulatory organizations (‘‘SROs’’).
In particular, the Commission exempted
DCMs from all or part of the following
provisions:
• Commission regulation § 1.59,
which addresses limitations on the use
and disclosure of non-public
information; 83
77 See
Commission regulation § 38.5(a).
Commission regulation § 38.5(d).
79 See Section II(b)(7) for a description of the
rulemaking implementing regulatory obligations of
SEFs in which the current version of Commission
regulation 37.5 was adopted.
80 See Commission regulation § 37.5(d).
81 See 2012 Part 38 Final Rule, 77 FR 36612 at
36615. See Section II(b)(1) herein for a description
of the previous version of Commission regulation
§ 38.2.
82 Id.
83 Commission regulation § 38.2 exempts DCMs
from Commission regulation § 1.59(b) (requiring
self-regulatory organizations to, by rule, prohibit
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• Commission regulation § 1.63,
which restricts persons with certain
disciplinary histories from serving on
governing boards or committees; 84
• Commission regulation § 1.64,
which addresses composition of
governing boards and disciplinary
committees; 85 and
• Commission regulation § 1.69,
which addresses voting by conflicted
members of governing boards and
committees.86
In exempting DCMs from the
provisions listed above, the Commission
noted that Commission regulation § 38.2
will likely be amended if and when the
referenced rules are eliminated from the
regulations or modified.87
7. 2013 Part 37 Final Rule
On June 4, 2013, the Commission
adopted a final rulemaking (the ‘‘Part 37
Final Rule’’) which established
regulatory obligations that SEFs—a new
category of regulated entity introduced
under the Dodd-Frank Act.88 In the Part
37 Final Rule, the Commission adopted
rules establishing the manner in which
a SEF must comply with several of the
SEF core principles, and also adopted
guidance and acceptable practices for
certain of the SEF core principles. In the
Part 37 Final Rule, the Commission did
not adopt the guidance on, and
acceptable practices in, compliance
with the conflicts of interest core
principle that the Commission had
adopted to date for DCMs. In the
employees from trading in certain contracts traded
on or cleared by the self-regulatory organization or
related to those traded on or cleared by the selfregulatory organization, and from trading on or
disclosing material non-public information), and
Commission regulation § 1.59(c) (requiring selfregulatory organizations to, by rule, prohibit
governing board members, committee members, and
consultants from disclosing material non-public
information gained as a result of official duties).
DCMs remain subject to Commission regulations
§§ 1.59(a) (definitions) and 1.59(d) (prohibiting selfregulatory organization employees, governing board
members, committee members, and consultants
from trading on or disclosing material non-public
information).
84 Commission regulation § 38.2 exempts DCMs
from all paragraphs of Commission regulation § 1.63
except for Commission regulation § 1.63(c), which
states that no person may serve on a disciplinary
committee, arbitration panel, oversight panel or
governing board of a self-regulatory organization if
such person is subject to any of the conditions
listed in Commission regulation § 1.63(b)(1) through
(6), which lists certain disqualifying offenses,
suspensions, settlements, revocations, bars, and
denials.
85 Commission regulation § 38.2 exempts DCMs
from the entirety of Commission regulation § 1.64.
86 Commission regulation § 38.2 exempts DCMs
from the entirely of Commission regulation § 1.69.
87 See 2012 Part 38 Final Rule, 77 FR 36612 at
36615.
88 See Core Principles and Other Requirements for
Swap Execution Facilities, 78 FR 33476 (June 4,
2013) (the ‘‘Part 37 Final Rule’’).
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adopting release, the Commission
explained that, as noted in the notice of
proposed rulemaking for the Part 37
Final Rule, the substantive regulations
implementing SEF Core Principle 12
(Conflicts of Interest) were proposed in
a separate release, the Mitigation of
Conflicts of Interest NPRM. The
Commission noted that until such time
as it may adopt the substantive rules
implementing Core Principle 12, SEFs
have reasonable discretion to comply
with this core principle as stated in
§ 37.100.89
As discussed above, the Commission
never adopted the Mitigation of
Conflicts of Interest NPRM as final
rules.
Pursuant to Commission regulation
§ 37.2, adopted in the Part 37 Final
Rule, SEFs are subject, in their entirety,
to Commission regulations §§ 1.59, 1.63,
1.64 and 1.69 which, as discussed
above, address conflicts of interest and
governance for self-regulatory
organizations. Therefore, SEFs are
currently subject to a different set of
conflicts of interest and governance
requirements than DCMs.
In the Part 37 Final Rule, the
Commission adopted rules to
implement the Chief Compliance Officer
core principle for SEFs that, among
other things, addressed the CCO’s duties
and the annual compliance report
requirement, provided that the CCO’s
duties include supervising the SEF’s
self-regulatory program with respect to,
among other regulatory responsibilities,
trade practice surveillance, market
surveillance, real-time market
monitoring, compliance with audit trail
requirements, enforcement and
disciplinary proceedings, audits, and
examinations.90 In addition, the rules
provided that the CCO’s duties included
supervising the effectiveness and
sufficiency of any regulatory services
provided to the SEF by a permitted
89 Id.
at 33538.
Part 37 Final Rule, 78 FR 33476, which
adds CCO duties beyond those contained in SEF
Core Principle 15, including (1) providing examples
of the types of conflicts of interest that a CCO must
resolve, including conflicts between business
considerations and compliance requirements, and
(2) supervising the SEF’s self-regulatory program
with respect to trade practice surveillance, market
surveillance, real-time market monitoring,
compliance with audit trail requirements,
enforcement and disciplinary proceedings, audits,
examinations, and other regulatory responsibilities
with respect to members and market participants
(including ensuring compliance with, if applicable,
financial integrity, financial reporting, sales
practice, recordkeeping, and other requirements),
and (3) supervising the effectiveness and
sufficiency of any regulatory services provided by
a regulatory service provider pursuant to
Commission regulation § 37.204.
90 See
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regulatory service provider.91 With
respect to the annual compliance report,
the rules provided that the CCO must,
prior to submission to the Commission,
provide the report for review to the
SEF’s board of directors or, in the
absence of a board of directors, to the
senior officer of the SEF.92 Members of
the board of directors or the SEF’s
senior officer (as applicable) must not
require the CCO to make any changes to
the report.93
The Part 37 Final Rule adopted equity
transfer notification requirements for
SEFs, but they differ in three areas from
those applicable to DCMs pursuant to
the 2012 Part 38 Final Rule. First, under
Commission regulation § 37.5(c), SEFs
must notify the Commission when they
enter into a transaction involving the
transfer of 50 percent or more of the
equity interest in the SEF.94 This is a
higher percentage than the 10 percent or
more percentage that applies with
respect to DCM equity interest transfers,
and is therefore effectively a lower
notification standard. Second,
Commission regulation § 37.5(c)
specifically authorizes the Commission,
upon receipt of notification from a SEF
of an equity interest transfer, to request
supporting documentation regarding the
transaction; this authority also is
delegated to the Director of the Division
of Market Oversight or such other
employee(s) as the Director may
designate from time to time. Finally,
upon an equity interest transfer, SEFs
are affirmatively required to certify to
the Commission, no later than two
business days after the transfer takes
place, that the SEF meets all of the
requirements of section 5h of the CEA
(which includes the statutory SEF core
principles) and the Commission’s
91 Id. at 33594. Commission regulation § 37.204(a)
permits a SEF to utilize another registered entity,
a registered futures association, and, in the case of
SEFs, the Financial Industry Regulatory Authority,
for the provision of services to assist in complying
with the CEA and Commission regulations.
Commission regulation § 37.204(b) provides that a
SEF that chooses to use a regulatory service
provider shall retain sufficient staff to supervise the
regulatory services, that SEF compliance staff shall
hold regular meetings with the regulatory service
provider to discuss matters of regulatory concern,
and that the SEF must conduct periodic reviews of
the services provided. Further, Commission
regulation § 37.204(b) requires that the SEF
carefully document such periodic reviews and
provide them to the Commission upon request.
Commission regulation § 37.204(c) states that a SEF
that chooses to use a regulatory service provider
shall retain exclusive authority in all substantive
decisions made by the regulatory service provider,
and that the SEF must document any instances
where its actions differ from those recommended by
the regulatory service provider.
92 See Commission regulation § 37.1501(e)(1).
93 Id.
94 See Commission regulation § 37.5(c).
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regulations thereunder.95 There is
currently no analogous certification
requirement that applies to a DCM
under Commission regulation
§ 38.5(c).96
8. 2021 Part 37 Amendments—CCO
Duties and Annual Compliance Report
On May 12, 2021, the Commission
adopted final rules amending SEF
requirements related to audit trail data,
financial resources, and CCO
obligations, including the rules
addressing the CCO’s obligation to
submit an annual report to the
Commission (‘‘Part 37 Updates’’).97 The
Commission stated that the purpose of
the CCO amendments was to streamline
requirements for the CCO position,
allow SEF management to exercise
greater discretion in CCO oversight, and
simplify the preparation and submission
of the required annual compliance
report.98 Among other changes, the
Commission clarified that a CCO did not
need to include in the annual
compliance report a review of all the
Commission regulations applicable to a
SEF or an identification of the written
policies and procedures designed to
ensure compliance with the CEA and
Commission regulations. The
amendments clarified that the CCO was
required to include in the annual report
a description and self-assessment of the
effectiveness of the written policies and
procedures of the SEF to ‘‘reasonably
ensure’’ compliance with the CEA and
applicable Commission regulations.
Additionally, the amendments clarified
that CCOs are required to discuss only
‘‘material’’ noncompliance matters in
the annual report, instead of all
‘‘noncompliance issues.’’
In the Part 37 Updates, the
Commission also modified SEF CCO
requirements in several other ways,
including by: (1) consolidating certain
CCO duties; 99 (2) eliminating ROC95 See
Commission regulation § 37.5(c)(4).
2018, as part of a notice of proposed
rulemaking relating to SEFs and the trade execution
requirement, the Commission proposed to amend
Commission regulation § 37.5 to (i) require
notification in the event of any transaction that
results in the transfer of direct or indirect
ownership of 50 percent or more of the equity
interest in the SEF; and (ii) delete the part 40 filing
requirement. See Swap Execution Facilities and the
Trade Execution Requirement, 83 FR 61946, 71–72
(Nov. 30, 2018). The Commission withdrew this
proposal in 2021. See 86 FR 9304 (Feb. 12, 2021).
97 Swap Execution Facilities, 86 FR 9224 (Feb. 11,
2021) (the ‘‘Part 37 Updates’’).
98 Id. at 9225.
99 The Commission explained that the rules
would allow a CCO to identify non-compliance
matters through ‘‘any means’’ in addition to the
means previously provided in the rule, which were
by compliance office review, look-back, internal or
external audit finding, self-reported error, or
validated complaint. Id. at 9235 n.171. The
96 In
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19653
related components of part 37; 100 (3)
allowing the CCO to consult with the
board of directors or senior officer of the
SEF in developing the SEF’s policies
and procedures; (4) allowing a CCO to
meet with the senior officer of the SEF
on an annual basis, in lieu of an annual
meeting with the board of directors; and
(5) allowing a CCO to provide selfregulatory program information to the
SEF’s senior officer, in addition to the
board of directors. The modifications
identified as (3), (4) and (5) in the
preceding sentence enhance the role of
the SEF’s senior officer, providing for an
oversight role over the CCO equivalent
to that of the board of directors. The
Commission considered this change to
be consistent with SEF Core Principle
15, which requires a CCO to report to
the SEF’s board of directors or senior
officer.101
In addition, the Commission amended
the rules addressing the removal of a
CCO. The rules previously had
restricted CCO removal authority to a
majority of the board of directors, or in
the absence of a board, to a senior
officer. In the Part 37 Updates, the
Commission amended the requirement
to establish that either the board or
senior officer of the SEF may remove the
CCO. The Commission stated that in
many instances, the senior officer may
be better positioned than the board of
directors to provide day-to-day
oversight of the SEF and the CCO, as
well as to determine whether to remove
a CCO.102
The Part 37 Updates also amended the
duties of the CCO to allow a CCO to
identify noncompliance issues through
‘‘any means’’ and clarified that the
procedures that the CCO takes to
address noncompliance issues must be
‘‘reasonably designed’’ to handle,
Commission modified the duty for a CCO to
establish procedures for the remediation of
noncompliance issues to clarify that a CCO must
establish procedures reasonably designed to handle,
respond, remediate, retest, and resolve
noncompliance issues, based on an
acknowledgement that a CCO may not be able to
design procedures that detect all possible
noncompliance issues and noted that a CCO may
utilize a variety of resources to identify
noncompliance issues beyond a limited set of
means. Id. at 9235.
100 The ROC-related components of part 37
included a mandatory quarterly meeting of the CCO
with the ROC, and the requirement that a CCO
provide self-regulatory program information to the
ROC. Id. at 9233–34. In determining to eliminate
the ROC-related components of the regulation, the
Commission stated that Core Principle 15 does not
require a SEF to establish a ROC and the
Commission has not finalized a rule that establishes
requirements for a ROC. See id. at 9234. Pursuant
to proposed § 37.1206 in this proposed rulemaking,
the Commission now seeks to establish explicit
requirements for a SEF ROC.
101 See Commission regulation § 37.1500(b)(1).
102 Part 37 Updates, 86 FR 9224 at 9234.
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respond to, remediate, retest, and
resolve those issues.103 Such changes
provide the CCO with additional
flexibility in identifying and addressing
noncompliance, and recognize that a
CCO may not be able to design
procedures that detect all possible
noncompliance issues and may utilize a
variety of resources to identify
noncompliance issues.104
In addition, the Commission amended
the CCO’s duty to resolve conflicts of
interest, requiring the CCO to take
‘‘reasonable steps’’ to resolve ‘‘material’’
conflicts of interest that may arise.105 In
adding the concepts of reasonableness
and materiality, the Commission stated
that the current requirement was overly
broad and impractical because a CCO
cannot be reasonably expected to
successfully resolve every potential
conflict of interest that may arise.106
c. Industry Changes and Impact on
Regulatory Developments
By 2007, when the Commission
adopted the acceptable practices
relating to conflicts of interest and
governance standards,107 the futures
industry had begun shifting from
mutually-owned exchanges into forprofit institutions.108 For example, in
2000, the Commission approved rules
relating to plans by CME,109 NYMEX,110
and CBOT 111 to convert from non-profit
corporations owned by their members to
for-profit corporations.112 Given that
demutualization was relatively new and
evolving, the Commission provided
flexibility regarding governance
structures and conflicts of interest
provisions.113 In contrast to many of the
103 See
id. at 9235.
id.
105 See id.
106 See id.
107 See Section II(b)(2).
108 In 2007, DCM Core Principle 15 addressed
conflicts of interest. In the Dodd-Frank Act, the
DCM conflicts of interest core principle was
renumbered to be Core Principle 16. See DoddFrank Act, section 735(b); 7 U.S.C. 7(d)(16).
109 See Commission Release #4407–00, https://
www.cftc.gov/sites/default/files/opa/press00/
opa4407-00.htm.
110 See Commission Release #4427–00, https://
www.cftc.gov/sites/default/files/opa/press00/
opa4427-00.htm.
111 See Commission Release #4434–00, https://
www.cftc.gov/sites/default/files/opa/press00/
opa4434-00.htm.
112 The process continued through 2020, when
MGEX went through demutualization. https://
www.cftc.gov/sites/default/files/filings/documents/
2020/orgdcmmgexordertransfer201124.pdf; https://
www.mgex.com/documents/MIAX_MGEX_
SeatVote_PressRelease_000.pdf.
113 On July 7, 2006, the Commission proposed the
acceptable practices that it finalized in the 2007
Final Release. Conflicts of Interest in SelfRegulation and Self-Regulatory Organizations, 71
FR 38739 (July 7, 2006). In that proposal, the
Commission acknowledged that the U.S. futures
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104 See
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other SEF and DCM core principles, to
date the Commission has not adopted
rules to prescribe the manner in which
compliance with the conflicts of interest
core principle for SEFs or DCMs, or the
governance fitness standards core
principle for DCMs, must be
demonstrated. While the guidance on
compliance with the relevant DCM core
principles sets forth important
considerations that the Commission
believes should be taken into account by
DCMs in complying with those core
principles, and the acceptable
practices 114 for the DCM conflicts of
interest core principle additionally set
forth examples of how DCMs may
satisfy particular requirements under
that core principle, neither the guidance
nor the acceptable practices establish
mandatory compliance obligations for
DCMs. With respect to the conflicts of
interest core principle for SEFs, the
Commission to date has not adopted
guidance or acceptable practices for
compliance with the core principle.
While the statutory core principles are
intended to be broad and flexible, the
Commission is mindful that, in certain
circumstances, flexibility in the manner
of compliance may create confusion.
Practically speaking, while this
flexibility exists, Commission staff has
found that all DCMs have chosen to
adopt the acceptable practices to
demonstrate compliance with DCM Core
Principle 16.
The Commission preliminarily
believes that establishing affirmative,
industry was being transformed by, among other
things, the demutualization of member-owned
exchanges and their conversion to publicly traded
stock corporations. Id. at 38740–38741. The
Commission noted that the acceptable practices
would, among other things, ensure that industry
expertise, experience, and knowledge continue to
play a vital role in self-regulatory organization
governance and administration and thus, preserve
the ‘‘self’’ in self-regulation. Id. at 38741–38742. In
the 2007 Final Release, the Commission reiterated
that the acceptable practices were being adopted in
response to, among other things, demutualization.
The Commission observed that it did identify
industry changes that it believed create new
structural conflicts of interest within selfregulation, 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. The
Commission further noted that 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.
2007 Final Release, 72 FR 6936 at 6944.
114 Through its acceptable practices, the
Commission provides exchanges with specific
practices that DCMs may adopt to demonstrate a
safe harbor for compliance with selected
requirements aspects of a core principle, but such
acceptable practices were not intended as the
exclusive means of compliance. See CEA section
5c(a)(1), 7 U.S.C. 7a–2(a)(1).
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harmonized requirements for
governance fitness standards and the
mitigation of conflicts of interest are
necessary to promote the integrity of
SEFs and DCMs as self-regulatory
organizations and to ensure the effective
and impartial fulfillment of those
functions. In particular, the Commission
has recently observed an increase in the
number of SEFs and DCMs that are part
of corporate families that also have
other Commission registrants and other
market participants. In conducting SEF
regulatory consultations that were
completed in 2021, Commission staff
identified several SEFs that were in the
same corporate family as intermediaries
that also traded on the SEF. Similarly,
in 2021, Commission staff conducted an
informal inquiry into which DCMs were
in corporate families with
intermediaries who traded on the DCM,
and identified three such DCMs.
Where multiple Commission
registrants or other market participants
exist in the same corporate family, the
risk of conflicts of interest may increase.
For example, when a SEF or DCM is in
the same corporate family as an
intermediary, like an introducing broker
(‘‘IB’’) or a futures commission
merchant (‘‘FCM’’), that trades on or
brings trades to the SEF or DCM for
execution, the SEF’s or DCM’s market
regulation obligations 115 may conflict
with interests of the intermediary, such
as in circumstances where there are
questions about the intermediary’s
compliance with a SEF or DCM rule.116
The emergence of these affiliations
could also affect certain key
components of a SEF’s or DCM’s
framework for addressing conflicts of
interest that may impact market
regulation functions. With respect to
determining whether an individual
satisfies the public director standard, as
outlined in the DCM Core Principal 16
Acceptable Practices, certain
relationships that the individual may
have with an affiliate of the DCM would
need to be evaluated. Furthermore,
officers and members of the board of
director may need to evaluate whether
certain relationships with an affiliate of
115 For example, Commission regulation § 38.152
requires DCMs that allow intermediation to prohibit
customer-related abuses such as trading ahead of
customer orders, trading against customer orders,
accommodation trading, and improper cross
trading. Commission regulation § 37.203 imposes a
similar requirement on SEFs.
116 In contrast to situations in which a DCM and
DCO are in the same corporate family—which the
Commission has observed over the past two
decades—a SEF or DCM being in the same
corporate family as an intermediary registrant raises
unique issues. Rena S. Miller, Congressional
Research Service, Conflicts of Interest in Derivatives
Clearing (2011), https://crsreports.congress.gov/
product/pdf/R/R41715/4.
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the DCM or SEF would give rise to an
actual or potential conflict of interest
that could impact decision-making.
Accordingly, the Commission is herein
proposing conflict of interest rules that
focus on the identification, management
and resolution of conflicts of interest
related to a SEF’s or DCM’s market
regulation functions, as preliminarily
defined by the Commission below, as
well as related governance standards
that the Commission believes support
the mitigation of such conflicts of
interest. The set of rules proposed
herein draw on many years of
Commission staff’s experience
conducting its routine oversight of SEFs
and DCMs, and reflect the Commission’s
identification of specific, harmonized
measures that it preliminarily believes
will help to ensure that SEFs and DCMs
fulfill their market regulation functions
in an effective and impartial manner.
Separately, on June 28, 2023,
Commission staff issued a Request for
Comment on the Impact of Affiliations
Between Certain CFTC-Regulated
Entities (‘‘RFC’’).117 The RFC sought
public comment in order to better
inform Commission staff’s
understanding of a broad range of
potential issues that may arise if a DCM,
DCO or SEF is affiliated with an
intermediary, such as an FCM or IB, or
other market participant such as a
trading entity.118 The Commission also
notes that on December 18, 2023, its
Divisions of Clearing and Risk, Market
Oversight, and Market Participants
issued a staff advisory on affiliations
between a DCM, DCO or a SEF and an
intermediary, such as an FCM, or other
market participant, such as a trading
entity. The advisory reminds DCOs,
DCMs, and SEFs that have an affiliated
intermediary or trading entity, as well as
the affiliated intermediary or trading
entities themselves, of their obligations
to ensure compliance with existing
statutory and regulatory requirements
with this affiliate relationship in
mind.119
1. Market Regulation Functions
This rule proposal addresses certain
conflicts of interest that may impact a
SEF’s or DCM’s market regulation
functions. For purposes of this rule
proposal, the Commission is proposing
to define as ‘‘market regulation
functions’’ the responsibilities related to
trade practice surveillance, market
surveillance, real-time market
monitoring, audit trail data and
recordkeeping enforcement,
investigations of possible SEF or DCM
rule violations, and disciplinary
actions.120 The Commission believes
that effective performance of these
market regulation functions require
SEFs and DCMs, consistent with their
core principle obligations, to establish a
process for identifying, minimizing, and
resolving actual and potential conflicts
of interest that may arise between and
among any of the SEF’s or DCM’s
market regulation functions and its
commercial interests; or the several
interests of its management, members,
owners, customers and market
participants, other industry participants,
and other constituencies.
Proposed § 37.1201(b)(9) defines
‘‘market regulation functions’’ as the
SEF functions required by SEF Core
Principle 2 (Compliance with Rules),
SEF Core Principle 4 (Monitoring of
Trading and Trade Processing), SEF
Core Principle 6 (Position Limits or
Accountability), SEF Core Principle 10
(Recordkeeping) and the Commission’s
regulations thereunder. Proposed
§ 38.851(b)(9) defines ‘‘market
regulation functions’’ as the DCM
functions required by DCM Core
Principle 2 (Compliance with Rules),
DCM Core Principle 4 (Monitoring of
Trading), DCM Core Principle 5
(Position Limits or Accountability),
DCM Core Principle 10 (Trade
Information), DCM Core Principle 12
(Protection of Markets and Market
Participants), DCM Core Principle 13
117 Request
ddrumheller on DSK120RN23PROD with PROPOSALS2
for Comment on the Impact of
Affiliations of Certain CFTC-Regulated Entities,
CFTC Release 8734–23, June 28, 2023. https://
www.cftc.gov/PressRoom/PressReleases/8734-23.
118 The Commission received a number of
comments raising concerns about the impact of
affiliation, and anticipates proposing regulations
that will address issues identified as a result of the
RFC, including additional concerns raised by
commenters about the conflicts of interest,
specifically relating to market regulation functions,
posed by affiliations. This rulemaking does not
reflect the comments submitted in response to the
Commission staff’s RFC. Those comments will not
be made part of the administrative record before the
Commission in connection with this proposal.
119 Staff Advisory on Affiliations Among CFTCRegulated Entities, CFTC Release 8839–23, Dec. 18,
2023. https://www.cftc.gov/PressRoom/
d. Conflicts of Interest Relating to
Market Regulation Functions
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PressReleases/8839-23. In addition to the increased
focus on affiliate relationships, another market
structure development relates to the participation of
intermediaries on SEF and DCM markets. With
limited exceptions, derivatives trading today is
conducted through regulated intermediaries who
perform many important functions, such as
providing customers with access to exchanges and
clearinghouses, processing transactions, ensuring
compliance with federal regulations, and
guaranteeing performance of the derivatives
contract to the clearinghouse. Recently, the
Commission has observed a trend in which
registered entities pursue a ‘‘non-intermediated’’
model, or direct trading and clearing of margined
products to retail customers.
120 See proposed §§ 38.851(b)(9) and
37.1201(b)(9).
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19655
(Disciplinary Procedures), DCM Core
Principle 18 (Recordkeeping) and the
Commission’s regulations thereunder.
The Commission’s proposed
definition of ‘‘market regulation
functions’’ does not include certain
other SEF or DCM obligations. For
example, the proposed definition does
not include DCM Core Principle 11
(Financial Integrity of Transactions), the
related financial surveillance
requirements for DCMs under
Commission regulation § 1.52, or a
SEF’s obligations under Core Principle 7
(Financial Integrity of Transactions).
As noted above, the Commission
staff’s RFC sought public comment on a
range of potential issues that may arise
if a DCM, DCO or SEF is affiliated with
an intermediary, such as an FCM or IB,
or other market participant such as a
trading entity. While the scope of the
proposed term ‘‘market regulation
functions’’ in this rulemaking is limited
to SEF and DCM functions under
specific core principles, the
Commission notes that public comment
in response to the RFC may inform
future Commission action. The
Commission may further address SEF or
DCM conflicts of interest obligations
that may impact broader self-regulation
functions of SEFs and DCMs, including
their obligations under SEF Core
Principle 7 and DCM Core Principle 11.
The Commission notes that any future
action impacting broader self-regulatory
functions may consider whether those
self-regulatory functions should be
subject to requirements that are similar
or different to the requirements being
proposed in this rulemaking. As
discussed further below, the main
objective of this rulemaking is to
establish requirements to mitigate
certain conflicts of interest that may
impact those SEF and DCM functions
most closely tied to the SEF’s or DCM’s
market regulation function.
2. Questions for Comment
The Commission seeks comment on
the questions set forth below regarding
the proposed definition of ‘‘market
regulation functions.’’
1. Has the Commission appropriately
defined ‘‘market regulation functions’’
for purposes of this rule proposal? Are
there additional functions that should
be included in the proposed definition?
2. In this rule proposal, and for
purposes of the conflicts of interest that
it is intended to address, has the
Commission appropriately
distinguished ‘‘market regulation
functions’’ from the broader selfregulatory functions of a SEF or DCM?
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3. Conflicts of Interest Between Market
Regulation Functions and Commercial
Interests
SEFs’ and DCMs’ obligations to
perform market regulation functions
may conflict with their commercial
interests. For example, performing
market regulation functions requires the
use of staff and resources that might
otherwise be dedicated to commercial
functions, such as seeking new market
participants or promoting new
products.121 In addition, SEFs and
DCMs have a commercial interest to
earn fees from market participants, and
to avoid deterring participants from
trading on their platforms. Fulfillment
by a SEF or DCM of its market
regulation functions may result in the
SEF or DCM taking actions, such as
enforcement actions or the imposition of
fines, that may deter the use of the
platform by certain market participants,
and therefore run counter to commercial
interests of the platform. Commercial
pressure, such as competition among
SEFs and among DCMs, may strain
market regulation obligations.122
III. Proposed Governance Fitness
Requirements
a. Overview
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The Commission is proposing rules
that would require SEFs and DCMs to
establish minimum fitness standards for
certain categories of individuals who are
responsible for exchange governance,
management, and disciplinary
functions, or who have potential
influence over those functions. These
proposed requirements are intended to
help ensure that SEFs and DCMs
effectively fulfill their critical role as
self-regulatory organizations by
excluding individuals with a history of
certain disciplinary or criminal offenses
from serving in roles with influence
over the governance and operations of
the exchange. The integrity of these
functions is critically important to their
respective operations, markets, and
121 See Commission regulations §§ 38.155 (DCM)
and 37.203(c) (SEF).
122 Proposed Acceptable Practices for compliance
with section 5(d)(15) of the Commodity Exchange
Act, 71 FR 38740, 38741 n.10 (July 7, 2006) (citing
five separate domestic and international studies
reaching the same conclusion); See also Kristin N.
Johnson, Governing Financial Markets: Regulating
Conflicts, 88 Wash. L.Rev. 185, 221 (2013) (‘‘While
clearinghouses and exchanges are private
businesses, these institutions provide a critical,
public, infrastructure resource within financial
markets. The self-regulatory approach adopted in
financial markets presumes that clearinghouses and
exchanges will provide a public service and engage
in market oversight. The owners of exchanges and
clearinghouses may, however, prioritize profitmaximizing strategies that de-emphasize or conflict
with regulatory goals.’’)
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market regulation functions.
Accordingly, it is essential that the
individuals responsible for governing a
SEF or DCM, such as officers and
members of the board of directors,
committees, disciplinary panels, and
dispute resolution panels, are ethically
and morally fit to serve in their roles.
Similarly, the Commission believes it is
important that minimum fitness
standards be applicable to an individual
who owns 10 percent or more of a SEF
or DCM and has the ability to control or
direct the SEF’s or DCM’s management
or policies.
The Commission also believes
establishing the same minimum fitness
requirements for both SEFs and DCMs is
necessary given that their officers and
members of the board of directors,
committees, disciplinary panels, and
dispute resolution panels have identical
responsibilities for governing and
administering operations, including the
operations of the market regulation
functions. Straightforward and
consistent minimum fitness
requirements are reasonably necessary
to promote the hiring and designation of
officers and members of the board of
directors, committees, disciplinary
panels, and dispute resolution panels
that have the appropriate character and
integrity to perform their duties.
b. Minimum Fitness Standards—
Proposed §§ 37.207 and 38.801
1. Existing Regulatory Framework
DCM Core Principle 15 requires a
DCM to establish and enforce
appropriate fitness standards for
members of the board of directors,
members of any disciplinary committee,
members of the DCM, other persons
with direct access to the DCM, and ‘‘any
party affiliated’’ with any of the
foregoing persons. The DCM Core
Principle 15 Guidance states that
minimum fitness standards for ‘‘persons
who have member voting privileges,
governing obligations or
responsibilities, or who exercise
disciplinary authority,’’ and ‘‘natural
persons who directly or indirectly have
greater than a ten percent ownership
interest in a designated contract’’ should
include those bases for refusal to
register a person under section 8a(2) of
the CEA.123 Additionally, the DCM Core
123 Appendix B to Part 38, Guidance on, and
Acceptable Practices in, Compliance with Core
Principles; Core Principle 15, Governance Fitness
Standards. This Guidance was promulgated under
the 2001 Regulatory Framework in direct response
to the recognition that with the de-mutualization of
DCMs, the governance role of ‘‘members’’ is
exercised by the DCM’s owner or owners. The
Commission has previously noted that the 10
percent ownership threshold is consistent with the
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Principle 15 Guidance states that
persons who have governing obligations
or responsibilities, or who exercise
disciplinary authority, should not have
a significant history of serious
disciplinary offenses, such as those that
would be disqualifying under
Commission regulation § 1.63 124 The
DCM Core Principle 15 Guidance also
states that DCMs should have standards
for the collection and verification of
information supporting compliance
with the DCM’s fitness standards.
Pursuant to Commission regulation
§ 38.2, DCMs are exempt from some of
the provisions of Commission regulation
§ 1.63. They are not exempt, however,
from Commission regulation § 1.63(c),
which prohibits persons that are subject
to any of the disciplinary offenses set
forth in Commission regulation § 1.63(b)
from serving on a disciplinary
committee, arbitration panel, oversight
panel or governing board of a selfregulatory organization.
SEFs are not subject to a specific core
principle requirement to establish
fitness standards. However, as
authorized by the CEA,125 SEFs must
comply with all requirements in
Commission regulation § 1.63, which
sets forth requirements and procedures
to prevent persons with certain
disciplinary histories from serving in
certain governing or oversight capacities
at a self-regulatory organization.
2. Proposed Rules
The Commission is proposing
identical fitness requirements for SEFs
and DCMs. The Commission believes
the proposed rules are reasonably
necessary to effectuate a DCM’s
same 10 percent threshold for fitness standards that
Congress itself adopted for exempt commercial
markets in section 2(h)(5)(A)(iii) of the CEA, prior
to the Dodd Frank amendments. See 2001
Regulatory Framework, 66 FR 42255, 42262 n.40.
Exempt commercial markets were eliminated as a
category in the CEA pursuant to Title VII of the
Dodd Frank Act, which also introduced SEFs as a
new category of CFTC-regulated exchange. Public
Law 106–554, 114 Stat. 2763 (Dec. 21, 2000); See
also Repeal of the Exempt Commercial Market and
Exempt Board of Trade Exemptions, 80 FR 59575
(Oct. 2, 2015).
124 Id. The DCM Core Principle 15 Guidance
states that members with trading privileges but
having no or only minimal equity in the DCM and
non-member market participants who are not
intermediated ‘‘and do not have these privileges,
obligations, or responsibilities or disciplinary
authority’’ could satisfy minimum fitness standards
by meeting the standards that they must meet to
qualify as a ‘‘market participant.’’
125 Commission Regulation § 1.63 was adopted
pursuant to the following statutory authority: 7
U.S.C. 2, 2a, 4, 4a, 6, 6a, 6b, 6c, 6d, 6e, 6f, 6g, 6h,
6i, 6j, 6k, 6l, 6m, 6n, 6o, 7, 7a, 8, 9, 12, 12a, 12c,
13a, 13a–l, 16,19, 21, 23, and 24, Service on SelfRegulatory Organization Governing Boards or
Committees by Persons with Disciplinary Histories,
55 FR 7884, 7890 (March 6, 1990, Final Rule).
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obligations to establish and enforce
appropriate fitness standards under
DCM Core Principle 15, and to
effectuate a SEF’s obligations to
establish and enforce rules governing
the operation of the SEF under SEF Core
Principle 2.126 A SEF’s ability to
effectively operate as both a market and
SRO, and to perform its market
regulation functions, is largely
dependent upon the individuals who
govern or control the SEF’s operations,
including officers, and members of the
board of directors, disciplinary
committees, dispute resolution panels,
members and controlling owners. Given
this relationship, the Commission
believes that it is reasonably necessary
to extend the same governance fitness
standards to SEFs as to DCMs.127
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i. Categories of Persons Subject to
Minimum Fitness Standards
In proposed §§ 37.207(a) and
38.801(a), the Commission is requiring
that SEFs and DCMs establish and
enforce appropriate fitness standards for
officers; for members of its board of
directors, committees, disciplinary
panels, and dispute resolution panels
(or anyone performing functions similar
to the foregoing); for members of the
SEF or DCM; for any other person with
direct access to the SEF or DCM; and for
any person who owns 10 percent or
more of a SEF or DCM and who, either
directly or indirectly, through
agreement or otherwise, in any other
manner, may control or direct the
management or policies of the SEF or
DCM, and any party affiliated with any
of those persons.
Specifically, the Commission notes
that proposed §§ 37.207(a) and 38.801(a)
would extend minimum fitness
requirements to certain individuals,
including officers and owners of 10
percent or more of a SEF or DCM, and
SEF and DCM members with voting
privileges, who were not historically
subject to DCM fitness requirements
under DCM Core Principle 15, or SEF
and DCM fitness requirements under
Commission regulation § 1.63(c).
However, as discussed below, the
Commission believes applying
consistent minimum fitness standards to
classes of individuals enumerated in
proposed §§ 37.207(a) and 38.801(a) is
reasonably necessary given that these
individuals have: (1) obligations with
respect to a SEF’s or DCM’s governance
126 CEA
section 5h(f)(2); 7 U.S.C. 7b–3(f)(2).
Commission is proposing to exercise its
authority under CEA section 8a(5) to establish the
SEFs fitness standards; DCMs are already subject to
a similar requirement to set appropriate fitness
standards. CEA section 5(d); 7 U.S.C. 7(d)(15).
127 The
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or disciplinary process; or (2) the ability
to exercise control over a SEF or DCM.
First, officers of a SEF or DCM would
be subject to the minimum fitness
requirements in proposed §§ 37.207(a)
and 38.801(a).128 The Commission
believes this is reasonably necessary
because officers—like members of the
board of directors, committee members,
or members of disciplinary or dispute
resolution panels, and members with
voting privileges 129—also have
governing, decision-making, and
disciplinary responsibilities within a
SEF or DCM, and therefore must be able
to demonstrate standards of integrity
and rectitude in order to effectively
perform their duties.
Second, members with voting
privileges would also be subject to the
minimum fitness requirements in
proposed §§ 37.207(a) and 38.801(a).130
Although DCM Core Principle 15
applies to a broad class of individuals
associated with a DCM, including
members with voting privileges, there is
no parallel application for SEFs. The
Commission acknowledges that SEF and
DCM members with voting privileges
may not have the same governing duties
as officers and members of its board of
directors, committees, disciplinary
panels, or dispute resolution panels.
Nevertheless, they may have the ability
to influence or control, either directly
through their voting privileges or
through other indirect means, the
operations or decision-making of the
SEF or DCM. Accordingly, the
Commission believes it is reasonably
necessary to establish and enforce
certain minimum standards of fitness
for such individuals.
Third, certain owners of 10 percent or
more of a SEF or DCM would also be
subject to the minimum fitness
requirements in proposed §§ 37.207(a)
and 38.801(a).131 Although the guidance
to DCM Core Principle 15 lists a broad
class of individuals, including natural
128 Officers are also subject to the 8a(2) and 8a(3)
minimum fitness requirements in proposed
§§ 37.207(b) and 38.801(b), and the disqualifying
offenses in proposed §§ 37.207(c) and 38.801(c).
129 In addition to the three categories of
individuals highlighted in this section, members of
its board of directors, committees, disciplinary
panels, and dispute resolution panels, all members
of the SEF or DCM, and any other person with
direct access to the SEF, are subject to the
requirement to have appropriate fitness
requirements in §§ 37.207(a) and 38.801(a).
130 Members with voting privileges are also
subject to the 8a(2) and 8a(3) minimum fitness
requirements in proposed §§ 37.207(b) and
38.801(b).
131 Owners of 10 percent or more of a SEF or
DCM, who also may control or direct the
management or policies of a SEF or DCM, are also
subject to the 8a(2) and 8a(3) minimum fitness
requirements in proposed §§ 37.207(b) and
38.801(b).
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persons who directly or indirectly have
greater than a 10 percent ownership
interest in a DCM, there is no parallel
application for a SEF. While individuals
who own 10 percent or more of a SEF
or DCM may not be involved in the
daily operations of a SEF or DCM, their
sizeable ownership interest may, either
directly or indirectly, enable them to
exert influence or control over various
aspects of decision-making, including
decisions that may impact market
regulation functions.132 As an example,
a person with a 10 percent ownership
interest in the SEF or DCM may have
competing business interests that are
improperly prioritized, particularly if
that person has influence in selecting
officers or members of the board of
directors. Similarly, a person with 10
percent ownership may have influence
or control over the SEF’s or DCM’s
contracts with third party service
providers, or, even the ability to wield
his or her influence in determining
whether to investigate potential rule
violations. Therefore, the Commission
believes it is reasonably necessary to
require that persons owning 10 percent
or more of the SEF or DCM, and who,
either directly or indirectly, through
agreement or otherwise, in any other
manner, control or direct the
management or policies of the SEF or
DCM 133 be subject to certain minimum
fitness requirements, as described
below.
ii. Minimum Fitness Standards
Proposed §§ 37.207(b) and 38.801(b)
would set forth minimum standards of
fitness SEFs and DCMs must establish
and enforce for officers and members of
its board of directors,134 committees,
132 As noted below concerning the proposed
changes to Commission regulations § 37.5(c), if one
entity holds a 10 percent equity share in a SEF it
may have a significant voice in the operation and/
or decision-making of the SEF.
133 The language of the proposed fitness standards
for owners of 10 percent or more of a SEF or DCM
intentionally generally mirrors the language from
the Appendices to Part 37 and 38, Form SEF and
Form DCM, Exhibit A. Exhibit A to Form SEF and
Form DCM require disclosure of owners of 10
percent or more of the applicant’s stock as part of
the application for registration or designation. A
similar 10 percent or more ownership threshold is
found in other Commission regulations, e.g., the
definition of Principal in Commission regulation
§ 3.1 and section 8a(2)(H) of the CEA, which
effectively prevent individuals subject to the
grounds for refusal to register in CEA section 8a(2)
or section 8a(3) from owning 10 percent of voting
stock in an intermediary subject to registration
requirements. The 10 percent ownership interest
threshold is similarly found in the reporting
requirements for ‘‘insiders’’ in section 16 of the
Securities Exchange Act of 1934. See also 17 CFR
240.16a–2.
134 For purposes of the rules proposed herein, the
Commission is proposing to define ‘‘board of
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disciplinary panels, and dispute
resolution panels (or anyone performing
functions similar to the foregoing), for
members with voting privileges,135 and
any person who owns 10 percent or
more of the SEF or DCM and who, either
directly or indirectly, through
agreement or otherwise, in any other
manner, may control or direct the
management or policies of the DCM,136
to include the bases for refusal to
register a person under sections 8a(2)
and 8a(3) of the CEA.137 DCM Core
Principle 15 Guidance includes the
bases for refusal to register under CEA
section 8a(2), but it does not include the
bases for refusal to register a person
under section 8a(3). However, as
described below, the Commission
believes inclusion of the section 8a(3)
disqualifications for individuals with
governance or disciplinary
responsibilities at the SEF or DCM, or
the ability to control or direct the
management or policies of the SEF or
DCM, is reasonably necessary for SEFs
and DCMs to fulfill their responsibilities
as SROs without influence from
individuals with backgrounds
incompatible with such responsibility.
Sections 8a(2) and 8a(3) of the CEA
provide a consistent, minimum industry
framework to promote high ethical
standards among officers, directors and
other individuals with controlling
influence over intermediaries or other
registrants in the futures and swaps
industry.138 In proposing to extend the
directors’’ as a group of people serving as the
governing body of a SEF or DCM, or—for SEFs or
DCMs whose organizational structure does not
include a board of directors—a body performing a
function similar to a board of directors. See
proposed §§ 37.1201(b)(2) and 38.851(b)(2).
135 Consistent with current Core Principle 15
Guidance, members with voting privileges have the
same minimum fitness standards as other
individuals with the ability to directly affect the
operations or governance of the Exchange, whereas
members without voting privileges are subject only
to the requirement that the DCM or SEF set
appropriate fitness standards for them, as set out in
proposed regulations §§ 37.207(a) and 38.801(a). In
light of industry changes, the Commission is
requesting comment on whether ‘‘members with
voting privileges’’ remains a relevant category that
should be subject to this distinction.
136 These categories of individuals are similar to
those subject to the 8a(2) standards in the DCM
Core Principle 15 Guidance.
137 Section 8a(2) and 8a(3) bases include, for
example, revocation of registration, convictions or
guilty pleas for violations of the CEA, the Securities
Act of 1933, the Securities Exchange Act of 1934,
misdemeanors involving embezzlement, theft, or
fraud, past failure to supervise, willful
misrepresentations or omissions, and ‘‘other good
cause.’’
138 CEA sections 8a(2) and (3), 7 U.S.C. 12a(2) and
(3); Principals, including officers, managing
members, directors and owners of 10 percent or
more voting stock of FCMs, IBs, and other
registrants, may already be disqualified from
registration pursuant to CEA sections 8a(2) and
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sections 8a(2) and 8a(3) minimum
fitness standards to individuals subject
to the fitness requirements in proposed
§§ 37.207(a) and 38.801(a), the
Commission is extending the same
consistent, minimum industry
framework 139 to promote high ethical
standards among individuals with
similar control or influence over the
important self-regulatory functions at
SEFs and DCMs. These standards are
reasonably necessary to promote
consistent high ethical industry
standards for a SEF or DCM to serve as
an effective SRO.
Proposed §§ 37.207(c) and 38.801(c)
would require SEFs and DCMs to
establish and enforce additional
minimum fitness standards for certain
individuals—officers and for members
of its board of directors, committees,
disciplinary panels, and dispute
resolution panels (or anyone performing
functions similar to the foregoing).
These additional fitness requirements
include ineligibility based on six types
of disciplinary offenses that generally
track the disciplinary offenses listed in
§§ 1.63(b)(1)–(6), with certain
modifications. In effect, the proposed
rules would apply the fitness
requirements of Commission regulation
§ 1.63 consistently to both SEFs and
8a(3), which in turn may result in the revocation
of the registration of the FCM, IB or other registrant.
(CEA section 8a(2)(H), 7 U.S.C. 12a(2)(H), defining
‘‘Principal,’’ to include any officer, director, or
beneficial owner of at least 10 percent of the voting
shares of the corporation, and any other person that
the Commission by rule, regulation, or order
determines has the power, directly or indirectly,
through agreement or otherwise, to exercise a
controlling influence over the activities of such
person which are subject to regulation by the
Commission. Both sections 8a(2) and 8a(3) provide
for the revocation of registration of an FCM, IB, or
other registrant where a principal of the registrant
is subject to a statutory disqualification found in
CEA sections 8a(2) or 8a(3).) As stated in the
interpretative statement to CEA section 8a(3)(M), in
Appendix A to part 3, which provides the
Commission with the authority to refuse
registration of any person for other good cause, any
inability to deal fairly with the public and
consistent with the just and equitable principles of
trade may render an applicant or registrant unfit for
registration, given the high ethical standards which
must prevail in the industry.
139 Individuals serving as officers, board
members, disciplinary committee members,
members with voting privileges, and owners with
10 percent or more of a DCM or SEF and with the
ability to control or direct the management or
policies of the SEF or DCM should not be subject
to lower fitness standards than the fitness standards
applied to principals of intermediaries facilitating
trading on SEF or DCM. Otherwise, an individual
could be disqualified from serving as the principal
of an FCM or IB, due to the factors set out under
CEA 8a(2) or 8a(3), but be allowed to serve in a role
exercising influence or control over the selfregulatory functions of a SEF or DCM; the SEF or
DCM is the front-line regulator of the trading
activity facilitated by FCMs and IBs on a SEF or
DCM.
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DCMs, subject to certain enhancements
as further described below.
The six disciplinary offenses in
proposed §§ 37.207(c)(1)–(6) and
38.801(c)(1)–(6) are substantially similar
to the existing ineligibility requirements
in § 1.63(b).
• Proposed §§ 37.207(c)(1) and
38.801(c)(1), require that an individual
would be ineligible if they were found,
in a final, non-appealable 140 order by a
court of competent jurisdiction, an
administrative law judge, the
Commission, a self-regulatory
organization,141 or the SEC, to have
committed any of four offenses
described in proposed
§§ 37.207(c)(1)(i)–(iv) and
38.801(c)(1)(i)–(iv) within the previous
three years.142 This requirement is
substantially the same as the
ineligibility requirement found in
§ 1.63(b)(1), except for the addition of
findings by the SEC.
• Proposed §§ 37.207(c)(1)(i)–(iv) and
38.801(c)(1)(i)–(iv), include, in
substance, the same four disciplinary
offenses listed in § 1.63(a)(6)(i)–(iv).
• Proposed §§ 37.207(c)(2)–(6) and
38.801(c)(2)–(6) mirror, in substance,
the disciplinary offenses found in
§ 1.63(b)(6)(2)–(6), with minor
enhancements to expressly include both
SEFs and DCMs when referencing
suspensions from trading on a contract
market.
Proposed §§ 37.207(c) and 38.801(c)
also enhance the existing minimum
fitness requirements in several ways,
compared to the requirements in
Commission regulation § 1.63. The
language in proposed §§ 37.207(c) and
38.801(c) does not use the limiters
‘‘significant history’’ or ‘‘serious
disciplinary offenses’’ in setting forth
disqualifying offenses. These terms
appear in DCM Core Principle 15
Guidance 143 and the Commission
proposes to clarify which disciplinary
offenses are included by specifying
which offenses would automatically be
140 The final, non-appealable order language
comes from the definition of ‘‘final decision’’ found
in Commission regulation § 1.63(a)(5).
141 With the exception of the addition of the SEC,
these are the same categories as in the definition of
‘‘final decision’’ found in Commission regulation
§ 1.63(a)(5).
142 Pursuant to Commission regulation
§ 1.63(b)(1), an individual is ineligible to serve on
disciplinary committees, arbitration panels,
oversight panels or governing board if, within the
past three years, that individual was found to have
committed a ‘‘disciplinary offense.’’
143 DCM Core Principle 15 Guidance provides
that, among other things, persons who have
governing obligations or responsibilities, or who
exercise disciplinary authority, should not have a
significant history of serious disciplinary offenses,
such as those that would be disqualifying under
Commission regulation § 1.63.
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disqualifying. As described above, the
list of disciplinary offenses in proposed
§§ 37.207(c) and 38.801(c) includes, in
substance, the same offenses identified
in Commission regulation § 1.63,144 and
expands the disqualifying offenses to
include agreements not to apply for, or
to be disqualified from applying for,
registration in any capacity with the
SEC, or any self-regulatory organization,
including the Financial Industry
Regulatory Authority (‘‘FINRA’’).145
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iii. Verification and Documentation of
Minimum Fitness Standards
Proposed §§ 37.207(d) and 38.801(d)
would require each SEF and DCM to
establish appropriate procedures for the
collection and verification of
information supporting compliance
with appropriate fitness standards. The
Commission believes that, to be
effective, such procedures must be
written, must be in a location where
people who would use them can find
them, and must be preserved and ready
for the Commission to review.146 The
Commission anticipates staff will
review the procedures and fitness
determinations as part of its routine
oversight.
In conducting its oversight of SEFs
and DCMs, Commission staff has
learned that some SEFs and DCMs
accepted fitness representations from
the individual subject to the fitness
standard without any practice of
independent verification. Independent
verification of fitness information is
particularly important because certain
individuals could be disincentivized
from self-reporting fitness information
that could disqualify them from
service.147 The Commission believes
144 The disciplinary offenses generally include a
decision by a court or a self-regulatory organization
(or a settlement) of: violations of the substantive
rules of a self-regulatory organization, felonies,
convictions involving fraud or deceit, violations of
the CEA or Commission regulations, or a
suspension or denial by a self-regulatory
organization to serve on a board or disciplinary
panel.
145 Commission regulation § 1.63(b)(6) provides
as disqualifying anyone who is currently subject to
a denial, suspension or disqualification from
serving on the disciplinary committee, arbitration
panel or governing board of any self-regulatory
organization as that term is defined in section
3(a)(26) of the Securities Exchange Act of 1934.
146 The Commission believes that in the absence
of a cohesive set of SEF or DCM conflicts of interest
policies and procedures, individuals with potential
conflicts of interest may have difficulty ascertaining
the policies and procedures that apply to a given
situation. The Commission believes that similar
concerns would be raised where there is not a
cohesive set of procedures related to the verification
fitness information.
147 Both the NFA and FINRA conduct background
checks to confirm information provided in the Form
U4 is accurate, and FINRA Rule 3110(e) requires
SEC-registered member firms to verify the
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SEFs and DCMs should verify fitness
information provided by individuals by
collecting information from third
parties, for example, via the National
Futures Association’s (‘‘NFA’’)
Background Affiliation Status
Information Center (‘‘BASIC’’) system or
background checks.
Commission staff also discovered
during the course of its oversight that
some SEFs and DCMs did not have a
practice to verify an individual’s
compliance with applicable fitness
standards prior to the individual
starting to serve in the capacity
requiring the fitness standard.
Additionally, some SEFs and DCMs
lacked practices for regular verification
of fitness standards, allowing fitness
information to become stale. Without
these practices for verifying and
documenting fitness information, the
Commission believes there is an
increased risk that individuals will
serve in a capacity for which they are
not fit. Proposed §§ 37.207(d)(1)(i)–(iv)
and 38.801(d)(1)(i)–(iv) would address
these practices by requiring: (i) fitness
information be verified at least
annually, (ii) the SEF or DCM have
procedures providing for immediate
notice to the SEF or DCM if an
individual no longer meets the
minimum fitness standards to serve in
their role, (iii) the initial verification of
information supporting an individual’s
compliance with relevant fitness
standard be completed prior to the
individual serving in the capacity with
fitness standards, and (iv) the SEF and
DCM to document their findings with
respect to the verification of fitness
information.
The Commission further proposes to
clarify the applicability of the
governance fitness requirements to SEFs
and DCMs by locating them,
respectively, within parts 37 and 38 of
the Commission’s regulations, rather
than within part 1 of the Commission’s
regulations. The Commission also
proposes to make conforming
amendments to Commission regulations
§§ 37.2 and 38.2 to exempt SEFs and
DCMs from Commission regulation
§ 1.63 in its entirety.
iv. Additional Considerations for
Minimum Fitness Requirements
The Commission is considering
whether additional fitness requirements
would enhance the performance and
accountability of the individuals who
are charged with governing a SEF or
DCM or its operations, or have the
information provided in a Form U4 using
‘‘reasonably available public records, or a thirdparty provider.’’
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19659
ability to influence such functions.
Therefore, the Commission is seeking
comment on whether SEFs and DCMs
should consider additional eligibility
criteria to prevent individuals from
serving as an officer or member of the
board of directors if their background,
although not automatically
disqualifying under proposed
§§ 38.801(c) or 37.207(c), raises
concerns about the individual’s ability
to effectively govern, manage, or
influence the operations or decisionmaking of a SEF or DCM. For example,
the Commission notes that at least three
SEFs have already implemented a ‘‘good
repute’’ requirement for members of
their board of directors,148 and the same
requirement exists for members of the
management body of regulated markets
in the European Union.149 The purpose
of a ‘‘sufficiently good repute’’ standard
would be to identify individuals with a
well-established history of honesty,
integrity, and fairness in their personal,
public, and professional matters. The
Commission’s potential standard could
be as follows:
Minimum standards of fitness for the SEF’s
and DCM’s officers and for members of its
board of directors must include the
requirement that each such individuals be of
sufficiently good repute; provided, however,
that SEFs and DCMs have flexibility to
establish the criteria for how individuals
demonstrate good repute, as appropriate for
their respective markets.
The Commission also seeks comment
on whether SEFs and DCMs should also
consider, in defining ‘‘good repute,’’ the
type of information that is subject to
disclosure in the Uniform Application
for Securities Regulation (‘‘Form U4’’)
for consideration by FINRA for
registration.150 Other examples for
consideration include instances where
the license of a licensed professional
(such as a certified public accountant or
attorney) has been involuntarily
suspended or revoked, or where an
individual is suspended by an order of
148 See CBOE SEF Rulebook, Rule 202; Bloomberg
SEF Rulebook, Rule 201; ICAP Global Derivatives
SEF Rulebook, Annex 1, Governance Policy.
Additionally, at least five DCMs and one SEF
require their members or market participants to be
of ‘‘good repute,’’ ‘‘good moral character,’’ or ‘‘good
reputation.’’
149 Article 45(2)(a) to (c) of the Markets in
Financial Instruments Directive 2014/65/EU
(‘‘MiFID II’’) (requiring members of the management
body of market operators to be of ‘‘sufficiently good
repute’’); Article 4(36) defines ‘‘management body’’
to include the individuals ‘‘empowered to set the
entity’s strategy, objectives, and overall direction,
and which oversee and monitor management
decision-making . . .’’).
150 The Form U4 includes information such as
criminal charges, pending regulatory cases, license
suspensions or revocations, and decisions by
foreign courts.
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a foreign regulator or court in foreign
jurisdiction.
IV. Proposed Substantive Requirements
for Identifying, Managing and
Resolving Actual and Potential
Conflicts of Interest
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3. Questions for Comment
The Commission requests comment
on all aspects of the proposed fitness
standards for SEFs and DCMs. The
Commission further requests comment
on the questions set forth below.
1. Should SEFs and DCMs be required
to establish additional fitness standards
for officers or members of the board of
directors whose background, although
not automatically disqualifying under
proposed §§ 37.207 or 38.801, raises
concerns about the individual’s ability
to effectively govern, manage, or
influence the operations or decisionmaking of a SEF or DCM? If so, is
‘‘sufficiently good repute’’ an
appropriate fitness standard for officers
and members of the board of directors
(or anyone performing similar
functions) of a SEF or DCM?
2. The Commission quoted above a
‘‘sufficiently good repute’’ standard, for
purposes of a potential requirement that
SEFs and DCMs require members of
their boards of directors and officers be
of good repute. Please explain whether
you agree with that standard. Does such
standard provide sufficient flexibility to
SEFs and DCMs? Should such standard
be more detailed and list specific
criteria or factors evidencing good
repute? Would ‘‘sufficiently good
repute,’’ already be encompassed in
CEA section 8a(3)(M), ‘‘other good
cause?’’
3. Is a 10 percent or more ownership
interest the appropriate threshold to
trigger minimum fitness requirements
for owners? Is the ability to control or
direct the management or policies of the
DCM the appropriate qualifier to trigger
minimum fitness standards for 10
percent or more owners of a SEF or
DCM?
4. Should owners of 10 percent or
more be subject to the disqualifying
disciplinary offenses in proposed
§§ 37.207(c) and 38.801(c)?
5. Proposed §§ 37.207(b) and
38.801(b) apply to ‘‘members of the
designated contract market with voting
privileges’’ and ‘‘members of the swap
execution facility with voting
privileges,’’ respectively. Is this an
appropriate category of persons to
subject to the proposed minimum
fitness standard requirements? Does this
category remain relevant to current SEF
and DCM governance and business
structures, or is it no longer applicable?
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a. General Requirements for Conflicts of
Interest and Definitions—Proposed
§§ 37.1201 and 38.851
1. Existing Regulatory Framework and
Definitions
As described above, SEFs and DCMs
must establish and enforce rules to
minimize conflicts of interest in their
decision-making processes and establish
a process for resolving such conflicts,
pursuant to SEF Core Principle 12 and
DCM Core Principle 16. SEFs and DCMs
have different standards for addressing
conflicts of interest. The DCM Core
Principle 16 Acceptable Practices
provide specific practices that DCMs
may adopt to demonstrate compliance
with aspects of DCM Core Principle 16.
The Commission has not adopted
guidance on, or acceptable practices in,
compliance with the conflicts of interest
requirements under SEF Core Principle
12. Commission regulation § 1.59,
however, addresses the management of
conflicts of interest for SEFs in
connection with protecting material
non-public information from misuse
and disclosure.151
There are several terms defined in the
DCM Core Principle 16 Acceptable
Practices and Commission regulation
§ 1.59(a) which the Commission
believes are relevant to identifying and
resolving conflicts of interest that may
impact a SEF’s or DCM’s market
regulation functions, and which the
Commission is proposing to adopt in
these proposed new conflict of interest
rules with certain minor modifications
as discussed below. The DCM Core
Principle 16 Acceptable Practices
defines a ‘‘public director’’ as an
individual with no material relationship
to the DCM and describes the term
‘‘immediate family’’ to include spouse,
parents, children, and siblings. The
terms ‘‘material information,’’ ‘‘nonpublic information,’’ ‘‘commodity
interest,’’ ‘‘related commodity interest,’’
and ‘‘linked exchange’’ are defined in
Commission regulation § 1.59. ‘‘Material
information’’ is defined in § 1.59(a)(5) to
mean information which, if such
information were publicly known,
would be considered important by a
151 Commission regulation § 1.59 addresses the
management of conflicts of interest for selfregulatory organizations, including SEFs and DCMs,
in connection with protecting material, non-public
information from use and disclosure. Pursuant to
Commission regulation § 38.2, DCMs are exempt
from § 1.59(b) and (c), but must comply with
§ 1.59(a) and (d); SEFs must comply with all
subparts of § 1.59.
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reasonable person in deciding whether
to trade a particular commodity interest
on a contract market or a swap
execution facility, or to clear a swap
contract through a derivatives clearing
organization.152 ‘‘Non-public
information’’ is defined in § 1.59(a)(6),
as information which has not been
disseminated in a manner which makes
it generally available to the trading
public. Commission regulations
§§ 1.59(a)(8) and (9) define ‘‘commodity
interest,’’ to include all futures, swaps,
and options traded on or subject to the
rules of a SEF or DCM 153 and ‘‘related
commodity interest’’ to include any
commodity interest which is traded on
or subject to the rules of a SEF, DCM,
linked exchange, or other board of trade,
exchange, or market, or cleared by a
DCO, other than the self-regulatory
organization 154 by which a person is
employed, and which is subject to a
self-regulatory organization’s
intermarket spread margins or other
special margin treatment.
2. Proposed Rules
Proposed §§ 37.1201(a) and 38.851(a)
would set forth the foundational
requirement that SEFs and DCMs,
respectively, must establish a process
for identifying, minimizing, and
resolving actual and potential conflicts
of interest that may arise, including, but
not limited to, conflicts between and
among any of the SEF’s or DCM’s
market regulation functions; its
commercial interests; and the several
interests of its management, members,
owners, customers and market
participants, other industry participants,
and other constituencies. These
proposed rules would largely codify
existing language from the DCM Core
Principle 16 Acceptable Practices.155
Proposed §§ 37.1201(b) and 38.851(b)
would establish definitions. As
discussed above, many of the terms are
already defined in existing Commission
regulations, and in the acceptable
152 The definition of material information in
Commission regulation § 1.59(a)(5) also provides
that as used in that section, ‘‘material information’’
includes, but is not limited to, information relating
to present or anticipated cash positions, commodity
interests, trading strategies, the financial condition
of members of self-regulatory organizations or
members of linked exchanges or their customers, or
the regulatory actions or proposed regulatory
actions of a self-regulatory organization or a linked
exchange.
153 The definition of commodity interest also
includes futures or swaps cleared by a Designated
Clearing Organization. Commission regulation
§ 1.59(a)(8).
154 Commission regulation § 1.3 defines this term
as a contract market (as defined in § 1.3(h)), a swap
execution facility (as defined in § 1.3(rrrr)), or a
registered futures association under section 17 of
the CEA.
155 Part 38, Appendix B, Core Principle 16.
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practices for compliance with the DCM
conflicts of interest core principle, and
would be duplicated with minor
modifications. The Commission believes
that specifically defining these terms in
parts 37 and 38 of its regulations would
provide greater clarity to SEFs and
DCMs, and to the public, regarding
regulatory requirements applicable to
these entities. Additional reasons for
proposing these defined terms are
discussed below.
First, the terms ‘‘material
information,’’ ‘‘non-public
information,’’ ‘‘commodity interest,’’
‘‘related commodity interest,’’ and
‘‘linked exchange’’ would be defined in
proposed §§ 37.1202(b) and 38.851(b) as
they are in § 1.59(a), but modified
specifically to reference SEFs and
DCMs, respectively. Additionally, as
addressed below, proposed
§§ 37.1202(b) and 38.851(b) would
define ‘‘public director’’ and ‘‘family
relationship.’’ 156 ‘‘Family relationship’’
would replace the term ‘‘immediate
family’’ that is currently used in the
DCM Core Principle 16 Acceptable
Practices.157 As discussed above,158
proposed §§ 37.1201 and 38.851 focus
on conflicts of interests involving a
subset of a SEF or DCM’s self-regulatory
functions—those that are generally
related to the SEF’s or DCM’s
obligations to ensure market integrity
and proper and orderly conduct in its
markets, and to deter abusive trading
practices. Those functions include trade
practice surveillance, market
surveillance, real-time market
monitoring, audit trail and
recordkeeping enforcement,
investigations of possible rule
violations, and disciplinary actions. As
discussed above, the Commission is
proposing to define ‘‘market regulation
functions’’ in §§ 37.1201(b)(9) and
38.851(b)(9) to describe the selfregulatory functions addressed in this
rule proposal.
Finally, the Commission is proposing
a new definition for the term ‘‘affiliate.’’
The Commission recognizes that this
term is defined elsewhere in the
Commission regulations. However, the
definition of ‘‘affiliate’’ elsewhere in
Commission regulations does not apply
to SEFs or DCMs.159 For the limited
156 See Section V(b)(3) (addressing the term
public director) and Section IV(b)(3) (addressing the
term family relationship).
157 Section IV(c)(3) herein provides details
regarding the proposed definitions for public
director and family relationship.
158 See Section II(d) herein.
159 For example, § 162.2(a) defines ‘‘affiliate’’
specifically in relation to futures commission
merchant, retail foreign exchange dealer,
commodity trading advisor, commodity pool
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purpose of this rule proposal, the
Commission proposes defining
‘‘affiliate’’ in proposed §§ 37.1201(b)(1)
and 38.851(b)(1), to mean a person that
directly or indirectly controls, or is
controlled by, or is under common
control with, the SEF or DCM (as
applicable). The definition of affiliate in
proposed §§ 37.1201(b)(1) and
38.851(b)(1) would establish that, for
purposes of this rule proposal,
‘‘affiliate’’ broadly includes direct or
indirect common ownership or control.
b. Conflicts of Interest in DecisionMaking—Proposed §§ 37.1202 and
38.852
1. Background
Officers, members of the board of
directors, committees, and disciplinary
panels, are the key decision-makers at a
SEF or DCM that can directly affect the
day-to-day execution of market
regulation functions. Therefore, the
Commission believes individuals
fulfilling these roles must have the
ability to make informed and impartial
decisions. If any of these decisionmakers have an actual or potential
conflict of interest, it can impair the
decision-making process of the SEF or
DCM. Accordingly, the Commission is
proposing to codify and harmonize for
SEFs and DCMs, in proposed §§ 37.1202
and 38.852, respectively, certain
elements of Commission regulation
§ 1.69 that require a self-regulatory
organization to address the avoidance of
conflicts of interest in the execution of
its self-regulatory functions. As noted
above, SEFs are currently subject to the
requirements of Commission regulation
§ 1.69; however, DCMs are exempt from
these requirements pursuant to
Commission regulation § 38.2.
Nonetheless, Commission staff has
found that as a matter of practice, most
DCMs have adopted rules that
voluntarily implement these
requirements.
2. Existing Regulatory Framework
Commission regulation § 1.69
generally requires self-regulatory
organizations to have rules requiring
any member of the board of directors,
disciplinary committee, or oversight
panel, to abstain from deliberating and
voting on certain matters that may raise
conflicts of interest. Commission
regulation § 1.69(a) includes a list of
definitions relevant to the section,
including the definition of ‘‘named
party in interest,’’ which means a
person or entity that is identified by
name as a subject of any matter being
operator, introducing broker, major swap
participant, or swap dealer.
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considered by a governing board,
disciplinary committee, or oversight
panel. Commission regulation
§ 1.69(b)(1)(i)(A)–(E) enumerates a list of
relationships. If a member of the board
of directors, disciplinary committee, or
oversight panel, has such a relationship
with a named party in interest, then this
would require the member to abstain
from deliberating and voting on that
matter. Prior to the consideration of any
matter involving a named party in
interest, Commission regulation
§ 1.69(b)(1)(ii) requires members of a
governing board, disciplinary committee
or oversight panel to disclose their
relationships with the named party in
interest. Commission regulation
§ 1.69(b)(1)(iii) requires self-regulatory
organizations to establish procedures for
determining whether any members of
governing boards, disciplinary
committees or oversight panels are
subject to a conflicts restriction in any
matter involving a named party in
interest, and specifies certain
requirements for making such
determinations.
Commission regulation § 1.69(b)(2)
requires members of governing boards,
disciplinary committees or oversight
panels to abstain from deliberating and
voting in any significant action if the
member knowingly has a direct and
substantial financial interest in the
result of the vote. Additional
requirements for disclosure of interest
and the procedures for making a
conflicts determination are addressed in
Commission regulations §§ 1.69(b)(2)(ii)
and (iii), respectively. Commission
regulation § 1.69(b)(3) permits members
of governing boards, disciplinary
committees or oversight panels, who
otherwise would be required to abstain
from deliberations and voting on a
matter because of a conflict under
Commission regulation § 1.69(b)(2), to
deliberate but not vote on the matter
under certain circumstances.160 Finally,
Commission regulation § 1.69(b)(4)
requires self-regulatory organizations to
document certain conflicts
determination requirements.
3. Proposed Rules
The Commission proposes to include
certain elements of Commission
regulation § 1.69 in proposed §§ 37.1202
and 38.852, and to make a conforming
amendment to Commission regulation
160 Commission regulation § 1.64(b)(3)(ii) lists the
following factors for the deliberating body to
consider in determining whether to allow such
member to participate in deliberations: (1) if the
member’s participation is necessary to achieve a
quorum; and (2) whether the member has unique
or special expertise, knowledge or experience in the
matter under consideration.
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§ 37.2 to exempt SEFs from Commission
regulation § 1.69. While the intent
behind Commission regulation § 1.69
remains relevant, the Commission
believes that certain modifications and
enhancements are necessary to reflect
the current state of the futures and
swaps markets. For example,
Commission regulation § 1.69(b)(1)(i)(C)
describes a relationship with a named
party in interest through a ‘‘broker
association’’ as defined in § 156.1.
While this relationship may have been
significant at the time Commission
regulation § 1.69 was adopted, the
Commission does not believe it is
necessary to include it in proposed
§§ 37.1202 and 38.852 given the decline
of open outcry trading. Furthermore, the
scope of proposed §§ 37.1202 and
38.852 would require a relationship
with an individual as part of a broker
association, as well as other professional
associations, to be disclosed regardless
of whether it is an enumerated
relationship. The scope of proposed
§§ 37.1202 and 38.852 expressly covers
officers, as well as members of boards of
directors, committees, and disciplinary
panels,161 to accurately reflect the
individuals and governing bodies that
are involved in the decision-making
processes of a SEF or DCM and that may
therefore be subject to the same conflicts
of interest.
The Commission notes that
Commission regulation § 1.69(a)(2)
currently includes ‘‘family relationship’’
as one of the enumerated relationships,
which is defined as a person’s spouse,
parent, stepparent, child, stepchild,
sibling, stepbrother, stepsister, or inlaw. The Commission proposes
redefining ‘‘family relationship,’’ as the
person’s spouse, parents, children, and
siblings, in each case, whether by blood,
marriage, or adoption, or any person
residing in the home of the person, as
set forth in proposed §§ 37.1201(b)(7)
and 38.851(b)(7). This proposed
definition focuses on the closeness of
the relationship that the committee
member has with the subject of the
matter being considered. The proposed
definition also reflects a more modern
description of the relationships
intended to be covered. The
Commission emphasizes that the
relationships listed in this proposed
definition are not exhaustive; rather,
each relationship should be viewed in
light of the particular circumstances
surrounding the relationship and the
closeness of the relationship.
161 Commission regulation § 1.69(a) defines
‘‘disciplinary committee(s),’’ ‘‘governing board(s),’’
and ‘‘oversight panel(s).’’
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Proposed §§ 37.1202(a) and 38.852(a)
require SEFs and DCMs, respectively, to
establish policies and procedures
requiring any officer or member of its
board of directors, committees, or
disciplinary panels to disclose any
actual or potential conflicts of interest
that may be present prior to considering
any matter. The proposed language is a
modernized version of the requirement
in Commission regulation § 1.69(b).
Although not exhaustive, proposed
§§ 37.1202(a)(1) and 38.852(a)(1)
enumerate certain conflicts in which the
member or officer: (1) is the subject of
any matter being considered; (2) is an
employer, employee, or colleague 162 of
the subject of any matter being
considered; (3) has a family relationship
with the subject of any matter being
considered; or (4) has any ongoing
business relationship with or a financial
interest in the subject of any matter
being considered.163 The Commission is
proposing §§ 37.1202(a)(2) and
38.852(a)(2) to extend the conflicts of
interest enumerated in proposed
§§ 37.1202(a)(1) and 38.852(a)(1) to also
apply to relationships that an officer or
member of its board of directors,
committees, or disciplinary panels has
with an affiliate of the subject of any
matter being considered.
As discussed above, the evolution of
market structures has increased the
interconnectedness between SEFs,
DCMs, and their affiliates. This
relationship between a SEF or DCM and
its affiliates—and by extension, the
officers, members of the board of
directors, committees, or disciplinary
panels—could create, in the
Commission’s view, an actual or
potential conflict of interest.
Accordingly, the Commission believes
proposed §§ 37.1202(a)(2) and
38.852(a)(2) is necessary to mitigate
162 The Commission proposes replacing the
current term ‘‘fellow employee’’ with ‘‘colleague’’ to
include individuals with whom the officer or
director may have a collegial relationship, but may
not be employed by the same employer. As an
example, two individuals who worked in the same
office, where the first is a full-time employee of the
organization, and the other works alongside the first
but is employed by an outside contractor, would be
considered colleagues for purposes of proposed
§§ 37.1202 and 38.852.
163 The Commission believes that this
relationship, along with the overarching
requirement in proposed §§ 37.1202(a) and
38.852(a) requiring an officer or member of its board
of directors, committees, or disciplinary panels to
disclose any actual or potential conflicts of interest
that may be present prior to considering any matter,
are sufficient for addressing conflicts of interest
involving financial interest. Accordingly, the
Commission is not proposing to include in
proposed §§ 37.1202 or 38.852 a parallel to existing
Commission regulation § 1.69(b)(2)’s requirements
concerning financial interests in significant actions.
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conflicts of interest in a SEF’s or DCM’s
decision-making.
Proposed §§ 37.1202(b) and 38.852(b)
largely track existing requirements in
Commission regulation § 1.69(b)(4) and
require the board of directors,
committee, or disciplinary panel to
document its processes for complying
with the requirements of the proposed
rules, and such documentation must
include: (1) the names of all members
and officers who attended the relevant
meeting in person or who otherwise
were present by electronic means; and
(2) the names of any members and
officers who voluntarily recused
themselves or were required to abstain
from deliberations or voting on a matter
and the reason for the recusal or
abstention. To ensure the intent of
proposed §§ 37.1202 and 38.852 is
captured, the Commission continues to
require voluntary recusals to be
documented, in addition to the
instances in which a determination was
made to require the abstention of an
officer or member of a board of
directors, committee, or disciplinary
panel.
In a limited number of circumstances,
Commission regulation § 1.69(b)(3)
permits members of governing boards,
disciplinary committee, or oversight
panel, who otherwise would be required
to abstain from deliberations and voting
on a matter because of a conflict under
Commission regulation § 1.69(b)(2), to
deliberate but not vote on the matter.
The Commission is not proposing to
adopt this exemption. If a board of
directors, committee or panel believes
that it has insufficient expertise to
consider a matter, the Commission
encourages the committee to seek
information from an expert or
consultant that is not subject to a
conflicts restriction. The Commission
believes it is imperative for boards of
directors, committees, and disciplinary
panels to have access to unbiased,
conflict-free information to assist in
decision-making.
4. Questions for Comment
The Commission requests comment
on all aspects of the proposed conflicts
of interest in decision-making rules. The
Commission further requests comment
on the questions set forth below.
1. Should the Commission enumerate
certain other relationships or
circumstances that may give rise to an
actual or potential conflict of interest? If
so, which relationships or
circumstances?
2. Does the proposed definition of
‘‘family relationship’’ cover the
appropriate types of relationships?
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c. Limitations on the Use and Disclosure
of Material Non-public Information—
Proposed §§ 37.1203 and 38.853
1. Background
Preventing the misuse and disclosure
of material non-public information at
SEFs and DCMs further the objectives of
promoting self-regulation of exchanges
and maintaining public confidence in
SEF and DCM markets. The CEA
includes prohibitions on the misuse and
disclosure of material non-public
information. It is unlawful for any
person who is an employee, member of
the governing board, or member of any
committee of a board of trade, to
willfully and knowingly (1) trade for
such person’s own account, or for or on
behalf of any other account, in contracts
for future delivery or option thereon on
the basis of any material non-public
information obtained through special
access related to the performance of
such person’s official duties as an
employee or member; or (2) to disclose
for any purpose inconsistent with the
performance of such person’s official
duties as an employee or member, any
material non-public information
obtained through special access related
to the performance of such duties.164
Furthermore, a potential conflict of
interest arises when employees or
insiders with access to material nonpublic information leverage their insider
access to advance their personal
interests, or the interests of others, to
the detriment of the decision-making
process of the contract market. The
Commission believes reducing the
potential for such misuse of material
nonpublic information helps to mitigate
conflicts of interest. Accordingly, the
Commission is proposing new rules to
implement elements of the conflicts of
interest core principles for SEFs and
DCMs, within parts 37 and 38,
respectively, that are consistent with
existing requirements under current
Commission regulation § 1.59, which
establishes limitations on the use and
disclosure of material non-public
information. The proposed rules would
establish prohibitions on the use or
disclosure of material non-public
information by: (1) employees of the
SEF or DCM; and (2) members of the
board of directors, committee members,
consultants and those with an
ownership interest of 10 percent or
more in the SEF or DCM.
Moreover, the Commission is
proposing to harmonize and streamline
164 CEA
section 9(e), 7 U.S.C. 13(e).
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SEF and DCM requirements related to
the safeguarding of material non-public
information by proposing rules under
§§ 37.1203 and 38.853, and to make
conforming amendments to Commission
regulation § 37.2 to exempt SEFs from
Commission regulation § 1.59. As
discussed in more detail below, the
proposal would establish consistent
rules for SEFs and DCMs related to the
use and disclosure of material nonpublic information.
2. Existing Regulatory Framework
Commission regulation § 1.59
generally requires self-regulatory
organizations to adopt rules prohibiting
employees, governing board members,
committee members or consultants from
trading commodity interests on the basis
of material non-public information
obtained in the course of their official
duties. Under Commission regulation
§ 1.59, employees of self-regulatory
organizations are subject to stricter
trading prohibitions than governing
board members, committee members or
consultants. Specifically, employees are
prohibited from trading in any
commodity interest traded on or cleared
by the employing SEF, DCM or DCO, or
from trading in any related commodity
interest. Additionally, employees
having access to material non-public
information concerning a commodity
interest are prohibited from trading in
any such commodity interest that is
traded on or cleared by any SEF, DCM
or DCO, or any linked exchange.165
Members of the board of directors,
committee members, and consultants of
a self-regulatory organization, on the
other hand, are prohibited from using
material non-public information for any
purpose other than the performance of
their official duties. The possession of
material non-public information,
therefore, does not absolutely bar these
individuals from trading commodity
interests. Rather, under Commission
regulation § 1.59(d), members of the
board of directors, committee members,
or consultants of a self-regulatory
organization are directly prohibited
from trading for their own account, or
for or on behalf of any other account,
based on this material non-public
information.
The direct prohibitions under
Commission regulation § 1.59(d) were
adopted in 1993 to effectuate section
165 Commission regulation § 1.59(a)(7) defines
linked exchange to include any exchange or board
of trade outside of the United States that lists
products traded on the SEF or DCM, or that has an
agreement with a SEF or DCM to permit positions
in one commodity interest to be liquidated on the
other market, or any clearing organizations that
clears the products in any of the foregoing markets.
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214 of the Futures Trading Practices Act
(‘‘FTPA’’) of 1992, which, among other
things, makes it a felony for employees
and governing members of selfregulatory organizations to disclose or
trade on inside information and for
tippees of such insiders to trade on
inside information so disclosed.166
Historically, the Commission has
adopted a more lenient standard for
governing board members and
committee members.167 A more lenient
standard helps to ensure that a trading
prohibition does not impair the ability
or diminish willingness of
knowledgeable industry members who
also are active traders from serving on
a self-regulatory organization’s board of
directors or its major policy or
disciplinary committees.
While § 1.59(b) prohibits trading in
commodity interests or related
commodity interests by employees, the
rule also provides that exemptions may
be granted. Under current
§ 1.59(b)(2)(ii)(b), a self-regulatory
organization may adopt rules setting
forth circumstances under which
exemptions may be granted, as long as
those exemptions are consistent with
the CEA, the purposes of § 1.59, just and
equitable principles of trade, and the
public interest. Exemptions also may be
granted, under rules adopted by a selfregulatory organization, in situations
where an employee participates in a
pooled investment vehicle without
direct or indirect control of such
vehicle.168
The prohibitions and requirements
under § 1.59 apply differently to SEFs
and DCMs. As a result of the core
principles framework promulgated
under the Commodity Futures
Modernization Act of 2000, DCMs were
relieved from many rule-based
requirements in favor of core principles.
Consequently, DCMs were exempted
from § 1.59(b) and (c). However,
employees, governing board members,
committee members, and consultants at
DCMs are not exempted from
166 Final Rule, Prohibition on Insider Trading, 58
FR 54966 (Oct. 25, 1993).
167 When Commission regulation § 1.59 was first
proposed, it proposed to apply the same standard
to employees and governing board members and
committee members. Activities of Self-Regulatory
Organization Employees and Governing Members
Who Possess Material, Nonpublic Information, 50
FR 24533 (June 11, 1985). In response to public
comment, however, the Commission initially
finalized § 1.59 without addressing what obligations
applied to members of the governing board of
committee members. Instead, the Commission
adopted the more lenient standard in a separate
rulemaking. Activities of Self-Regulatory
Organization Employees Who Possess Material,
Non-Public Information, 51 FR 44866 (Dec. 12,
1986).
168 Commission regulation § 1.59(b)(ii)(b).
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§ 1.59(d).169 In addition to the
Commission’s statutory authority on
insider trading,170 the DCM Core
Principle 16 Guidance states that DCMs
should provide for appropriate
limitations on the use or disclosure of
material non-public information gained
through performance of official duties
by members of the board of directors,
committee members, and DCM
employees or gained by those through
an ownership interest in the DCM.171
In contrast, Commission regulation
§ 1.59 applies in its entirety to SEFs.
Unlike for DCMs, the Commission did
not adopt any guidance or acceptable
practices addressing how a SEF may
demonstrate compliance with SEF Core
Principle 12 related to appropriate
limitations on the use and disclosure of
material non-public information.
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3. Proposed Rules
The Commission is proposing
harmonized rules for SEFs and DCMs
related to the use and disclosure of
material non-public information from
§ 1.59.172 Proposed §§ 37.1203(a) and
38.853(a) require SEFs and DCMs to
establish and enforce policies and
procedures on safeguarding the use and
disclosure of material non-public
information. These policies and
procedures must, at a minimum,
prohibit a SEF or DCM employee,
member of the board of directors,
committee member, consultant, or
owner with a 10 percent or more
interest in the SEF or DCM, from trading
commodity interests or related
commodity interests based on, or
disclosing, any non-public information
obtained through the performance of
their official duties. As discussed in
169 Under the provisions of Commission
regulation § 1.59(d), no employee, governing board
member, committee member, or consultant shall
trade for such person’s own account, or for or on
behalf of any other account, in any commodity
interest, on the basis of any material, non-public
information obtained through special access related
to the performance of such person’s official duties
as an employee, governing board member,
committee member, or consultant. Furthermore,
such persons must not disclose for any purpose
inconsistent with the performance of their official
duties as an employee, governing board member,
committee member, or consultant any material,
non-public information obtained through special
access related to the performance of such duties. In
addition, no person shall trade for their own
account, or for or on behalf of any other account,
in any commodity interest, on the basis of any
material, non-public information that such person
knows was obtained in violation of paragraph (d)(1)
of § 1.59 from an employee, governing board
member, committee member, or consultant.
170 CEA section 9(e).
171 Part 38, Appendix B, Core Principle 16.
172 This rule proposal would not amend
Commission regulation § 1.59, which will remain
unchanged and continue to be applicable to
registered futures associations.
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more detail below, the scope of
individuals subject to trading
limitations under this proposed rule is
consistent with those individuals
subject to the trading limitations under
both existing § 1.59 and existing Core
Principle 16 Guidance. The proposal
codifies existing Core Principle 16
Guidance which considers appropriate
limitations on those with an ownership
interest in the exchange. The proposal
clarifies that the limitation would apply
to those with an ownership interest of
10 percent or more in the SEF or DCM.
Proposed §§ 37.1203(b) and 38.853(b)
require SEFs and DCMs, respectively, to
prohibit employees from certain types of
trading 173 or disclosing for any purpose
inconsistent with the performance of the
person’s official duties as an employee
any material non-public information
obtained as a result of such person’s
employment. The Commission believes
that such a stringent restriction is
necessary for employees, who, by virtue
of their official position, have access to
material non-public information.
However, the Commission also
recognizes that there may be limited
circumstances under which employees
should be exempted from the trading
restrictions, so long as the subject
trading is not pursuant to material nonpublic information. Accordingly, the
Commission is proposing rules
requiring SEFs and DCMs to oversee
exemptions from the trading prohibition
granted to employees.174 Proposed
§§ 37.1203(c) and 38.853(c) would allow
SEFs and DCMs, respectively, to grant
exemptions that are (1) approved by the
SEF or DCM ROC; (2) granted only in
limited circumstances in which the
employee requesting the exemption can
demonstrate that the trading is not being
conducted on the basis of material nonpublic information gained through the
performance of their official duties; and
(3) individually documented by the SEF
173 Proposed §§ 37.1203(b)(1) and 38.853(b)(1)
restrict trading directly or indirectly, in the
following: (1) Any commodity interest traded on the
employing designated contract market; (2) Any
related commodity interest; (3) A commodity
interest traded on designated contract markets or
swap execution facilities or cleared by derivatives
clearing organizations other than the employing
designated contract market if the employee has
access to material non-public information
concerning such commodity interest; or (4) A
commodity interest traded on or cleared by a linked
exchange if the employee has access to material
non-public information concerning such
commodity interest.
174 The exemptions, applicable only to SEF or
DCM employees trading on the SEF or DCM, or
trading in the same or related commodity interests,
would be administered on a case-by-case basis, at
the level of granularity appropriate for the situation,
considering all relevant factors. The exemptions
would be reviewed by Commission staff as part of
its routine oversight of SEFs and DCMs.
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or DCM in accordance with
requirements in existing Commission
regulations §§ 37.1000 and 37.1001 or
§§ 38.950 and 38.951, respectively.
In its routine oversight, Commission
staff has observed certain deficiencies in
the manner in which DCMs evaluated,
granted, and documented exemptions
from their trading prohibitions. As a
result, the Commission is proposing
§§ 37.1203(d) and 38.853(d) to require
SEFs and DCMs, respectively, to
establish and enforce policies and
procedures to diligently monitor the
trading activity conducted under any
exemptions granted to ensure
compliance with any applicable
conditions of the exemptions and the
SEF’s or DCM’s policies and procedures
on the use and disclosure of material
non-public information. The
Commission believes that SEFs and
DCMs have an obligation to monitor and
ensure compliance with any applicable
conditions of the exemptions that may
be granted by the exchange. Moreover,
SEFs and DCMs must ensure that any
granted exemptions are in accordance
with the exchange’s policies and
procedures governing employees’ use
and disclosure of material non-public
information, as well as the CEA and
Commission regulations. The
Commission believes that SEFs and
DCMs should already have existing
programs to monitor, detect, and deter
abuses that may arise from trading
conducted pursuant to an exemption
from the employee trading prohibition.
Accordingly, a SEF or DCM should
utilize its existing surveillance program
to monitor trading by employees or
other insiders who are granted trading
exemptions pursuant to proposed
§§ 37.1203(c) and 38.853(c). Such
surveillance should focus on the
commodity interests or related
commodity interests to which the nonpublic information relates and the time
period during which misuse of such
information reasonably could be
expected to occur.
The Commission continues to believe
it is an important policy objective to
ensure that the trading prohibition does
not impair the ability or diminish the
willingness of knowledgeable members
of the industry who also are active
traders from serving on a SEF’s or
DCM’s board of directors or its major
policy or disciplinary committees. The
Commission, therefore, is maintaining
its historical policy of allowing SEFs
and DCMs flexibility, within limits, to
establish rules that may restrict
governing board members, committee
members, employees, and consultants
from trading in commodity interests for
their own account, or for or on behalf
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of any other account, based on this
material non-public information.
Accordingly, proposed §§ 37.1203(e)
and 38.853(e) require SEFs and DCMs,
respectively, to establish and enforce
policies and procedures that, at a
minimum, prohibit members of the
board of directors, committee members,
employees, consultants, and those with
an ownership interest of 10 percent or
more from: (1) trading in any
commodity interest or related
commodity interest on the basis of any
material non-public information
obtained through the performance of
such person’s official duties; (2) trading
in any commodity interest or related
commodity interest on the basis of any
material non-public information that
such person knows was obtained in
violation of this section; or (3)
disclosing for any purpose inconsistent
with the performance of the person’s
official duties any material non-public
information obtained as a result of their
official duties.
The Commission is expanding the
scope of the direct prohibition on
trading based on material non-public
information under proposed
§§ 37.1203(e) and 38.853(e) as compared
to existing Commission regulation § 1.59
in three ways. First, the Commission is
proposing to apply the prohibitions
already applicable to employees in
§ 1.59(b), regarding trading in ‘‘related
commodity interests,’’ to governing
board members, committee members,
and consultants who are in possession
of material non-public information.175
Consistent with the definition of
‘‘related commodity interests,’’ in
§ 1.59(a)(9), the Commission believes
that the direct prohibitions on trading
while in the possession of material nonpublic information should include
related commodity interests whose price
movements correlate with the price
movements of a commodity interest
traded on or subject to the rules of a SEF
or DCM to such a degree that
intermarket spread margins or special
margin treatment is recognized or
established by the employer SEF or
DCM.176 Second, the Commission is
proposing to codify existing DCM Core
Principle 16 Guidance related to those
with an ownership interest in
§§ 37.1203(e)(3) and 38.853(e)(3). While
this expands the scope of individuals
subject to trading limitations as
compared to existing Commission
regulation § 1.59, it is codifying existing
Core Principle 16 Guidance, with one
175 Proposed
§§ 37.1203(e)(1) and 38.853(e)(1).
proposed §§ 37.1201(b)(15) and
38.851(b)(15) (defining ‘‘related commodity
interests’’).
176 See
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clarification. Specifically, with regards
to owners, the Commission is clarifying
that the direct prohibition under
§§ 37.1203(e) and 38.853(e) would only
apply to those with an ownership
interest of 10 percent or more in the SEF
or DCM.177 Third, while the proposed
rules continue to maintain a restriction
on the disclosure of material non-public
information, the proposal would
address differences in the existing
language between §§ 1.59(b)(1)(D)(ii)
and 1.59(d)(ii) regarding the restrictions
on the disclosure of material non-public
information. The Commission is
proposing the same restriction on
disclosure for both employees under
§§ 37.1203(b)(2) and 38.853(b)(3) and
members of the board of directors,
committee members, consultants, and
those with an ownership interest of 10
percent or more under §§ 37.1203(e)(3)
and 38.853(e)(3), to make clear that
these ‘‘insiders’’ would be subject to the
same restriction from disclosing
material non-public information
obtained as a result of their official
duties at a SEF or DCM.
As mentioned in Section IV.b, the
Commission is proposing to include
substantial sections of existing
definitions from Commission regulation
§ 1.59 in proposed parts 37 and 38. For
example, the proposal includes, for
purposes of §§ 37.1203 and 38.853, the
same historical definitions of (1)
‘‘commodity interest,’’ (2) ‘‘linked
exchange,’’ (3) ‘‘material information,’’
(4) ‘‘non-public information,’’ and (5)
‘‘pooled investment vehicle.’’ The
Commission is proposing nonsubstantive changes to the (1)
‘‘commodity interest’’ and (2) ‘‘related
commodity interest’’ definitions. The
proposal would update the definition of
a commodity interest by removing the
phrase ‘‘of a board of trade which has
been designated as a’’ and keep the
reference to ‘‘designated contract
market.’’ For the ‘‘related commodity
interest’’ definition, the proposal
replaces the reference to ‘‘self-regulatory
organization’’ with a reference to either
a SEF or DCM in the regulatory text in
parts 37 and 38. The Commission
believes that it is appropriate for a SEF
or DCM to have the ability to grant an
exemption from the trading prohibition
where an employee is participating in
pooled investment vehicles where the
employee has no direct or indirect
control with respect to transactions
177 Owners of 10 percent or more of a company
are considered ‘‘insiders’’ pursuant to section 16 of
the Securities Exchange Act of 1934. See section
IV(C) herein.
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19665
executed for or on behalf of such
vehicles.178
4. Questions for Comment
The Commission requests comment
on all aspects of the proposed rules
regarding the use and disclosure of
material non-public information. The
Commission further requests comment
on the questions set forth below.
1. Has the Commission proposed an
appropriate definition for ‘‘material’’? If
not, why not? What would be a better
alternative?
2. Has the Commission proposed an
appropriate definition for ‘‘non-public
information’’? If not, why not? What
would be a better alternative?
3. Has the Commission proposed
appropriate limitations on the use and
disclosure of material non-public
information for SEF and DCM board of
directors, committee members,
employees, consultants, and those with
an ownership interest of 10 percent or
more? If not, why not? What would be
a better alternative?
4. With regards to owners, has the
Commission proposed an appropriate
limitation in applying the restrictions
under §§ 37.1203(e) and 38.853(e) to
those with an ownership interest of 10
percent or more in the SEF or DCM?
Should the restriction be applied to all
those with an ownership interest in the
SEF or DCM? If not, why not? What
would be a better alternative?
V. Proposed Structural Governance
Requirements for Identifying, Managing
and Resolving Actual and Potential
Conflicts of Interest
In general, the proposed structural
governance requirements are intended
to mitigate conflicts of interest at a SEF
or DCM by introducing a perspective
independent of competitive,
commercial, or industry considerations
to the deliberations of governing bodies
(i.e., the board of directors and
committees). The Commission believes
that such independent perspective
would be more likely to encompass
regulatory considerations, and accord
such considerations proper weight. The
Commission believes that such
independent perspective also would
more likely contemplate the manner in
which a decision might affect all
constituencies, as opposed to
178 In particular, that it would be appropriate to
grant an employee an exemption to trade in a
pooled investment vehicle organized and operated
as a commodity pool within the meaning of
§ 4.10(d) of the Commission regulations, and whose
units of participation have been registered under
the Securities Act of 1933, or a trading vehicle for
which Commission regulation § 4.5 makes available
relief from registration as a commodity pool
operation.
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concentrating on the manner in which
a decision affects the interests of one or
a limited number of constituencies.179
The Commission further believes that
independent decision-makers are
necessary to protect a SEF’s or DCM’s
market regulation functions from its
commercial interests and that of its
constituencies.
Accordingly, the Commission is
proposing to require a SEF’s or DCM’s
board of directors, and any executive
committee, to include at least 35 percent
public directors. The Commission also
proposes establishing two committees to
further enhance the structural
governance of SEFs and DCMs. First, the
proposed rules would require a
nominating committee that is comprised
of at least 51 percent public directors to
enhance the transparency of the board
of directors. Second, the proposed rules
would require a ROC comprised solely
of public directors to protect the
integrity of the market regulation
function of SEFs and DCMs. The
Commission is also proposing a new
DCM CRO requirement, and updating
the existing SEF CCO requirement, to
clearly establish these roles as central to
the SEF’s or DCM’s management of
conflicts of interest that may impact
market regulation functions.
a. Composition and Related
Requirements for Board of Directors—
Proposed §§ 37.1204 and 38.854
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1. Background
As the ultimate decision-maker of an
exchange, governing boards are an
essential component in an exchange’s
ability to identify, manage, and resolve
conflicts of interest.180 In particular, the
board of directors, along with senior
management, set the ‘‘tone at the top’’
for a SEF’s or DCM’s governance and
compliance culture.181 In its routine
179 See 2007 Final Release, 72 FR 6936 at 6947
(stating 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 selfregulation).
180 See 2007 Final Release, 72 FR 6936.
181 Donald C. Langevoort, Cultures of
Compliance, 54 a.m. CRIM. L. REV. 933, 946–947
(2017); Group of Thirty, Banking Conduct and
Culture, A Call for Sustained and Comprehensive
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oversight, Commission staff has
observed that board composition
standards have become a key piece of
SEFs’ and DCMs’ structural governance,
and when coupled with clear,
comprehensive policies and procedures
to address conflicts of interest, have
helped to minimize conflicts of interests
faced by members of the board of
directors. For example, the presence of
public directors, both on the board of
directors and the ROC, has created an
avenue for DCMs, SEFs, their officers
and employees to escalate, and
eventually seek resolution of, conflicts
of interest.
2. Existing Regulatory Framework
Currently, the board of director
composition component of the DCM
Core Principle 16 Acceptable Practices
provides that a DCM’s board of directors
or executive committees include at least
35 percent public directors.182 In
adopting this acceptable practice, the
Commission stated that the 35 percent
figure struck an appropriate balance
between (1) the need to minimize
conflicts of interest in DCM decisionmaking processes and (2) the need for
expertise and efficiency in such
processes.183
As compared to DCMs, SEFs are
currently subject to substantially
different board composition standards.
Specifically, SEFs are subject to
Commission regulation § 1.64(b)(1),
which establish a 20 percent ‘‘nonmember’’ requirement.184 This
requirement was adopted in 1993 for
SROs when exchanges were memberowned. At the time, the Commission
sought to ensure that an SRO governing
board fairly represented the diversity of
Reform, Washington, DC, July 2015; The Role of the
Board of Directors and Senior Management in
Enterprise Risk Management, by Bruce C. Branson,
Chapter 4, Enterprise Risk Management: Today’s
Leading Research and Best Practices for
Tomorrow’s Executives, 2nd Edition, edited by John
R. S. Fraser, Rob Quail, Betty Simkins, Copyright
2021 John Wiley & Sons; See also comments from
former SEC Chair Mary Jo White, to the Stanford
University Rock Center for Corporate Governance,
June 23, 2014, https://www.sec.gov/news/speech/
2014-spch062314mjw (accessed June 24, 2023) (‘‘It
is up to directors, along with senior management
under the purview of the board, to set the allimportant ‘‘tone at the top’’ [regarding compliance
with federal securities laws] for the entire
company.’’).
182 Part 38, Appendix B, Core Principle 16
Acceptable Practices (b)(1).
183 2007 Final Release, 72 FR 6936 at 6946–6947.
184 Commission regulation § 1.64(b)(1) requires
that twenty percent of the board of directors must
be persons who are (1) knowledgeable of futures
trading or financial regulation or otherwise capable
of contributing to governing board deliberations;
and (2) not members of the SEF, not currently
salaried employees of the SEF, not primarily
performing services for the SEF, and not officers,
principals or employees of a member firm.
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membership interest at such SRO 185
and would not have an exclusively
member perspective.186 While this was
a laudable goal at the time, Commission
regulation § 1.64(b)(1) requirements are
no longer relevant for SEFs and DCMs
given that exchanges are no longer
member-owned. The Commission’s goal
through this proposal is to ensure that
SEFs and DCMs have sufficient
independent perspective in their
decision-making, taking into account
that SEFs and DCMs are now for-profit
entities that also are charged with
market regulation functions. Applying
Commission regulation § 1.64(b)(1) has
created an unintentional consequence of
allowing SEFs to compose their boards
of directors with ‘‘insiders.’’ SEFs with
no independent voice on the board,
either through inclusion of public
directors or other non-affiliated
directors, have been able to meet the
requirements of Commission regulation
§ 1.64(b)(1). For example, if an executive
was seconded to the SEF from an
affiliate (therefore, not a ‘‘salaried
employee’’), and only spent a fraction of
their time performing services for the
SEF (therefore, not ‘‘primarily
performing services’’ for the SEF), the
executive could arguably be deemed to
satisfy the ‘‘non-member’’ requirement
of Commission regulation § 1.64(b)(1).
Under the current DCM Core Principle
16 Acceptable Practices, however, the
executive would not likely be
considered a public director and
therefore, to meet the acceptable
practices, could not be included as a
director that satisfies the board
composition standards.
The Commission continues to believe
that the practice of including in the
board of directors at least 35 percent
public directors, as reflected in the DCM
Core Principle 16 Acceptable Practices,
is appropriate for DCMs, and that it is
also is appropriate for SEFs. In reaching
this conclusion, the Commission has
considered the board composition
requirements applicable to publiclytraded companies, which require that a
majority of the board of directors must
be ‘‘independent’’ directors.187
However, the goal of this higher
threshold, which is to protect
shareholders of publicly-traded
companies through boards of directors
that are sufficiently independent from
185 Final Rule and Rule Amendments Concerning
Composition of Various Self-Regulatory
Organization Governing Boards and Major
Disciplinary Committees, 58 FR 37644 at 37646
(July 13, 1993).
186 Id. at 37647.
187 NYSE American Company Guide Rule 802;
Nasdaq Rule 5605(b).
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management, is not entirely the same as
the Commission’s concern at hand.
The Commission’s primary goal with
respect to Core Principle 16 is to ensure
that the commercial interests of SEFs
and DCMs and of its constituencies do
not compromise market regulation
functions. Accordingly, the Commission
recognizes the need to have individuals
on the board of directors with sufficient
background and expertise to support the
SEF’s or DCM’s market functions. The
Commission, however, also is cognizant
of the importance of having individuals
with sufficient independent
perspectives on the board of directors to
ensure that the SEF or DCM can
properly manage conflicts in its
decision-making. Indeed, publiclytraded companies are moving towards
requiring that a majority of the board of
directors must be independent directors.
However, the Commission believes that
imposing a majority threshold in all
circumstances may deny SEFs and
DCMs the flexibility necessary to ensure
that the board of directors includes
individuals with adequate market
expertise. The Commission is currently
unaware of any circumstances that
would support requiring public
directors to constitute a majority of the
board of directors of every SEF or DCM.
Therefore, the Commission is proposing
a bright-line threshold that would
balance the need to ensure proper
representation of impartial views with
the need for market expertise. In doing
so, the Commission recognizes that SEF
and DCM boards of directors may vary
in size. However, based on the
Commission’s observation of existing
SEFs and DCMs, the Commission
believes that a minimum threshold of 35
percent public directors would lead to
at least two public directors on most
SEF and DCM boards of directors. At the
same time, the proposal would allow
SEFs and DCMs the discretion to
establish a higher threshold.
The Commission requests comment
on all aspects of the proposed 35
percent public director board
composition requirements, including
comments on the specific questions
listed below in this section.
3. Proposed Rules
The Commission proposes to enhance
the existing board composition
standards for both SEFs and DCMs by:
(1) codifying in proposed § 38.854(a)(1)
the practice under the DCM Core
Principle 16 Acceptable Practices that
DCM boards of directors be composed of
at least 35 percent ‘‘public
directors;’’ 188 (2) extending this
188 Proposed
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requirement to SEF boards of directors
under proposed § 37.1204(a)(1); 189 and
(3) adopting additional requirements to
increase transparency and
accountability of the board of directors.
The Commission believes that in
addressing these board of director
composition requirements in proposed
§ 37.1204, it is necessary to amend
Commission regulation § 37.2 to exempt
SEFs from Commission regulation
§ 1.64, including the board of directors
composition requirements under
Commission regulation § 1.64(b)(1).
In addition to proposing board of
director composition requirements, the
Commission proposes the substantive
requirements set forth below, which aim
to enhance transparency and the
accountability of the SEF and DCM
board of directors regarding the manner
in which such board of directors causes
the SEF or DCM to discharge all
statutory, regulatory, or self-regulatory
responsibilities under the CEA,
including the market regulation
functions.
• A SEF or DCM must establish and
enforce policies and procedures
outlining the roles and responsibilities
of the board of directors, including the
manner in which the board of directors
oversees compliance with all statutory,
regulatory, and self-regulatory
responsibilities under the CEA and the
regulations promulgated thereunder.190
• A SEF or DCM must have
procedures to remove a member from
the board of directors, where the
conduct of such member is likely to be
prejudicial to the sound and prudent
management of the SEF or DCM.191
• A SEF or DCM must notify the
Commission within five business days
of any changes to the membership of the
board of directors or its committees.192
Given the complex nature of the SEF
and DCM marketplace, their role as selfregulators over their markets, and the
overall impact of such exchanges on the
integrity, resilience, and vibrancy of
U.S. derivatives and financial markets,
the Commission proposes in
§§ 37.1204(b) and 38.854(b) to require
that each member of a SEF or DCM
board of directors have relevant
expertise to fulfill the roles and
responsibilities of their position. The
Commission believes that experience in
financial services, risk management, and
financial regulation are examples of
relevant expertise.
The Commission proposes
§§ 37.1204(c) and 38.854(c) to prohibit
189 Proposed
§ 37.1204(a)(1).
§§ 37.1204(a)(2) and 38.854(a)(2).
191 Proposed §§ 37.1204(e) and 38.854(e).
192 Proposed §§ 37.1204(f) and 38.854(f).
190 Proposed
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linking the compensation of public
directors and other non-executive
members of the board of directors to the
business performance of the SEF or
DCM, or any affiliate of the SEF or DCM.
The Commission believes prohibiting
compensation in this manner would
help enable non-executive directors to
remain independent and focused on
making objective decisions for the SEF
or DCM. The Commission further
believes it is necessary to capture all
compensation—from either the SEF or
the DCM or an affiliate—that a public
director or non-executive member of the
board could receive. Whether a specific
compensation arrangement is ‘‘directly
dependent on the business
performance’’ of the SEF or DCM, or its
affiliates, as contemplated under
proposed §§ 37.1204(c) and 38.854(c),
would depend on specific facts and
circumstances. The Commission
understands that it may be industry
practice to include some form of
nominal equity in a compensation
package. The Commission does not
consider nominal equity ownership
interest, in and of itself, to be
compensation that is ‘‘directly
dependent on the business
performance’’ of the SEF or DCM or its
affiliates. However, the Commission
considers any equity ownership interest
in a SEF or DCM or its affiliates that is
more than nominal to be compensation
that is ‘‘directly dependent on the
business performance’’ of the SEF or
DCM or its affiliates. In addition, the
Commission believes that providing
bonuses based on specific sales or
customer acquisition targets would
constitute compensation that is
‘‘directly dependent on the business
performance’’ of the SEF or DCM or its
affiliates. Finally, any equity ownership
included as a component of public
director compensation that reasonably
could be viewed as being substantial
enough to potentially compromise the
impartiality of a public director would
not be considered nominal.
Proposed §§ 37.1204(d) and 38.854(d)
require SEFs’ and DCMs’ board of
directors to conduct an annual selfassessment to review their performance.
The Commission believes that such selfassessments will encourage boards of
directors to reflect on their performance
and will enhance their accountability to
the Commission regarding the manner
in which such board of directors causes
the SEF or DCM to discharge all
statutory, regulatory, and self-regulatory
responsibilities under the CEA,
including market regulation functions.
For example, Commission staff may
request to see the results of the self-
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assessment during a rule enforcement
review of the SEF or DCM. The
Commission notes that many SEF and
DCM boards of directors already
conduct self-assessments, and that this
proposal provides significant discretion
to SEFs and DCMs to determine how
best to implement such an assessment.
The Commission believes that SEFs and
DCMs should consider including the
following in the self-assessment: (1)
observations relating to the flow of
information provided to the board of
directors; (2) the effects of any changes
to the board composition, succession
planning and human capital
management; (3) potential improvement
to the SEF’s or DCM’s governance
structure; and (4) any other information
or analysis that would improve the
board’s ability to perform its duties and
responsibilities.
4. Questions for Comment
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The Commission requests comment
on all aspects of the proposed board
composition requirements. The
Commission further requests comment
on the questions set forth below.
1. Have there been any industry
changes since the adoption of the DCM
Core Principle 16 Acceptable Practices
that the Commission should consider in
adopting board composition
requirements for SEFs and DCMs?
2. Is the 35 percent public director
requirement sufficient to introduce an
independent perspective on a SEF’s or
DCM’s board of directors?
3. Should the Commission increase
the required percentage of public
directors to 51 percent?
4. Is there a number less than 51
percent but greater than 35 percent that
would be more appropriate?
5. Should the Commission prohibit
public director compensation from
including any equity ownership?
6. Should the Commission prescribe a
specific numerical limit on the amount
of equity ownership paid to a public
director, and, if so, what is the
appropriate limit?
7. What are examples of
compensation that would be more than
nominal or directly dependent on the
business performance of a SEF or DCM?
b. Public Director Definition—Proposed
§§ 37.1201(b)(12) and 38.851(b)(12)
1. Background
Public directors can be a valuable
governance tool for organizations,
including SEFs and DCMs. As
‘‘outsiders,’’ public directors are in a
unique position to bring an unbiased
perspective. Their objectivity and
independence may enhance the
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accountability of the board of directors
and lend credibility to the organization,
its leaders, and its governance
arrangements. Since public directors do
not have a material relationship with
the SEF or DCM, the Commission
believes they are well-suited to balance
the commercial interests of the SEF or
DCM and its regulatory obligations,
including its market regulation
functions.
2. Existing Regulatory Framework
The current ‘‘public director’’
definition found in the DCM Core
Principle 16 Acceptable Practices
provides for the DCM’s board of
directors to determine, on the record,
that the director has no ‘‘material
relationship’’ with the DCM (the
‘‘overarching materiality test’’).193 A
‘‘material relationship’’ is ‘‘one that
reasonably could affect the independent
judgment or decision-making of the
director.’’ Additionally, the public
director definition contains a list of per
se material relationships (the ‘‘brightline disqualifiers’’) that disqualify
service as a public director if: (1) such
director is an officer or an employee of
the DCM or an officer or an employee
of its affiliate; (2) such director is a
member of the DCM; (3) such director,
or a firm in which the director is an
officer, director, or partner, receives
more than $100,000 in aggregate annual
payments 194 for legal, accounting, or
consulting services from the DCM, or an
affiliate of the DCM.195 Such list is
neither exclusive nor exhaustive; even if
the bright-line disqualifiers are not
triggered, each public director nominee
must satisfy the overarching materiality
test. Additionally, the bright-line
disqualifiers apply to a member of the
director’s ‘‘immediate family,’’ which
includes spouse, parents, children and
siblings.196 Both the overarching
materiality test and the bright-line
disqualifiers are subject to a one-year
look-back period.197 The public director
definition in the DCM Core Principle 16
Acceptable Practices provides that a
DCM’s public directors may also serve
as directors of the DCM’s affiliate, so
193 Part 38, Appendix B, Core Principle 16
Acceptable Practices (b)(2)(i).
194 However, compensation for services as a
director of the DCM or as a director of an affiliate
of the DCM 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.
195 Part 38, Appendix B, Core Principle 16
Acceptable Practices (b)(2)(ii).
196 Part 38, Appendix B, Core Principle 16
Acceptable Practices (b)(2)(ii)(D).
197 Part 38, Appendix B, Core Principle 16
Acceptable Practices (b)(2)(iii).
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long as they satisfy the requirements of
the public director definition.198
Finally, a DCM is obligated to disclose
to the Commission which members of
its board of directors are public
directors, and the basis for those
determinations.199
3. Proposed Rules
The Commission proposes to adopt in
§§ 37.1201(b)(12) and 38.851(b)(12) a
public director definition, similar to the
definition in the DCM Core Principle 16
Acceptable Practices, for SEFs and
DCMs, respectively. The Commission
believes that SEFs and DCMs must have
a board of directors that includes
sufficient representation of independent
perspective through public directors.
The Commission believes that, in
determining whether an individual
qualifies as a public director, it must be
considered whether there are any
specific interests that would affect the
individual’s decision-making. In the
Commission’s experience, through its
routine oversight of SEFs and DCMs, a
‘‘material relationship’’ that is based on
certain personal or professional interests
or financial incentives, could affect an
individual’s decision-making.
While Commission regulation § 1.64
seeks to address the conflict of interest
that was prevalent when SROs were
member-owned—i.e., that governing
boards would have an exclusively
member perspective 200—this is no
longer the predominant concern for
existing SEFs and DCMs. In a
demutualized exchange environment,
the conflicts between commercial
interests and market regulation
functions are exacerbated. The
Commission believes that the higher
standard created by the proposed public
director definition is reasonably
necessary to ensure an independent
perspective in a demutualized exchange
environment. Commission staff has
identified, through its oversight of SEFs,
that some SEFs have voluntarily
adopted board composition
requirements that reflect the DCM Core
Principle 16 Acceptable Practices public
director definition.
The Commission proposes to codify
the existing DCM Core Principle 16
Acceptable Practices public director
definition for both SEFs and DCMs,
with some modifications. First, the
proposed definition would amend the
bright-line disqualifier that applies to a
director receiving more than $100,000
198 Part 38, Appendix B, Core Principle 16
Acceptable Practices (b)(2)(iv).
199 Part 38, Appendix B, Core Principle 16
Acceptable Practices (b)(2)(v).
200 58 FR 37644 at 37647.
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in aggregate annual payments to remove
the reference ‘‘for legal, accounting, or
consulting services’’ from the SEF or
DCM, or an affiliate of the SEF or DCM.
The bright-line disqualifier would now
limit receiving any payments in excess
of $100,000 for any purpose. The
proposed rule also would amend this
bright-line disqualifier to apply to
situations where a director is an
employee of a firm receiving such
payments.
Second, the proposed rule expands
the bright-line disqualifier that applies
to a situation where a director is a
member of the SEF or DCM or a
director, an officer of a member, to also
apply where: (1) such director is an
employee of a member of the SEF or
DCM; and (2) extends the
disqualification to apply to the
prospective director’s relationships, as a
director, officer or employee, with an
affiliate of a member of the SEF or DCM.
Third, the Commission proposes
expanding the scope of the bright-line
disqualifiers to account for relationships
that the director may have with an
affiliate of the SEF or DCM or an
affiliate of a member of the SEF or DCM.
Fourth, the Commission proposes to
establish a new bright-line disqualifier
that would prohibit an individual who,
directly or indirectly, owns more than
10 percent of the SEF or DCM or an
affiliate of the swap execution facility,
or is an officer or employee of an entity
that directly or indirectly owns more
than 10 percent of the swap execution
facility, from serving as a public
director.
Fifth, the proposed public director
definition replaces the term ‘‘immediate
family’’ and expands the bright-line
disqualifiers to apply to any person with
whom the director has a ‘‘family
relationship,’’ as set forth in proposed
§§ 37.1201(b)(7) and 38.851(b)(7).
Finally, the proposed definition
includes a new requirement to clarify
that the public director determination
must be made ‘‘upon the nomination or
appointment of the director and at least
on an annual basis thereafter.’’
Consistent with the proposed fitness
requirements in proposed
§§ 37.1201(b)(12) and 38.851(b)(12), the
Commission believes all determinations
with respect to the public director status
of members of the board of directors
should be completed upon their
nomination to the board of directors—
i.e., prior to their appointment. Further,
Commission staff’s oversight has
revealed that not all DCMs were
diligently reviewing their public
director determinations for existing
directors on an annual basis.
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The Commission believes that the
above-mentioned amendments to the
public director definition are necessary
to capture the full scope of the
relationships that could affect a
prospective director’s ability to bring an
independent perspective to the
decision-making of a SEF or DCM.
Eliminating ‘‘legal, accounting, or
consulting service’’ from the bright-line
disqualifier that applies to payments in
excess of $100,000 is necessary, as the
provision of other services could also be
‘‘material’’ for purposes of establishing
whether an individual qualifies as a
public director. The Commission also
proposes to expand the bright-line
disqualifiers to certain relationships in
which the director is an employee of: (1)
a member of a SEF or DCM or its
affiliate; and (2) an entity that receives
more than $100,000 in aggregate annual
payments from the SEF or DCM or its
affiliate. In these situations, the
Commission believes the ties between
the outside entity and the SEF or DCM
are close enough to impact the actual or
perceived ability of the prospective
director to bring an independent
perspective. Furthermore, the
Commission notes that such employees
would likely be restricted from serving
as public directors under the
overarching materiality test. Similarly,
the Commission is also expanding the
bright-line disqualifier to include
certain relationships with affiliates. The
Commission has found, as detailed
above, as market structures have
evolved, growing interconnectedness
between SEFs, DCMs, and their
affiliates. This relationship between a
SEF or DCM and its affiliates—and by
extension, their employees and
officers—creates, in the Commission’s
view, a ‘‘material relationship.’’ Finally,
although the 10 percent ownership
bright-line disqualifier would be new,
the Commission believes that an
individual with an ownership interest
greater than 10 percent would not
currently qualify as a public director
under the overarching materiality test. A
10 percent ownership of a SEF or DCM
is significant enough to call into
question, whether in actuality or
perception, a public director’s ability to
act in an impartial manner to ensure
business concerns do not impact market
regulation functions.
4. Questions for Comment
The Commission requests comment
on all aspects of the proposed public
director definition. The Commission
further requests comment on the
questions set forth below.
1. Are there other circumstances that
the Commission should include as
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bright-line disqualifiers? Are there
circumstances that the Commission
should remove from such tests?
2. Should the Commission increase or
decrease the $100,000 in aggregate
payment threshold?
3. Is the one-year look back period
sufficient, in order to protect market
regulation functions from directors that
are conflicted due to industry ties?
4. Should the Commission continue to
permit public directors to serve on the
board of directors of a SEF’s or DCM’s
affiliate? Why or why not?
c. Nominating Committee and Diverse
Representation—Proposed §§ 37.1205
and 38.855
1. Background
As described herein,201 the structural
governance requirements applicable to
boards of directors of SEFs and DCMs
aim to mitigate conflicts of interest
through the representation of
independent perspectives. Public
director composition requirements
alone may not be sufficient to ensure the
representation of such independent
perspective. Commission staff’s routine
oversight has found that many SEFs and
DCMs do not currently have formal
policies or procedures for identifying
potential members of the board of
directors, and instead rely entirely on
the personal networks of members of
their boards of directors or executives.
The Commission believes that an
independent perspective on the SEF or
DCM board of directors is necessary to
mitigate conflicts of interest. Lack of
policies or procedures for identifying
potential members of the board of
directors may result in delays in the
appointment process.
2. Existing Regulatory Framework
DCM Core Principle 17 requires the
governance arrangements of a board of
directors of a DCM to permit
consideration of the views of market
participants. Similarly, pursuant to
Commission regulation § 1.64(b)(3),
members of self-regulatory organization
governing boards, including SEF
governing boards, must include a
diversity of membership interests.
However, neither DCMs nor SEFs are
currently obligated by Commission
regulations to have a nominating
committee to identify or manage the
process for nominating potential
members of the board of directors.
To help protect the integrity of the
process by which a SEF or DCM selects
members of its board of directors, the
Commission proposes requiring each
201 See Section V(a) herein; Proposed §§ 37.1204
and 38.854.
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SEF or DCM to have a nominating
committee. The role of the nominating
committee would be to: (1) identify a
diverse pool of individuals qualified to
serve on the board of directors,
consistent with Commission
regulations; and (2) administer a process
for the nomination of individuals to the
board of directors.
required to be appointed by the
nominating committee.
3. Proposed Rules
Proposed §§ 37.1205 and 38.855
would require a nominating committee
to identify a pool of candidates who are
qualified and represent diverse
interests, including the interests of the
participants and members of the SEF or
DCM. Thus, proposed §§ 37.1205 and
38.855 incorporate, and expand upon,
the diversity of membership
requirements found in Commission
regulation § 1.64, and, with respect to
DCMs, are consistent with DCM Core
Principle 17, and reasonably necessary
to advance DCM Core Principle 16.
Accordingly, the Commission proposes
conforming amendments to Commission
regulation § 37.2 to exempt SEFs from
Commission regulation § 1.64.
Proposed §§ 37.1205 and 38.855
would require that public directors
comprise at least 51 percent of the
nominating committee, that a public
director chair the nominating
committee, and that the nominating
committee report directly to the board of
directors. The Commission proposes
that the nominating committee be at
least 51 percent public directors to limit
the influence of non-public directors
that are already involved in the
governance and management of a SEF or
DCM, and to help ensure a broader pool
of candidates for consideration, in turn
promoting diversity and independent
perspectives in the governing bodies of
SEFs and DCMs. The nominating
committee takes the first steps in
identifying the pool of future members
of the board of directors, and a broad
pool of candidates is critical to
maintaining independent perspectives
on the board of directors. Therefore, the
Commission is proposing that public
directors should represent a majority of
members of the nominating committee.
Proposed §§ 37.1205 and 38.855 also
would require the nominating
committee to administer a process for
nominating individuals to the board of
directors. This process must be adopted
prior to registration as a SEF or
designation as a DCM. Similarly, boards
of directors must be appointed prior to
registration or designation. However, as
set out in proposed §§ 37.1205(b) and
38.855(b) the initial members of the
board of directors serving upon
registration or designation would not be
1. Background
SEFs and DCMs are faced with
commercial pressures to remain
competitive in an industry where
business models, trading practices, and
products are rapidly evolving. As
business enterprises, SEFs and DCMs
are also tasked with maximizing
shareholder value, generating profits,
and satisfying the diverse needs of their
constituencies. SEFs and DCMs,
therefore, may face conflicts between
their commercial interests and their
market regulation obligations.
Other competing demands may
unduly influence a SEF’s or DCM’s
market regulation functions, such as the
interests of their ownership,
management, market participants,
membership, customers, and other
constituencies. Externally, SEFs and
DCMs may find themselves conflicted
with affiliated entities—including
affiliated entities that are directly or
indirectly trading on or subject to the
rules of the SEF or DCM, affiliated
entities that are in possession of data
acquired by or generated from the SEF
or DCM, and affiliated entities to whom
SEF or DCM employees owe duties
based on participating in the functions
of both the affiliated entities and the
SEF or DCM. The Commission
published the ROC component of the
DCM Core Principle 16 Acceptable
Practices in 2007 to minimize these
conflicts by helping to insulate core
regulatory functions from improper
influences and pressures.202 In the
Commission’s experience, ROCs can
serve one of the most critical elements
of a DCM’s governance structure for
mitigating conflicts of interests.
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4. Questions for Comment
The Commission requests comment
on all aspects of the proposed
nominating committee requirements.
d. Regulatory Oversight Committee—
Proposed §§ 37.1206 and 38.857
2. Existing Regulatory Framework
In proposing requirements for SEF
and DCM ROCs, the Commission is
largely codifying language found in the
ROC component of the DCM Core
Principle 16 Acceptable Practices.203
Currently, to demonstrate compliance
under the acceptable practices, a DCM
must establish a ROC, consisting of only
public directors, to assist it in
minimizing actual and potential
202 2007
Final Release, 72 FR 6936 at 6940.
38, Appendix B, Core Principle 16
Acceptable Practices.
203 Part
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conflicts of interest.204 A ROC is a
standing committee of the board of
directors.205 The purpose of the ROC is
to oversee the DCM’s regulatory
program on behalf of the board of
directors, which in turn delegates
sufficient authority, dedicates sufficient
resources, and allows sufficient time for
the ROC to fulfill its mandate.206 The
Acceptable Practices for DCM Core
Principle 16 describe a ROC that is
responsible for the following: (1)
monitoring the DCM’s regulatory
program for sufficiency, effectiveness,
and independence; (2) overseeing all
facets of the program; 207 (3) reviewing
the size and allocation of the regulatory
budget and resources; and the number,
hiring and termination, and
compensation of regulatory personnel;
(4) supervising the DCM’s CRO, who
will report directly to the ROC; (5)
preparing an annual report assessing the
DCM’s self-regulatory program for the
board of directors and the Commission;
(6) recommending changes that would
ensure fair, vigorous, and effective
regulation; and (7) reviewing regulatory
proposals and advising the board of
directors as to whether and how such
changes may impact regulation.208 In
performing these functions, the ROC
plays a critical role in insulating the
CRO and the DCM’s self-regulatory
function from undue influence that may
exert pressure over the CRO to put a
DCM’s commercial interests ahead of its
market regulation functions. The ROC’s
is specifically tasked with oversight of
a SEF’s or DCM’s market regulation
functions. Conversely, while the
interests of the ROC and a DCM’s CRO
or a SEF’s CCO are aligned, only the
ROC carries with it the authority
granted by the board of directors.
Accordingly, the ROC, along with the
board of directors and CCO or CRO, are
all integral components of a SEF’s or
DCM’s conflicts of interest framework.
Given that SEFs and DCMs face
similar pressures that may conflict with
their market regulation functions—such
as trade practice surveillance, market
surveillance, real-time market
monitoring, audit trail enforcement,
investigations of possible rule
violations, and disciplinary actions—the
204 Part 38, Appendix B, Core Principle 16
Acceptable Practices (b)(3)(i).
205 Id.
206 Id.
207 This includes including trade practice and
market surveillance; audits, examinations, and
other regulatory responsibilities with respect to
member firms (including ensuring compliance with
financial integrity, financial reporting, sales
practice, recordkeeping, and other requirements);
and the conduct of investigations.
208 Part 38, Appendix B, Core Principle 16
Acceptable Practices (b)(3)(ii).
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Commission believes that SEFs and
DCMs would benefit from the
protections that are offered by a ROC.
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3. Proposed Rules
i. Codifying DCM Core Principle 16 ROC
Acceptable Practices
Accordingly, the Commission
proposes to require in § 38.857(a) that
DCMs must have a ROC composed of
only public directors. Commission staff
has found, through its general oversight
of DCMs, that existing DCM ROCs are
effective in providing structural
governance protections that help DCMs
to minimize conflicts of interest. For
example, in their role as members of the
ROC, these public directors are not
tasked with making decisions on
commercial matters or other interests of
the SEF or DCM that may conflict with
market regulation functions.
Accordingly, Commission staff has
found that ROC members have provided
DCM CROs a ‘‘safe space’’ to raise
concerns and have advocated, when
appropriate, for the CRO and the market
regulation functions.
Second, the Commission proposes in
§ 37.1206(a) to include a ROC
requirement for SEFs, which, like
DCMs, also perform market regulation
functions. Through its experience with
SEF registrations, routine
communications with SEFs, and
regulatory consultations, Commission
staff has found that some SEFs
established ROCs that included nonpublic directors and SEF executives (or
executives of SEF affiliates). As a result,
a committee intended to insulate the
market regulation function from
commercial interests had its own
potential conflicts of interest.
Accordingly, the Commission proposes
to include in § 37.1206(a), just as it is
proposing to include in § 38.857(a), a
requirement that SEFs have a ROC
composed only of public directors.
Under proposed §§ 37.1206(d) and
38.857(d), both SEF and DCM ROCs
would generally have identical
oversight duties over market regulation
functions, including: (1) monitoring the
SEF’s or DCM’s market regulation
functions for sufficiency, effectiveness,
and independence; (2) overseeing all
facets of the market regulation
functions; 209 (3) approving the size and
209 The Commission is proposing a more
simplified version of the ROC’s current duties to
oversee all facets of the regulatory program,
including trade practice and market surveillance;
audits, examinations, and other regulatory
responsibilities with respect to member firms
(including ensuring compliance with financial
integrity, financial reporting, sales practice,
recordkeeping, and other requirements); and the
conduct of investigations.
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allocation of the regulatory budget and
resources; and the number, hiring and
termination, and compensation of staff
required pursuant to §§ 37.203(c) and
38.155(a); (4) recommending changes
that would promote fair, vigorous, and
effective self-regulation; and (5)
reviewing all regulatory proposals prior
to implementation and advising the
board of directors as to whether and
how such proposals may impact market
regulation functions.210
The Commission recognizes that SEFs
are also subject to a statutory core
principle requirement (SEF Core
Principle 15) to designate a CCO to
monitor the SEF’s adherence to
statutory, regulatory, and self-regulatory
requirements and to resolve conflicts of
interest that may impede such
adherence.211 Additionally, the CCO
must report to the SEF board of
directors (or similar governing body) or
the senior SEF officer.212 To account for
the standing CCO requirements and to
integrate the addition of a ROC, the
Commission envisions the CCO
continuing their duties to supervise the
SEF’s self-regulatory program,213 as well
as making recommendations in
consultation with the ROC (in the event
a conflict of interest involving the CCO
exists).214 As further discussed
below,215 the Commission believes
involving the ROC in such matters will
help to ensure that the CCO remains
insulated from undue pressures and that
conflicts of interest are appropriately
managed.
To ensure that the ROC can fulfill its
mandate, proposed §§ 37.1206(c) and
38.857(c) require that the board of
directors delegate sufficient authority,
dedicate sufficient resources, and allow
sufficient time for the ROC to perform
its functions. The Commission has
previously stated that the ROC should
have the authority, discretion and
necessary resources to conduct its own
inquiries; consult directly with
regulatory staff; interview employees,
210 This includes, for example, proposed rules,
and business initiatives, etc.
211 See CEA section 5h(f)(15); 7 U.S.C. 7b–3(f)(15).
212 See CEA section 5h(f)(15)(B)(i); 7 U.S.C. 7b–
3(f)(15)(B)(i).
213 See Commission regulation § 37.1501(c)(7),
which requires the CCO to supervise the SEF’s selfregulatory program with respect to trade practice
surveillance, market surveillance, real-time market
monitoring, compliance with audit trail
requirements, enforcement and disciplinary
proceedings, audits, examinations, and other
regulatory responsibilities with respect to members
and market participants (including ensuring
compliance with, if applicable, financial integrity,
financial reporting, sales practice, recordkeeping,
and other requirements). Part 37 Final Rule, 78 FR
33476.
214 Proposed § 37.1501(c).
215 See Section V(h)(3) herein.
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19671
officers, members, and others; review
relevant documents; retain independent
legal counsel, auditors, and other
professional services; and otherwise
exercise its independent analysis and
judgment to fulfill its regulatory
obligations.’’ 216
ii. Additional Proposed Requirements
To Enhance SEF and DCM ROCs
In addition to codifying the existing
DCM ROC acceptable practices for both
SEFs and DCMs, the Commission
proposes enhancing the ROC
requirements with best practices
Commission staff has identified through
the course of its routine oversight.
Commission staff has found that DCMs
have substantial differences in their
implementation of ROC administrative
and procedural standards. For example,
some DCMs have limited individuals
other than ROC members or DCM staff
performing market regulation functions
from attending the ROC meetings, while
others have allowed DCM executives
and non-ROC members of the board of
directors to attend. The Commission
believes the former practice is preferable
as the latter practice invites to ROC
meetings the very conflicts of interest
that the establishment of a ROC is
intended to address. Accordingly, as
discussed below, the Commission is
proposing certain requirements related
to ROC procedures, meetings, and
documentation to help ensure that the
manner in which SEFs and DCMs
structure and administer their ROCs
does not give rise to conflicts of interest.
In the DCM Core Principle 15 Release,
the Commission stressed that ROCs
conduct oversight and review, and are
not intended to assume managerial
responsibilities or to perform direct
compliance work.217 Accordingly, the
Commission is not proposing to adopt
the existing component of the
Acceptable Practices for DCM Core
Principle 16 addressing the ROC’s
supervision of the DCM CRO. As further
discussed in proposed § 38.856,218
proposed § 38.856(b)(1) would require
the CRO to report to the board or senior
officer of the DCM.219 Similar to other
employees and executives at SEFs and
DCMs, the Commission expects that
CCOs and CROs, respectively, would
report up to a senior officer for
216 See DCM Core Principle 15 Release, 71 FR
38740 at 38744–45, as it relates to the DCM
acceptable practices in Appendix B to part 38.
217 See 2007 Final Release, 72 FR 6936 at 6950.
218 See Section V(f) herein.
219 The Commission is using the term ‘‘report to’’
in proposed § 38.856(b) instead of the concept of
supervision used in the DCM CP 16 Acceptable
Practices because a board of directors, as an entity,
cannot ‘‘supervise’’ a person.
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managerial and administrative matters.
The Commission believes this approach
allows the ROC to focus its resources on
its core responsibilities related to
overseeing a SEF’s or DCM’s market
regulation functions. Finally, the ROC
will be involved in matters related to
the appointment, removal and
compensation of the SEF CCO or DCM
CRO, under proposed §§ 37.1501(a)(4)
and (5) and 38.856(c) and (d),
respectively.
Based on Commission staff’s routine
oversight of SEFs and DCMs, the
Commission’s experience is that the
ROC has served a crucial role in the
management of conflicts of interest. As
a board-of-directors-level committee of
public directors, the Commission
believes the ROC is well-positioned to
manage conflicts that may impact
market regulation functions. The
conflicts of interest with which the
Commission envisions the ROC’s
involvement are not merely potential or
hypothetical. The Commission’s
oversight of SEFs and DCMs has
identified instances involving actual
conflicts of interest impacting market
regulation functions which were
adequately managed and addressed only
when the SEF or DCM had a strong
governance structure and sound
conflicts of interest policies and
procedures. Accordingly, the
Commission is including in the duties
in proposed §§ 37.1206(d) and 38.857(d)
that the ROC, a standing committee of
the board of directors, is charged with
consulting with the SEF CCO or DCM
CRO with identifying, minimizing and
resolving any actual or potential
conflicts of interest involving market
regulation functions.
Proposed §§ 37.1206(e) and 38.857(e)
require the ROC to periodically report to
the board of directors. The Commission
expects that this reporting would occur,
for example, in regularly scheduled
board of director meetings.
The Commission is also proposing
several requirements related to
procedures and documentation for ROC
meetings. The Commission believes
these requirements reflect best practices
that certain DCMs already implement.
Proposed §§ 37.1206(f) and 38.857(f)
address ROC meetings and
communications. Both SEF and DCM
ROCs would be required to meet
quarterly. These meetings may include
CROs or CCOs and will allow the ROC
to share information, discuss matters of
mutual concern, and speak freely about
potentially sensitive issues that may
relate to the SEF’s or DCM’s
management. To facilitate this open line
of communication, the proposed rules
prohibit, except for the limited
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circumstances referenced below, any
individuals with actual or potential
conflicts of interest from attending ROC
meetings.
The Commission recognizes, however,
that there may be limited circumstances
in which it would be appropriate for
individuals outside of the ROC–
including business executives or
employees whose interest may conflict
in certain respects with the ROC’s
market regulation functions—to attend
portions of ROC meetings. In particular,
if a business executive or non-marketemployee had a legitimate need 220 to
attend a portion of a ROC meeting, the
Commission’s preliminary view is that
it would not be inappropriate for the
ROC to elect to allow these individuals
to attend such portion of the meeting.
However, the Commission preliminarily
believes these individuals should not
attend any portion of the ROC meeting
outside of the discussion of their
business. These individuals should not
be present, in any capacity, during
discussions of the SEF’s or DCM’s
market regulation functions, such as
surveillance, investigation, or
enforcement work.
To account for these circumstances,
the Commission proposes in
§§ 37.1206(f)(1)(iii) and 38.857(f)(1)(iii)
that the following information must be
included in ROC meeting minutes: (a)
list of the attendees; (b) their titles; (c)
whether they were present for the
entirety of the meeting or a portion
thereof (and if so, what portion); and (d)
a summary of all meeting discussions.
Finally, proposed §§ 37.1206(f)(2) and
38.857(f)(2) would require the ROC to
maintain documentation of the
committee’s findings, recommendations,
deliberations, or other communications
related to the performance of its duties.
If SEFs and DCMs make their ROC
meeting minutes available for
distribution, including to the board of
directors or another committee, the
Commission believes any information
relating to the SEF’s or DCM’s market
regulation functions, including
surveillance, investigations, and
pending enforcement actions should be
redacted to avoid any undue influence
on these market regulation functions.
Finally, the Commission proposes to
codify for both SEFs and DCMs, and to
enhance, the existing annual report
component of the ROC duties under the
Acceptable Practices for DCM Core
Principle 16.221 These acceptable
220 For example, to present new product launches
or discuss personnel or policy changes unrelated to
market regulation functions.
221 The Commission recognizes that SEF CCOs
also prepare an annual report; however, the ROC
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practices contemplate that the ROC, as
part of its duties, will prepare an annual
report assessing the DCM’s selfregulatory program for the board of
directors and for 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. In
addition to codifying and enhancing
this as an annual report requirement, in
proposed §§ 37.1206(g)(1) and
38.857(g)(1), the Commission proposes
requiring ROC annual reports to contain
a list of any actual or potential conflicts
of interest that were reported to the
ROC, including a description of how
such conflicts of interest were managed
and resolved and an assessment of the
impact of any conflicts of interest on the
SEF’s or DCM’s ability to perform its
market regulation functions, as well as
requiring disclosure of details relating to
all actions taken by the board of
directors pursuant to recommendations
of the ROC.
The Commission also proposes in
§§ 37.1206(g)(2) and 38.857(g)(2) new
SEF and DCM rules addressing filing
requirements for the ROC annual report.
The procedural requirements would
mirror the SEF annual compliance
report requirements 222 including
specifying a filing deadline no later than
90 days after the end of the SEF’s or
DCM’s fiscal year, establishing a process
for report amendments and extension
requests, recordkeeping requirements,
and providing to the Division of Market
Oversight delegated authority to grant or
deny extensions. Finally, proposed
§§ 37.1206(g)(3) and 38.857(g)(3) would
establish a recordkeeping requirement
for the SEF or DCM to maintain all
records demonstrating compliance with
the duties of the ROC and the
preparation and submission of the
annual report.
4. Questions for Comment
The Commission requests comment
on all aspects of the proposed ROC
requirements. The Commission further
requests comment on the questions set
forth below.
annual report will provide a critically important,
independent perspective to assess the market
regulation function, including the CCO.
Additionally, the ROC annual report expressly
requires disclosures of actual or potential conflicts
of interest reported to the ROC and details of any
instances of the board of directors rejecting the
recommendations of the ROC, regardless of whether
the same information would qualify as ‘‘material
non-compliance matters,’’ subject to disclosure
pursuant to § 37.1501(d)(4).
222 See Commission regulation § 37.1501(d).
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1. Are there any additional duties that
should be included within the scope of
the ROC’s duties under proposed
§§ 37.1206 and 38.857? Are there any
additional requirements the
Commission should consider
prescribing for the ROC annual report?
2. Should business executives and
employees working outside of the SEF’s
or DCM’s market regulation functions be
permitted to attend even portions of
ROC meetings that relate to their
business? Or should ROC meetings be
strictly limited to ROC members and
employees who perform work related to
the SEF’s or DCM’s market regulation
functions?
e. Disciplinary Panel Composition—
Proposed §§ 37.1207 and 38.858
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1. Background
As part of its market regulation
function, each SEF and DCM must have
a disciplinary program to discipline,
suspend, or expel members or market
participants that violate the SEF’s or
DCM’s rules.223 Disciplinary panels
administer this program by conducting
hearings, rendering decisions, and
imposing sanctions with respect to
disciplinary matters. The Commission
believes that fair disciplinary
procedures require SEF and DCM
disciplinary panels to be: (1)
independent of outside influences, (2)
impartial, and (3) representative of a
diversity of perspectives and
experiences. Accordingly, the
Commission is proposing rules
implementing elements of the conflicts
of interest obligations under DCM Core
Principle 16 and SEF Core Principle 12
in order to promote and support these
panel attributes.
2. Existing Regulatory Framework
Currently, the DCM Core Principle 16
Acceptable Practices provide that DCMs
establish disciplinary panel
composition rules that preclude any
group or class of industry participants
from dominating or exercising
disproportionate influence on such
panels.224 Furthermore, the DCM Core
Principle 16 Acceptable Practices
provide for all disciplinary panels (and
appellate bodies) to include at least one
person who would qualify as a public
director, except in cases limited to
decorum, attire, or the timely
submission of accurate records required
for clearing or verifying each day’s
transactions.225
223 CEA section 5(d)(13); 7 U.S.C. 7(d)(13); CEA
section 5h(f)(2)(B); 7 U.S.C. 7b–3(f)(2)(B).
224 Part 38, Appendix B, Core Principle 16
Acceptable Practices (b)(4).
225 Id.
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Commission regulation § 1.64(c),
which applies to SEFs, requires each
major disciplinary committee 226 or
hearing panel to include: (1) at least one
member who is not a member of the
SEF; and (2) sufficient different
membership interests so as to ensure
fairness and to prevent special treatment
or preference for any person in the
conduct of a committee’s or the panel’s
responsibility.
3. Proposed Rules
The Commission is proposing to
adopt rules in proposed §§ 37.1207 and
38.858, respectively, that would codify,
with certain enhancements, the DCM
Core Principle 16 Acceptable Practices
with respect to disciplinary panel
composition. While the Commission
believes that both the DCM Core
Principle 16 Acceptable Practices and
Commission regulation § 1.64(c) seek to
promote fairness in the disciplinary
process by introducing a diversity of
interests to serve on disciplinary panels,
the Commission believes that the DCM
Core Principle 16 Acceptable Practices
establish more appropriate practices for
achieving fairness in today’s SEF and
DCM environments. For example,
providing for a public participant on the
disciplinary panel to be the chair
introduces an independent perspective
in a steering role that the Commission
believes will enhance the overall
fairness of the disciplinary process. The
Commission believes that if SEFs are
subject to rules that codify the DCM
Core Principle 16 Acceptable Practices
with respect to disciplinary panel
composition, it would not be necessary
for SEFs also to be subject to the
requirements of Commission regulation
§ 1.64(c). As noted above in Section
V(c)(3) herein, the Commission is also
proposing to amend Commission
regulation § 37.2 to exempt SEFs from
Commission regulation § 1.64 in its
entirety.
Proposed § 38.858(a)(1) would require
that DCMs adopt rules to preclude any
group or class of participants from
dominating or exercising
disproportionate influence on a
disciplinary panel, and proposed
§ 37.1207(a)(1) would establish an
analogous requirement for SEFs.
Accordingly, the proposed rules would
be consistent with the disciplinary
226 Commission regulation § 1.64(a)(2) defines a
‘‘Major disciplinary committee’’ as a committee of
persons who are authorized by a self-regulatory
organization to conduct disciplinary hearings, to
settle disciplinary charges, to impose disciplinary
sanctions or to hear appeals thereof in cases
involving any violation of the rules of the selfregulatory organization subject to certain
exceptions.
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19673
panel component of the DCM Core
Principle 16 Acceptable Practices. The
Commission believes the proposed rules
are reasonably necessary to promote
impartial disciplinary panels, which are
critical decision-makers in fulfilling a
SEF’s or DCM’s market regulation
functions.
The Commission is also proposing
additional requirements to enhance the
existing regulatory framework. First, the
proposal would clarify in proposed
§§ 37.1207(a) and (b) and 38.858(a) and
(b) that SEFs’ and DCMs’ disciplinary
panels and appellate panels must
consist of two or more persons. The
Commission believes a disciplinary
panel must have more than one person
in order to preclude any group or class
of participants from dominating or
exercising disproportionate influence,
as currently contemplated under the
DCM Core Principle 16 Acceptable
Practices, and proposed in these rules.
Second, proposed §§ 37.1207 and
38.858 would prohibit any member of a
disciplinary panel from participating in
deliberations or voting on any matter in
which the member has an actual or
potential conflict of interest, consistent
with the general conflicts of interest
provisions proposed in §§ 37.1202 and
38.852. Third, proposed §§ 37.1207(b)
and 38.858(b) would extend the public
participant requirement to any SEF and
DCM committee to which disciplinary
panel decisions may be appealed.
Fourth, the Commission proposes
technical amendments to Commission
regulations §§ 37.206(b) and 38.702 to
remove the references that disciplinary
panels must meet the composition
requirements of part 40,227 and replace
these references with references to the
composition requirements of proposed
regulations §§ 37.1207 and 38.858,
respectively. The Commission also
proposes changing the reference to
‘‘compliance’’ staff to ‘‘market
regulation’’ staff. This is intended for
clarity and is consistent with proposed
changes to §§ 38.155(a) and 37.203(c).
4. Questions for Comment
The Commission requests comment
on all aspects of the proposed
disciplinary panel composition
requirements. The Commission further
requests comment on the questions set
forth below.
1. Are there any situations in which
it would be appropriate for a
disciplinary panel to be comprised of
only one individual? If so, please
describe.
227 There are currently no composition
requirements in part 40 of the Commission’s
regulations.
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2. Should the Commission exempt
requiring a public participant on a
disciplinary panel in cases solely
involving decorum or attire?
f. DCM Chief Regulatory Officer—
Proposed § 38.856
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1. Background
The Commission is proposing to
codify current DCM practices regarding
the CRO position. The DCM Core
Principle 16 Acceptable Practices do not
provide that DCMs have a CRO.
However, Commission staff has found
through its oversight activities that all
DCMs either have a CRO, or an
individual performing the same
functions as a CRO. DCM CROs
generally are responsible for
administering a DCM’s market
regulation functions.
2. Existing Regulatory Framework
Although not expressly a component
of the DCM Core Principle Acceptable
Practices, the framework created under
the DCM Core Principle 16 Acceptable
Practices clearly envisioned the
establishment of a CRO position.
Specifically, supervising the ‘‘the
contract market’s chief regulatory
officer, who will report directly to the
ROC’’ is one of the ROCs enumerated
duties.228 In adopting the DCM Core
Principle 16 Acceptable Practices, the
Commission emphasized that the
relationship between the ROC and the
CRO is a key element of the insulation
and oversight provided by the ROC
structure, and that, along with the board
of directors, it 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.229
While the Commission did not
explicitly require DCMs to appoint
CROs as part of the DCM Final Rules,
the Commission noted that current
industry practice is for DCMs to
designate an individual as chief
regulatory officer, and it will be difficult
for a DCM to meet the staffing and
resource requirements of § 38.155
without a chief regulatory officer or
similar individual to supervise its
regulatory program, including any
services rendered to the DCM by a
regulatory service provider.230
228 Part 38, Appendix B, Core Principle 16
Acceptable Practices (b)(3)(ii)(D).
229 2007 Final Release, 72 FR 6936 at 6951 n.80.
230 The Commission understands that some DCMs
use a slightly different title for their CRO position.
For example, they may use the term Chief
Compliance Officer, as opposed to Chief Regulatory
Officer, but such position is the functional
equivalent to the CRO role proposed herein.
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3. Proposed Rules
Proposed § 38.856(a)(1) requires each
DCM to establish the position of CRO
and designate an individual to serve in
that capacity and to administer the
DCM’s market regulation functions. The
proposed rule further requires that (1)
the position of CRO must carry with it
the authority and resources necessary to
fulfill the duties set forth for CROs; and
(2) the CRO must have supervisory
authority over all staff performing the
DCM’s market regulation functions. The
Commission believes that the abovedescribed requirements of the proposed
rule would ensure that a CRO has
authority over any staff and resources
while they are acting in furtherance of
the DCM’s market regulation functions.
Of course, any such employees are
subject to the DCM’s conflicts of interest
policies and procedures that DCMs must
establish and enforce pursuant to DCM
Core Principle 16 and corresponding
proposed regulations §§ 38.851 and
38.852.
Proposed § 38.856(a)(2) requires that
the individual designated to serve as
CRO must have the background and
skills appropriate for fulfilling the
duties of the position. The Commission
notes that a DCM should identify the
needs of its particular market regulation
functions, and ensure that the CRO has
the requisite surveillance and
investigatory experience necessary to
perform the CRO’s role. In addition,
proposed § 38.856(a)(2) would provide
that no individual disqualified from
registration pursuant to sections 8a(2) or
8a(3) of the CEA may serve as a CRO.
Proposed § 38.856(b) sets forth
reporting line requirements for the CRO,
providing that the CRO must report
directly to the DCM’s board of directors
or to a senior officer. This is a change
from the existing supervisory structure
contemplated under the DCM Core
Principle 16 Acceptable Practices,
which provide for the ROC to supervise
the CRO.231 Commission staff has
found, through its RERs and general
DCM oversight activities, that most
CROs, like other exchange executives,
report to a senior officer for purposes of
performance evaluations and approval
of administrative requests. The ROC
may not be the appropriate body for a
CRO to report to, as the ROC might meet
only on a quarterly basis. The DCM’s
senior officer represents the highest
level of authority at the exchange, other
231 Part 38, Appendix B, Core Principle 16
Acceptable Practices (b)(3)(ii)(D). Additionally, the
Commission is using the term ‘‘report to’’ in
proposed § 38.856(b) instead of the concept of
supervision used in the DCM CP 16 Acceptable
Practices because a board of directors, as an entity,
cannot ‘‘supervise’’ a person.
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than the board of directors or its
committees. Consequently, the
Commission believes that it would be
appropriate for the CRO to report to the
senior officer.
However, proposed § 38.856(b) should
be interpreted in conjunction with
proposed § 38.856(f), discussed below,
which specifies, among other things,
that a CRO must disclose actual or
potential conflicts of interest to the
ROC, and that a qualified person
temporarily serve in place of the CRO
for any matter in respect of which the
CRO has such a conflict. A DCM’s ROC
would therefore be involved in
minimizing any actual or potential
conflicts of interest of the CRO, which
would include conflicts of interest
between the duties of the CRO and the
DCM’s commercial interests. As the
Commission previously stated, the
CRO–ROC relationship 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.232 The DCM is responsible for
establishing the reporting lines for the
CRO to ensure that conflicts of interest
are routed to the appropriate decisionmakers.
Finally, the Commission notes
generally that a CRO reporting structure
in which the CRO has a direct line to
the board of directors or the senior
officer allows the CRO to more easily
gain approval for any new policies
related to the DCM’s market regulation
functions that the CRO needed to
implement, to the extent that they
required approval of a senior officer or
the board of directors. Since DCM rule
changes often need to be approved by
the board of directors, having the CRO
report to the board of directors or to the
senior officer (who likely regularly
communicates with the board) would
allow the CRO to more easily explain
the need for rule changes, and to answer
questions from the board of directors or
the senior officer about such changes.
Proposed § 38.856(c) provides the
following CRO appointment and
removal procedures: (1) the
appointment or removal of a DCM’s
CRO must occur only with the approval
of the DCM’s ROC; (2) the DCM must
notify the Commission within two
business days of the appointment of any
new CRO, whether interim or
permanent; and (3) the DCM must notify
the Commission within two business
days of removal of the CRO. These
procedures help ensure that the CRO is
232 2007
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properly insulated from undue
influence, including commercial
interests. For example, the requirement
of ROC approval means that a senior
officer of the DCM may not take
unilateral action to replace the CRO if
there is any dispute over the CRO’s
decisions or role in any market
regulation function. In addition, the
procedures requiring notification to the
Commission ensure appropriate staff
within the Commission are aware of
who is fulfilling this key role and can
initiate communications with the CRO
as necessary. Moreover, the Commission
will be aware if there is any lag in the
appointment of a replacement CRO, and
can take appropriate oversight action in
such a scenario, as well.
Proposed § 38.856(d) provides that the
board of directors or the senior officer
of the DCM, in consultation with the
DCM’s ROC, must approve the
compensation of the CRO. Involving the
ROC in approving the compensation of
the CRO further ensures that the CRO’s
role is insulated from improper
influence or direction from the DCM’s
commercial interests. The Commission
notes that while some portion of
compensation may be in the form of
equity, DCMs should avoid tying a
CRO’s salary to business performance in
order to avoid potential conflicts of
interest. The Commission believes the
ROC is well-situated to determine
whether specific compensation
structures could raise potential conflicts
of interest.
Proposed § 38.856(e) details the duties
of the CRO, which include: (1)
supervising the DCM’s market
regulation functions; (2) establishing
and administering policies and
procedures related to the DCM’s market
regulation functions; (3) supervising the
effectiveness and sufficiency of any
regulatory services provided to the DCM
by a regulatory service provider in
accordance with § 38.154; (4) reviewing
any proposed rule or programmatic
changes that may have a significant
regulatory impact on the DCM’s market
regulation functions, and advising the
ROC on such matters; and (5) in
consultation with the DCM’s ROC,
identifying, minimizing, managing, and
resolving conflicts of interest involving
the DCM’s market regulation functions.
The Commission views a CRO’s role
as being narrower than that of a CCO.
As contemplated in these proposed
rules, both CCOs and CROs would be
required to have supervisory authority
over certain staff,233 and supervise the
233 Proposed § 37.1501(a)(1)(ii) requires the SEF
CCO to have supervisory authority over all staff
acting at the CCO’s direction. Proposed
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quality of regulatory services received,
as applicable.234 CCOs have additional
responsibilities deriving from the
statutory chief compliance officer core
principle for SEFs, for which there is no
DCM analogue. For example, CCOs are
responsible for overall compliance of
the SEF with section 5h of the CEA and
related Commission rules,235 for
establishing and administering written
policies to prevent violation of the CEA
and Commission rules,236 and for
establishing procedures to address
noncompliance issues identified
through any means, such as look-back,
internal or external audit findings, selfreported errors, or validated
complaints.237 The Commission
understands that in some instances,
CROs may take on these additional
responsibilities, such as supervising the
DCM’s financial surveillance program
under Core Principle 11 and associated
Commission regulations.
Finally, and as discussed above,
proposed § 38.856(f) provides that each
DCM must establish procedures for the
CRO’s disclosure of actual or potential
conflicts of interest to the ROC and
designation of a qualified person to
serve in the place of the CRO for any
matter in respect of which the CRO has
such a conflict, and documentation of
such disclosure and designation.
4. Questions for Comment
The Commission requests comment
on all aspects of the proposed CRO
regulatory requirements. The
Commission further requests comment
on the questions set forth below.
1. Is the Commission correct that all
DCMs have CROs or an individual
performing CRO functions?
2. Are there any additional duties that
should be included under proposed
§ 38.856(e)? Are there any that should
be removed?
g. Staffing and Investigations—Proposed
Changes to §§ 38.155, 38.158, and
37.203
1. Background
The Commission is proposing
amendments to existing SEF and DCM
rules relating to staffing and
§ 38.856(a)(1)(iii) requires the DCM CRO to have
supervisory authority over all staff performing the
DCM’s market regulation functions. Similarly,
proposed § 38.856(e)(1) specifies that the DCM CRO
must supervise the DCM’s market regulation
functions.
234 Proposed §§ 37.1501(b)(8) and 38.856(e)(3).
235 CEA section 5h(f)(15)(B)(v); 7 U.S.C. 7b–
3(f)(15)(B)(v).
236 CEA section 5h(f)(15)(B)(iv); 7 U.S.C. 7b–
3(f)(15)(B)(iv).
237 CEA section 5h(f)(15)(B)(vi); 7 U.S.C. 7b–
3(f)(15)(B)(vi).
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19675
investigations. As discussed below,
Commission staff has found there is a
lack of clarity that has led to
inconsistent approaches with respect to
compliance with SEF and DCM market
regulation staff and resource
requirements. The Commission
proposes enhancing SEF staffing
requirements to require annual
monitoring of staff size and workload to
ensure SEFs have sufficient staff and
resources dedicated to performing
market regulation functions.238 This
would align SEF staffing obligations
with existing DCM staffing obligations.
Finally, for the purpose of clarity, staff
is proposing certain non-substantive
amendments.
2. Existing Regulatory Framework
Commission regulation § 38.155(a)
provides that each DCM must establish
and maintain sufficient compliance
department resources and staff to ensure
that it can conduct effective audit trail
reviews, trade practice surveillance,
market surveillance, and real-time
market monitoring. A DCM’s
compliance staff also must be sufficient
to address unusual market or trading
events as they arise, and to conduct and
complete investigations in a timely
manner. Commission regulation
§ 38.155(b) provides that a DCM must
monitor the size and workload of its
compliance staff annually, and ensure
that its compliance resources and staff
are at appropriate levels. In determining
the appropriate level of compliance
resources and staff, the DCM should
consider trading volume increases, the
number of new products or contracts to
be listed for trading, any new
responsibilities to be assigned to
compliance staff, the results of any
internal review demonstrating that work
is not completed in an effective or
timely manner, and any other factors
suggesting the need for increased
resources and staff.
Existing Commission regulation
§ 37.203(c), similar to existing
Commission regulation § 38.155(a),
provides that a SEF must have sufficient
compliance staff and resources to ensure
it can conduct effective audit trail
reviews, trade practice surveillance,
market surveillance, and real-time
market monitoring. However, part 37 of
the Commission’s regulations does not
include for SEFs a regulation parallel to
Commission regulation § 38.155(b)’s
requirement for DCMs to annually
238 As discussed below, the Commission also is
proposing a technical amendment to existing
§ 38.155(a) to replace the list of duties a DCM must
have sufficient staff to perform with the term
‘‘market regulation functions.’’
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monitor the sufficiency of staff and
resources.
Existing regulations §§ 38.158 and
37.203(f) relate to SEF and DCM
obligations, respectively, regarding
investigations and investigation reports.
These provisions generally address
investigation timeliness, substance of
investigation reports, and how
frequently warning letters may be
issued.
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3. Proposed Rules
The Commission is proposing
amendments to existing §§ 38.155(a)
and 37.203(c). First, the Commission
proposes to replace references to
‘‘compliance staff’’ with ‘‘staff.’’ Second,
proposed §§ 38.155(a) and 37.203(c)
would amend the first sentence of the
existing regulations to provide that SEFs
and DCMs must establish and maintain
sufficient staff and resources to
‘‘effectively perform market regulation
functions’’ rather than listing the
individual functions.239 The
Commission does not view these as
substantive changes. References to staff
rather than compliance staff are
intended for clarity. Compliance staff
could be viewed as a broad term that
encompasses individuals who have
obligations for compliance with all of
the CEA and Commission regulations.
To avoid confusion and a lack of clarity
about which staff might fall within the
scope of this broad term, the
Commission proposes simply to replace
references to ‘‘compliance staff’’ with
‘‘staff.’’ As noted, Commission
regulations §§ 38.155(a) and 37.203(c)
solely are focused on staff dedicated to
performing market regulation functions.
The Commission also proposes to
amend § 37.203 to add a new paragraph
(d). The proposed provision would
require SEFs to annually monitor the
size and workload of its staff, and
ensure its resources and staff effectively
perform market regulation functions at
appropriate levels. In determining the
appropriate level of resources and staff,
the proposed rule lists factors SEFs
should consider. These factors include
trading volume increases, the number of
new products or contracts to be listed
for trading, any new responsibilities to
be assigned to staff, any responsibilities
that staff have at affiliated entities, the
results of any internal review
demonstrating that work is not
completed in an effective or timely
manner, any conflicts of interest that
prevent staff from working on certain
239 See Sections I and II(d)(1) herein for a
description of the definition of ‘‘market regulation
functions’’ in proposed §§ 38.851(b)(9) and
37.1201(b)(9).
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matters and any other factors suggesting
the need for increased resources and
staff. In addition, paragraph (d) would
include a reference to paragraph (c) to
clarify that it applies to staff responsible
for conducting market regulation
functions.
Proposed § 37.203(d) is virtually
identical to existing § 38.155(b) for
DCMs. Given that SEFs and DCMs have
the same obligation to perform market
regulation functions, the Commission
believes it is equally important for SEFs
to annually review their staffing and
resources to ensure they are appropriate
and sufficient to adequately perform
market regulation functions.
Accordingly, consistent with the
language in proposed § 37.203(d), the
Commission is proposing to add to the
list of factors that a DCM should
consider in determining the appropriate
level of resources and staff: (1) any
responsibilities that staff have at
affiliated entities; and (2) any conflicts
of interest that prevent staff from
working on certain matters. The
Commission believes that the addition
of these factors is necessary to account
for potential constraints on resources
and staff.
Additionally, the Commission
proposes the following non-substantive
changes to existing Commission
regulation §§ 38.155 and 38.158.
Proposed § 38.155 would rename the
regulation ‘‘Sufficient staff and
resources.’’ Proposed § 38.155(b) would
add an internal reference to paragraph
(a). This change is intended to clarify
that the annual staff and resource
monitoring requirement pertains to staff
performing market regulation functions
required under § 38.155(a). Proposed
§ 38.158(a) would replace the reference
to ‘‘compliance staff’’ with ‘‘staff
responsible for conducting market
regulation functions.’’ Proposed
§ 38.158(b) would delete the reference to
‘‘compliance staff investigation’’ being
required to be completed in a timely
manner, and instead provide, more
simply, that ‘‘[e]ach investigation must
be completed in a timely manner.’’
Finally, proposed §§ 38.158(c) and (d)
would delete the modifier ‘‘compliance’’
when referencing to staff.
Finally, the Commission proposes the
following non-substantive changes to
existing Commission regulation
§ 37.203. Proposed § 37.203(c) would
rename the paragraph ‘‘Sufficient staff
and resources.’’ The addition of
proposed § 37.203(d) would result in
renumbering the remaining provisions
of § 37.203. Proposed § 37.203(g)(1),
which would replace existing
Commission regulation § 37.203(f)(1),
adds a reference to ‘‘market regulation
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functions,’’ consistent with the new
proposed defined term. Similarly, to
avoid lack of clarity, the Commission
proposes to delete the modifier
‘‘compliance’’ when referencing staff in
existing § 37.203(f)(2)–(4).
4. Questions for Comment
The Commission requests comment
on all aspects of the proposed changes
to §§ 38.155, 38.158 and 37.203.
h. SEF Chief Compliance Officer—
Proposed Changes to § 37.1501
1. Background
The Commission is proposing
amendments to § 37.1501 for several
reasons. First, the Commission proposes
certain amendments to the existing SEF
CCO requirements to ensure that, to the
extent applicable, these requirements
are consistent with the proposed DCM
CRO requirements. Second, the
Commission is proposing additional
SEF CCO requirements to harmonize the
language with other aspects of this rule
proposal, namely proposed amendments
that pertain to the board of directors and
conflicts of interest procedures. Third,
the Commission is proposing
amendments that will more closely
align § 37.1501 with the language of SEF
Core Principle 15, which is codified in
§ 37.1500.240
2. Existing Regulatory Framework
The statutory framework for SEFs
requires each SEF to designate an
individual to serve as a CCO.241 The
CCO must report to the SEF’s board of
directors or senior officer,242 and is
responsible for certain enumerated
duties, including compliance with the
CEA and Commission regulations and
resolving conflicts of interest.243 The
CCO is also responsible for designing
the procedures to establish the
handling, management response,
remediation, retesting, and closing of
240 See
Commission regulation § 37.1500(b)(1).
section 5h(f)(15)(A); 7 U.S.C. 7b–
3(f)(15)(A).
242 CEA section 5h(f)(15)(B)(i); 7 U.S.C. 7b–
3(f)(15)(B)(i).
243 CEA section 5h(f)(15)(B) (ii)–(vi); 7 U.S.C. 7b–
3(f)(15)(B)(ii)–(vi) establishes the following CCO
duties: (1) reviewing compliance with the core
principles; (2) in consultation with the board, a
body performing a function similar to that of a
board, or the senior officer of the SEF, resolving any
conflicts of interest that may arise; (3) being
responsible for establishing and administering the
policies and procedures required to be established
pursuant to this section; (4) ensuring compliance
with the CEA and the rules and regulations issued
under the CEA, including rules prescribed by the
Commission pursuant to section 5h of the CEA; and
(5) establishing procedures for the remediation of
noncompliance issues found during compliance
office reviews, look backs, internal or external audit
findings, self-reported errors, or through validated
complaints.
241 CEA
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noncompliance issues.244 Finally, the
CCO is required to prepare an annual
report describing the SEF’s compliance
with the CEA and the policies and
procedures of the SEF.245 These
statutory requirements also are codified
in Commission regulation § 37.1500.
Commission regulation § 37.1501
further implements the statutory CCO
requirements. First, Commission
regulation § 37.1501(a) establishes
definitions for the terms ‘‘board of
directors’’ and ‘‘senior officer.’’ Second,
Commission regulation § 37.1501(b)(1)
addresses the authority of the CCO,
stating that the position shall: (1) carry
with it the authority and resources to
fulfill the CCO’s duties; and (2) have
supervisory authority over all staff
acting at the discretion of the CCO.
Third, Commission regulation
§ 37.1501(b)(2) establishes qualifications
for the CCO, including a requirement
that the CCO must: (1) have the
appropriate background and skills; and
(2) must not be disqualified from
registration under CEA 8a(2) or 8a(3).
Fourth, Commission regulation
§ 37.1501(b)(3) outlines the appointment
and removal procedures for the CCO,
which state that: (1) only the SEF’s
board of directors or senior officer may
appoint or remove the CCO; and (2) the
SEF shall notify the Commission within
two business days of a CCO’s
appointment or removal. Fifth,
Commission regulation § 37.1501(b)(4)
requires the SEF’s board of directors or
senior officer to approve the CCO’s
compensation. Sixth, Commission
regulation § 37.1501(b)(5) requires the
CCO to meet with the SEF’s board of
directors or senior officer at least
annually. Seventh, Commission
regulation § 37.1501(b)(6) requires the
CCO to provide any information
regarding the self-regulatory program of
the SEF as requested by the board of
directors or the senior officer.
Commission regulation § 37.1501(c)
further outlines the duties of the CCO,
expanding on those already required
under SEF Core Principle 15. For
example, Commission regulation
§ 37.1501(c)(2) details that the CCO
must take reasonable steps, in
consultation with the board of directors
or the senior officer of the SEF, to
resolve any material conflicts of interest
that may arise, including, but not
limited to: (1) conflicts between
business considerations and compliance
requirements; (2) conflicts between
business considerations and the
244 CEA section 5h(f)(15)(C); 7 U.S.C. 7b–
3(f)(15)(C).
245 CEA section 5h(f)(15)(D); 7 U.S.C. 7b–
3(f)(15)(D).
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requirement that the SEF provide fair,
open, and impartial access as set forth
in § 37.202; and; (3) conflicts between a
SEF’s management and members of the
board of directors. In connection with
establishing and administering the
requisite procedures under Core
Principle 15, Commission regulation
§ 37.1501(c)(6) specifies that the CCO
must establish and administer a
compliance manual designed to
promote compliance with the applicable
laws, rules, and regulations and a
written code of ethics for the SEF
designed to prevent ethical violations
and to promote honesty and ethical
conduct by SEF personnel. Finally,
Commission regulation §§ 37.1501(c)(7)
and (c)(8) detail the requirement that the
CCO supervise the SEF’s self-regulatory
program as well as the effectiveness and
sufficiency of any regulatory service
provider, respectively.
Commission regulation § 37.1501(d)
addresses the statutory requirement
under SEF Core Principle 15 requiring
a CCO to prepare an annual compliance
report. Commission regulation
§ 37.1501(d) details that the report must
contain, at a minimum: (1) a description
and self-assessment of the effectiveness
of the written policies and procedures of
the SEF; (2) any material changes made
to compliance policies and procedures
during the coverage period for the report
and any areas of improvement or
recommended changes to the
compliance program; (3) a description of
the financial, managerial, and
operational resources set aside for
compliance with the CEA and
applicable Commission regulations; (4)
any material non-compliance matters
identified and an explanation of the
corresponding action taken to resolve
such non-compliance matters; and (5) a
certification by the CCO that, to the best
of his or her knowledge and reasonable
belief, and under penalty of law, the
annual compliance report is accurate
and complete in all material respects.246
Commission regulation § 37.1501(e)
addresses the submission of the annual
compliance report, stating that: (1) the
CCO must provide the annual
compliance report for review to the
board of directors or senior officer, who
shall not require the CCO to make any
changes to the report; (2) the annual
compliance report must be submitted
electronically to the Commission no
later than 90 calendar days after the end
of the SEF’s fiscal year; (3) promptly
upon discovery of any material error or
omission made in a previously filed
annual compliance report, the CCO
must file an amendment with the
246 Commission
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19677
Commission; and (4) the SEF may
request an extension of time to file its
annual compliance report from the
Commission. Commission regulation
§ 37.1501(f) requires the SEF to
maintain all records demonstrating
compliance with the duties of the CCO
and the preparation and submission of
annual compliance reports consistent
with Commission regulations §§ 37.1000
and 37.1001.
Finally, Commission regulation
§ 37.1501(g) delegates to the Director of
the Division of Market Oversight the
authority to grant or deny a request for
an extension of time for a SEF to file its
annual compliance report under
Commission regulation § 37.1501(e).
3. Proposed Rules
The Commission is proposing to move
the terms ‘‘board of directors’’ and
‘‘senior officer’’ from existing regulation
§ 37.1501(a) to proposed § 37.1201(b).
The meaning of each term would remain
unchanged, with one exception.
Specifically, the Commission seeks to
clarify the existing definition of ‘‘board
of directors’’ by including the
introductory language ‘‘a group of
people’’ serving as the governing body
of the SEF. The Commission notes that
deleting the definitions from
Commission regulation § 37.1501(a) will
result in renumbering the remaining
provisions of Commission regulation
§ 37.1501.
The Commission is not proposing any
changes to existing Commission
regulation § 37.1501(b)(1) or (b)(2).247
However, the Commission is proposing
a new § 37.1501(a)(3) that would require
the CCO to report directly to the board
or to the senior officer of the SEF. This
would be a new provision in § 37.1501,
but it is consistent with the language of
SEF Core Principle 15, which is codified
in § 37.1500.248 Additionally, the
language is consistent with the
proposed supervisory requirements for a
DCM CRO set forth in proposed
§ 38.856(b)(1).
Proposed § 37.1501(a)(4)(i) would
amend the language in existing
Commission regulation
§ 37.1501(b)(3)(i) to provide that the
board of directors or senior officer may
appoint or remove the CCO with the
approval of the SEF’s regulatory
oversight committee. This addition is
intended to help insulate the position of
CCO from improper or undue influence.
Proposed § 37.1501(a)(4)(ii) would
retain the two-business day notification
247 These provisions would be renumbered under
the proposal as Commission regulation
§ 37.1501(a)(1) and (a)(2), respectively.
248 See Commission regulation § 37.1500(b)(1).
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requirement to the Commission of the
removal of a CCO under Commission
regulation § 37.1501(b)(3)(ii).
Proposed § 37.1501(a)(5) would
amend the existing requirement in
Commission regulation § 37.1501(b)(4)
that the board of directors or the senior
officer of the SEF shall approve the
compensation of the CCO, to now
require this approval to occur in
consultation with the SEF’s ROC. The
Commission believes this proposed
requirement would help ensure that the
CCO position will remain free of
improper influence.
The duties of the CCO under
proposed § 37.1501(b) are substantively
similar to existing Commission
regulation § 37.1501(c), with two
exceptions. First, proposed
§ 37.1501(b)(2) provides that the CCO
must take reasonable steps in
consultation with the SEF’s board of
directors ‘‘or a committee thereof’’ to
manage and resolve material conflicts of
interest. Regarding the CCO’s duties to
‘‘manage and resolve’’ material conflicts
of interest, the Commission notes there
are multiple ways a conflict of interest
could be managed and resolved. One
example would be simply replacing a
conflicted individual with an
independent and qualified back-up.
Another method to manage and resolve
a conflict would be not to pursue a
business priority where there is no other
way in which to resolve the conflict.
The added reference to ‘‘committee’’
accounts for the ROC’s role in resolving
conflicts of interest, which is provided
in proposed § 37.1206(d)(4).
Second, proposed § 37.1501(b)(2)(i)
specifies that conflicts of interest
between business considerations and
compliance requirements includes, with
respect to compliance requirements, the
SEF’s ‘‘market regulation functions.’’ 249
The Commission believes that this
proposed added language will help to
clarify for SEFs and CCOs the obligation
of CCOs to resolve conflicts of interest
that relate to SEF Core Principle 2, SEF
Core Principle 4, SEF Core Principle 6,
Core Principle 10 and the applicable
Commission regulations thereunder.
Existing Commission regulation
§ 37.1501(c)(7) provides that the CCO
must supervise the SEF’s ‘‘selfregulatory program,’’ which includes
trade practice surveillance; market
surveillance; real time market
monitoring; compliance with audit trail
requirements; enforcement and
disciplinary proceedings; audits,
249 Proposed § 37.1501(b)(2)(ii) includes a
technical edit to add the words ‘‘implementation
of’’ prior to the clause ‘‘of the requirement that the
swap execution facility provide fair, open, and
impartial access as set forth in § 37.202.’’
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examinations, and other regulatory
responsibilities (including taking
reasonable steps to ensure compliance
with, if applicable, financial integrity,
financial reporting, sales practice,
recordkeeping, and other requirements).
Proposed § 37.1501(b)(7) would amend
this provision to state that the CCO is
responsible for supervising the SEF’s
self-regulatory program, including the
market regulation functions set forth in
§ 37.1201(b)(9). Proposed § 37.1201(b)(9)
defines ‘‘market regulation functions’’ to
mean SEF functions required by SEF
Core Principle 2, SEF Core Principle 4,
SEF Core Principle 6, SEF Core
Principle 10 and the applicable
Commission regulations thereunder.
The Commission is proposing this
amendment for clarity and ease of
reference.250 The Commission views the
proposed change as being consistent
with the CCO’s duties as described in
existing Commission regulation
§ 37.1501(c)(7).251
Proposed § 37.1501(c) is an entirely
new regulation that addresses conflicts
of interest involving the CCO. The
proposed rule requires the SEF to
establish procedures for the disclosure
of actual or potential conflicts of interest
to the ROC. In addition, the SEF must
designate a qualified person to serve in
the place of the CCO for any matter for
which the CCO has such a conflict, and
maintain documentation of such
disclosure and designation. As noted
above, proposed § 37.1206(d)(4) requires
the ROC to consult with the CCO in
managing and resolving any actual or
potential conflicts of interest involving
the SEF’s market regulation functions.
The CCO’s disclosure of actual or
potential conflicts of interest to the ROC
will facilitate the ROC’s assistance in
managing and resolving conflicts of
interest involving the SEF’s market
regulation functions. The requirement
that the SEF have procedures to
designate a qualified person to serve in
the place of the CCO for any matter in
which the CCO is conflicted will help
ensure there is a person with sufficient
independence, expertise and authority
to address such matters. The
Commission believes that a qualified
substitute for the CCO must, at a
minimum, meet the qualification
provisions set forth in existing
Commission regulation § 37.1501(b)(2),
but that a qualified substitute also
should be free from conflicts of interest
relating to the matter under
consideration.
Proposed § 37.1501(d)(5) amends the
existing annual compliance report
requirement under Commission
regulation § 37.1501(d) to require the
annual report to include any actual or
potential conflicts of interests that were
identified to the CCO during the
coverage period for the report, including
a description of how such conflicts of
interest were managed or resolved, and
an assessment of the impact of any
conflicts of interest on the swap
execution facility’s ability to perform its
market regulation functions. The
Commission proposes this requirement
to help ensure it has sufficient notice of
conflicts of interest, how they were
resolved and whether they were
resolved effectively.
250 The CCO’s market regulation function duties
are referenced in various contexts throughout the
proposed rules including proposed §§ 37.1201,
37.1206(a), (d) and (f)).
251 For avoidance of doubt, the term ‘‘selfregulatory program,’’ as used in proposed
§ 37.1501(b)(7), continues to include the full scope
of areas described in existing Commission
regulation § 37.1501(c)(7): trade practice
surveillance, market surveillance, real time market
monitoring, compliance with audit trail
requirements, enforcement and disciplinary
proceedings, audits, examinations, and other
regulatory responsibilities (including financial
integrity, financial reporting, sales practice,
recordkeeping, and other requirements).
VI. Conforming Changes
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4. Questions for Comment
The Commission requests comment
on all aspects of the proposed changes
to the SEF CCO regulatory requirements.
The Commission further requests
comment on the question set forth
below.
1. Has the Commission struck the
appropriate balance between the
responsibilities of the CCO and the ROC
with respect to identifying, managing
and resolving conflicts of interest? Are
there ways in which this balance should
be modified?
2. Proposed § 37.1501(a)(5) provides
that the board of directors or the senior
officer of the SEF, in consultation with
the ROC, shall approve the
compensation of the CCO. Proposed
§ 38.856(d) provides the same
requirement for the DCM’s CRO. Should
the Commission expand on this
requirement, to also prohibit CCO and
CRO compensation from being directly
dependent on the SEF’s or DCM’s
business performance?
a. Commission Regulations §§ 37.2,
38.2, and Part 1
The Commission proposes adopting
certain existing requirements from part
1, in particular those from Commission
regulations §§ 1.59, 1.63, 1.64 and 1.69,
into new regulations for SEFs and DCMs
in parts 37 and 38, respectively.
Accordingly, and as discussed in more
detail above, the Commission is
proposing to amend Commission
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regulations §§ 37.2 and 38.2 to clarify
the specific part 1 regulations that will
no longer be applicable to SEFs and
DCMs. Commission regulations §§ 1.59,
1.63, 1.64 and 1.69 would then apply
only to registered futures associations.
As part of the proposed amendments to
38.2 in this release, the Commission is
proposing a ministerial amendment to
eliminate from 38.2 any references to
sections that are either ‘‘reserved’’ or
have been removed.252 Specifically, the
Commission is proposing a ministerial
amendment by eliminating references to
(i) sections 1.44, 1.53, and 1.62, all of
which have been reserved by the
Commission, and (ii) part 8, which has
been removed and reserved. Finally,
consistent with the exemption language
now included in proposed regulation
§ 37.2, the Commission is renaming this
‘‘Exempt Provision.’’
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b. Transfer of Equity Interest—
Commission Regulations §§ 37.5(c) and
38.5(c)
1. Background
The Commission proposes to amend
regulations §§ 37.5(c) and 38.5(c) to: (1)
ensure the Commission receives timely
and sufficient information in the event
of certain changes in the ownership or
corporate or organizational structure of
a SEF or DCM; (2) clarify what
information is required to be provided
and the relevant deadlines; and (3)
conform to similar existing and
proposed requirements applicable to
DCOs. SEFs and DCMs can enter into
transactions that result in a change in
ownership or corporate or
organizational structure. In those
situations, Commission staff conducts
due diligence to determine whether the
change will impact adversely the
operations of the SEF or DCM or its
ability to comply with the CEA and
Commission regulations. Similarly,
Commission staff also considers
whether any term or condition
contained in a transaction agreement is
inconsistent with the self-regulatory
responsibilities of the SEF or DCM or
with the CEA or Commission
regulations. Commission staff’s ability
to undertake a timely and effective due
diligence review of the impact, if any,
of such transactions is essential.
While SEFs and DCMs are registered
entities subject to Commission
oversight, many of these entities are part
of larger corporate families. SEF and
DCM affiliates, including parent entities
that own or control the SEF or DCM, are
not necessarily registered with the
252 Final Rule that deleted part 8—Final Rule,
Adaptation of Regulations to Incorporate Swaps, 77
FR 66288 (November 2, 2012).
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Commission or otherwise subject to
Commission regulations. Understanding
how these larger corporate families are
structured and how they operate may be
critical to Commission staff
understanding how a change in
ownership or corporate or
organizational structure could impact a
SEF’s or DCM’s ability to comply with
the CEA and Commission regulations.
For example, how finances and
resources are connected or shared
between a parent, affiliates, and the SEF
or DCM are critical facts that can impact
the SEF’s or DCM’s core principle
compliance. Similarly, how much
control the parent company or an
affiliate can legally exert over a SEF or
DCM may impact the exchange’s
compliance culture, including
governance policies.
Additionally, budgetary concerns
might cause reductions in compliance
staff, or a change in surveillance
vendors. Changes in affiliate framework
might also necessitate enhanced
conflicts of interest procedures. In light
of the corporate changes that can occur
with respect to SEFs and DCMs, and the
considerable impact such changes may
have on the SEF’s or DCM’s business,
products, rules, and overall compliance
with the CEA and Commission
regulations, the Commission is
proposing rules that will clarify and
enhance the Commission’s authority to
request information and documents in
the event of certain changes in a SEF’s
or DCM’s ownership or corporate or
organizational structure.
2. Existing Regulatory Framework
Commission regulations §§ 37.5(c)(1)
and 38.5(c)(1) require SEFs and DCMs,
respectively, to notify the Commission
in the event of an equity interest
transfer. However, the notification
requirement differs in two respects.
First, the threshold that obligates a DCM
to notify the Commission is when the
DCM enters into a transaction involving
the transfer of 10 percent or more of the
equity interest in the DCM. In
comparison, a SEF is required to notify
the Commission when it enters into a
transaction involving the transfer of 50
percent or more of the equity interest in
the SEF. Second, Commission
regulation § 37.5(c)(1) provides that the
Commission may, ‘‘upon receiving such
notification, request supporting
documentation of the transaction.’’
Commission regulation § 38.5(c)(1) does
not contain a similar explicit authority
for the Commission to request such
documentation for DCMs.
Commission regulations §§ 37.5(c)(2)
and 38.5(c)(2) set forth the timing of the
equity interest transfer notification to
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19679
the Commission. These regulations are
substantively similar and require
notification at the earliest possible time,
but in no event later than the open of
business 10 business days following the
date upon which the SEF or DCM enters
into a firm obligation to transfer the
equity interest.
Commission regulations §§ 37.5(c)(3)
and 38.5(c)(3) govern rule filing
obligations that may be prompted by the
equity interest transfer. Specifically, if
any aspect of the transfer necessitates
the filing of a rule as defined part 40 of
the Commission’s regulations, then the
SEF or DCM is required to comply with
the rule filing requirements and
procedures under section 5c(c) of the
CEA and applicable Commission
regulations.
Commission regulation § 37.5(c)(4)
provides a certification requirement
where a SEF is required to notify the
Commission no later than two days after
the equity transfer takes place that the
SEF meets all of the requirements of
section 5h of the CEA and the
Commission regulations adopted
thereunder. DCMs do not have an
analogous certification requirement.
Finally, Commission regulations
§§ 37.5(d) and 38.5(d) make certain
delegations of authority to the Director
of the Division of Market Oversight.
Commission regulation § 37.5(d)
provides that the Commission delegates
the authority ‘‘set forth in this section’’
to the Director of the Division of Market
Oversight. Therefore, the delegation of
authority applies to information
requests related to the business of the
SEF in regulation § 37.5(a),
demonstrations of compliance with the
core principles and Commission
regulations in § 37.5(b), and equity
interest transfers in § 37.5(c). In
contrast, the delegation of authority
under Commission regulation § 38.5(d)
provides that the Commission delegates
the authority ‘‘set forth in paragraph (b)
of this section’’ to the Director of the
Division of Market Oversight. The scope
of the delegation of authority provisions
under § 38.5(d) is therefore limited to
DCM demonstrations of compliance
with the core principles and
Commission regulations in § 38.5(b) and
does not extend to requests for
information related to the business of
the DCM in § 38.5(a) and equity interest
transfers in § 38.5(c).
3. Proposed Rules
The Commission proposes to amend
regulation § 37.5(c)(1) to require SEFs to
file with the Commission notification of
transactions involving the transfer of at
least 10 percent of the equity interest in
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the SEF.253 The proposed change to
revise the reporting threshold from 50
percent to 10 percent would conform
the SEF requirement with existing
regulation § 38.5(c)(1) for DCMs and
Commission regulation § 39.19(c)(4)(ix)
for DCOs. As the Commission
previously stated for DCMs, a 10 percent
threshold is appropriate because a
change in ownership of such magnitude
may have an impact on the operations
of the DCM.254 The Commission
believes the same is true for SEFs. The
Commission also believes that such
impact may be present even if the
transfer of equity interest does not result
in a change in control. For example, if
one entity holds a 10 percent equity
share in a SEF it may have a more
significant voice in the operation and/or
decision-making of the SEF than five
entities each with a minority two
percent equity interest.
Given the potential impact that a
change in ownership could have on the
operations of a DCM, the Commission
believes it is appropriate to require a
DCM to certify after such change that it
will continue to comply with all
obligations under the CEA and
Commission regulations. The
Commission believes that conforming
§ 38.5(c) to the SEF certification
requirement will better allow the
Commission to fulfill its oversight
obligations, without undue burdens on
DCMs.
The Commission also is proposing to
amend regulations §§ 37.5(c)(1) and
38.5(c)(1) to expand the types of
changes of ownership or corporate or
organizational structure that would
trigger a notification obligation to the
Commission. The proposed
amendments would require SEFs and
DCMs to report any anticipated change
in the ownership or corporate or
organizational structure of the SEF or
DCM, or its respective parent(s) that
would: (1) result in at least a 10 percent
change of ownership of the SEF or DCM,
or a change to the entity or person
holding a controlling interest in the SEF
or DCM, whether through an increase in
direct ownership or voting interest in
the SEF or DCM, or in a direct or
indirect corporate parent entity of the
SEF or DCM; (2) create a new subsidiary
or eliminate a current subsidiary of the
SEF or DCM; or (3) result in the transfer
253 In 2011, the Commission proposed a 10
percent equity interest transfer threshold for SEFs.
Core Principles and Other Requirements for Swap
Execution Facilities, 76 FR 1214 (Jan. 7, 2011). The
final rule increased the threshold to 50 percent. Part
37 Final Rule, 78 FR 33476 (June 4, 2013).
254 Core Principles and Other Requirements for
Designated Contract Markets; Proposed Rule, 75 FR
80572 at 80576 n.32 (Dec. 22, 2010).
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of all or substantially all of the assets of
the SEF or DCM to another legal entity.
The proposed language generally tracks
the current requirement for DCOs in
Commission regulation
§ 39.19(c)(4)(ix)(A), as amended by the
Commission’s Final Rule on Reporting
and Information Requirements for
Derivatives Clearing Organizations.255
This final rule amended Commission
regulation § 39.19(c)(4)(ix)(A)(1) to
require a DCO to notify the Commission
of changes that result in at least a 10
percent change of ownership of the
derivatives clearing organization or a
change to the entity or person holding
a controlling interest in the derivatives
clearing organization, whether through
an increase in direct ownership or
voting interest in the derivatives
clearing organization or in a direct or
indirect corporate parent entity of the
derivatives clearing organization.256
In proposing this amendment, the
Commission explained that it was
proposing to amend the provision to
require a DCO to report any change to
the entity or person that holds a
controlling interest, either directly or
indirectly, in the DCO. The Commission
noted that, because the current rule was
tied to changes in ownership of the DCO
by percentage share of ownership, DCOs
are not currently required to report all
instances in which there is a change in
control of the DCO. It is possible that a
change in ownership of less than 10
percent could result in a change in
control of the DCO. For example, if an
entity increases its stake in the DCO
from 45 percent ownership to 51
percent, it is possible that control of the
DCO would change without any
required reporting. In addition, in some
instances, a DCO is owned by a parent
company, and a change in ownership or
control of the parent was not required
to be reported under the current rule
despite the fact that it could change
corporate control of the DCO. The
Commission noted that the proposed
changes to the rule would ensure that
the Commission has accurate knowledge
of the individuals or entities that control
a DCO and its activities.257
The Commission believes the same
rationale is applicable to SEFs and
DCMs. It is possible that an increase in
equity interest in an exchange from 45
percent to 51 percent, would change
control of the exchange without
required reporting under the current
255 Reporting and Information Requirements for
Derivatives Clearing Organizations, 88 FR 53664
(Aug. 8, 2023).
256 Reporting and Information Requirements for
Derivatives Clearing Organizations, 87 FR 76698,
76716–17 (Dec. 15, 2022). See id. at 76716–17.
257 See id. at 76704.
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SEF and DCM regulations. Similarly, a
change in ownership or control of a
SEF’s or DCM’s parent is not required to
be reported under the current
regulations even though it could change
corporate control of the SEF or DCM.
The proposed changes would help to
ensure that the Commission has
accurate knowledge of the individuals
or entities that control a SEF or DCM
and its activities.258
The Commission is proposing to
amend Commission regulations
§§ 37.5(c)(2) and 38.5(c)(2) to clarify
what information must be submitted to
the Commission as part of a notification
pursuant to Commission regulations
§§ 37.5(c)(1) and 38.5(c)(1), as proposed
to be amended. Existing Commission
regulation § 37.5(c)(1) provides that
upon receiving notification of an equity
interest transfer from a SEF, the
Commission may request the SEF to
provide ‘‘supporting documentation of
the transaction.’’ Although Commission
regulation § 38.5(c)(1) currently
includes a notification requirement for
DCMs regarding equity interest
transfers, it does not grant the
Commission the specific authority to
request supporting documentation upon
the receipt of such a notification.
Accordingly, the Commission proposes
to harmonize and enhance the
requirements between SEFs and DCMs
by amending Commission regulations
§§ 37.5(c)(2) and 38.5(c)(2) to state that,
as part of a notification pursuant to
Commission regulations §§ 37.5(c)(1) or
38.5(c)(1), as proposed to be amended,
a SEF or DCM must provide ‘‘required
information’’ including: a chart
outlining the new ownership or
corporate or organizational structure, a
brief description of the purpose or the
impact of the change, and any relevant
agreement effecting the change and
corporate documents such as articles of
incorporation and bylaws.259 Pursuant
to proposed regulations §§ 37.5(c)(2)(i)
and 38.5(c)(2)(i), the Commission may,
258 The Commission’s Division of Market
Oversight generally addressed concepts of
ownership in another rulemaking. See, e.g.,
Ownership and Control Reports, Forms 102/102S,
40/40S, and 71; Final Rule, 78 FR 69178, 69261
(Parent—for purposes of Form 40, a person is a
parent of a reporting trader if it has a direct or
indirect controlling interest in the reporting trader;
and a person has a controlling interest if such
person has the ability to control the reporting trader
through the ownership of voting equity, by contract,
or otherwise.)
259 The Commission notes that regulation
§ 39.19(c)(4)(ix)(B) currently requires a DCO to
provide the Commission with the following: A chart
outlining the new ownership or corporate or
organizational structure; a brief description of the
purpose and impact of the change; and any relevant
agreements effecting the change and corporate
documents such as articles of incorporation and
bylaws.
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after receiving such information, request
additional supporting documentation
related to the change in ownership or
corporate or organizational structure,
such as amended Form DCM or Form
SEF exhibits, to demonstrate that the
SEF or DCM will, following the change,
continue to meet all the requirements in
section 5 or 5h of the CEA (as
applicable) and applicable Commission
regulations.
The Commission believes that
clarifying and enhancing its authority to
request this information will encourage
SEFs and DCMs to remain mindful of
their self-regulatory and market
regulation responsibilities when
negotiating the terms of significant
equity interest transfers or other changes
in ownership or corporate or
organizational structure. The
Commission believes that it also will
enhance Commission staff’s ability to
undertake a timely and effective due
diligence review of the impact, if any,
of such changes. In particular, parts 37
and 38 of the Commission’s regulations
require the filing of certain exhibits
when a SEF or DCM applies for
designation or registration. These
include, among others, Exhibit A (the
name of any person who owns ten
percent (10%) or more of the
Applicant’s stock or who, either directly
or indirectly, through agreement or
otherwise, in any other manner, may
control or direct the management or
policies of the Applicant); Exhibit B (a
list of the present owners, directors,
governors or persons performing similar
functions, including a description of
any disqualifications or disciplinary
actions related such persons under
sections 8b and 8c of the Act); Exhibit
E (a description of the personnel
qualifications for each category of
professional employees), Exhibit F (an
analysis of staffing requirements
necessary to carry out key operations),
Exhibit H (a brief description of any
material legal proceedings to which the
SEF or DCM or any of its affiliates is a
party), Exhibit M (the rulebook), Exhibit
N (applicant agreements, including with
third party service providers and
member or user agreements), and
Exhibit O (the compliance manual). In
the event of a transfer of equity interest
or similar ownership or corporate or
organizational change to a SEF or DCM,
the proposed amendments would
strengthen Commission staff’s authority
to seek updated copies of such exhibits
and other documents to confirm that the
SEF or DCM will continue to be able to
meet its regulatory obligations.
Pursuant to proposed regulations
§§ 37.5(c)(2)(i) and 38.5(c)(2)(i),
Commission staff would have clear
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authority to request amended Form SEF
or DCM exhibits, such as Exhibit A.
Exhibit A requires the full name and
address of each such person. One
potential scenario is that such updated
exhibit reflects a non-U.S. 10 percent
owner. Such information may cause
Commission staff to undertake further
inquiry as to whether the SEF or DCM,
with such new non-U.S. owner, can
demonstrate it has the ability to
continue satisfying all of the
requirements of section 5 of the CEA
and applicable Commission regulations.
Additionally, an amended Exhibit B of
the Form SEF or Form DCM may reflect
that an officer or director is disqualified
or had disciplinary action taken against
them under the Act.260 The Commission
also notes pursuant to proposed
§§ 37.207(a) and 38.801(a), SEFs and
DCMs must establish and enforce
appropriate fitness standards for, among
others, their officers, directors and any
person who owns 10 percent or more of
the SEF or DCM and who, either
directly or indirectly, through
agreement or otherwise, in any other
manner, may control or direct the
management or policies of the SEF or
DCM, and any party affiliated with any
of those persons. Information obtained
through proposed regulations
§§ 37.5(c)(2) and 38.5(c)(2) will inform
the Commission as to whether the SEF
or DCM remains compliant with such
minimum fitness standards.
Next, proposed §§ 37.5(c)(3) and
38.5(c)(3) will require a notification
pursuant to Commission regulations
§§ 37.5(c)(1) or 38.5(c)(1), as proposed to
be amended, to be submitted no later
than three months prior to the
anticipated change, provided that the
SEF or DCM may report the anticipated
change later than three months prior to
the anticipated change if it does not
know and reasonably could not have
known of the anticipated change three
months prior to the anticipated change.
In such event, the SEF or DCM shall
immediately report such change to the
Commission as soon as it knows of such
change. The Commission believes the
proposed timing requirement strikes the
appropriate balance between allowing
Commission staff sufficient time to
review the impact of the change and
assess compliance with applicable
260 Exhibit B requires: a description of: (1) Any
order of the Commission with respect to such
person pursuant to section 5e of the CEA; (2) Any
conviction or injunction against such person within
the past ten (10) years; (3) Any disciplinary action
with respect to such person within the last five (5)
years; (4) Any disqualification under sections 8b
and 8d of the CEA; (5) Any disciplinary action
under section 8c of the CEA; and (6) Any violation
pursuant to section 9 of the CEA.
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19681
statutory and regulatory requirements,
while also preserving flexibility to the
SEF or DCM if the anticipated change
occurs more quickly than within three
months.
In addition to the new reporting
requirements, the proposal includes a
new certification requirement for DCMs.
Existing Commission regulation
§ 37.5(c)(4) requires the SEF, upon a
transfer of equity interest, to file a
certification that it meets all of the
requirements of section 5h of the CEA
and the Commission regulations
adopted thereunder. The certification
must be filed no later than two business
days following the date on which the
subject equity interest was acquired.
DCMs currently do not have an
analogous certification requirement.261
Therefore, the Commission is proposing
to amend Commission regulation
§ 38.5(c) by adding a certification
requirement in regulation § 38.5(c)(5).
The certification will require a DCM,
upon a change in ownership or
corporate organizational structure
described in Commission regulation
§ 38.5(c)(1), to file with the Commission
a certification that the DCM meets all of
the requirements of section 5 of the CEA
and applicable Commission regulations.
The certification must be filed no later
than two business days following the
date on which the change in ownership
or corporate or organizational structure
takes effect. This should be interpreted
to mean two business days after the
change contemplated by the effectuating
agreements actually occurred.
The Commission believes that there is
no substantive difference necessitating
disparate treatment between SEFs and
DCMs regarding the certification. Given
their roles as self-regulatory
organizations, in the event of a subject
change in ownership or corporate or
organizational structure, the
Commission believes it is imperative for
the SEF or DCM to certify its
compliance with the CEA and
Commission regulations. The
certification will help ensure that any
such changes do not result in noncompliance. Toward that end, proposed
§§ 37.5(c)(6) and 38.5(c)(6) provide that
a change in the ownership or corporate
or organizational structure of a SEF or
DCM that results in the failure of the
SEF or DCM to comply with any
261 In the final rule implementing part 38 of the
Commission’s regulations, the Commission stated
that the documentation that the Commission may
request under Commission regulation § 38.5 may
include a certification that the DCM continues to
meet all of the requirements of section 5(d) of the
CEA and Commission regulations adopted
thereunder. See Part 38 Final Rule, 77 FR 36612 at
36619.
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provision of the Act, or any regulation
or order of the Commission thereunder,
shall be cause for the suspension of the
registration or designation of the SEF or
DCM, or the revocation of registration or
designation as a SEF or DCM, in
accordance with sections 5e and 6(b) of
the CEA. The proposed rule further
provides that the Commission may
make and enter an order directing that
the SEF or DCM cease and desist from
such violation, in accordance with
sections 6b and 6(b) of the CEA.262
Section 6(b) of the CEA authorizes the
Commission to suspend or revoke
registration or designation of a SEF or
DCM if the exchange has violated the
CEA or Commission orders or
regulations. Section 6(b) includes a
number of procedural safeguards,
including that it requires notice to the
SEF or DCM, a hearing on the record,
and appeal rights to the court of appeals
for the circuit in which the SEF or DCM
has its principal place of business. It is
imperative that SEFs and DCMs,
regardless of ownership or control
changes, continue to comply with the
CEA and all Commission regulations to
promote market integrity and protect
market participants.
Finally, the Commission proposes to
amend existing regulation § 38.5(d) by
extending the delegation of authority
provisions to the Director of the
Division of Market Oversight to include
information requests related to the
business of the DCM in § 38.5(a) and
equity interest transfers in § 38.5(c).
This amendment would conform
§ 38.5(d) to the existing delegated
authority the Division of Market
Oversight has with respect to SEFs
under § 37.5(d). Changes in ownership
or control of a DCM can occur relatively
quickly. Therefore, the Commission
believes it is important for effective
oversight to provide the Director of the
Division of Market Oversight with the
authority in such circumstances, to
immediately request information and
documents to confirm continued
compliance by a DCM with the CEA and
relevant Commission regulations.
4. Questions for Comment
1. Proposed regulation § 37.5(c)(1)
revises the notification threshold for
SEFs from 50 percent to 10 percent to
align with the DCM requirement in
§ 38.5(c)(1). Is there any reason why the
threshold should be different for SEFs?
2. Do the proposed rules provide
sufficient notice and clarity to SEFs and
DCMs regarding what documents and
information may be requested by the
Commission?
262 7
U.S.C 7b; 7 U.S.C. 13a; 7 U.S.C 8(b).
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3. Are the timing provisions for the
required notification (proposed
regulations §§ 37.5(c)(3) and 38.5(c)(3))
and certification (proposed regulations
§§ 37.5(c)(5) and 38.5(c)(5)) sufficiently
clear? Do such timing provisions allow
sufficient time for SEFs and DCMs to
provide the required notification and
certification?
VII. Effective and Compliance Dates
The Commission is proposing that the
effective date for the proposed rules be
sixty days after publication of final
regulations in the Federal Register. The
Commission believes that the proposed
effective date would be appropriate
given that DCMs have implemented
many of the proposed rules’
requirements that are being adopted
from the DCM Core Principle 16
Acceptable Practices. Additionally,
many SEFs have voluntarily adopted
elements of these standards to
demonstrate compliance with SEF Core
Principle 12. The Commission also
proposes a compliance date of one-year
after the effective date of the final
regulations. The Commission believes
this will provide current SEFs and
DCMs, as well as prospective SEF and
DCM applicants, with sufficient time to
comply with the final regulations.
Question for Comment
The Commission requests comment
on whether the proposed effective date
is appropriate and, if not, the
Commission further requests comment
on possible alternative effective dates
and the basis for any such alternative
dates.
VIII. Related Matters
a. Cost-Benefit Considerations
1. Introduction
As described above, the Commission
proposes to establish governance
standards and conflicts of interest rules
related to market regulation functions,
for SEFs and DCMs. Although SEFs and
DCMs have similar obligations with
respect to market regulation functions,
they are subject to different obligations
with respect to governance fitness
standards and mitigating conflicts of
interest. SEFs and DCMs are required to
minimize and resolve conflicts of
interest pursuant to identical statutory
core principles.263 However, with
respect to governance fitness standards,
DCMs are subject to specific statutory
core principles addressing
263 See SEF Core Principle 12, Commodity
Exchange Act (‘‘CEA’’) section 5h(f)(12), 7 U.S.C.
7b–3(f)(12), and DCM Core Principle 16, CEA
section 5(d)(16), 7 U.S.C. 7(d)(16).
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governance,264 while SEFs do not have
parallel core principle requirements.
Additionally, SEFs and DCMs currently
have different regulatory obligations
with respect to governance fitness
standards.265 Further, while both SEFs
and DCMs are subject to equity transfer
requirements,266 the applicable
regulatory provisions currently have
different notification thresholds and
obligations.
Section 15(a) of the CEA requires the
Commission to consider the costs and
benefits of its actions before
promulgating a regulation under the
CEA or issuing certain orders.267
Section 15(a) further specifies that the
costs and benefits shall be evaluated in
light of the following 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
considers the costs and benefits
resulting from its discretionary
determinations with respect to the
section 15(a) factors (collectively
referred to herein as ‘‘Section 15(a)
Factors’’) below.
The goal of the proposed rulemaking
is to provide SEFs and DCMs with a
clear regulatory framework for
implementing governance standards to
promote the integrity of its selfregulatory functions and for identifying,
managing, and resolving conflicts of
interest related to their market
regulation functions. Specifically, the
proposed rulemaking harmonizes and
enhances the existing SEF and DCM
regulations by proposing: (1) new rules
to implement DCM Core Principle 15
(Governance Fitness Standards) that are
consistent with the existing guidance on
compliance with DCM Core Principle 15
(Governance Fitness Standards); (2) new
rules to implement DCM Core Principle
16 (Conflicts of Interest) that are
consistent with the DCM Core Principle
16 Guidance and Acceptable Practices;
(3) new rules to implement SEF Core
Principle 2 (Compliance With Rules)
264 See DCM Core Principles 15 and 17, CEA
section 5(d)(15), 7 U.S.C. 7(d)(15), and CEA section
5(d)(17), 7 U.S.C. 7(d)(17), respectively.
265 As discussed below, SEFs, but not DCMs, are
required to comply with requirements under part 1
of the Commission’s regulations addressing the
sharing of nonpublic information, service on the
board or committees by persons with disciplinary
histories, board composition, and voting by board
or committee members persons where there may be
a conflict of interest.
266 Commission regulation § 37.5(c) (SEFs) and
Commission regulation § 38.5(c) (DCMs).
267 7 U.S.C. 19(a).
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that are consistent with the DCM Core
Principle 15 Guidance; (4) new rules to
implement SEF Core Principle 12
(Conflicts of Interest) that are consistent
with the DCM Core Principle 16
Guidance and Acceptable Practices; (5)
new rules under part 37 of the
Commission’s regulations for SEFs and
part 38 of the Commission’s regulations
for DCMs that are consistent with
existing conflicts of interest and
governance requirements under
Commission regulations §§ 1.59 and
1.63; (6) new rules for DCM Chief
Regulatory Officers (‘‘CROs’’); (7)
amendments to certain requirements
relating to SEF Chief Compliance
Officers (‘‘CCOs’’); and (8) new rules for
SEFs and DCMs relating to the
establishment and operation of a
Regulatory Oversight Committee
(‘‘ROC’’).
The Commission recognizes that the
proposed changes in this release could
result in benefits, but also could impose
costs. Any initial and recurring
compliance costs for any SEF or DCM
will depend on the size, existing
infrastructure, practices, and cost
structure of the entity. The Commission
has endeavored to provide qualitative
analysis of costs based on its experience
overseeing SEFs and DCMs. The
Commission generally requests
comment on all aspects of its costbenefit considerations, including the
identification and assessment of any
costs and benefits not discussed herein;
data and any other information to assist
or otherwise inform the Commission’s
ability to quantify or qualitatively
describe the costs and benefits of the
proposed amendments; and
substantiating data, statistics, and any
other information to support positions
posited by commenters with respect to
the Commission’s discussion. The
Commission welcomes comment on
such costs and benefits.
2. Baseline
The baseline for the Commission’s
consideration of the costs and benefits
of this proposed rulemaking is the
existing statutory and regulatory
framework regarding conflicts of
interests and governance standards for
SEFs and DCMs. The existing
governance requirements and conflicts
of interest standards for SEFs are set
forth in SEF Core Principles 2, 12 and
15,268 and certain regulations in part 1
of the Commission’s regulations that
apply to SROs, including SEFs. SEFs
must comply with SEF Core Principle 2,
268 See CEA section 5h(f)(2), 7 U.S.C. 7b–3(f)(2),
CEA section 5h(f)(12), 7 U.S.C. 7b–3(f)(12) and CEA
section 5h(f)(15), 7 U.S.C. 7b–3(f)(15).
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requiring SEFs to establish and enforce
rules governing the operation of the
SEF.269 Commission regulation § 1.59
provides limits on the use and
disclosure of SEF material, non-public
information. Commission regulation
§ 1.63 restricts persons with certain
disciplinary histories from serving on
disciplinary committees, arbitration
panels, oversight panels or the
governing board of a SEF. Commission
regulation § 1.64 sets forth requirements
for the composition of SEF governing
boards and major disciplinary
committees. Commission regulation
§ 1.69 requires a SEF to have rules to
prevent members of the board of
directors, disciplinary committees, or
oversight panels, to abstain from
deliberating and voting on certain
matters that may raise conflicts of
interest.
The existing requirements for DCMs
to minimize and resolve conflicts of
interests are outlined in DCM Core
Principle 16.270 DCMs must also comply
with DCM Core Principle 15, which sets
forth governance fitness standards for
members of the board of directors or
disciplinary committees, members of
the contract market, any other person
with direct access to the facility, and
any person affiliated with those
enumerated individuals. Additionally,
DCM Core Principle 17 requires a
DCM’s governance arrangements be
designed to consider the views of
market participants and DCM and Core
Principle 22 requires DCMs that are
publicly traded to endeavor to have
boards of directors and other decisionmaking bodies composed of diverse
individuals. DCMs are also subject to
existing regulatory requirements in
Commission regulation § 1.63(c), that
disqualifies individuals with certain
disciplinary histories from serving on
DCM governing boards, arbitration or
oversight panels, or disciplinary
committees. disciplinary committees,
arbitration panels, oversight panels or
the governing board of a DCM. Although
DCMs are exempt from Commission
regulation § 1.59(b) and (c), Commission
regulation § 1.59(d) directly prohibits
members of the board of directors,
committee members, or consultants of a
self-regulatory organization from trading
for their own account, or for or on
269 CEA
section 5h(f)(2), 7 U.S.C. 7b–3(f)(2).
Commission, however, notes that—as a
practical matter—all of the DCMs that are currently
designated by the Commission rely on the
acceptable practices to comply with Core Principle
16, in lieu of any other means for compliance. As
such, the actual costs and benefits of the
codification of those acceptable practices with
respect to DCMs, as realized in the market, may not
be as significant.
270 The
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19683
behalf of any other account, based on
this material non-public information.
Both SEFs and DCMs are subject to
equity interest transfer requirements set
forth in Commission regulations
§§ 37.5(c) and 38.5(c), respectively.
The Commission notes that this costbenefit consideration is based on its
understanding that the derivatives
market regulated by the Commission
functions internationally with: (1)
transactions that involve U.S. entities
occurring across different international
jurisdictions; (2) some entities organized
outside of the United States that are
registered with the Commission; and (3)
some entities that typically operate both
within and outside the United States
and that follow substantially similar
business practices wherever located.
Where the Commission does not
specifically refer to matters of location,
the discussion of costs and benefits
below refers to the effects of the
proposed rules on all relevant
derivatives activity, whether based on
their actual occurrence in the United
States or on their connection with, or
effect on, U.S. commerce.271
3. Proposed Rules
i. Minimum Fitness Standards—
Proposed §§ 37.207 and 38.801
SEFs must comply with SEF CP 2,
which requires SEFs to establish and
enforce rules governing the operation of
its facility.272 Currently, SEFs must also
comply with all requirements in
Commission regulation § 1.63, which
restricts persons with certain
disciplinary histories from serving on
disciplinary committees, arbitration
panels, oversight panels or the
governing board of a SEF, because SEFs
qualify as SROs and are not otherwise
exempt. While DCMs are also SROs,
they are exempt from Commission
regulations §§ 1.63(a), (b), and (d)–(f),
pursuant to Commission regulation
§ 38.2. DCMs are not, however, exempt
from Commission regulation 1.63(c),
which provides that persons are
disqualified from serving on
disciplinary committees, arbitration
panels, oversight panels or the
governing board of a DCM if they are
subject to any of the disciplinary
offenses found in § 1.63(b). DCMs must
also comply with DCM Core Principle
15, requiring DCMs to establish and
enforce appropriate fitness standards for
directors, members of any disciplinary
committee, members of the contract
market, and any other person with
direct access to the facility (including
271 See,
272 CEA
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any party affiliated with any person
described in this paragraph).273
Proposed §§ 37.207(a) and 38.801(a)
would require SEFs and DCMs to
establish and enforce appropriate fitness
requirements for officers, members of its
board directors, committees,
disciplinary panels, dispute resolution
panels, any other persons with direct
access to the SEF or DCM, any person
who owns 10 percent or more of the SEF
or DCM and who, either directly or
indirectly, through agreement or
otherwise, in any other manner, may
control or direct the management or
policies of the SEF or DCM, and for any
party affiliated with any of the
foregoing. In subparts (b), and (c) of
proposed §§ 37.207 and 38.801, the
Commission has identified certain
minimum fitness standards that SEFs
and DCMs would be required to
establish and enforce. First, under
subpart (b), SEFs and DCMs would be
required to include the basis for refusal
to register a person under sections
8(a)(2) and 8a(3) of the CEA as
minimum fitness standards for members
of its board of directors, committees,
disciplinary panels, dispute resolution
panels, for members with voting
privileges, and any person who owns 10
percent or more of the SEF or DCM and
who, either directly or indirectly,
through agreement or otherwise, in any
other manner, may control or direct the
management or policies of the SEF or
DCM. Second, under subpart (c), SEF
and DCM minimum fitness standards
would be required to include six
offenses the Commission has identified
as disqualifying for key decisionmakers, including members of its board
of directors, committees, disciplinary
panels, and dispute resolution panels.
Commission regulation § 1.63(d)
requires each SRO to provide the
Commission with a certified list of
persons removed from a disciplinary
committee, arbitration panel, or
oversight panel, in the previous year. In
addition to the above standards,
proposed §§ 37.207(d) and 38.801(d)
would require that SEFs and DCMs to
establish new procedures for the initial
and annual collection, verification, and
preservation of information supporting
compliance with appropriate fitness
standards.
A. Benefits
The Commission believes that
requiring appropriate, minimum fitness
standards for individuals with the
ability to exercise influence or control
over the operations of SEFs and DCMs,
including their market regulation
273 CEA
section 5(d)(15); 7 U.S.C. 7(d)(15).
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functions, will improve the integrity
and effectiveness of SEFs and DCMs in
their role as SROs. By establishing
automatic disqualifiers, including
disqualifications described in CEA
sections 8a(2) and 8a(3), or a history of
disciplinary offenses described in
Commission regulation § 1.63, SEFs and
DCMs may benefit by attracting
individuals with demonstrated ethical
conduct and sound decision-making to
those influential roles. Proposed
§§ 37.207 and 38.801 are likely to
reduce the likelihood and the extent of
harm caused by individuals with a
history of disciplinary offenses to the
operations of SEFs and DCMs, including
their market regulation functions. In
addition, clear minimum standards for
individuals with the ability to influence
or control the governance of SEFs and
DCMs will provide market participants
using exchange services, as well as
exchange shareholders, with greater
confidence in key SEF and DCM
decision-makers. Ongoing verification of
the fitness of these decision-makers may
also provide greater accountability and
trust in the management and operations
of SEFs and DCMs. Such requirements
may also increase the trust of market
participants using exchange services.
Establishing automatic disqualifiers
and establishing independent fitness
verification procedures for SEFs and
DCMs are likely to aid in identifying
trustworthy individuals to serve in roles
with the ability to control or influence
the governance of the exchange or its
market regulation functions. It is
important that the individuals able to
influence or control a SEF’s and DCM’s
governance, management, and
disciplinary standards have a record of
integrity and rectitude. Such record
provides confidence that those
individuals will be able to effectuate a
SEF’s or DCM’s obligations to establish
and enforce its rules, and a DCM’s
obligation to establish and enforce
appropriate minimum fitness
requirements.274
Finally, as discussed above, SEFs
currently must comply with all
requirements in Commission regulation
§ 1.63. To the extent SEFs are already
compliant with this regulation, the
benefits of proposed § 37.207 may be
less significant. Similarly, DCMs
currently must comply with
Commission regulation § 1.63(c) and
274 The minimum fitness requirements facilitate a
SEF’s and DCM’s ability to establish and enforce
their rules, in accordance with SEF Core Principle
2 (Compliance with Rules), CEA section 5h(f)(2); 7
U.S.C. 7b–3(f)(2), DCM Core Principle 2
(Compliance with Rules), CEA section 5(d)(2); 7
U.S.C. 7(d)(2), and DCM Core Principle 15,
respectively.
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DCM Core Principle 15. To the extent
that DCMs are already compliant with
§ 1.63(c) and DCM Core Principle 15,
the benefits of proposed § 38.801 may be
less significant. Finally, to the extent
that SEFs or DCMs have already
implemented rules consistent with all
aspects of the DCM Core Principle 15
Guidance, the benefits of proposed
§ 37.207 and § 38.801 may be less
significant.275
B. Costs
The Commission believes that SEFs
and DCMs would incur additional costs
from proposed §§ 37.207 and 38.801
through the additional hours SEF and
DCM employees might need to spend
analyzing the compliance of their
existing rules and procedures with these
proposed requirements, and
implementing new or amended rules
and procedures, as necessary.
Specifically, SEFs and DCMs may incur
costs in the form of administrative time
related to drafting new policies to
comply with the proposed fitness
standards and verification procedures.
Costs associated with complying with
proposed §§ 37.207 and 38.801 may
further vary based on the size of the SEF
or DCM, available resources, and
existing practices and policies.
Accordingly, those costs would be
impracticable to reasonably quantify.
The Commission believes that the
policies and procedures required for
implementing minimum fitness
standards would likely not change
significantly from year to year, so after
the initial creation of the policies and
procedures, the time required to
maintain those policies and procedures
would be negligible.
When implementing proposed
§§ 37.207 and 38.801, to the extent that
the current officers or membership of
their board of directors, or committees
do not meet the proposed minimum
fitness requirements, SEFs and DCMs
may need to make changes to their
officers, members of their board of
directors, or committees. This might
lead to additional costs related to any
time and efforts SEFs and DCMs may
need to take to find suitable candidates.
The Commission notes that, regarding
DCMs, the above costs may be mitigated
to the extent that a DCM is already
complying with DCM Core Principle 15
and Commission regulation § 1.63(c).
Additionally, to the extent a DCM has
already implemented practices
275 As described supra, Section III(a)(Proposed
Governance Fitness Standards—Proposed §§ 37.207
and 38.801), the proposed minimum fitness
standards are consistent with the existing DCM
Core Principle 15 Guidance, subject to certain
enhancements described therein.
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consistent with DCM Core Principle 15
Guidance, some of the costs may have
been already realized. The DCM Core
Principle 15 Guidance states that
minimum fitness standards for persons
who have member voting privileges,
governing obligations or
responsibilities, or who exercise
disciplinary authority, should include
those bases for refusal to register a
person under section 8a(2) of the
CEA.276 Additionally, the DCM Core
Principle 15 Guidance states that
persons who have governing obligations
or responsibilities, or who exercise
disciplinary authority, should not have
a significant history of serious
disciplinary offenses, such as those that
would be disqualifying under
Commission regulation § 1.63.277 As a
practical matter, many DCMs may have
already adopted practices consistent
with the Core Principle 15 Guidance. As
such, the actual costs of the proposed
rules amendments may be less
significant.
The costs to implement the proposed
§§ 37.207 and 38.801 minimum fitness
requirements for SEFs may be mitigated
to the extent that they already have a
framework in place to comply with
existing Commission regulation § 1.63,
which sets forth requirements and
procedures to prevent persons with
certain disciplinary histories from
serving in certain governing or oversight
capacities as an SRO.
Proposed §§ 37.207 and 38.801
require each SEF and DCM to establish
appropriate procedures for the
collection and verification of
information supporting compliance
with appropriate fitness standards.
Ongoing implementation of the
proposed rules would also impose costs
associated with the time required to
collect and verify a candidate’s fitness
in a timely manner, to document the
findings with respect to the fitness
standards, to make the findings
available to the Commission as a part of
staff’s oversight activities, and to reverify fitness eligibility on an annual
basis. Similar to above, a SEF’s or
DCM’s costs may be less significant if it
is already following the DCM Core
Principle 15 Guidance, which states that
DCMs should have standards for the
collection and verification of
information supporting compliance
with the DCM’s fitness standards.
The Commission requests comments
on the potential costs of proposed
§§ 37.207 and 38.801, including any
276 See Appendix B to part 38, Guidance to Core
Principle 15 of section 5(d) of the Act, Governance
Fitness Standards.
277 Id.
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costs that would be imposed on SEFs,
DCMs, other market participants, or the
financial system more broadly.
C. Section 15(a) Factors
In addition to the discussion above,
the Commission has evaluated the costs
and benefits of proposed §§ 37.207 and
38.801 with regard to the specific
considerations identified in Section
15(a) of the CEA. The Commission
believes that proposed §§ 37.207 and
38.801 may protect market participants
and the public, as well as the financial
integrity of the markets, by ensuring the
integrity of individuals influencing the
decisions made by SEFs and DCMs. By
having fit and reputable decisionmakers, the Commission believes SEFs
and DCMs are likely able to increase
industry and public trust in their
organizations and markets. Minimum
fitness standards also may increase the
confidence in the decisions made by
officers and members of its board of
directors, committees, disciplinary
panels, dispute resolution panels, and
certain owners. The Commission
believes that trust and confidence in
SEF and DCM leadership fosters market
participation, which could in turn
enhance liquidity, price discovery, and
the financial integrity of markets. The
Commission has considered the other
Section 15(a) Factors and believes that
they are not implicated by the proposed
amendments to §§ 37.207 and 38.801.
ii. General Requirements for Addressing
Conflicts of Interest and Definitions—
Proposed §§ 37.1201 and 38.851
Currently, both SEFs and DCMs have
an obligation under SEF Core Principle
12 and DCM Core Principle 16 to
minimize and resolve conflicts of
interest in their decision-making.
Additionally, DCM Core Principle 16
Acceptable Practices set forth practices
for complying with Core Principle 16.
By contrast, there are no acceptable
practices or guidance for SEF Core
Principle 12.
Proposed §§ 37.1201(a) and 38.851(a)
require SEFs and DCMs to establish
processes for identifying, minimizing,
and resolving actual and potential
conflicts of interest that may arise.
Proposed §§ 37.1201(b) and 38.851(b)
revise existing definitions 278 and define
278 The DCM Core Principle 16 Acceptable
Practices defines a ‘‘public director’’ as an
individual with no material relationship to the
DCM and describes the term ‘‘immediate family’’ to
include spouse, parents, children, and siblings. The
terms ‘‘material information,’’ ‘‘non-public
information,’’ ‘‘commodity interest,’’ ‘‘related
commodity interest,’’ and ‘‘linked exchange’’ are
defined in Commission regulation § 1.59. ‘‘Material
information’’ is defined in § 1.59(a)(5) to mean
information which, if such information were
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19685
two new terms. First, the term ‘‘market
regulation function,’’ under
§ 38.851(b)(9) means DCM functions
required by DCM Core Principle 2, DCM
Core Principle 4, DCM Core Principle 5,
DCM Core Principle 10, DCM Core
Principle 12, DCM Core Principle 13,
DCM Core Principle 17 and the
applicable Commission regulations
thereunder. ‘‘Market regulation
function’’ under § 37.1201(b)(9) means
SEF functions required by SEF Core
Principle 2, SEF Core Principle 4, SEF
Core Principle 6, SEF Core Principle 10
and the applicable Commission
regulations thereunder. Second, the
proposed rules define the term
‘‘affiliate,’’ which refers to a person that
directly, or indirectly, controls, or is
controlled by, or is under common
control with, the SEF or DCM.
A. Benefits
The Commission believes that SEF
and DCM conflict of interest processes,
as required by proposed §§ 37.1201(a)
and 38.851(a), are likely to provide the
framework necessary for SEFs and
DCMs to minimize conflicts of interest
and comply with their core principle
requirements. The specific conflicts of
interest this proposal addresses relate to
market regulation functions, i.e., SEF
and DCM functions that promote market
integrity and orderly conduct in the
markets.279
The Commission believes that the
new definitions for ‘‘market regulation
functions’’ and ‘‘affiliate’’ in proposed
§§ 37.1201(b) and 38.851(b) will provide
benefits, including operational
efficiency. SEFs and DCMs will spend
less time and resources in determining
how to comply with regulatory
requirements. Moreover, the definitions
will provide additional regulatory
certainty and risk reduction; delineate
publicly known, would be considered important by
a reasonable person in deciding whether to trade a
particular commodity interest on a contract market
or a swap execution facility, or to clear a swap
contract through a derivatives clearing organization.
‘‘Non-public information’’ is defined in § 1.59(a)(6),
as information which has not been disseminated in
a manner which makes it generally available to the
trading public. Commission regulations § 1.59(a)(8)
and (9) define ‘‘commodity interest,’’ to include all
futures, swaps, and options traded on or subject to
the rules of a SEF or DCM and ‘‘related commodity
interest’’ to include any commodity interest which
is traded on or subject to the rules of a SEF, DCM,
linked exchange, or other board of trade, exchange,
or market, or cleared by a DCO, other than the selfregulatory organization by which a person is
employed, and which is subject to a self-regulatory
organization’s intermarket spread margins or other
special margin treatment. Commission regulations
§ 1.59(a)(5), (a)(6), (a)(8), and (a)(9).
279 E.g., trade practice surveillance, market
surveillance, real-time market monitoring, audit
trail data and recordkeeping enforcement,
investigations of possible SEF or DCM rule
violations, and disciplinary actions.
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the responsibilities addressed by SEF
and DCM regulations, including which
functions are considered self-regulatory
versus market regulation; and clarify
which relationships are affiliate
relationships. Reducing ambiguities
regarding the meaning of these terms
should promote regulatory compliance.
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B. Costs
SEFs and DCMs may incur additional
costs from proposed §§ 37.1201(a) and
38.851(a) in terms of employee hours
spent analyzing whether existing rules
and procedures comply with the
proposed requirements, and drafting
and implementing new or amended
rules and procedures, as necessary.
Costs associated with complying with
proposed §§ 37.1201 and 38.851 may
further vary based on the size of the SEF
or DCM, available resources, and
existing practices, rules, and
procedures. Accordingly, those costs
would be impracticable to reasonably
quantify. Further, rules and procedures
required for implementing the proposed
conflict of interest requirements would
likely not change significantly from year
to year, so after the initial creation of
such rules and procedures, the time
required to maintain those rules and
procedures would be negligible.
The Commission does not believe that
there any independent costs related to
the amended and new definitions in
proposed §§ 37.1201(b) and 38.851(b).
Costs that might be associated with the
proposed definitions will likely arise in
connection with implementing the
conflict of interest requirements under
proposed §§ 37.1201(a) and 38.851(a).
The Commission requests comments
on the potential costs of proposed
§§ 37.1201 and 38.851, including any
costs that would be imposed on SEFs,
DCMs, other market participants, or the
financial system more broadly.
C. Section 15(a) Factors
In addition to the discussion above,
the Commission has evaluated the costs
and benefits of proposed §§ 37.1201 and
38.851 with regard to the specific
considerations identified in Section
15(a) of the CEA. The Commission
believes that proposed §§ 37.1201 and
38.851 may have a beneficial effect on
the protection of market participants
and the public, as well as on the
financial integrity of the markets by
ensuring that SEFs and DCMs have an
adequate framework for addressing
potential conflicts of interest.
Procedures for identifying conflicts of
interest also may reduce the risk of
decision-makers being influenced by
concerns that are not in the best interest
of the SEF’s or DCM’s market regulation
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functions. Rules and processes to
identify and manage conflicts of interest
also aid in ensuring that decisionmakers are accountable to SEFs and
DCMs, and therefore, proposed
§§ 37.1201 and 38.851 may lead to
increased trust in SEF and DCM markets
by market participants and the public.
The Commission has considered the
other Section 15(a) Factors and believes
they are not implicated by proposed
§§ 37.1201 and 38.851.
iii. Conflicts of Interest in DecisionMaking—Proposed §§ 37.1202 and
38.852
As described above, SEFs are subject
to the requirements of SEF Core
Principle 12, requiring SEFs to establish
and enforce rules and processes to
identify and resolve conflicts of
interest.280 Currently, SEFs are also
required to comply with Commission
regulation § 1.69, which requires SROs
to have rules requiring any member of
its board of directors, disciplinary
committees, or oversight panels to
disclose conflicts of interest and abstain
from deliberating and voting in actions
with certain personal or financial
conflicts of interest. DCMs, however, are
exempt from these requirements
pursuant to Commission regulation
§ 38.2.
The Commission is proposing to make
a conforming amendment to
Commission regulation § 37.2 to exempt
SEFs from Commission regulation
§ 1.69. However, the Commission is also
proposing §§ 37.1202 and 38.852, which
incorporate certain elements of existing
Commission regulation § 1.69, for both
SEFs and DCMs, along with certain
modifications and enhancements.
Notably, the Commission proposes to
redefine the term ‘‘family relationship’’
to enhance and modernize the conflict
of interest disclosure requirements.
For example, under § 1.69, if a
member of the board of directors,
disciplinary committee, or oversight
panel, has a relationship with a named
party in interest 281 that falls within the
enumerated relationships in
§ 1.69(b)(1)(i)(A)–(E), the member is
required to abstain from deliberating
and voting on that matter. One of the
enumerated relationships is a ‘‘family
relationship,’’ which is currently
defined as a person’s spouse, parent,
stepparent, child, stepchild, sibling,
stepbrother, stepsister, or in-law.282
In proposed §§ 37.1201(b)(7) and
38.851(b)(7), the Commission redefines
‘‘family relationship,’’ as the person’s
280 Supra
Section II(a).
defined in Commission regulation § 1.69(a).
282 Commission regulation § 1.69(a)(2).
281 As
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spouse, parents, children, and siblings,
in each case, whether by blood,
marriage, or adoption, or any person
residing in the home of the person. This
proposed definition focuses on the
closeness of the relationship that the
officer, or member of the board of
directors, committee, or disciplinary
panel has with the subject of the matter
being considered. The proposed
definition also reflects a more modern
description of the relationships
intended to be covered.
More broadly, proposed §§ 37.1202(a)
and 38.852(a) require SEFs and DCMs to
establish policies and procedures
requiring any officer or member of their
board of directors, committees, or
disciplinary panels to disclose any
actual or potential conflicts of interest
that may be present prior to considering
any matter. Proposed §§ 37.1202(a)(1)
and 38.852(a)(1) provide a list of
enumerated relationships that are
deemed to be conflicts of interest, and
proposed §§ 37.1202(a)(2) and
38.852(a)(2) would extend the
applicability of these enumerated
relationships that an officer or member
of their board of directors, committees,
or disciplinary panels has with an
affiliate of the subject of any matter
being considered. Similar to existing
§ 1.69(b)(4), proposed §§ 37.1202(b) and
38.852(b) require documentation of
conflict of interest determinations.
Specifically, under the proposed rules,
SEFs and DCMs must require members
of their board of directors, committees,
and disciplinary panels to document in
meeting minutes, or otherwise
document in a comparable manner,
compliance with the applicable
requirements.
A. Benefits
Requiring SEF and DCM officers, and
members of their board of directors,
committees, or disciplinary panels to
disclose conflicts of interests before
considering a matter, under proposed
§§ 37.1202 and 38.852, is essential to
implementing the goals of this proposed
rulemaking. Given the governing
authority bestowed upon key decisionmakers, it is crucial that their decisionmaking is guided by the best interests of
the SEF or DCM, and is not influenced
by personal or financial gain. In
requiring these key decisions-makers to
be transparent about relationships that
may raise conflicts of interest, SEFs and
DCMs are better able to hold these
individuals accountable. Additionally,
the Commission believes that proposed
§§ 37.1202(a) and 38.852(a) are
beneficial because requirements to
disclose conflicts of interests promote
transparency in the decision-making
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process relating to SEF and DCM market
regulation functions, further promoting
confidence in their markets.
The Commission believes that the
proposed §§ 37.1202(b) and 38.852(b)
documentation requirements have
several additional benefits. First,
documentation requirements identifying
conflicts of interest and recusals
promotes transparency, ensures that
conflicts of interests have been
managed, and provides useful precedent
for how the SEF or DCM can manage
similar types of conflicts of interest in
the future. Second, requiring conflicts of
interest to be documented, rather than
simply disclosed, is likely to promote
more accountability among members of
the board of directors, committees, and
disciplinary panels. Third, this
documentation is important evidence
demonstrating compliance efforts,
which can aid the SEF, DCM, and the
Commission, in conducting oversight.
SEFs currently are subject to
Commission regulation § 1.69.
Therefore, to the extent SEFs already are
compliant with Commission regulation
§ 1.69, the benefits of proposed
§ 37.1202 may be less significant.
Similarly, if DCMs, as a matter of
industry practice, already have
procedures in place consistent with
Commission regulation § 1.69
requirements, the benefits of proposed
§ 38.852 may be less significant.
B. Costs
The Commission believes that SEFs
will not incur significant costs
implementing proposed § 37.1202 as the
requirements of the proposed rule are
similar to the existing Commission
regulation§ 1.69 requirements. SEFs
may incur some administrative costs of
analyzing their existing rules and
procedures to determine whether they
comply with proposed § 37.1202, as the
proposed rule, as discussed above,
contains some enhancements, such as
the new definition of ‘‘family
relationship,’’ that do not exist in
Commission regulation § 1.69.
DCMs may incur costs implementing
proposed § 38.852, including the
administrative costs of analyzing their
existing rules and procedures to
determine whether they comply with
the proposed requirements, and drafting
and implementing new or amended
rules and procedures, as necessary.
Additionally, proposed § 38.852
requires disclosures to be made by DCM
officers or members of the board of
directors when any actual or potential
conflict of interest may be present, and
requires these officers or members of the
board of directors to abstain from
deliberations and voting on issues
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where the individual is conflicted. Costs
will arise not only from administrative
time in handling the disclosure, but also
in the required documentation to ensure
compliance with the intent of the
proposed rules. Furthermore, there may
be additional costs incurred when
conflicted individuals abstain from
deliberations and the DCM officers, and
members of the board of directors,
committees, and disciplinary panels
potentially need to seek additional
information from independent, nonconflicted experts and consultants.
Finally, the Commission believes that
DCMs will incur costs related to
collecting and storing documents
evidencing conflicts of interest
determinations. The Commission notes
that some of these costs may be less
significant to the extent that DCMs have
voluntarily adopted the requirements of
Commission regulation § 1.69.
Costs associated with complying with
the proposed §§ 37.1202 and 38.852
may further vary based on the size of the
SEF or DCM, available resources, and
existing practices and policies. Further,
conflict of interest policies required for
implementing proposed §§ 37.1202 and
38.852, would likely not significantly
change from year to year, so after the
initial creation of the policies, the time
required to maintain and amend rules
and procedures would be negligible.
The Commission requests comments
on the potential costs of proposed
§§ 37.1202 and 38.852, including any
costs that would be imposed on SEFs,
DCMs, other market participants, or the
financial system more broadly.
C. Section 15(a) Factors
In addition to the discussion above,
the Commission has evaluated the costs
and benefits of proposed §§ 37.1202 and
38.852 in light of the specific
considerations identified in Section
15(a) of the CEA. The Commission
believes that proposed §§ 37.1202 and
38.852 may have a beneficial effect on
protection of market participants and
the public, as well as on the financial
integrity of the markets, by taking steps
to help ensure the impartiality of key
SEF and DCM decision-makers,
particularly those persons responsible
for the exchange’s market regulation
functions. Identifying and documenting
actual and potential conflicts of interest
before reviewing a matter may reduce
the risk of decision-makers being
influenced by personal interests rather
than acting in best interest of the SEF or
DCM, and, ultimately, market
participants and the public. Such a
requirement also is likely to hold
decision-makers accountable to SEFs
and DCMs and may foster market
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19687
participant and public trust in the SEFs
and DCMs, which is also essential to
maintaining the integrity of markets.
The Commission has considered the
other Section 15(a) factors and believes
that they are not implicated by proposed
§§ 37.1202 and 38.852.
iv. Limitations on the Use and
Disclosure of Material Non-Public
Information—Proposed §§ 37.1203 and
38.853
Currently, Commission regulation
§ 1.59 generally requires SROs to adopt
rules prohibiting employees, governing
board members, committee members or
consultants from trading commodity
interests on the basis of material nonpublic information. DCMs are exempt
from Commission regulation § 1.59(b)
and (c), but the entirety of § 1.59 applies
to SEFs. As previously described in
detail,283 both SEFs and DCMs must
comply with the requirements of
Commission regulation § 1.59(d), which
prohibits members of the board of
directors, committee members, or
consultants of the SRO from trading for
their own account, or for or on behalf
of any other account, based on material
non-public information.
In addition to the Commission’s
statutory authority on insider trading,284
DCMs are subject to Core Principle 16,
which requires DCMs to establish and
enforce rules to minimize conflicts of
interest. DCM Core Principle 16
Guidance provides that DCMs should
provide appropriate limitations on the
use or disclosure of material non-public
information gained through
performance of official duties by
members of the board of directors,
committee members, and DCM
employees, or gained by those through
an ownership interest in the DCM.285
Proposed §§ 37.1203 and 38.853
would require SEFs and DCMs to
establish and enforce policies and
procedures for their employees,
members of the board of directors,
committee members, and consultants to
prohibit the disclosure of material nonpublic information and to prohibit
trading if the individual has access to
material non-public information.
Additionally, proposed §§ 37.1203 and
38.853 would provide conditions under
which exemptions to employee trading
prohibitions could be granted.
Proposed §§ 37.1203(c) and 38.853(c)
state that SEFs and DCMs may grant
trading exemptions to employees
pursuant to its policies and procedures,
283 Supra
Section IV(c).
CEA section 9(e), 7 U.S.C. 13(e).
285 See Appendix B to part 38, Core Principle 16
Guidance.
284 See
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on a case-by-case basis, only if certain
requirements are met, including: (1) the
ROC approves the trading exemption;
(2) the employee can demonstrate that
the trading is not being conducted on
the basis of material non-public
information gained through the
performance of their official duties; and
(3) the SEF or DCM documents the
employee’s exemption in accordance
with requirements in existing
Commission regulations §§ 37.1000 and
37.1001, or 38.950 and 38.951, as
applicable. Additionally, proposed
§§ 37.1203(d) and 38.853(d) would
require SEFs and DCMs to diligently
monitor trading activity conducted
pursuant to such exemptions.
A. Benefits
The Commission believes proposed
§§ 37.1203(a) and 38.853(a), requiring
SEFs and DCMs to establish policies
and procedures to safeguard the use and
disclosure of material non-public
information, will result in several
benefits. Generally, the Commission
believes that these proposed rules are
likely to result in benefits by reducing
the instances of conflicts of interest
where persons responsible for exchange
governance or market regulation
functions take advantage of their roles
for personal financial benefit.
Establishing consistent and clearly
defined standards is likely to reduce
instances of the misuse and disclosure
of material non-public information by
employees, members of the board of
directors, committee members, and
consultants at SEFs and DCMs and
promote public confidence in the
markets. In addition, preventing SEF
and DCM employees or insiders with
access to material non-public
information from leveraging their access
to benefit themselves, or others,
commercially or otherwise, promotes
fair and transparent markets, which will
benefit all the market participants.
There also will be benefits from the
requirements in proposed §§ 37.1203(b)
and 38.853(b), which prohibit
employees from certain types of trading
or disclosing for any purpose
inconsistent with the performance of the
person’s official duties as an employee
any material non-public information
obtained as a result of such person’s
employment. Additionally, the
parameters outlined in proposed
§§ 37.1203(c) and 38.853(c) for granting
exemptions to the employee trading
prohibition, along with the new
requirement to monitor such
exemptions under proposed
§§ 37.1203(d) and 38.853(d), are likely
to deter misuse of the employee trading
exemptions. Additionally, these
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proposed rules may also promote
confidence in the market regulation
functions of SEFs and DCMs because
they are: (1) requiring SEFs and DCMs
to limit the issuance of exemptions to
specific, case-by-case instances; and (2)
protecting the markets from trading by
employees with unfair, informational
advantages.
As noted above, Commission
regulation § 1.59 currently requires SEFs
to adopt rules prohibiting employees,
governing board members, committee
members or consultants from trading
commodity interests on the basis of
material non-public information. Both
SEFs and DCMs must comply with the
requirements of Commission regulation
§ 1.59(d), which prohibits members of
the board of directors, committee
members, or consultants of an SRO from
trading for their own account, or for or
on behalf of any other account, based on
material non-public information. DCM
Core Principle 16 Guidance states that
DCMs should provide for appropriate
limitations on the use or disclosure of
material non-public information. To the
extent that SEFs and DCMs have
policies and procedures consistent with
Commission regulation § 1.59, DCM
Core Principle 16 Guidance, or have
existing programs to monitor trading
conducted pursuant to an exemption
from the employee trading prohibition,
the discussed benefits may be less
significant.
The Commission believes that
enhancing SEFs’ and DCMs’ obligations
regarding their oversight of the
exemptions they grant is an appropriate
balance between limiting the misuse of
exemptions and ensuring that the
employee trading prohibition is not
overly broad. One of the benefits of the
proposed requirements related to the
permitted trading exemptions is that
providing such exemptions, as
appropriate, will not impair the ability
or diminish willingness of potential
employees to accept employment
opportunities with a SEF or DCM.
Similarly, the proposed regulatory
limitations on the use and disclosure of
material non-public information as well
as the new requirements on
administering the exemptions will
result in a more efficient process where
there is transparency of the trading
conducted by SEF or DCM employees.
The proposed rules’ expansion of the
trading prohibition to ‘‘related
commodity interests’’ at the product
level, as well as the expansion of the
trading prohibition on direct owners on
the person/entity level, are also likely to
have benefits. The Commission believes
that expanding these limitations are
likely to prevent and reduce the
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instances of conflicts of interest even as
to those contracts that are
interconnected due to having price
movements correlate with the price
movements of a commodity interest
traded on, or subject to the rules of a
SEF or a DCM to such a degree that
intermarket spread margins or special
margin treatment is recognized or
established by the SEF or DCM.
The Commission also believes that
proposed §§ 37.1203(e) and 38.853(e)
prohibiting certain trading by members
of the board of directors, committee
members and consultants in possession
of material non-public information and
barring the release of material nonpublic information will have benefits by
promoting confidence in SEF and DCM
market regulation functions and the
integrity of the marketplace. The
Commission also believes that
preventing decision-makers from
trading on or disclosing material nonpublic information, is beneficial in that
is further prevents such decision-makers
from exploiting unfair informational
advantages. In turn, that helps create
integrity and fairness in the markets.
Finally, by restricting the disclosure of
material non-public information, SEF
and DCM decision-makers are less likely
to share information that might put
other market participants at a
disadvantage.
Regarding proposed non-substantive
changes to certain terms such as
‘‘commodity interest’’ and ‘‘related
commodity interest,’’ as fully discussed
above,286 the Commission believes these
changes enhance ease of reference for
SEF and DCM staff.
B. Costs
Proposed §§ 37.1203 and 38.853
would require that SEFs and DCMs
implement policies and procedures to
safeguard against the misuse of material
non-public information. SEFs and DCMs
would incur additional costs from this
proposal through the additional hours
SEF or DCM employees might need to
spend analyzing the compliance of their
rules and procedures with these
requirements, and drafting and
implementing new or amended rules
and procedures, when necessary. Costs
associated with complying with the
proposed §§ 37.1203 and 38.853 may
further vary based on the size of the SEF
or DCM, available resources the SEF or
DCM may have, and existing practices
and policies the SEF or DCM may have
in place.
While the Commission believes that
most SEFs and DCMs already have
policies and procedures in place to
286 Supra
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prevent the misuse and disclosure of
material non-public information,
proposed §§ 37.1203 and 38.853 would
likely require SEFs and DCMs to
allocate employee administrative time
dedicated to either draft new or amend
existing policies to ensure the SEF and
DCM are complying with any regulatory
proposed rules on the limitations on the
use and disclosure of material nonpublic information. The amount of time
required would vary based on a number
of factors, including whether the SEF or
DCM already has policies complying
with the proposed rules and the amount
of time needed for each SEF and DCM
to draft new or amended polices where
necessary. For example, there will likely
be costs associated with ensuring the
policies and procedures apply to each
class of individuals described in
proposed §§ 37.1203 and 38.853. Costs
associated with complying with
proposed §§ 37.1203 and 38.853 may
further vary based on the size of the SEF
or DCM, available resources, and
existing practices, rules, and
procedures. Accordingly, those costs
would be impracticable to reasonably
quantify. Further, the Commission
believes that the rules, policies and
procedures required to implement the
limitations on the use and disclosure of
material non-public information would
likely not change significantly from year
to year, so after the initial creation of the
policies and procedures, the time
required to maintain those policies and
procedures would be negligible.
Additionally, to the extent the SEF or
DCM seeks to provide employee trading
exemptions, there will likely be costs to
revise or draft policies and procedures
consistent with proposed §§ 37.1203
and 38.853 requirements, and to
evaluate those exemptions on a case-bycase basis. Furthermore, any exemptions
being granted would require review by
the ROC and be individually
documented by the SEF or DCM, all
which would take administrative time.
SEFs and DCMs will incur additional
costs if they grant employee trading
exemptions, but do not already have
processes in place to diligently monitor
the trading by those employees.
However, the Commission believes that
SEFs and DCMs should have existing
programs to monitor, detect, and deter
abuses that may arise from trading
conducted pursuant to an exemption
from the employee trading prohibition.
A SEF or DCM should, for example,
utilize its existing surveillance program
to monitor trading by employees or
other insiders subject to proposed
§§ 37.1203 and 38.853. Such existing
resources may alleviate some of the
burden and costs associated with
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compliance with proposed §§ 37.1203
and 38.853.
The Commission requests comments
on the potential costs of proposed
§§ 37.1203 and 38.853, including any
costs that would be imposed on SEFs,
DCMs, other market participants, or the
financial system more broadly.
C. Section 15(a) Factors
In addition to the discussion above,
the Commission has evaluated the costs
and benefits of the proposed
amendments to §§ 37.1203 and 38.853
in light of the specific considerations
identified in Section 15(a) of the CEA.
The Commission believes that proposed
§§ 37.1203 and 38.853 may have a
beneficial effect on protection of market
participants and the public, as well as
on the financial integrity of the markets.
The Commission believes that
preventing members of the board of
directors, committee members,
employees, consultants, and those with
an ownership interest of 10 percent or
more in the SEF or DCM with access to
material non-public information from
leveraging their access to benefit
themselves, or others, commercially or
otherwise, upholds the principle of fair
markets. Furthermore, the Commission
believes that the requirements related to
granting and monitoring employee
trading exemptions to will enhance
employee accountability and promote
transparency, which are essential for
establishing the integrity of markets.
The Commission has considered the
other Section 15(a) Factors and believes
that they are not implicated by proposed
§§ 37.1203 and 38.853.
v. Composition and Related
Requirements for Board of Directors—
Proposed §§ 37.1204 and 38.854
DCMs are not subject to a specific
statutory or regulatory requirement to
have a certain threshold of public
directors.287 Existing Commission
regulation § 1.64(b)(1) requires SEFs to
include at least 20 percent ‘‘nonmember’’ directors in the board of
directors.
The Commission proposes the
following composition standards for the
board of directors for both SEFs and
DCMs by: (i) codifying in proposed
§ 38.854(a)(1) the DCM Core Principle
287 However, the DCM Core Principle 16
Acceptable Practices set forth practices to
demonstrate compliance with DCM Core Principle
16. Among other topics, the acceptable practices
provide that a DCM’s board of directors or executive
committees would be comprised of at least 35
percent public directors. The Commission notes
that currently all of the DCMs that are designated
by the Commission rely on the acceptable practices
to comply with Core Principle 16, in lieu of any
other means for compliance.
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19689
16 Acceptable Practice standards that
DCM boards of directors be composed of
at least 35 percent public directors; (ii)
extending this requirement to SEF
boards of directors under proposed
§ 37.1204(a)(1); 288 and (iii) adopting
additional requirements to increase
transparency and accountability of the
board of directors. Proposed
§§ 37.1204(b) and 38.854(b) require that
each member of a SEF’s or DCM’s board
of directors, including public directors,
have relevant expertise to fulfill the
roles and responsibilities of being a
director.
Proposed §§ 37.1204(c) and 38.854(c)
prohibit linking the compensation of
public directors and other nonexecutive members of the board of
directors, to either the business
performance of the SEF or DCM or an
affiliate. Proposed §§ 37.1204(d) and
38.854(d) require SEFs’ and DCMs’
board of directors to conduct an annual
self-assessment to review their
performance.
A. Benefits
In general, a board of directors plays
a crucial role in an exchange’s ability to
identify, manage, and resolve conflicts
of interest. Together with senior
management, the board of directors set
the ‘‘tone at the top’’ for a SEF’s or
DCM’s governance and compliance
culture. The Commission believes that
the proposed 35 percent public director
standard is likely to provide benefits for
both SEFs and DCMs. For example, in
comparison to the existing twentypercent ‘‘non-member’’ requirement for
SEFs in existing § 1.64(b)(1), which has
created an unintentional consequence of
allowing SEFs to compose their boards
of directors entirely with ‘‘insiders’’
such as executives at the SEF’s affiliate,
the proposed rule will promote
independent decision-making on the
board of directors. Composition
standards for the board of directors that
promote a well-functioning governing
body with the presence of directors that
are independent from the executive
team, coupled with clear,
comprehensive policies and procedures,
will minimize conflicts of interests at
SEFs and DCMs, and the resulting
impact that such conflicts could have on
a SEF’s or DCM’s market regulation
functions. Since all current DCMs have
adopted the DCM Core Principle 16
Acceptable Practices, which include 35
percent public directors, the benefits of
the proposed 35 percent composition
requirement will be limited. It is
important to note that the proposed 35
percent threshold is less than the
288 See
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composition requirements applicable to
publicly-traded companies, which
require that the majority of the board of
directors to be ‘‘independent’’ directors.
While the proposed threshold is lower
than the standard that applies to
publicly-traded companies, the
Commission seeks to strike the
appropriate balance between promoting
independence on the board of directors
and providing enough flexibility to
include directors with the necessary
industry expertise.
By setting the percentage of public
directors at 35 percent and requiring
enhanced accountability by board of
directors through an annual selfassessment, the Commission believes
that proposed §§ 37.1204(a) and
38.854(a) will provide multiple benefits.
First, public directors may offer
perspectives and experiences that differ
but complement the views of internal
directors to aid decision-making at
exchanges. Second, establishing clear
roles and responsibilities for board of
directors will enhance accountability.
Third, the proposed §§ 37.1204(b) and
38.854(b) requirements that members of
SEF’s and DCM’s board of directors
have relevant expertise will ensure
these individuals can contribute to a
well-functioning board of directors that
is capable of addressing complex
problems that SEFs and DCMs face.
To further minimize conflicts of
interest, proposed §§ 37.1204(c) and
38.854(c) prohibit the compensation of
public directors and other nonexecutive members of the board of
directors from being directly dependent
on the business performance of either
the SEF or DCM or an affiliate. This
requirement helps to ensure that nonexecutive directors remain independent
and make objective decisions for the
SEF or DCM—not for their own
financial benefit. This also should
promote public confidence in the ability
of the board of directors to effectively
govern the SEF or DCM.
The Commission believes that
proposed §§ 37.1204(c) and 38.854(c)
requirements for SEF and DCM boards
of directors to conduct annual selfassessments should enhance boards of
directors’ accountability and improve
their ability to meet the standards of
conduct expected by the proposed rules,
which in turn will benefit SEFs, DCMs,
market participants, and the financial
system more broadly. The
documentation process will also create
benefits by allowing Commission staff to
request to see the results of the selfassessment during the course of rule
enforcement reviews. To the extent that
SEFs and DCMs already conduct selfassessments of their boards of directors,
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these benefits will be limited or may
already have been realized.
B. Costs
The requirements in proposed
§§ 37.1204(a)(1) and (3) and 38.854(a)(1)
and (3) requiring SEF and DCM board of
directors and executive committees to
be composed of 35 percent public
directors could cause SEFs and DCMs to
incur higher costs, compared to nonpublic directors, because public
directors must meet additional
qualifications and therefore it may take
SEF and DCM staff additional time to
identify such persons. Similarly,
requiring members of the board of
directors to have relevant expertise,
under proposed §§ 37.1204(b) and
38.854(b) and will impose costs in terms
of SEF and DCM staff time. When the
composition requirements are first
established, some SEFs and DCMs will
incur initial costs to identify and
appoint new members for their boards
of directors that satisfy the composition
requirements of proposed §§ 37.1204(b)
and 38.854(b). Time requirements will
vary based on SEFs and DCMs current
composition of the board of directors.
Proposed §§ 37.1204(a)(2) and
38.854(a)(2) will require SEFs and
DCMs to draft policies and procedures
setting forth the requirements of the
board of directors, including how the
board oversees the entity’s compliance
with statutory, regulatory, and selfregulatory responsibilities. At a
minimum, existing board of directors’
policies would need to be reviewed,
and, as necessary, such policies would
need to be revised. To the extent that
such policies are approved by the board
of directors, the board of directors
would need to devote additional
meeting time to approve such policies.
Prohibiting compensation being
directly linked to business performance,
for public directors and other nonexecutive members, as required by
proposed §§ 37.1204(c) and 38.854(c)
will impose costs in terms of time
necessary to review existing
compensation plans, and revise such
plans if they are not in compliance.
The requirements under proposed
§§ 37.1204(d) and 38.854(d) for a SEF’s
and DCM’s board of directors to conduct
an annual self-assessment will impose
costs in terms of conducting such a
review, including reviewing policies
and procedures and interviewing SEF or
DCM staff. Additionally, there will be
costs of the time of the board of
directors evaluating and approving the
self-assessment at board meetings.
Proposed §§ 37.1204(e) and 38.854(e)
require procedures for removing
members of the board of directors, when
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the conduct of a member is likely to be
prejudicial to the sound and prudent
management of the SEF or DCM. The
proposed requirements will impose
costs relating to reviewing existing
procedures, drafting new procedures if
necessary, and board of director’s time
in assessing situations where a
member’s conduct may be problematic.
The requirements in proposed
§§ 37.1204(f) and 38.854(f) relating to
reporting to the Commission within five
business days of any change in board
membership or any of its committees
will require SEF and DCM staff time in
notifying the Commission, as
applicable, when changes to the
membership of the board of directors or
any of its committees occur.
Generally, costs associated with
complying with proposed §§ 37.1204
and 38.854 may further vary based on
the size of the SEF or DCM, available
resources, and existing practices, rules,
and procedures. Accordingly, those
costs would be impracticable to
reasonably quantify. Further, rules and
procedures required for implementing
the proposed board of director
requirements would likely not change
significantly from year to year, so after
the initial creation of the rules and
procedures, the time required to
maintain those procedures would be
negligible. To the extent that SEFs and
DCMs have adopted existing board of
director composition standards under
DCM Core Principle 16 Acceptable
Practices, some of the costs identified
above will have already been realized.
The Commission requests comments
on the potential costs of proposed
§§ 37.1204 and 38.854, including any
costs that would be imposed on SEFs,
DCMs, other market participants, or the
financial system more broadly.
C. Section 15(a) Factors
In addition to the discussion above,
the Commission has evaluated the costs
and benefits of proposed §§ 37.1204 and
38.854 in light of the specific
considerations identified in Section
15(a) of the CEA. The Commission
believes that proposed §§ 37.1204 and
38.854 may have a beneficial effect on
protection of market participants and
the public, as well as on the financial
integrity of the markets. Public
directors, with their independent
perspective, might consider and
advocate for stakeholders that nonpublic directors do not consider. As a
result, this might lead to greater
protection of the wider public. The
Commission has considered the other
Section 15(a) Factors and believes that
they are not implicated by proposed
§§ 37.1204 and 38.854.
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vi. Public Director Definition—Proposed
§§ 37.1201(b)(12) and 38.851(b)(12)
the SEFs’ or DCMs’ decision-making
process.
The definition of ‘‘public director’’ in
proposed §§ 37.1201(b)(12) and
38.851(b)(12) excludes a person who has
a ‘‘material relationship’’ with the SEF
or DCM from serving as a public
director, and defines a ‘‘material
relationship’’ as one that could affect
the independent judgment or decisionmaking ability of the director. The
public director definition enumerates
certain relationships that are deemed to
be material: (1) the director is an officer
or an employee of the SEF or DCM, or
an officer or an employee of its affiliate;
(2) the director is a member of the DCM
or is a director, officer, or an employee
of either a member or an affiliate of a
member; (3) the director directly or
indirectly owns more than 10 percent of
the SEF or DCM or an affiliate of the
SEF or DCM, or is an officer or
employee of an entity that directly or
indirectly owns more than 10 percent of
SEF or DCM; (4) the director, or an
entity in which the director is a partner,
an officer, an employee, or a director
receives more than $100,000 in
aggregate annual payments from the SEF
or DCM, or an affiliate of the SEF or
DCM. A material relationship
disqualifies a person from being a
public director. The material
relationship disqualifier also applies to
any person with whom the director has
a ‘‘family relationship,’’ as set forth in
proposed §§ 37.1201(b)(7) and
38.851(b)(7), and is subject to a one-year
look-back period.
B. Costs
The Commission does not believe that
there are costs associated with the
definition of ‘‘public director’’ in
proposed §§ 37.1201(b)(12) and
38.851(b)(12). However, SEFs and DCMs
will incur costs associated with making
determinations on whether an
individual is qualified to serve as a
public director. Those costs include the
process to identify, minimize, and
resolve conflicts of interests as proposed
by §§ 37.1201(a) and 38.851(a), and to
determine whether a person meets
fitness standards under proposed
§§ 37.207 and 38.801, discussed above.
Finally, the Commission notes that if an
individual is found not to be eligible to
serve, the SEF or DCM can mitigate the
costs incurred with making such
determination if it chooses to nominate
the individual as a non-public director.
Costs associated with complying with
the proposed §§ 37.1201(b)(12) and
38.851(b)(12) may vary based on the size
of the SEF and DCM, its available
resources, and its existing practices and
policies. To the extent that SEFs and
DCMs have voluntarily adopted existing
public director standards under the
DCM Core Principle 16 Acceptable
Practices, some of the costs identified
above will have already been realized.
The Commission requests comments
on the potential costs of proposed
§§ 37.1201(b)(12) and 38.851(b)(12),
including any costs that would be
imposed on SEFs, DCMs, other market
participants, or the financial system
more broadly.
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A. Benefits
The Commission believes that
codifying the public director definition
for both SEFs and DCMs in proposed
§§ 37.1201(b)(12) and 38.851(b)(12) will
provide several benefits. First,
expanding the disqualifying factors to
prohibit individuals who, directly or
indirectly, own more than 10 percent of
either the SEF or DCM or an affiliate
will further prevent individuals with
specific conflicts of interests, including
personal financial interests, from
serving as public directors and makes it
more likely that decision-makers will
remain independent. Second, applying
the disqualifying factors to family
relationships ensures that public
directors are not influenced by familial
connections. Third, requiring both an
initial and annual review of the
qualifications of public directors should
reduce the risk that existing public
directors may become disqualified in
the course of the service on the board
of directors and become conflicted in
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C. Section 15(a) Factors
In addition to the discussion above,
the Commission has evaluated the costs
and benefits of proposed
§§ 37.1201(b)(12) and 38.851(b)(12) in
light of the specific considerations
identified in Section 15(a) of the CEA.
The Commission believes that the
public director definition under
proposed §§ 37.1201(b)(12) and
38.851(b)(12) may have a beneficial
effect on the protection of market
participants and the public, as well as
on the financial integrity of the
markets.289 Ensuring sufficient
independent judgment through the
inclusion of public directors will
improve the overall decision-making of
a SEF or DCM and protect the market
regulation functions. The Commission
has considered the other Section 15(a)
289 See supra, Section V(b), ‘‘public director’’
definition—proposed §§ 37.1201(b)(12) and
38.851(b)(12).
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19691
Factors and believes that they are not
implicated by proposed
§§ 37.1201(b)(12) and 38.851(b)(12).
vii. Nominating Committee—Proposed
§§ 37.1205 and 38.855
Currently, neither SEFs nor DCMs are
obligated by Commission regulations to
have a nominating committee to identify
or manage the process for nominating
potential members of the board of
directors. DCM Core Principle 17
requires the governance arrangements of
a board of directors of a DCM to permit
consideration of the views of market
participants. Similarly, pursuant to
Commission regulation § 1.64(b)(3), an
SRO, such as a SEF, must include a
diversity of membership interests on
their governing boards.
The Commission is proposing
§§ 37.1205 and 38.855 to require SEFs
and DCMs to have a nominating
committee. The role of the nominating
committee would be to identify a pool
of candidates who are qualified to serve
on the board of directors who represent
diverse interests, including the interests
of the participants and members of the
SEF or DCM. Furthermore, proposed
§§ 37.1205 and 38.855 would require: at
least 51 percent of the nominating
committee be comprised of public
directors, the nominating committee be
chaired by a public director, and the
nominating committee report directly to
the board of directors.
A. Benefits
The Commission believes that
proposed §§ 37.1205 and 38.855
establishing SEF and DCM nominating
committees will help protect the
integrity of selecting members for the
board of directors and assist SEFs and
DCMs in identifying qualified
candidates. The Commission believes
that requiring 51 percent of the
nominating committee to be public
directors will help maintain
independence and objectivity in
selecting nominees for the board of
directors. Additionally, the requirement
in proposed §§ 37.1205 and 38.855 that
the nominating committee identify
individuals that reflect the views of
market participants will help ensure
that a broader pool of candidates with
more diverse viewpoints are considered
to serve on the board of directors. The
Commission believes that these diverse
viewpoints may improve the decisionmaking of the SEF or DCM. These
benefits, in turn, will improve the
governance and public perception of the
SEF or DCM.
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B. Costs
integrity of the markets. The
Commission believes that the proposed
rules requiring SEF and DCM
nominating committees will have a
beneficial effect on the identification of
nominees for the board of directors who
have independent and diverse
experiences. Such characteristics, the
Commission believes, will aid in
recruiting members for the board of
directors who will contribute to making
sound decisions for SEFs and DCMs,
and, ultimately, for the markets. The
Commission has considered the other
Section 15(a) Factors and believes that
they are not implicated by proposed
§§ 37.1205 and 38.855.
Since SEFs and DCMs are not
currently required to have nominating
committees, some entities would need
to revise their existing policies and
procedures to create a nominating
committee in accordance with proposed
§§ 37.1205 and 38.855. Accordingly,
proposed §§ 37.1205 and 38.855 would
impose some costs on these SEFs and
DCMs, including costs that could arise
from additional hours SEF and DCM
employees might need to spend time
reviewing existing SEF and DCM
policies and procedures, and designing
and implementing new or amended
rules and procedures, as necessary.
Specifically, drafting new policies
and procedures to form a nominating
committee would cost administrative
time. Those administrative costs
associated with complying with
proposed §§ 37.1205 and 38.855 may
vary based on the size of the SEF or
DCM, available resources, and existing
practices, rules, and procedures.
Accordingly, those costs would be
impracticable to reasonably quantify.
Further, rules and procedures required
to administer a nominating committee
would likely not change significantly
from year to year, so after the initial
creation of the rules and procedures, the
time required to maintain those
procedures would be negligible.
When the nominating committee is
first established, the SEF and DCM will
incur initial costs related to identifying
potential members for the nominating
committee, including public directors
that must comprise 51 percent of the
committee. Ongoing implementation of
proposed §§ 37.1205 and 38.855 would
also impose costs whenever the
nominating committee meets to identify
new candidates for the board of
directors, nominates individuals to the
board of directors, and reports their
decisions to the SEF or DCM board of
directors.
The Commission requests comments
on the potential costs of proposed
§§ 37.1205 and 38.855, including any
costs that would be imposed on SEFs,
DCMs, other market participants, or the
financial system more broadly.
ddrumheller on DSK120RN23PROD with PROPOSALS2
C. Section 15(a) Factors
In addition to the discussion above,
the Commission has evaluated the costs
and benefits of proposed §§ 37.1205 and
38.855 in light of the specific
considerations identified in Section
15(a) of the CEA. The Commission
believes that proposed §§ 37.1205 and
38.855 may have a beneficial effect on
protection of market participants and
the public, as well as on the financial
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viii. Regulatory Oversight Committee—
Proposed §§ 37.1206 and 38.857
Currently, the DCM Core Principle 16
Acceptable Practices provide that DCMs
establish a ROC, consisting of only
public directors, to assist in minimizing
actual and potential conflicts of interest.
The purpose of the ROC is to oversee
the DCM’s regulatory program on behalf
of the board of directors, which in turn,
delegates the necessary authority,
resources, and time for the ROC to fulfill
its mandate. The ROC is responsible for:
(1) monitoring the DCM’s regulatory
program for sufficiency, effectiveness,
and independence; (2) overseeing all
facets of the regulatory program; (3)
reviewing the size and allocation of the
regulatory budget and resources; and the
number, hiring and termination, and
compensation of regulatory personnel;
(4) supervising the DCM’s CRO, who
reports directly to the ROC; (5)
preparing an annual report assessing the
DCM’s self-regulatory program for the
board of directors and the Commission;
(6) recommending changes that would
ensure fair, vigorous, and effective
regulation; and (7) reviewing regulatory
proposals and advising the board as to
whether and how such changes may
impact regulation. In performing these
functions, the ROC plays a critical role
in insulating the CRO and the DCM’s
self-regulatory function from undue
influence.
Currently, SEFs do not have any
requirements for establishing a ROC but
they are subject to Core Principle 15,
which requires SEFs to designate a CCO
to monitor its adherence to statutory,
regulatory, and self-regulatory
requirements and to resolve conflicts of
interest that may impede such
adherence. The CCO is required to
report to the SEF board of directors (or
similar governing body) or the senior
SEF officer.
The Commission is proposing to
codify the ROC component of the DCM
Core Principle 16 Acceptable Practices
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for both SEFs and DCMs. Proposed
§§ 37.1206(a) and 38.857(a),
respectively, require SEFs and DCMs to
establish a ROC composed of only
public directors. In addition, the
Commission is proposing §§ 37.1206(c)
and 38.857(c), which require the board
of directors to delegate sufficient
authority, dedicate sufficient resources,
and allow sufficient time to perform its
functions to ensure that the ROC can
fulfill its mandate and duties.
Furthermore, proposed §§ 37.1206(d)
and 38.857(d) would require SEF and
DCM ROCs, respectively, to have
oversight duties over the market
regulation functions, including: (1)
monitoring the SEF’s or DCM’s market
regulation functions for sufficiency,
effectiveness, and independence; (2)
overseeing all facets of the market
regulation functions; (3) approving the
size and allocation of the regulatory
budget and resources; and the number,
hiring and termination, and
compensation of staff; (4)
recommending changes that would
promote fair, vigorous, and effective
self-regulation; and (5) reviewing all
regulatory proposals prior to
implementation and advising the board
of directors as to whether and how such
proposals may impact market regulation
functions.
The Commission also is proposing
several new requirements related to
procedures and documentation for ROC
meetings that reflect the best practices
that have been identified during the
Commission’s oversight of DCMs.
Proposed §§ 37.1206(f) and 38.857(f)
would require SEF and DCM ROCs to
meet quarterly. In addition, proposed
§§ 37.1206(f)(1)(iii) and 38.857(f)(1)(iii)
would require that ROC meeting
minutes include: (a) list of the
attendees; (b) their titles; (c) whether
they were present for the entirety of the
meeting or a portion thereof (and if so,
what portion); and (d) a summary of all
meeting discussions. Proposed
§§ 37.1206(f)(2) and 38.857(f)(2) would
require the ROC to maintain
documentation of the committee’s
findings, recommendations, and any
other discussions or deliberations
related to the performance of its duties.
The Commission also is proposing rules
to require an annual ROC report, which
would enhance the ROC report
procedures currently set forth in the
DCM Core Principle 16 Acceptable
Practices. Specifically, the Commission
is proposing §§ 37.1206(g)(1) and
38.857(g)(1) to require that ROC annual
reports include a list of any actual or
potential conflicts of interest that were
reported to the ROC and a description
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of how such conflicts of interest were
managed and resolved and an
assessment of the impact of any
conflicts of interest on the SEF’s or
DCM’s ability to perform its market
regulation functions. In addition,
proposed §§ 37.1206(g)(2) and
38.857(g)(2) would establish a process
for filing the ROC annual report which
mirrors the existing SEF annual
compliance report requirements in
Commission regulation § 37.1501(e).
These proposed requirements would
establish the following: (1) a filing
deadline no later than 90 days after the
end of the fiscal year; (2) a process for
amendments and extension requests; (3)
recordkeeping requirements; and (4)
delegated authority to the Division of
Market Oversight to grant or deny
extensions. Finally, proposed
§§ 37.1206(g)(3) and 38.857(g)(3) require
SEFs and DCMs to maintain all records
demonstrating compliance with the
duties of the ROC and the preparation
and submission of its annual report.
A. Benefits
Proposed §§ 37.1206 and 38.857
establish the creation and duties for SEF
and DCM ROCs. These proposed rules
will generate benefits by establishing
effective structural governance
protections to assist SEFs and DCMs in
minimizing conflicts of interest that
may impact their market regulation
functions. The ROC will help to ensure
that improper influences and pressures
from a SEF’s or DCM’s commercial
interest do not denigrate the integrity of
the market regulation functions.
Because both SEFs and DCMs are SROs,
these benefits extend well beyond the
internal functioning of a SEF or DCM.
Since SEFs and DCMs have similar
commercial interests that may conflict
with their market regulation functions,
the Commission believes that applying
similar ROC structures across SEFs and
DCMs will result in a more level and
resilient marketplace, which in turn will
promote competition in the derivatives
markets.
The proposed rules address the types
of conflicts of interest Commission staff
has identified through its SEF and DCM
oversight activities. Accordingly, the
proposed rules are based on existing,
identifiable solutions that have already
benefitted SEFs and DCMs. To the
extent that the existing SEF and DCM
practices are similar to the proposed
requirements, the benefits will be
limited or already have been realized.
The requirements under proposed
§§ 37.1206(f) and 38.857(f) relating to
ROC meetings and documentation
should provide a number of benefits.
First, the quarterly meeting requirement
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facilitates the free-flow of information
between the ROC and the SEF’s CCO or
the DCM’s CRO. This is an opportunity
to share information, discuss matters of
mutual concern, and speak freely about
potentially sensitive issues that may
relate to the SEF’s or DCM’s
management. Such communication may
enable the SEF or DCM to more
effectively fulfill its market regulation
function. Similarly, restricting
individuals with actual or potential
conflicts of interest from attending ROC
meetings ensures that sensitive
information related to the market
regulation function is not broadly
disseminated. The documentation
requirements, such as requiring ROC
meeting minutes under proposed
§§ 37.1206(f)(1)(iii) and 38.857(f)(1)(iii),
and the ROC annual reporting
requirements under proposed
§§ 37.1206(g)(1) and 38.857(g)(1), are
mechanisms to enhance the
accountability of the ROC and promote
transparency for all stakeholders.
Ultimately, market participants will
benefit from the improvements in SEF
and DCM governance operations.
B. Costs
The proposed rules would impose
some costs on SEFs and DCMs. To the
extent that DCMs and some SEFs
already have established a ROC, they
may incur some costs related to
updating their ROC policies and
procedures to comply with proposed
§§ 37.1204 and 38.854. Costs could arise
from additional hours SEF and DCM
employees might need to spend
analyzing the compliance of their rules
and procedures with these
requirements, drafting and
implementing new or amended rules
and procedures, when necessary. While
some SEFs have chosen to create ROCs,
those SEFs that do not current have
ROCs may incur additional costs
associated with establishing the
committee and identifying the public
directors that will serve on the
committee. Specifically, drafting new
policies to form this committee would
cost administrative time. The amount of
time required to establish this
committee would vary based on a
number of factors, including whether
the SEF’s or DCM’s existing policies
complying with the proposed rules, and
the amount of time necessary for each
SEF and DCM to draft and implement
new or amended polices, where
necessary. Further, policies required for
implementing the proposed rules would
likely not change significantly from year
to year, so after the initial creation of the
policies, the time required to create
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19693
rules and procedures would be
negligible.
When the ROC is initially established,
the SEF or DCM will incur costs for the
time spent to identify potential
members that meet public director
composition requirement. Ongoing
implementation of the proposed rules
also would impose costs. For example,
there may be costs associated with
providing necessary information to the
ROC for its consideration, and time
spent by the members of a SEF’s or
DCM’s board of directors or senior
officer to meet and consult with the
ROC, and consider and respond to any
information requested by the ROC. A
ROC’s operation also would require
time from its members to meet at least
on a quarterly basis, as required by
proposed §§ 37.1206(f) and 38.857(f).
ROC members also will spend time on
the duties outlined in proposed
§§ 37.1206(d) and 38.857(d).
There may be additional costs related
to ROC meetings, reporting, and
recordkeeping. Proposed
§§ 37.1206(f)(1)(iii) and 38.857(f)(1)(iii)
require ROCs to keep minutes of their
meetings and proposed §§ 37.1206(f)(2)
and 38.857(f)(2) require ROCs to
maintain documentation of findings,
recommendations, and any other
discussions or deliberations. Proposed
§§ 37.1206(g)(1) and 38.857(g)(1) require
ROCs to prepare an annual report for the
board of directors and the Commission.
The time spent drafting the annual
report will include time spent assessing
the SEF’s or DCM’s self-regulatory
program and preparing the report with
the information required in proposed
§§ 37.1206(g)(1)(i)–(vi) and
38.857(g)(1)(i)–(vi). Finally, SEFs and
DCMs may incur some initial costs
associated with establishing a process to
maintain all records demonstrating
compliance with the duties of the ROC
and the preparation and submission of
annual reports, as required by proposed
§§ 37.1206(g)(3) and 38.857(g)(3).
Costs associated with complying with
proposed §§ 37.1206(f) and 38.857(f)
may vary based on the size of the SEF
and DCM, available resources, and
existing practices and policies. To the
extent that SEFs and DCMs have
adopted existing ROC standards under
the DCM Core Principle 16 Acceptable
Practices, some of the costs identified
above will have already been realized.
The Commission requests comments
on the potential costs of proposed
§§ 37.1206 and 38.857, including any
costs that would be imposed on SEFs,
DCMs, other market participants, or the
financial system more broadly. In
particular, for those SEFs and DCMs
that already have ROCs in place, the
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Commission requests comment on the
extent to which the proposed rules
would require changes to existing ROC
policies and procedures.
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C. Section 15(a) Factors
In addition to the discussion above,
the Commission has evaluated the costs
and benefits of proposed §§ 37.1206 and
38.857 in light of the specific
considerations identified in Section
15(a) of the CEA. The Commission
believes that proposed §§ 37.1206 and
38.857 may have a beneficial effect on
protection of market participants and
the public, as well as on the financial
integrity of the markets by strengthening
the boards oversight of the market
regulation functions of SEFs and DCMs.
The Commission has considered the
other Section 15(a) Factors and believes
that they are not implicated by proposed
§§ 37.1206 and 38.857.
ix. Disciplinary Panel Composition—
Proposed §§ 37.1207 and 38.858
Currently, the DCM Core Principle 16
Acceptable Practices provide that DCMs
establish disciplinary panel
composition standards. Those
acceptable practices state that no group
or class of industry participants may
dominate or exercise disproportionate
influence on such panels. Furthermore,
the DCM Core Principle 16 Acceptable
Practices provide that all disciplinary
panels (and appellate bodies) include at
least one person who would qualify as
a public director, except in cases limited
to decorum, attire, or the timely
submission of accurate records required
for clearing or verifying each day’s
transactions. Currently, Commission
regulation § 1.64(c) requires SEF major
disciplinary committees to include: (1)
at least one member who is not a
member of the SEF; and (2) sufficient
different membership interests to ensure
fairness and to prevent special treatment
or preference for any person in the
conduct of a committee’s or the panel’s
responsibility.
The Commission is proposing
§§ 37.1207 and 38.858 for both SEFs and
DCMs, respectively, to adopt
disciplinary panel composition
requirements which prohibit any
member of a disciplinary panel from
participating in deliberations or voting
on any matter in which the member has
an actual or potential conflict of
interest. With this proposed rulemaking,
SEFs will be exempt from complying
with Commission regulation § 1.64(c)
since they will be subject to this new
rule.
In addition, the Commission is
proposing §§ 37.1207(a) and (b) and
38.858(a) and (b) to clarify that SEF and
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DCM disciplinary panels and appellate
panels must consist of two or more
persons. The Commission is also
proposing §§ 37.1207(b) and 38.858(b)
to extend the public participant
requirement to any SEF and DCM
committee to which disciplinary panel
decisions may be appealed. Finally, the
Commission is proposing technical
amendments to Commission regulations
§§ 37.206(b) and 38.702 to remove the
references that disciplinary panels must
meet the composition requirements of
part 40 and replace these references
with references to proposed regulations
§§ 37.1207 and 38.858, respectively. The
Commission also proposes changing the
reference to ‘‘compliance’’ staff to
‘‘market regulation’’ staff. This is
intended for clarity and is consistent
with proposed changes to §§ 38.155(a)
and 37.203(c).
A. Benefits
The requirement under proposed
§§ 37.1207 and 38.858 for SEFs and
DCMs to establish disciplinary panel
requirements is likely to provide a
number of benefits. The composition
requirements of §§ 37.1207(a) and
38.858(a) instill fairness in the
disciplinary process by requiring a
minimum of two members, one of
whom must be a public participant.
This ensures that the disciplinary
panels have a degree of independence
from outside influences, and are capable
of functioning impartially. Proposed
§§ 37.1207(a)(1) and (2) and 38.858(a)(1)
and (2) further these goals by precluding
any group or class of participants from
dominating or exercising
disproportionate influence on a
disciplinary panel, and prohibiting any
member of a disciplinary panel from
participating in deliberations or voting
on any matter in which the member has
an actual or potential conflict of
interest. These safeguards increase the
likelihood that disciplinary proceedings
are handled by competent individuals
that represent a diversity of
perspectives, and are free of conflicts of
interest. This, in turn, may benefit the
overall integrity of the derivatives
markets.
B. Costs
SEFs and DCMs are already required
to establish disciplinary panels
pursuant to Commission regulations
§§ 37.206(b) and 38.702. Accordingly,
the potential cost is limited to the
changes necessary to comply with
proposed §§ 37.1207 and 38.858. Initial
costs could arise from additional
administrative hours SEF and DCM
employees might need to spend
analyzing the compliance of their rules
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and procedures with these
requirements, and drafting and
implementing new or amended rules, as
necessary. Once these rules and policies
are established, they would likely not
change significantly from year to year.
SEFs and DCMs may need to change
the composition of their disciplinary
panels to satisfy the requirements of
proposed §§ 37.1207(a) and 38.858(a),
and ensure that these requirements are
extended to appellate panels, as
required by proposed §§ 37.1207(b) and
38.858(b). Additionally, proposed
§§ 37.1207 and 38.858 prohibit any
member of the panel from voting on
issues in which they have a conflict of
interest, which may reduce the number
of potential suitable individuals who
may serve on the disciplinary panel.
Costs associated with complying with
the proposed §§ 37.1207(b) and
38.858(b) may further vary based on the
size of the SEF and DCM, its available
resources, its existing practices and
policies. To the extent that SEFs and
DCMs have adopted existing
disciplinary panel standards under the
Acceptable Practices for DCM Core
Principle 16, some of the costs
identified above will have already been
realized. The Commission requests
comments on the potential costs of
proposed §§ 37.1207 and 38.858,
including any costs that would be
imposed on SEFs, DCMs, other market
participants, or the financial system
more broadly. In particular, for those
SEFs and DCMs that already have
disciplinary panels in place, the
Commission requests comment on the
extent to which the proposed rules
would require changes to existing
policies and procedures regarding their
disciplinary panels.
C. Section 15(a) Factors
In addition to the discussion above,
the Commission has evaluated the costs
and benefits of the proposed
amendments to §§ 37.1207 and 38.858
in light of the specific considerations
identified in Section 15(a) of the CEA.
The Commission believes that proposed
§§ 37.1207 and 38.858 may have a
beneficial effect on protection of market
participants and the public, as well as
on the financial integrity of the markets.
The Commission believes that by better
ensuring the fairness of the disciplinary
process, market participants can have
greater trust in the oversight process of
SEF and DCM rules. The Commission
has considered the other Section 15(a)
Factors and believes that they are not
implicated by proposed §§ 37.1207 and
38.858.
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x. DCM Chief Regulatory Officer—
Proposed § 38.856
Commission regulations do not
currently require DCMs to have a CRO.
However, the framework created under
the DCM Core Principle 16 Acceptable
Practices includes a reference to a CRO,
who reports directly to the ROC.
The Commission is proposing
§ 38.856(a)(1) to require DCMs to
establish the position of a CRO to
administer a DCM’s market regulation
functions. The proposed rules would
require that (i) the position of CRO must
carry with it the authority and resources
necessary to fulfill the duties set forth
in this section for CROs; and (ii) the
CRO must have supervisory authority
over all staff performing the DCM’s
market regulation functions.
In addition, the Commission is
proposing § 38.856(a)(2) to require that
the individual designated to serve as
CRO must have the background and
skills appropriate for fulfilling the
duties of the position. A DCM, therefore,
is expected to identify the needs of its
own market regulation functions and
ensure that the CRO has the requisite
surveillance and investigatory
experience necessary to perform the
role. Moreover, individuals disqualified
from registration pursuant to sections
8a(2) or 8a(3) of the CEA are ineligible
to serve as a CRO.
Proposed § 38.856(b) requires the CRO
to report directly to the DCM’s board of
directors or senior officer. The
Commission is also proposing
§ 38.856(c) to require (1) the
appointment or removal of a DCM’s
CRO to occur only with the approval of
the DCM’s ROC; (2) the DCM to notify
the Commission within two business
days of the appointment of any new
CRO, whether interim or permanent;
and (3) the DCM to notify the
Commission within two business days
of removal of the CRO. The Commission
is proposing § 38.856(d) to require the
board of directors or the senior officer
of the DCM, in consultation with the
DCM’s ROC, to approve the
compensation of the CRO.
The Commission is proposing
§ 38.856(e) to establish the duties of the
CRO, which include: (1) supervising the
DCM’s market regulation functions; (2)
establishing and administering policies
and procedures related to the DCM’s
market regulation functions; (3)
supervising the effectiveness and
sufficiency of any regulatory services
provided to the DCM by a regulatory
service provider in accordance with
existing § 38.154; (4) reviewing any
proposed rule or programmatic changes
that may have a significant regulatory
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impact and advising the ROC on such
matters; and (5) in consultation with the
DCM’s ROC, identifying, minimizing,
managing, and resolving conflicts of
interest involving the DCM’s market
regulation functions.
Finally, proposed§ 38.856(f) requires
DCMs to establish procedures for the
CRO’s disclosure of actual or potential
conflicts of interest to the ROC, and
designation of a qualified person to
serve in the place of the CRO if the CRO
has such a conflict of interest. The
proposed rules also require
documentation of any such disclosure
regarding conflicts of interest.
A. Benefits
The Commission preliminarily
believes that establishing a position of a
CRO under proposed § 38.856(a)(1) will
enable DCMs to comply with their
statutory and regulatory obligation to
fulfill their market regulation functions.
Proposed § 38.856(a)(2) provides that
the CRO must have the necessary
background and skills appropriate for
fulfilling the responsibilities of the
position. This requirement will benefit
DCMs by ensuring CROs have the
requisite experience necessary to
oversee the DCM’s market regulation
functions. CROs who lack appropriate
background and skills for their position
would have a harder time effectively
fulfilling their duties, which could be
detrimental to the DCM’s role as a SRO.
Furthermore, proposed § 38.856(b),
which requires the CRO to directly
report to the board of directors or to the
senior officer, would make it easier for
the CRO to fulfill the duties critical to
the DCM’s market regulation functions.
For example, having a direct line to the
board of directors or the senior officer
would allow the CRO to more easily
gain approval for any new policies
related to the DCM’s market regulation
functions that the CRO needed to
implement, to the extent that they
required approval of a senior officer or
the board of directors. Since DCM rule
changes often need to be approved by
the board of directors, having the CRO
report to the board of directors or to the
senior officer (who likely regularly
communicates with the board of
directors) would allow the CRO to more
easily explain the need for rule changes,
and to answer questions from the board
of directors or the senior officer about
such changes.
Proposed §§ 38.856(c) and (d) require
the ROC to (1) approve the appointment
or removal of the CRO, and (2) consult
with the board of directors or senior
officer regarding the compensation of
the CRO. The ROC is composed of
exclusively public directors who have
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19695
no material relationship with the
exchange, and therefore, is wellpositioned to protect the CRO from
interference from commercial interests.
If the senior officer or the board of
directors sought to terminate the CRO or
decrease the CRO’s compensation, as
retaliation for not advancing the DCM’s
commercial interests ahead of the
interests of the market regulation
function, the ROC could step in to
protect the CRO. By requiring the DCM
to notify the Commission upon the
appointment of a new CRO, the
proposed rule will facilitate
Commission staff being able to contact
the new CRO to discuss regulatory
concerns. Additionally, Commission
staff can ask questions about the
removal of the old CRO, and identify
whether the ROC was involved.
Additionally, proposed § 38.856(e),
which establishes the duties of a CRO,
will provide benefits by establishing
clear and transparent standards for the
CRO duties, and may prevent the board
of directors or senior officer from
unreasonably limiting the CRO’s role.
For example, a board of directors or
senior officer would be prohibited from
taking over the market regulation
functions in order to prioritize
commercial interests.
Finally, proposed § 38.856(f), which
requires the CRO to disclose to the ROC
and document any actual or potential
conflicts of interest identified by the
CRO, is likely to provide benefits by
promoting integrity and further allowing
CROs to fulfill their duties. If the CRO
did not have to disclose their own
conflicts, the CRO’s involvement in
resolving conflicts of interest could
exacerbate, rather than mitigate,
conflicts of interest in the critical
market regulation functions of the DCM.
Therefore, proposed § 38.856(f) may
further mitigate potential conflicts of
interests in the DCM’s role as an SRO.
B. Costs
Commission regulations do not
currently require a DCM to appoint a
CRO. However, the Commission noted
that current industry practice is for
DCMs to designate an individual to
serve as CRO, and it would be difficult
for a DCM to meet the staffing and
resource requirements of § 38.155
without a CRO. However, even if all
DCMs currently have a CRO, it is
possible that some DCMs may incur
costs by having to adjust their existing
staffing structure to ensure it complies
with the specific regulatory
requirements of proposed § 38.856(a)(1).
These costs could arise from additional
hours DCM employees might need to
spend analyzing their rules, policies,
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and procedures for compliance with
these requirements, and drafting and
implementing new or amended rules,
policies, and procedures, when
necessary. Additionally, there may be
costs incurred in implementing the
appropriate policies and procedures to
ensure that the CRO has the resources
required to perform the duties set forth
in proposed § 38.856(a)(1).
DCMs may also expend
administrative time finding a suitable
candidate for the CRO position if the
DCM either does not have a CRO, or
does not have a CRO that meets the
requirements of proposed § 38.856(a)(2).
If a DCM does not already have a CRO,
the costs to identify and hire a new CRO
could be significant. Where DCMs have
existing CROs, the cost of implementing
the proposed rules may be lower.
Nevertheless, there may costs related to
ensuring the existing CRO role satisfies
all of the requirements set forth in
proposed § 38.856. Ongoing costs may
include employment costs for the
position itself, as well as time spent by
the board of directors or senior officer
to supervise the CRO and the
administrative costs associated with
notifying the Commission of the
appointment of a new CRO or the
removal of an existing CRO. The
Commission requests comments on the
potential costs of proposed § 38.856,
including any costs that would be
imposed on DCMs, other market
participants, or the financial system
more broadly. In particular, for those
DCMs that already have CROs, the
Commission requests comment on the
extent to which the proposed rules
would require changes to existing
policies and procedures regarding the
CRO position.
C. Section 15(a) Factors
In addition to the discussion above,
the Commission has evaluated the costs
and benefits of proposed § 38.856 in
light of the specific considerations
identified in Section 15(a) of the CEA.
The Commission believes that proposed
§ 38.856 may have a beneficial effect on
protection of market participants and
the public, as well as on the financial
integrity of the markets. The
Commission believes that designating a
CRO to administer the market regulation
functions of the DCM will promote
compliance with the proposed rules
related to identifying and minimizing
DCM conflicts of interest, which, in
turn, will allow the DCMs to better
provide services as an exchange. The
Commission has considered the other
Section 15(a) Factors and believes that
they are not implicated by proposed
§ 38.856.
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xi. Staffing and Investigations—
Proposed Changes to Commission
Regulations §§ 38.155, 38.158, and
37.203
Commission regulation § 38.155(a)
requires a DCM to: (1) establish and
maintain sufficient compliance
department resources and staff to ensure
that it can conduct effective audit trail
reviews, trade practice surveillance,
market surveillance, and real-time
market monitoring; (2) maintain
sufficient compliance staff to address
unusual market or trading events as they
arise; and (3) conduct and complete
investigations in a timely manner.
Furthermore, Commission regulation
§ 38.155(b) requires a DCM to: (1)
monitor the size and workload of its
compliance staff annually and ensure
that its compliance resources and staff
are at appropriate levels; and (2)
consider trading volume increases, the
number of new products or contracts to
be listed for trading, any new
responsibilities to be assigned to
compliance staff, the results of any
internal review demonstrating that work
is not completed in an effective or
timely manner, and any other factors
suggesting the need for increased
resources and staff.
Similarly, existing Commission
regulation § 37.203(c) requires SEFs to
have sufficient compliance staff and
resources to ensure it can conduct
effective audit trail reviews, trade
practice surveillance, market
surveillance, and real-time market
monitoring. Currently, SEFs are not
subject to a regulation parallel to
Commission regulation § 38.155(b)
where DCMs are required to annually
monitor the sufficiency of staff and
resources.
Finally, existing regulations
§§ 37.203(f) and 38.158, respectively,
relate to SEF and DCM obligations
regarding investigations and
investigation reports. These provisions
generally address investigation
timeliness, substance of investigation
reports, and the issuance of warning
letters.
The Commission is proposing
amendments to existing §§ 37.203(c)
and 38.155(a). First, the Commission
proposes to replace references to
‘‘compliance staff’’ with ‘‘staff.’’ Second,
proposed §§ 37.203(c) and 38.155(a)
would amend the first sentence of the
existing regulations to provide that SEFs
and DCMs must establish and maintain
sufficient staff and resources to
‘‘effectively perform market regulation
functions’’ rather than listing the
individual functions. The Commission
does not view these as substantive
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changes. References to ‘‘staff’’ rather
than ‘‘compliance staff’’ are intended for
clarity. As noted, Commission
regulations §§ 37.203(c) and 38.155(a)
are solely focused on staff dedicated to
performing market regulation functions.
The Commission also proposes to
amend § 37.203 to add a new paragraph
(d). The proposed provision would
require SEFs to annually monitor the
size and workload of their staff, and
ensure its resources and staff effectively
perform market regulation functions at
appropriate levels. In addition,
paragraph (d) would include a reference
to paragraph (c) to clarify that it applies
to staff responsible for conducting
market regulation functions. In addition,
with respect to both proposed
§ 37.203(d) and amended § 38.155(b),
the Commission is proposing to add to
the list of factors that a SEF or DCM
should consider in determining the
appropriate level of resources and staff:
(1) any responsibilities that staff have at
affiliated entities; and (2) any conflicts
of interest that prevent staff from
working on certain matters.
Additionally, the Commission
proposes certain non-substantive
changes to existing Commission
regulations §§ 38.155 and 38.158.
Proposed § 38.155 would rename the
regulation ‘‘Sufficient staff and
resources.’’ Proposed § 38.155(b) would
add an internal reference to paragraph
(a). This change is intended to clarify
that the annual staff and resource
monitoring requirement pertains to staff
performing market regulation functions
required under § 38.155(a). Proposed
§ 38.158(a) would replace the reference
to ‘‘compliance staff’’ with ‘‘staff
responsible for conducting market
regulation functions.’’ Proposed
§ 38.158(b) would delete the reference to
‘‘compliance staff investigation’’ being
required to be completed in a timely
manner, and instead provide, more
simply, that ‘‘[e]ach investigation must
be completed in a timely manner.’’
Finally, proposed §§ 38.158(c) and (d)
would delete the modifier ‘‘compliance’’
when referencing to staff.
Finally, the Commission also
proposes certain non-substantive
changes to existing Commission
regulation § 37.203. Proposed
§ 37.203(c) would rename the paragraph
‘‘Sufficient staff and resources.’’ The
addition of proposed § 37.203(d) would
result in redesignating the remaining
paragraphs of § 37.203. Proposed
§ 37.203(g)(1), which would replace
existing Commission regulation
§ 37.203(f)(1), and adds a reference to
‘‘market regulation functions,’’
consistent with the new proposed
defined term. Proposed § 37.203(g)(1),
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which would replace existing
Commission regulation § 37.203(f)(1),
adds a reference to ‘‘market regulation
functions,’’ consistent with the new
proposed defined term. Proposed
§ 37.203(g)(2)–(4) deletes the modifier
‘‘compliance’’ when referencing staff.
A. Benefits
As explained above, the Commission
is proposing certain non-substantive
changes to existing §§ 37.203(c) and
38.155(a). These changes include
replacing references to ‘‘compliance
staff’’ with ‘‘staff.’’ Proposed
§§ 37.203(c) and 38.155(a) would also
amend the first sentence of the existing
regulations to provide that SEFs and
DCMs must establish and maintain
sufficient staff and resources to
‘‘effectively perform market regulation
functions’’ rather than listing the
individual functions. Additionally, as
noted above, the Commission proposes
non-substantive changes to existing
Commission regulations §§ 38.155,
38.158 and § 37.203. Proposed
§ 37.203(c) and § 38.155 would both be
renamed as ‘‘Sufficient staff and
resources.’’ Proposed § 37.203(g)(1)
would add reference to ‘‘market
regulation functions,’’ and 38.155(b)
would add an internal reference to
paragraph (a) to achieve the same result.
Proposed § 38.158(a) would replace the
reference to ‘‘compliance staff’’ with
‘‘staff responsible for conducting market
regulation functions.’’ Proposed
§ 38.158(b) would delete the reference to
‘‘compliance staff investigation’’ being
required to be completed in a timely
manner, and instead provide, more
simply, that ‘‘[e]ach investigation must
be completed in a timely manner.’’
Finally, proposed §§ § 37.203(g)(2)–(4)
and 38.158(c) and (d) would delete the
modifier ‘‘compliance’’ when
referencing to staff. These amendments
provide additional clarity to those
regulations. Such changes may provide
benefits through enhanced regulatory
clarity for SEFs and DCMs. However, as
they are non-substantive changes,
benefits will not be significant.
The Commission also proposes to
amend § 37.203 to add a new paragraph
(d). The proposed rule would require
SEFs to annually monitor the size and
workload of its staff, and ensure its
resources and staff effectively perform
market regulation functions at
appropriate levels. In addition,
paragraph (d) would include a reference
to paragraph (c) to clarify that it applies
to staff responsible for conducting
market regulation functions. In addition,
as noted above, with respect to both
proposed § 37.203(d) and amended
§ 38.155(b), the Commission is
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19697
proposing to add to the list of factors
that a SEF or DCM should consider in
determining the appropriate level of
resources and staff: (1) any
responsibilities that staff have at
affiliated entities; and (2) any conflicts
of interest that prevent staff from
working on certain matters. Market
regulation functions are critical for the
performance of a SEF’s self-regulatory
obligations. This amendment is
beneficial because it will help ensure
sufficiency of SEF staff responsible for
performing market regulation functions
and identify in a timely way any
potential conflicts of interest relating to
market regulations staff, particularly
regarding a SEF’s or DCM’s affiliates.
clarity to SEFs and DCMs, and any costs
associated with such changes will be
negligible.
The Commission requests comments
on the potential costs of the proposed
amendments to §§ 37.203, 38.155, and
38.158, including any costs that would
be imposed on SEFs, DCMs, other
market participants, or the financial
system more broadly. In particular, for
those SEFs and DCMs that already have
these requirements in place, the
Commission requests comment on the
extent to which the proposed rules
would require changes to existing
policies and procedures.
B. Costs
The Commission also proposes to
amend § 37.203 to add a new paragraph
(d). The proposed provision would
require SEFs to annually monitor the
size and workload of its staff, and
ensure its resources and staff effectively
perform market regulation functions at
appropriate levels. SEFs may need to
adjust their policies and procedures to
comply with this new monitoring
requirement. Costs could arise from
additional hours SEF employees might
need to spend analyzing the compliance
of their rules and procedures with these
requirements, drafting new or amended
rules and procedures when necessary,
and implementing these new or
amended rules and procedures. Costs
may further vary based on the size of the
SEF, available resources the SEF may
have, and with existing practices and
policies the SEF may have in place. If
a SEF has insufficient staff, it will need
to find suitable candidates and hire staff
as necessary. As noted above, the
Commission proposes to amend
§ 38.155(b), to add to the list of factors
that a DCM should consider in
determining the appropriate level of
resources and staff: (1) any
responsibilities that staff have at
affiliated entities; and (2) any conflicts
of interest that prevent staff from
working on certain matters. The
Commission believes that any costs
imposed by such additional two factors
will be negligible, as DCMs are currently
obligated under existing Commission
regulation § 38.155(b) to monitor the
size and workload of its compliance
staff annually, and already lists various
factors they should consider in making
that determination of sufficiency of
resources.
Finally, as noted above, the
Commission proposes various nonsubstantive changes to Commission
regulations §§ 37.203, 38.155, and
38.158. These will provide additional
In addition to the discussion above,
the Commission has evaluated the costs
and benefits of the proposed
amendments to §§ 38.155, 38.158, and
37.203 in light of the specific
considerations identified in Section
15(a) of the CEA. The Commission
believes that the proposed amendments
to §§ 38.155, 38.158, and 37.203 may
have a beneficial effect on protection of
market participants and the public, as
well as on the financial integrity of the
markets by requiring a more direct link
between exchange management and the
staff performing market regulation
functions, hence providing a more
direct way of effectuating compliance
with Commission rules. The
Commission has considered the other
Section 15(a) Factors and believes that
they are not implicated by the proposed
amendments to §§ 38.155, 38.158, and
37.203.
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C. Section 15(a) Factors
xii. SEF Chief Compliance Officer—
Proposed Changes to Commission
Regulation § 37.1501
In general, the statutory framework
provided in SEF Core Principle 15
requires each SEF to designate an
individual to serve as a CCO.290 SEF
Core Principle 15 also provides
requirements relating to the CCO’s
reporting structure and duties.291
Commission regulation § 37.1501
further implements the statutory CCO
requirements. In particular, Commission
regulation § 37.1501 currently
establishes definitions for the terms
‘‘board of directors’’ and ‘‘senior
officer;’’ addresses the authority of the
CCO; establishes qualifications for the
CCO; outlines the appointment and
removal procedures for the CCO;
requires the SEF’s board of directors or
senior officer to approve the CCO’s
compensation; and requires the CCO to
290 CEA
291 See
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meet with the SEF’s board of directors
or senior officer at least annually.292
Commission regulation § 37.1501(c)
further outlines the duties of the CCO.
For example, Commission regulation
§ 37.1501(c)(2) details that the CCO
must take reasonable steps, in
consultation with the board of directors
or the senior officer of the SEF, to
resolve any material conflicts of interest
that may arise, including, but not
limited to: (1) conflicts between
business considerations and compliance
requirements; (2) conflicts between
business considerations and
implementation of the requirement that
the SEF provide fair, open, and
impartial access as set forth in § 37.202;
and (3) conflicts between a SEF’s
management and members of the board
of directors. Commission regulation
§ 37.1501(c)(6) specifies that the SEF’s
CCO must establish and administer a
compliance manual designed to
promote compliance with the applicable
laws, rules, and regulations and a
written code of ethics for the SEF
designed to prevent ethical violations
and to promote honesty and ethical
conduct by SEF personnel. Finally,
Commission regulation §§ 37.1501(c)(7)
and (c)(8) detail the requirement that the
CCO supervise the SEF’s self-regulatory
program as well as the effectiveness and
sufficiency of any regulatory service
provider, respectively.
Commission regulation § 37.1501(d)
addresses the statutory requirement
under SEF Core Principle 15 requiring
a CCO to prepare an annual compliance
report. Commission regulation
§ 37.1501(d) details the information the
report must contain.293 Commission
regulation § 37.1501(e) addresses the
submission of the annual compliance
report; Commission regulation
§ 37.1501(f) requires the SEF to
maintain all records demonstrating
compliance with the duties of the CCO
and the preparation and submission of
annual compliance reports consistent
with Commission regulations §§ 37.1000
and 37.1001. Finally, Commission
regulation § 37.1501(g) delegates to the
Director of the Division of Market
Oversight the authority to grant or deny
a request for an extension of time for a
SEF to file its annual compliance report
under Commission regulation
§ 37.1501(e).
The Commission is proposing several
amendments to § 37.1501. First, the
Commission proposes amendments to
the existing SEF CCO requirements to
ensure that, to the extent applicable,
these requirements are consistent with
292 See
Commission regulation § 37.1501(a)–(b).
regulation § 37.1500(d)(1)–(5).
293 Commission
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the proposed DCM CRO requirements.
Second, the Commission is proposing
additional SEF CCO requirements to
harmonize the language with other
aspects of this proposal, namely
proposed amendments that pertain to
the board of directors and conflicts of
interest procedures. Third, the
Commission is proposing amendments
that will more closely align § 37.1501
with the language of SEF Core Principle
15.
The Commission is proposing to move
the terms ‘‘board of directors’’ and
‘‘senior officer’’ from existing regulation
§ 37.1501(a) to proposed § 37.1201(b).
The meaning of each term would remain
unchanged, with one exception.
Specifically, the Commission seeks to
clarify the existing definition of ‘‘board
of directors’’ by including the
introductory language ‘‘a group of
people’’ serving as the governing body
of the SEF.
The Commission also is proposing a
new § 37.1501(a)(3) that would require
the CCO to report directly to the board
of directors or to the senior officer of the
SEF. This would be a new provision in
§ 37.1501, but it is consistent with the
language of SEF Core Principle 15, as set
out in § 37.1500. Proposed
§ 37.1501(a)(4)(i) would amend the
language in existing Commission
regulation § 37.1501(b)(3)(i) to provide
that the board of directors or senior
officer may appoint or remove the CCO
‘‘with the approval of the [SEF’s]
regulatory oversight committee.’’ 294
Finally, proposed § 37.1501(a)(5) would
amend the existing requirement in
Commission regulation § 37.1501(b)(4)
that the board of directors or the senior
officer of the SEF shall approve the
compensation of the CCO, to now
require this approval to occur ‘‘in
consultation with the [SEF’s ROC].’’ 295
The duties of the CCO under
proposed § 37.1501(b) are substantively
similar to existing Commission
regulation § 37.1501(c), with two
exceptions. First, proposed
§ 37.1501(b)(2) provides that the CCO
must take reasonable steps in
consultation with the SEF’s board of
directors ‘‘or a committee thereof’’ to
manage and resolve material conflicts of
interest. The added reference to
‘‘committee’’ accounts for the ROC’s
role in resolving conflicts of interest,
which is provided in proposed
§ 37.1206(d)(4). Second, proposed
§ 37.1501(b)(2)(i) specifies that conflicts
of interest between business
considerations and compliance
requirements includes, with respect to
294 Proposed
295 Proposed
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§ 37.1501(a)(4)(i).
§ 37.1501(a)(5).
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compliance requirements, the SEF’s
‘‘market regulation functions.’’
Existing Commission regulation
§ 37.1501(c)(7) provides that the CCO
must supervise the SEF’s ‘‘selfregulatory program,’’ which includes
trade practice surveillance; market
surveillance; real time market
monitoring; compliance with audit trail
requirements; enforcement and
disciplinary proceedings; audits,
examinations, and other regulatory
responsibilities (including taking
reasonable steps to ensure compliance
with, if applicable, financial integrity,
financial reporting, sales practice,
recordkeeping, and other requirements).
Proposed § 37.1501(b)(7) would amend
this provision to state that the CCO is
responsible for supervising the SEF’s
self-regulatory program, including the
market regulation functions set forth in
§ 37.1201(b)(9).
Proposed § 37.1501(c) is an entirely
new rule that addresses conflicts of
interest involving the CCO. The
proposed rules requires the SEF to
establish procedures for the disclosure
of actual or potential conflicts of interest
to the ROC. In addition, the SEF must
designate a qualified person to serve in
the place of the CCO for any matter for
which the CCO has such a conflict, and
maintain documentation of such
disclosure and designation.
Proposed § 37.1501(d)(5) amends the
existing annual compliance report
requirement under Commission
regulation § 37.1501(d) to require the
annual report to include any actual or
potential conflicts of interests that were
identified to the CCO during the
coverage period for the report, including
a description of how such conflicts of
interest were managed or resolved, and
an assessment of the impact of any
conflicts of interest on the swap
execution facility’s ability to perform its
market regulation functions.
A. Benefits
The Commission believes that
proposed § 37.1201(b) and the proposed
amendments to § 37.1501(a) are likely to
provide benefits as they enhance the
existing definition for the board of
directors to include the introductory
language ‘‘a group of people,’’ which
provides clarity and ease of reference.
This, in turn, should enhance the SEF’s
ability to comply with the regulation.
Proposed § 37.1501(a)(3), which
requires the CCO to directly report to
the SEF’s board of directors or to the
senior officer of the SEF, is likely to
provide benefits by allowing the CCO to
report directly to the ROC, which
insulates the CCO’s role from
commercial interests and allows that
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person to more effectively fulfill its
critical market regulations functions and
other self-regulatory obligations. This
may result in improved overall SEF
compliance with Commission
regulations. It is, however, important to
note that providing the SEF an option to
have its CCO to report to a senior officer
may introduce a possibility of
interference by the management team,
as senior officers are likely to have
incentives that conflict with that of a
CCO. For example, senior officers are
sometimes responsible for performance
evaluations and approving
administrative requests, which might
compromise the effectiveness of the
CCO and may limit the benefits of the
proposed rule.
Proposed § 37.1501(a)(4)(i), which
will allow the board of directors or a
senior officer to appoint or remove the
CCO with the approval of the SEF’s
ROC, is likely to generate benefits as it
further insulates the CCO from improper
or undue influence from the commercial
interests of the SEF. These benefits,
however, are likely to be limited as SEFs
have been operating under an existing
similar standard. Furthermore, by
requiring the board of directors or the
senior officer to consult with the ROC
in approving the compensation of the
CCO, proposed § 37.1501(a)(5) is likely
to provide benefits as it may further
insulate the CCO from interference from
the commercial interests of the SEF.
In addition, by requiring the ROC’s
involvement in resolving conflicts of
interest and by explicitly including the
SEF’s market regulation function in the
list of conflicts considered for
compliance requirements, proposed
§ 37.1501(b) will allow the CCO to be in
a better position to resolve conflicts of
interest that relate to surveillance,
investigations, and disciplinary
functions which, in turn, will enhance
the SEF’s important role as an SRO.
The proposed amendment to
§ 37.1501(b)(7) will explicitly refer to a
SEF’s market regulation function in
referring to the CCO’s supervision
responsibility. The term ‘‘market
regulation functions’’ is defined in
proposed § 37.1201(b)(9), and will
provide clarity and ease of reference to
compliance standards. Such clarity and
ease of reference should enhance a
SEF’s ability to comply with core
principle and regulatory requirements.
To the extent that a SEF’s CCO is
already carrying out such
responsibilities, the benefits may be less
significant.
Proposed § 37.1501(c), requires SEFs
to establish procedures for disclosing
conflicts of interest to the ROC,
designate a qualified person to serve in
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the place of the CCO for any matter in
which the CCO has a conflict, and
maintain documentation of such
designation. These requirements are
likely to provide benefits by better
facilitating the ROC’s assistance in
managing and resolving conflicts of
interest. This will allow the SEF to
effectively perform its market regulation
functions and maintain regulatory
compliance. In addition, the
requirement in proposed regulation
§ 37.1501(c) that the SEF have
procedures to designate a qualified
person to serve in the place of the CCO
for any matter in which the CCO is
conflicted is likely to provide benefits as
it will increase the likelihood that the
conflict of interest is managed and
resolved by a person with sufficient
independence, expertise and authority,
which, in turn, will allow the SEF to
effectively perform its market regulation
functions.
In addition, proposed § 37.1501(d)(5),
which amends the annual compliance
report requirements to include a report
of any actual or potential conflicts of
interests and how such conflicts of
interests were managed or resolved, will
increase the chances that the
Commission has timely notice and
sufficient knowledge of conflicts of
interest and how they are resolved.
Such disclosures allow the Commission
to have effective oversight over SEFs
and enhances SEF governance
transparency and accountability.
B. Costs
In order to comply with the proposed
amendments to § 37.1501, SEFs may
need to adjust their policies and
procedures regarding CCOs. This may
impose some administrative costs on
SEFs. Costs could arise from additional
hours SEF employees might need to
spend analyzing the compliance of their
rules and procedures with the proposed
requirements, drafting new or amended
rules and procedures when necessary,
and implementing these new or
amended rules and procedures.
More specifically, SEFs may have
additional costs associated with the
CCO position resulting from the time
requirements on the board of directors
or senior officer meeting with the CCO,
and administrative costs associated with
the ROC actions being required to hire
or remove a CCO and to approve CCO
compensation. To the extent that SEFs
already have such rules and procedures
in place, costs may have been already
realized.
The Commission requests comment
on the potential costs of the proposed
amendments to § 37.1501, including any
costs that would be imposed on SEFs,
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19699
other market participants, or the
financial system more broadly.
C. Section 15(a) Factors
In addition to the discussion above,
the Commission has evaluated the costs
and benefits of the proposed
amendments to § 37.1501 in light of the
specific considerations identified in
Section 15(a) of the CEA. The
Commission believes that the proposed
amendments to § 37.1501 may have a
beneficial effect on protection of market
participants and the public, as well as
on the financial integrity of the markets
because the proposed amendments
should support and effectuate better
compliance with core principles.
Increased independence of the CCO
position and additional requirements
pertaining to the resolution and
documentation of conflicts of interest
will enhance SEF governance,
accountability, and promote
transparency, which is an essential
factor for establishing the integrity of
derivatives markets. The Commission
has considered the other Section 15(a)
Factors and believes that they are not
implicated by the proposed
amendments to § 37.1501.
xiii. Transfer of Equity Interest—
Proposed Changes to Commission
Regulations §§ 37.5(c) and 38.5(c)
Currently, Commission regulations
§§ 37.5(c)(1) and 38.5(c)(1) require SEFs
and DCMs, respectively, to notify the
Commission in the event of an equity
interest transfer. The threshold that
triggers the notification requirement
when a DCM enters a transaction is the
transfer of 10 percent or more of the
DCM’s equity. In comparison, a SEF is
required to notify the Commission when
it enters a transaction to transfer 50
percent or more of the SEF’s equity.
Commission regulation § 37.5(c)(1)
provides that the Commission may
‘‘upon receiving such notification,
request supporting documentation of
the transaction.’’ Commission regulation
§ 38.5(c)(1) does not include a similar
provision for DCMs.
Commission regulations §§ 37.5(c)(2)
and 38.5(c)(2) govern the timing of the
equity interest transfer notification to
the Commission. These provisions
require notification at the earliest
possible time, but in no event later than
the open of business 10 business days
following the date upon which the SEF
or DCM enters a firm obligation to
transfer the equity interest. Commission
regulations §§ 37.5(c)(3) and 38.5(c)(3)
govern rule filing obligations that may
be prompted by the equity interest
transfer. Commission regulation
§ 37.5(c)(4) requires a SEF to certify to
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the Commission no later than two days
after an equity transfer takes place that
the SEF meets all of the requirements of
section 5h of the CEA and applicable
Commission regulations. Commission
regulation § 38.5(c) does not have an
analogous certification requirement for
DCMs.
Commission regulations §§ 37.5(d)
and 38.5(d) establish Commission
delegation of authority provisions to the
Director of the Division of Market
Oversight. The delegation authority
under § 37.5(d) permits the Director to
request any of the information specified
in § 37.5, including information relating
to the business of the SEF, information
demonstrating compliance with the core
principles, or with the SEF’s other
obligations under the CEA or the
Commission’s regulations, and
information relating to an equity interest
transfer. In contrast, the scope of the
delegation of authority in Commission
regulation 38.5(d) limits the Director to
requesting information from a DCM
pursuant to Commission regulation
§ 38.5(b) demonstrating compliance
with the DCM core principles and the
CEA. The Director’s delegation authority
does not extend to requests for
information related to the business of
the DCM or to equity interest transfers.
The Commission proposes to amend
regulations §§ 37.5(c) and 38.5(c) to: (1)
ensure the Commission receives timely
and sufficient information in the event
of certain changes in the ownership or
corporate or organizational structure of
a SEF or DCM; (2) clarify what
information is required to be provided
and the relevant deadlines; and (3)
conform to similar requirements
applicable to DCOs.
The Commission proposes to amend
regulation § 37.5(c)(1) to require SEFs to
file with the Commission notification of
transactions involving the transfer of at
least 10 percent of the equity interest in
the SEF. The Commission also is
proposing to amend regulations
§§ 37.5(c)(1) and 38.5(c)(1) to expand
the types of changes of ownership or
corporate or organizational structure
that would trigger a notification
obligation to the Commission. The
proposed amendments would require
SEFs and DCMs to report any
anticipated change in the ownership or
corporate or organizational structure of
the SEF or DCM, or its respective
parent(s) that would: (1) result in at
least a 10 percent change of ownership
of the SEF or DCM, or a change to the
entity or person holding a controlling
interest in the SEF or DCM, whether
through an increase in direct ownership
or voting interest in the SEF or DCM, or
in a direct or indirect corporate parent
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entity of the SEF or DCM; (2) create a
new subsidiary or eliminate a current
subsidiary of the SEF or DCM; or (3)
result in the transfer of all or
substantially all of the assets of the SEF
or DCM to another legal entity.
The Commission also is proposing to
amend regulations §§ 37.5(c)(2) and
38.5(c)(2) to clarify what information
must be submitted to the Commission as
part of a notification pursuant to
Commission regulations §§ 37.5(c)(1)
and 38.5(c)(1), as proposed to be
amended. The Commission proposes to
harmonize and enhance the
requirements between SEFs and DCMs
by amending regulations §§ 37.5(c)(2)
and 38.5(c)(2) to state that, as part of a
notification pursuant to Commission
regulations §§ 37.5(c)(1) or 38.5(c)(1), a
SEF or DCM must provide ‘‘required
information’’ including: a chart
outlining the new ownership or
corporate or organizational structure, a
brief description of the purpose or the
impact of the change, and any relevant
agreement effecting the change and
corporate documents such as articles of
incorporation and bylaws. As proposed,
the Commission may, after receiving
such information, request additional
supporting documentation related to the
change in ownership or corporate or
organizational structure, such as
amended Form SEF or Form DCM
exhibits, to demonstrate that the SEF or
DCM will, following the change,
continue to meet all the requirements in
section 5 or 5h of the CEA (as
applicable) and applicable Commission
regulations.
Proposed §§ 37.5(c)(3) and 38.5(c)(3)
will require a notification pursuant to
Commission regulations §§ 37.5(c)(1) or
38.5(c)(1) to be submitted no later than
three months prior to the anticipated
change, provided that the SEF or DCM
may report the anticipated change later
than three months prior to the
anticipated change if it does not know
and reasonably could not have known of
the anticipated change three months
prior to the anticipated change. In such
event, the SEF or DCM shall
immediately report such change to the
Commission as soon as it knows of such
change.
In addition to the new reporting
requirements, the proposal includes a
new certification requirement for DCMs.
The Commission is proposing to amend
Commission regulation § 38.5(c) by
adding a certification requirement in
regulation § 38.5(c)(5). The certification
will require a DCM, upon a change in
ownership or corporate organizational
structure described in Commission
regulation § 38.5(c)(1), file with the
Commission a certification that the
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DCM meets all of the requirements of
section 5 of the CEA and applicable
Commission regulations. The
certification must be filed no later than
two business days following the date on
which the change in ownership or
corporate or organizational structure
takes effect.
The Commission proposes a new
§§ 37.5(c)(6) and 38.5(c)(6), which
provide that a change in the ownership
or corporate or organizational structure
of a SEF or DCM that results in the
failure of the SEF or DCM to comply
with any provision of the Act, or any
regulation or order of the Commission
thereunder, shall be cause for the
suspension of the registration or
designation of the SEF or DCM, or the
revocation of registration or designation
as a SEF or DCM, in accordance with
sections 5e and 6(b) of the CEA. The
proposed rule further provides that the
Commission may make and enter an
order directing that the SEF or DCM
cease and desist from such violation, in
accordance with sections 6b and 6(b) of
the CEA. Section 6(b) of the CEA
authorizes the Commission to suspend
or revoke registration or designation of
a SEF or DCM if the exchange has
violated the CEA or Commission orders
or regulations. Section 6(b) includes a
number of procedural safeguards,
including that it requires notice to the
SEF or DCM, a hearing on the record,
and appeal rights to the court of appeals
for the circuit in which the SEF or DCM
has its principal place of business. It is
imperative that SEFs and DCMs,
regardless of ownership or control
changes, continue to comply with the
CEA and all Commission regulations to
promote market integrity and protect
market participants.
Finally, the Commission proposes to
amend existing regulation § 38.5(d) by
extending the delegation of authority
provisions to the Director of the
Division of Market Oversight to include
information requests related to the
business of the DCM in § 38.5(a) and
changes in ownership or corporate or
organizational structure in § 38.5(c).
A. Benefits
The proposed change to revise the
reporting threshold for SEFs from 50
percent to 10 percent would harmonize
the regulatory standard currently in
place for DCMs and DCOs. In addition,
lowering the notification standard for
SEFs may better allow the Commission
to fulfill its oversight obligations. The
Commission recognizes that a
notification based on a percentage of
ownership change that is set too low
will result in notifications of changes
that do not have a consequential change
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in who has control over the exchange or
impact on SEF operations. In contrast, a
threshold set too high will reduce the
instances of notification of changes in
ownership or corporate or
organizational structure to the
Commission that are consequential to
the operations of a SEF. The
Commission believes that lowering the
threshold to 10 percent results in an
appropriate balance. In this connection,
the 10 percent threshold represents a
level where the Commission would
receive notice of a SEF’s ownership or
corporate or organizational structure
changes, when such changes actually
reflect meaningful changes in who
potentially could impact a SEF’s
compliance with the CEA and
Commission regulations. Therefore, the
proposed amendment will benefit SEF
market participants and the public given
the increased transparency to the
Commission in terms of who potentially
controls the SEF.
As discussed in the preamble above,
under the existing regulations, an
increase in equity interest of less than
10 percent could still result in change
of control of the exchange. Proposed
§§ 37.5(c)(1) and 38.5(c)(1) expand the
scope of corporate changes that require
notification to include changes not only
in ownership, but also corporate and
organizational structural changes. These
proposed changes will help ensure that
the Commission has accurate knowledge
of the individuals or entities that control
a SEF or DCM and its activities, thereby
promoting market integrity. The
Commission believes that proposed
§§ 37.5(c)(2) and 38.5(c)(2) will
encourage SEFs and DCMs to remain
mindful of their self-regulatory
responsibilities when negotiating the
terms of significant equity interest
transfers or other changes in ownership
or corporate or organizational structure.
In addition, the proposed rules help
maintain an orderly marketplace despite
changes in the ownership or corporate
or organizational structure of the
exchange. The proposed amendments
will enhance Commission staff’s ability
to undertake a timely and effective due
diligence review of the impact, if any,
of such changes. These enhanced
requirements will allow Commission
staff to seek updated copies of exhibits
and other documents that provide
valuable and timely information
regarding the professional staff, legal
proceedings, rulebook changes, third
party service provider agreements,
member and user agreements, and
compliance manual changes. Those
documents are important to confirm that
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the registrant will continue to be able to
meet its regulatory obligations.
The Commission believes that new
provisions §§ 37.5(c)(3) and 38.5(c)(3)
that require the SEF or the DCM
notification three months prior to the
anticipated change or immediately as
soon as it knows of such a change, will
allow the Commission staff sufficient
time to review the change and confirm
compliance with applicable statutory
and regulatory requirements. The new
rules will also provide flexibility to the
SEF or DCM if the anticipated change
occurs more quickly than within three
months.
Given their roles as SROs, the
proposed amendments to § 38.5(c) are
likely to provide benefits by establishing
consistent regulations among SEFs and
DCMs in the manner they certify their
compliance with the CEA and
Commission regulations. Furthermore,
to the extent that the certification
requirement will help ensure any
changes to ownership or corporate or
organizational structure do not result in
non-compliance, the certification
requirement will improve confidence in
the marketplace and promote market
integrity.
Finally, the proposal extends the
delegation of authority provisions to the
Director of the Division of Market
Oversight regarding DCMs to include
information requests related to the
business and changes to ownership or
corporate or organizational structure of
a DCM. Proposed § 38.5(d) provides a
standard for DCMs that conforms to the
existing standard for SEFs and
establishes a consistent regulatory
framework. Furthermore, since changes
to ownership or corporate or
organizational structure of a DCM can
occur relatively quickly with significant
consequences, the amendments are
likely to provide benefits by providing
the Director of the Division of Market
Oversight with the authority to
immediately request information and
documents to confirm continued
compliance with the CEA and relevant
regulations, which in turn should result
in more effective DCM oversight.
B. Costs
As described above, the Commission
proposes to amend regulations
§§ 37.5(c) and 38.5(c) to ensure the
Commission receives timely and
sufficient information in the event of
certain changes in the ownership or
corporate or organizational structure of
a SEF or DCM.
To comply with the proposed rules,
SEFs and DCMs may need to adjust
their policies and procedures, which
would impose some costs. SEF and
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19701
DCM costs could arise from additional
hours employees might need to spend
analyzing the compliance of their rules
and procedures with these
requirements, drafting new or amended
rules and procedures when necessary,
and implementing these new or
amended rules and procedures. Costs
associated with complying with the
proposed §§ 37.5(c) and 38.5(c) may
further vary based on the size of the SEF
and DCM, available resources, and the
existing practices and policies they may
already have in place. Finally, costs will
depend significantly on how often a
change in ownership or corporate or
ownership structure occurs.
More specifically, while DCMs are
already required to notify the
Commission in the event of a 10 percent
change in ownership interest, this 10
percent threshold requirement is being
extended to SEFs, which will impose
additional costs whenever such a
transfer occurs. Additionally, the
proposed rules also require both SEFs
and DCMs to report any anticipated
change in the ownership or corporate or
organizational structure of the SEF or
DCM, or its respective parent(s) that
would result in at least a 10 percent
change of ownership of the SEF or DCM,
or a change to the entity or person
holding a controlling interest in the SEF
or DCM. This additional reporting in the
event of anticipated change will
generate additional costs for both SEFs
and DCMs. Under proposed §§ 37.5(c)(3)
and 38.5(c)(3), this additional reporting
is required to be submitted to the
Commission no later than three months
prior to the anticipated change which
will add additional employee time and
costs to any anticipated change in
ownership or organizational structure
event that requires notification under
the proposed rules.
With respect to DCMs, proposed
§ 38.5(c)(5) will add a certification
requirement in the event of a change in
ownership or organizational structure
similar to the existing requirements for
SEFs. This certification must be no later
than two business days following the
date on which the change in ownership
or corporate or organizational structure
took effect, and will add direct costs to
any such change event.
Finally, the Commission proposes to
amend existing Commission regulation
§ 38.5(d) to delegate to the Director of
the Division of Market Oversight the
authority to request information related
to the DCM’s business and changes in
ownership or corporate or
organizational structure. Information or
document requests initiated by the
Director, as opposed to the Commission,
should not, on its own, impose
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additional costs on DCMs. Therefore,
costs to DCMs relating to this change
should be negligible. The Commission
acknowledges that a streamlined
process for requesting information and
documents may result in more frequent
information or document requests under
§ 38.5. In that respect, direct costs to
DCMs could increase.
The Commission requests comments
on the potential costs of the proposed
amendments to §§ 37.5(c) and 38.5(c)
and (d), including any costs that would
be imposed on SEFs, DCMs, other
market participants, or the financial
system more broadly.
C. Section 15(a) Factors
In addition to the discussion above,
the Commission has evaluated the costs
and benefits of the proposed
amendments to §§ 37.5(c) and 38.5(c)
and (d) in light of the specific
considerations identified in Section
15(a) of the CEA. The Commission
believes that the proposed amendments
may have a beneficial effect on
protection of market participants and
the public, as well as on the integrity of
the markets through improved
Commission awareness and oversight of
significant changes to ownership or
corporate or organizational structure of
SEFs. The Commission has considered
the other Section 15(a) Factors and
believes that they are not implicated by
the proposed amendments to §§ 37.5(c)
and 38.5(c)–(d).
ddrumheller on DSK120RN23PROD with PROPOSALS2
Summary 15(a) Factors
In addition to the discussion above,
the Commission has evaluated the costs
and benefits of the proposed rules in
light of the following five broad areas of
market and public concern identified in
Section 15(a) of the CEA: (1) protection
of market participants and the public;
(2) efficiency, competitiveness, and
financial integrity of markets; (3) price
discovery; (4) sound risk management
practices; and (5) other public interest
considerations. The Commission
believes that the proposed rules will
have a beneficial effect on sound risk
management practices and on the
protection of market participants and
the public.
1. Protection of Market Participants and
the Public
The Commission believes that the
proposed rules will enhance the
protection of market participants and
the public by improving the ability of
SEFs and DCMs to identify, manage and
resolve conflicts of interest. The
proposed rules will allow the exchanges
to properly and orderly perform their
function in facilitating markets, which
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in turn will reduce the likelihood that
market participants and the public face
unanticipated costs. The proposed rules
will enhance the transparency and
consistency of governance fitness
standards, which in turn increases the
likelihood that exchanges provide
reliable services to the market
participants. Finally, the proposed rules
will provide the public and the
Commission with transparent
information regarding changes in
ownership of SEFs or DCMs, which
enhances the protection of the public.
2. Efficiency, Competitiveness, and
Financial Integrity
The proposed rules will benefit the
financial integrity of the derivatives
markets by promoting the transparency
and the integrity of the governance
practices and proper identification and
handling of conflicts of interest through
the adoption of the proposed rules. The
proposed rules will also benefit the
marketplace by allowing a consistent
approach on managing conflicts of
interest and implementation of
governance fitness standards.
Additionally, the proposed rules will
promote SEF’s and DCM’s ability to
complete their self-regulatory
obligations by promoting the resources
necessary to effectively complete those
obligations.
3. Price Discovery
Price discovery is the process of
determining the price level for an asset
through the interaction of buyers and
sellers and based on supply and
demand conditions. The Commission
has not identified any effect of the
proposed rules on the price discovery
process.
4. Sound Risk Management Practices
The proposed rules seek to establish
transparent and consistent governance
fitness standards and proposes rules for
proper identification and handling of
conflicts of interest, which will support
sound risk management practices at
SEFs and DCMs. Nevertheless, the
proposed rules will not necessarily
impact the sound risk management
practices by other market participants
per se.
5. Other Public Interest Considerations
The Commission has not identified
any effect of the proposed rule on other
public interest considerations.
4. Question for Comment
As noted above regarding the
regulatory baseline, the Commission’s
understanding is that all of the DCMs
that are currently designated by the
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Commission rely on the acceptable
practices to comply with Core Principle
16, and therefore the actual costs and
benefits of the codification of those
acceptable practices with respect to
DCMs may not be as significant. Is this
understanding correct in all cases or are
there situations where DCMs using other
means to satisfy the core principles? If
so, what are these means?
b. Regulatory Flexibility Act
The Regulatory Flexibility Act
(‘‘RFA’’) requires Federal agencies to
consider whether the regulations they
propose will have a significant
economic impact on a substantial
number of small entities and, if so,
provide a regulatory flexibility analysis
with respect to such impact.296 The
regulations proposed herein will
directly affect SEFs, DCMs, and their
market participants. The Commission
has previously established certain
definitions of ‘‘small entities’’ to be used
by the Commission in evaluating the
impact of its regulations on small
entities in accordance with the RFA.297
The Commission previously concluded
that SEFs are not small entities for the
purpose of the RFA.298 The Commission
has also previously stated its belief in
the context of relevant rulemakings that
SEFs’ market participants, which are all
required to be eligible contract
participants (‘‘ECPs’’) 299 as defined in
section 1a(18) of the CEA,300 are not
small entities for purposes of the
RFA.301 Similarly, Commission
previously determined that DCMs are
not small entities for purposes of the
RFA because DCMs are required to
demonstrate compliance with a number
of core principles, including principles
concerning the expenditure of sufficient
financial resources to establish and
maintain an adequate self-regulatory
program.302 Therefore, the Chairman, on
behalf of the Commission, hereby
certifies, pursuant to 5 U.S.C. 605(b),
that the proposed rules will not have a
significant economic impact on a
substantial number of small entities.
296 5
U.S.C. 601 et seq.
FR at 18618–21 (Apr. 30, 1982).
298 See Part 37 Final Rule, 78 FR 33476 at 33548
(citing 47 FR 18618, 18621 (Apr. 30, 1982)
(discussing DCMs)).
299 Commission regulation 37.703.
300 7 U.S.C. 1(a)(18).
301 Opting Out of Segregation, 66 FR 20740 at
20743 (Apr. 25, 2001) (stating that ECPs by the
nature of their definition in the CEA should not be
considered small entities).
302 See Policy Statement and Establishment of
Definitions of ‘‘Small Entities’’ for Purposes of the
Regulatory Flexibility Act, 47 FR 18618, 18619
(Apr. 30, 1982); See also, e.g., DCM Core Principle
21 applicable to DCMs under section 735 of the
Dodd-Frank Act.
297 47
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The Commission invites the public and
other federal agencies to comment on
the above determination.
c. Paperwork Reduction Act
The Paperwork Reduction Act of 1995
(‘‘PRA’’) 303 imposes certain
requirements on federal agencies,
including the Commission, in
connection with their conducting or
sponsoring any ‘‘collection of
information,’’ as defined by the PRA.
Under the PRA, an agency may not
conduct or sponsor, and a person is not
required to respond to, a collection of
information unless it displays a valid
control number from the Office of
Management and Budget (‘‘OMB’’).304
The PRA is intended, in part, to
minimize the paperwork burden created
for individuals, businesses, and other
persons as a result of the collection of
information by federal agencies, and to
ensure the greatest possible benefit and
utility of information created, collected,
maintained, sued, shared, and
disseminated by or for the Federal
Government.305 The PRA applies to all
information, regardless of form or
format, whenever the Federal
Government is obtaining, causing to be
obtained, or soliciting information, and
includes required disclosure to third
parties or the public, of facts or
opinions, when the information
collection calls for answers to identical
questions posed to, or identical
reporting or recordkeeping requirements
imposed on, 10 or more persons.306
This NPRM, if adopted, would result
in a collection of information within the
meaning of the PRA, as discussed
below. The proposal affects three
collections of information for which the
Commission has previously received a
control number from OMB: OMB
Control No. 3038–0052, ‘‘Core
Principles & Other Requirements for
DCMs;’’ 307 OMB Control No. 3038–
0074, ‘‘Core Principles and Other
Requirements for Swap Execution
Facilities;’’ 308 and OMB Control No.
303 5
U.S.C. 601, et seq.
44 U.S.C. 3507(a)(3); 5 CFR 1320.5(a)(3).
305 See 44 U.S.C. 3501.
306 See 44 U.S.C. 3502(3).
307 For the previously approved PRA estimates for
DCMs under OMB Control No. 3038–0052, see ICR
Reference No. 202207–3038–003, Conclusion Date
Aug. 24, 2022, at https://www.reginfo.gov/public/
do/PRAViewICR?ref_nbr=202207-3038-003. The
PRA analysis uses a count of 16 DCMs based on
Commission data accurate as of Sept. 29, 2023.
308 For the previously approved estimates for
SEFs under OMB Control No. 3038–0074, see ICR
Reference No. 202201–3038–002, Conclusion Date
Apr. 30, 2022, at https://www.reginfo.gov/public/
do/PRAViewICR?ref_nbr=202201-3038-002. The
PRA analysis uses a count of 23 SEFs based on
Commission data accurate as of Sept. 29, 2023.
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304 See
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3038–0093, ‘‘Part 40, Provisions
Common to Registered Entities.’’ 309
The Commission is therefore
submitting this NPRM to OMB for
review.310 Responses to this collection
of information would be mandatory.
The Commission will protect any
proprietary information according to the
Freedom of Information Act and part
145 of the Commission’s regulations.311
In addition, CEA section 8(a)(1) strictly
prohibits the Commission, unless
specifically authorized by the CEA, from
making public any data and information
that would separately disclose the
business transactions or market
positions of any person and trade
secrets or names of customers.312
Finally, the Commission is also required
to protect certain information contained
in a government system of records
according to the Privacy Act of 1974.313
1. Burden Estimates
For PRA purposes, there are 23
registered SEFs and 16 designated
DCMs. The proposed amendments
would impose new one-time and
ongoing reporting and recordkeeping
requirements on SEFs and DCMs related
to conflict of interest requirements and
associated governance requirements
under parts 37 and 38, along with
associated rule submissions under part
40. The estimated aggregate burden
imposed by the proposed amendments
is set out below.
2. Fitness Documentation and Written
Procedures (§§ 37.207(d) and 38.801(d))
The proposed amendments would
add requirements that SEFs and DCMs
establish appropriate procedures for the
collection of information supporting
compliance with appropriate fitness
standards, including the creation of
written procedures that are preserved
for Commission review. The new
provisions would codify and enhance
existing guidance covering DCMs (Core
Principle 15 Guidance) and Commission
regulation § 1.63 covering SEFs and
DCMs.
The Commission estimates that each
SEF and DCM will spend an additional
10 hours annually on recordkeeping for
§§ 37.207(d) and 38.801(d), plus a 40hour one-time start-up cost for the
initial written procedures. Accordingly,
the aggregate annual estimate for the
recordkeeping and reporting burden
309 OMB Control Number 3038–0093 has two
Information Collections: Part 40, Provisions
Common to Registered Entities; and Part 150,
Position Limits. See https://www.reginfo.gov/
public/do/PRAViewICR?ref_nbr=202102-3038-001.
310 See 44 U.S.C. 3507(d) and 5 CFR 1320.11.
311 See 5 U.S.C. 552; see also 17 CFR part 145
(Commission Records and Information).
312 7 U.S.C. 12(a)(1).
313 5 U.S.C. 552a.
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19703
associated as with the proposal, is as
follows:
DCMs—Recordkeeping § 38.801(d)
Estimated number of respondents: 16.
Estimated number of reports per
respondent: 1.
Average number of hours per report:
10.
Estimated gross annual recordkeeping
burden (hours): 160.
One-time start-up burden (hours): 40.
Estimated gross one-time start-up
burden (hours): 640.
SEFs—Recordkeeping § 37.207(d)
Estimated number of respondents: 23.
Estimated number of reports per
respondent: 1.
Average number of hours per report:
10.
Estimated gross annual recordkeeping
burden (hours): 230.
One-time start-up burden (hours): 40.
Estimated gross one-time start-up
burden (hours): 920.
3. Documentation of Conflict-of-Interest
Provisions (§§ 37.1202(b) and 38.852(b))
Proposed §§ 37.1202(b) and 38.852(b)
require the board of directors,
committee, or disciplinary panel to
document its processes for complying
with the requirements of the conflict-ofinterest rules, and such documentation
must include: (1) the names of all
members and officers who attended the
relevant meeting in person where a
conflict of interest was raised; and (2)
the names of any members and officers
who voluntarily recused themselves or
were required to abstain from
deliberations or voting on a matter and
the reason for the recusal or abstention.
Although these provisions currently
exist for SEFs in § 1.69, they are new for
DCMs.
The Commission estimates that each
SEF and DCM will spend an additional
one hour four times a year on
recordkeeping associated with the
proposal. Accordingly, the aggregate
annual estimate for the reporting burden
associated with proposed new
§§ 37.1202(b) and 38.852(b) is as
follows:
DCMs—Recordkeeping § 38.852(b)
Estimated number of respondents: 16.
Estimated number of reports per
respondent: 4.
Average number of hours per report:
1.
Estimated gross annual recordkeeping
burden (hours): 64.
SEFs—Recordkeeping § 37.1202(b)
Estimated number of respondents: 23.
Estimated number of reports per
respondent: 4.
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Average number of hours per report:
1.
Estimated gross annual recordkeeping
burden (hours): 92.
4. Trading on Material Non-Public
Information (§§ 37.1203 and 38.853)
The amendments include
documentation and recordkeeping
requirements connected to a new
requirement that SEFs and DCMs take
certain steps to prevent an employee,
member of the board of directors,
committee member, consultant, or
owner with more than a 10 percent
interest in the SEF or DCM, from trading
commodity interests or related
commodity interests based on, or
disclosing, any non-public information
obtained through the performance of
their official duties. The proposal would
replace an existing regulation applicable
to SEFs and partially to DCMs (§ 1.59),
and guidance applicable to DCMs (Core
Principle 16 Guidance). Under the
proposed amendments, SEFs and DCMs
must continue to document any
exemptions from trading restrictions, in
accordance with requirements in
existing Commission regulations
§§ 37.1000 and 37.1001 or 38.950 and
38.951, respectively.
The Commission estimates that each
SEF and DCM will spend an estimated
additional 10 hours annually on
recordkeeping associated with this
proposal, with a one-time burden of 10
hours to review and update existing
policies and procedures. Accordingly,
the aggregate annual estimate for the
reporting burden associated with
proposed new §§ 37.1203 and 38.853, is
as follows:
DCMs—Recordkeeping § 38.853
Estimated number of respondents: 16.
Estimated number of reports per
respondent: 1.
Average number of hours per report:
10.
Estimated gross annual reporting
burden (hours): 160.
One-time start-up burden (hours): 10.
Estimated gross one-time start-up
burden (hours): 160.
ddrumheller on DSK120RN23PROD with PROPOSALS2
SEFs—Recordkeeping § 37.1203
Estimated number of respondents: 23.
Estimated number of reports per
respondent: 1.
Average number of hours per report:
10.
Estimated gross annual reporting
burden (hours): 230.
One-time start-up burden (hours): 10.
Estimated gross one-time start-up
burden (hours): 230.
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5. Annual Self-Assessment
§§ 37.1204(d) and 38.854(d)
Estimated gross annual reporting
burden (hours): 46.
Proposed §§ 37.1204(d) and 38.854(d)
are new requirements that SEF and
DCM Boards perform an annual selfassessment and performance review,
and document the results for possible
Commission review.
The Commission estimates that the
documentation and recordkeeping for
the annual review will take 25 hours.
Accordingly, the aggregate annual
estimate for the recordkeeping burden
associated with §§ 37.1204(d) and
38.854(d) is as follows:
7. ROC Meeting Minutes and
Documentation (§§ 37.1206(f)(1)(iii) and
38.857(f)(1)(iii); §§ 37.1206(f)(2) and
38.857(f)(2))
DCMs—§ 38.854(d)
Estimated number of respondents: 16.
Estimated number of reports per
respondent: 1.
Average number of hours per report:
25.
Estimated gross annual reporting
burden (hours): 400.
SEFs—§ 37.1204(d)
Estimated number of respondents: 23.
Estimated number of reports per
respondent: 1.
Average number of hours per report:
25.
Estimated gross annual reporting
burden (hours): 575.
6. Commission Notice of Membership
Changes of the Board of Directors
(§§ 37.1204(f) and 38.854(f))
This new proposed provision would
require SEFs and DCMs to notify the
Commission within five business days
of any changes to the membership of the
board of directors or its committees.
The Commission believes that
although the ongoing burden will be
low, it constitutes a burden for PRA
purposes. Each notification will take an
estimated one hour, and each SEF and
DCM will on average change two board
or committee members a year (in total).
Accordingly, the aggregate annual
estimate for the reporting burden
associated with proposed §§ 37.1204(f)
and 38.854(f) is as follows:
DCMs—§ 38.854(f) Reporting
Estimated number of respondents: 16.
Estimated number of reports per
respondent: 2.
Average number of hours per report:
1.
Estimated gross annual reporting
burden (hours): 32.
SEF—§ 37.1204(f) Reporting
Estimated number of respondents: 23.
Estimated number of reports per
respondent: 2.
Average number of hours per report:
1.
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The proposed provisions in
§§ 37.1206(f)(1)(iii) and 38.857(f)(1)(iii)
would require that SEF and DCM ROC
meeting minutes include the following
specific information: (a) list of the
attendees; (b) their titles; and (c)
whether they were present for the
entirety of the meeting or a portion
thereof (and if so, what portion); and (d)
a summary of all meeting discussions.
In addition, new §§ 37.1206(f)(2) and
38.857(f)(2) would require the ROCs to
maintain documentation of the
committee’s findings, recommendations,
and any other discussions or
deliberations related to the performance
of its duties.
The Commission estimates that these
new requirements will add an
additional four hours of recordkeeping
for an estimated four quarterly ROC
meetings for each SEF and DCM.
Accordingly, the aggregate annual
estimate for the reporting burden
associated with the proposal is as
follows:
DCMs—§ 38.857(f)(1)(iii) and
38.857(f)(2) Recordkeeping
Estimated number of respondents: 16.
Estimated number of reports per
respondent: 4.
Average number of hours per report:
4.
Estimated gross annual reporting
burden (hours): 256.
SEFs—§§ 37.1206(f)(1)(iii) and
37.1206(f)(2) Recordkeeping
Estimated number of respondents: 23.
Estimated number of reports per
respondent: 4.
Average number of hours per report:
4.
Estimated gross annual reporting
burden (hours): 368.
8. ROC Annual Report ((§§ 37.1206(g)(1)
and (g)(2) and 38.857(g)(1) and (g)(2))
Currently, DCMs prepare annual ROC
reports pursuant to the Acceptable
Practices for DCM Core Principle 16, but
SEFs do not have a similar requirement.
Proposed §§ 37.1206(g)(1) and
38.857(g)(1) would codify annual report
requirements for SEFs and DCMs.
Proposed §§ 37.1206(g)(2) and
38.857(g)(2) would set out the filing
requirements for the reports.
The current PRA estimated burden for
the DCM ROC reports is 70 hours for
one annual report. The Commission has
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reevaluated the ROC report burden and
now revises its estimate down to 40
hours, including the new requirements.
In the Commission’s recent experience,
the ROC report is less extensive and
burdensome to prepare than the SEF
Annual Compliance Report, which has
a burden of 52 hours. 40 hours more
accurately reflects the preparation
required for the ROC report, including
the new reporting requirements added
by the proposal. The proposal would
add a new burden of 40 hours for one
annual SEF ROC report.
Accordingly, the aggregate annual
estimate for the reporting burden
associated the proposal is as follows:
DCMs—§ 38.857(g)(1) and (g)(2)
Reporting
Estimated number of respondents: 16.
Estimated number of reports per
respondent: 1.
Average number of hours per report:
40.
Estimated gross annual reporting
burden (hours): 640.
SEFs—§ 37.1206(g)(1) and (g)(2)
Reporting
Estimated number of respondents: 23.
Estimated number of reports per
respondent: 1.
Average number of hours per report:
40.
Estimated gross annual reporting
burden (hours): 920.
9. ROC Recordkeeping (§§ 37.1206(g)(3)
and 38.857(g)(3))
Proposed §§ 37.1206(g)(3) and
38.857(g)(3) establish a recordkeeping
requirement to maintain all records
demonstrating compliance with the
duties of the ROC and the preparation
and submission of the annual report.
The Commission estimates that the
proposal will add an additional two
hours of burden per an estimated four
quarterly ROC meetings. Accordingly,
the aggregate annual estimate for the
reporting burden associated with the
proposal is as follows:
ddrumheller on DSK120RN23PROD with PROPOSALS2
Estimated number of respondents: 16.
Estimated number of reports per
respondent: 4.
Average number of hours per report:
2.
Estimated gross annual reporting
burden (hours): 128.
SEFs—§ 37.1206(g)(3) Recordkeeping
Estimated number of respondents: 23.
Estimated number of reports per
respondent: 4.
Average number of hours per report:
2.
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10. DCM CRO Appointment and
Removal Notification (§ 38.856(c))
Under proposed new § 38.856(c),
DCMs must notify the Commission
when a CRO is appointed or removed.
A similar requirement for SEFs is
proposed in § 37.1501(a)(4)(ii), but does
not add a reporting burden since the
requirement already exists in
Commission regulation
§ 37.1501(b)(3)(ii) for SEF CCOs.
The Commission estimates that a CRO
would be replaced on average every two
years at a maximum, and the required
notice would require 0.5 hours.
Accordingly, the aggregate annual
estimate for the reporting burden
associated with the proposal is as
follows:
DCMs—§ 38.856(c) Reporting
Estimated number of respondents: 16.
Estimated number of reports per
respondent: 0.5.
Average number of hours per report:
0.5.
Estimated gross annual reporting
burden (hours): 4.
11. Documentation of CCO/CRO
Conflicts of Interest (§§ 37.1501(c) and
38.856(f))
Proposed §§ 37.1501(c) and 38.856(f)
require SEFs and DCMs to maintain
documentation when a CCO (SEF) or
CRO (DCM) discloses a conflict of
interest to the ROC.
The Commission estimates that the
proposal would require an additional
four hours of recordkeeping for each
SEF and DCM once per year.
Accordingly, the aggregate annual
estimate for the reporting burden
associated with is as follows:
DCMs—§ 38.856(f) Recordkeeping
DCMs—§ 38.857(g)(3) Recordkeeping
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Estimated gross annual reporting
burden (hours): 184.
Estimated number of respondents: 16.
Estimated number of reports per
respondent: 1.
Average number of hours per report:
4.
Estimated gross annual reporting
burden (hours): 64.
SEFs—§ 37.1501(c) Recordkeeping
Estimated number of respondents: 23.
Estimated number of reports per
respondent: 1.
Average number of hours per report:
4.
Estimated gross annual reporting
burden (hours): 92.
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19705
12. Conflicts of Interests Reported in
SEF Annual Compliance Report
(§ 37.1501(d)(5))
Proposed § 37.1501(d)(5) requires any
actual or potential conflicts reported to
the CCO to be included in the SEF
Annual Compliance Report (ACR) to the
Commission. The Commission estimates
that this new requirement would add
one hour to the existing 52 hours
burden associated with the SEF ACR,
for a total of 53 hours. Accordingly, the
aggregate annual estimate for the
reporting burden associated with the
proposal is as follows:
SEFs—Reporting
Estimated number of respondents: 23.
Estimated number of reports per
respondent: 1.
Average number of hours per report:
53.
Estimated gross annual reporting
burden (hours): 1,219.
13. Reports of Anticipated Changes in
Ownership or Corporate Structure
(§§ 37.5(c)(1) and 38.5(c)(1));
§§ 37.5(c)(2) and 38.5(c)(2)
The proposal would amend
§§ 37.5(c)(1) and 38.5(c)(1) to require
that SEFs and DCMs report anticipated
changes of corporate structure or
ownership that would result in certain
significant changes to ownership,
subsidiaries, or transfer of assets to
another legal entity. The amendments to
§§ 37.5(c)(1) and 38.5(c)(1) would
require SEFs and DCMs to file with the
Commission reports of anticipated
changes in ownership or corporate
structure that would (i) result in at least
a 10 percent change of ownership of the
SEF or DCM or a change to the entity
or person holding a controlling interest
in the SEF or DCM; (ii) create a new
subsidiary or eliminate a current
subsidiary of the SEF or DCM; or (iii)
result in the transfer of all or
substantially all of the assets of the SEF
or DCM to another legal entity.
The proposed amendments to
§§ 37.5(c)(2) and 38.5(c)(2) would set
out the documents that must be
submitted to the Commission in such
reports, including a chart outlining the
new ownership or corporate or
organizational structure; a brief
description of the purpose and impact
of the change; and any relevant
agreements effecting the change and
corporate documents such as articles of
incorporation and bylaws; and any
additional supporting documents
requested by the Commission.
The Commission estimates that each
SEF and DCM would file one report
every four years, which would require
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40 hours of burden. Accordingly, the
aggregate annual estimate for the
reporting burden associated with the
proposal is as follows:
15. SEF and DCM Updates to Rulebooks
and Internal Procedures (§§ 40.5 and
40.6; Parts 37 and 38)
DCMs—§ 38.5(c)(1) and (c)(2) Reporting
Estimated number of respondents: 16.
Estimated number of reports per
respondent: 0.25.
Average number of hours per report:
40.
Estimated gross annual reporting
burden (hours): 160.
SEFs—§ 38.5(c)(1) and (c)(2)
Estimated number of respondents: 23.
Estimated number of reports per
respondent: 0.25.
Average number of hours per report:
40.
Estimated gross annual reporting
burden (hours): 230.
14. Change in Ownership/Structure
Certification Requirement (§§ 37.4(c)(4)
and 38.5(c)(5))
The Commission is proposing to
amend § 38.5(c) by adding a certification
requirement that will require a DCM,
upon a change in ownership or
corporate organizational structure, to
certify that the DCM meets all of the
requirements of section 5h of the Act
and applicable Commission regulations.
SEFs have an existing similar
requirement in § 37.4(c)(4) with no new
increase in burden from the proposed
rule. However, the SEF burden will be
listed here for clarity, since it is not
separately accounted for in the current
PRA approval.
The Commission estimates that each
SEF and DCM would file one report
under the proposed amendments every
four years, and each report would
require an additional two hours of
burden. Accordingly, the aggregate
annual estimate for the reporting burden
associated with the proposed
amendments is as follows:
ddrumheller on DSK120RN23PROD with PROPOSALS2
DCMs—§ 38.5(c)(5) Reporting
Estimated number of respondents: 16.
Estimated number of reports per
respondent: 0.25.
Average number of hours per report:
2.
Estimated gross annual reporting
burden (hours): 8.
SEFs—§ 37.4(c)(4)—Reporting
Estimated number of respondents: 23.
Estimated number of reports per
respondent: 0.25.
Average number of hours per report:
2.
Estimated gross annual reporting
burden (hours): 11.5.
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The proposal would institute
organizational changes that may require
one-time updates to SEF and DCM
rulebooks and internal procedures, such
as compliance manuals, or require
submissions to the Commission under
part 40.
Under §§ 40.5 and 40.6, registered
entities must submit a written
certification to the Commission in
connection with a new or amended rule.
However, this burden is already covered
in the existing part 40 PRA
collection.314
To comply with parts 37 and 38, SEFs
and DCMs must maintain policies and
procedures for ensuring compliance
with regulatory requirements, such as
compliance manuals. The Commission
estimates that the proposed rules would
require one-time updates to SEF and
DCM internal procedures, with an
estimated burden of 20 hours.
Accordingly, the aggregate annual
estimate for the recordkeeping and
reporting burden associated with the
proposed amendments is as follows:
DCMs—Internal Procedures
Recordkeeping and Reporting (Part 38)
Estimated number of respondents: 16.
Estimated number of reports per
respondent: 1.
Average number of hours per report:
20.
Estimated gross one-time reporting
and recordkeeping burden (hours): 320.
SEFs—Internal Procedures Manual
Recordkeeping and Reporting (Part 37)
Estimated number of respondents: 23.
Estimated number of reports per
respondent: 1.
Average number of hours per report:
20.
Estimated gross one-time reporting
and recordkeeping burden (hours): 460.
314 The Commission accounts for the burden
associated with the part 40 filings under Collection
No. 3038–0093, ‘‘Part 40, Provisions Common to
Registered Entities,’’ which includes updates to
rulebooks in response to new Commission
regulations and other actions. The CFTC bases its
burden estimates under this clearance on the
number of annual rule filings with the Commission.
Based on those numbers, the Commission has
estimated that these reporting requirements entail a
burden of approximately 2,800 hours annually for
covered entities (70 respondents × 20 reports per
respondent × 2 hours per report = 2,800 hours
annually). The Commission is retaining its existing
burden estimates under the existing clearance. The
Commission believes that these estimates are
adequate to account for any incremental burden
associated with part 40 filings that may result from
the proposed organizational changes.
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16. Request for Comment
The Commission invites the public
and other Federal agencies to comment
on any aspect of the proposed
information collection requirements
discussed above. Pursuant to 44 U.S.C.
3506(c)(2)(B), the Commission will
consider public comments on this
proposed collection of information in:
(1) Evaluating whether the proposed
collection of information is necessary
for the proper performance of the
functions of the Commission, including
whether the information will have a
practical use;
(2) Evaluating the accuracy of the
estimated burden of the proposed
collection of information, including the
degree to which the methodology and
the assumptions that the Commission
employed were valid;
(3) Enhancing the quality, utility, and
clarity of the information proposed to be
collected; and
(4) Minimizing the burden of the
proposed information collection
requirements on registered entities,
including through the use of appropriate
automated, electronic, mechanical, or
other technological information
collection techniques, e.g., permitting
electronic submission of responses.
Copies of the submission from the
Commission to OMB are available from
the CFTC Clearance Officer, 1155 21st
Street NW, Washington, DC 20581, (202)
418–5160 or from https://RegInfo.gov.
Organizations and individuals desiring
to submit comments on the proposed
information collection requirements
should send those comments to:
• The Office of Information and
Regulatory Affairs, Office of
Management and Budget, Room 10235,
New Executive Office Building,
Washington, DC 20503, Attn: Desk
Officer of the Commodity Futures
Trading Commission;
• (202) 395–6566 (fax); or
• OIRAsubmissions@omb.eop.gov
(email).
Please provide the Commission with
a copy of submitted comments so that
comments can be summarized and
addressed in the final rulemaking, and
please refer to the ADDRESSES section of
this rulemaking for instructions on
submitting comments to the
Commission. OMB is required to make
a decision concerning the proposed
information collection requirements
between 30 and 60 days after
publication of this release in the Federal
Register. Therefore, a comment to OMB
is best assured of receiving full
consideration if OMB receives it within
30 calendar days of publication of this
release. Nothing in the foregoing affects
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the deadline enumerated above for
public comment to the Commission on
the proposed rules.
d. Antitrust Considerations
Section 15(b) of the CEA requires the
Commission to take into consideration
the public interest to be protected by the
antitrust laws and endeavor to take the
least anticompetitive means of
achieving the purposes of the CEA, in
issuing any order or adopting any
Commission rule or regulation.315
The Commission believes that the
public interest to be protected by the
antitrust laws is the promotion of
competition. The Commission requests
comment on whether the proposed
amendments implicate any other
specific public interest to be protected
by the antitrust laws. The Commission
has considered the proposed rulemaking
to determine whether it is
anticompetitive and has identified no
anticompetitive effects. The
Commission requests comment on
whether the proposed rulemaking is
anticompetitive and, if it is, what the
anticompetitive effects are.
Because the Commission has
determined that the proposed rule
amendments are not anticompetitive
and have no anticompetitive effects, the
Commission has not identified any less
anticompetitive means of achieving the
purposes of the CEA. The Commission
requests comment on whether there are
less anticompetitive means of achieving
the relevant purposes of the CEA that
would otherwise be served by adopting
the proposed rule amendments.
List of Subjects
17 CFR Part 37
Compliance with rules, Conflicts of
interest, Designation of Chief
Compliance Officer, General Provisions.
17 CFR Part 38
Compliance with rules, Conflicts of
Interest, Disciplinary procedures,
General provisions.
For the reasons stated in the
preamble, the Commodity Futures
Trading Commission proposes to amend
17 CFR chapter I as follows:
ddrumheller on DSK120RN23PROD with PROPOSALS2
PART 37—SWAP EXECUTION
FACILITIES
1. The authority citation for part 37
continues to read as follows:
■
Authority: 7 U.S.C. 1a, 2, 5, 6, 6c, 7, 7a–
2, 7b–3, and 12a, as amended by Titles VII
and VIII of the Dodd-Frank Wall Street
Reform and Consumer Protection Act, Pub. L.
111–203, 124 Stat. 1376.
315 7
U.S.C. 19(b).
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■
2. Revise § 37.2 to read as follows:
§ 37.2
Exempt provisions.
A swap execution facility, the swap
execution facility’s operator and
transactions executed on or pursuant to
the rules of a swap execution facility
must comply with all applicable
requirements under Title 17 of the Code
of Federal Regulations, except for the
requirements of §§ 1.59(b) and (c), 1.63,
1.64, and 1.69.
■ 3. In § 37.5, revise paragraph (c) to
read as follows:
§ 37.5 Information relating to swap
execution facility compliance.
*
*
*
*
*
(c) Change in ownership or corporate
or organizational structure—(1)
Reporting requirement. A swap
execution facility must report to the
Commission any anticipated change in
the ownership or corporate or
organizational structure of the swap
execution facility or its parent(s) that
would:
(i) Result in at least a ten percent
change of ownership of the swap
execution facility or a change to the
entity or person holding a controlling
interest in the swap execution facility,
whether through an increase in direct
ownership or voting interest in the swap
execution facility or in a direct or
indirect corporate parent entity of the
swap execution facility;
(ii) Create a new subsidiary or
eliminate a current subsidiary of the
swap execution facility; or
(iii) Result in the transfer of all or
substantially all of the assets of the
swap execution facility to another legal
entity.
(2) Required information. The
information reported under paragraph
(c)(1) of this section must include: A
chart outlining the new ownership or
corporate or organizational structure; a
brief description of the purpose and
impact of the change; and any relevant
agreements effecting the change and
corporate documents such as articles of
incorporation and bylaws.
(i) The Commission may, after
receiving such report, request additional
supporting documentation relating to
the anticipated change in the ownership
or corporate or organizational structure
of the swap execution facility, including
amended Form SEF exhibits, to
demonstrate that the swap execution
facility will continue to meet all of the
requirements of section 5h of the Act
and applicable Commission regulations
following such change.
(ii) [Reserved]
(3) Time of report. The report under
paragraph (c)(1) of this section must be
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submitted to the Commission no later
than three months prior to the
anticipated change, provided that the
swap execution facility may report the
anticipated change to the Commission
later than three months prior to the
anticipated change if the swap
execution facility does not know and
reasonably could not have known of the
anticipated change three months prior
to the anticipated change. In such event,
the swap execution facility must
immediately report such change to the
Commission as soon as it knows of such
change. The report must be filed
electronically with the Secretary of the
Commission at submissions@cftc.gov
and with the Division of Market
Oversight at DMOSubmissions@cftc.gov.
(4) Rule filing. Notwithstanding the
provisions of paragraphs (c)(1) through
(3) of this section, if any aspect of a
change in ownership or corporate or
organizational structure described in
paragraph (c)(1) of this section requires
a swap execution facility to file a rule
as defined in § 40.1(i) of this chapter,
then the swap execution facility must
comply with the rule filing
requirements of section 5c(c) of the Act
and part 40 of this chapter, and all other
applicable Commission regulations.
(5) Certification. Upon a change in
ownership or corporate or
organizational structure described in
paragraph (c)(1) of this section, a swap
execution facility must file
electronically with the Secretary of the
Commission at submissions@cftc.gov
and with the Division of Market
Oversight at DMOSubmissions@cftc.gov,
a certification that the swap execution
facility meets all of the requirements of
section 5h of the Act and applicable
Commission regulations, no later than
two business days following the date on
which the change in ownership or
corporate or organizational structure
described in paragraph (c)(1) of this
section takes effect.
(6) Failure to comply. A change in the
ownership or corporate or
organizational structure of a swap
execution facility that results in the
failure of the swap execution facility to
comply with any provision of the Act,
or any regulation or order of the
Commission thereunder—
(i) Shall be cause for the suspension
of the registration of the swap execution
facility or the revocation of registration
as a swap execution facility, in
accordance with the procedures
provided in sections 5e and 6(b) of the
Act, including notice and a hearing on
the record; or
(ii) May be cause for the Commission
to make and enter an order directing
that the swap execution facility cease
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and desist from such violation, in
accordance with the procedures
provided in sections 6b and 6(b) of the
Act, including notice and a hearing on
the record.
*
*
*
*
*
■ 4. Amend § 37.203 as follows:
■ a. Revise paragraph (c);
■ b. Redesignate paragraphs (d), (e), (f),
and (g) as paragraphs (e), (f), (g), and (h);
■ c. Add a new paragraph (d); and
■ d. Revise newly redesignated
paragraph (g).
The revisions and addition read as
follows:
§ 37.203
Rule enforcement program.
ddrumheller on DSK120RN23PROD with PROPOSALS2
*
*
*
*
*
(c) Sufficient staff and resources. A
swap execution facility must establish
and maintain sufficient staff and
resources to effectively perform market
regulation functions, as defined in
§ 37.1201(b)(9). Such staff must be
sufficient to address unusual market or
trading events as they arise, and to
conduct and complete investigations in
a timely manner, as set forth in
§ 37.203(g).
(d) Ongoing monitoring of staff and
resources. A swap execution facility
must monitor the size and workload of
its staff required under paragraph (c) of
this section annually and ensure that its
staff and resources are at appropriate
levels. In determining the appropriate
level of staff and resources, the swap
execution facility should consider
trading volume increases, the number of
new products or contracts to be listed
for trading, any new responsibilities to
be assigned to staff, any responsibilities
that staff have at affiliated entities, the
results of any internal review
demonstrating that work is not
completed in an effective or timely
manner, any conflicts of interest that
prevent staff from working on certain
matters, and any other factors suggesting
the need for increased staff and
resources.
*
*
*
*
*
(g) Investigations and investigation
reports—(1) Procedures. A swap
execution facility shall establish and
maintain procedures that require its
staff responsible for market regulation
functions to conduct investigations of
possible rule violations. An
investigation shall be commenced upon
the receipt of a request from
Commission staff or upon the discovery
or receipt of information by the swap
execution facility that indicates a
reasonable basis for finding that a
violation may have occurred or will
occur.
(2) Timeliness. Each investigation
shall be completed in a timely manner.
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Absent mitigating factors, a timely
manner is no later than 12 months after
the date that an investigation is opened.
Mitigating factors that may reasonably
justify an investigation taking longer
than 12 months to complete include the
complexity of the investigation, the
number of firms or individuals involved
as potential wrongdoers, the number of
potential violations to be investigated,
and the volume of documents and data
to be examined and analyzed by staff.
(3) Investigation reports when a
reasonable basis exists for finding a
violation. Staff shall submit a written
investigation report for disciplinary
action in every instance in which staff
determines from surveillance or from an
investigation that a reasonable basis
exists for finding a rule violation. The
investigation report shall include the
reason the investigation was initiated; a
summary of the complaint, if any; the
relevant facts; staff’s analysis and
conclusions; and a recommendation as
to whether disciplinary action should be
pursued.
(4) Investigation reports when no
reasonable basis exists for finding a
violation. If after conducting an
investigation, staff determines that no
reasonable basis exists for finding a rule
violation, it shall prepare a written
report including the reason the
investigation was initiated; a summary
of the complaint, if any; the relevant
facts; and staff’s analysis and
conclusions.
(5) Warning letters. No more than one
warning letter may be issued to the
same person or entity found to have
committed the same rule violation
within a rolling twelve month period.
*
*
*
*
*
■ 5. In § 37.206, revise paragraph (b) to
read as follows:
§ 37.206 Disciplinary procedures and
sanctions.
*
*
*
*
*
(b) Disciplinary panels. A swap
execution facility must establish one or
more disciplinary panels that are
authorized to fulfill their obligations
under the rules of this subpart.
Disciplinary panels must meet the
composition requirements of § 37.1207,
and must not include any members of
the swap execution facility’s market
regulation staff or any person involved
in adjudicating any other stage of the
same proceeding.
*
*
*
*
*
■ 6. Add § 37.207 in subpart C to read
as follows:
§ 37.207
Minimum fitness standards.
(a) In general. A swap execution
facility must establish and enforce
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appropriate fitness standards for its
officers and for members of its board of
directors, committees, disciplinary
panels, and dispute resolution panels
(or anyone performing functions similar
to the foregoing), for members of the
swap execution facility, for any other
person with direct access to the swap
execution facility, any person who owns
10 percent or more of the SEF and who,
either directly or indirectly, through
agreement or otherwise, in any other
manner, may control or direct the
management or policies of the SEF, and
for any party affiliated with any person
described in this paragraph.
(b) Minimum standards for certain
persons—bases for refusal to register.
Minimum standards of fitness for the
swap execution facility’s officers and for
members of its board of directors,
committees, disciplinary panels, and
dispute resolution panels (or anyone
performing functions similar to the
foregoing), for members of the swap
execution facility with voting privileges,
and any person who owns 10 percent or
more of the SEF and who, either directly
or indirectly, through agreement or
otherwise, in any other manner, may
control or direct the management or
policies of the SEF, must include the
bases for refusal to register a person
under sections 8a(2) and 8a(3) of the
Act.
(c) Additional minimum fitness
standards for certain persons—history
of disciplinary offenses. Minimum
standards of fitness for the swap
execution facility’s officers and for
members of its board of directors,
committees, disciplinary panels, and
dispute resolution panels (or anyone
performing functions similar to the
foregoing), must include ineligibility
based on the disciplinary offenses listed
in the following paragraphs (c)(1)
through (6):
(1) Was found within the prior three
years by a final, non-appealable
decision of a self-regulatory
organization, an administrative law
judge, a court of competent jurisdiction,
the Securities Exchange Commission, or
the Commission to have committed:
(i) A violation of the rules of a selfregulatory organization, except rules
related to decorum or attire, financial
requirements, or reporting or
recordkeeping resulting in fines
aggregating $5,000 or less within a
calendar year; or
(ii) A violation of any rule of a selfregulatory organization if the violation
involved fraud, deceit, or conversion, or
resulted in suspension or expulsion; or
(iii) Any violation of the Act or the
regulations promulgated thereunder; or
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(iv) Any failure to exercise
supervisory responsibility in violation
of the rules of a self-regulatory
organization, or the Act, or regulations
promulgated thereunder.
(2) Entered into a settlement
agreement within the prior three years
in which the acts charged, or findings
included any of the violations described
in paragraph (c)(1) of this section;
(3) Currently is suspended from
trading on any designated contract
market or swap execution facility, is
suspended or expelled from
membership with any self-regulatory
organization, is serving any sentence of
probation, or owes any portion of a fine
imposed due to a finding or settlement
described in paragraphs (c)(1) or (2) of
this section;
(4) Currently is subject to an
agreement with the Commission, the
Securities Exchange Commission, or any
self-regulatory organization, not to
apply for registration with the Securities
Exchange Commission, Commission or
membership in any self-regulatory
organization;
(5) Currently is subject to or has had
imposed on him or her within the prior
three years a Commission registration
revocation or suspension in any
capacity for any reason, or has been
convicted within the prior three years of
any of the felonies listed in section
8a(2)(D)(ii) through (iv) of the Act; or
(6) Currently is subject to a denial,
suspension or disqualification from
serving on the disciplinary panel,
arbitration panel or governing board of
any self-regulatory organization as that
term is defined in section 3(a)(26) of the
Securities Exchange Act of 1934.
(d) Collection and verification of
fitness information. (1) A swap
execution facility must have appropriate
procedures for the collection and
verification of information supporting
compliance with appropriate fitness
standards, including, at a minimum, the
following:
(i) A swap execution facility must, on
at least an annual basis, collect and
verify fitness information for each
person acting in the capacity subject to
the fitness standards;
(ii) A swap execution facility must
require each person acting in any
capacity subject to the fitness standards
to provide immediate notice if that
person no longer meets the minimum
fitness standards to act in that capacity;
(iii) An initial verification of fitness
information must be completed prior to
the person commencing to act in the
capacity for which the person is subject
to fitness standards; and
(iv) A swap execution facility must
document its findings with respect to
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the verification of fitness information
for each person acting in the capacity
subject to the fitness standards.
(2) [Reserved]
■ 7. Add § 37.1201 in subpart M to read
as follows:
§ 37.1201
General requirements.
(a) Establishment of process. A swap
execution facility must establish a
process for identifying, minimizing, and
resolving actual or potential conflicts of
interest that may arise, including, but
not limited to, conflicts between and
among any of the swap execution
facility’s market regulation functions; its
commercial interests; and the several
interests of its management, members,
owners, customers and market
participants, other industry participants,
and other constituencies.
(b) Definitions. For purposes of this
section:
(1) Affiliate means a person that
directly or indirectly controls, is
controlled by, or is under common
control with, the swap execution
facility.
(2) Board of directors means a group
of people serving as the governing body
of a swap execution facility, or for a
swap execution facility whose
organizational structure does not
include a board of directors, a body
performing a function similar to a board
of directors.
(3) Commodity interest means any
commodity futures, commodity option
or swap contract traded on or subject to
the rules of a designated contract
market, a swap execution facility or
linked exchange, or cleared by a
derivatives clearing organization, or
cash commodities traded on or subject
to the rules of a designated contract
market.
(4) Disciplinary panel means a panel
of two or more persons authorized to
conduct hearings, render decisions,
approve settlements, and impose
sanctions with respect to disciplinary
matters.
(5) Dispute resolution panel means a
panel of two or more persons authorized
to resolve disputes involving a swap
execution facility’s members, market
participants, and any intermediaries.
(6) Executive committee means a
committee of the board of directors that
may exercise the authority delegated to
it by the board of directors with respect
to the decision-making of the company
or organization.
(7) Family relationship means a
person’s relationship with a spouse,
parents, children, or siblings, in each
case, whether by blood, marriage, or
adoption, or the person’s relationship
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with any person residing in the home of
the person.
(8) Linked exchange means:
(i) Any board of trade, exchange or
market outside the United States, its
territories or possessions, which has an
agreement with a designated contract
market or swap execution facility in the
United States that permits positions in
a commodity interest which have been
established on one of the two markets to
be liquidated on the other market;
(ii) Any board of trade, exchange or
market outside the United States, its
territories or possessions, the products
of which are listed on a United States
designated contract market, swap
execution facility, or a trading facility
thereof;
(iii) Any securities exchange, the
products of which are held as margin in
a commodity account or cleared by a
securities clearing organization
pursuant to a cross-margining
arrangement with a futures clearing
organization; or
(iv) Any clearing organization which
clears the products of any of the
foregoing markets.
(9) Market regulation functions means
SEF functions required by SEF Core
Principle 2, SEF Core Principle 4, SEF
Core Principle 6, SEF Core Principle 10
and the applicable Commission
regulations thereunder.
(10) Material information means
information which, if such information
were publicly known, would be
considered important by a reasonable
person in deciding whether to trade a
particular commodity interest on a
designated contract market or a swap
execution facility, or to clear a swap
contract through a derivatives clearing
organization. As used in this section,
‘‘material information’’ includes, but is
not limited to, information relating to
present or anticipated cash positions,
commodity interests, trading strategies,
the financial condition of members of
self-regulatory organizations or
members of linked exchanges or their
customers, or the regulatory actions or
proposed regulatory actions of a swap
execution facility or a linked exchange.
(11) Non-public information means
information which has not been
disseminated in a manner which makes
it generally available to the trading
public.
(12) Pooled investment vehicle means
a trading vehicle organized and
operated as a commodity pool within
the meaning of § 4.10(d) of this chapter,
and whose units of participation have
been registered under the Securities Act
of 1933, or a trading vehicle for which
§ 4.5 of this chapter makes available
relief from regulation as a commodity
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pool operator, i.e., registered investment
companies, insurance company separate
accounts, bank trust funds, and certain
pension plans.
(13) Public director means a member
of the board of directors who has been
found, by the board of directors of the
swap execution facility, on the record,
to have no material relationship with
the swap execution facility. The board
of directors must make such finding
upon the nomination of the director and
at least on an annual basis thereafter.
(i) For purposes of this definition, a
‘‘material relationship’’ is one that
reasonably could affect the independent
judgment or decision-making of the
member of the board of directors.
Circumstances in which a member of
the board of directors shall be
considered to have a ‘‘material
relationship’’ with the swap execution
facility include, but are not limited to,
the following:
(A) Such director is an officer or an
employee of the swap execution facility
or an officer or an employee of its
affiliate;
(B) Such director is a member of the
swap execution facility, or a director, an
officer, or an employee of either a
member or an affiliate of a member. In
this context, ‘‘member’’ shall have the
meaning set forth in § 1.3 of this
chapter;
(C) Such director directly or indirectly
owns more than 10 percent of the swap
execution facility or an affiliate of the
swap execution facility, or is an officer
or employee of an entity that directly or
indirectly owns more than 10 percent of
the swap execution facility;
(D) Such director, or an entity in
which the director is a partner, an
officer, an employee, or a director,
receives more than $100,000 in
aggregate annual payments from the
swap execution facility, or an affiliate of
the swap execution facility.
Compensation for services as a director
of the swap execution facility or as a
director of an affiliate of the swap
execution facility does not count toward
the $100,000 payment limit, nor does
deferred compensation for services
rendered prior to becoming a director of
the swap execution facility, so long as
such compensation is in no way
contingent, conditioned, or revocable; or
(E) The director shall be considered to
have a ‘‘material relationship’’ with the
swap execution facility when any of the
circumstances described in paragraphs
(b)(13)(i)(A) through (D) of this section
apply to any person with whom the
director has a family relationship.
(ii) All of the circumstances described
in paragraph (b)(13)(i) of this section
shall be subject to a one-year look back.
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(iii) A public director of the swap
execution facility may also serve as a
public director of an affiliate of the
swap execution facility if they otherwise
meet the requirements of this section.
(iv) A swap execution facility must
disclose to the Commission which
members of its board are public
directors, and the basis for those
determinations.
(14) Related commodity interest
means any commodity interest which is
traded on or subject to the rules of a
designated contract market, swap
execution facility, linked exchange, or
other board of trade, exchange, or
market, or cleared by a derivatives
clearing organization, other than the
swap execution facility by which a
person is employed, and with respect to
which:
(i) Such employing swap execution
facility has recognized or established
intermarket spread margins or other
special margin treatment between that
other commodity interest and a
commodity interest which is traded on
or subject to the rules of the employing
swap execution facility; or
(ii) Such other swap execution facility
has recognized or established
intermarket spread margins or other
special margin treatment with another
commodity interest as to which the
person has access to material nonpublic
information.
(15) Self-regulatory organization shall
have the meaning set forth in § 1.3 of
this chapter.
(16) Senior officer means the chief
executive officer or other equivalent
officer of the swap execution facility.
■ 8. Add § 37.1202 in subpart M to read
as follows:
in the subject of any matter being
considered.
(2) Any relationship of the type listed
in paragraphs (a)(1)(i) through (iv) of
this section that is with an affiliate of
the subject of any matter being
considered would be deemed an actual
or potential conflict of interest for
purposes of this section.
(3) The swap execution facility must
establish policies and procedures that
require any officer or member of a board
of directors, committee, or disciplinary
panel of a swap execution facility that
has an actual or potential conflict of
interest, including any of the
relationships listed in paragraphs (a)(1)
and (2) of this section, to abstain from
deliberating or voting on such matter.
(b) Documentation of conflicts of
interest determinations. The board of
directors, committees, and disciplinary
panels of a swap execution facility must
document in meeting minutes, or
otherwise document in a comparable
manner, compliance with the applicable
requirements of this section. Such
documentation demonstrating
compliance must also include:
(1) The names of all members and
officers who attended the relevant
meeting in person or who otherwise
were present by electronic means; and
(2) The names of any members and
officers who voluntarily recused
themselves or were required to abstain
from deliberations or voting on a matter
and the reason for the recusal or
abstention.
■ 9. Add § 37.1203 in subpart M to read
as follows:
§ 37.1202
(a) In general. A swap execution
facility must establish and enforce
policies and procedures on safeguarding
the use and disclosure of material nonpublic information. Such policies and
procedures must provide for appropriate
limitations on the use or disclosure of
material non-public information gained
through the performance of official
duties by members of the board of
directors, committee members, and
employees, or through an ownership
interest in the swap execution facility.
(b) Prohibited conduct by employees.
A swap execution facility must establish
and enforce policies and procedures
that, at a minimum, prohibit employees
of the swap execution facility from the
following:
(1) Trading directly or indirectly, in
the following:
(i) Any commodity interest traded on
the employing swap execution facility;
(ii) Any related commodity interest;
Conflicts of interest.
(a) Conflicts of interest in the
decision-making of a swap execution
facility. (1) A swap execution facility
must establish policies and procedures
that require any officer or member of its
board of directors, committees, or
disciplinary panels to disclose any
actual or potential conflicts of interest
that may be present prior to considering
any matter. Such conflicts of interests
include, but are not limited to, conflicts
of interest that may arise when such
member or officer:
(i) Is the subject of any matter being
considered;
(ii) Is an employer, employee, or
colleague of the subject of any matter
being considered;
(iii) Has a family relationship with the
subject of any matter being considered;
or
(iv) Has any ongoing business
relationship with or a financial interest
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§ 37.1203 Limitations on the use and
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(iii) A commodity interest traded on
designated contract markets or swap
execution facilities or cleared by
derivatives clearing organizations other
than the employing swap execution
facility if the employee has access to
material non-public information
concerning such commodity interest; or
(iv) A commodity interest traded on
or cleared by a linked exchange if the
employee has access to material nonpublic information concerning such
commodity interest.
(2) Disclosing for any purpose
inconsistent with the performance of the
person’s official duties as an employee
any material non-public information
obtained as a result of such person’s
employment at the swap execution
facility; provided, however, that such
policies and procedures shall not
prohibit disclosures made in the
performance by the employee, acting in
the employee’s official capacity or the
employee’s official duties, including to
another self-regulatory organization,
linked exchange, court of competent
jurisdiction or representative of any
agency or department of the federal or
a state government.
(c) Permitted exemptions. A swap
execution facility may grant exemptions
from the trading prohibitions contained
in paragraph (b)(1) of this section. Such
exemptions must be:
(1) Consistent with policies and
procedures established by the swap
execution facility that set forth the
circumstances under which such
exemptions may be granted;
(2) Administered by the swap
execution facility on a case-by-case
basis;
(3) Approved by the swap execution
facility’s regulatory oversight
committee;
(4) Granted only in limited
circumstances in which the employee
requesting the exemption can
demonstrate that the trading is not being
conducted on the basis of material nonpublic information gained through the
performance of official duties, which
limited circumstances may include
participation by an employee in pooled
investment vehicles where the
employee has no direct or indirect
control with respect to transactions
executed for or on behalf of such
vehicles; and
(5) Individually documented by the
swap execution facility, with the
documentation maintained by the swap
execution facility in accordance with
§§ 37.1000 and 37.1001.
(d) Monitoring for Permitted
Exemptions. A swap execution facility
must establish and enforce policies and
procedures to diligently monitor the
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trading activity conducted under any
exemptions granted under paragraph (c)
of this section to ensure compliance
with any applicable conditions of the
exemptions and the swap execution
facility’s policies and procedures on the
use and disclosure of material nonpublic information that are required
pursuant to this section.
(e) Prohibited conduct by members of
the board of directors, committee
members, employees, consultants, or
owners. A swap execution facility must
establish and enforce policies and
procedures that, at a minimum, prohibit
members of the board of directors,
committee members, employees,
consultants, and those with an
ownership interest of 10 percent or
more in the swap execution facility,
from the following:
(1) Trading for such person’s own
account, or for or on behalf of any other
account, in any commodity interest or
related commodity interest, on the basis
of any material non-public information
obtained through the performance of
such person’s official duties as a
member of the board of directors,
committee member, employee,
consultant, or those with an ownership
interest of 10 percent or more in the
swap execution facility;
(2) Trading for such person’s own
account, or for or on behalf of any other
account, in any commodity interest or
related commodity interest, on the basis
of any material non-public information
that such person knows was obtained in
violation of this section from a member
of the board of directors, committee
member, employee, consultant, or those
with an ownership interest of 10 percent
or more in the swap execution facility;
or
(3) Disclosing for any purpose
inconsistent with the performance of the
person’s official duties any material
non-public information obtained as a
result of their official duties at the swap
execution facility; provided, however,
that such policies and procedures shall
not prohibit disclosures made in the
performance of such person’s official
duties, including to another selfregulatory organization, linked
exchange, court of competent
jurisdiction or representative of any
agency or department of the federal or
state government acting in their official
capacity.
■ 10. Add § 37.1204 in subpart M to
read as follows:
§ 37.1204
Board of directors.
(a) In general. (1) The board of
directors of a swap execution facility
must be composed of at least thirty-five
percent public directors.
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(2) A swap execution facility must
establish and enforce policies and
procedures outlining the roles and
responsibilities of the board of directors,
including the manner in which the
board of directors oversees the swap
execution facility’s compliance with all
statutory, regulatory, and self-regulatory
responsibilities of the swap execution
facility under the Act and the
regulations promulgated thereunder.
(3) Any executive committee (or any
similarly empowered body) must be
composed of at least thirty-five percent
public directors.
(b) Expertise. Each member of the
board of directors, including public
directors, of the swap execution facility,
must have relevant expertise to fulfill
the roles and responsibilities of such
member.
(c) Compensation. The compensation
of public directors and other nonexecutive members of the board of
directors of a swap execution facility
must not be directly dependent on the
business performance of such swap
execution facility or any affiliate of the
swap execution facility.
(d) Annual self-assessment. The board
of directors of a swap execution facility
must annually conduct a selfassessment of its performance and that
of its committees. Such self-assessments
must be documented and made
available to the Commission for
inspection.
(e) Removal of a member of the board
of directors. A swap execution facility
must have procedures to remove a
member from the board of directors,
where the conduct of such member is
likely to be prejudicial to the sound and
prudent management of the swap
execution facility.
(f) Reporting to the Commission. A
swap execution facility must notify the
Commission within five business days
of any changes to the membership of the
board of directors or any of its
committees.
■ 11. Add § 37.1205 in subpart M to
read as follows:
§ 37.1205
Nominating committee.
(a) In general. A swap execution
facility must have a board-level
nominating committee, which must, at a
minimum:
(1) Identify a diverse panel of
individuals qualified to serve on the
board of directors, consistent with the
fitness requirements set forth in
§ 37.207, the composition requirements
set forth in § 37.1204, and that reflect
the views of market participants; and
(2) Administer a process for the
nomination of individuals to the board
of directors.
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(b) Applicability. The requirements in
paragraphs (a)(1) and (2) of this section
apply to all nominations that occur after
the initial establishment of the
nominating committee and the
appointment of members to the
nominating committee.
(c) Reporting. The nominating
committee must report to the board of
directors of the swap execution facility.
(d) Composition. The nominating
committee must be composed of at least
fifty-one percent public directors. The
chair of the nominating committee must
be a public director.
■ 12. Add § 37.1206 in subpart M to
read as follows:
ddrumheller on DSK120RN23PROD with PROPOSALS2
§ 37.1206
Regulatory oversight committee.
(a) In general. Each swap execution
facility must establish a regulatory
oversight committee, as a standing
committee of the board of directors, to
oversee the swap execution facility’s
market regulation functions on behalf of
the board of directors.
(b) Composition. The regulatory
oversight committee must be composed
entirely of public directors, and must
include no less than two directors.
(c) Delegation. The board of directors
must delegate sufficient authority,
dedicate sufficient resources, and allow
sufficient time for the regulatory
oversight committee to fulfill its
mandate and duties.
(d) Duties. The regulatory oversight
committee must:
(1) Monitor the sufficiency,
effectiveness, and independence of the
swap execution facility’s market
regulation functions;
(2) Oversee all facets of the swap
execution facility’s market regulation
functions;
(3) Approve the size and allocation of
the regulatory budget and resources, and
the number, hiring, termination, and
compensation of staff required pursuant
to § 37.203(c);
(4) Consult with the chief compliance
officer in managing and resolving any
actual or potential conflicts of interest
involving the swap execution facility’s
market regulation functions;
(5) Recommend changes that would
promote fair, vigorous, and effective
self-regulation; and
(6) Review all regulatory proposals
prior to implementation and advising
the board of directors as to whether and
how such proposals may impact the
swap execution facility’s market
regulation functions.
(e) Reporting. The regulatory
oversight committee must periodically
report to the board of directors of the
swap execution facility.
(f) Meetings and documentation. (1)
The regulatory oversight committee
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must have processes related to the
conducting of meetings, including, but
not limited to, the following:
(i) The regulatory oversight committee
must meet no less than on a quarterly
basis;
(ii) The regulatory oversight
committee must not permit any
individuals with actual or potential
conflicts of interest to attend any
discussions or deliberations in its
meetings that relate to the swap
execution facility’s market regulation
functions; and
(iii) The regulatory oversight
committee must maintain minutes of its
meetings. Such minutes must include a
list of the attendees; their titles; whether
they were present for the entirety of the
meeting or a portion thereof (and if so,
what portion); and a summary of all
meeting discussions.
(2) The regulatory oversight
committee must maintain
documentation of the committee’s
findings, recommendations,
deliberations, or other communications
related to the performance of its duties.
(g) Annual report—(1) Preparation.
The regulatory oversight committee
must prepare an annual report of the
swap execution facility’s market
regulation functions for the board of
directors and the Commission, which
includes an assessment, at a minimum,
of the following:
(i) Details of all market regulation
function expenses;
(ii) A description of staffing, structure,
and resources for the swap execution
facility’s market regulation functions;
(iii) A description of disciplinary
actions taken during the year;
(iv) A review of the performance of
the swap execution facility’s
disciplinary panels;
(v) A list of any actual or potential
conflicts of interests reported to the
regulatory oversight committee,
including a description of how such
conflicts of interest were managed or
resolved, and an assessment of the
impact of any conflicts of interest on the
swap execution facility’s ability to
perform its market regulation functions;
and
(vi) Details related to all actions taken
by the board of directors of a swap
execution facility pursuant to a
recommendation of the regulatory
oversight committee, which details must
include the following:
(A) The recommendation or action of
the regulatory oversight committee;
(B) The rationale for such
recommendation or action of the
regulatory oversight committee;
(C) The rationale of the board of
directors for rejecting such
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recommendation or superseding such
action of the regulatory oversight
committee, if applicable; and
(D) The course of action that the board
of directors decided to take that differs
from such recommendation or action of
the regulatory oversight committee, if
applicable.
(2) Submission of the annual report to
the Commission—(i) Timing. The
annual report must be submitted
electronically to the Commission no
later than 90 days after the end of the
swap execution facility’s fiscal year.
(ii) Request for extension. A swap
execution facility may request an
extension of time to file its annual
report from the Commission. Reasonable
and valid requests for extensions of the
filing deadline may be granted at the
discretion of the Commission.
(iii) Delegation of authority. The
Commission hereby delegates, until it
orders otherwise, to the Director of the
Division of Market Oversight or such
other employee or employees as the
Director may designate from time to
time, the authority to grant or deny a
request for an extension of time for a
swap execution facility to file its annual
report under paragraph (g)(2)(ii) of this
section. The Director may submit to the
Commission for its consideration any
matter that has been delegated in this
paragraph. Nothing in this paragraph
prohibits the Commission, at its
election, from exercising the authority
delegated in this paragraph.
(3) Records. The swap execution
facility must maintain all records
demonstrating compliance with the
duties of the regulatory oversight
committee and the preparation and
submission of annual reports consistent
with §§ 37.1000 and 37.1001.
■ 13. Add § 37.1207 in subpart M to
read as follows:
§ 37.1207
Disciplinary panel composition.
(a) Composition. Each disciplinary
panel must include at least two persons,
including one public participant. A
public participant is a person who
would meet the eligibility requirements
of a public director in § 37.1201(b)(12),
provided that such person need not be
a member of the board of directors of the
swap execution facility. A public
participant must chair each disciplinary
panel. In addition, a swap execution
facility must adopt rules that would, at
a minimum:
(1) Preclude any group or class of
participants from dominating or
exercising disproportionate influence on
a disciplinary panel; and
(2) Prohibit any member of a
disciplinary panel from participating in
deliberations or voting on any matter in
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which the member has an actual or
potential conflict of interest as set forth
in § 37.1202(a).
(b) Appeals. If the rules of the swap
execution facility provide that the
decision of a disciplinary panel may be
appealed to another committee of the
board of directors, then such committee
must also include at least two persons,
including one public participant, and
such public participant must chair the
committee.
(c) Exception. Paragraphs (a) and (b)
of this section do not apply to a
disciplinary panel convened for cases
solely involving decorum or attire.
*
*
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■ 14. In § 37.1501, revise paragraphs (a)
through (d) to read as follows:
ddrumheller on DSK120RN23PROD with PROPOSALS2
§ 37.1501
Chief compliance officer.
(a) Chief compliance officer—(1)
Authority of chief compliance officer. (i)
The position of chief compliance officer
must carry with it the authority and
resources to develop, in consultation
with the board of directors or senior
officer, the policies and procedures of
the swap execution facility and enforce
such policies and procedures to fulfill
the duties set forth for chief compliance
officers in the Act and Commission
regulations.
(ii) The chief compliance officer must
have supervisory authority over all staff
acting at the direction of the chief
compliance officer.
(2) Qualifications of chief compliance
officer. (i) The individual designated to
serve as chief compliance officer must
have the background and skills
appropriate for fulfilling the
responsibilities of the position.
(ii) No individual disqualified from
registration pursuant to sections 8a(2) or
8a(3) of the Act may serve as a chief
compliance officer.
(3) Reporting line of the chief
compliance officer. The chief
compliance officer must report directly
to the board of directors or to the senior
officer of the swap execution facility.
(4) Appointment and removal of chief
compliance officer. (i) Only the board of
directors or the senior officer, with the
approval of the swap execution facility’s
regulatory oversight committee, may
appoint or remove the chief compliance
officer.
(ii) The swap execution facility must
notify the Commission within two
business days of the appointment or
removal, whether interim or permanent,
of a chief compliance officer.
(5) Compensation of the chief
compliance officer. The board of
directors or the senior officer, in
consultation with the swap execution
facility’s regulatory oversight
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committee, must approve the
compensation of the chief compliance
officer.
(6) Annual meeting with the chief
compliance officer. The chief
compliance officer must meet with the
board of directors or senior officer of the
swap execution facility at least
annually.
(7) Information requested of the chief
compliance officer. The chief
compliance officer must provide any
information regarding the self-regulatory
program of the swap execution facility
as requested by the board of directors or
the senior officer.
(b) Duties of chief compliance officer.
The duties of the chief compliance
officer must include, but are not limited
to, the following:
(1) Overseeing and reviewing
compliance of the swap execution
facility with section 5h of the Act and
any related rules adopted by the
Commission;
(2) Taking reasonable steps, in
consultation with the swap execution
facility’s board of directors, or a
committee thereof, or the senior officer
of the swap execution facility, to
manage and resolve any material
conflicts of interest that may arise
relating to:
(i) Conflicts between business
considerations and compliance
requirements, including the swap
execution facility’s market regulation
functions;
(ii) Conflicts between business
considerations and implementation of
the requirement that the swap execution
facility provide fair, open, and impartial
access as set forth in § 37.202; and
(iii) Conflicts between a swap
execution facility’s management and
members of the board of directors.
(3) Establishing and administering
written policies and procedures
reasonably designed to prevent
violations of the Act and the rules of the
Commission;
(4) Taking reasonable steps to ensure
compliance with the Act and the rules
of the Commission;
(5) Establishing procedures
reasonably designed to handle, respond,
remediate, retest, and resolve
noncompliance issues identified by the
chief compliance officer through any
means, including any compliance office
review, look-back, internal or external
audit finding, self-reported error, or
validated complaint; and
(6) Establishing and administering a
compliance manual designed to
promote compliance with the applicable
laws, rules, and regulations and a
written code of ethics for the swap
execution facility designed to prevent
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ethical violations and to promote
honesty and ethical conduct by
personnel of the swap execution facility.
(7) Supervising the swap execution
facility’s self-regulatory program,
including the market regulation
functions set forth in § 37.1201(b)(9);
and
(8) If applicable, supervising the
effectiveness and sufficiency of any
regulatory services provided to the swap
execution facility by a regulatory service
provider in accordance with § 37.204.
(c) Conflicts of interest involving the
chief compliance officer. Each swap
execution facility must establish
procedures for the chief compliance
officer’s disclosure of actual or potential
conflicts of interest involving the chief
compliance officer to the regulatory
oversight committee and designation of
a qualified person to serve in the place
of the chief compliance officer for any
matter in which the chief compliance
officer has such a conflict, and
documentation of such disclosure and
designation.
(d) Preparation of annual compliance
report. The chief compliance officer
must, not less than annually, prepare
and sign an annual compliance report
that covers the prior fiscal year. The
report must, at a minimum, contain:
(1) A description and self-assessment
of the effectiveness of the written
policies and procedures of the swap
execution facility, including the code of
ethics and conflict of interest policies,
to reasonably ensure compliance with
the Act and applicable Commission
regulations;
(2) Any material changes made to
policies and procedures related to the
swap execution facility’s self-regulatory
functions during the coverage period for
the report and any areas of improvement
or recommended changes such policies
and procedures;
(3) A description of the financial,
managerial, and operational resources
set aside for compliance with the Act
and applicable Commission regulations;
(4) Any material non-compliance
matters identified and an explanation of
the corresponding action taken to
resolve such non-compliance matters;
(5) Any actual or potential conflicts of
interests that were identified to the chief
compliance officer during the coverage
period for the report, including a
description of how such conflicts of
interest were managed or resolved, and
an assessment of the impact of any
conflicts of interest on the swap
execution facility’s ability to perform its
market regulation functions; and
(6) A certification by the chief
compliance officer that, to the best of
his or her knowledge and reasonable
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belief, and under penalty of law, the
annual compliance report is accurate
and complete in all material respects.
*
*
*
*
*
PART 38—DESIGNATED CONTRACT
MARKETS
15. The authority citation for part 38
continues to read as follows:
■
Authority: 7 U.S.C. 1a, 2, 6, 6a, 6c, 6d, 6e,
6f, 6g, 6i, 6j, 6k, 6l, 6m, 6n, 7, 7a–2, 7b, 7b–
1, 7b–3, 8, 9, 15, and 21, as amended by the
Dodd-Frank Wall Street Reform and
Consumer Protection Act, Pub. L. 111–203,
124 Stat. 1376.
■
16. Revise § 38.2 to read as follows:
§ 38.2
Exempt provisions.
A designated contract market, the
designated contract market’s operator
and transactions traded on or through a
designated contract market under
section 5 of the Act shall comply with
all applicable regulations under Title 17
of the Code of Federal Regulations,
except for the requirements of
§§ 1.39(b), 1.54, 1.59(b) and (c), 1.63,
1.64, 1.69, 100.1, 155.2, and part 156 of
this chapter.
■ 17. In § 38.5, revise paragraphs (c) and
(d) to read as follows:
§ 38.5 Information relating to contract
market compliance.
ddrumheller on DSK120RN23PROD with PROPOSALS2
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*
(c) Change in ownership or corporate
or organizational structure—(1)
Reporting requirement. A designated
contract market must report to the
Commission any anticipated change in
the ownership or corporate or
organizational structure of the
designated contract market or its
parent(s) that would:
(i) Result in at least a ten percent
change of ownership of the designated
contract market or a change to the entity
or person holding a controlling interest
in the designated contract market,
whether through an increase in direct
ownership or voting interest in the
designated contract market or in a direct
or indirect corporate parent entity of the
designated contract market;
(ii) Create a new subsidiary or
eliminate a current subsidiary of the
designated contract market; or
(iii) Result in the transfer of all or
substantially all of the assets of the
designated contract market to another
legal entity.
(2) Required information. The
information reported under paragraph
(c)(1) of this section must include: A
chart outlining the new ownership or
corporate or organizational structure; a
brief description of the purpose and
impact of the change; and any relevant
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agreements effecting the change and
corporate documents such as articles of
incorporation and bylaws.
(i) The Commission may, after
receiving such report, request additional
supporting documentation relating to
the anticipated change in the ownership
or corporate or organizational structure
of the designated contract market,
including amended Form DCM exhibits,
to demonstrate that the designated
contract market will continue to meet
all of the requirements of section 5 of
the Act and applicable Commission
regulations following such change.
(ii) [Reserved]
(3) Time of report. The report under
paragraph (c)(1) of this section must be
submitted to the Commission no later
than three months prior to the
anticipated change, provided that the
designated contract market may report
the anticipated change to the
Commission later than three months
prior to the anticipated change if the
designated contract market does not
know and reasonably could not have
known of the anticipated change three
months prior to the anticipated change.
In such event, the designated contract
market must immediately report such
change to the Commission as soon as it
knows of such change. The report must
be filed electronically with the Secretary
of the Commission at submissions@
cftc.gov and with the Division of Market
Oversight at DMOSubmissions@cftc.gov.
(4) Rule filing. Notwithstanding the
provisions of paragraphs (c)(1) through
(3) of this section, if any aspect of a
change in ownership or corporate or
organizational structure described in
paragraph (c)(1) of this section requires
a designated contract market to file a
rule as defined in § 40.1(i) of this
chapter, then the designated contract
market must comply with the rule filing
requirements of section 5c(c) of the Act
and part 40 of this chapter, and all other
applicable Commission regulations.
(5) Certification. Upon a change in
ownership or corporate or
organizational structure described in
paragraph (c)(1) of this section, a
designated contract market must file
electronically with the Secretary of the
Commission at submissions@cftc.gov
and with the Division of Market
Oversight at DMOSubmissions@cftc.gov,
a certification that the designated
contract market meets all of the
requirements of section 5 of the Act and
applicable Commission regulations, no
later than two business days following
the date on which the change in
ownership or corporate or
organizational structure described in
paragraph (c)(1) of this section takes
effect.
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(6) Failure to comply. A change in the
ownership or corporate or
organizational structure of a designated
contract market that results in the
failure of the designated contract market
to comply with any provision of the Act,
or any regulation or order of the
Commission thereunder—
(i) Shall be cause for the suspension
of the designation of the designated
contract market or the revocation of
designation as a designated contract
market, in accordance with the
procedures provided in sections 5e and
6(b) of the Act, including notice and a
hearing on the record; or
(ii) May be cause for the Commission
to make and enter an order directing
that the designated contract market
cease and desist from such violation, in
accordance with the procedures
provided in sections 6b and 6(b) of the
Act, including notice and a hearing on
the record.
(d) Delegation of authority. The
Commission hereby delegates, until it
orders otherwise, the authority set forth
in this section to the Director of the
Division of Market Oversight or such
other employee or employees as the
Director may designate from time to
time. The Director may submit to the
Commission for its consideration any
matter that has been delegated in this
paragraph. Nothing in this paragraph
prohibits the Commission, at its
election, from exercising the authority
delegated in this paragraph.
■ 18. Revise § 38.155 to read as follows:
§ 38.155
Sufficient staff and resources.
(a) Sufficient staff and resources. A
designated contract market must
establish and maintain sufficient staff
and resources to effectively perform
market regulation functions, as defined
in § 38.851(b)(9). Such staff must be
sufficient to address unusual market or
trading events as they arise, and to
conduct and complete investigations in
a timely manner, as set forth in
§ 38.158(b).
(b) Ongoing monitoring of staff and
resources. A designated contract market
must monitor the size and workload of
its staff required under paragraph (a) of
this section annually and ensure that its
staff and resources are at appropriate
levels. In determining the appropriate
level of staff and resources, the
designated contract market should
consider trading volume increases, the
number of new products or contracts to
be listed for trading, any new
responsibilities to be assigned to staff,
any responsibilities that staff have at
affiliated entities, the results of any
internal review demonstrating that work
is not completed in an effective or
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timely manner, any conflicts of interest
that prevent staff from working on
certain matters, and any other factors
suggesting the need for increased staff
and resources.
■ 19. In § 38.158, revise paragraphs (a)
through (d) to read as follows:
ddrumheller on DSK120RN23PROD with PROPOSALS2
§ 38.158
reports.
Investigations and investigation
(a) Procedures. A designated contract
market must establish and maintain
procedures that require staff responsible
for market regulation functions to
conduct investigations of possible rule
violations. An investigation must be
commenced upon the receipt of a
request from Commission staff or upon
the discovery or receipt of information
by the designated contract market that
indicates a reasonable basis for finding
that a violation may have occurred or
will occur.
(b) Timeliness. Each investigation
must be completed in a timely manner.
Absent mitigating factors, a timely
manner is no later than 12 months after
the date that an investigation is opened.
Mitigating factors that may reasonably
justify an investigation taking longer
than 12 months to complete include the
complexity of the investigation, the
number of firms or individuals involved
as potential wrongdoers, the number of
potential violations to be investigated,
and the volume of documents and data
to be examined and analyzed by staff.
(c) Investigation reports when a
reasonable basis exists for finding a
violation. Staff must submit a written
investigation report for disciplinary
action in every instance in which such
staff determines from surveillance or
from an investigation that a reasonable
basis exists for finding a rule violation.
The investigation report must include
the reason the investigation was
initiated; a summary of the complaint,
if any; the relevant facts; staff’s analysis
and conclusions; and a recommendation
as to whether disciplinary action should
be pursued.
(d) Investigation reports when no
reasonable basis exists for finding a
violation. If after conducting an
investigation, staff determines that no
reasonable basis exists for finding a
violation, it must prepare a written
report including the reason(s) the
investigation was initiated; a summary
of the complaint, if any; the relevant
facts; and staff’s analysis and
conclusions.
*
*
*
*
*
■ 20. Revise § 38.702 to read as follows:
§ 38.702
Disciplinary panels.
A designated contract market must
establish one or more disciplinary
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panels that are authorized to fulfill their
obligations under the rules of this
subpart. Disciplinary panels must meet
the composition requirements of
§ 38.858, and must not include any
members of the designated contract
market’s market regulation staff or any
person involved in adjudicating any
other stage of the same proceeding.
■ 21. Revise § 38.801 to read as follows:
§ 38.801
Minimum fitness standards.
(a) In general. A designated contract
market must establish and enforce
appropriate fitness standards for its
officers and for members of its board of
directors, committees, disciplinary
panels, and dispute resolution panels
(or anyone performing functions similar
to the foregoing), for members of the
designated contract market, for any
other person with direct access to the
contract market, any person who owns
10 percent or more of the DCM and
who, either directly or indirectly,
through agreement or otherwise, in any
other manner, may control or direct the
management or policies of the DCM,
and for any party affiliated with any
person described in this paragraph.
(b) Minimum standards for certain
persons—bases for refusal to register.
Minimum standards of fitness for the
designated contract market’s officers
and for members of its board of
directors, committees, disciplinary
panels, and dispute resolution panels
(or anyone performing functions similar
to the foregoing), for members of the
designated contract market with voting
privileges, and any person who owns 10
percent or more of the DCM and who,
either directly or indirectly, through
agreement or otherwise, in any other
manner, may control or direct the
management or policies of the DCM,
must include the bases for refusal to
register a person under sections 8a(2)
and 8a(3) of the Act.
(c) Additional minimum fitness
standards for certain persons—history
of disciplinary offenses. Minimum
standards of fitness for the designated
contract market’s officers and for
members of its board of directors,
committees, disciplinary panels, and
dispute resolution panels (or anyone
performing functions similar to the
foregoing), must include ineligibility
based on the disciplinary offenses listed
in the following paragraphs (c)(1)
through (6):
(1) Was found within the prior three
years by a final, non-appealable
decision of a self-regulatory
organization, an administrative law
judge, a court of competent jurisdiction,
the Securities Exchange Commission, or
the Commission to have committed:
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(i) A violation of the rules of a selfregulatory organization, except rules
related to decorum or attire, financial
requirements, or reporting or
recordkeeping resulting in fines
aggregating $5,000 or less within a
calendar year; or
(ii) A violation of any rule of a selfregulatory organization if the violation
involved fraud, deceit, or conversion, or
resulted in suspension or expulsion; or
(iii) Any violation of the Act or the
regulations promulgated thereunder; or
(iv) Any failure to exercise
supervisory responsibility in violation
of the rules of a self-regulatory
organization, or the Act, or regulations
promulgated thereunder.
(2) Entered into a settlement
agreement within the prior three years
in which the acts charged, or findings
included any of the violations described
in paragraph (c)(1) of this section;
(3) Currently is suspended from
trading on any designated contract
market or swap execution facility, is
suspended or expelled from
membership with any self-regulatory
organization, is serving any sentence of
probation, or owes any portion of a fine
imposed due to a finding or settlement
described in paragraphs (c)(1) or (2) of
this section;
(4) Currently is subject to an
agreement with the Commission, the
Securities Exchange Commission, or any
self-regulatory organization, not to
apply for registration with the Securities
Exchange Commission, Commission or
membership in any self-regulatory
organization;
(5) Currently is subject to or has had
imposed on him or her within the prior
three years a Commission registration
revocation or suspension in any
capacity for any reason, or has been
convicted within the prior three years of
any of the felonies listed in section
8a(2)(D) (ii) through (iv) of the Act; or
(6) Currently is subject to a denial,
suspension or disqualification from
serving on the disciplinary panel,
arbitration panel or governing board of
any self-regulatory organization as that
term is defined in section 3(a)(26) of the
Securities Exchange Act of 1934.
(d) Collection and verification of
fitness information. (1) A designated
contract market must have appropriate
procedures for the collection and
verification of information supporting
compliance with appropriate fitness
standards, including, at a minimum, the
following:
(i) A designated contract market must,
on at least an annual basis, collect and
verify fitness information for each
person acting in the capacity subject to
the fitness standards;
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(ii) A designated contract market must
require each person acting in any
capacity subject to the fitness standards
to provide immediate notice if that
person no longer meets the minimum
fitness standards to act in that capacity;
(iii) An initial verification of fitness
information must be completed prior to
the person commencing to act in the
capacity for which the person is subject
to fitness standards; and
(iv) A designated contract market
must document its findings with respect
to the verification of fitness information
for each person acting in the capacity
subject to the fitness standards.
(2) [Reserved]
■ 22. Revise § 38.851 to read as follows:
ddrumheller on DSK120RN23PROD with PROPOSALS2
§ 38.851
General requirements.
(a) Establishment of process. A
designated contract market must
establish a process for identifying,
minimizing, and resolving actual or
potential conflicts of interest that may
arise, including, but not limited to,
conflicts between and among any of the
designated contract market’s market
regulation functions; its commercial
interests; and the several interests of its
management, members, owners,
customers and market participants,
other industry participants, and other
constituencies.
(b) Definitions. For purposes of this
section:
(1) Affiliate means a person that
directly or indirectly controls, is
controlled by, or is under common
control with, the designated contract
market.
(2) Board of directors means a group
of people serving as the governing body
of a designated contract market, or for
a designated contract market whose
organizational structure does not
include a board of directors, a body
performing a function similar to a board
of directors.
(3) Commodity interest means any
commodity futures, commodity option
or swap contract traded on or subject to
the rules of a designated contract
market, a swap execution facility or
linked exchange, or cleared by a
derivatives clearing organization, or
cash commodities traded on or subject
to the rules of a designated contract
market.
(4) Disciplinary panel means a panel
of two or more persons authorized to
conduct hearings, render decisions,
approve settlements, and impose
sanctions with respect to disciplinary
matters.
(5) Dispute resolution panel means a
panel of two or more persons authorized
to resolve disputes involving a
designated contract market’s members,
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market participants, and any
intermediaries.
(6) Executive committee means a
committee of the board of directors that
may exercise the authority delegated to
it by the board of directors with respect
to the decision-making of the company
or organization.
(7) Family relationship means a
person’s relationship with a spouse,
parents, children, or siblings, in each
case, whether by blood, marriage, or
adoption, or the person’s relationship
with any person residing in the home of
the person.
(8) Linked exchange means:
(i) Any board of trade, exchange or
market outside the United States, its
territories or possessions, which has an
agreement with a designated contract
market or swap execution facility in the
United States that permits positions in
a commodity interest which have been
established on one of the two markets to
be liquidated on the other market;
(ii) Any board of trade, exchange or
market outside the United States, its
territories or possessions, the products
of which are listed on a United States
designated contract market, swap
execution facility, or a trading facility
thereof;
(iii) Any securities exchange, the
products of which are held as margin in
a commodity account or cleared by a
securities clearing organization
pursuant to a cross-margining
arrangement with a futures clearing
organization; or
(iv) Any clearing organization which
clears the products of any of the
foregoing markets.
(9) Market regulation functions means
DCM functions required by DCM Core
Principle 2, DCM Core Principle 4, DCM
Core Principle 5, DCM Core Principle
10, DCM Core Principle 12, DCM Core
Principle 13, DCM Core Principle 17
and the applicable Commission
regulations thereunder.
(10) Material information means
information which, if such information
were publicly known, would be
considered important by a reasonable
person in deciding whether to trade a
particular commodity interest on a
designated contract market or a swap
execution facility, or to clear a swap
contract through a derivatives clearing
organization. As used in this section,
‘‘material information’’ includes, but is
not limited to, information relating to
present or anticipated cash positions,
commodity interests, trading strategies,
the financial condition of members of
self-regulatory organizations or
members of linked exchanges or their
customers, or the regulatory actions or
proposed regulatory actions of a
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designated contract market or a linked
exchange.
(11) Non-public information means
information which has not been
disseminated in a manner which makes
it generally available to the trading
public.
(12) Pooled investment vehicle means
a trading vehicle organized and
operated as a commodity pool within
the meaning of § 4.10(d) of this chapter,
and whose units of participation have
been registered under the Securities Act
of 1933, or a trading vehicle for which
§ 4.5 of this chapter makes available
relief from regulation as a commodity
pool operator, i.e., registered investment
companies, insurance company separate
accounts, bank trust funds, and certain
pension plans.
(13) Public director means a member
of the board of directors who has been
found, by the board of directors of the
designated contract market, on the
record, to have no material relationship
with the designated contract market.
The board of directors must make such
finding upon the nomination of the
director and at least on an annual basis
thereafter.
(i) For purposes of this definition, a
‘‘material relationship’’ is one that
reasonably could affect the independent
judgment or decision-making of the
member of the board of directors.
Circumstances in which a member of
the board of directors shall be
considered to have a ‘‘material
relationship’’ with the designated
contract market include, but are not
limited to, the following:
(A) Such director is an officer or an
employee of the designated contract
market or an officer or an employee of
its affiliate;
(B) Such director is a member of the
designated contract market, or a
director, an officer, or an employee of
either a member or an affiliate of the
member. In this context, ‘‘member’’
shall have the meaning set forth in § 1.3
of this chapter;
(C) Such director directly or indirectly
owns more than 10 percent of the
designated contract market or an
affiliate of the designated contract
market, or is an officer or employee of
an entity that directly or indirectly owns
more than 10 percent of the designated
contract market;
(D) Such director, or an entity in
which the director is a partner, an
officer, an employee, or a director,
receives more than $100,000 in
aggregate annual payments from the
designated contract market, or an
affiliate of the designated contract
market. Compensation for services as a
director of the designated contract
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market or as a director of an affiliate of
the designated contract market does not
count toward the $100,000 payment
limit, nor does deferred compensation
for services rendered prior to becoming
a director of the designated contract
market, so long as such compensation is
in no way contingent, conditioned, or
revocable; or
(E) The director shall be considered to
have a ‘‘material relationship’’ with the
designated contract market when any of
the circumstances described in
paragraphs (b)(13)(i)(A) through (D) of
this section apply to any person with
whom the director has a family
relationship.
(ii) All of the circumstances described
in paragraph (b)(13)(i) of this section
shall be subject to a one-year look back.
(iii) A public director of the
designated contract market may also
serve as a public director of an affiliate
of the designated contract market if they
otherwise meet the requirements of this
section.
(iv) A designated contract market
must disclose to the Commission which
members of its board are public
directors, and the basis for those
determinations.
(14) Related commodity interest
means any commodity interest which is
traded on or subject to the rules of a
designated contract market, swap
execution facility, linked exchange, or
other board of trade, exchange, or
market, or cleared by a derivatives
clearing organization, other than the
designated contract market by which a
person is employed, and with respect to
which:
(i) Such employing designated
contract market has recognized or
established intermarket spread margins
or other special margin treatment
between that other commodity interest
and a commodity interest which is
traded on or subject to the rules of the
employing designated contract market;
or
(ii) Such other designated contract
market has recognized or established
intermarket spread margins or other
special margin treatment with another
commodity interest as to which the
person has access to material nonpublic
information.
(15) Self-regulatory organization shall
have the meaning set forth in § 1.3 of
this chapter.
(16) Senior officer means the chief
executive officer or other equivalent
officer of the designated contract
market.
■ 23. Add § 38.852 in subpart Q to read
as follows:
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§ 38.852
Conflicts of interest.
(a) Conflicts of interest in the
decision-making of a designated
contract market. (1) A designated
contract market must establish policies
and procedures that require any officer
or member of its board of directors,
committees, or disciplinary panels to
disclose any actual or potential conflicts
of interest that may be present prior to
considering any matter. Such conflicts
of interests include, but are not limited
to, conflicts of interest that may arise
when such member or officer:
(i) Is the subject of any matter being
considered;
(ii) Is an employer, employee, or
colleague of the subject of any matter
being considered;
(iii) Has a family relationship with the
subject of any matter being considered;
or
(iv) Has any ongoing business
relationship with or a financial interest
in the subject of any matter being
considered.
(2) Any relationship of the type listed
in paragraphs (a)(1)(i) through (iv) of
this section that is with an affiliate of
the subject of any matter being
considered would be deemed an actual
or potential conflict of interest for
purposes of this section.
(3) The designated contract market
must establish policies and procedures
that require any officer or member of a
board of directors, committee, or
disciplinary panel of a designated
contract market that has an actual or
potential conflict of interest, including
any of the relationships listed in
paragraphs (a)(1) and (2) of this section,
to abstain from deliberating or voting on
such matter.
(b) Documentation of conflicts of
interest determinations. The board of
directors, committees, and disciplinary
panels of a designated contract market
must document in meeting minutes, or
otherwise document in a comparable
manner, compliance with the applicable
requirements of this section. Such
documentation demonstrating
compliance must also include:
(1) The names of all members and
officers who attended the relevant
meeting in person or who otherwise
were present by electronic means; and
(2) The names of any members and
officers who voluntarily recused
themselves or were required to abstain
from deliberations or voting on a matter
and the reason for the recusal or
abstention.
■ 24. Add § 38.853 in subpart Q to read
as follows:
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§ 38.853 Limitations on the use and
disclosure of material non-public
information.
(a) In general. A designated contract
market must establish and enforce
policies and procedures on safeguarding
the use and disclosure of material nonpublic information. Such policies and
procedures must provide for appropriate
limitations on the use or disclosure of
material non-public information gained
through the performance of official
duties by members of the board of
directors, committee members, and
employees, or through an ownership
interest in the designated contract
market.
(b) Prohibited conduct by employees.
A designated contract market must
establish and enforce policies and
procedures that, at a minimum, prohibit
employees of the designated contract
market from the following:
(1) Trading directly or indirectly, in
the following:
(i) Any commodity interest traded on
the employing designated contract
market;
(ii) Any related commodity interest;
(iii) A commodity interest traded on
designated contract markets or swap
execution facilities or cleared by
derivatives clearing organizations other
than the employing designated contract
market if the employee has access to
material non-public information
concerning such commodity interest; or
(iv) A commodity interest traded on
or cleared by a linked exchange if the
employee has access to material nonpublic information concerning such
commodity interest.
(2) Disclosing for any purpose
inconsistent with the performance of the
person’s official duties as an employee
any material non-public information
obtained as a result of such person’s
employment at the designated contract
market; provided, however, that such
policies and procedures shall not
prohibit disclosures made in the
performance by the employee, acting in
the employee’s official capacity or the
employee’s official duties, including to
another self-regulatory organization,
linked exchange, court of competent
jurisdiction or representative of any
agency or department of the federal or
a state government.
(c) Permitted exemptions. A
designated contract market may grant
exemptions from the trading
prohibitions contained in paragraph
(b)(1) of this section. Such exemptions
must be:
(1) Consistent with policies and
procedures established by the
designated contract market that set forth
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the circumstances under which such
exemptions may be granted;
(2) Administered by the designated
contract market on a case-by-case basis;
(3) Approved by the designated
contract market’s regulatory oversight
committee;
(4) Granted only in limited
circumstances in which the employee
requesting the exemption can
demonstrate that the trading is not being
conducted on the basis of material nonpublic information gained through the
performance of official duties, which
limited circumstances may include
participation by an employee in pooled
investment vehicles where the
employee has no direct or indirect
control with respect to transactions
executed for or on behalf of such
vehicles; and
(5) Individually documented by the
designated contract market, with the
documentation maintained by the
designated contract market in
accordance with §§ 38.950 and 38.951.
(d) Monitoring for Permitted
Exemptions. A designated contract
market must establish and enforce
policies and procedures to diligently
monitor the trading activity conducted
under any exemptions granted under
paragraph (c) of this section to ensure
compliance with any applicable
conditions of the exemptions and the
designated contract market’s policies
and procedures on the use and
disclosure of material non-public
information that are required pursuant
to this section.
(e) Prohibited conduct by members of
the board of directors, committee
members, employees, consultants, or
owners. A designated contract market
must establish and enforce policies and
procedures that, at a minimum, prohibit
members of the board of directors,
committee members, employees,
consultants, and those with an
ownership interest of 10 percent or
more in the designated contract market,
from the following:
(1) Trading for such person’s own
account, or for or on behalf of any other
account, in any commodity interest or
related commodity interest, on the basis
of any material non-public information
obtained through the performance of
such person’s official duties as a
member of the board of directors,
committee member, employee,
consultant, or those with an ownership
interest of 10 percent or more in the
designated contract market;
(2) Trading for such person’s own
account, or for or on behalf of any other
account, in any commodity interest or
related commodity interest, on the basis
of any material non-public information
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that such person knows was obtained in
violation of this section from a member
of the board of directors, committee
member, employee, consultant, or those
with an ownership interest of 10 percent
or more in the designated contract
market; or
(3) Disclosing for any purpose
inconsistent with the performance of the
person’s official duties any material
non-public information obtained as a
result of their official duties at the
designated contract market; provided,
however, that such policies and
procedures shall not prohibit
disclosures made in the performance of
such person’s official duties, including
to another self-regulatory organization,
linked exchange, court of competent
jurisdiction or representative of any
agency or department of the federal or
state government acting in their official
capacity.
■ 25. Add § 38.854 in subpart Q to read
as follows:
§ 38.854
Board of directors.
(a) In general. (1) The board of
directors of a designated contract market
must be composed of at least thirty-five
percent public directors.
(2) A designated contract market must
establish and enforce policies and
procedures outlining the roles and
responsibilities of the board of directors,
including the manner in which the
board of directors oversees the
designated contract market’s
compliance with all statutory,
regulatory, and self-regulatory
responsibilities of the designated
contract market under the Act and the
regulations promulgated thereunder.
(3) Any executive committee (or any
similarly empowered body) must be
composed of at least thirty-five percent
public directors.
(b) Expertise. Each member of the
board of directors, including public
directors, of the designated contract
market, must have relevant expertise to
fulfill the roles and responsibilities of
such member.
(c) Compensation. The compensation
of public directors and other nonexecutive members of the board of
directors of a designated contract market
must not be directly dependent on the
business performance of such
designated contract market or any
affiliate of the designated contract
market.
(d) Annual self-assessment. The board
of directors of a designated contract
market must annually conduct a selfassessment of its performance and that
of its committees. Such self-assessments
must be documented and made
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available to the Commission for
inspection.
(e) Removal of a member of the board
of directors. A designated contract
market must have procedures to remove
a member from the board of directors,
where the conduct of such member is
likely to be prejudicial to the sound and
prudent management of the designated
contract market.
(f) Reporting to the Commission. A
designated contract market must notify
the Commission within five business
days of any changes to the membership
of the board of directors or any of its
committees.
■ 26. Add § 38.855 in subpart Q to read
as follows:
§ 38.855
Nominating committee.
(a) In general. A designated contract
market must have a board-level
nominating committee, which must, at a
minimum:
(1) Identify a diverse panel of
individuals qualified to serve on the
board of directors, consistent with the
fitness requirements set forth in
§ 38.801, the composition requirements
set forth in § 38.853, and that reflect the
views of market participants; and
(2) Administer a process for the
nomination of individuals to the board
of directors.
(b) Applicability. The requirements in
paragraphs (a)(1) and (2) of this section
apply to all nominations that occur after
the initial establishment of the
nominating committee and the
appointment of members to the
nominating committee.
(c) Reporting. The nominating
committee must report to the board of
directors of the designated contract
market.
(d) Composition. The nominating
committee must be composed of at least
fifty-one percent public directors. The
chair of the nominating committee must
be a public director.
■ 27. Add § 38.856 in subpart Q to read
as follows:
§ 38.856
Chief regulatory officer.
(a) Designation and qualifications of
chief regulatory officer. (1) Each
designated contract market must
establish the position of chief regulatory
officer, and designate an individual to
serve in that capacity, to administer the
designated contract market’s market
regulation functions.
(i) The position of chief regulatory
officer must carry with it the authority
and resources necessary to fulfill the
duties set forth in this section for chief
regulatory officers.
(ii) The chief regulatory officer must
have supervisory authority over all staff
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performing the designated contract
market’s market regulation functions.
(2) The individual designated to serve
as chief regulatory officer must have the
background and skills appropriate for
fulfilling the duties of the position. No
individual disqualified from registration
pursuant to sections 8a(2) or 8a(3) of the
Act may serve as a chief regulatory
officer.
(b) Reporting line of the chief
regulatory officer. (1) The chief
regulatory officer must report directly to
the board of directors or to the senior
officer of the designated contract
market.
(2) The designated contract market’s
regulatory oversight committee must
oversee the chief regulatory officer to
minimize any actual or potential
conflicts of interest, including conflicts
of interest between the duties of the
chief regulatory officer and the
designated contract market’s
commercial interests.
(c) Appointment and removal of the
chief regulatory officer. (1) The
appointment or removal of a designated
contract market’s chief regulatory officer
must occur only with the approval of
the designated contract market’s
regulatory oversight committee.
(2) The designated contract market
must notify the Commission within two
business days of the appointment of any
new chief regulatory officer, whether
interim or permanent.
(3) The designated contract market
must notify the Commission within two
business days of removal of the chief
regulatory officer.
(d) Compensation of the chief
regulatory officer. The board of directors
or the senior officer of the designated
contract market, in consultation with
the designated contract market’s
regulatory oversight committee, must
approve the compensation of the chief
regulatory officer.
(e) Duties of the chief regulatory
officer. The chief regulatory officer’s
duties must include, but are not limited
to, the following:
(1) Supervising the designated
contract market’s market regulation
functions;
(2) Establishing and administering
policies and procedures related to the
designated contract market’s market
regulation functions.
(3) Supervising the effectiveness and
sufficiency of any regulatory services
provided to the designated contract
market by a regulatory service provider
in accordance with § 38.154;
(4) Reviewing any proposed rule or
programmatic changes that may have a
significant regulatory impact on the
designated contract market’s market
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regulation functions and advising the
regulatory oversight committee on such
matters; and
(5) In consultation with the
designated contract market’s regulatory
oversight committee, identifying,
minimizing, managing, and resolving
conflicts of interest involving the
designated contract market’s market
regulation functions.
(f) Conflicts of interest involving the
chief regulatory officer. Each designated
contract market must establish
procedures for the chief regulatory
officer’s disclosure of actual or potential
conflicts of interest involving the chief
regulatory officer to the regulatory
oversight committee and designation of
a qualified person to serve in the place
of the chief regulatory officer for any
matter in which the chief regulatory
officer has such a conflict, and
documentation of such disclosure and
designation.
■ 28. Add § 38.857 in subpart Q to read
as follows:
§ 38.857
Regulatory oversight committee.
(a) In general. Each designated
contract market must establish a
regulatory oversight committee, as a
standing committee of the board of
directors, to oversee the designated
contract market’s market regulation
functions on behalf of the board of
directors.
(b) Composition. The regulatory
oversight committee must be composed
entirely of public directors, and must
include no less than two directors.
(c) Delegation. The board of directors
must delegate sufficient authority,
dedicate sufficient resources, and allow
sufficient time for the regulatory
oversight committee to fulfill its
mandate and duties.
(d) Duties. The regulatory oversight
committee must:
(1) Monitor the sufficiency,
effectiveness, and independence of the
designated contract market’s market
regulation functions;
(2) Oversee all facets of the designated
contract market’s market regulation
functions;
(3) Approve the size and allocation of
the regulatory budget and resources, and
the number, hiring, termination, and
compensation of staff required pursuant
to § 38.155(a);
(4) Consult with the chief regulatory
officer in managing and resolving any
actual or potential conflicts of interest
involving the designated contract
market’s market regulation functions;
(5) Recommend changes that would
promote fair, vigorous, and effective
self-regulation; and
(6) Review all regulatory proposals
prior to implementation and advising
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19719
the board of directors as to whether and
how such proposals may impact the
designated contract market’s market
regulation functions.
(e) Reporting. The regulatory
oversight committee must periodically
report to the board of directors of the
designated contract market.
(f) Meetings and documentation. (1)
The regulatory oversight committee
must have processes related to the
conducting of meetings, including, but
not limited to, the following:
(i) The regulatory oversight committee
must meet no less than on a quarterly
basis;
(ii) The regulatory oversight
committee must not permit any
individuals with actual or potential
conflicts of interest to attend any
discussions or deliberations in its
meetings that relate to the designated
contract market’s market regulation
functions; and
(iii) The regulatory oversight
committee must maintain minutes of its
meetings. Such minutes must include a
list of the attendees; their titles; whether
they were present for the entirety of the
meeting or a portion thereof (and if so,
what portion); and a summary of all
meeting discussions.
(2) The regulatory oversight
committee must maintain
documentation of the committee’s
findings, recommendations,
deliberations, or other communications
related to the performance of its duties.
(g) Annual report—(1) Preparation.
The regulatory oversight committee
must prepare an annual report of the
designated contract market’s market
regulation functions for the board of
directors and the Commission, which
includes an assessment, at a minimum,
of the following:
(i) Details of all market regulation
function expenses;
(ii) A description of staffing, structure,
and resources for the designated
contract market’s market regulation
functions;
(iii) A description of disciplinary
actions taken during the year;
(iv) A review of the performance of
the designated contract market’s
disciplinary panels; and
(v) A list of any actual or potential
conflicts of interests reported to the
regulatory oversight committee,
including a description of how such
conflicts of interest were managed or
resolved, and an assessment of the
impact of any conflicts of interest on the
swap execution facility’s ability to
perform its market regulation functions;
and
(vi) Details related to all actions taken
by the board of directors of a designated
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contract market pursuant to a
recommendation of the regulatory
oversight committee, which details must
include the following:
(A) The recommendation or action of
the regulatory oversight committee;
(B) The rationale for such
recommendation or action of the
regulatory oversight committee;
(C) The rationale of the board of
directors for rejecting such
recommendation or superseding such
action of the regulatory oversight
committee, if applicable; and
(D) The course of action that the board
of directors decided to take that differs
from such recommendation or action of
the regulatory oversight committee, if
applicable.
(2) Submission of the annual report to
the Commission—(i) Timing. The
annual report must be submitted
electronically to the Commission no
later than 90 days after the end of the
designated contract market’s fiscal year.
(ii) Request for extension. A
designated contract market may request
an extension of time to file its annual
report from the Commission. Reasonable
and valid requests for extensions of the
filing deadline may be granted at the
discretion of the Commission.
(iii) Delegation of authority. The
Commission hereby delegates, until it
orders otherwise, to the Director of the
Division of Market Oversight or such
other employee or employees as the
Director may designate from time to
time, the authority to grant or deny a
request for an extension of time for a
designated contract market to file its
annual report under paragraph (g)(2)(ii)
of this section. The Director may submit
to the Commission for its consideration
any matter that has been delegated in
this paragraph. Nothing in this
paragraph prohibits the Commission, at
its election, from exercising the
authority delegated in this paragraph.
(3) Records. The designated contract
market must maintain all records
demonstrating compliance with the
duties of the regulatory oversight
committee and the preparation and
submission of annual reports consistent
with §§ 38.950 and 38.951.
■ 29. Add § 38.858 in subpart Q to read
as follows:
§ 38.858
Disciplinary panel composition.
(a) Composition. Each disciplinary
panel must include at least two persons,
including one public participant. A
public participant is a person who
would meet the eligibility requirements
of a public director in § 38.851(b)(13),
provided that such person need not be
a member of the board of directors of the
designated contract market. A public
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participant must chair each disciplinary
panel. In addition, a designated contract
market must adopt rules that would, at
a minimum:
(1) Preclude any group or class of
participants from dominating or
exercising disproportionate influence on
a disciplinary panel; and
(2) Prohibit any member of a
disciplinary panel from participating in
deliberations or voting on any matter in
which the member has an actual or
potential conflict of interest as set forth
in § 38.852(a).
(b) Appeals. If the rules of the
designated contract market provide that
the decision of a disciplinary panel may
be appealed to another committee of the
board of directors, then such committee
must also include at least two persons,
including one public participant, and
such public participant must chair the
committee.
(c) Exception. Paragraphs (a) and (b)
of this section do not apply to a
disciplinary panel convened for cases
solely involving decorum or attire.
■ 30. Amend Appendix B to part 38 by
revising ‘‘Core Principle 15 of section
5(d) of the Act’’ and ‘‘Core Principle 16
of section 5(d) of the Act’’ 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
[Reserved]
Core Principle 16 of section 5(d) of the Act
[Reserved]
*
*
*
*
*
Issued in Washington, DC, on March 4,
2024, by the Commission.
Christopher Kirkpatrick,
Secretary of the Commission.
NOTE: The following appendices will not
appear in the Code of Federal Regulations.
Appendices to Requirements for
Designated Contract Markets and Swap
Execution Facilities Regarding
Governance and the Mitigation of
Conflicts of Interest Impacting Market
Regulation Functions—Commission
Voting Summary, Chairman’s
Statement, and Commissioners’
Statements
Appendix 1—Commission Voting
Summary
On this matter, Chairman Behnam and
Commissioners Goldsmith Romero and Pham
voted in the affirmative. Commissioners
Johnson and Mersinger voted in the negative.
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Appendix 2—Statement of Support of
Chairman Rostin Behnam
I support the proposed rules for designated
contract markets (DCMs) and swap execution
facilities (SEFs) that would establish
governance and fitness requirements with
respect to market regulation functions and
related conflict of interest standards. This
action continues my commitment to ensure
that conflicts of interest are appropriately
mitigated, and that SEF and DCM governing
bodies adequately incorporate an
independent perspective. Advancements in
technology, coupled with demand for ever
greater efficiency and speed, are pushing
markets and market structure in new
directions. This new disruption raises new
and novel policy issues in all aspects of
markets, including conflicts of interest. This
proposal is just one step towards addressing
potential and existing conflicts of interest in
CFTC markets, to ensure markets remain
strong, resilient, and transparent.
The proposed rules would enhance
substantive requirements for identifying,
managing, and resolving conflicts of interest
related to market regulation functions. The
rules also establish structural governance
requirements regarding the makeup of SEF
and DCM governing bodies. Importantly,
these proposed rules would simplify the
CFTC’s rules for conflicts and governance
fitness standards by harmonizing the
regulatory regimes for SEFs and DCMs. In
addition, these proposed rules would
harmonize and enhance rules for SEFs and
DCMs regarding the notification of a transfer
of equity interest in a SEF or DCM, and
would confirm the CFTC’s authority to obtain
information concerning continued regulatory
compliance in the event of a change in
ownership of a SEF or DCM.
I look forward to hearing the public’s
comments on the proposed amendments to
the regulations for SEFs and DCMs. I thank
staff in the Division of Market Oversight,
Office of the General Counsel, and the Office
of the Chief Economist for all of their work
on the proposal.
Appendix 3—Dissenting Statement of
Commissioner Kristin N. Johnson
I. Introduction
I dissent from this conflicts of interest and
equity ownership transfer proposal (Proposed
Rule). For nearly two years, in Commodity
Futures Trading Commission (Commission or
CFTC) public meetings, speeches, and
engaged conversations with my fellow
Commissioners, staff, and diverse market
participants, I have advocated for the
Commission to address two critical gaps in
our regulations: incomplete and disparate
conflicts of interest rules as well as
Commission rules governing the transfer of
ownership interests in a registered entity.1
1 Commissioner Kristin N. Johnson, Keynote
Address at Digital Assets @Duke Conference (Jan.
26, 2023), https://www.cftc.gov/PressRoom/
SpeechesTestimony/opajohnson2; Commissioner
Kristin N. Johnson, Statement Calling for the CFTC
to Initiate a Rulemaking Process for CFTC
Registered DCOs Engaged in Crypto or Digital Asset
Clearing Activities (May 30, 2023), https://
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In the Commission’s December 2023 open
meeting, I expressly stated that I cannot
support the Commission in permitting
conflicts-laden market structures without
effective regulation.2 It is imperative to note
that this Proposed Rule will not address the
conflicts of interest that I and many others
have advocated for the Commission to
address.
The Proposed Rule is materially
incomplete. The Proposed Rule ignores
conflicts of interest in novel segments of our
markets where the Commission lacks
visibility and the market lacks the benefit of
robust regulatory oversight. While the
Commission could have used this rulemaking
to address endemic conflicts of interest in
emerging markets such as cryptocurrency or
digital asset markets, this Proposed Rule does
not address these deeply concerning,
pernicious conflicts of interest.
The Proposed Rule undermines
harmonization of conflicts regulations across
our markets. Over a century ago, in passing
the Grain Futures Act and, later, the
Commodity Exchange Act (CEA), Congress
expressly emphasized the necessity of
governing conflicts of interest and
registration standards in the oversight of the
derivatives markets.
In 2010, in the wake of the financial crisis,
Congress passed the Dodd-Frank Wall Street
Reform and Consumer Protection Act (DoddFrank Act) and expressly tasked the
Commission with introducing clearing
infrastructure regulation in the bespoke,
bilateral over-the-counter (OTC) swaps
market. In 2011, the Commission adopted a
rule proposal to establish conflicts of interest
regulations for derivatives clearing
organizations (DCOs), derivatives contract
markets (DCMs) and swap execution facilities
(SEFs).3 This proposal was withdrawn. In an
approach that splintered the proposed rule
and may have stymied harmonization, the
www.cftc.gov/PressRoom/SpeechesTestimony/
johnsonstatement053023; Commissioner Kristin N.
Johnson, Keynote Speech at the Salzburg Global
Finance Forum (June 29, 2023), https://
www.cftc.gov/PressRoom/SpeechesTestimony/
opajohnson4; Commissioner Kristin N. Johnson,
Opening Statement Before the Market Risk
Advisory Committee (July 10, 2023), https://
www.cftc.gov/PressRoom/SpeechesTestimony/
johnsonstatement071023; Commissioner Kristin N.
Johnson, Opening Statement Before the Market Risk
Advisory Committee Meeting (Dec. 11, 2023),
https://www.cftc.gov/PressRoom/
SpeechesTestimony/johnsonstatement121123;
Commissioner Kristin N. Johnson, Opening
Statement Regarding the Open Commission Meeting
on December 13, 2023 (Dec. 13, 2023), https://
www.cftc.gov/PressRoom/SpeechesTestimony/
johnsonstatement121323; Commissioner Kristin N.
Johnson, A Call for the CFTC to Begin a Formal
Rulemaking to Address Vertical Integration (Dec.
18, 2023), https://www.cftc.gov/PressRoom/
SpeechesTestimony/johnsonstatement121823c
#:∼:text=I%20strongly%20advocate%20
for%20the,risk%20or%20
financial%20stability%20concerns.
2 Opening Statement Regarding the Open
Commission Meeting on December 13, 2023, supra
note 1.
3 Governance Requirements for Derivatives
Clearing Organizations, Designated Contract
Markets, and Swap Execution Facilities; Additional
Requirements Regarding the Mitigation of Conflicts
of Interest, 76 FR 722 (Jan. 6, 2011).
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Commission proceeded with separate,
disparate conflicts of interest final
rulemakings. It adopted conflicts
requirements in 2012 for DCMs, in 2013 for
SEFs, and in 2020 for all DCOs.4
This fractured approach has led to
entrenched challenges and resulted in
different rules for different registered entities.
While some tailoring may be appropriate to
acknowledge differences in market design
and the role and obligation of registered
entities, the Commission should not permit
weaker conflicts rules in certain segments of
our markets. It is imperative that any final
rule governing conflicts address conflicts of
interest comprehensively across our existing
regulatory landscape.
Conflicts of interest have the potential to
create governance risks. Governance plays a
critical role in operational, market, credit and
general risk management decision-making.
Any post-mortem of the financial crisis offers
dozens of illustrations regarding the potential
for conflicts of interest to trigger the very
types of disruption that may undermine
enterprise risk management, market stability
and integrity, and potentially generate risks
that may be antecedents to systemic crises.
Because we know well the consequences of
failing to introduce effective risk
management and governance regulation, the
Commission must act now.
I have repeatedly called on the
Commission to initiate a rulemaking that
addresses the conflicts of interest that may
arise from adopting vertically integrated
market structures. This concern is intimately
connected with the previously articulated
concern. The CFTC’s enforcement actions
filed in the wake of FTX’s bankruptcy detail
the potential for a market participant to
interface with retail market participants
through a series of affiliated entities that
share a common ownership structure among
the exchange, market maker, broker dealer,
and custodian. These concerns should
prompt the Commission to act within our
existing authority and as part of this conflicts
rulemaking.
In an increasing number of instances,
businesses with no history of operating in
derivatives markets, no track record of
compliance with federal financial market
regulations, and limited evidence of
corporate governance and risk management
infrastructure have expressed interest in
acquiring or have acquired CFTC-registered
entities. Some may conclude that it is
cheaper to purchase a business licensed to
operate in our markets than to engage with
the Commission in the rigorous and
extensive licensing application process.
It is important for the Commission to
carefully consider regulations governing
equity interest transfers and ensure that
anyone acquiring a registered entity is
prepared to comply with the entire regulatory
regime applicable to CFTC-registered firms.
Similar to the proposed conflicts of interest
4 Core Principles and Other Requirements for
Designated Contract Markets, 77 FR 36612 (June 19,
2012); Core Principles and Other Requirements for
Swap Execution Facilities, 78 FR 33476 (June 4,
2013); Derivatives Clearing Organization General
Provisions and Core Principles, 85 FR 4800 (Jan. 27,
2020).
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rules, I am concerned that the Commission’s
actions are not commensurate with the risks
presented by emerging market conditions.
For these reasons and as explained below,
I dissent from the Commission’s decision to
adopt the Proposed Rule.
II. Background of the Proposed Rule
I support the Commission’s efforts to
enhance the integrity of the decision-making
process of SEFs and DCMs and reduce
conflicts of interest. The Proposed Rule seeks
to ensure that conflicts of interest are
mitigated for SEFs and DCMs. The
Commission proposes enhancing conflicts of
interest requirements to ensure that SEFs and
DCMs identify, manage, and resolve conflicts
related to ‘‘market regulation functions.’’ In
the Proposed Rule, the Division of Market
Oversight (DMO) identifies a set of issues
that the Commission has carefully considered
addressing for over a decade. I deeply respect
and appreciate the tireless efforts and
expertise of the Commission staff.
I applaud the staff’s identification of and
focus on addressing conflicts of interest in
certain self-regulatory functions of SEFs and
DCMs. The carefully developed rule text
seeks to impose heightened governance
fitness and structural standards to ensure that
a SEF and DCM board of directors and
disciplinary panels incorporate independent
and expert perspectives.
For almost two decades, I have advocated
for the Commission to enhance conflicts
regulations. The Proposed Rule reflects a
thoughtful commitment to addressing an area
of conflicts that has not received sufficient
attention. The Commission is also proposing
to strengthen the notification requirements
with respect to changes in the ownership or
corporate or organizational structure of a SEF
or DCM.
The Commission is proposing:
• new rules to implement DCM Core
Principle 15 (Governance Fitness Standards)
that are consistent with the existing
Guidance on compliance with DCM Core
Principle 15;
• new rules to implement DCM Core
Principle 16 (Conflicts of Interest) that are
consistent with the existing Guidance on,
and Acceptable Practices in, compliance with
DCM Core Principle 16;
• new rules to implement SEF Core
Principle 2 (Compliance with Rules) that are
consistent with the existing DCM Core
Principle 15 Guidance;
• new rules to implement SEF Core
Principle 12 (Conflicts of Interest) that are
consistent with the existing DCM Core
Principle 16 Guidance and Acceptable
Practices;
• new rules under Part 37 of the
Commission’s regulations for SEFs and Part
38 of the Commission’s regulations for DCMs
that are consistent with existing conflicts of
interest and governance requirements under
Commission Regulations 1.59 and 1.63;
• new rules for DCM chief regulatory
officers (CROs);
• amendments to certain requirements
relating to SEF chief compliance officers
(CCOs); and
• new rules for SEFs and DCMs relating to
the establishment and operation of a
Regulatory Oversight Committee (ROC).
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I thank the staff for their constructive
engagement and cooperation with my office.
DMO staff addressed and incorporated my
comments into the Proposed Rule, which
materially improve and strengthen both the
conflicts of interest and governance
requirements. Through coordinated efforts
with my office, we have made our markets
stronger and safer.
Section 5h of the CEA sets forth
requirements for SEFs.5 To be registered and
maintain registration with the Commission, a
SEF must comply with 15 core principles
and any requirement that the Commission
may impose by rule or regulation pursuant to
Section 8a(5) of the CEA.6 Similarly, Section
5 of the CEA sets forth requirements for
DCMs.7 The CEA requires that to be
designated and maintain designation by the
Commission, a DCM must comply with 23
core principles, and any requirement that the
Commission may impose by rule or
regulation pursuant to Section 8a(5) of the
CEA.8
Section 8a(5) authorizes the Commission to
make and promulgate rules and regulations
that, in the judgment of the Commission, are
reasonably necessary to effectuate any of the
provisions or to accomplish any of the
purposes of the CEA.9 As noted in the
Preamble to the Proposed Rule, the CEA
contains a finding that the transactions
subject to the CEA are affected with a
‘‘national public interest by providing a
means for managing and assuming price
risks, discovering prices, or disseminating
pricing information through trading in liquid,
fair and financially secure trading facilities,’’
and among the CEA’s purposes are to serve
the aforementioned public interests through
a system of ‘‘effective self-regulation of
trading facilities.’’ 10
A SEF or DCM has reasonable discretion to
establish the manner in which it complies
with a particular core principle unless the
Commission adopts more prescriptive
requirements by rule or regulation. In the
Proposed Rule, the Commission is
prescribing heightened requirements for SEFs
and DCMs.
III. Limitations of the Conflicts Rules
SEFs, DCMs, and DCOs, as self-regulatory
organizations, are tasked with the important
responsibility of regulating the derivatives
market and fostering market integrity. The
CEA requires effective self-regulation of
trading facilities, clearing systems
(clearinghouses), market participants and
market professionals under the oversight of
the Commission.11
A SEF’s or DCM’s decision-making process
encompasses a broad range of regulatory
functions, including certain self-regulatory
obligations subject to the influence or capture
of interested decision-makers. Under the
existing conflicts of interest framework, both
SEFs and DCMs are subject to a respective
core principle (DCM Core Principle 16 and
SEF Core Principle 12) to minimize and have
a process to resolve conflicts of interest in
their decision-making processes.12
Under the Proposed Rule, SEFs and DCMs
will be required, by regulation, to establish
a process for identifying, managing, and
resolving actual and potential conflicts of
interest that may arise between and among
any of the SEF’s or DCM’s ‘‘market regulation
functions’’ and its commercial interests as
well as the interests of its management,
members, owners, customers, market
participants, other industry participants, and
other constituencies.
Specifically, both SEFs and DCMs are
required to establish a ROC, a standing
committee of the board consisting of only
public directors tasked with minimizing
conflicts of interest, overseeing the DCM’s
market regulation functions, and preparing
an annual report assessing the market
regulation functions for the Commission
(among other responsibilities). The DCM is
required to designate a CRO responsible for
the market regulation function. A SEF is
required to designate a CCO or a similar
senior officer. The CRO and CCO must report
to the board or a senior officer. SEFs and
DCMs must also limit the use or disclosure
of material non-public information by certain
decision-makers, employees, and owners.
Notwithstanding my general support for
the conflicts regulation that the Proposed
Rule advances, I am unable to support the
conflicts provisions in the Proposed Rule for
several reasons.
First, the Proposed Rule is incomplete. The
Proposed Rule fails to modernize similar
conflicts of interest rules for DCOs. The
Commission should take a comprehensive
approach to conflicts of interest across our
various market structures to avoid potential
inconsistencies, contradictions, and
inefficiencies.
Second, last year in a series of public
statements and speeches, I clearly and
unequivocally signaled to the Commission
that we must adopt comprehensive conflicts
rules.13 The proposed conflicts regulation
overlooks the need for conflicts regulation for
certain market participants adopting
vertically integrated market structures. I
repeat my call for the Commission to commit
to engage in a public rulemaking with formal
notice and comment period on vertically
integrated structures.14
A. Failure To Address Conflicts of Interest for
DCOs
The Commission should adopt enhanced
conflicts of interest rules that parallel today’s
proposed conflicts rules for DCOs. DCOs play
a central role in derivatives markets. Since
the passage of the Dodd-Frank Act, market
participants have cleared significant volumes
12 7
U.S.C.A. 7, 7b–3.
supra note 1.
14 A Call for the CFTC to Begin a Formal
Rulemaking to Address Vertical Integration, supra
note 1 (‘‘I strongly advocate for the Commission to
initiate a rulemaking. More market participants are
adopting a vertically-integrated market structure,
and the Commission must ensure that such
structure does not raise systemic risk or financial
stability concerns.’’).
13 See
57
U.S.C. 7b–3.
U.S.C. 7b–3(f).
7 7 U.S.C. 7.
8 7 U.S.C. 7(d)(1)(A).
9 7 U.S.C. 12a(5).
10 7 U.S.C. 5.
11 Id.
67
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of OTC derivatives transactions through
DCOs. Clearing OTC derivatives through
registered clearinghouses may lead to greater
concentration of risk.
In the Preamble to the Proposed Rule,
DMO cited to an article I published a decade
ago that explores how CCP boards of
directors face persistent and pernicious
conflicts of interest that impede objective risk
oversight. The preamble acknowledges my
view that:
While clearinghouses and exchanges are
private businesses, these institutions provide
a critical, public, infrastructure resource
within financial markets. The self-regulatory
approach adopted in financial markets
presumes that clearinghouses and exchanges
will provide a public service and engage in
market oversight. The owners of exchanges
and clearinghouses may, however, prioritize
profit-maximizing strategies that deemphasize or conflict with regulatory goals.15
It is imperative that, to the extent the
Commission advances the Proposed Rule, it
also adopts well-tailored governance reforms
to address conflicts and prevent DCO owners’
self-interested commercial incentives or
other institutional constraints from triggering
systemic risk concerns.
DCOs are subject to Core Principle P
regarding conflicts of interest.16 CFTC
Regulation 39.25 implements DCO Core
Principle P and is identical in all material
respects to the existing SEF and DCM core
principles and implementing regulations on
conflicts of interest. A DCO is also required
‘‘to establish and enforce rules to minimize
conflicts of interest in the decision-making
process,’’ ‘‘establish a process for resolving
conflicts of interest,’’ and ‘‘have procedures
for identifying, addressing, and managing
conflicts of interest involving their
members.’’ 17
The Commission has improved the
conflicts requirements for SEFs and DCMs
but did not propose parallel revised rules for
DCOs. For example, the Proposed Rule
introduces common scenarios in which a
conflict of interest may arise and imposes
requirements to document conflicts of
interest determinations.18
At a minimum, the Commission should
advance parallel rules to assist DCOs in
identifying, managing, and resolving
conflicts of interest in their decision-making
process.19
B. Commit to a Conflicts Rulemaking on
Vertical Integration
It is essential that the Commission adopt a
comprehensive approach to addressing deepseated conflicts of interest concerns, instead
of its piece-meal and fragmented approach. I
15 See also Kristin N. Johnson, Governing
Financial Markets: Regulating Conflicts, 88 Wash.
L.Rev. 185, 221 (2013).
16 7 U.S.C. 7a–1.
17 17 CFR 39.25.
18 Proposed 17 CFR 37.1202, 38.852.
19 Commissioner Kristin N. Johnson, Statement of
Commissioner Kristin N. Johnson Regarding the
CFTC’s Notice of Proposed Rulemaking on
Operational Resilience Program for FCMs, SDs, and
MSPs (Dec. 18, 2023); https://www.cftc.gov/
PressRoom/SpeechesTestimony/
johnsonstatement121823.
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have repeatedly called for the Commission to
initiate a comprehensive rulemaking process
across all market infrastructures—DCOs,
SEFs, and DCMs—to address inherent
conflicts of interest issues that arise in
vertically integrated structures, including,
most recently, in my statement on the
Bitnomial DCM application where I outlined
numerous important Commission conflicts of
interest regulations.20
A Rulemaking on Vertical Integration Is
Essential
The Preamble to the Proposed Rule notes
that in 2021, Commission staff identified
several SEFs and three DCMs that were in the
same corporate family as intermediaries
engaged in trading on the affiliated-SEF or
DCM. Such organizational structures increase
the risk of conflicts of interest.
The Commission’s request for comment
and staff advisory are helpful initial steps.
On June 28, 2023, Commission staff issued a
Request for Comment on the Impact of
Affiliations Between Certain CFTC-Regulated
Entities (RFC on Vertical Integration) to
better understand a broad range of potential
issues that may arise if a DCO, DCM, or SEF
is affiliated with an intermediary that uses its
platform.21 On December 18, 2023, the
Commission issued a staff advisory on
affiliations between a DCM, DCO, or a SEF
and an intermediary or other market
participant to remind them of their regulatory
obligations.22
The Commission staff indicates that we
should anticipate proposed conflicts
regulations addressing vertical integration,
including responses to concerns related to
market regulation functions posed by
affiliations. It is, however, unacceptable that
this commitment note appears only in a
footnote that fails to provide a clear and
unambiguous commitment to undertake a
rulemaking.
Industry comments related to SEFs and
DCMs with affiliated trading members
highlight the urgent need for a regulatory
response. Many of the comments to the RFC
on Vertical Integration echo these concerns.
It is particularly disappointing that the
Commission is delaying a resolution of the
matter when certain questions in the RFC on
Vertical Integration directly implicate the
narrowly-defined ‘‘market regulation
functions.’’
ddrumheller on DSK120RN23PROD with PROPOSALS2
A Piecemeal Approach Risks Inconsistencies
and Contradictions
The Proposed Rule’s significant gaps are
likely to demand future rulemakings
addressing them. For example, the Proposed
Rule is silent on the sharing of certain key
executive functions and other key personnel,
20 Opening Statement Regarding the Open
Commission Meeting on December 13, 2023, supra
note 1.
21 Request for Comment on the Impact of
Affiliations of Certain CFTC-Regulated Entities,
CFTC Release 8734–23, June 28, 2023, https://
www.cftc.gov/PressRoom/PressReleases/8734-23.
22 Staff Advisory on Affiliations Among CFTCRegulated Entities, CFTC Release 8839–23, Dec. 18,
2023, https://www.cftc.gov/PressRoom/
PressReleases/8839-23.
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which is not an unusual operating model for
vertically integrated structures.23
While the Proposed Rule requires a DCM’s
CRO and an SEF’s CCO to report to the board
of directors or a senior officer of the SEF or
DCM, it does not require that the CCO report
to the ROC, which is comprised of only
public directors.24 A member of the board,
including a shared officer—e.g., the chief
executive officer—may have supervisory
authority over the CRO and CCO. This raises
the question of whether the Commission has
adequately insulated the CRO and CCO from
commercial pressures when a CRO or CCO is
required to make decisions about a member
that is affiliated with the SEF or DCM.
Compounding this issue, the Commission is
allowing the CRO and CCO to be paid based
on the profits of the SEF or DCM, which
could create perverse incentives.
I am disappointed that the Commission has
elected to proceed with the Proposed Rule on
conflicts concerns without initiating a formal
rulemaking to establish effective conflicts
rules in the context of vertically integrated
structures.25 The Commission’s piecemeal
approach to regulating the derivatives market
leaves key issues unaddressed.
IV. Failure To Adequately Reinforce the
Commission’s Right To Take Regulatory
Action Upon a Change of Ownership
Since the early months of my tenure as a
Commissioner, I have raised questions
regarding a change of control in the
ownership of a registered entity.
I welcome the Commission’s efforts to
address the disparate regulations that govern
the two approaches for acquiring access to
our markets. I find, however, that the
Proposed Rule advances and codifies
deficiencies and reinforces an antiquated
understanding of markets.
In any instance in which an applicant
seeks to register with the CFTC, transfer a
designation, or acquire a controlling
percentage of the equity interest in a licensed
registrant, the CFTC must be confident that
the party assuming control over a registrant
will continue to comply with our regulations
in a manner consistent with the
Commission’s expectations of the registrant
at the time of the approval of the registrant’s
initial application.
While the Commission retains the
authority to suspend or revoke the
registration of or impose a cease and desist
23 See CME Comment Letter in response to
General CFTC Request for Comment on the Impact
of Affiliations of Certain CFTC-Regulated Entities at
16–17 (Sept. 20, 2023), https://comments.cftc.gov/
PublicComments/CommentList.aspx?id=7401;
Global Association of Central Counterparties
Comment Letter in response to General CFTC
Request for Comment on the Impact of Affiliations
of Certain CFTC-Regulated Entities at 3 (Sept. 28,
2023), https://comments.cftc.gov/PublicComments/
CommentList.aspx?id=7401.
24 See Futures Industry Association Comment
Letter in response to General CFTC Request for
Comment on the Impact of Affiliations of Certain
CFTC-Regulated Entities at 10 (Sept. 28, 2023),
https://comments.cftc.gov/PublicComments/
CommentList.aspx?id=7401.
25 A Call for the CFTC to Begin a Formal
Rulemaking to Address Vertical Integration, supra
note 1.
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19723
order on a SEF or DCM that fails to comply
with the CEA and Commission regulations,
our regulations should clearly state that the
Commission will object to a transfer of
ownership in such circumstances or has an
outright approval right.
The efforts of the Commission staff are
commendable but not sufficient. With respect
to a change in ownership or corporation or
organizational structure of the SEF or DCM,
if a SEF or DCM does not have the ability to
comply with the CEA and Commission
regulations in connection with such a
change, the Commission should have the
ability to approve or object to such change.
New Equity Transfer Provisions
Commission Regulation 38.5(c)(1)
currently provides that a DCM must file with
the Commission a notification of each
transaction it enters into involving the
transfer of ten percent or more of the equity
interest in the DCM.26 The regulation does
not indicate that Commission approval is
required for the acquisition. Similar
provisions apply to SEFs in CFTC Regulation
37.5(c), but the threshold that triggers a
notice event is fifty percent or more of the
equity interest of the SEF. Under Regulation
37.5(c), a SEF must also certify as to its
compliance with the CEA and Commission
regulations.27 DMO staff review the relevant
notifications.
The Commission proposes to amend CFTC
Regulations 37.5(c) and 38.5(c) to:
• ensure the Commission receives timely
and sufficient information in the event of
certain changes in the ownership or
corporate or organizational structure of a SEF
or DCM;
• clarify what information is required to be
provided and the relevant deadlines;
• conform to similar existing and proposed
requirements applicable to DCOs; and
• impose a certification requirement.
The Proposed Rule emphasizes the
importance of disclosures related to the
ownership structure of registrants. In our
registration process, staff carefully evaluates
significant volumes of data regarding an
entity that seeks to be licensed by and subject
to the Commission’s authority. The
disclosures enable the Commission to assess
whether the entity demonstrates the requisite
ability to comply with our regulation.
The Proposed Rule acknowledges the
significant business organizational shifts in
our markets. For many years market
participants were organized as cooperative
structures or private partnerships.
Demutualization and an increase in
registrants choosing to become publiclytraded companies alters the market
landscape. In addition to a transformation in
how risks and default risks are managed, this
approach has led to significant consolidation
in some contexts.
A ten percent change in the equity
ownership may create a notable difference in
governance and risk management decisionmaking authority within a firm. Finally, our
regulations note that an asset purchase may
have the same effect as an equity interest
26 17
27 17
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CFR 38.5(c).
CFR 37.5(c).
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transfer. The Proposed Rule requires SEFs
and DCMs to notify the CFTC if substantially
all of the assets of the SEF or DCM are
transferred to another legal entity.
Limitations of the Equity Transfer Provisions
The Proposed Rule should clearly state that
the Commission has the regulatory authority
to take traditional and well-recognized
regulatory action in the context of a change
in the ownership or corporate or
organizational structure of a SEF or DCM.
From as early as 2022, I have raised alarms
with respect to the Commission’s explicit
and express authority under Commission
regulations to engage in a robust dialogue
with a registrant planning a significant equity
interest transfer.28 The Proposed Rule fails to
fully address my concerns.
I am deeply concerned that some may
mistakenly interpret the Proposed Rule to
indicate that the Commission has no explicit
or express legal authority to take regulatory
action upon disclosure of an acquisition of
our registrant where the Commission believes
that the registrant will no longer comply with
the CEA or Commission regulations.
In addition to this concern, I strongly
believe that the Commission has missed an
opportunity to ensure that all entities
entering in our markets are subject to the
same rules whether they are acquiring a
significant equity interest in a registered
entity or registering as a registrant. The best
method of addressing these twin concerns is
to first clarify the Commission’s existing
authority and to ensure that across our
markets the equity interest transfer
regulations are similar and that these
regulations involve inquiries as robust and
effectively enforced as disclosures provided
at the time that an entity registers with the
Commission.
ddrumheller on DSK120RN23PROD with PROPOSALS2
Objecting to a Change in Equity Ownership
As part of the registration process, SEFs
and DCMs are required to demonstrate, prior
to registration, compliance with the CEA and
related core principles. An entity seeking
designation as a SEF or DCM must include
ownership information in its Form DCM or
Form SEF application. This authority is
parallel to the authority the Commission
exercises when a registered entity
experiences a change of control.
The Proposed Rule should clarify that the
Commission may object to a proposed change
in ownership or corporate or organizational
structure for SEFs and DCMs if such change
could result in a failure of a registrant to
comply with the CEA or Commission
regulations. In parallel to the Commission’s
authority to grant registration is the
Commission’s authority to revoke
registration.
28 Commissioner Kristin N. Johnson, Keynote
Address at UC Berkeley Law Crypto Regulation
Virtual Conference (Feb. 8, 2023), https://
www.cftc.gov/PressRoom/SpeechesTestimony/
opajohnson3 (‘‘During a more recent speech at Duke
University. . . I also called for Congress to consider
including in any legislation expanding the CFTC’s
authority a provision that enables the Commission
to have greater authority including, in the least, a
robust dialogue in advance of the acquisition of a
controlling equity ownership stake in any registered
market participant.’’).
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Approving a Change in Ownership
The Proposed Rule should state that the
Commission has an approval right in the
event of a change in ownership or corporate
or organizational structure. This approval
authority parallels the authority that the
Commission exercises at the time of
registration. Rule text that explicitly states
the same would clarify the Commission’s
authority for market participants.
For example, certain prudential regulations
are consistent with this understanding. The
Office of the Comptroller of the Currency
(OCC), for example, requires that any party
seeking to acquire control of a national bank
give notice of such change to the OCC. Upon
the filing of such notice, the OCC has the
power to disapprove (i.e., object to) such
changes set out in the notice.29 Similarly,
under FINRA Rule 1017, a member is
required to file an application with FINRA
for approval of a 25% change in equity
ownership of the member.
V. Conclusion
I believe the Commission should adopt
parallel conflicts regulations across our
markets and must adopt conflicts rules that
effectively govern conflicts among affiliated
entities. I believe that the Commission has
notable authority with respect to any entity
seeking to acquire a controlling equity
interest in a business in our markets,
including the authority to suspend, revoke,
or enter a cease and desist order, should the
ownership change result in a violation of a
statutory or regulatory requirement or a
Commission order. I would like to see the
Commission go farther and adopt a
rulemaking that gives the Commission the
right to approve or object to a change in
ownership or corporate or organizational
structure to the same extent.
I would like to extend my sincere gratitude
to the DMO team, including Rachel
Berdansky, Swati Shah, Marilee Dahlman,
Jennifer Tveiten-Rifman, David Steinberg,
Lillian Cardona, Caitlin Holzem, and Rebecca
Mersand.
Appendix 4—Statement of
Commissioner Christy Goldsmith
Romero
Conflicts of interest at exchanges and swap
execution facilities (SEFs) present serious
risk to market fairness, integrity, and
financial stability. The CFTC plays a critical
role in implementing strong rules to prevent
conflicts from hurting customers, markets,
market participants, and end users. As
designated self-regulatory organizations,
exchanges serve as the front line for market
integrity.1 And given the contribution to the
financial crisis of opaque caveat emptor
29 12
CFR 5.50(f)(3).
are responsible for setting financial
and reporting rules, including involving customer
funds. Exchanges must also supervise compliance
with exchange rules and Commission regulations
related to capital, customer protection, risk
management, financial reporting, and record
keeping. They have a responsibility to investigate
and discipline those who violate those
requirements.
1 Exchanges
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swaps markets,2 the Dodd-Frank Act created
SEFs and gave them important regulatory
responsibilities to ensure transparency in the
swaps markets.3 In order for markets to
function well and fairly, these important
regulatory responsibilities must be performed
free of conflicts of interest.
Existing CFTC rules already require
exchanges and SEFs to establish and enforce
rules to minimize conflicts of interest, and
we have issued accompanying guidance to
exchanges. Though I support the rule, I
consider it to be a baseline minimum, largely
codifying existing guidance,4 extending it to
swap execution facilities, and adding a few
additional requirements.
This proposed rule would not create an
adequate conflicts of interest regulatory
regime to cover conflicts that come from
affiliated entities serving multiple functions
(i.e. broker, exchange, clearinghouse, etc.)–so
called ‘‘vertical integration,’’ which the
proposal acknowledges.5 Therefore, this rule
does not serve as a basis for future approval
of additional vertically integrated structures
that break from the traditional structure on
which the Commodity Exchange Act and
CFTC rules are based.
The proposal purposely attempts to carve
out vertical integration from this rulemaking
and commits to addressing it in the future in
light of the recently completed request for
comment on affiliated entities. By September,
the CFTC received more than 100 comments
expressing significant concern over conflicts
of interest with vertically integrated market
structures.6 Serious concerns about vertically
integrated market structures in digital assets
had already been expressed by the White
House in the Economic Report of the
President,7 the Financial Stability Oversight
2 See Business Conduct Standards for Swap
Dealers and Major Swap Participants with
Counterparties, 77 FR 9734, 9805 (Feb. 17, 2012)
(Comment of CFA/AFR).
3 SEFs have important regulatory responsibilities,
including reporting transactions and maintaining an
audit trail. SEFs are required to establish and
enforce rules for trading or processing swaps, and
to have the capacity to investigate violations and
enforce these rules.
4 See 17 CFR part 38, Appendix B.
5 See Proposal at note 118 (‘‘The Commission
received a number of comments raising concerns
about the impact of affiliation, and anticipates
proposing regulations that will address issues
identified as a result of the [request for comment]
RFC, including additional concerns raised by
commenters about the conflicts of interest,
specifically relating to market regulation functions,
posed by affiliations. This rulemaking does not
reflect the comments submitted in response to the
Commission staff’s RFC. Those comments will not
be made part of the administrative record before the
Commission in connection with this proposal’’).
6 The comments were in response to a request for
comment on the impact of affiliated entities. I have
raised concerns about the risk posed by these
arrangements, including the immediately apparent
risk of conflict of interest. See CFTC Commissioner
Christy Goldsmith Romero, https://www.cftc.gov/
PressRoom/SpeechesTestimony/
romerostatement062823, (June 28, 2023); See also
CFTC Commissioner Christy Goldsmith Romero,
https://www.cftc.gov/PressRoom/
SpeechesTestimony/oparomero3, (Oct. 26, 2022).
7 See The White House, https://
www.whitehouse.gov/wp-content/uploads/2023/03/
ERP-2023.pdf, (Mar. 2023).
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Council (FSOC),8 Treasury Secretary Janet
Yellen,9 then-Federal Reserve Vice Chair Lael
Brainard,10 and Acting Comptroller of the
Currency Michael Hsu before we issued the
request for comment.11 The CFTC has not
issued any new rules or guidance based on
those comments. Last month, the
Commission approved a vertically integrated
market structure for the first time (on which
I dissented given that we were in the middle
of studying the risks and had not engaged in
rulemaking),12 and it was said in the open
meeting that there are other pending
applications. As this proposal’s record will
not reflect comments submitted in response
to the request for comment on vertical
integration, I encourage commenters to
resubmit relevant sections of those comments
in response to this proposal.
ddrumheller on DSK120RN23PROD with PROPOSALS2
Requirements of the Proposed Rule
The rule would require an exchange or SEF
to report any change to the entity or person
that holds a controlling interest, either
directly or indirectly, as opposed to the more
limited notification requirements (10%
change in ownership of an exchange or 50%
ownership of a SEF). Any owners of
exchanges and SEFs may have other interests
(financial or otherwise) that may not align
with the exchange’s or SEF’s responsibilities.
The rule would require officers or directors
with an actual or potential conflict of interest
in the subject of a matter to abstain from both
voting and deliberation. The proposal also
creates a baseline definition of what is a
conflict of interest, and requires
documentation of compliance with the rule,
which facilitates oversight.
Officers, directors, those with an
ownership interest in the exchange of at least
10%, and employees would be banned from
trading on or disclosing material non-public
information. I would like to hear from
commenters if the 10% ownership threshold
is appropriate or should be lowered. I would
also like to hear whether commenters think
the proposed requirements are sufficient to
prevent the misuse of non-public
information, especially in cases where
employees, officers, directors or owners are
also employed by a company that trades in
contracts for commodities traded on the
exchange. I am especially interested in
comments about whether the Commission
should ban use of material non-public
information for trades on a spot exchange by
8 See Financial Stability Oversight Council,
https://home.treasury.gov/system/files/261/FSOCDigital-Assets-Report-2022.pdf, (Oct. 3, 2022).
9 See https://home.treasury.gov/news/featuredstories/remarks-by-secretary-of-the-treasury-janet-lyellen-at-the-national-association-for-businesseconomics-39th-annual-economic-policyconference, (Mar. 30, 2023).
10 See Federal Reserve Board Vice-Chair Lael
Brainard, https://www.federalreserve.gov/
newsevents/speech/brainard20220708a.htm, (July
8, 2022).
11 See Acting Comptroller of the Currency
Michael J. Hsu, https://www.occ.treas.gov/newsissuances/speeches/2022/pub-speech-2022-125.pdf,
(Oct. 11, 2022).
12 See CFTC Commissioner Christy Goldsmith
Romero, https://www.cftc.gov/PressRoom/
SpeechesTestimony/romerostatement121823b,
(December 18, 2023).
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an officer, director, owner or employee of an
affiliated derivatives exchange.13
The proposal would codify guidance by
requiring establishment of a regulatory
oversight committee, comprised entirely of
independent public directors tasked with
monitoring the effectiveness of an exchange
or SEF’s regulatory functions and minimizing
and resolving conflicts of interest, and
requires every exchange to have a Chief
Regulatory Officer (‘‘CRO’’).14 Requirements
for the regulatory oversight committee
include approving the size and allocation of
resources and the number of market
regulation staff.
The proposal does not address the issue of
shared resources of affiliated entities,
including for example dual-hatted
employees. Shared resources lead to
concerns about whose interest will dominate
when it counts the most, during times of
stress. Shared resources also raise concerns
over capacity to fulfill regulatory
responsibilities, including for example, a
derivatives exchange’s ability to fulfill its
front-line market integrity responsibility
when using shared resources of an affiliated
spot exchange.15
I want to thank the staff for working with
me to strengthen this proposal, including in
the way it incorporates affiliates in certain
areas, particularly given that affiliated
entities can raise conflicts of interest even
outside of the vertical integration structure.
I continue to urge further rulemaking to
address conflicts of interest, including those
associated with vertically integrated market
structures.
Appendix 5—Statement of
Commissioner Caroline D. Pham
I am voting to publish the Notice of
Proposed Rulemaking on Requirements for
Designated Contract Markets (DCMs) and
Swap Execution Facilities (SEFs) Regarding
Governance and the Mitigation of Conflicts of
Interest Impacting Market Regulation
Functions (DCM and SEF Conflicts of Interest
Proposal or NPRM) because the public must
have an opportunity to weigh in on these
important issues that raise serious concerns.
I would like to thank Lillian Cardona,
Jennifer Tveiten-Rifman, Marilee Dahlman,
Swati Shah, and Rachel Berdansky in the
Division of Market Oversight for their time
and efforts, and I take this opportunity to
recognize the importance of their rule
enforcement reviews program for DCMs and
13 The Commission currently requires an
exchange to provide for ‘‘appropriate’’ limitations
on the use of material non-public information by
employees, officers, and directors, but does not
include a spot exchange trading ban as one of its
specific requirements for such limitations.
14 SEFs are required to have a Chief Compliance
Officer with similar duties and responsibilities. The
regulatory oversight committee would be required
to minimize any conflicts of interest involving the
CRO or CCO. Compensation of the position would
require consultation with the public directors in the
ROC. The exchange would also be required to
disclose and minimize any conflicts of interest
involving the CRO or CCO.
15 See CFTC Commissioner Christy Goldsmith
Romero, https://www.cftc.gov/PressRoom/
SpeechesTestimony/romerostatement062823, (June
28, 2023).
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Fmt 4701
Sfmt 4702
19725
SEFs. I appreciate the staff working with me
to make revisions to address my concerns.
Unfortunately, while the NPRM has been
improved, it is far from perfect.
Overall, I believe the public comment
process is a critical component of good
government. That is why, although I have
serious concerns about the DCM and SEF
Conflicts of Interest Proposal, I am voting to
publish it for transparency and public
engagement on this flawed rulemaking.
The CFTC cannot haphazardly codify
guidance as rules. That goes against the very
essence of the statutory framework to
regulate derivatives markets under the
Commodity Exchange Act (CEA). Here,
public input will serve as a valuable tool in
refining the NPRM by providing insights that
may not have been considered in changing
the CFTC’s longstanding principles-based
approach to oversight of self-regulatory
organizations (SROs) such as DCMs and
SEFs, who establish their own rule books and
bring enforcement actions against market
participants for violations.1 In 2012, when
the CFTC first adopted its DCM rules and
decided to leave certain areas as guidance on
acceptable best practices, the CFTC
thoroughly examined each regulation and
explained where guidance was more
appropriate than a rule in recognition of the
need to maintain flexibility for DCMs to
establish rules that are appropriate for their
products, markets, and participants,
including associated risks.2 I have serious
concerns with the CFTC proceeding down a
path to finalizing a rule that is overly
prescriptive and unsupported by data or
other evidence.
Specific Areas for Public Comment
Separately, I am highlighting two
additional issues for commenters:
1 See Statement of Commissioner Caroline D.
Pham Regarding Request for Comment on the
Impact of Affiliations Between Certain CFTCRegulated Entities (June 28, 2023), https://
www.cftc.gov/PressRoom/SpeechesTestimony/
phamstatement062823; Statement of Commissioner
Caroline D. Pham on Effective Self-Regulation and
Notice of Proposed Rulemaking to Amend Part 40
Regulations (July 26, 2023), https://www.cftc.gov/
PressRoom/SpeechesTestimony/
phamstatement072623b.
2 See Core Principles and Other Requirements for
Designated Contract Markets, 77 FR 36612, 36614
(June 19, 2012), https://www.federalregister.gov/
documents/2012/06/19/2012-12746/core-principlesand-other-requirements-for-designated-contractmarkets (explaining the process as ‘‘In determining
whether to codify a compliance practice in the form
of a rule or guidance/acceptable practice, the
Commission was guided by whether the practice
consisted of a commonly-accepted industry
practice. Where there is a standard industry
practice that the Commission has determined to be
an acceptable compliance practice, the Commission
believes that the promulgation of clear-cut
regulations will provide greater legal certainty and
transparency to DCMs in determining their
compliance obligations, and to market participants
in determining their obligations as DCM members,
and will facilitate the enforcement of such
provisions. Several of the rules adopted in this
notice of final rulemaking largely codify practices
that are commonly accepted in the industry and are
currently being undertaken by most, if not all,
DCMs.’’).
E:\FR\FM\19MRP2.SGM
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19726
Federal Register / Vol. 89, No. 54 / Tuesday, March 19, 2024 / Proposed Rules
Material Non-Public Information
The Commission is refusing to fix the
references to ‘‘material non-public
information’’ in Parts 37 and 38. Even though
the NPRM cites Regulation 1.59(d) and its
use of ‘‘material, non-public information,’’
and that the intent is to copy the
requirements in Regulation 1.59(d) to Parts
37 and 38 purely for housekeeping purposes,
the Commission is potentially creating a
loophole by making a small but very
substantive change in using ‘‘material nonpublic information’’ in Parts 37 and 38. The
former—with a comma—broadly captures
information that is material and non-public.
The latter—with no comma—is an incorrect
usage of a well-established term of art under
securities laws that is too narrow to address
the potential conflicts in derivatives markets,
creates unnecessary confusion for market
participants, and undermines robust
compliance programs by introducing
uncertainty.3 ‘‘Consistency’’ is a goal
repeated throughout the NPRM, and I do not
understand why we are refusing to resolve
the inconsistency here.
The Commission must protect all
confidential information—not just material
information—in order to effectively mitigate,
prevent, or avoid conflicts of interest. In
some circumstances, there must be a
complete information barrier or segregation
of activities between business units or
ddrumheller on DSK120RN23PROD with PROPOSALS2
3 See Dissenting Statement of Commissioner
Caroline D. Pham on Misappropriation Theory in
Derivatives Markets (Sept. 27, 2023), https://
www.cftc.gov/PressRoom/SpeechesTestimony/
phamstatement092723.
VerDate Sep<11>2014
18:21 Mar 18, 2024
Jkt 262001
personnel to protect sensitive and
confidential information about customer
trades or positions in order to prevent
potential market manipulation or other
abusive trading practices. The Commission’s
misguided approach is not enough to protect
our markets from misconduct.4
Revocation of Registration
I am deeply concerned about proposed
Regulations 37.5(c)(6) and 38.5(c)(6).5 This is
the first time that the CFTC has decided to
promulgate a rule to revoke the registration
of a registered entity since section 5e of the
Commodity Exchange Act was enacted in
1998, with insufficient explanation to
demonstrate a reasonable basis and reasoned
decision-making as required by the
Administrative Procedure Act,6 and
4 Id.
5 The language is the same for both SEFs and
DCMs, so for brevity I will only include it for SEFs
here: Reg. 37.5(c)(6) A change in the ownership or
corporate or organizational structure of a SEF that
results in the failure of the SEF to comply with any
provision of the CEA, or any regulation or order of
the Commission thereunder—(i) shall be cause for
the suspension of the registration of the SEF or the
revocation of registration as a SEF, in accordance
with the procedures provided in sections 5e and
6(b) of the CEA, including notice and a hearing on
the record; or (ii) may be cause for the Commission
to make and enter an order directing that the SEF
cease and desist from such violation, in accordance
with the procedures provided in sections 6b and
6(b) of the CEA, including notice and a hearing on
the record.
6 The only justification provided is ‘‘[i]t is
imperative that SEFs and DCMs, regardless of
ownership or control changes, continue to comply
with the CEA and all Commission regulations to
PO 00000
Frm 00082
Fmt 4701
Sfmt 9990
insufficient procedural safeguards to ensure
due process for DCMs and SEFs. The
government must ensure due process under
the Constitution, including judicial review,
before taking away the rights of the public in
what may well be a death knell for trading
venues. Anything less is an abuse of power.7
Further, the rules are clearly overbroad
because the CFTC could revoke registration
due to changes ‘‘in the ownership or
corporate or organizational structure’’ of a
DCM or SEF (emphasis added). This could
include simple changes in headcount and
other staffing reorganizations, making it all
too easy for the CFTC to manufacture a
reason to revoke registration. I sincerely hope
that this is not the Commission’s intent.
What is even more puzzling is that the CFTC
is choosing to propose structural changes as
cause to revoke registration, but not grave
misconduct such as fraud, abuse, or
manipulation. This is nonsensical. I urge
commenters to pay close attention to the full
import of the revocation of registration
proposed rules.
I look forward to reviewing the comments
on the DCM and SEF Conflicts of Interest
Proposal.
[FR Doc. 2024–04938 Filed 3–18–24; 8:45 am]
BILLING CODE 6351–01–P
promote market integrity and protect market
participants.’’
7 See Statement of Commissioner Caroline D.
Pham on Effective Self-Regulation and Notice of
Proposed Rulemaking to Amend Part 40
Regulations (July 26, 2023), https://www.cftc.gov/
PressRoom/SpeechesTestimony/
phamstatement072623b.
E:\FR\FM\19MRP2.SGM
19MRP2
Agencies
[Federal Register Volume 89, Number 54 (Tuesday, March 19, 2024)]
[Proposed Rules]
[Pages 19646-19726]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 2024-04938]
[[Page 19645]]
Vol. 89
Tuesday,
No. 54
March 19, 2024
Part II
Commodity Futures Trading Commission
-----------------------------------------------------------------------
17 CFR Parts 37 and 38
Requirements for Designated Contract Markets and Swap Execution
Facilities Regarding Governance and the Mitigation of Conflicts of
Interest Impacting Market Regulation Functions; Proposed Rule
Federal Register / Vol. 89 , No. 54 / Tuesday, March 19, 2024 /
Proposed Rules
[[Page 19646]]
-----------------------------------------------------------------------
COMMODITY FUTURES TRADING COMMISSION
17 CFR Parts 37 and 38
RIN 3038-AF29
Requirements for Designated Contract Markets and Swap Execution
Facilities Regarding Governance and the Mitigation of Conflicts of
Interest Impacting Market Regulation Functions
AGENCY: Commodity Futures Trading Commission.
ACTION: Notice of proposed rulemaking.
-----------------------------------------------------------------------
SUMMARY: The Commodity Futures Trading Commission (``Commission'' or
``CFTC'') is proposing new rules and amendments to its existing
regulations for designated contract markets (``DCMs'') and swap
execution facilities (``SEFs'') that would establish governance and
fitness requirements with respect to market regulation functions, as
well as related conflict of interest standards. The proposed new rules
and amendments include minimum fitness standards, requirements for
identifying, managing, and resolving conflicts of interest, and
structural governance requirements to ensure that SEF and DCM governing
bodies adequately incorporate an independent perspective. The proposal
also address requirements relating to the following: composition
requirements for board of directors and disciplinary panels;
limitations on the use and disclosure by employees and certain others
of material non-public information; requirements relating to Chief
Regulatory Officers, Chief Compliance Officers, and Regulatory
Oversight Committees; and notification of certain changes in the
ownership or corporate or organizational structure of a SEF or DCM.
DATES: Comments must be received on or before April 22, 2024.
ADDRESSES: You may submit comments, identified by ``Requirements for
Designated Contract Markets and Swap Execution Facilities Regarding
Governance and the Mitigation of Conflicts of Interest'' and RIN 3038-
AF29, by any of the following methods:
CFTC Comments Portal: https://comments.cftc.gov. Select
the ``Submit Comments'' link for this rulemaking and follow the
instructions on the Public Comment Form.
Mail: Send to Christopher Kirkpatrick, Secretary of the
Commission, Commodity Futures Trading Commission, Three Lafayette
Centre, 1155 21st Street NW, Washington, DC 20581.
Hand Delivery/Courier: Follow the same instructions as for
Mail, above.
Please submit your comments using only one of these methods.
Submissions through the CFTC Comments Portal are encouraged.
All comments must be submitted in English, or if not, accompanied
by an English translation. Comments will be posted as received to
https://comments.cftc.gov. You should submit only information that you
wish to make available publicly. If you wish the Commission to consider
information that you believe is exempt from disclosure under the
Freedom of Information Act (``FOIA''), a petition for confidential
treatment of the exempt information may be submitted according to the
procedures established in Sec. 145.9 of the Commission's
regulations.\1\
---------------------------------------------------------------------------
\1\ 17 CFR 145.9.
---------------------------------------------------------------------------
The Commission reserves the right, but shall have no obligation, to
review, pre-screen, filter, redact, refuse, or remove any or all of
your submission from https://www.comments.cftc.gov that it may deem to
be inappropriate for publication, such as obscene language. All
submissions that have been redacted or removed that contain comments on
the merits of the rulemaking will be retained in the public comment
file and will be considered as required under the Administrative
Procedure Act and other applicable laws, and may be accessible under
FOIA.
FOR FURTHER INFORMATION CONTACT: Rachel Berdansky, Deputy Director,
[email protected], 202-418-5429; Swati Shah, Associate Director,
[email protected], 202-418-5042; Marilee Dahlman, Special Counsel,
[email protected], 202-418-5264; Jennifer L. Tveiten-Rifman, Special
Counsel, [email protected], 312-802-3848; Lillian Cardona,
[email protected], Assistant Chief Counsel, 202-418-5012.
SUPPLEMENTARY INFORMATION:
Table of Contents
I. Introduction
II. Background
a. Statutory Requirements for SEFs and DCMs
b. Proposed and Final Rules Addressing SEF and DCM Governance
and Conflicts of Interest
1. 2001 Regulatory Framework
2. 2007 Final Release, Conflicts of Interest Acceptable
Practices for DCMs
3. 2009 Final Release, Definition of Public Director
4. 2010 Conflicts of Interest Rule Proposal
5. 2011 Governance and Conflicts of Interest NPRM
6. 2012 Part 38 Final Rule
7. 2013 Part 37 Final Rule
8. 2021 Part 37 Amendments--CCO Duties and Annual Compliance
Report
c. Industry Changes and Impact on Regulatory Developments
d. Conflicts of Interest Relating to Market Regulation Functions
1. Market Regulation Functions
2. Questions for Comment
3. Conflicts of Interest Between Market Regulation Functions and
Commercial Interests
III. Proposed Governance Fitness Requirements
a. Overview
b. Minimum Fitness Standards--Proposed Sec. Sec. 37.207 and
38.801
1. Existing Regulatory Framework
2. Proposed Rules
3. Questions for Comment
IV. Proposed Substantive Requirements for Identifying, Managing and
Resolving Actual and Potential Conflicts of Interest
a. General Requirements for Conflicts of Interest and
Definitions--Proposed Sec. Sec. 37.1201 and 38.851
1. Existing Regulatory Framework and Definitions
2. Proposed Rules
b. Conflicts of Interest in Decision-Making--Proposed Sec. Sec.
37.1202 and 38.852
1. Background
2. Existing Regulatory Framework
3. Proposed Rules
4. Questions for Comment
c. Limitations on the Use and Disclosure of Material Non-Public
Information--Proposed Sec. Sec. 37.1203 and 38.853
1. Background
2. Existing Regulatory Framework
3. Proposed Rules
4. Questions for Comment
V. Proposed Structural Governance Requirements for Identifying,
Managing and Resolving Actual and Potential Conflicts of Interest
a. Composition and Related Requirements for Board of Directors--
Proposed Sec. Sec. 37.1204 and 38.854
1. Background
2. Existing Regulatory Framework
3. Proposed Rules
4. Questions for Comment
b. Public Director Definition--Proposed Sec. Sec.
37.1201(b)(12) and 38.851(b)(12)
1. Background
2. Existing Regulatory Framework
3. Proposed Rules
4. Questions for Comment
c. Nominating Committee and Diverse Representation--Proposed
Sec. Sec. 37.1205 and 38.855
1. Background
2. Existing Regulatory Framework
3. Proposed Rules
4. Questions for Comment
d. Regulatory Oversight Committee--Proposed Sec. Sec. 37.1206
and 38.857
1. Background
2. Existing Regulatory Framework
3. Proposed Rules
4. Questions for Comment
e. Disciplinary Panel Composition--Proposed Sec. Sec. 37.1207
and 38.858
1. Background
2. Existing Regulatory Framework
3. Proposed Rules
4. Questions for Comment
[[Page 19647]]
f. DCM Chief Regulatory Officer--Proposed Sec. 38.856
1. Background
2. Existing Regulatory Framework
3. Proposed Rules
4. Questions for Comment
g. Staffing and Investigations--Proposed Changes to Sec. Sec.
38.155, 38.158, and 37.203
1. Background
2. Existing Regulatory Framework
3. Proposed Rules
4. Questions for Comment
h. SEF Chief Compliance Officer--Proposed Changes to Sec.
37.1501
1. Background
2. Existing Regulatory Framework
3. Proposed Rules
4. Questions for Comment
VI. Conforming Changes
a. Commission Regulations Sec. Sec. 37.2, 38.2, and Part 1
b. Transfer of Equity Interest--Commission Regulations
Sec. Sec. 37.5(c) and 38.5(c)
1. Background
2. Existing Regulatory Framework
3. Proposed Rules
4. Questions for Comment
VII. Effective and Compliance Dates
VIII. Related Matters
a. Cost-Benefit Considerations
1. Introduction
2. Baseline
3. Proposed Rules
4. Question for Comment
b. Regulatory Flexibility Act
c. Paperwork Reduction Act
d. Antitrust Considerations
IX. Proposed Rule Text
I. Introduction
The Commission proposes to establish governance fitness regulations
related to market regulation functions,\2\ and related conflict of
interest requirements, for swap execution facilities (``SEFs'') and
designated contract markets (``DCMs''). Although SEFs and DCMs have
similar obligations with respect to market regulation functions, they
are subject to different obligations with respect to governance fitness
standards and mitigating conflicts of interest. SEFs and DCMs are
required to minimize and resolve conflicts of interest pursuant to
identical statutory core principles.\3\ However, SEF and DCM regulatory
requirements addressing governance fitness standards currently differ.
With respect to governance fitness standards, DCMs are subject to
specific statutory core principles addressing governance,\4\ while SEFs
do not have parallel core principle requirements. Additionally, SEFs
and DCMs currently have different regulatory obligations with respect
to governance fitness standards.\5\ Further, while both SEFs and DCMs
are subject to equity transfer requirements,\6\ the applicable
regulatory provisions currently have different notification thresholds
and obligations.
---------------------------------------------------------------------------
\2\ As discussed further below, the Commission is proposing to
define ``market regulation functions'' to include the SEF functions
required by SEF Core Principles 2 (Compliance with Rules), 4
(Monitoring of Trading and Trade Processing), and 6 (Position Limits
or Accountability), the DCM functions required by DCM Core
Principles 2 (Compliance with Rules), 4 (Prevention of Market
Disruption), 5 (Position Limitations or Accountability), 10 (Trade
Information), 12 (Protection of Markets and Market Participants),
and 13 (Disciplinary Procedures), and regulations thereunder. These
responsibilities include, but are not limited to, the
responsibilities of SEFs and DCMs to conduct trade practice
surveillance, market surveillance, real-time market monitoring,
audit trail enforcement, investigations of possible SEF or DCM rule
violations, and disciplinary actions. See proposed Sec. Sec.
37.1201(b)(9) and 38.851(b)(9).
\3\ See SEF Core Principle 12, Commodity Exchange Act (``CEA'')
section 5h(f), 7 U.S.C. 7b-3(f), and DCM Core Principle 16, CEA
section 5(d), 7 U.S.C. 7(d).
\4\ See DCM Core Principles 15 and 17, CEA section 5(d)(15), 7
U.S.C. 7(d)(15), and CEA section 5(d)(17), 7 U.S.C. 7(d)(17),
respectively.
\5\ As discussed below, SEFs, but not DCMs, are required to
comply with requirements under part 1 of the Commission's
regulations addressing the sharing of nonpublic information, service
on the board or committees by persons with disciplinary histories,
board composition, and voting by board or committee members where
there may be a conflict of interest.
\6\ Commission regulation Sec. 37.5(c) (SEFs) and Commission
regulation Sec. 38.5(c) (DCMs).
---------------------------------------------------------------------------
In this proposal, the Commission is drawing on staff experience in
conducting its routine oversight of SEF and DCM ``market regulation
functions,'' which include responsibilities related to trade practice
surveillance, market surveillance, real-time market monitoring, audit
trail data and recordkeeping enforcement, investigations of possible
SEF or DCM rule violations, and disciplinary actions. Commission staff
conducts oversight of these market regulation functions in a number of
ways, including rule enforcement reviews,\7\ SEF regulatory
consultations and registration application reviews, DCM designation
application reviews, and regular engagement with SEFs and DCMs.\8\
---------------------------------------------------------------------------
\7\ See Rule Enforcement Reviews of Designated Contract Markets,
https://www.cftc.gov/IndustryOversight/TradingOrganizations/DCMs/dcmruleenf.html.
\8\ As explained below, this proposal is not addressing SEF and
DCM obligations relating to core principles that specifically
address the financial integrity of transactions under SEF Core
Principle 7 and DCM Core Principle 11.
---------------------------------------------------------------------------
Through its oversight, Commission staff has identified areas where
it preliminarily believes that SEF and DCM regulations should be
enacted, in lieu of existing guidance and acceptable practices, to
further support the statutory objective of ensuring that conflicts of
interest are appropriately mitigated. The Commission is proposing
enhanced substantive requirements for identifying, managing, and
resolving conflicts of interest related to a SEF's or DCM's market
regulation functions, and structural governance requirements to ensure
that SEF and DCM governing bodies adequately incorporate an independent
perspective. The Commission is also proposing additional amendments to
address governance standards as they relate to the performance of the
market regulation function. The Commission is further proposing
enhanced notification requirements with respect to changes in the
ownership or corporate or organizational structure of a SEF or DCM.
More specifically, the Commission proposes: (1) new rules to
implement DCM Core Principle 15 (Governance Fitness Standards) that are
consistent with the existing guidance on compliance with DCM Core
Principle 15; \9\ (2) new rules to implement DCM Core Principle 16
(Conflicts of Interest) that are consistent with the existing guidance
on, and acceptable practices in, compliance with DCM Core Principle 16;
\10\ (3) new rules to implement SEF Core Principle 2 (Compliance With
Rules) that are consistent with the DCM Core Principle 15 Guidance;
\11\ (4) new rules to implement SEF Core Principle 12 (Conflicts of
Interest) that are consistent with the DCM Core Principle 16 Guidance
and Acceptable Practices; (5) new rules under part 37 of the
Commission's regulations for SEFs and part 38 of the Commission's
regulations for DCMs that are consistent with existing conflicts of
interest and governance requirements under Commission regulations
Sec. Sec. 1.59 and 1.63; \12\ (6) new rules for DCM Chief Regulatory
Officers (``CROs''); (7) amendments to certain requirements relating to
SEF Chief Compliance Officers (``CCOs''); and (8) new rules for SEFs
and DCMs relating to the establishment and operation of a Regulatory
Oversight Committee (``ROC''). The Commission also is proposing to
remove the guidance on
[[Page 19648]]
compliance with DCM Core Principle 15, as well as the guidance on, and
acceptable practices in, compliance with DCM Core Principle 16.
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\9\ Part 38, Appendix B, Core Principle 15 Guidance.
\10\ Part 38, Appendix B, Core Principle 16 Acceptable
Practices.
\11\ As discussed further below, SEF Core Principle 2 requires
SEFs to establish rules governing the operations of the facility. To
effectuate this requirement, the Commission preliminarily believes
it is necessary to establish governance fitness standards for the
individuals responsible for directing the operations of the SEF. See
Section III(a) herein.
\12\ The Commission is also proposing conforming amendments to
remove SEFs and DCMs from the scope of these part 1 requirements.
See Section V(a) herein.
---------------------------------------------------------------------------
The Commission also proposes amendments to existing rules in part
37 and part 38 of its regulations regarding the notification of a
transfer of equity interest in a SEF or DCM. The proposal would
harmonize and enhance the rules for SEFs and DCMs, and would also
harmonize these SEF and DCM rules with the corollary rules for
derivatives clearing organizations (``DCOs'') under part 39 of the
Commission's regulations.\13\ The proposal would further confirm the
Commission's authority to obtain information concerning continued
regulatory compliance in the event of changes in the ownership or
corporate or organizational structure of a SEF or DCM.
---------------------------------------------------------------------------
\13\ See, e.g., part 39 of the Commission's regulations, adopted
pursuant to Derivatives Clearing Organization General Provisions and
Core Principles, 76 FR 39333 (Nov. 8, 2011).
---------------------------------------------------------------------------
Finally, the Commission is proposing certain technical and
conforming changes to SEF and DCM rules relating to disciplinary
panels, staffing, and investigations.\14\
---------------------------------------------------------------------------
\14\ See Section V(e)-(g) herein.
---------------------------------------------------------------------------
In developing the rules proposed in this NPRM, the Commission has
consulted with the Securities and Exchange Commission (``SEC''),
pursuant to section 712(a)(1) of the Dodd-Frank Act.\15\
---------------------------------------------------------------------------
\15\ 15 U.S.C. 8302 (Providing that before commencing any
rulemaking or issuing an order regarding swaps, swap dealers, major
swap participants, swap data repositories, derivative clearing
organizations with regard to swaps, persons associated with a swap
dealer or major swap participant, eligible contract participants, or
swap execution facilities pursuant to the applicable subtitle, the
CFTC must consult and coordinate to the extent possible with the SEC
and the prudential regulators for the purposes of assuring
regulatory consistency and comparability, to the extent possible).
---------------------------------------------------------------------------
II. Background
a. Statutory Requirements for SEFs and DCMs
Section 5h \16\ of the CEA sets forth requirements for SEFs. CEA
section 5h(f)(1)(A) provides that in order to be registered, and to
maintain registration, with the Commission, a SEF must comply with (1)
15 core principles, and (2) any requirement that the Commission may
impose by rule or regulation pursuant to section 8a(5) of the CEA.\17\
Unless otherwise determined by the Commission by rule or regulation, a
SEF has reasonable discretion to establish the manner in which it
complies with a particular core principle. As of January 2024, there
were 21 registered SEFs.
---------------------------------------------------------------------------
\16\ 7 U.S.C. 7b-3.
\17\ 7 U.S.C. 7b-3(f).
---------------------------------------------------------------------------
Similarly, Section 5 of the CEA sets forth requirements for DCMs.
CEA section 5(d)(1)(A) requires that to be designated, and to maintain
designation, by the Commission, a DCM must comply with (1) 23 core
principles, and (2) any requirement that the Commission may impose by
rule or regulation pursuant to section 8a(5) of the CEA.\18\ Unless
otherwise determined by the Commission by rule or regulation, a DCM has
reasonable discretion to establish the manner in which it complies with
a particular core principle.\19\ As of January 2024, there were 17
registered DCMs.
---------------------------------------------------------------------------
\18\ CEA section 8a(5), 7 U.S.C. 12a(5), authorizes the
Commission to make and promulgate such rules and regulations as, in
the judgment of the Commission, are reasonably necessary to
effectuate any of the provisions or to accomplish any of the
purposes of the CEA. The CEA contains a finding that the
transactions subject to the CEA are affected with a ``national
public interest by providing a means for managing and assuming price
risks, discovering prices, or disseminating pricing information
through trading in liquid, fair and financially secure trading
facilities,'' and among the CEA's purposes are to serve the
aforementioned public interests through a system of ``effective
self-regulation of trading facilities.'' See CEA section 3.
\19\ CEA section 5(d)(1)(B), 7 U.S.C. 7(d)(1)(B).
---------------------------------------------------------------------------
Both SEFs and DCMs are subject to a respective core principle
addressing conflicts of interest. Pursuant to SEF Core Principle 12 and
DCM Core Principle 16, both SEFs and DCMs must establish and enforce
rules to minimize conflicts of interest in their decision-making
processes, and must establish a process for resolving such
conflicts.\20\
---------------------------------------------------------------------------
\20\ CEA sections 5(d)(16), 5h(f)(12). DCM Core Principle 16 and
SEF Core Principle 12 are substantively identical in the statute.
---------------------------------------------------------------------------
SEFs are also subject to a Chief Compliance Officer core principle.
SEF Core Principle 15 requires SEFs to designate an individual to serve
as a CCO, sets forth CCO duties,\21\ including a duty to resolve
conflicts of interest,\22\ and requires CCOs to prepare and submit an
annual report to the Commission describing the SEF's compliance with
the CEA and the SEF's policies and procedures, including the SEF's code
of ethics and conflicts of interest policies.\23\ There is no
equivalent statutory core principle for DCMs.\24\
---------------------------------------------------------------------------
\21\ The duties include to report directly to the board or
senior officer of the SEF; review compliance with the core
principles; resolve conflicts of interest in consultation with the
board, a body performing a function similar to that of a board, or
the senior officer of the facility; be responsible for establishing
and administering the SEF's self-regulatory policies and procedures;
ensure compliance with the CEA and rules and regulations issued
thereunder; and establish a procedure for remedying noncompliance
issues found during compliance office reviews, look backs, internal
or external audit findings, self-reported errors, or validated
complaints. See CEA section 5h(f)(15)(B), 7 U.S.C. 7b-3(f)(15)(B).
\22\ The CCO must fulfill this duty in consultation with the
board of directors, a body performing a function similar to that of
a board, or the senior officer of the SEF. CEA section
5h(f)(15)(B)(iii), 7 U.S.C. 7b-3(f)(15)(B)(iii).
\23\ CEA section 5h(f)(15)(D), 7 U.S.C. 7b-3(f)(15)(D).
\24\ The Core Principle 16 Acceptable Practices specify that
DCMs should have a Regulatory Oversight Committee that, among other
things, supervises the DCM's chief regulatory officer, who will
report directly to the Regulatory Oversight Committee. See section
V(f)(3) herein for a discussion of the difference between a chief
regulatory officer and a chief compliance officer.
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DCMs are additionally subject to three core principles addressing
governance.\25\ DCM Core Principle 15 requires a DCM to establish and
enforce appropriate fitness standards for members of its board of
directors, disciplinary committee members, members of the DCM, persons
with direct access to the DCM, and any party affiliated with of any of
the foregoing persons. DCM Core Principle 17 establishes that a DCM's
governance arrangements ``shall be designed to permit consideration of
the views of market participants.'' \26\ DCM Core Principle 22 requires
publicly-traded DCMs to endeavor to recruit individuals to serve on the
board of directors and other decision-making bodies of the DCM from
among, and to have the composition of these bodies reflect, a broad and
culturally diverse pool of qualified candidates.\27\ While there are no
SEF core principles directly addressing governance, the Commission
believes a SEF cannot effectively manage its SEF Core Principle 2
obligations without effective governance.
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\25\ Related governance requirements for SEFs exist in part 1 of
the Commission's regulations. Commission regulation Sec. 1.69(b)
requires SEFs to adopt rules requiring any member of the board of
directors, disciplinary committee or oversight panel to abstain from
deliberating and voting on any matter involving a conflict of
interest. Commission regulation Sec. 1.69 applies to ``self-
regulatory organizations'' (``SRO''), as defined in Commission
regulation Sec. 1.3, which includes SEFs and DCMs. However,
pursuant to Commission regulation Sec. 38.2, DCMs are exempt from
the requirements of Commission regulation Sec. 1.69.
\26\ Commission regulation Sec. 38.900, DCM Core Principle 17,
Composition of Governing Boards of Contract Markets.
\27\ This proposal is not addressing the requirements identified
in DCM Core Principles 17 and 22.
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b. Proposed and Final Rules Addressing SEF and DCM Governance and
Conflicts of Interest
Since 2001, the Commission has proposed and adopted guidance and
acceptable practices addressing conflicts
[[Page 19649]]
of interest and governance standards for SEFs and DCMs.
1. 2001 Regulatory Framework
On August 10, 2001, the Commission adopted a regulatory framework
(``2001 Regulatory Framework'') implementing the Commodity Futures
Modernization Act of 2000 (``CFMA''), effective October 9, 2001.\28\
The CFMA required the Commission to implement a framework of flexible
core principles in lieu of detailed regulatory prescriptions. Section
110 of the CFMA, codified in section 5(d)(1) of the CEA, stated that a
DCM shall have reasonable discretion in establishing the manner in
which it complies with the core principles.
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\28\ A New Regulatory Framework for Trading Facilities,
Intermediaries and Clearing Organizations, 66 FR 42256 (Aug. 10,
2001) (``2001 Regulatory Framework'').
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The CFMA contained core principles, that among other things,
related to governance fitness standards and conflicts of interest. DCM
Core Principle 14 (Governance Fitness Standards) \29\ provided that
boards of trade shall establish and enforce appropriate fitness
standards for directors, members of any disciplinary committee, members
of the contract market, and any other persons with direct access to the
facility (including any parties affiliated with any of the persons
described in this paragraph).\30\ DCM Core Principle 15 (Conflicts of
Interest) \31\ provided that boards of trade shall establish and
enforce rules to minimize conflicts of interest in the decision-making
process of the contract market and shall establish a process for
resolving such conflicts of interest.\32\
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\29\ In 2001, DCM Core Principle 14 addressed governance fitness
standards. In the Dodd-Frank Act, the DCM conflicts of interest core
principle was renumbered to be Core Principle 15. See Dodd-Frank
Act, section 735(b); 7 U.S.C. 7(d)(15).
\30\ See CFMA section 110, codified at CEA section 5(d)(14).
\31\ In 2001, DCM Core Principle 15 addressed conflicts of
interest. In the Dodd-Frank Act, the DCM conflicts of interest core
principle was renumbered to be Core Principle 16. See Dodd-Frank
Act, section 735(b); 7 U.S.C. 7(d)(16).
\32\ See CFMA section 110, codified at CEA section 5(d)(15).
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The 2001 Regulatory Framework implemented guidance for DCM Core
Principles 14 (Governance Fitness Standards) and 15 (Conflicts of
Interest). Guidance provides contextual information regarding the core
principles, including important concerns which the Commission believes
should be taken into account in complying with specific core
principles.\33\ The guidance for a core principle is illustrative only
of the types of matters a DCM may address, and is not intended to be
used as a mandatory checklist.\34\
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\33\ The 2001 Regulatory Framework described the guidance
contained therein as ``application guidance,'' but the concept is
substantively similar to the ``guidance'' in part 38, Appendix B,
sec. 1. See 2001 Regulatory Framework, 66 FR 42256 at 42278.
\34\ Part 38, Appendix B, sec 1.
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The guidance for DCM Core Principle 14 states that minimum fitness
standards for ``persons who have member voting privileges, governing
obligations or responsibilities, or who exercise disciplinary
authority,'' and ``natural persons who directly or indirectly have
greater than a ten percent ownership interest in a designated
contract'' should include those bases for refusal to register a person
under section 8a(2) of the CEA.\35\ Additionally, the guidance states
that persons who have governing obligations or responsibilities, or who
exercise disciplinary authority, should not have a significant history
of serious disciplinary offenses, such as those that would be
disqualifying under Commission regulation Sec. 1.63.\36\ The guidance
further states that fitness standards should include providing the
Commission with fitness information for such persons, whether
registration information, certification to the fitness of such persons,
an affidavit of such persons' fitness by the contract market's counsel
or other information substantiating the fitness of such persons.\37\
Finally, the guidance provides that if a contract market provides
certification of the fitness of such a person, the Commission believes
that such certification should be based on verified information that
the person is fit to be in his or her position.\38\
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\35\ See 2001 Regulatory Framework, 66 FR 42256 at 42283.
\36\ Id. The DCM Core Principle 14 Guidance states that members
with trading privileges but having no or only minimal equity in the
DCM and non-member market participants who are not intermediated
``and do not have these privileges, obligations, or responsibilities
or disciplinary authority'' could satisfy minimum fitness standards
by meeting the standards that they must meet to qualify as a
``market participant.''
\37\ 2001 Regulatory Framework, 66 FR 42256 at 42283.
\38\ Id.
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The guidance for DCM Core Principle 15 (Conflicts of Interest)
provides that the means to address conflicts of interest in a DCM
should include methods to ascertain the presence of conflicts of
interest and to make decisions in the event of such a conflict.\39\ The
guidance also states that a DCM should provide appropriate limitations
on the use or disclosure of material non-public information gained
through the performance of official duties by board members, committee
members, and contract market employees, or gained through an ownership
interest in the contract market.
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\39\ Id. In 2001, DCM Core Principle 15 addressed conflicts of
interest. In the Dodd-Frank Act, the DCM conflicts of interest core
principle was renumbered to be Core Principle 16. See Dodd-Frank
Act, section 735(b); 7 U.S.C. 7(d)(16).
---------------------------------------------------------------------------
In the 2001 Regulatory Framework, the Commission adopted Commission
regulation Sec. 38.2, which exempted ``agreements, contracts, or
transactions'' traded on a DCM, as well as the ``contract market''
itself, and the ``contract market's operator'' from all Commission
regulations for such activity, except for the requirements of part 38
and Sec. Sec. thnsp;1.3, 1.12(e), 1.31, 1.38, 1.52, 1.59(d), 1.63(c),
1.67, 33.10, part 9, parts 15 through 21, part 40, and part 190.\40\
The Commission did so in the context of the CFMA, which provided DCMs
with a framework of flexible core principles in lieu of detailed
regulatory prescriptions.\41\
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\40\ See 2001 Regulatory Framework, 66 FR 42256 at 42277. See
also id. at 42257.
\41\ See Section II(b)(6) herein for a description of a revised
version of Commission regulation 38.2.
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2. 2007 Final Release, Conflicts of Interest Acceptable Practices for
DCMs
On February 14, 2007, the Commission adopted ``acceptable
practices'' \42\ as a way for DCMs to demonstrate compliance with the
conflicts of interest core principle (``2007 Final Release'').\43\
Acceptable practices are more detailed examples of how DCMs may satisfy
particular requirements of the core principles.\44\ Similar to
guidance, acceptable practices are for illustrative purposes only and
do not establish a mandatory or exclusive means of compliance with a
core principle. Acceptable practices, however, are intended to assist
DCMs by outlining specific practices for core principle compliance. As
the Commission has stated, acceptable practices provide examples of how
DCMs may satisfy particular requirements of the core principles; they
do not, however, establish mandatory
[[Page 19650]]
means of compliance.\45\ Acceptable practices apply only to compliance
with specific aspects of a core principle, and do not protect the DCM
with respect to charges of violations of other sections of the CEA or
other aspects of the core principle.\46\
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\42\ See Section II(b)(1) herein for a description of acceptable
practices, and how acceptable practices compare to guidance.
\43\ Conflicts of Interest in Self-Regulation and Self-
Regulatory Organizations, 72 FR 6936 (Feb, 14, 2007) (``2007 Final
Release'').
\44\ See 2001 Regulatory Framework, 66 FR 42256 at 42279; Part
38, Appendix B, sec 2. Acceptable practices were adopted in the 2001
Regulatory Framework for core principles other than those relating
to governance fitness standards and conflicts of interest. For
example, acceptable practices were adopted for DCM Core Principles
2, 3, 4, 5, 6, 9, 10, 13, and 17. See 2001 Regulatory Framework, 66
FR 42256 at 42279-83.
\45\ Core Principles and Other Requirements for Designated
Contract Markets, 77 FR 36612 at 36614 n.13 (June 19, 2012); 7
U.S.C. 7(d)(1) (amended 2010).
\46\ Id.
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The DCM Core Principle 16 acceptable practices have several key
provisions. First, the acceptable practices provided that DCM boards of
directors, and any executive committees or similarly empowered bodies,
be comprised of at least 35 percent ``public directors.'' Second, the
acceptable practices also established a definition of who would
constitute a ``public director'' for purposes of the acceptable
practices. Third, the acceptable practices provided that a DCM
establish a ROC comprised exclusively of public directors, which would
have among its duties to supervise the contract market's CRO, who will
report directly to the ROC.\47\ The Commission explained that 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 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.\48\
---------------------------------------------------------------------------
\47\ Id. at 6951 n.80.
\48\ Id. at 6950-51.
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The Commission also underscored the importance of a DCM's ROC being
composed of 100 percent public directors, particularly given the
industry shift toward demutualization.\49\ The Commission stated that
it strongly believed that new structural conflicts of interest within
self-regulation require an appropriate response within DCMs. The
Commission further stated that it believed that ROCs, consisting
exclusively of public directors, are a vital element of any such
response. The Commission observed that 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.\50\
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\49\ By 2007, the futures industry had been shifting away from
mutually owned exchanges, starting in 2000 with the rule amendment
approvals for CME and NYMEX to move from not-for-profit corporations
to for-profit corporations. See Commission Release #4407-00 (June
16, 2000) https://www.cftc.gov/sites/default/files/opa/press00/opa4407-00.htm and Commission Release #4427-00 (July 28, 2000)
https://www.cftc.gov/sites/default/files/opa/press00/opa4427-00.htm,
respectively. The Commission also approved a demutualization plan
for the Chicago Board of Trade (CBOT) on April 18, 2005. See
Certified Rule Submissions, https://www.cftc.gov/IndustryOversight/IndustryFilings/deaapprovalofrulestable.html.
\50\ See 2007 Final Release, 72 FR 6936 at 6951.
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Fourth, the acceptable practices specified that DCM disciplinary
panels should not be dominated by any group or class of DCM members or
participants, and provided that at least one person who would qualify
as a public director be included on the panel.
The Commission provided existing DCMs with a phase-in period of the
lesser of two years or two regularly scheduled elections of the board
of directors to demonstrate full compliance with the conflicts of
interest core principle for DCMs.\51\ Then, on March 26, 2007, the
Commission proposed certain amendments to the ``public director''
definition.\52\ With the ``public director'' definition in flux, the
Commission stayed the phase-in period for existing DCMs to demonstrate
full compliance with the conflicts of interest core principle.\53\
---------------------------------------------------------------------------
\51\ See id.
\52\ Conflicts of Interest in Self-Regulation and Self-
Regulatory Organizations, 72 FR 14051 (March 26, 2007).
\53\ Id. at 65659.
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3. 2009 Final Release, Definition of Public Director
On April 27, 2009, the Commission adopted final amendments to the
acceptable practices for complying with the conflicts of interest core
principle for DCMs (``2009 Final Release).\54\ The amendments
established a final definition of who constitutes a ``public director''
for purposes of the acceptable practices and the stay for demonstrating
full compliance with the conflicts of interest core principle was
lifted.\55\ In adopting the amendments, the Commission stated that
``self-regulation must be vigorous, effective, and impartial.'' \56\
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\54\ Conflicts of Interest in Self-Regulation and Self-
Regulatory Organizations, 74 FR 18982 (Apr. 27, 2009) (``2009 Final
Release'').
\55\ Id. at 18983.
\56\ Id. at 18984.
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The most important component of the ``public director'' definition
is an overarching materiality test, which provides that a public
director must have no material relationship with the DCM. Certain
circumstances are specified under which a director would be deemed to
have a material relationship. A director would be deemed to have a
material relationship by virtue of: (1) being an officer or employee of
the DCM, or an officer or employee of an affiliate of the DCM; (2)
being a member, or an officer or director of a member, of the DCM; or
(3) receiving more than $100,000 in annual payments from the DCM or an
affiliate of the DCM for legal, accounting, or consulting services. The
director would also have a material relationship if a family member had
any of the aforementioned relationships. Whether a director or family
member had any such relationship would be subject to a one-year look-
back period.
4. 2010 Conflicts of Interest Rule Proposal
On October 18, 2010, the Commission issued a rule proposal (the
``Mitigation of Conflicts of Interest NPRM''), which proposed
prophylactic measures aimed to mitigate conflicts of interest in the
operation of a SEF or DCM.\57\ After identifying certain potential
conflicts of interest, the Commission made rule proposals for SEFs and
DCMs concerning (1) governance, and (2) ownership of voting equity and
the exercise of voting rights. With respect to governance, the
Commission proposed, as rules, enhanced versions of the acceptable
practices that had previously been adopted for the DCM core principle
on conflicts of interest.\58\ Specifically, the Commission proposed to
require that each SEF or DCM have:
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\57\ Requirements for Derivatives Clearing Organizations,
Designated Contract Markets, and Swap Execution Facilities Regarding
the Mitigation of Conflicts of Interest, 75 FR 63732 (Oct. 18,
2010).
\58\ Id. at 63733. See also 2009 Final Release, 74 FR 18982
(which defined ``public director''); 2007 Final Release, 72 FR 6936
(Feb. 14, 2007) (which adopted final acceptable practices for the
DCM core principle on conflicts of interest); 71 FR 38740 (July 7,
2006) (which proposed acceptable practices for such DCM core
principle).
---------------------------------------------------------------------------
a board of directors with at least 35 percent, but no less
than two, public directors;
a nominating committee with at least 51 percent public
directors, and with a public director as chair;
one or more disciplinary panels, with a public participant
as chair;
a ROC with all public directors; and
a membership or participation committee, with 35 percent
public directors.
The Commission also proposed, as rules, certain limitations with
respect to the ownership of voting equity in the SEF or DCM and the
exercise of voting rights. These proposals limited SEF participants or
DCM members (and related persons) to: (1) beneficially
[[Page 19651]]
owning no more than 20 percent of any class of voting equity in the SEF
or DCM; and (2) exercising (whether directly or indirectly) no more
than 20 percent of the voting power of any class of equity interest in
the SEF or DCM.
The Commission never adopted the proposed rules as final rules.\59\
---------------------------------------------------------------------------
\59\ The proposal was withdrawn on the Fall 2020 Unified Agenda
and Regulatory Plan. The withdrawal entry is available at: https://www.reginfo.gov/public/do/eAgendaViewRule?pubId=202010&RIN=3038-AD37.
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5. 2011 Governance and Conflicts of Interest NPRM
On January 6, 2011, the Commission issued a post-Dodd-Frank Act
rule proposal (the ``2011 Governance and Conflicts of Interest NPRM'')
to establish the manner in which DCMs, SEFs and DCOs must comply with
their respective core principle obligations with regard to conflicts of
interest.\60\ The rule proposal aimed to mitigate conflicts of interest
through requirements regarding reporting, transparency in decision-
making, and limitations on the use or disclosure of non-public
information, among other things.\61\ The 2011 Governance and Conflicts
of Interest NPRM also proposed rules to establish the manner in which
DCMs and DCOs must comply with their respective core principle
obligations with regard to governance fitness standards \62\ and the
composition of governing bodies,\63\ and proposed rules to establish
the manner in which publicly traded DCMs must comply with their core
principle obligation with regard to the diversity of their board of
directors.\64\ The Commission never adopted the 2011 Governance and
Conflicts of Interest NPRM as final rules.\65\
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\60\ Governance Requirements for Derivatives Clearing
Organizations, Designated Contract Markets, and Swap Execution
Facilities; Additional Requirements Regarding the Mitigation of
Conflicts of Interest, 76 FR 722 (January 6, 2011).
\61\ Id.
\62\ See section 5(d)(15) of the CEA, 7 U.S.C. 7(d)(15) (DCM
core principle on governance fitness standards), as redesignated by
section 735 of the Dodd-Frank Act.
\63\ See section 5(d)(17) of the CEA, 7 U.S.C. 7(d)(17) (DCM
core principle on composition of governing boards), as added by
section 735 of the Dodd-Frank Act.
\64\ See section 5(d)(22) of the CEA, 7 U.S.C. 7(d)(22) (DCM
core principle on diversity of board of directors), as added by
section 735 of the Dodd-Frank Act.
\65\ The proposal was withdrawn on the Fall 2019 Unified Agenda
and Regulatory Plan. The withdrawal entry that appeared in the Fall
2019 Agenda is available at: https://www.reginfo.gov/public/do/eAgendaViewRule?pubId=201910&RIN=3038-AD36.
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6. 2012 Part 38 Final Rule
The Dodd-Frank Act overhauled or reversed key aspects of the
regulatory framework under the CFMA, but retained the core principles
framework. Importantly, however, the Dodd-Frank Act specifically
empowered the Commission to determine by rule or regulation, the manner
in which a DCM may comply with core principles. Section 735 of the
Dodd-Frank Act amended section 5 of the CEA to include the proviso that
``[u]nless otherwise determined by the Commission by rule or regulation
. . .'' boards of trade shall have reasonable discretion in
establishing the manner in which they comply with the core
principles.\66\ On June 19, 2012, the Commission adopted a rulemaking
to implement the Dodd-Frank Act's amendments to section 5 of the CEA
pertaining to the designation and operation of contract markets (the
``2012 Part 38 Final Rule'').\67\ Similar to the Commission's approach
in this rule proposal, the Commission's implementation of the new
provisions under the Dodd-Frank Act substituted rules in lieu of
guidance and acceptable practices for several of the DCM core
principles.\68\
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\66\ See CEA section 5(d)(1)(B) (emphasis added).
\67\ Core Principles and Other Requirements for Designated
Contract Markets, 77 FR 36612 (June 19, 2012) (the ``2012 Part 38
Final Rule'').
\68\ In 2007, DCM Core Principle 15 addressed conflicts of
interest. In the Dodd-Frank Act, the DCM conflicts of interest core
principle was renumbered to be Core Principle 16. See Dodd-Frank
Act, section 735(b); 7 U.S.C. 7(d)(16).
---------------------------------------------------------------------------
In the 2012 Part 38 Final Rule, the Commission adopted rules
establishing the manner in which a DCM must comply with several of the
DCM core principles. The Commission also adopted revised guidance and
acceptable practices for certain of the DCM core principles. The
Commission chose to maintain the existing guidance \69\ on compliance
with the DCM core principle on governance fitness standards, and to
maintain the existing guidance on,\70\ and acceptable practices in,
compliance with the DCM conflicts of interest core principle.\71\ This
included the acceptable practice that the DCM's ROC supervise the DCM's
CRO, who reports directly to the ROC. While the Commission did not
adopt rules to establish this as an affirmative requirement for all
DCMs, the Commission stated in the adopting release that current
industry practice is for DCMs to designate an individual as chief
regulatory officer, and it will be difficult for a DCM to meet the
compliance staff and resources requirements of Sec. 38.155 without a
chief regulatory officer or similar individual to supervise its
regulatory program, including any services rendered to the DCM by a
regulatory service provider.\72\ In the 2012 Part 38 Final Rule, the
Commission contemplated that rules implementing the DCM conflicts of
interest core principle might be adopted in the future.\73\
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\69\ See section II(b)(1) herein for a description of the
guidance adopted in 2001 relating to governance fitness standards.
\70\ See section II(b)(1) herein for a description of the
guidance adopted in 2001 relating to conflicts of interest.
\71\ 2012 Part 38 Final Rule, 77 FR 36612 at 36655-56. The
Commission added Commission regulation Sec. 38.851 to permit DCMs
to continue to rely on the conflicts of interest guidance in
Appendix B to part 38. See section II(b)(2)-(3) herein for a
description of acceptable practices adopted in 2007 and 2009
relating to conflicts of interest.
\72\ 2012 Part 38 Final Rule, 77 FR 36612 at 36628.
\73\ The Commission explained that until such time as it may
adopt the substantive rules implementing Core Principle 16, the
Commission was maintaining the current guidance and acceptable
practices under part 38 applicable to Conflicts of Interest
(formerly Core Principle 15). Accordingly, the existing Guidance and
Acceptable Practices from Appendix B of part 38 applicable to Core
Principle 16 were codified in the revised Appendix B adopted in the
final rulemaking. The Commission noted that at such time as it may
adopt the final rules implementing Core Principle 16, Appendix B
would be amended accordingly. 2012 Part 38 Final Rule, 77 FR 36612
at 36656.
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In the 2012 Part 38 Final Rule, the Commission also adopted equity
transfer notification requirements for DCMs. Pursuant to Sec. 38.5(c),
DCMs must notify the Commission when they enter into a transaction
involving the transfer of 10 percent or more of the equity interest in
the DCM.\74\ DCMs must notify the Commission of such a transfer at the
earliest possible time, but in no event later than the open of business
10 business days following the date upon which the DCM enters into a
firm obligation to transfer the equity interest.\75\ In particular, the
Commission explained that while DCMs may take up to 10 business days to
submit a notification, the DCM must provide Commission staff with
sufficient time, prior to consummating the equity interest transfer, to
review and consider the implications of the change in ownership,
including whether the change in ownership will adversely impact the
operations of the DCM or the DCM's ability to comply with the core
principles and the Commission's regulations thereunder.\76\
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\74\ See Commission regulation Sec. 38.5(c).
\75\ See id.
\76\ 2012 Part 38 Final Rule, 77 FR 36612 at 36619.
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In addition to Commission regulation Sec. 38.5(c)'s equity
interest transfer requirements, the Commission adopted regulations
requiring DCMs to submit certain information to the Commission.
[[Page 19652]]
Pursuant to Commission regulation Sec. 38.5(a), upon request, a DCM
must file with the Commission information related to its business as a
DCM, including information relating to data entry and trade details, in
the form and manner and within the time specified by the Commission in
its request.\77\
---------------------------------------------------------------------------
\77\ See Commission regulation Sec. 38.5(a).
---------------------------------------------------------------------------
The Commission notes that in the 2012 Part 38 Final Rule, pursuant
to Sec. 38.5(d), the Commission delegated ``the authority set forth in
paragraph (b) of this section'' (demonstration of compliance) to the
Director of the Division of Market Oversight.\78\ This differs from the
corresponding regulation for SEFs.\79\ Existing Commission regulation
Sec. 37.5(d) provides that the Commission delegates ``the authority
set forth in this section'' to the Director of the Division of Market
Oversight, which is a broader delegation compared to the Part 38
regulation. In particular, the delegation provision in Sec. 37.5(d)
includes the authority to request information pursuant to both
regulations Sec. Sec. 37.5(a) (requests for information) and (b)
(demonstration of compliance).\80\ The delegation provision in Sec.
38.5(d) does not apply to Sec. 38.5(a) (requests for information).
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\78\ See Commission regulation Sec. 38.5(d).
\79\ See Section II(b)(7) for a description of the rulemaking
implementing regulatory obligations of SEFs in which the current
version of Commission regulation 37.5 was adopted.
\80\ See Commission regulation Sec. 37.5(d).
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Finally, in the 2012 Part 38 Final Rule, the Commission adopted a
revised version of Sec. 38.2 that specified ``the Commission
regulations from which DCMs will be exempt'' as opposed to listing the
regulations that DCMs were obligated to comply with.\81\ The Commission
made this change to add clarity and to eliminate the need for the
Commission to continually update Sec. 38.2 when new regulations with
which DCMs must comply are codified.\82\ The Commission exempted DCMs
from certain provisions within part 1 of the Commission's regulations
that address conflicts of interest and governance for self-regulatory
organizations (``SROs''). In particular, the Commission exempted DCMs
from all or part of the following provisions:
---------------------------------------------------------------------------
\81\ See 2012 Part 38 Final Rule, 77 FR 36612 at 36615. See
Section II(b)(1) herein for a description of the previous version of
Commission regulation Sec. 38.2.
\82\ Id.
---------------------------------------------------------------------------
Commission regulation Sec. 1.59, which addresses
limitations on the use and disclosure of non-public information; \83\
---------------------------------------------------------------------------
\83\ Commission regulation Sec. 38.2 exempts DCMs from
Commission regulation Sec. 1.59(b) (requiring self-regulatory
organizations to, by rule, prohibit employees from trading in
certain contracts traded on or cleared by the self-regulatory
organization or related to those traded on or cleared by the self-
regulatory organization, and from trading on or disclosing material
non-public information), and Commission regulation Sec. 1.59(c)
(requiring self-regulatory organizations to, by rule, prohibit
governing board members, committee members, and consultants from
disclosing material non-public information gained as a result of
official duties). DCMs remain subject to Commission regulations
Sec. Sec. 1.59(a) (definitions) and 1.59(d) (prohibiting self-
regulatory organization employees, governing board members,
committee members, and consultants from trading on or disclosing
material non-public information).
---------------------------------------------------------------------------
Commission regulation Sec. 1.63, which restricts persons
with certain disciplinary histories from serving on governing boards or
committees; \84\
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\84\ Commission regulation Sec. 38.2 exempts DCMs from all
paragraphs of Commission regulation Sec. 1.63 except for Commission
regulation Sec. 1.63(c), which states that no person may serve on a
disciplinary committee, arbitration panel, oversight panel or
governing board of a self-regulatory organization if such person is
subject to any of the conditions listed in Commission regulation
Sec. 1.63(b)(1) through (6), which lists certain disqualifying
offenses, suspensions, settlements, revocations, bars, and denials.
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Commission regulation Sec. 1.64, which addresses
composition of governing boards and disciplinary committees; \85\ and
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\85\ Commission regulation Sec. 38.2 exempts DCMs from the
entirety of Commission regulation Sec. 1.64.
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Commission regulation Sec. 1.69, which addresses voting
by conflicted members of governing boards and committees.\86\
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\86\ Commission regulation Sec. 38.2 exempts DCMs from the
entirely of Commission regulation Sec. 1.69.
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In exempting DCMs from the provisions listed above, the Commission
noted that Commission regulation Sec. 38.2 will likely be amended if
and when the referenced rules are eliminated from the regulations or
modified.\87\
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\87\ See 2012 Part 38 Final Rule, 77 FR 36612 at 36615.
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7. 2013 Part 37 Final Rule
On June 4, 2013, the Commission adopted a final rulemaking (the
``Part 37 Final Rule'') which established regulatory obligations that
SEFs--a new category of regulated entity introduced under the Dodd-
Frank Act.\88\ In the Part 37 Final Rule, the Commission adopted rules
establishing the manner in which a SEF must comply with several of the
SEF core principles, and also adopted guidance and acceptable practices
for certain of the SEF core principles. In the Part 37 Final Rule, the
Commission did not adopt the guidance on, and acceptable practices in,
compliance with the conflicts of interest core principle that the
Commission had adopted to date for DCMs. In the adopting release, the
Commission explained that, as noted in the notice of proposed
rulemaking for the Part 37 Final Rule, the substantive regulations
implementing SEF Core Principle 12 (Conflicts of Interest) were
proposed in a separate release, the Mitigation of Conflicts of Interest
NPRM. The Commission noted that until such time as it may adopt the
substantive rules implementing Core Principle 12, SEFs have reasonable
discretion to comply with this core principle as stated in Sec.
37.100.\89\
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\88\ See Core Principles and Other Requirements for Swap
Execution Facilities, 78 FR 33476 (June 4, 2013) (the ``Part 37
Final Rule'').
\89\ Id. at 33538.
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As discussed above, the Commission never adopted the Mitigation of
Conflicts of Interest NPRM as final rules.
Pursuant to Commission regulation Sec. 37.2, adopted in the Part
37 Final Rule, SEFs are subject, in their entirety, to Commission
regulations Sec. Sec. 1.59, 1.63, 1.64 and 1.69 which, as discussed
above, address conflicts of interest and governance for self-regulatory
organizations. Therefore, SEFs are currently subject to a different set
of conflicts of interest and governance requirements than DCMs.
In the Part 37 Final Rule, the Commission adopted rules to
implement the Chief Compliance Officer core principle for SEFs that,
among other things, addressed the CCO's duties and the annual
compliance report requirement, provided that the CCO's duties include
supervising the SEF's self-regulatory program with respect to, among
other regulatory responsibilities, trade practice surveillance, market
surveillance, real-time market monitoring, compliance with audit trail
requirements, enforcement and disciplinary proceedings, audits, and
examinations.\90\ In addition, the rules provided that the CCO's duties
included supervising the effectiveness and sufficiency of any
regulatory services provided to the SEF by a permitted
[[Page 19653]]
regulatory service provider.\91\ With respect to the annual compliance
report, the rules provided that the CCO must, prior to submission to
the Commission, provide the report for review to the SEF's board of
directors or, in the absence of a board of directors, to the senior
officer of the SEF.\92\ Members of the board of directors or the SEF's
senior officer (as applicable) must not require the CCO to make any
changes to the report.\93\
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\90\ See Part 37 Final Rule, 78 FR 33476, which adds CCO duties
beyond those contained in SEF Core Principle 15, including (1)
providing examples of the types of conflicts of interest that a CCO
must resolve, including conflicts between business considerations
and compliance requirements, and (2) supervising the SEF's self-
regulatory program with respect to trade practice surveillance,
market surveillance, real-time market monitoring, compliance with
audit trail requirements, enforcement and disciplinary proceedings,
audits, examinations, and other regulatory responsibilities with
respect to members and market participants (including ensuring
compliance with, if applicable, financial integrity, financial
reporting, sales practice, recordkeeping, and other requirements),
and (3) supervising the effectiveness and sufficiency of any
regulatory services provided by a regulatory service provider
pursuant to Commission regulation Sec. 37.204.
\91\ Id. at 33594. Commission regulation Sec. 37.204(a) permits
a SEF to utilize another registered entity, a registered futures
association, and, in the case of SEFs, the Financial Industry
Regulatory Authority, for the provision of services to assist in
complying with the CEA and Commission regulations. Commission
regulation Sec. 37.204(b) provides that a SEF that chooses to use a
regulatory service provider shall retain sufficient staff to
supervise the regulatory services, that SEF compliance staff shall
hold regular meetings with the regulatory service provider to
discuss matters of regulatory concern, and that the SEF must conduct
periodic reviews of the services provided. Further, Commission
regulation Sec. 37.204(b) requires that the SEF carefully document
such periodic reviews and provide them to the Commission upon
request. Commission regulation Sec. 37.204(c) states that a SEF
that chooses to use a regulatory service provider shall retain
exclusive authority in all substantive decisions made by the
regulatory service provider, and that the SEF must document any
instances where its actions differ from those recommended by the
regulatory service provider.
\92\ See Commission regulation Sec. 37.1501(e)(1).
\93\ Id.
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The Part 37 Final Rule adopted equity transfer notification
requirements for SEFs, but they differ in three areas from those
applicable to DCMs pursuant to the 2012 Part 38 Final Rule. First,
under Commission regulation Sec. 37.5(c), SEFs must notify the
Commission when they enter into a transaction involving the transfer of
50 percent or more of the equity interest in the SEF.\94\ This is a
higher percentage than the 10 percent or more percentage that applies
with respect to DCM equity interest transfers, and is therefore
effectively a lower notification standard. Second, Commission
regulation Sec. 37.5(c) specifically authorizes the Commission, upon
receipt of notification from a SEF of an equity interest transfer, to
request supporting documentation regarding the transaction; this
authority also is delegated to the Director of the Division of Market
Oversight or such other employee(s) as the Director may designate from
time to time. Finally, upon an equity interest transfer, SEFs are
affirmatively required to certify to the Commission, no later than two
business days after the transfer takes place, that the SEF meets all of
the requirements of section 5h of the CEA (which includes the statutory
SEF core principles) and the Commission's regulations thereunder.\95\
There is currently no analogous certification requirement that applies
to a DCM under Commission regulation Sec. 38.5(c).\96\
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\94\ See Commission regulation Sec. 37.5(c).
\95\ See Commission regulation Sec. 37.5(c)(4).
\96\ In 2018, as part of a notice of proposed rulemaking
relating to SEFs and the trade execution requirement, the Commission
proposed to amend Commission regulation Sec. 37.5 to (i) require
notification in the event of any transaction that results in the
transfer of direct or indirect ownership of 50 percent or more of
the equity interest in the SEF; and (ii) delete the part 40 filing
requirement. See Swap Execution Facilities and the Trade Execution
Requirement, 83 FR 61946, 71-72 (Nov. 30, 2018). The Commission
withdrew this proposal in 2021. See 86 FR 9304 (Feb. 12, 2021).
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8. 2021 Part 37 Amendments--CCO Duties and Annual Compliance Report
On May 12, 2021, the Commission adopted final rules amending SEF
requirements related to audit trail data, financial resources, and CCO
obligations, including the rules addressing the CCO's obligation to
submit an annual report to the Commission (``Part 37 Updates'').\97\
The Commission stated that the purpose of the CCO amendments was to
streamline requirements for the CCO position, allow SEF management to
exercise greater discretion in CCO oversight, and simplify the
preparation and submission of the required annual compliance
report.\98\ Among other changes, the Commission clarified that a CCO
did not need to include in the annual compliance report a review of all
the Commission regulations applicable to a SEF or an identification of
the written policies and procedures designed to ensure compliance with
the CEA and Commission regulations. The amendments clarified that the
CCO was required to include in the annual report a description and
self-assessment of the effectiveness of the written policies and
procedures of the SEF to ``reasonably ensure'' compliance with the CEA
and applicable Commission regulations. Additionally, the amendments
clarified that CCOs are required to discuss only ``material''
noncompliance matters in the annual report, instead of all
``noncompliance issues.''
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\97\ Swap Execution Facilities, 86 FR 9224 (Feb. 11, 2021) (the
``Part 37 Updates'').
\98\ Id. at 9225.
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In the Part 37 Updates, the Commission also modified SEF CCO
requirements in several other ways, including by: (1) consolidating
certain CCO duties; \99\ (2) eliminating ROC-related components of part
37; \100\ (3) allowing the CCO to consult with the board of directors
or senior officer of the SEF in developing the SEF's policies and
procedures; (4) allowing a CCO to meet with the senior officer of the
SEF on an annual basis, in lieu of an annual meeting with the board of
directors; and (5) allowing a CCO to provide self-regulatory program
information to the SEF's senior officer, in addition to the board of
directors. The modifications identified as (3), (4) and (5) in the
preceding sentence enhance the role of the SEF's senior officer,
providing for an oversight role over the CCO equivalent to that of the
board of directors. The Commission considered this change to be
consistent with SEF Core Principle 15, which requires a CCO to report
to the SEF's board of directors or senior officer.\101\
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\99\ The Commission explained that the rules would allow a CCO
to identify non-compliance matters through ``any means'' in addition
to the means previously provided in the rule, which were by
compliance office review, look-back, internal or external audit
finding, self-reported error, or validated complaint. Id. at 9235
n.171. The Commission modified the duty for a CCO to establish
procedures for the remediation of noncompliance issues to clarify
that a CCO must establish procedures reasonably designed to handle,
respond, remediate, retest, and resolve noncompliance issues, based
on an acknowledgement that a CCO may not be able to design
procedures that detect all possible noncompliance issues and noted
that a CCO may utilize a variety of resources to identify
noncompliance issues beyond a limited set of means. Id. at 9235.
\100\ The ROC-related components of part 37 included a mandatory
quarterly meeting of the CCO with the ROC, and the requirement that
a CCO provide self-regulatory program information to the ROC. Id. at
9233-34. In determining to eliminate the ROC-related components of
the regulation, the Commission stated that Core Principle 15 does
not require a SEF to establish a ROC and the Commission has not
finalized a rule that establishes requirements for a ROC. See id. at
9234. Pursuant to proposed Sec. 37.1206 in this proposed
rulemaking, the Commission now seeks to establish explicit
requirements for a SEF ROC.
\101\ See Commission regulation Sec. 37.1500(b)(1).
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In addition, the Commission amended the rules addressing the
removal of a CCO. The rules previously had restricted CCO removal
authority to a majority of the board of directors, or in the absence of
a board, to a senior officer. In the Part 37 Updates, the Commission
amended the requirement to establish that either the board or senior
officer of the SEF may remove the CCO. The Commission stated that in
many instances, the senior officer may be better positioned than the
board of directors to provide day-to-day oversight of the SEF and the
CCO, as well as to determine whether to remove a CCO.\102\
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\102\ Part 37 Updates, 86 FR 9224 at 9234.
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The Part 37 Updates also amended the duties of the CCO to allow a
CCO to identify noncompliance issues through ``any means'' and
clarified that the procedures that the CCO takes to address
noncompliance issues must be ``reasonably designed'' to handle,
[[Page 19654]]
respond to, remediate, retest, and resolve those issues.\103\ Such
changes provide the CCO with additional flexibility in identifying and
addressing noncompliance, and recognize that a CCO may not be able to
design procedures that detect all possible noncompliance issues and may
utilize a variety of resources to identify noncompliance issues.\104\
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\103\ See id. at 9235.
\104\ See id.
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In addition, the Commission amended the CCO's duty to resolve
conflicts of interest, requiring the CCO to take ``reasonable steps''
to resolve ``material'' conflicts of interest that may arise.\105\ In
adding the concepts of reasonableness and materiality, the Commission
stated that the current requirement was overly broad and impractical
because a CCO cannot be reasonably expected to successfully resolve
every potential conflict of interest that may arise.\106\
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\105\ See id.
\106\ See id.
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c. Industry Changes and Impact on Regulatory Developments
By 2007, when the Commission adopted the acceptable practices
relating to conflicts of interest and governance standards,\107\ the
futures industry had begun shifting from mutually-owned exchanges into
for-profit institutions.\108\ For example, in 2000, the Commission
approved rules relating to plans by CME,\109\ NYMEX,\110\ and CBOT
\111\ to convert from non-profit corporations owned by their members to
for-profit corporations.\112\ Given that demutualization was relatively
new and evolving, the Commission provided flexibility regarding
governance structures and conflicts of interest provisions.\113\ In
contrast to many of the other SEF and DCM core principles, to date the
Commission has not adopted rules to prescribe the manner in which
compliance with the conflicts of interest core principle for SEFs or
DCMs, or the governance fitness standards core principle for DCMs, must
be demonstrated. While the guidance on compliance with the relevant DCM
core principles sets forth important considerations that the Commission
believes should be taken into account by DCMs in complying with those
core principles, and the acceptable practices \114\ for the DCM
conflicts of interest core principle additionally set forth examples of
how DCMs may satisfy particular requirements under that core principle,
neither the guidance nor the acceptable practices establish mandatory
compliance obligations for DCMs. With respect to the conflicts of
interest core principle for SEFs, the Commission to date has not
adopted guidance or acceptable practices for compliance with the core
principle.
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\107\ See Section II(b)(2).
\108\ In 2007, DCM Core Principle 15 addressed conflicts of
interest. In the Dodd-Frank Act, the DCM conflicts of interest core
principle was renumbered to be Core Principle 16. See Dodd-Frank
Act, section 735(b); 7 U.S.C. 7(d)(16).
\109\ See Commission Release #4407-00, https://www.cftc.gov/sites/default/files/opa/press00/opa4407-00.htm.
\110\ See Commission Release #4427-00, https://www.cftc.gov/sites/default/files/opa/press00/opa4427-00.htm.
\111\ See Commission Release #4434-00, https://www.cftc.gov/sites/default/files/opa/press00/opa4434-00.htm.
\112\ The process continued through 2020, when MGEX went through
demutualization. https://www.cftc.gov/sites/default/files/filings/documents/2020/orgdcmmgexordertransfer201124.pdf; https://www.mgex.com/documents/MIAX_MGEX_SeatVote_PressRelease_000.pdf.
\113\ On July 7, 2006, the Commission proposed the acceptable
practices that it finalized in the 2007 Final Release. Conflicts of
Interest in Self-Regulation and Self-Regulatory Organizations, 71 FR
38739 (July 7, 2006). In that proposal, the Commission acknowledged
that the U.S. futures industry was being transformed by, among other
things, the demutualization of member-owned exchanges and their
conversion to publicly traded stock corporations. Id. at 38740-
38741. The Commission noted that the acceptable practices would,
among other things, ensure that industry expertise, experience, and
knowledge continue to play a vital role in self-regulatory
organization governance and administration and thus, preserve the
``self'' in self-regulation. Id. at 38741-38742. In the 2007 Final
Release, the Commission reiterated that the acceptable practices
were being adopted in response to, among other things,
demutualization. The Commission observed that it did identify
industry changes that it believed 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. The Commission further noted that 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. 2007 Final Release, 72 FR
6936 at 6944.
\114\ Through its acceptable practices, the Commission provides
exchanges with specific practices that DCMs may adopt to demonstrate
a safe harbor for compliance with selected requirements aspects of a
core principle, but such acceptable practices were not intended as
the exclusive means of compliance. See CEA section 5c(a)(1), 7
U.S.C. 7a-2(a)(1).
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While the statutory core principles are intended to be broad and
flexible, the Commission is mindful that, in certain circumstances,
flexibility in the manner of compliance may create confusion.
Practically speaking, while this flexibility exists, Commission staff
has found that all DCMs have chosen to adopt the acceptable practices
to demonstrate compliance with DCM Core Principle 16.
The Commission preliminarily believes that establishing
affirmative, harmonized requirements for governance fitness standards
and the mitigation of conflicts of interest are necessary to promote
the integrity of SEFs and DCMs as self-regulatory organizations and to
ensure the effective and impartial fulfillment of those functions. In
particular, the Commission has recently observed an increase in the
number of SEFs and DCMs that are part of corporate families that also
have other Commission registrants and other market participants. In
conducting SEF regulatory consultations that were completed in 2021,
Commission staff identified several SEFs that were in the same
corporate family as intermediaries that also traded on the SEF.
Similarly, in 2021, Commission staff conducted an informal inquiry into
which DCMs were in corporate families with intermediaries who traded on
the DCM, and identified three such DCMs.
Where multiple Commission registrants or other market participants
exist in the same corporate family, the risk of conflicts of interest
may increase. For example, when a SEF or DCM is in the same corporate
family as an intermediary, like an introducing broker (``IB'') or a
futures commission merchant (``FCM''), that trades on or brings trades
to the SEF or DCM for execution, the SEF's or DCM's market regulation
obligations \115\ may conflict with interests of the intermediary, such
as in circumstances where there are questions about the intermediary's
compliance with a SEF or DCM rule.\116\ The emergence of these
affiliations could also affect certain key components of a SEF's or
DCM's framework for addressing conflicts of interest that may impact
market regulation functions. With respect to determining whether an
individual satisfies the public director standard, as outlined in the
DCM Core Principal 16 Acceptable Practices, certain relationships that
the individual may have with an affiliate of the DCM would need to be
evaluated. Furthermore, officers and members of the board of director
may need to evaluate whether certain relationships with an affiliate of
[[Page 19655]]
the DCM or SEF would give rise to an actual or potential conflict of
interest that could impact decision-making. Accordingly, the Commission
is herein proposing conflict of interest rules that focus on the
identification, management and resolution of conflicts of interest
related to a SEF's or DCM's market regulation functions, as
preliminarily defined by the Commission below, as well as related
governance standards that the Commission believes support the
mitigation of such conflicts of interest. The set of rules proposed
herein draw on many years of Commission staff's experience conducting
its routine oversight of SEFs and DCMs, and reflect the Commission's
identification of specific, harmonized measures that it preliminarily
believes will help to ensure that SEFs and DCMs fulfill their market
regulation functions in an effective and impartial manner.
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\115\ For example, Commission regulation Sec. 38.152 requires
DCMs that allow intermediation to prohibit customer-related abuses
such as trading ahead of customer orders, trading against customer
orders, accommodation trading, and improper cross trading.
Commission regulation Sec. 37.203 imposes a similar requirement on
SEFs.
\116\ In contrast to situations in which a DCM and DCO are in
the same corporate family--which the Commission has observed over
the past two decades--a SEF or DCM being in the same corporate
family as an intermediary registrant raises unique issues. Rena S.
Miller, Congressional Research Service, Conflicts of Interest in
Derivatives Clearing (2011), https://crsreports.congress.gov/product/pdf/R/R41715/4.
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Separately, on June 28, 2023, Commission staff issued a Request for
Comment on the Impact of Affiliations Between Certain CFTC-Regulated
Entities (``RFC'').\117\ The RFC sought public comment in order to
better inform Commission staff's understanding of a broad range of
potential issues that may arise if a DCM, DCO or SEF is affiliated with
an intermediary, such as an FCM or IB, or other market participant such
as a trading entity.\118\ The Commission also notes that on December
18, 2023, its Divisions of Clearing and Risk, Market Oversight, and
Market Participants issued a staff advisory on affiliations between a
DCM, DCO or a SEF and an intermediary, such as an FCM, or other market
participant, such as a trading entity. The advisory reminds DCOs, DCMs,
and SEFs that have an affiliated intermediary or trading entity, as
well as the affiliated intermediary or trading entities themselves, of
their obligations to ensure compliance with existing statutory and
regulatory requirements with this affiliate relationship in mind.\119\
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\117\ Request for Comment on the Impact of Affiliations of
Certain CFTC-Regulated Entities, CFTC Release 8734-23, June 28,
2023. https://www.cftc.gov/PressRoom/PressReleases/8734-23.
\118\ The Commission received a number of comments raising
concerns about the impact of affiliation, and anticipates proposing
regulations that will address issues identified as a result of the
RFC, including additional concerns raised by commenters about the
conflicts of interest, specifically relating to market regulation
functions, posed by affiliations. This rulemaking does not reflect
the comments submitted in response to the Commission staff's RFC.
Those comments will not be made part of the administrative record
before the Commission in connection with this proposal.
\119\ Staff Advisory on Affiliations Among CFTC-Regulated
Entities, CFTC Release 8839-23, Dec. 18, 2023. https://www.cftc.gov/PressRoom/PressReleases/8839-23. In addition to the increased focus
on affiliate relationships, another market structure development
relates to the participation of intermediaries on SEF and DCM
markets. With limited exceptions, derivatives trading today is
conducted through regulated intermediaries who perform many
important functions, such as providing customers with access to
exchanges and clearinghouses, processing transactions, ensuring
compliance with federal regulations, and guaranteeing performance of
the derivatives contract to the clearinghouse. Recently, the
Commission has observed a trend in which registered entities pursue
a ``non-intermediated'' model, or direct trading and clearing of
margined products to retail customers.
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d. Conflicts of Interest Relating to Market Regulation Functions
1. Market Regulation Functions
This rule proposal addresses certain conflicts of interest that may
impact a SEF's or DCM's market regulation functions. For purposes of
this rule proposal, the Commission is proposing to define as ``market
regulation functions'' the responsibilities related to trade practice
surveillance, market surveillance, real-time market monitoring, audit
trail data and recordkeeping enforcement, investigations of possible
SEF or DCM rule violations, and disciplinary actions.\120\ The
Commission believes that effective performance of these market
regulation functions require SEFs and DCMs, consistent with their core
principle obligations, to establish a process for identifying,
minimizing, and resolving actual and potential conflicts of interest
that may arise between and among any of the SEF's or DCM's market
regulation functions and its commercial interests; or the several
interests of its management, members, owners, customers and market
participants, other industry participants, and other constituencies.
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\120\ See proposed Sec. Sec. 38.851(b)(9) and 37.1201(b)(9).
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Proposed Sec. 37.1201(b)(9) defines ``market regulation
functions'' as the SEF functions required by SEF Core Principle 2
(Compliance with Rules), SEF Core Principle 4 (Monitoring of Trading
and Trade Processing), SEF Core Principle 6 (Position Limits or
Accountability), SEF Core Principle 10 (Recordkeeping) and the
Commission's regulations thereunder. Proposed Sec. 38.851(b)(9)
defines ``market regulation functions'' as the DCM functions required
by DCM Core Principle 2 (Compliance with Rules), DCM Core Principle 4
(Monitoring of Trading), DCM Core Principle 5 (Position Limits or
Accountability), DCM Core Principle 10 (Trade Information), DCM Core
Principle 12 (Protection of Markets and Market Participants), DCM Core
Principle 13 (Disciplinary Procedures), DCM Core Principle 18
(Recordkeeping) and the Commission's regulations thereunder.
The Commission's proposed definition of ``market regulation
functions'' does not include certain other SEF or DCM obligations. For
example, the proposed definition does not include DCM Core Principle 11
(Financial Integrity of Transactions), the related financial
surveillance requirements for DCMs under Commission regulation Sec.
1.52, or a SEF's obligations under Core Principle 7 (Financial
Integrity of Transactions).
As noted above, the Commission staff's RFC sought public comment on
a range of potential issues that may arise if a DCM, DCO or SEF is
affiliated with an intermediary, such as an FCM or IB, or other market
participant such as a trading entity. While the scope of the proposed
term ``market regulation functions'' in this rulemaking is limited to
SEF and DCM functions under specific core principles, the Commission
notes that public comment in response to the RFC may inform future
Commission action. The Commission may further address SEF or DCM
conflicts of interest obligations that may impact broader self-
regulation functions of SEFs and DCMs, including their obligations
under SEF Core Principle 7 and DCM Core Principle 11. The Commission
notes that any future action impacting broader self-regulatory
functions may consider whether those self-regulatory functions should
be subject to requirements that are similar or different to the
requirements being proposed in this rulemaking. As discussed further
below, the main objective of this rulemaking is to establish
requirements to mitigate certain conflicts of interest that may impact
those SEF and DCM functions most closely tied to the SEF's or DCM's
market regulation function.
2. Questions for Comment
The Commission seeks comment on the questions set forth below
regarding the proposed definition of ``market regulation functions.''
1. Has the Commission appropriately defined ``market regulation
functions'' for purposes of this rule proposal? Are there additional
functions that should be included in the proposed definition?
2. In this rule proposal, and for purposes of the conflicts of
interest that it is intended to address, has the Commission
appropriately distinguished ``market regulation functions'' from the
broader self-regulatory functions of a SEF or DCM?
[[Page 19656]]
3. Conflicts of Interest Between Market Regulation Functions and
Commercial Interests
SEFs' and DCMs' obligations to perform market regulation functions
may conflict with their commercial interests. For example, performing
market regulation functions requires the use of staff and resources
that might otherwise be dedicated to commercial functions, such as
seeking new market participants or promoting new products.\121\ In
addition, SEFs and DCMs have a commercial interest to earn fees from
market participants, and to avoid deterring participants from trading
on their platforms. Fulfillment by a SEF or DCM of its market
regulation functions may result in the SEF or DCM taking actions, such
as enforcement actions or the imposition of fines, that may deter the
use of the platform by certain market participants, and therefore run
counter to commercial interests of the platform. Commercial pressure,
such as competition among SEFs and among DCMs, may strain market
regulation obligations.\122\
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\121\ See Commission regulations Sec. Sec. 38.155 (DCM) and
37.203(c) (SEF).
\122\ Proposed Acceptable Practices for compliance with section
5(d)(15) of the Commodity Exchange Act, 71 FR 38740, 38741 n.10
(July 7, 2006) (citing five separate domestic and international
studies reaching the same conclusion); See also Kristin N. Johnson,
Governing Financial Markets: Regulating Conflicts, 88 Wash. L.Rev.
185, 221 (2013) (``While clearinghouses and exchanges are private
businesses, these institutions provide a critical, public,
infrastructure resource within financial markets. The self-
regulatory approach adopted in financial markets presumes that
clearinghouses and exchanges will provide a public service and
engage in market oversight. The owners of exchanges and
clearinghouses may, however, prioritize profit-maximizing strategies
that de-emphasize or conflict with regulatory goals.'')
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III. Proposed Governance Fitness Requirements
a. Overview
The Commission is proposing rules that would require SEFs and DCMs
to establish minimum fitness standards for certain categories of
individuals who are responsible for exchange governance, management,
and disciplinary functions, or who have potential influence over those
functions. These proposed requirements are intended to help ensure that
SEFs and DCMs effectively fulfill their critical role as self-
regulatory organizations by excluding individuals with a history of
certain disciplinary or criminal offenses from serving in roles with
influence over the governance and operations of the exchange. The
integrity of these functions is critically important to their
respective operations, markets, and market regulation functions.
Accordingly, it is essential that the individuals responsible for
governing a SEF or DCM, such as officers and members of the board of
directors, committees, disciplinary panels, and dispute resolution
panels, are ethically and morally fit to serve in their roles.
Similarly, the Commission believes it is important that minimum fitness
standards be applicable to an individual who owns 10 percent or more of
a SEF or DCM and has the ability to control or direct the SEF's or
DCM's management or policies.
The Commission also believes establishing the same minimum fitness
requirements for both SEFs and DCMs is necessary given that their
officers and members of the board of directors, committees,
disciplinary panels, and dispute resolution panels have identical
responsibilities for governing and administering operations, including
the operations of the market regulation functions. Straightforward and
consistent minimum fitness requirements are reasonably necessary to
promote the hiring and designation of officers and members of the board
of directors, committees, disciplinary panels, and dispute resolution
panels that have the appropriate character and integrity to perform
their duties.
b. Minimum Fitness Standards--Proposed Sec. Sec. 37.207 and 38.801
1. Existing Regulatory Framework
DCM Core Principle 15 requires a DCM to establish and enforce
appropriate fitness standards for members of the board of directors,
members of any disciplinary committee, members of the DCM, other
persons with direct access to the DCM, and ``any party affiliated''
with any of the foregoing persons. The DCM Core Principle 15 Guidance
states that minimum fitness standards for ``persons who have member
voting privileges, governing obligations or responsibilities, or who
exercise disciplinary authority,'' and ``natural persons who directly
or indirectly have greater than a ten percent ownership interest in a
designated contract'' should include those bases for refusal to
register a person under section 8a(2) of the CEA.\123\ Additionally,
the DCM Core Principle 15 Guidance states that persons who have
governing obligations or responsibilities, or who exercise disciplinary
authority, should not have a significant history of serious
disciplinary offenses, such as those that would be disqualifying under
Commission regulation Sec. 1.63 \124\ The DCM Core Principle 15
Guidance also states that DCMs should have standards for the collection
and verification of information supporting compliance with the DCM's
fitness standards. Pursuant to Commission regulation Sec. 38.2, DCMs
are exempt from some of the provisions of Commission regulation Sec.
1.63. They are not exempt, however, from Commission regulation Sec.
1.63(c), which prohibits persons that are subject to any of the
disciplinary offenses set forth in Commission regulation Sec. 1.63(b)
from serving on a disciplinary committee, arbitration panel, oversight
panel or governing board of a self-regulatory organization.
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\123\ Appendix B to Part 38, Guidance on, and Acceptable
Practices in, Compliance with Core Principles; Core Principle 15,
Governance Fitness Standards. This Guidance was promulgated under
the 2001 Regulatory Framework in direct response to the recognition
that with the de-mutualization of DCMs, the governance role of
``members'' is exercised by the DCM's owner or owners. The
Commission has previously noted that the 10 percent ownership
threshold is consistent with the same 10 percent threshold for
fitness standards that Congress itself adopted for exempt commercial
markets in section 2(h)(5)(A)(iii) of the CEA, prior to the Dodd
Frank amendments. See 2001 Regulatory Framework, 66 FR 42255, 42262
n.40. Exempt commercial markets were eliminated as a category in the
CEA pursuant to Title VII of the Dodd Frank Act, which also
introduced SEFs as a new category of CFTC-regulated exchange. Public
Law 106-554, 114 Stat. 2763 (Dec. 21, 2000); See also Repeal of the
Exempt Commercial Market and Exempt Board of Trade Exemptions, 80 FR
59575 (Oct. 2, 2015).
\124\ Id. The DCM Core Principle 15 Guidance states that members
with trading privileges but having no or only minimal equity in the
DCM and non-member market participants who are not intermediated
``and do not have these privileges, obligations, or responsibilities
or disciplinary authority'' could satisfy minimum fitness standards
by meeting the standards that they must meet to qualify as a
``market participant.''
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SEFs are not subject to a specific core principle requirement to
establish fitness standards. However, as authorized by the CEA,\125\
SEFs must comply with all requirements in Commission regulation Sec.
1.63, which sets forth requirements and procedures to prevent persons
with certain disciplinary histories from serving in certain governing
or oversight capacities at a self-regulatory organization.
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\125\ Commission Regulation Sec. 1.63 was adopted pursuant to
the following statutory authority: 7 U.S.C. 2, 2a, 4, 4a, 6, 6a, 6b,
6c, 6d, 6e, 6f, 6g, 6h, 6i, 6j, 6k, 6l, 6m, 6n, 6o, 7, 7a, 8, 9, 12,
12a, 12c, 13a, 13a-l, 16,19, 21, 23, and 24, Service on Self-
Regulatory Organization Governing Boards or Committees by Persons
with Disciplinary Histories, 55 FR 7884, 7890 (March 6, 1990, Final
Rule).
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2. Proposed Rules
The Commission is proposing identical fitness requirements for SEFs
and DCMs. The Commission believes the proposed rules are reasonably
necessary to effectuate a DCM's
[[Page 19657]]
obligations to establish and enforce appropriate fitness standards
under DCM Core Principle 15, and to effectuate a SEF's obligations to
establish and enforce rules governing the operation of the SEF under
SEF Core Principle 2.\126\ A SEF's ability to effectively operate as
both a market and SRO, and to perform its market regulation functions,
is largely dependent upon the individuals who govern or control the
SEF's operations, including officers, and members of the board of
directors, disciplinary committees, dispute resolution panels, members
and controlling owners. Given this relationship, the Commission
believes that it is reasonably necessary to extend the same governance
fitness standards to SEFs as to DCMs.\127\
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\126\ CEA section 5h(f)(2); 7 U.S.C. 7b-3(f)(2).
\127\ The Commission is proposing to exercise its authority
under CEA section 8a(5) to establish the SEFs fitness standards;
DCMs are already subject to a similar requirement to set appropriate
fitness standards. CEA section 5(d); 7 U.S.C. 7(d)(15).
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i. Categories of Persons Subject to Minimum Fitness Standards
In proposed Sec. Sec. 37.207(a) and 38.801(a), the Commission is
requiring that SEFs and DCMs establish and enforce appropriate fitness
standards for officers; for members of its board of directors,
committees, disciplinary panels, and dispute resolution panels (or
anyone performing functions similar to the foregoing); for members of
the SEF or DCM; for any other person with direct access to the SEF or
DCM; and for any person who owns 10 percent or more of a SEF or DCM and
who, either directly or indirectly, through agreement or otherwise, in
any other manner, may control or direct the management or policies of
the SEF or DCM, and any party affiliated with any of those persons.
Specifically, the Commission notes that proposed Sec. Sec.
37.207(a) and 38.801(a) would extend minimum fitness requirements to
certain individuals, including officers and owners of 10 percent or
more of a SEF or DCM, and SEF and DCM members with voting privileges,
who were not historically subject to DCM fitness requirements under DCM
Core Principle 15, or SEF and DCM fitness requirements under Commission
regulation Sec. 1.63(c). However, as discussed below, the Commission
believes applying consistent minimum fitness standards to classes of
individuals enumerated in proposed Sec. Sec. 37.207(a) and 38.801(a)
is reasonably necessary given that these individuals have: (1)
obligations with respect to a SEF's or DCM's governance or disciplinary
process; or (2) the ability to exercise control over a SEF or DCM.
First, officers of a SEF or DCM would be subject to the minimum
fitness requirements in proposed Sec. Sec. 37.207(a) and
38.801(a).\128\ The Commission believes this is reasonably necessary
because officers--like members of the board of directors, committee
members, or members of disciplinary or dispute resolution panels, and
members with voting privileges \129\--also have governing, decision-
making, and disciplinary responsibilities within a SEF or DCM, and
therefore must be able to demonstrate standards of integrity and
rectitude in order to effectively perform their duties.
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\128\ Officers are also subject to the 8a(2) and 8a(3) minimum
fitness requirements in proposed Sec. Sec. 37.207(b) and 38.801(b),
and the disqualifying offenses in proposed Sec. Sec. 37.207(c) and
38.801(c).
\129\ In addition to the three categories of individuals
highlighted in this section, members of its board of directors,
committees, disciplinary panels, and dispute resolution panels, all
members of the SEF or DCM, and any other person with direct access
to the SEF, are subject to the requirement to have appropriate
fitness requirements in Sec. Sec. 37.207(a) and 38.801(a).
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Second, members with voting privileges would also be subject to the
minimum fitness requirements in proposed Sec. Sec. 37.207(a) and
38.801(a).\130\ Although DCM Core Principle 15 applies to a broad class
of individuals associated with a DCM, including members with voting
privileges, there is no parallel application for SEFs. The Commission
acknowledges that SEF and DCM members with voting privileges may not
have the same governing duties as officers and members of its board of
directors, committees, disciplinary panels, or dispute resolution
panels. Nevertheless, they may have the ability to influence or
control, either directly through their voting privileges or through
other indirect means, the operations or decision-making of the SEF or
DCM. Accordingly, the Commission believes it is reasonably necessary to
establish and enforce certain minimum standards of fitness for such
individuals.
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\130\ Members with voting privileges are also subject to the
8a(2) and 8a(3) minimum fitness requirements in proposed Sec. Sec.
37.207(b) and 38.801(b).
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Third, certain owners of 10 percent or more of a SEF or DCM would
also be subject to the minimum fitness requirements in proposed
Sec. Sec. 37.207(a) and 38.801(a).\131\ Although the guidance to DCM
Core Principle 15 lists a broad class of individuals, including natural
persons who directly or indirectly have greater than a 10 percent
ownership interest in a DCM, there is no parallel application for a
SEF. While individuals who own 10 percent or more of a SEF or DCM may
not be involved in the daily operations of a SEF or DCM, their sizeable
ownership interest may, either directly or indirectly, enable them to
exert influence or control over various aspects of decision-making,
including decisions that may impact market regulation functions.\132\
As an example, a person with a 10 percent ownership interest in the SEF
or DCM may have competing business interests that are improperly
prioritized, particularly if that person has influence in selecting
officers or members of the board of directors. Similarly, a person with
10 percent ownership may have influence or control over the SEF's or
DCM's contracts with third party service providers, or, even the
ability to wield his or her influence in determining whether to
investigate potential rule violations. Therefore, the Commission
believes it is reasonably necessary to require that persons owning 10
percent or more of the SEF or DCM, and who, either directly or
indirectly, through agreement or otherwise, in any other manner,
control or direct the management or policies of the SEF or DCM \133\ be
subject to certain minimum fitness requirements, as described below.
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\131\ Owners of 10 percent or more of a SEF or DCM, who also may
control or direct the management or policies of a SEF or DCM, are
also subject to the 8a(2) and 8a(3) minimum fitness requirements in
proposed Sec. Sec. 37.207(b) and 38.801(b).
\132\ As noted below concerning the proposed changes to
Commission regulations Sec. 37.5(c), if one entity holds a 10
percent equity share in a SEF it may have a significant voice in the
operation and/or decision-making of the SEF.
\133\ The language of the proposed fitness standards for owners
of 10 percent or more of a SEF or DCM intentionally generally
mirrors the language from the Appendices to Part 37 and 38, Form SEF
and Form DCM, Exhibit A. Exhibit A to Form SEF and Form DCM require
disclosure of owners of 10 percent or more of the applicant's stock
as part of the application for registration or designation. A
similar 10 percent or more ownership threshold is found in other
Commission regulations, e.g., the definition of Principal in
Commission regulation Sec. 3.1 and section 8a(2)(H) of the CEA,
which effectively prevent individuals subject to the grounds for
refusal to register in CEA section 8a(2) or section 8a(3) from
owning 10 percent of voting stock in an intermediary subject to
registration requirements. The 10 percent ownership interest
threshold is similarly found in the reporting requirements for
``insiders'' in section 16 of the Securities Exchange Act of 1934.
See also 17 CFR 240.16a-2.
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ii. Minimum Fitness Standards
Proposed Sec. Sec. 37.207(b) and 38.801(b) would set forth minimum
standards of fitness SEFs and DCMs must establish and enforce for
officers and members of its board of directors,\134\ committees,
[[Page 19658]]
disciplinary panels, and dispute resolution panels (or anyone
performing functions similar to the foregoing), for members with voting
privileges,\135\ and any person who owns 10 percent or more of the SEF
or DCM and who, either directly or indirectly, through agreement or
otherwise, in any other manner, may control or direct the management or
policies of the DCM,\136\ to include the bases for refusal to register
a person under sections 8a(2) and 8a(3) of the CEA.\137\ DCM Core
Principle 15 Guidance includes the bases for refusal to register under
CEA section 8a(2), but it does not include the bases for refusal to
register a person under section 8a(3). However, as described below, the
Commission believes inclusion of the section 8a(3) disqualifications
for individuals with governance or disciplinary responsibilities at the
SEF or DCM, or the ability to control or direct the management or
policies of the SEF or DCM, is reasonably necessary for SEFs and DCMs
to fulfill their responsibilities as SROs without influence from
individuals with backgrounds incompatible with such responsibility.
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\134\ For purposes of the rules proposed herein, the Commission
is proposing to define ``board of directors'' as a group of people
serving as the governing body of a SEF or DCM, or--for SEFs or DCMs
whose organizational structure does not include a board of
directors--a body performing a function similar to a board of
directors. See proposed Sec. Sec. 37.1201(b)(2) and 38.851(b)(2).
\135\ Consistent with current Core Principle 15 Guidance,
members with voting privileges have the same minimum fitness
standards as other individuals with the ability to directly affect
the operations or governance of the Exchange, whereas members
without voting privileges are subject only to the requirement that
the DCM or SEF set appropriate fitness standards for them, as set
out in proposed regulations Sec. Sec. 37.207(a) and 38.801(a). In
light of industry changes, the Commission is requesting comment on
whether ``members with voting privileges'' remains a relevant
category that should be subject to this distinction.
\136\ These categories of individuals are similar to those
subject to the 8a(2) standards in the DCM Core Principle 15
Guidance.
\137\ Section 8a(2) and 8a(3) bases include, for example,
revocation of registration, convictions or guilty pleas for
violations of the CEA, the Securities Act of 1933, the Securities
Exchange Act of 1934, misdemeanors involving embezzlement, theft, or
fraud, past failure to supervise, willful misrepresentations or
omissions, and ``other good cause.''
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Sections 8a(2) and 8a(3) of the CEA provide a consistent, minimum
industry framework to promote high ethical standards among officers,
directors and other individuals with controlling influence over
intermediaries or other registrants in the futures and swaps
industry.\138\ In proposing to extend the sections 8a(2) and 8a(3)
minimum fitness standards to individuals subject to the fitness
requirements in proposed Sec. Sec. 37.207(a) and 38.801(a), the
Commission is extending the same consistent, minimum industry framework
\139\ to promote high ethical standards among individuals with similar
control or influence over the important self-regulatory functions at
SEFs and DCMs. These standards are reasonably necessary to promote
consistent high ethical industry standards for a SEF or DCM to serve as
an effective SRO.
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\138\ CEA sections 8a(2) and (3), 7 U.S.C. 12a(2) and (3);
Principals, including officers, managing members, directors and
owners of 10 percent or more voting stock of FCMs, IBs, and other
registrants, may already be disqualified from registration pursuant
to CEA sections 8a(2) and 8a(3), which in turn may result in the
revocation of the registration of the FCM, IB or other registrant.
(CEA section 8a(2)(H), 7 U.S.C. 12a(2)(H), defining ``Principal,''
to include any officer, director, or beneficial owner of at least 10
percent of the voting shares of the corporation, and any other
person that the Commission by rule, regulation, or order determines
has the power, directly or indirectly, through agreement or
otherwise, to exercise a controlling influence over the activities
of such person which are subject to regulation by the Commission.
Both sections 8a(2) and 8a(3) provide for the revocation of
registration of an FCM, IB, or other registrant where a principal of
the registrant is subject to a statutory disqualification found in
CEA sections 8a(2) or 8a(3).) As stated in the interpretative
statement to CEA section 8a(3)(M), in Appendix A to part 3, which
provides the Commission with the authority to refuse registration of
any person for other good cause, any inability to deal fairly with
the public and consistent with the just and equitable principles of
trade may render an applicant or registrant unfit for registration,
given the high ethical standards which must prevail in the industry.
\139\ Individuals serving as officers, board members,
disciplinary committee members, members with voting privileges, and
owners with 10 percent or more of a DCM or SEF and with the ability
to control or direct the management or policies of the SEF or DCM
should not be subject to lower fitness standards than the fitness
standards applied to principals of intermediaries facilitating
trading on SEF or DCM. Otherwise, an individual could be
disqualified from serving as the principal of an FCM or IB, due to
the factors set out under CEA 8a(2) or 8a(3), but be allowed to
serve in a role exercising influence or control over the self-
regulatory functions of a SEF or DCM; the SEF or DCM is the front-
line regulator of the trading activity facilitated by FCMs and IBs
on a SEF or DCM.
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Proposed Sec. Sec. 37.207(c) and 38.801(c) would require SEFs and
DCMs to establish and enforce additional minimum fitness standards for
certain individuals--officers and for members of its board of
directors, committees, disciplinary panels, and dispute resolution
panels (or anyone performing functions similar to the foregoing). These
additional fitness requirements include ineligibility based on six
types of disciplinary offenses that generally track the disciplinary
offenses listed in Sec. Sec. 1.63(b)(1)-(6), with certain
modifications. In effect, the proposed rules would apply the fitness
requirements of Commission regulation Sec. 1.63 consistently to both
SEFs and DCMs, subject to certain enhancements as further described
below.
The six disciplinary offenses in proposed Sec. Sec. 37.207(c)(1)-
(6) and 38.801(c)(1)-(6) are substantially similar to the existing
ineligibility requirements in Sec. 1.63(b).
Proposed Sec. Sec. 37.207(c)(1) and 38.801(c)(1), require
that an individual would be ineligible if they were found, in a final,
non-appealable \140\ order by a court of competent jurisdiction, an
administrative law judge, the Commission, a self-regulatory
organization,\141\ or the SEC, to have committed any of four offenses
described in proposed Sec. Sec. 37.207(c)(1)(i)-(iv) and
38.801(c)(1)(i)-(iv) within the previous three years.\142\ This
requirement is substantially the same as the ineligibility requirement
found in Sec. 1.63(b)(1), except for the addition of findings by the
SEC.
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\140\ The final, non-appealable order language comes from the
definition of ``final decision'' found in Commission regulation
Sec. 1.63(a)(5).
\141\ With the exception of the addition of the SEC, these are
the same categories as in the definition of ``final decision'' found
in Commission regulation Sec. 1.63(a)(5).
\142\ Pursuant to Commission regulation Sec. 1.63(b)(1), an
individual is ineligible to serve on disciplinary committees,
arbitration panels, oversight panels or governing board if, within
the past three years, that individual was found to have committed a
``disciplinary offense.''
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Proposed Sec. Sec. 37.207(c)(1)(i)-(iv) and
38.801(c)(1)(i)-(iv), include, in substance, the same four disciplinary
offenses listed in Sec. 1.63(a)(6)(i)-(iv).
Proposed Sec. Sec. 37.207(c)(2)-(6) and 38.801(c)(2)-(6)
mirror, in substance, the disciplinary offenses found in Sec.
1.63(b)(6)(2)-(6), with minor enhancements to expressly include both
SEFs and DCMs when referencing suspensions from trading on a contract
market.
Proposed Sec. Sec. 37.207(c) and 38.801(c) also enhance the
existing minimum fitness requirements in several ways, compared to the
requirements in Commission regulation Sec. 1.63. The language in
proposed Sec. Sec. 37.207(c) and 38.801(c) does not use the limiters
``significant history'' or ``serious disciplinary offenses'' in setting
forth disqualifying offenses. These terms appear in DCM Core Principle
15 Guidance \143\ and the Commission proposes to clarify which
disciplinary offenses are included by specifying which offenses would
automatically be
[[Page 19659]]
disqualifying. As described above, the list of disciplinary offenses in
proposed Sec. Sec. 37.207(c) and 38.801(c) includes, in substance, the
same offenses identified in Commission regulation Sec. 1.63,\144\ and
expands the disqualifying offenses to include agreements not to apply
for, or to be disqualified from applying for, registration in any
capacity with the SEC, or any self-regulatory organization, including
the Financial Industry Regulatory Authority (``FINRA'').\145\
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\143\ DCM Core Principle 15 Guidance provides that, among other
things, persons who have governing obligations or responsibilities,
or who exercise disciplinary authority, should not have a
significant history of serious disciplinary offenses, such as those
that would be disqualifying under Commission regulation Sec. 1.63.
\144\ The disciplinary offenses generally include a decision by
a court or a self-regulatory organization (or a settlement) of:
violations of the substantive rules of a self-regulatory
organization, felonies, convictions involving fraud or deceit,
violations of the CEA or Commission regulations, or a suspension or
denial by a self-regulatory organization to serve on a board or
disciplinary panel.
\145\ Commission regulation Sec. 1.63(b)(6) provides as
disqualifying anyone who is currently subject to a denial,
suspension or disqualification from serving on the disciplinary
committee, arbitration panel or governing board of any self-
regulatory organization as that term is defined in section 3(a)(26)
of the Securities Exchange Act of 1934.
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iii. Verification and Documentation of Minimum Fitness Standards
Proposed Sec. Sec. 37.207(d) and 38.801(d) would require each SEF
and DCM to establish appropriate procedures for the collection and
verification of information supporting compliance with appropriate
fitness standards. The Commission believes that, to be effective, such
procedures must be written, must be in a location where people who
would use them can find them, and must be preserved and ready for the
Commission to review.\146\ The Commission anticipates staff will review
the procedures and fitness determinations as part of its routine
oversight.
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\146\ The Commission believes that in the absence of a cohesive
set of SEF or DCM conflicts of interest policies and procedures,
individuals with potential conflicts of interest may have difficulty
ascertaining the policies and procedures that apply to a given
situation. The Commission believes that similar concerns would be
raised where there is not a cohesive set of procedures related to
the verification fitness information.
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In conducting its oversight of SEFs and DCMs, Commission staff has
learned that some SEFs and DCMs accepted fitness representations from
the individual subject to the fitness standard without any practice of
independent verification. Independent verification of fitness
information is particularly important because certain individuals could
be disincentivized from self-reporting fitness information that could
disqualify them from service.\147\ The Commission believes SEFs and
DCMs should verify fitness information provided by individuals by
collecting information from third parties, for example, via the
National Futures Association's (``NFA'') Background Affiliation Status
Information Center (``BASIC'') system or background checks.
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\147\ Both the NFA and FINRA conduct background checks to
confirm information provided in the Form U4 is accurate, and FINRA
Rule 3110(e) requires SEC-registered member firms to verify the
information provided in a Form U4 using ``reasonably available
public records, or a third-party provider.''
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Commission staff also discovered during the course of its oversight
that some SEFs and DCMs did not have a practice to verify an
individual's compliance with applicable fitness standards prior to the
individual starting to serve in the capacity requiring the fitness
standard. Additionally, some SEFs and DCMs lacked practices for regular
verification of fitness standards, allowing fitness information to
become stale. Without these practices for verifying and documenting
fitness information, the Commission believes there is an increased risk
that individuals will serve in a capacity for which they are not fit.
Proposed Sec. Sec. 37.207(d)(1)(i)-(iv) and 38.801(d)(1)(i)-(iv) would
address these practices by requiring: (i) fitness information be
verified at least annually, (ii) the SEF or DCM have procedures
providing for immediate notice to the SEF or DCM if an individual no
longer meets the minimum fitness standards to serve in their role,
(iii) the initial verification of information supporting an
individual's compliance with relevant fitness standard be completed
prior to the individual serving in the capacity with fitness standards,
and (iv) the SEF and DCM to document their findings with respect to the
verification of fitness information.
The Commission further proposes to clarify the applicability of the
governance fitness requirements to SEFs and DCMs by locating them,
respectively, within parts 37 and 38 of the Commission's regulations,
rather than within part 1 of the Commission's regulations. The
Commission also proposes to make conforming amendments to Commission
regulations Sec. Sec. 37.2 and 38.2 to exempt SEFs and DCMs from
Commission regulation Sec. 1.63 in its entirety.
iv. Additional Considerations for Minimum Fitness Requirements
The Commission is considering whether additional fitness
requirements would enhance the performance and accountability of the
individuals who are charged with governing a SEF or DCM or its
operations, or have the ability to influence such functions. Therefore,
the Commission is seeking comment on whether SEFs and DCMs should
consider additional eligibility criteria to prevent individuals from
serving as an officer or member of the board of directors if their
background, although not automatically disqualifying under proposed
Sec. Sec. 38.801(c) or 37.207(c), raises concerns about the
individual's ability to effectively govern, manage, or influence the
operations or decision-making of a SEF or DCM. For example, the
Commission notes that at least three SEFs have already implemented a
``good repute'' requirement for members of their board of
directors,\148\ and the same requirement exists for members of the
management body of regulated markets in the European Union.\149\ The
purpose of a ``sufficiently good repute'' standard would be to identify
individuals with a well-established history of honesty, integrity, and
fairness in their personal, public, and professional matters. The
Commission's potential standard could be as follows:
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\148\ See CBOE SEF Rulebook, Rule 202; Bloomberg SEF Rulebook,
Rule 201; ICAP Global Derivatives SEF Rulebook, Annex 1, Governance
Policy. Additionally, at least five DCMs and one SEF require their
members or market participants to be of ``good repute,'' ``good
moral character,'' or ``good reputation.''
\149\ Article 45(2)(a) to (c) of the Markets in Financial
Instruments Directive 2014/65/EU (``MiFID II'') (requiring members
of the management body of market operators to be of ``sufficiently
good repute''); Article 4(36) defines ``management body'' to include
the individuals ``empowered to set the entity's strategy,
objectives, and overall direction, and which oversee and monitor
management decision-making . . .'').
Minimum standards of fitness for the SEF's and DCM's officers
and for members of its board of directors must include the
requirement that each such individuals be of sufficiently good
repute; provided, however, that SEFs and DCMs have flexibility to
establish the criteria for how individuals demonstrate good repute,
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as appropriate for their respective markets.
The Commission also seeks comment on whether SEFs and DCMs should
also consider, in defining ``good repute,'' the type of information
that is subject to disclosure in the Uniform Application for Securities
Regulation (``Form U4'') for consideration by FINRA for
registration.\150\ Other examples for consideration include instances
where the license of a licensed professional (such as a certified
public accountant or attorney) has been involuntarily suspended or
revoked, or where an individual is suspended by an order of
[[Page 19660]]
a foreign regulator or court in foreign jurisdiction.
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\150\ The Form U4 includes information such as criminal charges,
pending regulatory cases, license suspensions or revocations, and
decisions by foreign courts.
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3. Questions for Comment
The Commission requests comment on all aspects of the proposed
fitness standards for SEFs and DCMs. The Commission further requests
comment on the questions set forth below.
1. Should SEFs and DCMs be required to establish additional fitness
standards for officers or members of the board of directors whose
background, although not automatically disqualifying under proposed
Sec. Sec. 37.207 or 38.801, raises concerns about the individual's
ability to effectively govern, manage, or influence the operations or
decision-making of a SEF or DCM? If so, is ``sufficiently good repute''
an appropriate fitness standard for officers and members of the board
of directors (or anyone performing similar functions) of a SEF or DCM?
2. The Commission quoted above a ``sufficiently good repute''
standard, for purposes of a potential requirement that SEFs and DCMs
require members of their boards of directors and officers be of good
repute. Please explain whether you agree with that standard. Does such
standard provide sufficient flexibility to SEFs and DCMs? Should such
standard be more detailed and list specific criteria or factors
evidencing good repute? Would ``sufficiently good repute,'' already be
encompassed in CEA section 8a(3)(M), ``other good cause?''
3. Is a 10 percent or more ownership interest the appropriate
threshold to trigger minimum fitness requirements for owners? Is the
ability to control or direct the management or policies of the DCM the
appropriate qualifier to trigger minimum fitness standards for 10
percent or more owners of a SEF or DCM?
4. Should owners of 10 percent or more be subject to the
disqualifying disciplinary offenses in proposed Sec. Sec. 37.207(c)
and 38.801(c)?
5. Proposed Sec. Sec. 37.207(b) and 38.801(b) apply to ``members
of the designated contract market with voting privileges'' and
``members of the swap execution facility with voting privileges,''
respectively. Is this an appropriate category of persons to subject to
the proposed minimum fitness standard requirements? Does this category
remain relevant to current SEF and DCM governance and business
structures, or is it no longer applicable?
IV. Proposed Substantive Requirements for Identifying, Managing and
Resolving Actual and Potential Conflicts of Interest
a. General Requirements for Conflicts of Interest and Definitions--
Proposed Sec. Sec. 37.1201 and 38.851
1. Existing Regulatory Framework and Definitions
As described above, SEFs and DCMs must establish and enforce rules
to minimize conflicts of interest in their decision-making processes
and establish a process for resolving such conflicts, pursuant to SEF
Core Principle 12 and DCM Core Principle 16. SEFs and DCMs have
different standards for addressing conflicts of interest. The DCM Core
Principle 16 Acceptable Practices provide specific practices that DCMs
may adopt to demonstrate compliance with aspects of DCM Core Principle
16. The Commission has not adopted guidance on, or acceptable practices
in, compliance with the conflicts of interest requirements under SEF
Core Principle 12. Commission regulation Sec. 1.59, however, addresses
the management of conflicts of interest for SEFs in connection with
protecting material non-public information from misuse and
disclosure.\151\
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\151\ Commission regulation Sec. 1.59 addresses the management
of conflicts of interest for self-regulatory organizations,
including SEFs and DCMs, in connection with protecting material,
non-public information from use and disclosure. Pursuant to
Commission regulation Sec. 38.2, DCMs are exempt from Sec. 1.59(b)
and (c), but must comply with Sec. 1.59(a) and (d); SEFs must
comply with all subparts of Sec. 1.59.
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There are several terms defined in the DCM Core Principle 16
Acceptable Practices and Commission regulation Sec. 1.59(a) which the
Commission believes are relevant to identifying and resolving conflicts
of interest that may impact a SEF's or DCM's market regulation
functions, and which the Commission is proposing to adopt in these
proposed new conflict of interest rules with certain minor
modifications as discussed below. The DCM Core Principle 16 Acceptable
Practices defines a ``public director'' as an individual with no
material relationship to the DCM and describes the term ``immediate
family'' to include spouse, parents, children, and siblings. The terms
``material information,'' ``non-public information,'' ``commodity
interest,'' ``related commodity interest,'' and ``linked exchange'' are
defined in Commission regulation Sec. 1.59. ``Material information''
is defined in Sec. 1.59(a)(5) to mean information which, if such
information were publicly known, would be considered important by a
reasonable person in deciding whether to trade a particular commodity
interest on a contract market or a swap execution facility, or to clear
a swap contract through a derivatives clearing organization.\152\
``Non-public information'' is defined in Sec. 1.59(a)(6), as
information which has not been disseminated in a manner which makes it
generally available to the trading public. Commission regulations
Sec. Sec. 1.59(a)(8) and (9) define ``commodity interest,'' to include
all futures, swaps, and options traded on or subject to the rules of a
SEF or DCM \153\ and ``related commodity interest'' to include any
commodity interest which is traded on or subject to the rules of a SEF,
DCM, linked exchange, or other board of trade, exchange, or market, or
cleared by a DCO, other than the self-regulatory organization \154\ by
which a person is employed, and which is subject to a self-regulatory
organization's intermarket spread margins or other special margin
treatment.
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\152\ The definition of material information in Commission
regulation Sec. 1.59(a)(5) also provides that as used in that
section, ``material information'' includes, but is not limited to,
information relating to present or anticipated cash positions,
commodity interests, trading strategies, the financial condition of
members of self-regulatory organizations or members of linked
exchanges or their customers, or the regulatory actions or proposed
regulatory actions of a self-regulatory organization or a linked
exchange.
\153\ The definition of commodity interest also includes futures
or swaps cleared by a Designated Clearing Organization. Commission
regulation Sec. 1.59(a)(8).
\154\ Commission regulation Sec. 1.3 defines this term as a
contract market (as defined in Sec. 1.3(h)), a swap execution
facility (as defined in Sec. 1.3(rrrr)), or a registered futures
association under section 17 of the CEA.
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2. Proposed Rules
Proposed Sec. Sec. 37.1201(a) and 38.851(a) would set forth the
foundational requirement that SEFs and DCMs, respectively, must
establish a process for identifying, minimizing, and resolving actual
and potential conflicts of interest that may arise, including, but not
limited to, conflicts between and among any of the SEF's or DCM's
market regulation functions; its commercial interests; and the several
interests of its management, members, owners, customers and market
participants, other industry participants, and other constituencies.
These proposed rules would largely codify existing language from the
DCM Core Principle 16 Acceptable Practices.\155\
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\155\ Part 38, Appendix B, Core Principle 16.
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Proposed Sec. Sec. 37.1201(b) and 38.851(b) would establish
definitions. As discussed above, many of the terms are already defined
in existing Commission regulations, and in the acceptable
[[Page 19661]]
practices for compliance with the DCM conflicts of interest core
principle, and would be duplicated with minor modifications. The
Commission believes that specifically defining these terms in parts 37
and 38 of its regulations would provide greater clarity to SEFs and
DCMs, and to the public, regarding regulatory requirements applicable
to these entities. Additional reasons for proposing these defined terms
are discussed below.
First, the terms ``material information,'' ``non-public
information,'' ``commodity interest,'' ``related commodity interest,''
and ``linked exchange'' would be defined in proposed Sec. Sec.
37.1202(b) and 38.851(b) as they are in Sec. 1.59(a), but modified
specifically to reference SEFs and DCMs, respectively. Additionally, as
addressed below, proposed Sec. Sec. 37.1202(b) and 38.851(b) would
define ``public director'' and ``family relationship.'' \156\ ``Family
relationship'' would replace the term ``immediate family'' that is
currently used in the DCM Core Principle 16 Acceptable Practices.\157\
As discussed above,\158\ proposed Sec. Sec. 37.1201 and 38.851 focus
on conflicts of interests involving a subset of a SEF or DCM's self-
regulatory functions--those that are generally related to the SEF's or
DCM's obligations to ensure market integrity and proper and orderly
conduct in its markets, and to deter abusive trading practices. Those
functions include trade practice surveillance, market surveillance,
real-time market monitoring, audit trail and recordkeeping enforcement,
investigations of possible rule violations, and disciplinary actions.
As discussed above, the Commission is proposing to define ``market
regulation functions'' in Sec. Sec. 37.1201(b)(9) and 38.851(b)(9) to
describe the self-regulatory functions addressed in this rule proposal.
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\156\ See Section V(b)(3) (addressing the term public director)
and Section IV(b)(3) (addressing the term family relationship).
\157\ Section IV(c)(3) herein provides details regarding the
proposed definitions for public director and family relationship.
\158\ See Section II(d) herein.
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Finally, the Commission is proposing a new definition for the term
``affiliate.'' The Commission recognizes that this term is defined
elsewhere in the Commission regulations. However, the definition of
``affiliate'' elsewhere in Commission regulations does not apply to
SEFs or DCMs.\159\ For the limited purpose of this rule proposal, the
Commission proposes defining ``affiliate'' in proposed Sec. Sec.
37.1201(b)(1) and 38.851(b)(1), to mean a person that directly or
indirectly controls, or is controlled by, or is under common control
with, the SEF or DCM (as applicable). The definition of affiliate in
proposed Sec. Sec. 37.1201(b)(1) and 38.851(b)(1) would establish
that, for purposes of this rule proposal, ``affiliate'' broadly
includes direct or indirect common ownership or control.
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\159\ For example, Sec. 162.2(a) defines ``affiliate''
specifically in relation to futures commission merchant, retail
foreign exchange dealer, commodity trading advisor, commodity pool
operator, introducing broker, major swap participant, or swap
dealer.
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b. Conflicts of Interest in Decision-Making--Proposed Sec. Sec.
37.1202 and 38.852
1. Background
Officers, members of the board of directors, committees, and
disciplinary panels, are the key decision-makers at a SEF or DCM that
can directly affect the day-to-day execution of market regulation
functions. Therefore, the Commission believes individuals fulfilling
these roles must have the ability to make informed and impartial
decisions. If any of these decision-makers have an actual or potential
conflict of interest, it can impair the decision-making process of the
SEF or DCM. Accordingly, the Commission is proposing to codify and
harmonize for SEFs and DCMs, in proposed Sec. Sec. 37.1202 and 38.852,
respectively, certain elements of Commission regulation Sec. 1.69 that
require a self-regulatory organization to address the avoidance of
conflicts of interest in the execution of its self-regulatory
functions. As noted above, SEFs are currently subject to the
requirements of Commission regulation Sec. 1.69; however, DCMs are
exempt from these requirements pursuant to Commission regulation Sec.
38.2. Nonetheless, Commission staff has found that as a matter of
practice, most DCMs have adopted rules that voluntarily implement these
requirements.
2. Existing Regulatory Framework
Commission regulation Sec. 1.69 generally requires self-regulatory
organizations to have rules requiring any member of the board of
directors, disciplinary committee, or oversight panel, to abstain from
deliberating and voting on certain matters that may raise conflicts of
interest. Commission regulation Sec. 1.69(a) includes a list of
definitions relevant to the section, including the definition of
``named party in interest,'' which means a person or entity that is
identified by name as a subject of any matter being considered by a
governing board, disciplinary committee, or oversight panel. Commission
regulation Sec. 1.69(b)(1)(i)(A)-(E) enumerates a list of
relationships. If a member of the board of directors, disciplinary
committee, or oversight panel, has such a relationship with a named
party in interest, then this would require the member to abstain from
deliberating and voting on that matter. Prior to the consideration of
any matter involving a named party in interest, Commission regulation
Sec. 1.69(b)(1)(ii) requires members of a governing board,
disciplinary committee or oversight panel to disclose their
relationships with the named party in interest. Commission regulation
Sec. 1.69(b)(1)(iii) requires self-regulatory organizations to
establish procedures for determining whether any members of governing
boards, disciplinary committees or oversight panels are subject to a
conflicts restriction in any matter involving a named party in
interest, and specifies certain requirements for making such
determinations.
Commission regulation Sec. 1.69(b)(2) requires members of
governing boards, disciplinary committees or oversight panels to
abstain from deliberating and voting in any significant action if the
member knowingly has a direct and substantial financial interest in the
result of the vote. Additional requirements for disclosure of interest
and the procedures for making a conflicts determination are addressed
in Commission regulations Sec. Sec. 1.69(b)(2)(ii) and (iii),
respectively. Commission regulation Sec. 1.69(b)(3) permits members of
governing boards, disciplinary committees or oversight panels, who
otherwise would be required to abstain from deliberations and voting on
a matter because of a conflict under Commission regulation Sec.
1.69(b)(2), to deliberate but not vote on the matter under certain
circumstances.\160\ Finally, Commission regulation Sec. 1.69(b)(4)
requires self-regulatory organizations to document certain conflicts
determination requirements.
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\160\ Commission regulation Sec. 1.64(b)(3)(ii) lists the
following factors for the deliberating body to consider in
determining whether to allow such member to participate in
deliberations: (1) if the member's participation is necessary to
achieve a quorum; and (2) whether the member has unique or special
expertise, knowledge or experience in the matter under
consideration.
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3. Proposed Rules
The Commission proposes to include certain elements of Commission
regulation Sec. 1.69 in proposed Sec. Sec. 37.1202 and 38.852, and to
make a conforming amendment to Commission regulation
[[Page 19662]]
Sec. 37.2 to exempt SEFs from Commission regulation Sec. 1.69. While
the intent behind Commission regulation Sec. 1.69 remains relevant,
the Commission believes that certain modifications and enhancements are
necessary to reflect the current state of the futures and swaps
markets. For example, Commission regulation Sec. 1.69(b)(1)(i)(C)
describes a relationship with a named party in interest through a
``broker association'' as defined in Sec. 156.1. While this
relationship may have been significant at the time Commission
regulation Sec. 1.69 was adopted, the Commission does not believe it
is necessary to include it in proposed Sec. Sec. 37.1202 and 38.852
given the decline of open outcry trading. Furthermore, the scope of
proposed Sec. Sec. 37.1202 and 38.852 would require a relationship
with an individual as part of a broker association, as well as other
professional associations, to be disclosed regardless of whether it is
an enumerated relationship. The scope of proposed Sec. Sec. 37.1202
and 38.852 expressly covers officers, as well as members of boards of
directors, committees, and disciplinary panels,\161\ to accurately
reflect the individuals and governing bodies that are involved in the
decision-making processes of a SEF or DCM and that may therefore be
subject to the same conflicts of interest.
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\161\ Commission regulation Sec. 1.69(a) defines ``disciplinary
committee(s),'' ``governing board(s),'' and ``oversight panel(s).''
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The Commission notes that Commission regulation Sec. 1.69(a)(2)
currently includes ``family relationship'' as one of the enumerated
relationships, which is defined as a person's spouse, parent,
stepparent, child, stepchild, sibling, stepbrother, stepsister, or in-
law. The Commission proposes redefining ``family relationship,'' as the
person's spouse, parents, children, and siblings, in each case, whether
by blood, marriage, or adoption, or any person residing in the home of
the person, as set forth in proposed Sec. Sec. 37.1201(b)(7) and
38.851(b)(7). This proposed definition focuses on the closeness of the
relationship that the committee member has with the subject of the
matter being considered. The proposed definition also reflects a more
modern description of the relationships intended to be covered. The
Commission emphasizes that the relationships listed in this proposed
definition are not exhaustive; rather, each relationship should be
viewed in light of the particular circumstances surrounding the
relationship and the closeness of the relationship.
Proposed Sec. Sec. 37.1202(a) and 38.852(a) require SEFs and DCMs,
respectively, to establish policies and procedures requiring any
officer or member of its board of directors, committees, or
disciplinary panels to disclose any actual or potential conflicts of
interest that may be present prior to considering any matter. The
proposed language is a modernized version of the requirement in
Commission regulation Sec. 1.69(b). Although not exhaustive, proposed
Sec. Sec. 37.1202(a)(1) and 38.852(a)(1) enumerate certain conflicts
in which the member or officer: (1) is the subject of any matter being
considered; (2) is an employer, employee, or colleague \162\ of the
subject of any matter being considered; (3) has a family relationship
with the subject of any matter being considered; or (4) has any ongoing
business relationship with or a financial interest in the subject of
any matter being considered.\163\ The Commission is proposing
Sec. Sec. 37.1202(a)(2) and 38.852(a)(2) to extend the conflicts of
interest enumerated in proposed Sec. Sec. 37.1202(a)(1) and
38.852(a)(1) to also apply to relationships that an officer or member
of its board of directors, committees, or disciplinary panels has with
an affiliate of the subject of any matter being considered.
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\162\ The Commission proposes replacing the current term
``fellow employee'' with ``colleague'' to include individuals with
whom the officer or director may have a collegial relationship, but
may not be employed by the same employer. As an example, two
individuals who worked in the same office, where the first is a
full-time employee of the organization, and the other works
alongside the first but is employed by an outside contractor, would
be considered colleagues for purposes of proposed Sec. Sec. 37.1202
and 38.852.
\163\ The Commission believes that this relationship, along with
the overarching requirement in proposed Sec. Sec. 37.1202(a) and
38.852(a) requiring an officer or member of its board of directors,
committees, or disciplinary panels to disclose any actual or
potential conflicts of interest that may be present prior to
considering any matter, are sufficient for addressing conflicts of
interest involving financial interest. Accordingly, the Commission
is not proposing to include in proposed Sec. Sec. 37.1202 or 38.852
a parallel to existing Commission regulation Sec. 1.69(b)(2)'s
requirements concerning financial interests in significant actions.
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As discussed above, the evolution of market structures has
increased the interconnectedness between SEFs, DCMs, and their
affiliates. This relationship between a SEF or DCM and its affiliates--
and by extension, the officers, members of the board of directors,
committees, or disciplinary panels--could create, in the Commission's
view, an actual or potential conflict of interest. Accordingly, the
Commission believes proposed Sec. Sec. 37.1202(a)(2) and 38.852(a)(2)
is necessary to mitigate conflicts of interest in a SEF's or DCM's
decision-making.
Proposed Sec. Sec. 37.1202(b) and 38.852(b) largely track existing
requirements in Commission regulation Sec. 1.69(b)(4) and require the
board of directors, committee, or disciplinary panel to document its
processes for complying with the requirements of the proposed rules,
and such documentation must include: (1) the names of all members and
officers who attended the relevant meeting in person or who otherwise
were present by electronic means; and (2) the names of any members and
officers who voluntarily recused themselves or were required to abstain
from deliberations or voting on a matter and the reason for the recusal
or abstention. To ensure the intent of proposed Sec. Sec. 37.1202 and
38.852 is captured, the Commission continues to require voluntary
recusals to be documented, in addition to the instances in which a
determination was made to require the abstention of an officer or
member of a board of directors, committee, or disciplinary panel.
In a limited number of circumstances, Commission regulation Sec.
1.69(b)(3) permits members of governing boards, disciplinary committee,
or oversight panel, who otherwise would be required to abstain from
deliberations and voting on a matter because of a conflict under
Commission regulation Sec. 1.69(b)(2), to deliberate but not vote on
the matter. The Commission is not proposing to adopt this exemption. If
a board of directors, committee or panel believes that it has
insufficient expertise to consider a matter, the Commission encourages
the committee to seek information from an expert or consultant that is
not subject to a conflicts restriction. The Commission believes it is
imperative for boards of directors, committees, and disciplinary panels
to have access to unbiased, conflict-free information to assist in
decision-making.
4. Questions for Comment
The Commission requests comment on all aspects of the proposed
conflicts of interest in decision-making rules. The Commission further
requests comment on the questions set forth below.
1. Should the Commission enumerate certain other relationships or
circumstances that may give rise to an actual or potential conflict of
interest? If so, which relationships or circumstances?
2. Does the proposed definition of ``family relationship'' cover
the appropriate types of relationships?
[[Page 19663]]
Should any relationships be added or removed from the proposed
definition?
c. Limitations on the Use and Disclosure of Material Non-public
Information--Proposed Sec. Sec. 37.1203 and 38.853
1. Background
Preventing the misuse and disclosure of material non-public
information at SEFs and DCMs further the objectives of promoting self-
regulation of exchanges and maintaining public confidence in SEF and
DCM markets. The CEA includes prohibitions on the misuse and disclosure
of material non-public information. It is unlawful for any person who
is an employee, member of the governing board, or member of any
committee of a board of trade, to willfully and knowingly (1) trade for
such person's own account, or for or on behalf of any other account, in
contracts for future delivery or option thereon on the basis of any
material non-public information obtained through special access related
to the performance of such person's official duties as an employee or
member; or (2) to disclose for any purpose inconsistent with the
performance of such person's official duties as an employee or member,
any material non-public information obtained through special access
related to the performance of such duties.\164\ Furthermore, a
potential conflict of interest arises when employees or insiders with
access to material non-public information leverage their insider access
to advance their personal interests, or the interests of others, to the
detriment of the decision-making process of the contract market. The
Commission believes reducing the potential for such misuse of material
nonpublic information helps to mitigate conflicts of interest.
Accordingly, the Commission is proposing new rules to implement
elements of the conflicts of interest core principles for SEFs and
DCMs, within parts 37 and 38, respectively, that are consistent with
existing requirements under current Commission regulation Sec. 1.59,
which establishes limitations on the use and disclosure of material
non-public information. The proposed rules would establish prohibitions
on the use or disclosure of material non-public information by: (1)
employees of the SEF or DCM; and (2) members of the board of directors,
committee members, consultants and those with an ownership interest of
10 percent or more in the SEF or DCM.
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\164\ CEA section 9(e), 7 U.S.C. 13(e).
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Moreover, the Commission is proposing to harmonize and streamline
SEF and DCM requirements related to the safeguarding of material non-
public information by proposing rules under Sec. Sec. 37.1203 and
38.853, and to make conforming amendments to Commission regulation
Sec. 37.2 to exempt SEFs from Commission regulation Sec. 1.59. As
discussed in more detail below, the proposal would establish consistent
rules for SEFs and DCMs related to the use and disclosure of material
non-public information.
2. Existing Regulatory Framework
Commission regulation Sec. 1.59 generally requires self-regulatory
organizations to adopt rules prohibiting employees, governing board
members, committee members or consultants from trading commodity
interests on the basis of material non-public information obtained in
the course of their official duties. Under Commission regulation Sec.
1.59, employees of self-regulatory organizations are subject to
stricter trading prohibitions than governing board members, committee
members or consultants. Specifically, employees are prohibited from
trading in any commodity interest traded on or cleared by the employing
SEF, DCM or DCO, or from trading in any related commodity interest.
Additionally, employees having access to material non-public
information concerning a commodity interest are prohibited from trading
in any such commodity interest that is traded on or cleared by any SEF,
DCM or DCO, or any linked exchange.\165\
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\165\ Commission regulation Sec. 1.59(a)(7) defines linked
exchange to include any exchange or board of trade outside of the
United States that lists products traded on the SEF or DCM, or that
has an agreement with a SEF or DCM to permit positions in one
commodity interest to be liquidated on the other market, or any
clearing organizations that clears the products in any of the
foregoing markets.
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Members of the board of directors, committee members, and
consultants of a self-regulatory organization, on the other hand, are
prohibited from using material non-public information for any purpose
other than the performance of their official duties. The possession of
material non-public information, therefore, does not absolutely bar
these individuals from trading commodity interests. Rather, under
Commission regulation Sec. 1.59(d), members of the board of directors,
committee members, or consultants of a self-regulatory organization are
directly prohibited from trading for their own account, or for or on
behalf of any other account, based on this material non-public
information.
The direct prohibitions under Commission regulation Sec. 1.59(d)
were adopted in 1993 to effectuate section 214 of the Futures Trading
Practices Act (``FTPA'') of 1992, which, among other things, makes it a
felony for employees and governing members of self-regulatory
organizations to disclose or trade on inside information and for
tippees of such insiders to trade on inside information so
disclosed.\166\ Historically, the Commission has adopted a more lenient
standard for governing board members and committee members.\167\ A more
lenient standard helps to ensure that a trading prohibition does not
impair the ability or diminish willingness of knowledgeable industry
members who also are active traders from serving on a self-regulatory
organization's board of directors or its major policy or disciplinary
committees.
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\166\ Final Rule, Prohibition on Insider Trading, 58 FR 54966
(Oct. 25, 1993).
\167\ When Commission regulation Sec. 1.59 was first proposed,
it proposed to apply the same standard to employees and governing
board members and committee members. Activities of Self-Regulatory
Organization Employees and Governing Members Who Possess Material,
Nonpublic Information, 50 FR 24533 (June 11, 1985). In response to
public comment, however, the Commission initially finalized Sec.
1.59 without addressing what obligations applied to members of the
governing board of committee members. Instead, the Commission
adopted the more lenient standard in a separate rulemaking.
Activities of Self-Regulatory Organization Employees Who Possess
Material, Non-Public Information, 51 FR 44866 (Dec. 12, 1986).
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While Sec. 1.59(b) prohibits trading in commodity interests or
related commodity interests by employees, the rule also provides that
exemptions may be granted. Under current Sec. 1.59(b)(2)(ii)(b), a
self-regulatory organization may adopt rules setting forth
circumstances under which exemptions may be granted, as long as those
exemptions are consistent with the CEA, the purposes of Sec. 1.59,
just and equitable principles of trade, and the public interest.
Exemptions also may be granted, under rules adopted by a self-
regulatory organization, in situations where an employee participates
in a pooled investment vehicle without direct or indirect control of
such vehicle.\168\
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\168\ Commission regulation Sec. 1.59(b)(ii)(b).
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The prohibitions and requirements under Sec. 1.59 apply
differently to SEFs and DCMs. As a result of the core principles
framework promulgated under the Commodity Futures Modernization Act of
2000, DCMs were relieved from many rule-based requirements in favor of
core principles. Consequently, DCMs were exempted from Sec. 1.59(b)
and (c). However, employees, governing board members, committee
members, and consultants at DCMs are not exempted from
[[Page 19664]]
Sec. 1.59(d).\169\ In addition to the Commission's statutory authority
on insider trading,\170\ the DCM Core Principle 16 Guidance states that
DCMs should provide for appropriate limitations on the use or
disclosure of material non-public information gained through
performance of official duties by members of the board of directors,
committee members, and DCM employees or gained by those through an
ownership interest in the DCM.\171\
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\169\ Under the provisions of Commission regulation Sec.
1.59(d), no employee, governing board member, committee member, or
consultant shall trade for such person's own account, or for or on
behalf of any other account, in any commodity interest, on the basis
of any material, non-public information obtained through special
access related to the performance of such person's official duties
as an employee, governing board member, committee member, or
consultant. Furthermore, such persons must not disclose for any
purpose inconsistent with the performance of their official duties
as an employee, governing board member, committee member, or
consultant any material, non-public information obtained through
special access related to the performance of such duties. In
addition, no person shall trade for their own account, or for or on
behalf of any other account, in any commodity interest, on the basis
of any material, non-public information that such person knows was
obtained in violation of paragraph (d)(1) of Sec. 1.59 from an
employee, governing board member, committee member, or consultant.
\170\ CEA section 9(e).
\171\ Part 38, Appendix B, Core Principle 16.
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In contrast, Commission regulation Sec. 1.59 applies in its
entirety to SEFs. Unlike for DCMs, the Commission did not adopt any
guidance or acceptable practices addressing how a SEF may demonstrate
compliance with SEF Core Principle 12 related to appropriate
limitations on the use and disclosure of material non-public
information.
3. Proposed Rules
The Commission is proposing harmonized rules for SEFs and DCMs
related to the use and disclosure of material non-public information
from Sec. 1.59.\172\ Proposed Sec. Sec. 37.1203(a) and 38.853(a)
require SEFs and DCMs to establish and enforce policies and procedures
on safeguarding the use and disclosure of material non-public
information. These policies and procedures must, at a minimum, prohibit
a SEF or DCM employee, member of the board of directors, committee
member, consultant, or owner with a 10 percent or more interest in the
SEF or DCM, from trading commodity interests or related commodity
interests based on, or disclosing, any non-public information obtained
through the performance of their official duties. As discussed in more
detail below, the scope of individuals subject to trading limitations
under this proposed rule is consistent with those individuals subject
to the trading limitations under both existing Sec. 1.59 and existing
Core Principle 16 Guidance. The proposal codifies existing Core
Principle 16 Guidance which considers appropriate limitations on those
with an ownership interest in the exchange. The proposal clarifies that
the limitation would apply to those with an ownership interest of 10
percent or more in the SEF or DCM.
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\172\ This rule proposal would not amend Commission regulation
Sec. 1.59, which will remain unchanged and continue to be
applicable to registered futures associations.
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Proposed Sec. Sec. 37.1203(b) and 38.853(b) require SEFs and DCMs,
respectively, to prohibit employees from certain types of trading \173\
or disclosing for any purpose inconsistent with the performance of the
person's official duties as an employee any material non-public
information obtained as a result of such person's employment. The
Commission believes that such a stringent restriction is necessary for
employees, who, by virtue of their official position, have access to
material non-public information. However, the Commission also
recognizes that there may be limited circumstances under which
employees should be exempted from the trading restrictions, so long as
the subject trading is not pursuant to material non-public information.
Accordingly, the Commission is proposing rules requiring SEFs and DCMs
to oversee exemptions from the trading prohibition granted to
employees.\174\ Proposed Sec. Sec. 37.1203(c) and 38.853(c) would
allow SEFs and DCMs, respectively, to grant exemptions that are (1)
approved by the SEF or DCM ROC; (2) granted only in limited
circumstances in which the employee requesting the exemption can
demonstrate that the trading is not being conducted on the basis of
material non-public information gained through the performance of their
official duties; and (3) individually documented by the SEF or DCM in
accordance with requirements in existing Commission regulations
Sec. Sec. 37.1000 and 37.1001 or Sec. Sec. 38.950 and 38.951,
respectively.
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\173\ Proposed Sec. Sec. 37.1203(b)(1) and 38.853(b)(1)
restrict trading directly or indirectly, in the following: (1) Any
commodity interest traded on the employing designated contract
market; (2) Any related commodity interest; (3) A commodity interest
traded on designated contract markets or swap execution facilities
or cleared by derivatives clearing organizations other than the
employing designated contract market if the employee has access to
material non-public information concerning such commodity interest;
or (4) A commodity interest traded on or cleared by a linked
exchange if the employee has access to material non-public
information concerning such commodity interest.
\174\ The exemptions, applicable only to SEF or DCM employees
trading on the SEF or DCM, or trading in the same or related
commodity interests, would be administered on a case-by-case basis,
at the level of granularity appropriate for the situation,
considering all relevant factors. The exemptions would be reviewed
by Commission staff as part of its routine oversight of SEFs and
DCMs.
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In its routine oversight, Commission staff has observed certain
deficiencies in the manner in which DCMs evaluated, granted, and
documented exemptions from their trading prohibitions. As a result, the
Commission is proposing Sec. Sec. 37.1203(d) and 38.853(d) to require
SEFs and DCMs, respectively, to establish and enforce policies and
procedures to diligently monitor the trading activity conducted under
any exemptions granted to ensure compliance with any applicable
conditions of the exemptions and the SEF's or DCM's policies and
procedures on the use and disclosure of material non-public
information. The Commission believes that SEFs and DCMs have an
obligation to monitor and ensure compliance with any applicable
conditions of the exemptions that may be granted by the exchange.
Moreover, SEFs and DCMs must ensure that any granted exemptions are in
accordance with the exchange's policies and procedures governing
employees' use and disclosure of material non-public information, as
well as the CEA and Commission regulations. The Commission believes
that SEFs and DCMs should already have existing programs to monitor,
detect, and deter abuses that may arise from trading conducted pursuant
to an exemption from the employee trading prohibition. Accordingly, a
SEF or DCM should utilize its existing surveillance program to monitor
trading by employees or other insiders who are granted trading
exemptions pursuant to proposed Sec. Sec. 37.1203(c) and 38.853(c).
Such surveillance should focus on the commodity interests or related
commodity interests to which the non-public information relates and the
time period during which misuse of such information reasonably could be
expected to occur.
The Commission continues to believe it is an important policy
objective to ensure that the trading prohibition does not impair the
ability or diminish the willingness of knowledgeable members of the
industry who also are active traders from serving on a SEF's or DCM's
board of directors or its major policy or disciplinary committees. The
Commission, therefore, is maintaining its historical policy of allowing
SEFs and DCMs flexibility, within limits, to establish rules that may
restrict governing board members, committee members, employees, and
consultants from trading in commodity interests for their own account,
or for or on behalf
[[Page 19665]]
of any other account, based on this material non-public information.
Accordingly, proposed Sec. Sec. 37.1203(e) and 38.853(e) require SEFs
and DCMs, respectively, to establish and enforce policies and
procedures that, at a minimum, prohibit members of the board of
directors, committee members, employees, consultants, and those with an
ownership interest of 10 percent or more from: (1) trading in any
commodity interest or related commodity interest on the basis of any
material non-public information obtained through the performance of
such person's official duties; (2) trading in any commodity interest or
related commodity interest on the basis of any material non-public
information that such person knows was obtained in violation of this
section; or (3) disclosing for any purpose inconsistent with the
performance of the person's official duties any material non-public
information obtained as a result of their official duties.
The Commission is expanding the scope of the direct prohibition on
trading based on material non-public information under proposed
Sec. Sec. 37.1203(e) and 38.853(e) as compared to existing Commission
regulation Sec. 1.59 in three ways. First, the Commission is proposing
to apply the prohibitions already applicable to employees in Sec.
1.59(b), regarding trading in ``related commodity interests,'' to
governing board members, committee members, and consultants who are in
possession of material non-public information.\175\ Consistent with the
definition of ``related commodity interests,'' in Sec. 1.59(a)(9), the
Commission believes that the direct prohibitions on trading while in
the possession of material non-public information should include
related commodity interests whose price movements correlate with the
price movements of a commodity interest traded on or subject to the
rules of a SEF or DCM to such a degree that intermarket spread margins
or special margin treatment is recognized or established by the
employer SEF or DCM.\176\ Second, the Commission is proposing to codify
existing DCM Core Principle 16 Guidance related to those with an
ownership interest in Sec. Sec. 37.1203(e)(3) and 38.853(e)(3). While
this expands the scope of individuals subject to trading limitations as
compared to existing Commission regulation Sec. 1.59, it is codifying
existing Core Principle 16 Guidance, with one clarification.
Specifically, with regards to owners, the Commission is clarifying that
the direct prohibition under Sec. Sec. 37.1203(e) and 38.853(e) would
only apply to those with an ownership interest of 10 percent or more in
the SEF or DCM.\177\ Third, while the proposed rules continue to
maintain a restriction on the disclosure of material non-public
information, the proposal would address differences in the existing
language between Sec. Sec. 1.59(b)(1)(D)(ii) and 1.59(d)(ii) regarding
the restrictions on the disclosure of material non-public information.
The Commission is proposing the same restriction on disclosure for both
employees under Sec. Sec. 37.1203(b)(2) and 38.853(b)(3) and members
of the board of directors, committee members, consultants, and those
with an ownership interest of 10 percent or more under Sec. Sec.
37.1203(e)(3) and 38.853(e)(3), to make clear that these ``insiders''
would be subject to the same restriction from disclosing material non-
public information obtained as a result of their official duties at a
SEF or DCM.
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\175\ Proposed Sec. Sec. 37.1203(e)(1) and 38.853(e)(1).
\176\ See proposed Sec. Sec. 37.1201(b)(15) and 38.851(b)(15)
(defining ``related commodity interests'').
\177\ Owners of 10 percent or more of a company are considered
``insiders'' pursuant to section 16 of the Securities Exchange Act
of 1934. See section IV(C) herein.
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As mentioned in Section IV.b, the Commission is proposing to
include substantial sections of existing definitions from Commission
regulation Sec. 1.59 in proposed parts 37 and 38. For example, the
proposal includes, for purposes of Sec. Sec. 37.1203 and 38.853, the
same historical definitions of (1) ``commodity interest,'' (2) ``linked
exchange,'' (3) ``material information,'' (4) ``non-public
information,'' and (5) ``pooled investment vehicle.'' The Commission is
proposing non-substantive changes to the (1) ``commodity interest'' and
(2) ``related commodity interest'' definitions. The proposal would
update the definition of a commodity interest by removing the phrase
``of a board of trade which has been designated as a'' and keep the
reference to ``designated contract market.'' For the ``related
commodity interest'' definition, the proposal replaces the reference to
``self-regulatory organization'' with a reference to either a SEF or
DCM in the regulatory text in parts 37 and 38. The Commission believes
that it is appropriate for a SEF or DCM to have the ability to grant an
exemption from the trading prohibition where an employee is
participating in pooled investment vehicles where the employee has no
direct or indirect control with respect to transactions executed for or
on behalf of such vehicles.\178\
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\178\ In particular, that it would be appropriate to grant an
employee an exemption to trade in a pooled investment vehicle
organized and operated as a commodity pool within the meaning of
Sec. 4.10(d) of the Commission regulations, and whose units of
participation have been registered under the Securities Act of 1933,
or a trading vehicle for which Commission regulation Sec. 4.5 makes
available relief from registration as a commodity pool operation.
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4. Questions for Comment
The Commission requests comment on all aspects of the proposed
rules regarding the use and disclosure of material non-public
information. The Commission further requests comment on the questions
set forth below.
1. Has the Commission proposed an appropriate definition for
``material''? If not, why not? What would be a better alternative?
2. Has the Commission proposed an appropriate definition for ``non-
public information''? If not, why not? What would be a better
alternative?
3. Has the Commission proposed appropriate limitations on the use
and disclosure of material non-public information for SEF and DCM board
of directors, committee members, employees, consultants, and those with
an ownership interest of 10 percent or more? If not, why not? What
would be a better alternative?
4. With regards to owners, has the Commission proposed an
appropriate limitation in applying the restrictions under Sec. Sec.
37.1203(e) and 38.853(e) to those with an ownership interest of 10
percent or more in the SEF or DCM? Should the restriction be applied to
all those with an ownership interest in the SEF or DCM? If not, why
not? What would be a better alternative?
V. Proposed Structural Governance Requirements for Identifying,
Managing and Resolving Actual and Potential Conflicts of Interest
In general, the proposed structural governance requirements are
intended to mitigate conflicts of interest at a SEF or DCM by
introducing a perspective independent of competitive, commercial, or
industry considerations to the deliberations of governing bodies (i.e.,
the board of directors and committees). The Commission believes that
such independent perspective would be more likely to encompass
regulatory considerations, and accord such considerations proper
weight. The Commission believes that such independent perspective also
would more likely contemplate the manner in which a decision might
affect all constituencies, as opposed to
[[Page 19666]]
concentrating on the manner in which a decision affects the interests
of one or a limited number of constituencies.\179\ The Commission
further believes that independent decision-makers are necessary to
protect a SEF's or DCM's market regulation functions from its
commercial interests and that of its constituencies.
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\179\ See 2007 Final Release, 72 FR 6936 at 6947 (stating 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).
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Accordingly, the Commission is proposing to require a SEF's or
DCM's board of directors, and any executive committee, to include at
least 35 percent public directors. The Commission also proposes
establishing two committees to further enhance the structural
governance of SEFs and DCMs. First, the proposed rules would require a
nominating committee that is comprised of at least 51 percent public
directors to enhance the transparency of the board of directors.
Second, the proposed rules would require a ROC comprised solely of
public directors to protect the integrity of the market regulation
function of SEFs and DCMs. The Commission is also proposing a new DCM
CRO requirement, and updating the existing SEF CCO requirement, to
clearly establish these roles as central to the SEF's or DCM's
management of conflicts of interest that may impact market regulation
functions.
a. Composition and Related Requirements for Board of Directors--
Proposed Sec. Sec. 37.1204 and 38.854
1. Background
As the ultimate decision-maker of an exchange, governing boards are
an essential component in an exchange's ability to identify, manage,
and resolve conflicts of interest.\180\ In particular, the board of
directors, along with senior management, set the ``tone at the top''
for a SEF's or DCM's governance and compliance culture.\181\ In its
routine oversight, Commission staff has observed that board composition
standards have become a key piece of SEFs' and DCMs' structural
governance, and when coupled with clear, comprehensive policies and
procedures to address conflicts of interest, have helped to minimize
conflicts of interests faced by members of the board of directors. For
example, the presence of public directors, both on the board of
directors and the ROC, has created an avenue for DCMs, SEFs, their
officers and employees to escalate, and eventually seek resolution of,
conflicts of interest.
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\180\ See 2007 Final Release, 72 FR 6936.
\181\ Donald C. Langevoort, Cultures of Compliance, 54 a.m.
CRIM. L. REV. 933, 946-947 (2017); Group of Thirty, Banking Conduct
and Culture, A Call for Sustained and Comprehensive Reform,
Washington, DC, July 2015; The Role of the Board of Directors and
Senior Management in Enterprise Risk Management, by Bruce C.
Branson, Chapter 4, Enterprise Risk Management: Today's Leading
Research and Best Practices for Tomorrow's Executives, 2nd Edition,
edited by John R. S. Fraser, Rob Quail, Betty Simkins, Copyright
2021 John Wiley & Sons; See also comments from former SEC Chair Mary
Jo White, to the Stanford University Rock Center for Corporate
Governance, June 23, 2014, https://www.sec.gov/news/speech/2014-spch062314mjw (accessed June 24, 2023) (``It is up to directors,
along with senior management under the purview of the board, to set
the all-important ``tone at the top'' [regarding compliance with
federal securities laws] for the entire company.'').
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2. Existing Regulatory Framework
Currently, the board of director composition component of the DCM
Core Principle 16 Acceptable Practices provides that a DCM's board of
directors or executive committees include at least 35 percent public
directors.\182\ In adopting this acceptable practice, the Commission
stated that the 35 percent figure struck an appropriate balance between
(1) the need to minimize conflicts of interest in DCM decision-making
processes and (2) the need for expertise and efficiency in such
processes.\183\
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\182\ Part 38, Appendix B, Core Principle 16 Acceptable
Practices (b)(1).
\183\ 2007 Final Release, 72 FR 6936 at 6946-6947.
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As compared to DCMs, SEFs are currently subject to substantially
different board composition standards. Specifically, SEFs are subject
to Commission regulation Sec. 1.64(b)(1), which establish a 20 percent
``non-member'' requirement.\184\ This requirement was adopted in 1993
for SROs when exchanges were member-owned. At the time, the Commission
sought to ensure that an SRO governing board fairly represented the
diversity of membership interest at such SRO \185\ and would not have
an exclusively member perspective.\186\ While this was a laudable goal
at the time, Commission regulation Sec. 1.64(b)(1) requirements are no
longer relevant for SEFs and DCMs given that exchanges are no longer
member-owned. The Commission's goal through this proposal is to ensure
that SEFs and DCMs have sufficient independent perspective in their
decision-making, taking into account that SEFs and DCMs are now for-
profit entities that also are charged with market regulation functions.
Applying Commission regulation Sec. 1.64(b)(1) has created an
unintentional consequence of allowing SEFs to compose their boards of
directors with ``insiders.'' SEFs with no independent voice on the
board, either through inclusion of public directors or other non-
affiliated directors, have been able to meet the requirements of
Commission regulation Sec. 1.64(b)(1). For example, if an executive
was seconded to the SEF from an affiliate (therefore, not a ``salaried
employee''), and only spent a fraction of their time performing
services for the SEF (therefore, not ``primarily performing services''
for the SEF), the executive could arguably be deemed to satisfy the
``non-member'' requirement of Commission regulation Sec. 1.64(b)(1).
Under the current DCM Core Principle 16 Acceptable Practices, however,
the executive would not likely be considered a public director and
therefore, to meet the acceptable practices, could not be included as a
director that satisfies the board composition standards.
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\184\ Commission regulation Sec. 1.64(b)(1) requires that
twenty percent of the board of directors must be persons who are (1)
knowledgeable of futures trading or financial regulation or
otherwise capable of contributing to governing board deliberations;
and (2) not members of the SEF, not currently salaried employees of
the SEF, not primarily performing services for the SEF, and not
officers, principals or employees of a member firm.
\185\ Final Rule and Rule Amendments Concerning Composition of
Various Self-Regulatory Organization Governing Boards and Major
Disciplinary Committees, 58 FR 37644 at 37646 (July 13, 1993).
\186\ Id. at 37647.
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The Commission continues to believe that the practice of including
in the board of directors at least 35 percent public directors, as
reflected in the DCM Core Principle 16 Acceptable Practices, is
appropriate for DCMs, and that it is also is appropriate for SEFs. In
reaching this conclusion, the Commission has considered the board
composition requirements applicable to publicly-traded companies, which
require that a majority of the board of directors must be
``independent'' directors.\187\ However, the goal of this higher
threshold, which is to protect shareholders of publicly-traded
companies through boards of directors that are sufficiently independent
from
[[Page 19667]]
management, is not entirely the same as the Commission's concern at
hand.
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\187\ NYSE American Company Guide Rule 802; Nasdaq Rule 5605(b).
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The Commission's primary goal with respect to Core Principle 16 is
to ensure that the commercial interests of SEFs and DCMs and of its
constituencies do not compromise market regulation functions.
Accordingly, the Commission recognizes the need to have individuals on
the board of directors with sufficient background and expertise to
support the SEF's or DCM's market functions. The Commission, however,
also is cognizant of the importance of having individuals with
sufficient independent perspectives on the board of directors to ensure
that the SEF or DCM can properly manage conflicts in its decision-
making. Indeed, publicly-traded companies are moving towards requiring
that a majority of the board of directors must be independent
directors. However, the Commission believes that imposing a majority
threshold in all circumstances may deny SEFs and DCMs the flexibility
necessary to ensure that the board of directors includes individuals
with adequate market expertise. The Commission is currently unaware of
any circumstances that would support requiring public directors to
constitute a majority of the board of directors of every SEF or DCM.
Therefore, the Commission is proposing a bright-line threshold that
would balance the need to ensure proper representation of impartial
views with the need for market expertise. In doing so, the Commission
recognizes that SEF and DCM boards of directors may vary in size.
However, based on the Commission's observation of existing SEFs and
DCMs, the Commission believes that a minimum threshold of 35 percent
public directors would lead to at least two public directors on most
SEF and DCM boards of directors. At the same time, the proposal would
allow SEFs and DCMs the discretion to establish a higher threshold.
The Commission requests comment on all aspects of the proposed 35
percent public director board composition requirements, including
comments on the specific questions listed below in this section.
3. Proposed Rules
The Commission proposes to enhance the existing board composition
standards for both SEFs and DCMs by: (1) codifying in proposed Sec.
38.854(a)(1) the practice under the DCM Core Principle 16 Acceptable
Practices that DCM boards of directors be composed of at least 35
percent ``public directors;'' \188\ (2) extending this requirement to
SEF boards of directors under proposed Sec. 37.1204(a)(1); \189\ and
(3) adopting additional requirements to increase transparency and
accountability of the board of directors. The Commission believes that
in addressing these board of director composition requirements in
proposed Sec. 37.1204, it is necessary to amend Commission regulation
Sec. 37.2 to exempt SEFs from Commission regulation Sec. 1.64,
including the board of directors composition requirements under
Commission regulation Sec. 1.64(b)(1).
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\188\ Proposed Sec. 38.854(a)(1).
\189\ Proposed Sec. 37.1204(a)(1).
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In addition to proposing board of director composition
requirements, the Commission proposes the substantive requirements set
forth below, which aim to enhance transparency and the accountability
of the SEF and DCM board of directors regarding the manner in which
such board of directors causes the SEF or DCM to discharge all
statutory, regulatory, or self-regulatory responsibilities under the
CEA, including the market regulation functions.
A SEF or DCM must establish and enforce policies and
procedures outlining the roles and responsibilities of the board of
directors, including the manner in which the board of directors
oversees compliance with all statutory, regulatory, and self-regulatory
responsibilities under the CEA and the regulations promulgated
thereunder.\190\
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\190\ Proposed Sec. Sec. 37.1204(a)(2) and 38.854(a)(2).
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A SEF or DCM must have procedures to remove a member from
the board of directors, where the conduct of such member is likely to
be prejudicial to the sound and prudent management of the SEF or
DCM.\191\
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\191\ Proposed Sec. Sec. 37.1204(e) and 38.854(e).
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A SEF or DCM must notify the Commission within five
business days of any changes to the membership of the board of
directors or its committees.\192\
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\192\ Proposed Sec. Sec. 37.1204(f) and 38.854(f).
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Given the complex nature of the SEF and DCM marketplace, their role
as self-regulators over their markets, and the overall impact of such
exchanges on the integrity, resilience, and vibrancy of U.S.
derivatives and financial markets, the Commission proposes in
Sec. Sec. 37.1204(b) and 38.854(b) to require that each member of a
SEF or DCM board of directors have relevant expertise to fulfill the
roles and responsibilities of their position. The Commission believes
that experience in financial services, risk management, and financial
regulation are examples of relevant expertise.
The Commission proposes Sec. Sec. 37.1204(c) and 38.854(c) to
prohibit linking the compensation of public directors and other non-
executive members of the board of directors to the business performance
of the SEF or DCM, or any affiliate of the SEF or DCM. The Commission
believes prohibiting compensation in this manner would help enable non-
executive directors to remain independent and focused on making
objective decisions for the SEF or DCM. The Commission further believes
it is necessary to capture all compensation--from either the SEF or the
DCM or an affiliate--that a public director or non-executive member of
the board could receive. Whether a specific compensation arrangement is
``directly dependent on the business performance'' of the SEF or DCM,
or its affiliates, as contemplated under proposed Sec. Sec. 37.1204(c)
and 38.854(c), would depend on specific facts and circumstances. The
Commission understands that it may be industry practice to include some
form of nominal equity in a compensation package. The Commission does
not consider nominal equity ownership interest, in and of itself, to be
compensation that is ``directly dependent on the business performance''
of the SEF or DCM or its affiliates. However, the Commission considers
any equity ownership interest in a SEF or DCM or its affiliates that is
more than nominal to be compensation that is ``directly dependent on
the business performance'' of the SEF or DCM or its affiliates. In
addition, the Commission believes that providing bonuses based on
specific sales or customer acquisition targets would constitute
compensation that is ``directly dependent on the business performance''
of the SEF or DCM or its affiliates. Finally, any equity ownership
included as a component of public director compensation that reasonably
could be viewed as being substantial enough to potentially compromise
the impartiality of a public director would not be considered nominal.
Proposed Sec. Sec. 37.1204(d) and 38.854(d) require SEFs' and
DCMs' board of directors to conduct an annual self-assessment to review
their performance. The Commission believes that such self-assessments
will encourage boards of directors to reflect on their performance and
will enhance their accountability to the Commission regarding the
manner in which such board of directors causes the SEF or DCM to
discharge all statutory, regulatory, and self-regulatory
responsibilities under the CEA, including market regulation functions.
For example, Commission staff may request to see the results of the
self-
[[Page 19668]]
assessment during a rule enforcement review of the SEF or DCM. The
Commission notes that many SEF and DCM boards of directors already
conduct self-assessments, and that this proposal provides significant
discretion to SEFs and DCMs to determine how best to implement such an
assessment. The Commission believes that SEFs and DCMs should consider
including the following in the self-assessment: (1) observations
relating to the flow of information provided to the board of directors;
(2) the effects of any changes to the board composition, succession
planning and human capital management; (3) potential improvement to the
SEF's or DCM's governance structure; and (4) any other information or
analysis that would improve the board's ability to perform its duties
and responsibilities.
4. Questions for Comment
The Commission requests comment on all aspects of the proposed
board composition requirements. The Commission further requests comment
on the questions set forth below.
1. Have there been any industry changes since the adoption of the
DCM Core Principle 16 Acceptable Practices that the Commission should
consider in adopting board composition requirements for SEFs and DCMs?
2. Is the 35 percent public director requirement sufficient to
introduce an independent perspective on a SEF's or DCM's board of
directors?
3. Should the Commission increase the required percentage of public
directors to 51 percent?
4. Is there a number less than 51 percent but greater than 35
percent that would be more appropriate?
5. Should the Commission prohibit public director compensation from
including any equity ownership?
6. Should the Commission prescribe a specific numerical limit on
the amount of equity ownership paid to a public director, and, if so,
what is the appropriate limit?
7. What are examples of compensation that would be more than
nominal or directly dependent on the business performance of a SEF or
DCM?
b. Public Director Definition--Proposed Sec. Sec. 37.1201(b)(12) and
38.851(b)(12)
1. Background
Public directors can be a valuable governance tool for
organizations, including SEFs and DCMs. As ``outsiders,'' public
directors are in a unique position to bring an unbiased perspective.
Their objectivity and independence may enhance the accountability of
the board of directors and lend credibility to the organization, its
leaders, and its governance arrangements. Since public directors do not
have a material relationship with the SEF or DCM, the Commission
believes they are well-suited to balance the commercial interests of
the SEF or DCM and its regulatory obligations, including its market
regulation functions.
2. Existing Regulatory Framework
The current ``public director'' definition found in the DCM Core
Principle 16 Acceptable Practices provides for the DCM's board of
directors to determine, on the record, that the director has no
``material relationship'' with the DCM (the ``overarching materiality
test'').\193\ A ``material relationship'' is ``one that reasonably
could affect the independent judgment or decision-making of the
director.'' Additionally, the public director definition contains a
list of per se material relationships (the ``bright-line
disqualifiers'') that disqualify service as a public director if: (1)
such director is an officer or an employee of the DCM or an officer or
an employee of its affiliate; (2) such director is a member of the DCM;
(3) such director, or a firm in which the director is an officer,
director, or partner, receives more than $100,000 in aggregate annual
payments \194\ for legal, accounting, or consulting services from the
DCM, or an affiliate of the DCM.\195\ Such list is neither exclusive
nor exhaustive; even if the bright-line disqualifiers are not
triggered, each public director nominee must satisfy the overarching
materiality test. Additionally, the bright-line disqualifiers apply to
a member of the director's ``immediate family,'' which includes spouse,
parents, children and siblings.\196\ Both the overarching materiality
test and the bright-line disqualifiers are subject to a one-year look-
back period.\197\ The public director definition in the DCM Core
Principle 16 Acceptable Practices provides that a DCM's public
directors may also serve as directors of the DCM's affiliate, so long
as they satisfy the requirements of the public director
definition.\198\ Finally, a DCM is obligated to disclose to the
Commission which members of its board of directors are public
directors, and the basis for those determinations.\199\
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\193\ Part 38, Appendix B, Core Principle 16 Acceptable
Practices (b)(2)(i).
\194\ However, compensation for services as a director of the
DCM or as a director of an affiliate of the DCM 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.
\195\ Part 38, Appendix B, Core Principle 16 Acceptable
Practices (b)(2)(ii).
\196\ Part 38, Appendix B, Core Principle 16 Acceptable
Practices (b)(2)(ii)(D).
\197\ Part 38, Appendix B, Core Principle 16 Acceptable
Practices (b)(2)(iii).
\198\ Part 38, Appendix B, Core Principle 16 Acceptable
Practices (b)(2)(iv).
\199\ Part 38, Appendix B, Core Principle 16 Acceptable
Practices (b)(2)(v).
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3. Proposed Rules
The Commission proposes to adopt in Sec. Sec. 37.1201(b)(12) and
38.851(b)(12) a public director definition, similar to the definition
in the DCM Core Principle 16 Acceptable Practices, for SEFs and DCMs,
respectively. The Commission believes that SEFs and DCMs must have a
board of directors that includes sufficient representation of
independent perspective through public directors. The Commission
believes that, in determining whether an individual qualifies as a
public director, it must be considered whether there are any specific
interests that would affect the individual's decision-making. In the
Commission's experience, through its routine oversight of SEFs and
DCMs, a ``material relationship'' that is based on certain personal or
professional interests or financial incentives, could affect an
individual's decision-making.
While Commission regulation Sec. 1.64 seeks to address the
conflict of interest that was prevalent when SROs were member-owned--
i.e., that governing boards would have an exclusively member
perspective \200\--this is no longer the predominant concern for
existing SEFs and DCMs. In a demutualized exchange environment, the
conflicts between commercial interests and market regulation functions
are exacerbated. The Commission believes that the higher standard
created by the proposed public director definition is reasonably
necessary to ensure an independent perspective in a demutualized
exchange environment. Commission staff has identified, through its
oversight of SEFs, that some SEFs have voluntarily adopted board
composition requirements that reflect the DCM Core Principle 16
Acceptable Practices public director definition.
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\200\ 58 FR 37644 at 37647.
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The Commission proposes to codify the existing DCM Core Principle
16 Acceptable Practices public director definition for both SEFs and
DCMs, with some modifications. First, the proposed definition would
amend the bright-line disqualifier that applies to a director receiving
more than $100,000
[[Page 19669]]
in aggregate annual payments to remove the reference ``for legal,
accounting, or consulting services'' from the SEF or DCM, or an
affiliate of the SEF or DCM. The bright-line disqualifier would now
limit receiving any payments in excess of $100,000 for any purpose. The
proposed rule also would amend this bright-line disqualifier to apply
to situations where a director is an employee of a firm receiving such
payments.
Second, the proposed rule expands the bright-line disqualifier that
applies to a situation where a director is a member of the SEF or DCM
or a director, an officer of a member, to also apply where: (1) such
director is an employee of a member of the SEF or DCM; and (2) extends
the disqualification to apply to the prospective director's
relationships, as a director, officer or employee, with an affiliate of
a member of the SEF or DCM. Third, the Commission proposes expanding
the scope of the bright-line disqualifiers to account for relationships
that the director may have with an affiliate of the SEF or DCM or an
affiliate of a member of the SEF or DCM.
Fourth, the Commission proposes to establish a new bright-line
disqualifier that would prohibit an individual who, directly or
indirectly, owns more than 10 percent of the SEF or DCM or an affiliate
of the swap execution facility, or is an officer or employee of an
entity that directly or indirectly owns more than 10 percent of the
swap execution facility, from serving as a public director.
Fifth, the proposed public director definition replaces the term
``immediate family'' and expands the bright-line disqualifiers to apply
to any person with whom the director has a ``family relationship,'' as
set forth in proposed Sec. Sec. 37.1201(b)(7) and 38.851(b)(7).
Finally, the proposed definition includes a new requirement to clarify
that the public director determination must be made ``upon the
nomination or appointment of the director and at least on an annual
basis thereafter.'' Consistent with the proposed fitness requirements
in proposed Sec. Sec. 37.1201(b)(12) and 38.851(b)(12), the Commission
believes all determinations with respect to the public director status
of members of the board of directors should be completed upon their
nomination to the board of directors--i.e., prior to their appointment.
Further, Commission staff's oversight has revealed that not all DCMs
were diligently reviewing their public director determinations for
existing directors on an annual basis.
The Commission believes that the above-mentioned amendments to the
public director definition are necessary to capture the full scope of
the relationships that could affect a prospective director's ability to
bring an independent perspective to the decision-making of a SEF or
DCM. Eliminating ``legal, accounting, or consulting service'' from the
bright-line disqualifier that applies to payments in excess of $100,000
is necessary, as the provision of other services could also be
``material'' for purposes of establishing whether an individual
qualifies as a public director. The Commission also proposes to expand
the bright-line disqualifiers to certain relationships in which the
director is an employee of: (1) a member of a SEF or DCM or its
affiliate; and (2) an entity that receives more than $100,000 in
aggregate annual payments from the SEF or DCM or its affiliate. In
these situations, the Commission believes the ties between the outside
entity and the SEF or DCM are close enough to impact the actual or
perceived ability of the prospective director to bring an independent
perspective. Furthermore, the Commission notes that such employees
would likely be restricted from serving as public directors under the
overarching materiality test. Similarly, the Commission is also
expanding the bright-line disqualifier to include certain relationships
with affiliates. The Commission has found, as detailed above, as market
structures have evolved, growing interconnectedness between SEFs, DCMs,
and their affiliates. This relationship between a SEF or DCM and its
affiliates--and by extension, their employees and officers--creates, in
the Commission's view, a ``material relationship.'' Finally, although
the 10 percent ownership bright-line disqualifier would be new, the
Commission believes that an individual with an ownership interest
greater than 10 percent would not currently qualify as a public
director under the overarching materiality test. A 10 percent ownership
of a SEF or DCM is significant enough to call into question, whether in
actuality or perception, a public director's ability to act in an
impartial manner to ensure business concerns do not impact market
regulation functions.
4. Questions for Comment
The Commission requests comment on all aspects of the proposed
public director definition. The Commission further requests comment on
the questions set forth below.
1. Are there other circumstances that the Commission should include
as bright-line disqualifiers? Are there circumstances that the
Commission should remove from such tests?
2. Should the Commission increase or decrease the $100,000 in
aggregate payment threshold?
3. Is the one-year look back period sufficient, in order to protect
market regulation functions from directors that are conflicted due to
industry ties?
4. Should the Commission continue to permit public directors to
serve on the board of directors of a SEF's or DCM's affiliate? Why or
why not?
c. Nominating Committee and Diverse Representation--Proposed Sec. Sec.
37.1205 and 38.855
1. Background
As described herein,\201\ the structural governance requirements
applicable to boards of directors of SEFs and DCMs aim to mitigate
conflicts of interest through the representation of independent
perspectives. Public director composition requirements alone may not be
sufficient to ensure the representation of such independent
perspective. Commission staff's routine oversight has found that many
SEFs and DCMs do not currently have formal policies or procedures for
identifying potential members of the board of directors, and instead
rely entirely on the personal networks of members of their boards of
directors or executives. The Commission believes that an independent
perspective on the SEF or DCM board of directors is necessary to
mitigate conflicts of interest. Lack of policies or procedures for
identifying potential members of the board of directors may result in
delays in the appointment process.
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\201\ See Section V(a) herein; Proposed Sec. Sec. 37.1204 and
38.854.
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2. Existing Regulatory Framework
DCM Core Principle 17 requires the governance arrangements of a
board of directors of a DCM to permit consideration of the views of
market participants. Similarly, pursuant to Commission regulation Sec.
1.64(b)(3), members of self-regulatory organization governing boards,
including SEF governing boards, must include a diversity of membership
interests. However, neither DCMs nor SEFs are currently obligated by
Commission regulations to have a nominating committee to identify or
manage the process for nominating potential members of the board of
directors.
To help protect the integrity of the process by which a SEF or DCM
selects members of its board of directors, the Commission proposes
requiring each
[[Page 19670]]
SEF or DCM to have a nominating committee. The role of the nominating
committee would be to: (1) identify a diverse pool of individuals
qualified to serve on the board of directors, consistent with
Commission regulations; and (2) administer a process for the nomination
of individuals to the board of directors.
3. Proposed Rules
Proposed Sec. Sec. 37.1205 and 38.855 would require a nominating
committee to identify a pool of candidates who are qualified and
represent diverse interests, including the interests of the
participants and members of the SEF or DCM. Thus, proposed Sec. Sec.
37.1205 and 38.855 incorporate, and expand upon, the diversity of
membership requirements found in Commission regulation Sec. 1.64, and,
with respect to DCMs, are consistent with DCM Core Principle 17, and
reasonably necessary to advance DCM Core Principle 16. Accordingly, the
Commission proposes conforming amendments to Commission regulation
Sec. 37.2 to exempt SEFs from Commission regulation Sec. 1.64.
Proposed Sec. Sec. 37.1205 and 38.855 would require that public
directors comprise at least 51 percent of the nominating committee,
that a public director chair the nominating committee, and that the
nominating committee report directly to the board of directors. The
Commission proposes that the nominating committee be at least 51
percent public directors to limit the influence of non-public directors
that are already involved in the governance and management of a SEF or
DCM, and to help ensure a broader pool of candidates for consideration,
in turn promoting diversity and independent perspectives in the
governing bodies of SEFs and DCMs. The nominating committee takes the
first steps in identifying the pool of future members of the board of
directors, and a broad pool of candidates is critical to maintaining
independent perspectives on the board of directors. Therefore, the
Commission is proposing that public directors should represent a
majority of members of the nominating committee.
Proposed Sec. Sec. 37.1205 and 38.855 also would require the
nominating committee to administer a process for nominating individuals
to the board of directors. This process must be adopted prior to
registration as a SEF or designation as a DCM. Similarly, boards of
directors must be appointed prior to registration or designation.
However, as set out in proposed Sec. Sec. 37.1205(b) and 38.855(b) the
initial members of the board of directors serving upon registration or
designation would not be required to be appointed by the nominating
committee.
4. Questions for Comment
The Commission requests comment on all aspects of the proposed
nominating committee requirements.
d. Regulatory Oversight Committee--Proposed Sec. Sec. 37.1206 and
38.857
1. Background
SEFs and DCMs are faced with commercial pressures to remain
competitive in an industry where business models, trading practices,
and products are rapidly evolving. As business enterprises, SEFs and
DCMs are also tasked with maximizing shareholder value, generating
profits, and satisfying the diverse needs of their constituencies. SEFs
and DCMs, therefore, may face conflicts between their commercial
interests and their market regulation obligations.
Other competing demands may unduly influence a SEF's or DCM's
market regulation functions, such as the interests of their ownership,
management, market participants, membership, customers, and other
constituencies. Externally, SEFs and DCMs may find themselves
conflicted with affiliated entities--including affiliated entities that
are directly or indirectly trading on or subject to the rules of the
SEF or DCM, affiliated entities that are in possession of data acquired
by or generated from the SEF or DCM, and affiliated entities to whom
SEF or DCM employees owe duties based on participating in the functions
of both the affiliated entities and the SEF or DCM. The Commission
published the ROC component of the DCM Core Principle 16 Acceptable
Practices in 2007 to minimize these conflicts by helping to insulate
core regulatory functions from improper influences and pressures.\202\
In the Commission's experience, ROCs can serve one of the most critical
elements of a DCM's governance structure for mitigating conflicts of
interests.
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\202\ 2007 Final Release, 72 FR 6936 at 6940.
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2. Existing Regulatory Framework
In proposing requirements for SEF and DCM ROCs, the Commission is
largely codifying language found in the ROC component of the DCM Core
Principle 16 Acceptable Practices.\203\ Currently, to demonstrate
compliance under the acceptable practices, a DCM must establish a ROC,
consisting of only public directors, to assist it in minimizing actual
and potential conflicts of interest.\204\ A ROC is a standing committee
of the board of directors.\205\ The purpose of the ROC is to oversee
the DCM's regulatory program on behalf of the board of directors, which
in turn delegates sufficient authority, dedicates sufficient resources,
and allows sufficient time for the ROC to fulfill its mandate.\206\ The
Acceptable Practices for DCM Core Principle 16 describe a ROC that is
responsible for the following: (1) monitoring the DCM's regulatory
program for sufficiency, effectiveness, and independence; (2)
overseeing all facets of the program; \207\ (3) reviewing the size and
allocation of the regulatory budget and resources; and the number,
hiring and termination, and compensation of regulatory personnel; (4)
supervising the DCM's CRO, who will report directly to the ROC; (5)
preparing an annual report assessing the DCM's self-regulatory program
for the board of directors and the Commission; (6) recommending changes
that would ensure fair, vigorous, and effective regulation; and (7)
reviewing regulatory proposals and advising the board of directors as
to whether and how such changes may impact regulation.\208\ In
performing these functions, the ROC plays a critical role in insulating
the CRO and the DCM's self-regulatory function from undue influence
that may exert pressure over the CRO to put a DCM's commercial
interests ahead of its market regulation functions. The ROC's is
specifically tasked with oversight of a SEF's or DCM's market
regulation functions. Conversely, while the interests of the ROC and a
DCM's CRO or a SEF's CCO are aligned, only the ROC carries with it the
authority granted by the board of directors. Accordingly, the ROC,
along with the board of directors and CCO or CRO, are all integral
components of a SEF's or DCM's conflicts of interest framework.
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\203\ Part 38, Appendix B, Core Principle 16 Acceptable
Practices.
\204\ Part 38, Appendix B, Core Principle 16 Acceptable
Practices (b)(3)(i).
\205\ Id.
\206\ Id.
\207\ This includes including trade practice and market
surveillance; audits, examinations, and other regulatory
responsibilities with respect to member firms (including ensuring
compliance with financial integrity, financial reporting, sales
practice, recordkeeping, and other requirements); and the conduct of
investigations.
\208\ Part 38, Appendix B, Core Principle 16 Acceptable
Practices (b)(3)(ii).
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Given that SEFs and DCMs face similar pressures that may conflict
with their market regulation functions--such as trade practice
surveillance, market surveillance, real-time market monitoring, audit
trail enforcement, investigations of possible rule violations, and
disciplinary actions--the
[[Page 19671]]
Commission believes that SEFs and DCMs would benefit from the
protections that are offered by a ROC.
3. Proposed Rules
i. Codifying DCM Core Principle 16 ROC Acceptable Practices
Accordingly, the Commission proposes to require in Sec. 38.857(a)
that DCMs must have a ROC composed of only public directors. Commission
staff has found, through its general oversight of DCMs, that existing
DCM ROCs are effective in providing structural governance protections
that help DCMs to minimize conflicts of interest. For example, in their
role as members of the ROC, these public directors are not tasked with
making decisions on commercial matters or other interests of the SEF or
DCM that may conflict with market regulation functions. Accordingly,
Commission staff has found that ROC members have provided DCM CROs a
``safe space'' to raise concerns and have advocated, when appropriate,
for the CRO and the market regulation functions.
Second, the Commission proposes in Sec. 37.1206(a) to include a
ROC requirement for SEFs, which, like DCMs, also perform market
regulation functions. Through its experience with SEF registrations,
routine communications with SEFs, and regulatory consultations,
Commission staff has found that some SEFs established ROCs that
included non-public directors and SEF executives (or executives of SEF
affiliates). As a result, a committee intended to insulate the market
regulation function from commercial interests had its own potential
conflicts of interest. Accordingly, the Commission proposes to include
in Sec. 37.1206(a), just as it is proposing to include in Sec.
38.857(a), a requirement that SEFs have a ROC composed only of public
directors.
Under proposed Sec. Sec. 37.1206(d) and 38.857(d), both SEF and
DCM ROCs would generally have identical oversight duties over market
regulation functions, including: (1) monitoring the SEF's or DCM's
market regulation functions for sufficiency, effectiveness, and
independence; (2) overseeing all facets of the market regulation
functions; \209\ (3) approving the size and allocation of the
regulatory budget and resources; and the number, hiring and
termination, and compensation of staff required pursuant to Sec. Sec.
37.203(c) and 38.155(a); (4) recommending changes that would promote
fair, vigorous, and effective self-regulation; and (5) reviewing all
regulatory proposals prior to implementation and advising the board of
directors as to whether and how such proposals may impact market
regulation functions.\210\
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\209\ The Commission is proposing a more simplified version of
the ROC's current duties to oversee all facets of the regulatory
program, including trade practice and market surveillance; audits,
examinations, and other regulatory responsibilities with respect to
member firms (including ensuring compliance with financial
integrity, financial reporting, sales practice, recordkeeping, and
other requirements); and the conduct of investigations.
\210\ This includes, for example, proposed rules, and business
initiatives, etc.
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The Commission recognizes that SEFs are also subject to a statutory
core principle requirement (SEF Core Principle 15) to designate a CCO
to monitor the SEF's adherence to statutory, regulatory, and self-
regulatory requirements and to resolve conflicts of interest that may
impede such adherence.\211\ Additionally, the CCO must report to the
SEF board of directors (or similar governing body) or the senior SEF
officer.\212\ To account for the standing CCO requirements and to
integrate the addition of a ROC, the Commission envisions the CCO
continuing their duties to supervise the SEF's self-regulatory
program,\213\ as well as making recommendations in consultation with
the ROC (in the event a conflict of interest involving the CCO
exists).\214\ As further discussed below,\215\ the Commission believes
involving the ROC in such matters will help to ensure that the CCO
remains insulated from undue pressures and that conflicts of interest
are appropriately managed.
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\211\ See CEA section 5h(f)(15); 7 U.S.C. 7b-3(f)(15).
\212\ See CEA section 5h(f)(15)(B)(i); 7 U.S.C. 7b-
3(f)(15)(B)(i).
\213\ See Commission regulation Sec. 37.1501(c)(7), which
requires the CCO to supervise the SEF's self-regulatory program with
respect to trade practice surveillance, market surveillance, real-
time market monitoring, compliance with audit trail requirements,
enforcement and disciplinary proceedings, audits, examinations, and
other regulatory responsibilities with respect to members and market
participants (including ensuring compliance with, if applicable,
financial integrity, financial reporting, sales practice,
recordkeeping, and other requirements). Part 37 Final Rule, 78 FR
33476.
\214\ Proposed Sec. 37.1501(c).
\215\ See Section V(h)(3) herein.
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To ensure that the ROC can fulfill its mandate, proposed Sec. Sec.
37.1206(c) and 38.857(c) require that the board of directors delegate
sufficient authority, dedicate sufficient resources, and allow
sufficient time for the ROC to perform its functions. The Commission
has previously stated that the ROC should have the authority,
discretion and necessary resources to conduct its own inquiries;
consult directly with regulatory staff; interview employees, officers,
members, and others; review relevant documents; retain independent
legal counsel, auditors, and other professional services; and otherwise
exercise its independent analysis and judgment to fulfill its
regulatory obligations.'' \216\
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\216\ See DCM Core Principle 15 Release, 71 FR 38740 at 38744-
45, as it relates to the DCM acceptable practices in Appendix B to
part 38.
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ii. Additional Proposed Requirements To Enhance SEF and DCM ROCs
In addition to codifying the existing DCM ROC acceptable practices
for both SEFs and DCMs, the Commission proposes enhancing the ROC
requirements with best practices Commission staff has identified
through the course of its routine oversight. Commission staff has found
that DCMs have substantial differences in their implementation of ROC
administrative and procedural standards. For example, some DCMs have
limited individuals other than ROC members or DCM staff performing
market regulation functions from attending the ROC meetings, while
others have allowed DCM executives and non-ROC members of the board of
directors to attend. The Commission believes the former practice is
preferable as the latter practice invites to ROC meetings the very
conflicts of interest that the establishment of a ROC is intended to
address. Accordingly, as discussed below, the Commission is proposing
certain requirements related to ROC procedures, meetings, and
documentation to help ensure that the manner in which SEFs and DCMs
structure and administer their ROCs does not give rise to conflicts of
interest.
In the DCM Core Principle 15 Release, the Commission stressed that
ROCs conduct oversight and review, and are not intended to assume
managerial responsibilities or to perform direct compliance work.\217\
Accordingly, the Commission is not proposing to adopt the existing
component of the Acceptable Practices for DCM Core Principle 16
addressing the ROC's supervision of the DCM CRO. As further discussed
in proposed Sec. 38.856,\218\ proposed Sec. 38.856(b)(1) would
require the CRO to report to the board or senior officer of the
DCM.\219\ Similar to other employees and executives at SEFs and DCMs,
the Commission expects that CCOs and CROs, respectively, would report
up to a senior officer for
[[Page 19672]]
managerial and administrative matters. The Commission believes this
approach allows the ROC to focus its resources on its core
responsibilities related to overseeing a SEF's or DCM's market
regulation functions. Finally, the ROC will be involved in matters
related to the appointment, removal and compensation of the SEF CCO or
DCM CRO, under proposed Sec. Sec. 37.1501(a)(4) and (5) and 38.856(c)
and (d), respectively.
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\217\ See 2007 Final Release, 72 FR 6936 at 6950.
\218\ See Section V(f) herein.
\219\ The Commission is using the term ``report to'' in proposed
Sec. 38.856(b) instead of the concept of supervision used in the
DCM CP 16 Acceptable Practices because a board of directors, as an
entity, cannot ``supervise'' a person.
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Based on Commission staff's routine oversight of SEFs and DCMs, the
Commission's experience is that the ROC has served a crucial role in
the management of conflicts of interest. As a board-of-directors-level
committee of public directors, the Commission believes the ROC is well-
positioned to manage conflicts that may impact market regulation
functions. The conflicts of interest with which the Commission
envisions the ROC's involvement are not merely potential or
hypothetical. The Commission's oversight of SEFs and DCMs has
identified instances involving actual conflicts of interest impacting
market regulation functions which were adequately managed and addressed
only when the SEF or DCM had a strong governance structure and sound
conflicts of interest policies and procedures. Accordingly, the
Commission is including in the duties in proposed Sec. Sec. 37.1206(d)
and 38.857(d) that the ROC, a standing committee of the board of
directors, is charged with consulting with the SEF CCO or DCM CRO with
identifying, minimizing and resolving any actual or potential conflicts
of interest involving market regulation functions.
Proposed Sec. Sec. 37.1206(e) and 38.857(e) require the ROC to
periodically report to the board of directors. The Commission expects
that this reporting would occur, for example, in regularly scheduled
board of director meetings.
The Commission is also proposing several requirements related to
procedures and documentation for ROC meetings. The Commission believes
these requirements reflect best practices that certain DCMs already
implement. Proposed Sec. Sec. 37.1206(f) and 38.857(f) address ROC
meetings and communications. Both SEF and DCM ROCs would be required to
meet quarterly. These meetings may include CROs or CCOs and will allow
the ROC to share information, discuss matters of mutual concern, and
speak freely about potentially sensitive issues that may relate to the
SEF's or DCM's management. To facilitate this open line of
communication, the proposed rules prohibit, except for the limited
circumstances referenced below, any individuals with actual or
potential conflicts of interest from attending ROC meetings.
The Commission recognizes, however, that there may be limited
circumstances in which it would be appropriate for individuals outside
of the ROC-including business executives or employees whose interest
may conflict in certain respects with the ROC's market regulation
functions--to attend portions of ROC meetings. In particular, if a
business executive or non-market-employee had a legitimate need \220\
to attend a portion of a ROC meeting, the Commission's preliminary view
is that it would not be inappropriate for the ROC to elect to allow
these individuals to attend such portion of the meeting. However, the
Commission preliminarily believes these individuals should not attend
any portion of the ROC meeting outside of the discussion of their
business. These individuals should not be present, in any capacity,
during discussions of the SEF's or DCM's market regulation functions,
such as surveillance, investigation, or enforcement work.
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\220\ For example, to present new product launches or discuss
personnel or policy changes unrelated to market regulation
functions.
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To account for these circumstances, the Commission proposes in
Sec. Sec. 37.1206(f)(1)(iii) and 38.857(f)(1)(iii) that the following
information must be included in ROC meeting minutes: (a) list of the
attendees; (b) their titles; (c) whether they were present for the
entirety of the meeting or a portion thereof (and if so, what portion);
and (d) a summary of all meeting discussions. Finally, proposed
Sec. Sec. 37.1206(f)(2) and 38.857(f)(2) would require the ROC to
maintain documentation of the committee's findings, recommendations,
deliberations, or other communications related to the performance of
its duties. If SEFs and DCMs make their ROC meeting minutes available
for distribution, including to the board of directors or another
committee, the Commission believes any information relating to the
SEF's or DCM's market regulation functions, including surveillance,
investigations, and pending enforcement actions should be redacted to
avoid any undue influence on these market regulation functions.
Finally, the Commission proposes to codify for both SEFs and DCMs,
and to enhance, the existing annual report component of the ROC duties
under the Acceptable Practices for DCM Core Principle 16.\221\ These
acceptable practices contemplate that the ROC, as part of its duties,
will prepare an annual report assessing the DCM's self-regulatory
program for the board of directors and for 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. In
addition to codifying and enhancing this as an annual report
requirement, in proposed Sec. Sec. 37.1206(g)(1) and 38.857(g)(1), the
Commission proposes requiring ROC annual reports to contain a list of
any actual or potential conflicts of interest that were reported to the
ROC, including a description of how such conflicts of interest were
managed and resolved and an assessment of the impact of any conflicts
of interest on the SEF's or DCM's ability to perform its market
regulation functions, as well as requiring disclosure of details
relating to all actions taken by the board of directors pursuant to
recommendations of the ROC.
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\221\ The Commission recognizes that SEF CCOs also prepare an
annual report; however, the ROC annual report will provide a
critically important, independent perspective to assess the market
regulation function, including the CCO. Additionally, the ROC annual
report expressly requires disclosures of actual or potential
conflicts of interest reported to the ROC and details of any
instances of the board of directors rejecting the recommendations of
the ROC, regardless of whether the same information would qualify as
``material non-compliance matters,'' subject to disclosure pursuant
to Sec. 37.1501(d)(4).
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The Commission also proposes in Sec. Sec. 37.1206(g)(2) and
38.857(g)(2) new SEF and DCM rules addressing filing requirements for
the ROC annual report. The procedural requirements would mirror the SEF
annual compliance report requirements \222\ including specifying a
filing deadline no later than 90 days after the end of the SEF's or
DCM's fiscal year, establishing a process for report amendments and
extension requests, recordkeeping requirements, and providing to the
Division of Market Oversight delegated authority to grant or deny
extensions. Finally, proposed Sec. Sec. 37.1206(g)(3) and 38.857(g)(3)
would establish a recordkeeping requirement for the SEF or DCM to
maintain all records demonstrating compliance with the duties of the
ROC and the preparation and submission of the annual report.
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\222\ See Commission regulation Sec. 37.1501(d).
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4. Questions for Comment
The Commission requests comment on all aspects of the proposed ROC
requirements. The Commission further requests comment on the questions
set forth below.
[[Page 19673]]
1. Are there any additional duties that should be included within
the scope of the ROC's duties under proposed Sec. Sec. 37.1206 and
38.857? Are there any additional requirements the Commission should
consider prescribing for the ROC annual report?
2. Should business executives and employees working outside of the
SEF's or DCM's market regulation functions be permitted to attend even
portions of ROC meetings that relate to their business? Or should ROC
meetings be strictly limited to ROC members and employees who perform
work related to the SEF's or DCM's market regulation functions?
e. Disciplinary Panel Composition--Proposed Sec. Sec. 37.1207 and
38.858
1. Background
As part of its market regulation function, each SEF and DCM must
have a disciplinary program to discipline, suspend, or expel members or
market participants that violate the SEF's or DCM's rules.\223\
Disciplinary panels administer this program by conducting hearings,
rendering decisions, and imposing sanctions with respect to
disciplinary matters. The Commission believes that fair disciplinary
procedures require SEF and DCM disciplinary panels to be: (1)
independent of outside influences, (2) impartial, and (3)
representative of a diversity of perspectives and experiences.
Accordingly, the Commission is proposing rules implementing elements of
the conflicts of interest obligations under DCM Core Principle 16 and
SEF Core Principle 12 in order to promote and support these panel
attributes.
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\223\ CEA section 5(d)(13); 7 U.S.C. 7(d)(13); CEA section
5h(f)(2)(B); 7 U.S.C. 7b-3(f)(2)(B).
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2. Existing Regulatory Framework
Currently, the DCM Core Principle 16 Acceptable Practices provide
that DCMs establish disciplinary panel composition rules that preclude
any group or class of industry participants from dominating or
exercising disproportionate influence on such panels.\224\ Furthermore,
the DCM Core Principle 16 Acceptable Practices provide for all
disciplinary panels (and appellate bodies) to include at least one
person who would qualify as a public director, except in cases limited
to decorum, attire, or the timely submission of accurate records
required for clearing or verifying each day's transactions.\225\
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\224\ Part 38, Appendix B, Core Principle 16 Acceptable
Practices (b)(4).
\225\ Id.
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Commission regulation Sec. 1.64(c), which applies to SEFs,
requires each major disciplinary committee \226\ or hearing panel to
include: (1) at least one member who is not a member of the SEF; and
(2) sufficient different membership interests so as to ensure fairness
and to prevent special treatment or preference for any person in the
conduct of a committee's or the panel's responsibility.
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\226\ Commission regulation Sec. 1.64(a)(2) defines a ``Major
disciplinary committee'' as a committee of persons who are
authorized by a self-regulatory organization to conduct disciplinary
hearings, to settle disciplinary charges, to impose disciplinary
sanctions or to hear appeals thereof in cases involving any
violation of the rules of the self-regulatory organization subject
to certain exceptions.
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3. Proposed Rules
The Commission is proposing to adopt rules in proposed Sec. Sec.
37.1207 and 38.858, respectively, that would codify, with certain
enhancements, the DCM Core Principle 16 Acceptable Practices with
respect to disciplinary panel composition. While the Commission
believes that both the DCM Core Principle 16 Acceptable Practices and
Commission regulation Sec. 1.64(c) seek to promote fairness in the
disciplinary process by introducing a diversity of interests to serve
on disciplinary panels, the Commission believes that the DCM Core
Principle 16 Acceptable Practices establish more appropriate practices
for achieving fairness in today's SEF and DCM environments. For
example, providing for a public participant on the disciplinary panel
to be the chair introduces an independent perspective in a steering
role that the Commission believes will enhance the overall fairness of
the disciplinary process. The Commission believes that if SEFs are
subject to rules that codify the DCM Core Principle 16 Acceptable
Practices with respect to disciplinary panel composition, it would not
be necessary for SEFs also to be subject to the requirements of
Commission regulation Sec. 1.64(c). As noted above in Section V(c)(3)
herein, the Commission is also proposing to amend Commission regulation
Sec. 37.2 to exempt SEFs from Commission regulation Sec. 1.64 in its
entirety.
Proposed Sec. 38.858(a)(1) would require that DCMs adopt rules to
preclude any group or class of participants from dominating or
exercising disproportionate influence on a disciplinary panel, and
proposed Sec. 37.1207(a)(1) would establish an analogous requirement
for SEFs. Accordingly, the proposed rules would be consistent with the
disciplinary panel component of the DCM Core Principle 16 Acceptable
Practices. The Commission believes the proposed rules are reasonably
necessary to promote impartial disciplinary panels, which are critical
decision-makers in fulfilling a SEF's or DCM's market regulation
functions.
The Commission is also proposing additional requirements to enhance
the existing regulatory framework. First, the proposal would clarify in
proposed Sec. Sec. 37.1207(a) and (b) and 38.858(a) and (b) that SEFs'
and DCMs' disciplinary panels and appellate panels must consist of two
or more persons. The Commission believes a disciplinary panel must have
more than one person in order to preclude any group or class of
participants from dominating or exercising disproportionate influence,
as currently contemplated under the DCM Core Principle 16 Acceptable
Practices, and proposed in these rules. Second, proposed Sec. Sec.
37.1207 and 38.858 would prohibit any member of a disciplinary panel
from participating in deliberations or voting on any matter in which
the member has an actual or potential conflict of interest, consistent
with the general conflicts of interest provisions proposed in
Sec. Sec. 37.1202 and 38.852. Third, proposed Sec. Sec. 37.1207(b)
and 38.858(b) would extend the public participant requirement to any
SEF and DCM committee to which disciplinary panel decisions may be
appealed. Fourth, the Commission proposes technical amendments to
Commission regulations Sec. Sec. 37.206(b) and 38.702 to remove the
references that disciplinary panels must meet the composition
requirements of part 40,\227\ and replace these references with
references to the composition requirements of proposed regulations
Sec. Sec. 37.1207 and 38.858, respectively. The Commission also
proposes changing the reference to ``compliance'' staff to ``market
regulation'' staff. This is intended for clarity and is consistent with
proposed changes to Sec. Sec. 38.155(a) and 37.203(c).
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\227\ There are currently no composition requirements in part 40
of the Commission's regulations.
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4. Questions for Comment
The Commission requests comment on all aspects of the proposed
disciplinary panel composition requirements. The Commission further
requests comment on the questions set forth below.
1. Are there any situations in which it would be appropriate for a
disciplinary panel to be comprised of only one individual? If so,
please describe.
[[Page 19674]]
2. Should the Commission exempt requiring a public participant on a
disciplinary panel in cases solely involving decorum or attire?
f. DCM Chief Regulatory Officer--Proposed Sec. 38.856
1. Background
The Commission is proposing to codify current DCM practices
regarding the CRO position. The DCM Core Principle 16 Acceptable
Practices do not provide that DCMs have a CRO. However, Commission
staff has found through its oversight activities that all DCMs either
have a CRO, or an individual performing the same functions as a CRO.
DCM CROs generally are responsible for administering a DCM's market
regulation functions.
2. Existing Regulatory Framework
Although not expressly a component of the DCM Core Principle
Acceptable Practices, the framework created under the DCM Core
Principle 16 Acceptable Practices clearly envisioned the establishment
of a CRO position. Specifically, supervising the ``the contract
market's chief regulatory officer, who will report directly to the
ROC'' is one of the ROCs enumerated duties.\228\ In adopting the DCM
Core Principle 16 Acceptable Practices, the Commission emphasized that
the relationship between the ROC and the CRO is a key element of the
insulation and oversight provided by the ROC structure, and that, along
with the board of directors, it 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.\229\
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\228\ Part 38, Appendix B, Core Principle 16 Acceptable
Practices (b)(3)(ii)(D).
\229\ 2007 Final Release, 72 FR 6936 at 6951 n.80.
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While the Commission did not explicitly require DCMs to appoint
CROs as part of the DCM Final Rules, the Commission noted that current
industry practice is for DCMs to designate an individual as chief
regulatory officer, and it will be difficult for a DCM to meet the
staffing and resource requirements of Sec. 38.155 without a chief
regulatory officer or similar individual to supervise its regulatory
program, including any services rendered to the DCM by a regulatory
service provider.\230\
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\230\ The Commission understands that some DCMs use a slightly
different title for their CRO position. For example, they may use
the term Chief Compliance Officer, as opposed to Chief Regulatory
Officer, but such position is the functional equivalent to the CRO
role proposed herein.
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3. Proposed Rules
Proposed Sec. 38.856(a)(1) requires each DCM to establish the
position of CRO and designate an individual to serve in that capacity
and to administer the DCM's market regulation functions. The proposed
rule further requires that (1) the position of CRO must carry with it
the authority and resources necessary to fulfill the duties set forth
for CROs; and (2) the CRO must have supervisory authority over all
staff performing the DCM's market regulation functions. The Commission
believes that the above-described requirements of the proposed rule
would ensure that a CRO has authority over any staff and resources
while they are acting in furtherance of the DCM's market regulation
functions. Of course, any such employees are subject to the DCM's
conflicts of interest policies and procedures that DCMs must establish
and enforce pursuant to DCM Core Principle 16 and corresponding
proposed regulations Sec. Sec. 38.851 and 38.852.
Proposed Sec. 38.856(a)(2) requires that the individual designated
to serve as CRO must have the background and skills appropriate for
fulfilling the duties of the position. The Commission notes that a DCM
should identify the needs of its particular market regulation
functions, and ensure that the CRO has the requisite surveillance and
investigatory experience necessary to perform the CRO's role. In
addition, proposed Sec. 38.856(a)(2) would provide that no individual
disqualified from registration pursuant to sections 8a(2) or 8a(3) of
the CEA may serve as a CRO.
Proposed Sec. 38.856(b) sets forth reporting line requirements for
the CRO, providing that the CRO must report directly to the DCM's board
of directors or to a senior officer. This is a change from the existing
supervisory structure contemplated under the DCM Core Principle 16
Acceptable Practices, which provide for the ROC to supervise the
CRO.\231\ Commission staff has found, through its RERs and general DCM
oversight activities, that most CROs, like other exchange executives,
report to a senior officer for purposes of performance evaluations and
approval of administrative requests. The ROC may not be the appropriate
body for a CRO to report to, as the ROC might meet only on a quarterly
basis. The DCM's senior officer represents the highest level of
authority at the exchange, other than the board of directors or its
committees. Consequently, the Commission believes that it would be
appropriate for the CRO to report to the senior officer.
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\231\ Part 38, Appendix B, Core Principle 16 Acceptable
Practices (b)(3)(ii)(D). Additionally, the Commission is using the
term ``report to'' in proposed Sec. 38.856(b) instead of the
concept of supervision used in the DCM CP 16 Acceptable Practices
because a board of directors, as an entity, cannot ``supervise'' a
person.
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However, proposed Sec. 38.856(b) should be interpreted in
conjunction with proposed Sec. 38.856(f), discussed below, which
specifies, among other things, that a CRO must disclose actual or
potential conflicts of interest to the ROC, and that a qualified person
temporarily serve in place of the CRO for any matter in respect of
which the CRO has such a conflict. A DCM's ROC would therefore be
involved in minimizing any actual or potential conflicts of interest of
the CRO, which would include conflicts of interest between the duties
of the CRO and the DCM's commercial interests. As the Commission
previously stated, the CRO-ROC relationship 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.\232\ The
DCM is responsible for establishing the reporting lines for the CRO to
ensure that conflicts of interest are routed to the appropriate
decision-makers.
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\232\ 2007 Final Release, 72 FR 6936 at 6951 n.80.
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Finally, the Commission notes generally that a CRO reporting
structure in which the CRO has a direct line to the board of directors
or the senior officer allows the CRO to more easily gain approval for
any new policies related to the DCM's market regulation functions that
the CRO needed to implement, to the extent that they required approval
of a senior officer or the board of directors. Since DCM rule changes
often need to be approved by the board of directors, having the CRO
report to the board of directors or to the senior officer (who likely
regularly communicates with the board) would allow the CRO to more
easily explain the need for rule changes, and to answer questions from
the board of directors or the senior officer about such changes.
Proposed Sec. 38.856(c) provides the following CRO appointment and
removal procedures: (1) the appointment or removal of a DCM's CRO must
occur only with the approval of the DCM's ROC; (2) the DCM must notify
the Commission within two business days of the appointment of any new
CRO, whether interim or permanent; and (3) the DCM must notify the
Commission within two business days of removal of the CRO. These
procedures help ensure that the CRO is
[[Page 19675]]
properly insulated from undue influence, including commercial
interests. For example, the requirement of ROC approval means that a
senior officer of the DCM may not take unilateral action to replace the
CRO if there is any dispute over the CRO's decisions or role in any
market regulation function. In addition, the procedures requiring
notification to the Commission ensure appropriate staff within the
Commission are aware of who is fulfilling this key role and can
initiate communications with the CRO as necessary. Moreover, the
Commission will be aware if there is any lag in the appointment of a
replacement CRO, and can take appropriate oversight action in such a
scenario, as well.
Proposed Sec. 38.856(d) provides that the board of directors or
the senior officer of the DCM, in consultation with the DCM's ROC, must
approve the compensation of the CRO. Involving the ROC in approving the
compensation of the CRO further ensures that the CRO's role is
insulated from improper influence or direction from the DCM's
commercial interests. The Commission notes that while some portion of
compensation may be in the form of equity, DCMs should avoid tying a
CRO's salary to business performance in order to avoid potential
conflicts of interest. The Commission believes the ROC is well-situated
to determine whether specific compensation structures could raise
potential conflicts of interest.
Proposed Sec. 38.856(e) details the duties of the CRO, which
include: (1) supervising the DCM's market regulation functions; (2)
establishing and administering policies and procedures related to the
DCM's market regulation functions; (3) supervising the effectiveness
and sufficiency of any regulatory services provided to the DCM by a
regulatory service provider in accordance with Sec. 38.154; (4)
reviewing any proposed rule or programmatic changes that may have a
significant regulatory impact on the DCM's market regulation functions,
and advising the ROC on such matters; and (5) in consultation with the
DCM's ROC, identifying, minimizing, managing, and resolving conflicts
of interest involving the DCM's market regulation functions.
The Commission views a CRO's role as being narrower than that of a
CCO. As contemplated in these proposed rules, both CCOs and CROs would
be required to have supervisory authority over certain staff,\233\ and
supervise the quality of regulatory services received, as
applicable.\234\ CCOs have additional responsibilities deriving from
the statutory chief compliance officer core principle for SEFs, for
which there is no DCM analogue. For example, CCOs are responsible for
overall compliance of the SEF with section 5h of the CEA and related
Commission rules,\235\ for establishing and administering written
policies to prevent violation of the CEA and Commission rules,\236\ and
for establishing procedures to address noncompliance issues identified
through any means, such as look-back, internal or external audit
findings, self-reported errors, or validated complaints.\237\ The
Commission understands that in some instances, CROs may take on these
additional responsibilities, such as supervising the DCM's financial
surveillance program under Core Principle 11 and associated Commission
regulations.
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\233\ Proposed Sec. 37.1501(a)(1)(ii) requires the SEF CCO to
have supervisory authority over all staff acting at the CCO's
direction. Proposed Sec. 38.856(a)(1)(iii) requires the DCM CRO to
have supervisory authority over all staff performing the DCM's
market regulation functions. Similarly, proposed Sec. 38.856(e)(1)
specifies that the DCM CRO must supervise the DCM's market
regulation functions.
\234\ Proposed Sec. Sec. 37.1501(b)(8) and 38.856(e)(3).
\235\ CEA section 5h(f)(15)(B)(v); 7 U.S.C. 7b-3(f)(15)(B)(v).
\236\ CEA section 5h(f)(15)(B)(iv); 7 U.S.C. 7b-3(f)(15)(B)(iv).
\237\ CEA section 5h(f)(15)(B)(vi); 7 U.S.C. 7b-3(f)(15)(B)(vi).
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Finally, and as discussed above, proposed Sec. 38.856(f) provides
that each DCM must establish procedures for the CRO's disclosure of
actual or potential conflicts of interest to the ROC and designation of
a qualified person to serve in the place of the CRO for any matter in
respect of which the CRO has such a conflict, and documentation of such
disclosure and designation.
4. Questions for Comment
The Commission requests comment on all aspects of the proposed CRO
regulatory requirements. The Commission further requests comment on the
questions set forth below.
1. Is the Commission correct that all DCMs have CROs or an
individual performing CRO functions?
2. Are there any additional duties that should be included under
proposed Sec. 38.856(e)? Are there any that should be removed?
g. Staffing and Investigations--Proposed Changes to Sec. Sec. 38.155,
38.158, and 37.203
1. Background
The Commission is proposing amendments to existing SEF and DCM
rules relating to staffing and investigations. As discussed below,
Commission staff has found there is a lack of clarity that has led to
inconsistent approaches with respect to compliance with SEF and DCM
market regulation staff and resource requirements. The Commission
proposes enhancing SEF staffing requirements to require annual
monitoring of staff size and workload to ensure SEFs have sufficient
staff and resources dedicated to performing market regulation
functions.\238\ This would align SEF staffing obligations with existing
DCM staffing obligations. Finally, for the purpose of clarity, staff is
proposing certain non-substantive amendments.
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\238\ As discussed below, the Commission also is proposing a
technical amendment to existing Sec. 38.155(a) to replace the list
of duties a DCM must have sufficient staff to perform with the term
``market regulation functions.''
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2. Existing Regulatory Framework
Commission regulation Sec. 38.155(a) provides that each DCM must
establish and maintain sufficient compliance department resources and
staff to ensure that it can conduct effective audit trail reviews,
trade practice surveillance, market surveillance, and real-time market
monitoring. A DCM's compliance staff also must be sufficient to address
unusual market or trading events as they arise, and to conduct and
complete investigations in a timely manner. Commission regulation Sec.
38.155(b) provides that a DCM must monitor the size and workload of its
compliance staff annually, and ensure that its compliance resources and
staff are at appropriate levels. In determining the appropriate level
of compliance resources and staff, the DCM should consider trading
volume increases, the number of new products or contracts to be listed
for trading, any new responsibilities to be assigned to compliance
staff, the results of any internal review demonstrating that work is
not completed in an effective or timely manner, and any other factors
suggesting the need for increased resources and staff.
Existing Commission regulation Sec. 37.203(c), similar to existing
Commission regulation Sec. 38.155(a), provides that a SEF must have
sufficient compliance staff and resources to ensure it can conduct
effective audit trail reviews, trade practice surveillance, market
surveillance, and real-time market monitoring. However, part 37 of the
Commission's regulations does not include for SEFs a regulation
parallel to Commission regulation Sec. 38.155(b)'s requirement for
DCMs to annually
[[Page 19676]]
monitor the sufficiency of staff and resources.
Existing regulations Sec. Sec. 38.158 and 37.203(f) relate to SEF
and DCM obligations, respectively, regarding investigations and
investigation reports. These provisions generally address investigation
timeliness, substance of investigation reports, and how frequently
warning letters may be issued.
3. Proposed Rules
The Commission is proposing amendments to existing Sec. Sec.
38.155(a) and 37.203(c). First, the Commission proposes to replace
references to ``compliance staff'' with ``staff.'' Second, proposed
Sec. Sec. 38.155(a) and 37.203(c) would amend the first sentence of
the existing regulations to provide that SEFs and DCMs must establish
and maintain sufficient staff and resources to ``effectively perform
market regulation functions'' rather than listing the individual
functions.\239\ The Commission does not view these as substantive
changes. References to staff rather than compliance staff are intended
for clarity. Compliance staff could be viewed as a broad term that
encompasses individuals who have obligations for compliance with all of
the CEA and Commission regulations. To avoid confusion and a lack of
clarity about which staff might fall within the scope of this broad
term, the Commission proposes simply to replace references to
``compliance staff'' with ``staff.'' As noted, Commission regulations
Sec. Sec. 38.155(a) and 37.203(c) solely are focused on staff
dedicated to performing market regulation functions.
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\239\ See Sections I and II(d)(1) herein for a description of
the definition of ``market regulation functions'' in proposed
Sec. Sec. 38.851(b)(9) and 37.1201(b)(9).
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The Commission also proposes to amend Sec. 37.203 to add a new
paragraph (d). The proposed provision would require SEFs to annually
monitor the size and workload of its staff, and ensure its resources
and staff effectively perform market regulation functions at
appropriate levels. In determining the appropriate level of resources
and staff, the proposed rule lists factors SEFs should consider. These
factors include trading volume increases, the number of new products or
contracts to be listed for trading, any new responsibilities to be
assigned to staff, any responsibilities that staff have at affiliated
entities, the results of any internal review demonstrating that work is
not completed in an effective or timely manner, any conflicts of
interest that prevent staff from working on certain matters and any
other factors suggesting the need for increased resources and staff. In
addition, paragraph (d) would include a reference to paragraph (c) to
clarify that it applies to staff responsible for conducting market
regulation functions.
Proposed Sec. 37.203(d) is virtually identical to existing Sec.
38.155(b) for DCMs. Given that SEFs and DCMs have the same obligation
to perform market regulation functions, the Commission believes it is
equally important for SEFs to annually review their staffing and
resources to ensure they are appropriate and sufficient to adequately
perform market regulation functions. Accordingly, consistent with the
language in proposed Sec. 37.203(d), the Commission is proposing to
add to the list of factors that a DCM should consider in determining
the appropriate level of resources and staff: (1) any responsibilities
that staff have at affiliated entities; and (2) any conflicts of
interest that prevent staff from working on certain matters. The
Commission believes that the addition of these factors is necessary to
account for potential constraints on resources and staff.
Additionally, the Commission proposes the following non-substantive
changes to existing Commission regulation Sec. Sec. 38.155 and 38.158.
Proposed Sec. 38.155 would rename the regulation ``Sufficient staff
and resources.'' Proposed Sec. 38.155(b) would add an internal
reference to paragraph (a). This change is intended to clarify that the
annual staff and resource monitoring requirement pertains to staff
performing market regulation functions required under Sec. 38.155(a).
Proposed Sec. 38.158(a) would replace the reference to ``compliance
staff'' with ``staff responsible for conducting market regulation
functions.'' Proposed Sec. 38.158(b) would delete the reference to
``compliance staff investigation'' being required to be completed in a
timely manner, and instead provide, more simply, that ``[e]ach
investigation must be completed in a timely manner.'' Finally, proposed
Sec. Sec. 38.158(c) and (d) would delete the modifier ``compliance''
when referencing to staff.
Finally, the Commission proposes the following non-substantive
changes to existing Commission regulation Sec. 37.203. Proposed Sec.
37.203(c) would rename the paragraph ``Sufficient staff and
resources.'' The addition of proposed Sec. 37.203(d) would result in
renumbering the remaining provisions of Sec. 37.203. Proposed Sec.
37.203(g)(1), which would replace existing Commission regulation Sec.
37.203(f)(1), adds a reference to ``market regulation functions,''
consistent with the new proposed defined term. Similarly, to avoid lack
of clarity, the Commission proposes to delete the modifier
``compliance'' when referencing staff in existing Sec. 37.203(f)(2)-
(4).
4. Questions for Comment
The Commission requests comment on all aspects of the proposed
changes to Sec. Sec. 38.155, 38.158 and 37.203.
h. SEF Chief Compliance Officer--Proposed Changes to Sec. 37.1501
1. Background
The Commission is proposing amendments to Sec. 37.1501 for several
reasons. First, the Commission proposes certain amendments to the
existing SEF CCO requirements to ensure that, to the extent applicable,
these requirements are consistent with the proposed DCM CRO
requirements. Second, the Commission is proposing additional SEF CCO
requirements to harmonize the language with other aspects of this rule
proposal, namely proposed amendments that pertain to the board of
directors and conflicts of interest procedures. Third, the Commission
is proposing amendments that will more closely align Sec. 37.1501 with
the language of SEF Core Principle 15, which is codified in Sec.
37.1500.\240\
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\240\ See Commission regulation Sec. 37.1500(b)(1).
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2. Existing Regulatory Framework
The statutory framework for SEFs requires each SEF to designate an
individual to serve as a CCO.\241\ The CCO must report to the SEF's
board of directors or senior officer,\242\ and is responsible for
certain enumerated duties, including compliance with the CEA and
Commission regulations and resolving conflicts of interest.\243\ The
CCO is also responsible for designing the procedures to establish the
handling, management response, remediation, retesting, and closing of
[[Page 19677]]
noncompliance issues.\244\ Finally, the CCO is required to prepare an
annual report describing the SEF's compliance with the CEA and the
policies and procedures of the SEF.\245\ These statutory requirements
also are codified in Commission regulation Sec. 37.1500.
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\241\ CEA section 5h(f)(15)(A); 7 U.S.C. 7b-3(f)(15)(A).
\242\ CEA section 5h(f)(15)(B)(i); 7 U.S.C. 7b-3(f)(15)(B)(i).
\243\ CEA section 5h(f)(15)(B) (ii)-(vi); 7 U.S.C. 7b-
3(f)(15)(B)(ii)-(vi) establishes the following CCO duties: (1)
reviewing compliance with the core principles; (2) in consultation
with the board, a body performing a function similar to that of a
board, or the senior officer of the SEF, resolving any conflicts of
interest that may arise; (3) being responsible for establishing and
administering the policies and procedures required to be established
pursuant to this section; (4) ensuring compliance with the CEA and
the rules and regulations issued under the CEA, including rules
prescribed by the Commission pursuant to section 5h of the CEA; and
(5) establishing procedures for the remediation of noncompliance
issues found during compliance office reviews, look backs, internal
or external audit findings, self-reported errors, or through
validated complaints.
\244\ CEA section 5h(f)(15)(C); 7 U.S.C. 7b-3(f)(15)(C).
\245\ CEA section 5h(f)(15)(D); 7 U.S.C. 7b-3(f)(15)(D).
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Commission regulation Sec. 37.1501 further implements the
statutory CCO requirements. First, Commission regulation Sec.
37.1501(a) establishes definitions for the terms ``board of directors''
and ``senior officer.'' Second, Commission regulation Sec.
37.1501(b)(1) addresses the authority of the CCO, stating that the
position shall: (1) carry with it the authority and resources to
fulfill the CCO's duties; and (2) have supervisory authority over all
staff acting at the discretion of the CCO. Third, Commission regulation
Sec. 37.1501(b)(2) establishes qualifications for the CCO, including a
requirement that the CCO must: (1) have the appropriate background and
skills; and (2) must not be disqualified from registration under CEA
8a(2) or 8a(3). Fourth, Commission regulation Sec. 37.1501(b)(3)
outlines the appointment and removal procedures for the CCO, which
state that: (1) only the SEF's board of directors or senior officer may
appoint or remove the CCO; and (2) the SEF shall notify the Commission
within two business days of a CCO's appointment or removal. Fifth,
Commission regulation Sec. 37.1501(b)(4) requires the SEF's board of
directors or senior officer to approve the CCO's compensation. Sixth,
Commission regulation Sec. 37.1501(b)(5) requires the CCO to meet with
the SEF's board of directors or senior officer at least annually.
Seventh, Commission regulation Sec. 37.1501(b)(6) requires the CCO to
provide any information regarding the self-regulatory program of the
SEF as requested by the board of directors or the senior officer.
Commission regulation Sec. 37.1501(c) further outlines the duties
of the CCO, expanding on those already required under SEF Core
Principle 15. For example, Commission regulation Sec. 37.1501(c)(2)
details that the CCO must take reasonable steps, in consultation with
the board of directors or the senior officer of the SEF, to resolve any
material conflicts of interest that may arise, including, but not
limited to: (1) conflicts between business considerations and
compliance requirements; (2) conflicts between business considerations
and the requirement that the SEF provide fair, open, and impartial
access as set forth in Sec. 37.202; and; (3) conflicts between a SEF's
management and members of the board of directors. In connection with
establishing and administering the requisite procedures under Core
Principle 15, Commission regulation Sec. 37.1501(c)(6) specifies that
the CCO must establish and administer a compliance manual designed to
promote compliance with the applicable laws, rules, and regulations and
a written code of ethics for the SEF designed to prevent ethical
violations and to promote honesty and ethical conduct by SEF personnel.
Finally, Commission regulation Sec. Sec. 37.1501(c)(7) and (c)(8)
detail the requirement that the CCO supervise the SEF's self-regulatory
program as well as the effectiveness and sufficiency of any regulatory
service provider, respectively.
Commission regulation Sec. 37.1501(d) addresses the statutory
requirement under SEF Core Principle 15 requiring a CCO to prepare an
annual compliance report. Commission regulation Sec. 37.1501(d)
details that the report must contain, at a minimum: (1) a description
and self-assessment of the effectiveness of the written policies and
procedures of the SEF; (2) any material changes made to compliance
policies and procedures during the coverage period for the report and
any areas of improvement or recommended changes to the compliance
program; (3) a description of the financial, managerial, and
operational resources set aside for compliance with the CEA and
applicable Commission regulations; (4) any material non-compliance
matters identified and an explanation of the corresponding action taken
to resolve such non-compliance matters; and (5) a certification by the
CCO that, to the best of his or her knowledge and reasonable belief,
and under penalty of law, the annual compliance report is accurate and
complete in all material respects.\246\
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\246\ Commission regulation Sec. 37.1501(d)(1)-(5).
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Commission regulation Sec. 37.1501(e) addresses the submission of
the annual compliance report, stating that: (1) the CCO must provide
the annual compliance report for review to the board of directors or
senior officer, who shall not require the CCO to make any changes to
the report; (2) the annual compliance report must be submitted
electronically to the Commission no later than 90 calendar days after
the end of the SEF's fiscal year; (3) promptly upon discovery of any
material error or omission made in a previously filed annual compliance
report, the CCO must file an amendment with the Commission; and (4) the
SEF may request an extension of time to file its annual compliance
report from the Commission. Commission regulation Sec. 37.1501(f)
requires the SEF to maintain all records demonstrating compliance with
the duties of the CCO and the preparation and submission of annual
compliance reports consistent with Commission regulations Sec. Sec.
37.1000 and 37.1001.
Finally, Commission regulation Sec. 37.1501(g) delegates to the
Director of the Division of Market Oversight the authority to grant or
deny a request for an extension of time for a SEF to file its annual
compliance report under Commission regulation Sec. 37.1501(e).
3. Proposed Rules
The Commission is proposing to move the terms ``board of
directors'' and ``senior officer'' from existing regulation Sec.
37.1501(a) to proposed Sec. 37.1201(b). The meaning of each term would
remain unchanged, with one exception. Specifically, the Commission
seeks to clarify the existing definition of ``board of directors'' by
including the introductory language ``a group of people'' serving as
the governing body of the SEF. The Commission notes that deleting the
definitions from Commission regulation Sec. 37.1501(a) will result in
renumbering the remaining provisions of Commission regulation Sec.
37.1501.
The Commission is not proposing any changes to existing Commission
regulation Sec. 37.1501(b)(1) or (b)(2).\247\ However, the Commission
is proposing a new Sec. 37.1501(a)(3) that would require the CCO to
report directly to the board or to the senior officer of the SEF. This
would be a new provision in Sec. 37.1501, but it is consistent with
the language of SEF Core Principle 15, which is codified in Sec.
37.1500.\248\ Additionally, the language is consistent with the
proposed supervisory requirements for a DCM CRO set forth in proposed
Sec. 38.856(b)(1).
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\247\ These provisions would be renumbered under the proposal as
Commission regulation Sec. 37.1501(a)(1) and (a)(2), respectively.
\248\ See Commission regulation Sec. 37.1500(b)(1).
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Proposed Sec. 37.1501(a)(4)(i) would amend the language in
existing Commission regulation Sec. 37.1501(b)(3)(i) to provide that
the board of directors or senior officer may appoint or remove the CCO
with the approval of the SEF's regulatory oversight committee. This
addition is intended to help insulate the position of CCO from improper
or undue influence. Proposed Sec. 37.1501(a)(4)(ii) would retain the
two-business day notification
[[Page 19678]]
requirement to the Commission of the removal of a CCO under Commission
regulation Sec. 37.1501(b)(3)(ii).
Proposed Sec. 37.1501(a)(5) would amend the existing requirement
in Commission regulation Sec. 37.1501(b)(4) that the board of
directors or the senior officer of the SEF shall approve the
compensation of the CCO, to now require this approval to occur in
consultation with the SEF's ROC. The Commission believes this proposed
requirement would help ensure that the CCO position will remain free of
improper influence.
The duties of the CCO under proposed Sec. 37.1501(b) are
substantively similar to existing Commission regulation Sec.
37.1501(c), with two exceptions. First, proposed Sec. 37.1501(b)(2)
provides that the CCO must take reasonable steps in consultation with
the SEF's board of directors ``or a committee thereof'' to manage and
resolve material conflicts of interest. Regarding the CCO's duties to
``manage and resolve'' material conflicts of interest, the Commission
notes there are multiple ways a conflict of interest could be managed
and resolved. One example would be simply replacing a conflicted
individual with an independent and qualified back-up. Another method to
manage and resolve a conflict would be not to pursue a business
priority where there is no other way in which to resolve the conflict.
The added reference to ``committee'' accounts for the ROC's role in
resolving conflicts of interest, which is provided in proposed Sec.
37.1206(d)(4).
Second, proposed Sec. 37.1501(b)(2)(i) specifies that conflicts of
interest between business considerations and compliance requirements
includes, with respect to compliance requirements, the SEF's ``market
regulation functions.'' \249\ The Commission believes that this
proposed added language will help to clarify for SEFs and CCOs the
obligation of CCOs to resolve conflicts of interest that relate to SEF
Core Principle 2, SEF Core Principle 4, SEF Core Principle 6, Core
Principle 10 and the applicable Commission regulations thereunder.
Existing Commission regulation Sec. 37.1501(c)(7) provides that the
CCO must supervise the SEF's ``self-regulatory program,'' which
includes trade practice surveillance; market surveillance; real time
market monitoring; compliance with audit trail requirements;
enforcement and disciplinary proceedings; audits, examinations, and
other regulatory responsibilities (including taking reasonable steps to
ensure compliance with, if applicable, financial integrity, financial
reporting, sales practice, recordkeeping, and other requirements).
Proposed Sec. 37.1501(b)(7) would amend this provision to state that
the CCO is responsible for supervising the SEF's self-regulatory
program, including the market regulation functions set forth in Sec.
37.1201(b)(9). Proposed Sec. 37.1201(b)(9) defines ``market regulation
functions'' to mean SEF functions required by SEF Core Principle 2, SEF
Core Principle 4, SEF Core Principle 6, SEF Core Principle 10 and the
applicable Commission regulations thereunder. The Commission is
proposing this amendment for clarity and ease of reference.\250\ The
Commission views the proposed change as being consistent with the CCO's
duties as described in existing Commission regulation Sec.
37.1501(c)(7).\251\
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\249\ Proposed Sec. 37.1501(b)(2)(ii) includes a technical edit
to add the words ``implementation of'' prior to the clause ``of the
requirement that the swap execution facility provide fair, open, and
impartial access as set forth in Sec. 37.202.''
\250\ The CCO's market regulation function duties are referenced
in various contexts throughout the proposed rules including proposed
Sec. Sec. 37.1201, 37.1206(a), (d) and (f)).
\251\ For avoidance of doubt, the term ``self-regulatory
program,'' as used in proposed Sec. 37.1501(b)(7), continues to
include the full scope of areas described in existing Commission
regulation Sec. 37.1501(c)(7): trade practice surveillance, market
surveillance, real time market monitoring, compliance with audit
trail requirements, enforcement and disciplinary proceedings,
audits, examinations, and other regulatory responsibilities
(including financial integrity, financial reporting, sales practice,
recordkeeping, and other requirements).
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Proposed Sec. 37.1501(c) is an entirely new regulation that
addresses conflicts of interest involving the CCO. The proposed rule
requires the SEF to establish procedures for the disclosure of actual
or potential conflicts of interest to the ROC. In addition, the SEF
must designate a qualified person to serve in the place of the CCO for
any matter for which the CCO has such a conflict, and maintain
documentation of such disclosure and designation. As noted above,
proposed Sec. 37.1206(d)(4) requires the ROC to consult with the CCO
in managing and resolving any actual or potential conflicts of interest
involving the SEF's market regulation functions. The CCO's disclosure
of actual or potential conflicts of interest to the ROC will facilitate
the ROC's assistance in managing and resolving conflicts of interest
involving the SEF's market regulation functions. The requirement that
the SEF have procedures to designate a qualified person to serve in the
place of the CCO for any matter in which the CCO is conflicted will
help ensure there is a person with sufficient independence, expertise
and authority to address such matters. The Commission believes that a
qualified substitute for the CCO must, at a minimum, meet the
qualification provisions set forth in existing Commission regulation
Sec. 37.1501(b)(2), but that a qualified substitute also should be
free from conflicts of interest relating to the matter under
consideration.
Proposed Sec. 37.1501(d)(5) amends the existing annual compliance
report requirement under Commission regulation Sec. 37.1501(d) to
require the annual report to include any actual or potential conflicts
of interests that were identified to the CCO during the coverage period
for the report, including a description of how such conflicts of
interest were managed or resolved, and an assessment of the impact of
any conflicts of interest on the swap execution facility's ability to
perform its market regulation functions. The Commission proposes this
requirement to help ensure it has sufficient notice of conflicts of
interest, how they were resolved and whether they were resolved
effectively.
4. Questions for Comment
The Commission requests comment on all aspects of the proposed
changes to the SEF CCO regulatory requirements. The Commission further
requests comment on the question set forth below.
1. Has the Commission struck the appropriate balance between the
responsibilities of the CCO and the ROC with respect to identifying,
managing and resolving conflicts of interest? Are there ways in which
this balance should be modified?
2. Proposed Sec. 37.1501(a)(5) provides that the board of
directors or the senior officer of the SEF, in consultation with the
ROC, shall approve the compensation of the CCO. Proposed Sec.
38.856(d) provides the same requirement for the DCM's CRO. Should the
Commission expand on this requirement, to also prohibit CCO and CRO
compensation from being directly dependent on the SEF's or DCM's
business performance?
VI. Conforming Changes
a. Commission Regulations Sec. Sec. 37.2, 38.2, and Part 1
The Commission proposes adopting certain existing requirements from
part 1, in particular those from Commission regulations Sec. Sec.
1.59, 1.63, 1.64 and 1.69, into new regulations for SEFs and DCMs in
parts 37 and 38, respectively. Accordingly, and as discussed in more
detail above, the Commission is proposing to amend Commission
[[Page 19679]]
regulations Sec. Sec. 37.2 and 38.2 to clarify the specific part 1
regulations that will no longer be applicable to SEFs and DCMs.
Commission regulations Sec. Sec. 1.59, 1.63, 1.64 and 1.69 would then
apply only to registered futures associations. As part of the proposed
amendments to 38.2 in this release, the Commission is proposing a
ministerial amendment to eliminate from 38.2 any references to sections
that are either ``reserved'' or have been removed.\252\ Specifically,
the Commission is proposing a ministerial amendment by eliminating
references to (i) sections 1.44, 1.53, and 1.62, all of which have been
reserved by the Commission, and (ii) part 8, which has been removed and
reserved. Finally, consistent with the exemption language now included
in proposed regulation Sec. 37.2, the Commission is renaming this
``Exempt Provision.''
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\252\ Final Rule that deleted part 8--Final Rule, Adaptation of
Regulations to Incorporate Swaps, 77 FR 66288 (November 2, 2012).
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b. Transfer of Equity Interest--Commission Regulations Sec. Sec.
37.5(c) and 38.5(c)
1. Background
The Commission proposes to amend regulations Sec. Sec. 37.5(c) and
38.5(c) to: (1) ensure the Commission receives timely and sufficient
information in the event of certain changes in the ownership or
corporate or organizational structure of a SEF or DCM; (2) clarify what
information is required to be provided and the relevant deadlines; and
(3) conform to similar existing and proposed requirements applicable to
DCOs. SEFs and DCMs can enter into transactions that result in a change
in ownership or corporate or organizational structure. In those
situations, Commission staff conducts due diligence to determine
whether the change will impact adversely the operations of the SEF or
DCM or its ability to comply with the CEA and Commission regulations.
Similarly, Commission staff also considers whether any term or
condition contained in a transaction agreement is inconsistent with the
self-regulatory responsibilities of the SEF or DCM or with the CEA or
Commission regulations. Commission staff's ability to undertake a
timely and effective due diligence review of the impact, if any, of
such transactions is essential.
While SEFs and DCMs are registered entities subject to Commission
oversight, many of these entities are part of larger corporate
families. SEF and DCM affiliates, including parent entities that own or
control the SEF or DCM, are not necessarily registered with the
Commission or otherwise subject to Commission regulations.
Understanding how these larger corporate families are structured and
how they operate may be critical to Commission staff understanding how
a change in ownership or corporate or organizational structure could
impact a SEF's or DCM's ability to comply with the CEA and Commission
regulations. For example, how finances and resources are connected or
shared between a parent, affiliates, and the SEF or DCM are critical
facts that can impact the SEF's or DCM's core principle compliance.
Similarly, how much control the parent company or an affiliate can
legally exert over a SEF or DCM may impact the exchange's compliance
culture, including governance policies.
Additionally, budgetary concerns might cause reductions in
compliance staff, or a change in surveillance vendors. Changes in
affiliate framework might also necessitate enhanced conflicts of
interest procedures. In light of the corporate changes that can occur
with respect to SEFs and DCMs, and the considerable impact such changes
may have on the SEF's or DCM's business, products, rules, and overall
compliance with the CEA and Commission regulations, the Commission is
proposing rules that will clarify and enhance the Commission's
authority to request information and documents in the event of certain
changes in a SEF's or DCM's ownership or corporate or organizational
structure.
2. Existing Regulatory Framework
Commission regulations Sec. Sec. 37.5(c)(1) and 38.5(c)(1) require
SEFs and DCMs, respectively, to notify the Commission in the event of
an equity interest transfer. However, the notification requirement
differs in two respects. First, the threshold that obligates a DCM to
notify the Commission is when the DCM enters into a transaction
involving the transfer of 10 percent or more of the equity interest in
the DCM. In comparison, a SEF is required to notify the Commission when
it enters into a transaction involving the transfer of 50 percent or
more of the equity interest in the SEF. Second, Commission regulation
Sec. 37.5(c)(1) provides that the Commission may, ``upon receiving
such notification, request supporting documentation of the
transaction.'' Commission regulation Sec. 38.5(c)(1) does not contain
a similar explicit authority for the Commission to request such
documentation for DCMs.
Commission regulations Sec. Sec. 37.5(c)(2) and 38.5(c)(2) set
forth the timing of the equity interest transfer notification to the
Commission. These regulations are substantively similar and require
notification at the earliest possible time, but in no event later than
the open of business 10 business days following the date upon which the
SEF or DCM enters into a firm obligation to transfer the equity
interest.
Commission regulations Sec. Sec. 37.5(c)(3) and 38.5(c)(3) govern
rule filing obligations that may be prompted by the equity interest
transfer. Specifically, if any aspect of the transfer necessitates the
filing of a rule as defined part 40 of the Commission's regulations,
then the SEF or DCM is required to comply with the rule filing
requirements and procedures under section 5c(c) of the CEA and
applicable Commission regulations.
Commission regulation Sec. 37.5(c)(4) provides a certification
requirement where a SEF is required to notify the Commission no later
than two days after the equity transfer takes place that the SEF meets
all of the requirements of section 5h of the CEA and the Commission
regulations adopted thereunder. DCMs do not have an analogous
certification requirement.
Finally, Commission regulations Sec. Sec. 37.5(d) and 38.5(d) make
certain delegations of authority to the Director of the Division of
Market Oversight. Commission regulation Sec. 37.5(d) provides that the
Commission delegates the authority ``set forth in this section'' to the
Director of the Division of Market Oversight. Therefore, the delegation
of authority applies to information requests related to the business of
the SEF in regulation Sec. 37.5(a), demonstrations of compliance with
the core principles and Commission regulations in Sec. 37.5(b), and
equity interest transfers in Sec. 37.5(c). In contrast, the delegation
of authority under Commission regulation Sec. 38.5(d) provides that
the Commission delegates the authority ``set forth in paragraph (b) of
this section'' to the Director of the Division of Market Oversight. The
scope of the delegation of authority provisions under Sec. 38.5(d) is
therefore limited to DCM demonstrations of compliance with the core
principles and Commission regulations in Sec. 38.5(b) and does not
extend to requests for information related to the business of the DCM
in Sec. 38.5(a) and equity interest transfers in Sec. 38.5(c).
3. Proposed Rules
The Commission proposes to amend regulation Sec. 37.5(c)(1) to
require SEFs to file with the Commission notification of transactions
involving the transfer of at least 10 percent of the equity interest in
[[Page 19680]]
the SEF.\253\ The proposed change to revise the reporting threshold
from 50 percent to 10 percent would conform the SEF requirement with
existing regulation Sec. 38.5(c)(1) for DCMs and Commission regulation
Sec. 39.19(c)(4)(ix) for DCOs. As the Commission previously stated for
DCMs, a 10 percent threshold is appropriate because a change in
ownership of such magnitude may have an impact on the operations of the
DCM.\254\ The Commission believes the same is true for SEFs. The
Commission also believes that such impact may be present even if the
transfer of equity interest does not result in a change in control. For
example, if one entity holds a 10 percent equity share in a SEF it may
have a more significant voice in the operation and/or decision-making
of the SEF than five entities each with a minority two percent equity
interest.
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\253\ In 2011, the Commission proposed a 10 percent equity
interest transfer threshold for SEFs. Core Principles and Other
Requirements for Swap Execution Facilities, 76 FR 1214 (Jan. 7,
2011). The final rule increased the threshold to 50 percent. Part 37
Final Rule, 78 FR 33476 (June 4, 2013).
\254\ Core Principles and Other Requirements for Designated
Contract Markets; Proposed Rule, 75 FR 80572 at 80576 n.32 (Dec. 22,
2010).
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Given the potential impact that a change in ownership could have on
the operations of a DCM, the Commission believes it is appropriate to
require a DCM to certify after such change that it will continue to
comply with all obligations under the CEA and Commission regulations.
The Commission believes that conforming Sec. 38.5(c) to the SEF
certification requirement will better allow the Commission to fulfill
its oversight obligations, without undue burdens on DCMs.
The Commission also is proposing to amend regulations Sec. Sec.
37.5(c)(1) and 38.5(c)(1) to expand the types of changes of ownership
or corporate or organizational structure that would trigger a
notification obligation to the Commission. The proposed amendments
would require SEFs and DCMs to report any anticipated change in the
ownership or corporate or organizational structure of the SEF or DCM,
or its respective parent(s) that would: (1) result in at least a 10
percent change of ownership of the SEF or DCM, or a change to the
entity or person holding a controlling interest in the SEF or DCM,
whether through an increase in direct ownership or voting interest in
the SEF or DCM, or in a direct or indirect corporate parent entity of
the SEF or DCM; (2) create a new subsidiary or eliminate a current
subsidiary of the SEF or DCM; or (3) result in the transfer of all or
substantially all of the assets of the SEF or DCM to another legal
entity. The proposed language generally tracks the current requirement
for DCOs in Commission regulation Sec. 39.19(c)(4)(ix)(A), as amended
by the Commission's Final Rule on Reporting and Information
Requirements for Derivatives Clearing Organizations.\255\
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\255\ Reporting and Information Requirements for Derivatives
Clearing Organizations, 88 FR 53664 (Aug. 8, 2023).
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This final rule amended Commission regulation Sec.
39.19(c)(4)(ix)(A)(1) to require a DCO to notify the Commission of
changes that result in at least a 10 percent change of ownership of the
derivatives clearing organization or a change to the entity or person
holding a controlling interest in the derivatives clearing
organization, whether through an increase in direct ownership or voting
interest in the derivatives clearing organization or in a direct or
indirect corporate parent entity of the derivatives clearing
organization.\256\
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\256\ Reporting and Information Requirements for Derivatives
Clearing Organizations, 87 FR 76698, 76716-17 (Dec. 15, 2022). See
id. at 76716-17.
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In proposing this amendment, the Commission explained that it was
proposing to amend the provision to require a DCO to report any change
to the entity or person that holds a controlling interest, either
directly or indirectly, in the DCO. The Commission noted that, because
the current rule was tied to changes in ownership of the DCO by
percentage share of ownership, DCOs are not currently required to
report all instances in which there is a change in control of the DCO.
It is possible that a change in ownership of less than 10 percent could
result in a change in control of the DCO. For example, if an entity
increases its stake in the DCO from 45 percent ownership to 51 percent,
it is possible that control of the DCO would change without any
required reporting. In addition, in some instances, a DCO is owned by a
parent company, and a change in ownership or control of the parent was
not required to be reported under the current rule despite the fact
that it could change corporate control of the DCO. The Commission noted
that the proposed changes to the rule would ensure that the Commission
has accurate knowledge of the individuals or entities that control a
DCO and its activities.\257\
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\257\ See id. at 76704.
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The Commission believes the same rationale is applicable to SEFs
and DCMs. It is possible that an increase in equity interest in an
exchange from 45 percent to 51 percent, would change control of the
exchange without required reporting under the current SEF and DCM
regulations. Similarly, a change in ownership or control of a SEF's or
DCM's parent is not required to be reported under the current
regulations even though it could change corporate control of the SEF or
DCM. The proposed changes would help to ensure that the Commission has
accurate knowledge of the individuals or entities that control a SEF or
DCM and its activities.\258\
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\258\ The Commission's Division of Market Oversight generally
addressed concepts of ownership in another rulemaking. See, e.g.,
Ownership and Control Reports, Forms 102/102S, 40/40S, and 71; Final
Rule, 78 FR 69178, 69261 (Parent--for purposes of Form 40, a person
is a parent of a reporting trader if it has a direct or indirect
controlling interest in the reporting trader; and a person has a
controlling interest if such person has the ability to control the
reporting trader through the ownership of voting equity, by
contract, or otherwise.)
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The Commission is proposing to amend Commission regulations
Sec. Sec. 37.5(c)(2) and 38.5(c)(2) to clarify what information must
be submitted to the Commission as part of a notification pursuant to
Commission regulations Sec. Sec. 37.5(c)(1) and 38.5(c)(1), as
proposed to be amended. Existing Commission regulation Sec. 37.5(c)(1)
provides that upon receiving notification of an equity interest
transfer from a SEF, the Commission may request the SEF to provide
``supporting documentation of the transaction.'' Although Commission
regulation Sec. 38.5(c)(1) currently includes a notification
requirement for DCMs regarding equity interest transfers, it does not
grant the Commission the specific authority to request supporting
documentation upon the receipt of such a notification. Accordingly, the
Commission proposes to harmonize and enhance the requirements between
SEFs and DCMs by amending Commission regulations Sec. Sec. 37.5(c)(2)
and 38.5(c)(2) to state that, as part of a notification pursuant to
Commission regulations Sec. Sec. 37.5(c)(1) or 38.5(c)(1), as proposed
to be amended, a SEF or DCM must provide ``required information''
including: a chart outlining the new ownership or corporate or
organizational structure, a brief description of the purpose or the
impact of the change, and any relevant agreement effecting the change
and corporate documents such as articles of incorporation and
bylaws.\259\ Pursuant to proposed regulations Sec. Sec. 37.5(c)(2)(i)
and 38.5(c)(2)(i), the Commission may,
[[Page 19681]]
after receiving such information, request additional supporting
documentation related to the change in ownership or corporate or
organizational structure, such as amended Form DCM or Form SEF
exhibits, to demonstrate that the SEF or DCM will, following the
change, continue to meet all the requirements in section 5 or 5h of the
CEA (as applicable) and applicable Commission regulations.
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\259\ The Commission notes that regulation Sec.
39.19(c)(4)(ix)(B) currently requires a DCO to provide the
Commission with the following: A chart outlining the new ownership
or corporate or organizational structure; a brief description of the
purpose and impact of the change; and any relevant agreements
effecting the change and corporate documents such as articles of
incorporation and bylaws.
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The Commission believes that clarifying and enhancing its authority
to request this information will encourage SEFs and DCMs to remain
mindful of their self-regulatory and market regulation responsibilities
when negotiating the terms of significant equity interest transfers or
other changes in ownership or corporate or organizational structure.
The Commission believes that it also will enhance Commission staff's
ability to undertake a timely and effective due diligence review of the
impact, if any, of such changes. In particular, parts 37 and 38 of the
Commission's regulations require the filing of certain exhibits when a
SEF or DCM applies for designation or registration. These include,
among others, Exhibit A (the name of any person who owns ten percent
(10%) or more of the Applicant's stock or who, either directly or
indirectly, through agreement or otherwise, in any other manner, may
control or direct the management or policies of the Applicant); Exhibit
B (a list of the present owners, directors, governors or persons
performing similar functions, including a description of any
disqualifications or disciplinary actions related such persons under
sections 8b and 8c of the Act); Exhibit E (a description of the
personnel qualifications for each category of professional employees),
Exhibit F (an analysis of staffing requirements necessary to carry out
key operations), Exhibit H (a brief description of any material legal
proceedings to which the SEF or DCM or any of its affiliates is a
party), Exhibit M (the rulebook), Exhibit N (applicant agreements,
including with third party service providers and member or user
agreements), and Exhibit O (the compliance manual). In the event of a
transfer of equity interest or similar ownership or corporate or
organizational change to a SEF or DCM, the proposed amendments would
strengthen Commission staff's authority to seek updated copies of such
exhibits and other documents to confirm that the SEF or DCM will
continue to be able to meet its regulatory obligations.
Pursuant to proposed regulations Sec. Sec. 37.5(c)(2)(i) and
38.5(c)(2)(i), Commission staff would have clear authority to request
amended Form SEF or DCM exhibits, such as Exhibit A. Exhibit A requires
the full name and address of each such person. One potential scenario
is that such updated exhibit reflects a non-U.S. 10 percent owner. Such
information may cause Commission staff to undertake further inquiry as
to whether the SEF or DCM, with such new non-U.S. owner, can
demonstrate it has the ability to continue satisfying all of the
requirements of section 5 of the CEA and applicable Commission
regulations. Additionally, an amended Exhibit B of the Form SEF or Form
DCM may reflect that an officer or director is disqualified or had
disciplinary action taken against them under the Act.\260\ The
Commission also notes pursuant to proposed Sec. Sec. 37.207(a) and
38.801(a), SEFs and DCMs must establish and enforce appropriate fitness
standards for, among others, their officers, directors and any person
who owns 10 percent or more of the SEF or DCM and who, either directly
or indirectly, through agreement or otherwise, in any other manner, may
control or direct the management or policies of the SEF or DCM, and any
party affiliated with any of those persons. Information obtained
through proposed regulations Sec. Sec. 37.5(c)(2) and 38.5(c)(2) will
inform the Commission as to whether the SEF or DCM remains compliant
with such minimum fitness standards.
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\260\ Exhibit B requires: a description of: (1) Any order of the
Commission with respect to such person pursuant to section 5e of the
CEA; (2) Any conviction or injunction against such person within the
past ten (10) years; (3) Any disciplinary action with respect to
such person within the last five (5) years; (4) Any disqualification
under sections 8b and 8d of the CEA; (5) Any disciplinary action
under section 8c of the CEA; and (6) Any violation pursuant to
section 9 of the CEA.
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Next, proposed Sec. Sec. 37.5(c)(3) and 38.5(c)(3) will require a
notification pursuant to Commission regulations Sec. Sec. 37.5(c)(1)
or 38.5(c)(1), as proposed to be amended, to be submitted no later than
three months prior to the anticipated change, provided that the SEF or
DCM may report the anticipated change later than three months prior to
the anticipated change if it does not know and reasonably could not
have known of the anticipated change three months prior to the
anticipated change. In such event, the SEF or DCM shall immediately
report such change to the Commission as soon as it knows of such
change. The Commission believes the proposed timing requirement strikes
the appropriate balance between allowing Commission staff sufficient
time to review the impact of the change and assess compliance with
applicable statutory and regulatory requirements, while also preserving
flexibility to the SEF or DCM if the anticipated change occurs more
quickly than within three months.
In addition to the new reporting requirements, the proposal
includes a new certification requirement for DCMs. Existing Commission
regulation Sec. 37.5(c)(4) requires the SEF, upon a transfer of equity
interest, to file a certification that it meets all of the requirements
of section 5h of the CEA and the Commission regulations adopted
thereunder. The certification must be filed no later than two business
days following the date on which the subject equity interest was
acquired. DCMs currently do not have an analogous certification
requirement.\261\ Therefore, the Commission is proposing to amend
Commission regulation Sec. 38.5(c) by adding a certification
requirement in regulation Sec. 38.5(c)(5). The certification will
require a DCM, upon a change in ownership or corporate organizational
structure described in Commission regulation Sec. 38.5(c)(1), to file
with the Commission a certification that the DCM meets all of the
requirements of section 5 of the CEA and applicable Commission
regulations. The certification must be filed no later than two business
days following the date on which the change in ownership or corporate
or organizational structure takes effect. This should be interpreted to
mean two business days after the change contemplated by the
effectuating agreements actually occurred.
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\261\ In the final rule implementing part 38 of the Commission's
regulations, the Commission stated that the documentation that the
Commission may request under Commission regulation Sec. 38.5 may
include a certification that the DCM continues to meet all of the
requirements of section 5(d) of the CEA and Commission regulations
adopted thereunder. See Part 38 Final Rule, 77 FR 36612 at 36619.
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The Commission believes that there is no substantive difference
necessitating disparate treatment between SEFs and DCMs regarding the
certification. Given their roles as self-regulatory organizations, in
the event of a subject change in ownership or corporate or
organizational structure, the Commission believes it is imperative for
the SEF or DCM to certify its compliance with the CEA and Commission
regulations. The certification will help ensure that any such changes
do not result in non-compliance. Toward that end, proposed Sec. Sec.
37.5(c)(6) and 38.5(c)(6) provide that a change in the ownership or
corporate or organizational structure of a SEF or DCM that results in
the failure of the SEF or DCM to comply with any
[[Page 19682]]
provision of the Act, or any regulation or order of the Commission
thereunder, shall be cause for the suspension of the registration or
designation of the SEF or DCM, or the revocation of registration or
designation as a SEF or DCM, in accordance with sections 5e and 6(b) of
the CEA. The proposed rule further provides that the Commission may
make and enter an order directing that the SEF or DCM cease and desist
from such violation, in accordance with sections 6b and 6(b) of the
CEA.\262\ Section 6(b) of the CEA authorizes the Commission to suspend
or revoke registration or designation of a SEF or DCM if the exchange
has violated the CEA or Commission orders or regulations. Section 6(b)
includes a number of procedural safeguards, including that it requires
notice to the SEF or DCM, a hearing on the record, and appeal rights to
the court of appeals for the circuit in which the SEF or DCM has its
principal place of business. It is imperative that SEFs and DCMs,
regardless of ownership or control changes, continue to comply with the
CEA and all Commission regulations to promote market integrity and
protect market participants.
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\262\ 7 U.S.C 7b; 7 U.S.C. 13a; 7 U.S.C 8(b).
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Finally, the Commission proposes to amend existing regulation Sec.
38.5(d) by extending the delegation of authority provisions to the
Director of the Division of Market Oversight to include information
requests related to the business of the DCM in Sec. 38.5(a) and equity
interest transfers in Sec. 38.5(c). This amendment would conform Sec.
38.5(d) to the existing delegated authority the Division of Market
Oversight has with respect to SEFs under Sec. 37.5(d). Changes in
ownership or control of a DCM can occur relatively quickly. Therefore,
the Commission believes it is important for effective oversight to
provide the Director of the Division of Market Oversight with the
authority in such circumstances, to immediately request information and
documents to confirm continued compliance by a DCM with the CEA and
relevant Commission regulations.
4. Questions for Comment
1. Proposed regulation Sec. 37.5(c)(1) revises the notification
threshold for SEFs from 50 percent to 10 percent to align with the DCM
requirement in Sec. 38.5(c)(1). Is there any reason why the threshold
should be different for SEFs?
2. Do the proposed rules provide sufficient notice and clarity to
SEFs and DCMs regarding what documents and information may be requested
by the Commission?
3. Are the timing provisions for the required notification
(proposed regulations Sec. Sec. 37.5(c)(3) and 38.5(c)(3)) and
certification (proposed regulations Sec. Sec. 37.5(c)(5) and
38.5(c)(5)) sufficiently clear? Do such timing provisions allow
sufficient time for SEFs and DCMs to provide the required notification
and certification?
VII. Effective and Compliance Dates
The Commission is proposing that the effective date for the
proposed rules be sixty days after publication of final regulations in
the Federal Register. The Commission believes that the proposed
effective date would be appropriate given that DCMs have implemented
many of the proposed rules' requirements that are being adopted from
the DCM Core Principle 16 Acceptable Practices. Additionally, many SEFs
have voluntarily adopted elements of these standards to demonstrate
compliance with SEF Core Principle 12. The Commission also proposes a
compliance date of one-year after the effective date of the final
regulations. The Commission believes this will provide current SEFs and
DCMs, as well as prospective SEF and DCM applicants, with sufficient
time to comply with the final regulations.
Question for Comment
The Commission requests comment on whether the proposed effective
date is appropriate and, if not, the Commission further requests
comment on possible alternative effective dates and the basis for any
such alternative dates.
VIII. Related Matters
a. Cost-Benefit Considerations
1. Introduction
As described above, the Commission proposes to establish governance
standards and conflicts of interest rules related to market regulation
functions, for SEFs and DCMs. Although SEFs and DCMs have similar
obligations with respect to market regulation functions, they are
subject to different obligations with respect to governance fitness
standards and mitigating conflicts of interest. SEFs and DCMs are
required to minimize and resolve conflicts of interest pursuant to
identical statutory core principles.\263\ However, with respect to
governance fitness standards, DCMs are subject to specific statutory
core principles addressing governance,\264\ while SEFs do not have
parallel core principle requirements. Additionally, SEFs and DCMs
currently have different regulatory obligations with respect to
governance fitness standards.\265\ Further, while both SEFs and DCMs
are subject to equity transfer requirements,\266\ the applicable
regulatory provisions currently have different notification thresholds
and obligations.
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\263\ See SEF Core Principle 12, Commodity Exchange Act
(``CEA'') section 5h(f)(12), 7 U.S.C. 7b-3(f)(12), and DCM Core
Principle 16, CEA section 5(d)(16), 7 U.S.C. 7(d)(16).
\264\ See DCM Core Principles 15 and 17, CEA section 5(d)(15), 7
U.S.C. 7(d)(15), and CEA section 5(d)(17), 7 U.S.C. 7(d)(17),
respectively.
\265\ As discussed below, SEFs, but not DCMs, are required to
comply with requirements under part 1 of the Commission's
regulations addressing the sharing of nonpublic information, service
on the board or committees by persons with disciplinary histories,
board composition, and voting by board or committee members persons
where there may be a conflict of interest.
\266\ Commission regulation Sec. 37.5(c) (SEFs) and Commission
regulation Sec. 38.5(c) (DCMs).
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Section 15(a) of the CEA requires the Commission to consider the
costs and benefits of its actions before promulgating a regulation
under the CEA or issuing certain orders.\267\ Section 15(a) further
specifies that the costs and benefits shall be evaluated in light of
the following 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 considers the costs and
benefits resulting from its discretionary determinations with respect
to the section 15(a) factors (collectively referred to herein as
``Section 15(a) Factors'') below.
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\267\ 7 U.S.C. 19(a).
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The goal of the proposed rulemaking is to provide SEFs and DCMs
with a clear regulatory framework for implementing governance standards
to promote the integrity of its self-regulatory functions and for
identifying, managing, and resolving conflicts of interest related to
their market regulation functions. Specifically, the proposed
rulemaking harmonizes and enhances the existing SEF and DCM regulations
by proposing: (1) new rules to implement DCM Core Principle 15
(Governance Fitness Standards) that are consistent with the existing
guidance on compliance with DCM Core Principle 15 (Governance Fitness
Standards); (2) new rules to implement DCM Core Principle 16 (Conflicts
of Interest) that are consistent with the DCM Core Principle 16
Guidance and Acceptable Practices; (3) new rules to implement SEF Core
Principle 2 (Compliance With Rules)
[[Page 19683]]
that are consistent with the DCM Core Principle 15 Guidance; (4) new
rules to implement SEF Core Principle 12 (Conflicts of Interest) that
are consistent with the DCM Core Principle 16 Guidance and Acceptable
Practices; (5) new rules under part 37 of the Commission's regulations
for SEFs and part 38 of the Commission's regulations for DCMs that are
consistent with existing conflicts of interest and governance
requirements under Commission regulations Sec. Sec. 1.59 and 1.63; (6)
new rules for DCM Chief Regulatory Officers (``CROs''); (7) amendments
to certain requirements relating to SEF Chief Compliance Officers
(``CCOs''); and (8) new rules for SEFs and DCMs relating to the
establishment and operation of a Regulatory Oversight Committee
(``ROC'').
The Commission recognizes that the proposed changes in this release
could result in benefits, but also could impose costs. Any initial and
recurring compliance costs for any SEF or DCM will depend on the size,
existing infrastructure, practices, and cost structure of the entity.
The Commission has endeavored to provide qualitative analysis of costs
based on its experience overseeing SEFs and DCMs. The Commission
generally requests comment on all aspects of its cost-benefit
considerations, including the identification and assessment of any
costs and benefits not discussed herein; data and any other information
to assist or otherwise inform the Commission's ability to quantify or
qualitatively describe the costs and benefits of the proposed
amendments; and substantiating data, statistics, and any other
information to support positions posited by commenters with respect to
the Commission's discussion. The Commission welcomes comment on such
costs and benefits.
2. Baseline
The baseline for the Commission's consideration of the costs and
benefits of this proposed rulemaking is the existing statutory and
regulatory framework regarding conflicts of interests and governance
standards for SEFs and DCMs. The existing governance requirements and
conflicts of interest standards for SEFs are set forth in SEF Core
Principles 2, 12 and 15,\268\ and certain regulations in part 1 of the
Commission's regulations that apply to SROs, including SEFs. SEFs must
comply with SEF Core Principle 2, requiring SEFs to establish and
enforce rules governing the operation of the SEF.\269\ Commission
regulation Sec. 1.59 provides limits on the use and disclosure of SEF
material, non-public information. Commission regulation Sec. 1.63
restricts persons with certain disciplinary histories from serving on
disciplinary committees, arbitration panels, oversight panels or the
governing board of a SEF. Commission regulation Sec. 1.64 sets forth
requirements for the composition of SEF governing boards and major
disciplinary committees. Commission regulation Sec. 1.69 requires a
SEF to have rules to prevent members of the board of directors,
disciplinary committees, or oversight panels, to abstain from
deliberating and voting on certain matters that may raise conflicts of
interest.
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\268\ See CEA section 5h(f)(2), 7 U.S.C. 7b-3(f)(2), CEA section
5h(f)(12), 7 U.S.C. 7b-3(f)(12) and CEA section 5h(f)(15), 7 U.S.C.
7b-3(f)(15).
\269\ CEA section 5h(f)(2), 7 U.S.C. 7b-3(f)(2).
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The existing requirements for DCMs to minimize and resolve
conflicts of interests are outlined in DCM Core Principle 16.\270\ DCMs
must also comply with DCM Core Principle 15, which sets forth
governance fitness standards for members of the board of directors or
disciplinary committees, members of the contract market, any other
person with direct access to the facility, and any person affiliated
with those enumerated individuals. Additionally, DCM Core Principle 17
requires a DCM's governance arrangements be designed to consider the
views of market participants and DCM and Core Principle 22 requires
DCMs that are publicly traded to endeavor to have boards of directors
and other decision-making bodies composed of diverse individuals. DCMs
are also subject to existing regulatory requirements in Commission
regulation Sec. 1.63(c), that disqualifies individuals with certain
disciplinary histories from serving on DCM governing boards,
arbitration or oversight panels, or disciplinary committees.
disciplinary committees, arbitration panels, oversight panels or the
governing board of a DCM. Although DCMs are exempt from Commission
regulation Sec. 1.59(b) and (c), Commission regulation Sec. 1.59(d)
directly prohibits members of the board of directors, committee
members, or consultants of a self-regulatory organization from trading
for their own account, or for or on behalf of any other account, based
on this material non-public information.
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\270\ The Commission, however, notes that--as a practical
matter--all of the DCMs that are currently designated by the
Commission rely on the acceptable practices to comply with Core
Principle 16, in lieu of any other means for compliance. As such,
the actual costs and benefits of the codification of those
acceptable practices with respect to DCMs, as realized in the
market, may not be as significant.
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Both SEFs and DCMs are subject to equity interest transfer
requirements set forth in Commission regulations Sec. Sec. 37.5(c) and
38.5(c), respectively.
The Commission notes that this cost-benefit consideration is based
on its understanding that the derivatives market regulated by the
Commission functions internationally with: (1) transactions that
involve U.S. entities occurring across different international
jurisdictions; (2) some entities organized outside of the United States
that are registered with the Commission; and (3) some entities that
typically operate both within and outside the United States and that
follow substantially similar business practices wherever located. Where
the Commission does not specifically refer to matters of location, the
discussion of costs and benefits below refers to the effects of the
proposed rules on all relevant derivatives activity, whether based on
their actual occurrence in the United States or on their connection
with, or effect on, U.S. commerce.\271\
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\271\ See, e.g., 7 U.S.C. 2(i).
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3. Proposed Rules
i. Minimum Fitness Standards--Proposed Sec. Sec. 37.207 and 38.801
SEFs must comply with SEF CP 2, which requires SEFs to establish
and enforce rules governing the operation of its facility.\272\
Currently, SEFs must also comply with all requirements in Commission
regulation Sec. 1.63, which restricts persons with certain
disciplinary histories from serving on disciplinary committees,
arbitration panels, oversight panels or the governing board of a SEF,
because SEFs qualify as SROs and are not otherwise exempt. While DCMs
are also SROs, they are exempt from Commission regulations Sec. Sec.
1.63(a), (b), and (d)-(f), pursuant to Commission regulation Sec.
38.2. DCMs are not, however, exempt from Commission regulation 1.63(c),
which provides that persons are disqualified from serving on
disciplinary committees, arbitration panels, oversight panels or the
governing board of a DCM if they are subject to any of the disciplinary
offenses found in Sec. 1.63(b). DCMs must also comply with DCM Core
Principle 15, requiring DCMs to establish and enforce appropriate
fitness standards for directors, members of any disciplinary committee,
members of the contract market, and any other person with direct access
to the facility (including
[[Page 19684]]
any party affiliated with any person described in this paragraph).\273\
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\272\ CEA section 5h(f)(2); 7 U.S.C. 7b-3(f)(2).
\273\ CEA section 5(d)(15); 7 U.S.C. 7(d)(15).
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Proposed Sec. Sec. 37.207(a) and 38.801(a) would require SEFs and
DCMs to establish and enforce appropriate fitness requirements for
officers, members of its board directors, committees, disciplinary
panels, dispute resolution panels, any other persons with direct access
to the SEF or DCM, any person who owns 10 percent or more of the SEF or
DCM and who, either directly or indirectly, through agreement or
otherwise, in any other manner, may control or direct the management or
policies of the SEF or DCM, and for any party affiliated with any of
the foregoing. In subparts (b), and (c) of proposed Sec. Sec. 37.207
and 38.801, the Commission has identified certain minimum fitness
standards that SEFs and DCMs would be required to establish and
enforce. First, under subpart (b), SEFs and DCMs would be required to
include the basis for refusal to register a person under sections
8(a)(2) and 8a(3) of the CEA as minimum fitness standards for members
of its board of directors, committees, disciplinary panels, dispute
resolution panels, for members with voting privileges, and any person
who owns 10 percent or more of the SEF or DCM and who, either directly
or indirectly, through agreement or otherwise, in any other manner, may
control or direct the management or policies of the SEF or DCM. Second,
under subpart (c), SEF and DCM minimum fitness standards would be
required to include six offenses the Commission has identified as
disqualifying for key decision-makers, including members of its board
of directors, committees, disciplinary panels, and dispute resolution
panels.
Commission regulation Sec. 1.63(d) requires each SRO to provide
the Commission with a certified list of persons removed from a
disciplinary committee, arbitration panel, or oversight panel, in the
previous year. In addition to the above standards, proposed Sec. Sec.
37.207(d) and 38.801(d) would require that SEFs and DCMs to establish
new procedures for the initial and annual collection, verification, and
preservation of information supporting compliance with appropriate
fitness standards.
A. Benefits
The Commission believes that requiring appropriate, minimum fitness
standards for individuals with the ability to exercise influence or
control over the operations of SEFs and DCMs, including their market
regulation functions, will improve the integrity and effectiveness of
SEFs and DCMs in their role as SROs. By establishing automatic
disqualifiers, including disqualifications described in CEA sections
8a(2) and 8a(3), or a history of disciplinary offenses described in
Commission regulation Sec. 1.63, SEFs and DCMs may benefit by
attracting individuals with demonstrated ethical conduct and sound
decision-making to those influential roles. Proposed Sec. Sec. 37.207
and 38.801 are likely to reduce the likelihood and the extent of harm
caused by individuals with a history of disciplinary offenses to the
operations of SEFs and DCMs, including their market regulation
functions. In addition, clear minimum standards for individuals with
the ability to influence or control the governance of SEFs and DCMs
will provide market participants using exchange services, as well as
exchange shareholders, with greater confidence in key SEF and DCM
decision-makers. Ongoing verification of the fitness of these decision-
makers may also provide greater accountability and trust in the
management and operations of SEFs and DCMs. Such requirements may also
increase the trust of market participants using exchange services.
Establishing automatic disqualifiers and establishing independent
fitness verification procedures for SEFs and DCMs are likely to aid in
identifying trustworthy individuals to serve in roles with the ability
to control or influence the governance of the exchange or its market
regulation functions. It is important that the individuals able to
influence or control a SEF's and DCM's governance, management, and
disciplinary standards have a record of integrity and rectitude. Such
record provides confidence that those individuals will be able to
effectuate a SEF's or DCM's obligations to establish and enforce its
rules, and a DCM's obligation to establish and enforce appropriate
minimum fitness requirements.\274\
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\274\ The minimum fitness requirements facilitate a SEF's and
DCM's ability to establish and enforce their rules, in accordance
with SEF Core Principle 2 (Compliance with Rules), CEA section
5h(f)(2); 7 U.S.C. 7b-3(f)(2), DCM Core Principle 2 (Compliance with
Rules), CEA section 5(d)(2); 7 U.S.C. 7(d)(2), and DCM Core
Principle 15, respectively.
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Finally, as discussed above, SEFs currently must comply with all
requirements in Commission regulation Sec. 1.63. To the extent SEFs
are already compliant with this regulation, the benefits of proposed
Sec. 37.207 may be less significant. Similarly, DCMs currently must
comply with Commission regulation Sec. 1.63(c) and DCM Core Principle
15. To the extent that DCMs are already compliant with Sec. 1.63(c)
and DCM Core Principle 15, the benefits of proposed Sec. 38.801 may be
less significant. Finally, to the extent that SEFs or DCMs have already
implemented rules consistent with all aspects of the DCM Core Principle
15 Guidance, the benefits of proposed Sec. 37.207 and Sec. 38.801 may
be less significant.\275\
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\275\ As described supra, Section III(a)(Proposed Governance
Fitness Standards--Proposed Sec. Sec. 37.207 and 38.801), the
proposed minimum fitness standards are consistent with the existing
DCM Core Principle 15 Guidance, subject to certain enhancements
described therein.
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B. Costs
The Commission believes that SEFs and DCMs would incur additional
costs from proposed Sec. Sec. 37.207 and 38.801 through the additional
hours SEF and DCM employees might need to spend analyzing the
compliance of their existing rules and procedures with these proposed
requirements, and implementing new or amended rules and procedures, as
necessary. Specifically, SEFs and DCMs may incur costs in the form of
administrative time related to drafting new policies to comply with the
proposed fitness standards and verification procedures. Costs
associated with complying with proposed Sec. Sec. 37.207 and 38.801
may further vary based on the size of the SEF or DCM, available
resources, and existing practices and policies. Accordingly, those
costs would be impracticable to reasonably quantify. The Commission
believes that the policies and procedures required for implementing
minimum fitness standards would likely not change significantly from
year to year, so after the initial creation of the policies and
procedures, the time required to maintain those policies and procedures
would be negligible.
When implementing proposed Sec. Sec. 37.207 and 38.801, to the
extent that the current officers or membership of their board of
directors, or committees do not meet the proposed minimum fitness
requirements, SEFs and DCMs may need to make changes to their officers,
members of their board of directors, or committees. This might lead to
additional costs related to any time and efforts SEFs and DCMs may need
to take to find suitable candidates.
The Commission notes that, regarding DCMs, the above costs may be
mitigated to the extent that a DCM is already complying with DCM Core
Principle 15 and Commission regulation Sec. 1.63(c). Additionally, to
the extent a DCM has already implemented practices
[[Page 19685]]
consistent with DCM Core Principle 15 Guidance, some of the costs may
have been already realized. The DCM Core Principle 15 Guidance states
that minimum fitness standards for persons who have member voting
privileges, governing obligations or responsibilities, or who exercise
disciplinary authority, should include those bases for refusal to
register a person under section 8a(2) of the CEA.\276\ Additionally,
the DCM Core Principle 15 Guidance states that persons who have
governing obligations or responsibilities, or who exercise disciplinary
authority, should not have a significant history of serious
disciplinary offenses, such as those that would be disqualifying under
Commission regulation Sec. 1.63.\277\ As a practical matter, many DCMs
may have already adopted practices consistent with the Core Principle
15 Guidance. As such, the actual costs of the proposed rules amendments
may be less significant.
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\276\ See Appendix B to part 38, Guidance to Core Principle 15
of section 5(d) of the Act, Governance Fitness Standards.
\277\ Id.
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The costs to implement the proposed Sec. Sec. 37.207 and 38.801
minimum fitness requirements for SEFs may be mitigated to the extent
that they already have a framework in place to comply with existing
Commission regulation Sec. 1.63, which sets forth requirements and
procedures to prevent persons with certain disciplinary histories from
serving in certain governing or oversight capacities as an SRO.
Proposed Sec. Sec. 37.207 and 38.801 require each SEF and DCM to
establish appropriate procedures for the collection and verification of
information supporting compliance with appropriate fitness standards.
Ongoing implementation of the proposed rules would also impose costs
associated with the time required to collect and verify a candidate's
fitness in a timely manner, to document the findings with respect to
the fitness standards, to make the findings available to the Commission
as a part of staff's oversight activities, and to re-verify fitness
eligibility on an annual basis. Similar to above, a SEF's or DCM's
costs may be less significant if it is already following the DCM Core
Principle 15 Guidance, which states that DCMs should have standards for
the collection and verification of information supporting compliance
with the DCM's fitness standards.
The Commission requests comments on the potential costs of proposed
Sec. Sec. 37.207 and 38.801, including any costs that would be imposed
on SEFs, DCMs, other market participants, or the financial system more
broadly.
C. Section 15(a) Factors
In addition to the discussion above, the Commission has evaluated
the costs and benefits of proposed Sec. Sec. 37.207 and 38.801 with
regard to the specific considerations identified in Section 15(a) of
the CEA. The Commission believes that proposed Sec. Sec. 37.207 and
38.801 may protect market participants and the public, as well as the
financial integrity of the markets, by ensuring the integrity of
individuals influencing the decisions made by SEFs and DCMs. By having
fit and reputable decision-makers, the Commission believes SEFs and
DCMs are likely able to increase industry and public trust in their
organizations and markets. Minimum fitness standards also may increase
the confidence in the decisions made by officers and members of its
board of directors, committees, disciplinary panels, dispute resolution
panels, and certain owners. The Commission believes that trust and
confidence in SEF and DCM leadership fosters market participation,
which could in turn enhance liquidity, price discovery, and the
financial integrity of markets. The Commission has considered the other
Section 15(a) Factors and believes that they are not implicated by the
proposed amendments to Sec. Sec. 37.207 and 38.801.
ii. General Requirements for Addressing Conflicts of Interest and
Definitions--Proposed Sec. Sec. 37.1201 and 38.851
Currently, both SEFs and DCMs have an obligation under SEF Core
Principle 12 and DCM Core Principle 16 to minimize and resolve
conflicts of interest in their decision-making. Additionally, DCM Core
Principle 16 Acceptable Practices set forth practices for complying
with Core Principle 16. By contrast, there are no acceptable practices
or guidance for SEF Core Principle 12.
Proposed Sec. Sec. 37.1201(a) and 38.851(a) require SEFs and DCMs
to establish processes for identifying, minimizing, and resolving
actual and potential conflicts of interest that may arise. Proposed
Sec. Sec. 37.1201(b) and 38.851(b) revise existing definitions \278\
and define two new terms. First, the term ``market regulation
function,'' under Sec. 38.851(b)(9) means DCM functions required by
DCM Core Principle 2, DCM Core Principle 4, DCM Core Principle 5, DCM
Core Principle 10, DCM Core Principle 12, DCM Core Principle 13, DCM
Core Principle 17 and the applicable Commission regulations thereunder.
``Market regulation function'' under Sec. 37.1201(b)(9) means SEF
functions required by SEF Core Principle 2, SEF Core Principle 4, SEF
Core Principle 6, SEF Core Principle 10 and the applicable Commission
regulations thereunder. Second, the proposed rules define the term
``affiliate,'' which refers to a person that directly, or indirectly,
controls, or is controlled by, or is under common control with, the SEF
or DCM.
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\278\ The DCM Core Principle 16 Acceptable Practices defines a
``public director'' as an individual with no material relationship
to the DCM and describes the term ``immediate family'' to include
spouse, parents, children, and siblings. The terms ``material
information,'' ``non-public information,'' ``commodity interest,''
``related commodity interest,'' and ``linked exchange'' are defined
in Commission regulation Sec. 1.59. ``Material information'' is
defined in Sec. 1.59(a)(5) to mean information which, if such
information were publicly known, would be considered important by a
reasonable person in deciding whether to trade a particular
commodity interest on a contract market or a swap execution
facility, or to clear a swap contract through a derivatives clearing
organization. ``Non-public information'' is defined in Sec.
1.59(a)(6), as information which has not been disseminated in a
manner which makes it generally available to the trading public.
Commission regulations Sec. 1.59(a)(8) and (9) define ``commodity
interest,'' to include all futures, swaps, and options traded on or
subject to the rules of a SEF or DCM and ``related commodity
interest'' to include any commodity interest which is traded on or
subject to the rules of a SEF, DCM, linked exchange, or other board
of trade, exchange, or market, or cleared by a DCO, other than the
self-regulatory organization by which a person is employed, and
which is subject to a self-regulatory organization's intermarket
spread margins or other special margin treatment. Commission
regulations Sec. 1.59(a)(5), (a)(6), (a)(8), and (a)(9).
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A. Benefits
The Commission believes that SEF and DCM conflict of interest
processes, as required by proposed Sec. Sec. 37.1201(a) and 38.851(a),
are likely to provide the framework necessary for SEFs and DCMs to
minimize conflicts of interest and comply with their core principle
requirements. The specific conflicts of interest this proposal
addresses relate to market regulation functions, i.e., SEF and DCM
functions that promote market integrity and orderly conduct in the
markets.\279\
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\279\ E.g., trade practice surveillance, market surveillance,
real-time market monitoring, audit trail data and recordkeeping
enforcement, investigations of possible SEF or DCM rule violations,
and disciplinary actions.
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The Commission believes that the new definitions for ``market
regulation functions'' and ``affiliate'' in proposed Sec. Sec.
37.1201(b) and 38.851(b) will provide benefits, including operational
efficiency. SEFs and DCMs will spend less time and resources in
determining how to comply with regulatory requirements. Moreover, the
definitions will provide additional regulatory certainty and risk
reduction; delineate
[[Page 19686]]
the responsibilities addressed by SEF and DCM regulations, including
which functions are considered self-regulatory versus market
regulation; and clarify which relationships are affiliate
relationships. Reducing ambiguities regarding the meaning of these
terms should promote regulatory compliance.
B. Costs
SEFs and DCMs may incur additional costs from proposed Sec. Sec.
37.1201(a) and 38.851(a) in terms of employee hours spent analyzing
whether existing rules and procedures comply with the proposed
requirements, and drafting and implementing new or amended rules and
procedures, as necessary. Costs associated with complying with proposed
Sec. Sec. 37.1201 and 38.851 may further vary based on the size of the
SEF or DCM, available resources, and existing practices, rules, and
procedures. Accordingly, those costs would be impracticable to
reasonably quantify. Further, rules and procedures required for
implementing the proposed conflict of interest requirements would
likely not change significantly from year to year, so after the initial
creation of such rules and procedures, the time required to maintain
those rules and procedures would be negligible.
The Commission does not believe that there any independent costs
related to the amended and new definitions in proposed Sec. Sec.
37.1201(b) and 38.851(b). Costs that might be associated with the
proposed definitions will likely arise in connection with implementing
the conflict of interest requirements under proposed Sec. Sec.
37.1201(a) and 38.851(a).
The Commission requests comments on the potential costs of proposed
Sec. Sec. 37.1201 and 38.851, including any costs that would be
imposed on SEFs, DCMs, other market participants, or the financial
system more broadly.
C. Section 15(a) Factors
In addition to the discussion above, the Commission has evaluated
the costs and benefits of proposed Sec. Sec. 37.1201 and 38.851 with
regard to the specific considerations identified in Section 15(a) of
the CEA. The Commission believes that proposed Sec. Sec. 37.1201 and
38.851 may have a beneficial effect on the protection of market
participants and the public, as well as on the financial integrity of
the markets by ensuring that SEFs and DCMs have an adequate framework
for addressing potential conflicts of interest. Procedures for
identifying conflicts of interest also may reduce the risk of decision-
makers being influenced by concerns that are not in the best interest
of the SEF's or DCM's market regulation functions. Rules and processes
to identify and manage conflicts of interest also aid in ensuring that
decision-makers are accountable to SEFs and DCMs, and therefore,
proposed Sec. Sec. 37.1201 and 38.851 may lead to increased trust in
SEF and DCM markets by market participants and the public. The
Commission has considered the other Section 15(a) Factors and believes
they are not implicated by proposed Sec. Sec. 37.1201 and 38.851.
iii. Conflicts of Interest in Decision-Making--Proposed Sec. Sec.
37.1202 and 38.852
As described above, SEFs are subject to the requirements of SEF
Core Principle 12, requiring SEFs to establish and enforce rules and
processes to identify and resolve conflicts of interest.\280\
Currently, SEFs are also required to comply with Commission regulation
Sec. 1.69, which requires SROs to have rules requiring any member of
its board of directors, disciplinary committees, or oversight panels to
disclose conflicts of interest and abstain from deliberating and voting
in actions with certain personal or financial conflicts of interest.
DCMs, however, are exempt from these requirements pursuant to
Commission regulation Sec. 38.2.
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\280\ Supra Section II(a).
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The Commission is proposing to make a conforming amendment to
Commission regulation Sec. 37.2 to exempt SEFs from Commission
regulation Sec. 1.69. However, the Commission is also proposing
Sec. Sec. 37.1202 and 38.852, which incorporate certain elements of
existing Commission regulation Sec. 1.69, for both SEFs and DCMs,
along with certain modifications and enhancements. Notably, the
Commission proposes to redefine the term ``family relationship'' to
enhance and modernize the conflict of interest disclosure requirements.
For example, under Sec. 1.69, if a member of the board of
directors, disciplinary committee, or oversight panel, has a
relationship with a named party in interest \281\ that falls within the
enumerated relationships in Sec. 1.69(b)(1)(i)(A)-(E), the member is
required to abstain from deliberating and voting on that matter. One of
the enumerated relationships is a ``family relationship,'' which is
currently defined as a person's spouse, parent, stepparent, child,
stepchild, sibling, stepbrother, stepsister, or in-law.\282\
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\281\ As defined in Commission regulation Sec. 1.69(a).
\282\ Commission regulation Sec. 1.69(a)(2).
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In proposed Sec. Sec. 37.1201(b)(7) and 38.851(b)(7), the
Commission redefines ``family relationship,'' as the person's spouse,
parents, children, and siblings, in each case, whether by blood,
marriage, or adoption, or any person residing in the home of the
person. This proposed definition focuses on the closeness of the
relationship that the officer, or member of the board of directors,
committee, or disciplinary panel has with the subject of the matter
being considered. The proposed definition also reflects a more modern
description of the relationships intended to be covered.
More broadly, proposed Sec. Sec. 37.1202(a) and 38.852(a) require
SEFs and DCMs to establish policies and procedures requiring any
officer or member of their board of directors, committees, or
disciplinary panels to disclose any actual or potential conflicts of
interest that may be present prior to considering any matter. Proposed
Sec. Sec. 37.1202(a)(1) and 38.852(a)(1) provide a list of enumerated
relationships that are deemed to be conflicts of interest, and proposed
Sec. Sec. 37.1202(a)(2) and 38.852(a)(2) would extend the
applicability of these enumerated relationships that an officer or
member of their board of directors, committees, or disciplinary panels
has with an affiliate of the subject of any matter being considered.
Similar to existing Sec. 1.69(b)(4), proposed Sec. Sec. 37.1202(b)
and 38.852(b) require documentation of conflict of interest
determinations. Specifically, under the proposed rules, SEFs and DCMs
must require members of their board of directors, committees, and
disciplinary panels to document in meeting minutes, or otherwise
document in a comparable manner, compliance with the applicable
requirements.
A. Benefits
Requiring SEF and DCM officers, and members of their board of
directors, committees, or disciplinary panels to disclose conflicts of
interests before considering a matter, under proposed Sec. Sec.
37.1202 and 38.852, is essential to implementing the goals of this
proposed rulemaking. Given the governing authority bestowed upon key
decision-makers, it is crucial that their decision-making is guided by
the best interests of the SEF or DCM, and is not influenced by personal
or financial gain. In requiring these key decisions-makers to be
transparent about relationships that may raise conflicts of interest,
SEFs and DCMs are better able to hold these individuals accountable.
Additionally, the Commission believes that proposed Sec. Sec.
37.1202(a) and 38.852(a) are beneficial because requirements to
disclose conflicts of interests promote transparency in the decision-
making
[[Page 19687]]
process relating to SEF and DCM market regulation functions, further
promoting confidence in their markets.
The Commission believes that the proposed Sec. Sec. 37.1202(b) and
38.852(b) documentation requirements have several additional benefits.
First, documentation requirements identifying conflicts of interest and
recusals promotes transparency, ensures that conflicts of interests
have been managed, and provides useful precedent for how the SEF or DCM
can manage similar types of conflicts of interest in the future.
Second, requiring conflicts of interest to be documented, rather than
simply disclosed, is likely to promote more accountability among
members of the board of directors, committees, and disciplinary panels.
Third, this documentation is important evidence demonstrating
compliance efforts, which can aid the SEF, DCM, and the Commission, in
conducting oversight.
SEFs currently are subject to Commission regulation Sec. 1.69.
Therefore, to the extent SEFs already are compliant with Commission
regulation Sec. 1.69, the benefits of proposed Sec. 37.1202 may be
less significant. Similarly, if DCMs, as a matter of industry practice,
already have procedures in place consistent with Commission regulation
Sec. 1.69 requirements, the benefits of proposed Sec. 38.852 may be
less significant.
B. Costs
The Commission believes that SEFs will not incur significant costs
implementing proposed Sec. 37.1202 as the requirements of the proposed
rule are similar to the existing Commission regulationSec. 1.69
requirements. SEFs may incur some administrative costs of analyzing
their existing rules and procedures to determine whether they comply
with proposed Sec. 37.1202, as the proposed rule, as discussed above,
contains some enhancements, such as the new definition of ``family
relationship,'' that do not exist in Commission regulation Sec. 1.69.
DCMs may incur costs implementing proposed Sec. 38.852, including
the administrative costs of analyzing their existing rules and
procedures to determine whether they comply with the proposed
requirements, and drafting and implementing new or amended rules and
procedures, as necessary. Additionally, proposed Sec. 38.852 requires
disclosures to be made by DCM officers or members of the board of
directors when any actual or potential conflict of interest may be
present, and requires these officers or members of the board of
directors to abstain from deliberations and voting on issues where the
individual is conflicted. Costs will arise not only from administrative
time in handling the disclosure, but also in the required documentation
to ensure compliance with the intent of the proposed rules.
Furthermore, there may be additional costs incurred when conflicted
individuals abstain from deliberations and the DCM officers, and
members of the board of directors, committees, and disciplinary panels
potentially need to seek additional information from independent, non-
conflicted experts and consultants. Finally, the Commission believes
that DCMs will incur costs related to collecting and storing documents
evidencing conflicts of interest determinations. The Commission notes
that some of these costs may be less significant to the extent that
DCMs have voluntarily adopted the requirements of Commission regulation
Sec. 1.69.
Costs associated with complying with the proposed Sec. Sec.
37.1202 and 38.852 may further vary based on the size of the SEF or
DCM, available resources, and existing practices and policies. Further,
conflict of interest policies required for implementing proposed
Sec. Sec. 37.1202 and 38.852, would likely not significantly change
from year to year, so after the initial creation of the policies, the
time required to maintain and amend rules and procedures would be
negligible.
The Commission requests comments on the potential costs of proposed
Sec. Sec. 37.1202 and 38.852, including any costs that would be
imposed on SEFs, DCMs, other market participants, or the financial
system more broadly.
C. Section 15(a) Factors
In addition to the discussion above, the Commission has evaluated
the costs and benefits of proposed Sec. Sec. 37.1202 and 38.852 in
light of the specific considerations identified in Section 15(a) of the
CEA. The Commission believes that proposed Sec. Sec. 37.1202 and
38.852 may have a beneficial effect on protection of market
participants and the public, as well as on the financial integrity of
the markets, by taking steps to help ensure the impartiality of key SEF
and DCM decision-makers, particularly those persons responsible for the
exchange's market regulation functions. Identifying and documenting
actual and potential conflicts of interest before reviewing a matter
may reduce the risk of decision-makers being influenced by personal
interests rather than acting in best interest of the SEF or DCM, and,
ultimately, market participants and the public. Such a requirement also
is likely to hold decision-makers accountable to SEFs and DCMs and may
foster market participant and public trust in the SEFs and DCMs, which
is also essential to maintaining the integrity of markets. The
Commission has considered the other Section 15(a) factors and believes
that they are not implicated by proposed Sec. Sec. 37.1202 and 38.852.
iv. Limitations on the Use and Disclosure of Material Non-Public
Information--Proposed Sec. Sec. 37.1203 and 38.853
Currently, Commission regulation Sec. 1.59 generally requires SROs
to adopt rules prohibiting employees, governing board members,
committee members or consultants from trading commodity interests on
the basis of material non-public information. DCMs are exempt from
Commission regulation Sec. 1.59(b) and (c), but the entirety of Sec.
1.59 applies to SEFs. As previously described in detail,\283\ both SEFs
and DCMs must comply with the requirements of Commission regulation
Sec. 1.59(d), which prohibits members of the board of directors,
committee members, or consultants of the SRO from trading for their own
account, or for or on behalf of any other account, based on material
non-public information.
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\283\ Supra Section IV(c).
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In addition to the Commission's statutory authority on insider
trading,\284\ DCMs are subject to Core Principle 16, which requires
DCMs to establish and enforce rules to minimize conflicts of interest.
DCM Core Principle 16 Guidance provides that DCMs should provide
appropriate limitations on the use or disclosure of material non-public
information gained through performance of official duties by members of
the board of directors, committee members, and DCM employees, or gained
by those through an ownership interest in the DCM.\285\
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\284\ See CEA section 9(e), 7 U.S.C. 13(e).
\285\ See Appendix B to part 38, Core Principle 16 Guidance.
---------------------------------------------------------------------------
Proposed Sec. Sec. 37.1203 and 38.853 would require SEFs and DCMs
to establish and enforce policies and procedures for their employees,
members of the board of directors, committee members, and consultants
to prohibit the disclosure of material non-public information and to
prohibit trading if the individual has access to material non-public
information. Additionally, proposed Sec. Sec. 37.1203 and 38.853 would
provide conditions under which exemptions to employee trading
prohibitions could be granted.
Proposed Sec. Sec. 37.1203(c) and 38.853(c) state that SEFs and
DCMs may grant trading exemptions to employees pursuant to its policies
and procedures,
[[Page 19688]]
on a case-by-case basis, only if certain requirements are met,
including: (1) the ROC approves the trading exemption; (2) the employee
can demonstrate that the trading is not being conducted on the basis of
material non-public information gained through the performance of their
official duties; and (3) the SEF or DCM documents the employee's
exemption in accordance with requirements in existing Commission
regulations Sec. Sec. 37.1000 and 37.1001, or 38.950 and 38.951, as
applicable. Additionally, proposed Sec. Sec. 37.1203(d) and 38.853(d)
would require SEFs and DCMs to diligently monitor trading activity
conducted pursuant to such exemptions.
A. Benefits
The Commission believes proposed Sec. Sec. 37.1203(a) and
38.853(a), requiring SEFs and DCMs to establish policies and procedures
to safeguard the use and disclosure of material non-public information,
will result in several benefits. Generally, the Commission believes
that these proposed rules are likely to result in benefits by reducing
the instances of conflicts of interest where persons responsible for
exchange governance or market regulation functions take advantage of
their roles for personal financial benefit. Establishing consistent and
clearly defined standards is likely to reduce instances of the misuse
and disclosure of material non-public information by employees, members
of the board of directors, committee members, and consultants at SEFs
and DCMs and promote public confidence in the markets. In addition,
preventing SEF and DCM employees or insiders with access to material
non-public information from leveraging their access to benefit
themselves, or others, commercially or otherwise, promotes fair and
transparent markets, which will benefit all the market participants.
There also will be benefits from the requirements in proposed
Sec. Sec. 37.1203(b) and 38.853(b), which prohibit employees from
certain types of trading or disclosing for any purpose inconsistent
with the performance of the person's official duties as an employee any
material non-public information obtained as a result of such person's
employment. Additionally, the parameters outlined in proposed
Sec. Sec. 37.1203(c) and 38.853(c) for granting exemptions to the
employee trading prohibition, along with the new requirement to monitor
such exemptions under proposed Sec. Sec. 37.1203(d) and 38.853(d), are
likely to deter misuse of the employee trading exemptions.
Additionally, these proposed rules may also promote confidence in the
market regulation functions of SEFs and DCMs because they are: (1)
requiring SEFs and DCMs to limit the issuance of exemptions to
specific, case-by-case instances; and (2) protecting the markets from
trading by employees with unfair, informational advantages.
As noted above, Commission regulation Sec. 1.59 currently requires
SEFs to adopt rules prohibiting employees, governing board members,
committee members or consultants from trading commodity interests on
the basis of material non-public information. Both SEFs and DCMs must
comply with the requirements of Commission regulation Sec. 1.59(d),
which prohibits members of the board of directors, committee members,
or consultants of an SRO from trading for their own account, or for or
on behalf of any other account, based on material non-public
information. DCM Core Principle 16 Guidance states that DCMs should
provide for appropriate limitations on the use or disclosure of
material non-public information. To the extent that SEFs and DCMs have
policies and procedures consistent with Commission regulation Sec.
1.59, DCM Core Principle 16 Guidance, or have existing programs to
monitor trading conducted pursuant to an exemption from the employee
trading prohibition, the discussed benefits may be less significant.
The Commission believes that enhancing SEFs' and DCMs' obligations
regarding their oversight of the exemptions they grant is an
appropriate balance between limiting the misuse of exemptions and
ensuring that the employee trading prohibition is not overly broad. One
of the benefits of the proposed requirements related to the permitted
trading exemptions is that providing such exemptions, as appropriate,
will not impair the ability or diminish willingness of potential
employees to accept employment opportunities with a SEF or DCM.
Similarly, the proposed regulatory limitations on the use and
disclosure of material non-public information as well as the new
requirements on administering the exemptions will result in a more
efficient process where there is transparency of the trading conducted
by SEF or DCM employees.
The proposed rules' expansion of the trading prohibition to
``related commodity interests'' at the product level, as well as the
expansion of the trading prohibition on direct owners on the person/
entity level, are also likely to have benefits. The Commission believes
that expanding these limitations are likely to prevent and reduce the
instances of conflicts of interest even as to those contracts that are
interconnected due to having price movements correlate with the price
movements of a commodity interest traded on, or subject to the rules of
a SEF or a DCM to such a degree that intermarket spread margins or
special margin treatment is recognized or established by the SEF or
DCM.
The Commission also believes that proposed Sec. Sec. 37.1203(e)
and 38.853(e) prohibiting certain trading by members of the board of
directors, committee members and consultants in possession of material
non-public information and barring the release of material non-public
information will have benefits by promoting confidence in SEF and DCM
market regulation functions and the integrity of the marketplace. The
Commission also believes that preventing decision-makers from trading
on or disclosing material non-public information, is beneficial in that
is further prevents such decision-makers from exploiting unfair
informational advantages. In turn, that helps create integrity and
fairness in the markets. Finally, by restricting the disclosure of
material non-public information, SEF and DCM decision-makers are less
likely to share information that might put other market participants at
a disadvantage.
Regarding proposed non-substantive changes to certain terms such as
``commodity interest'' and ``related commodity interest,'' as fully
discussed above,\286\ the Commission believes these changes enhance
ease of reference for SEF and DCM staff.
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\286\ Supra Section IV(c).
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B. Costs
Proposed Sec. Sec. 37.1203 and 38.853 would require that SEFs and
DCMs implement policies and procedures to safeguard against the misuse
of material non-public information. SEFs and DCMs would incur
additional costs from this proposal through the additional hours SEF or
DCM employees might need to spend analyzing the compliance of their
rules and procedures with these requirements, and drafting and
implementing new or amended rules and procedures, when necessary. Costs
associated with complying with the proposed Sec. Sec. 37.1203 and
38.853 may further vary based on the size of the SEF or DCM, available
resources the SEF or DCM may have, and existing practices and policies
the SEF or DCM may have in place.
While the Commission believes that most SEFs and DCMs already have
policies and procedures in place to
[[Page 19689]]
prevent the misuse and disclosure of material non-public information,
proposed Sec. Sec. 37.1203 and 38.853 would likely require SEFs and
DCMs to allocate employee administrative time dedicated to either draft
new or amend existing policies to ensure the SEF and DCM are complying
with any regulatory proposed rules on the limitations on the use and
disclosure of material non-public information. The amount of time
required would vary based on a number of factors, including whether the
SEF or DCM already has policies complying with the proposed rules and
the amount of time needed for each SEF and DCM to draft new or amended
polices where necessary. For example, there will likely be costs
associated with ensuring the policies and procedures apply to each
class of individuals described in proposed Sec. Sec. 37.1203 and
38.853. Costs associated with complying with proposed Sec. Sec.
37.1203 and 38.853 may further vary based on the size of the SEF or
DCM, available resources, and existing practices, rules, and
procedures. Accordingly, those costs would be impracticable to
reasonably quantify. Further, the Commission believes that the rules,
policies and procedures required to implement the limitations on the
use and disclosure of material non-public information would likely not
change significantly from year to year, so after the initial creation
of the policies and procedures, the time required to maintain those
policies and procedures would be negligible.
Additionally, to the extent the SEF or DCM seeks to provide
employee trading exemptions, there will likely be costs to revise or
draft policies and procedures consistent with proposed Sec. Sec.
37.1203 and 38.853 requirements, and to evaluate those exemptions on a
case-by-case basis. Furthermore, any exemptions being granted would
require review by the ROC and be individually documented by the SEF or
DCM, all which would take administrative time.
SEFs and DCMs will incur additional costs if they grant employee
trading exemptions, but do not already have processes in place to
diligently monitor the trading by those employees. However, the
Commission believes that SEFs and DCMs should have existing programs to
monitor, detect, and deter abuses that may arise from trading conducted
pursuant to an exemption from the employee trading prohibition. A SEF
or DCM should, for example, utilize its existing surveillance program
to monitor trading by employees or other insiders subject to proposed
Sec. Sec. 37.1203 and 38.853. Such existing resources may alleviate
some of the burden and costs associated with compliance with proposed
Sec. Sec. 37.1203 and 38.853.
The Commission requests comments on the potential costs of proposed
Sec. Sec. 37.1203 and 38.853, including any costs that would be
imposed on SEFs, DCMs, other market participants, or the financial
system more broadly.
C. Section 15(a) Factors
In addition to the discussion above, the Commission has evaluated
the costs and benefits of the proposed amendments to Sec. Sec. 37.1203
and 38.853 in light of the specific considerations identified in
Section 15(a) of the CEA. The Commission believes that proposed
Sec. Sec. 37.1203 and 38.853 may have a beneficial effect on
protection of market participants and the public, as well as on the
financial integrity of the markets. The Commission believes that
preventing members of the board of directors, committee members,
employees, consultants, and those with an ownership interest of 10
percent or more in the SEF or DCM with access to material non-public
information from leveraging their access to benefit themselves, or
others, commercially or otherwise, upholds the principle of fair
markets. Furthermore, the Commission believes that the requirements
related to granting and monitoring employee trading exemptions to will
enhance employee accountability and promote transparency, which are
essential for establishing the integrity of markets. The Commission has
considered the other Section 15(a) Factors and believes that they are
not implicated by proposed Sec. Sec. 37.1203 and 38.853.
v. Composition and Related Requirements for Board of Directors--
Proposed Sec. Sec. 37.1204 and 38.854
DCMs are not subject to a specific statutory or regulatory
requirement to have a certain threshold of public directors.\287\
Existing Commission regulation Sec. 1.64(b)(1) requires SEFs to
include at least 20 percent ``non-member'' directors in the board of
directors.
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\287\ However, the DCM Core Principle 16 Acceptable Practices
set forth practices to demonstrate compliance with DCM Core
Principle 16. Among other topics, the acceptable practices provide
that a DCM's board of directors or executive committees would be
comprised of at least 35 percent public directors. The Commission
notes that currently all of the DCMs that are designated by the
Commission rely on the acceptable practices to comply with Core
Principle 16, in lieu of any other means for compliance.
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The Commission proposes the following composition standards for the
board of directors for both SEFs and DCMs by: (i) codifying in proposed
Sec. 38.854(a)(1) the DCM Core Principle 16 Acceptable Practice
standards that DCM boards of directors be composed of at least 35
percent public directors; (ii) extending this requirement to SEF boards
of directors under proposed Sec. 37.1204(a)(1); \288\ and (iii)
adopting additional requirements to increase transparency and
accountability of the board of directors. Proposed Sec. Sec.
37.1204(b) and 38.854(b) require that each member of a SEF's or DCM's
board of directors, including public directors, have relevant expertise
to fulfill the roles and responsibilities of being a director.
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\288\ See proposed Sec. 37.1204(a)(1), herein.
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Proposed Sec. Sec. 37.1204(c) and 38.854(c) prohibit linking the
compensation of public directors and other non-executive members of the
board of directors, to either the business performance of the SEF or
DCM or an affiliate. Proposed Sec. Sec. 37.1204(d) and 38.854(d)
require SEFs' and DCMs' board of directors to conduct an annual self-
assessment to review their performance.
A. Benefits
In general, a board of directors plays a crucial role in an
exchange's ability to identify, manage, and resolve conflicts of
interest. Together with senior management, the board of directors set
the ``tone at the top'' for a SEF's or DCM's governance and compliance
culture. The Commission believes that the proposed 35 percent public
director standard is likely to provide benefits for both SEFs and DCMs.
For example, in comparison to the existing twenty-percent ``non-
member'' requirement for SEFs in existing Sec. 1.64(b)(1), which has
created an unintentional consequence of allowing SEFs to compose their
boards of directors entirely with ``insiders'' such as executives at
the SEF's affiliate, the proposed rule will promote independent
decision-making on the board of directors. Composition standards for
the board of directors that promote a well-functioning governing body
with the presence of directors that are independent from the executive
team, coupled with clear, comprehensive policies and procedures, will
minimize conflicts of interests at SEFs and DCMs, and the resulting
impact that such conflicts could have on a SEF's or DCM's market
regulation functions. Since all current DCMs have adopted the DCM Core
Principle 16 Acceptable Practices, which include 35 percent public
directors, the benefits of the proposed 35 percent composition
requirement will be limited. It is important to note that the proposed
35 percent threshold is less than the
[[Page 19690]]
composition requirements applicable to publicly-traded companies, which
require that the majority of the board of directors to be
``independent'' directors. While the proposed threshold is lower than
the standard that applies to publicly-traded companies, the Commission
seeks to strike the appropriate balance between promoting independence
on the board of directors and providing enough flexibility to include
directors with the necessary industry expertise.
By setting the percentage of public directors at 35 percent and
requiring enhanced accountability by board of directors through an
annual self-assessment, the Commission believes that proposed
Sec. Sec. 37.1204(a) and 38.854(a) will provide multiple benefits.
First, public directors may offer perspectives and experiences that
differ but complement the views of internal directors to aid decision-
making at exchanges. Second, establishing clear roles and
responsibilities for board of directors will enhance accountability.
Third, the proposed Sec. Sec. 37.1204(b) and 38.854(b) requirements
that members of SEF's and DCM's board of directors have relevant
expertise will ensure these individuals can contribute to a well-
functioning board of directors that is capable of addressing complex
problems that SEFs and DCMs face.
To further minimize conflicts of interest, proposed Sec. Sec.
37.1204(c) and 38.854(c) prohibit the compensation of public directors
and other non-executive members of the board of directors from being
directly dependent on the business performance of either the SEF or DCM
or an affiliate. This requirement helps to ensure that non-executive
directors remain independent and make objective decisions for the SEF
or DCM--not for their own financial benefit. This also should promote
public confidence in the ability of the board of directors to
effectively govern the SEF or DCM.
The Commission believes that proposed Sec. Sec. 37.1204(c) and
38.854(c) requirements for SEF and DCM boards of directors to conduct
annual self-assessments should enhance boards of directors'
accountability and improve their ability to meet the standards of
conduct expected by the proposed rules, which in turn will benefit
SEFs, DCMs, market participants, and the financial system more broadly.
The documentation process will also create benefits by allowing
Commission staff to request to see the results of the self-assessment
during the course of rule enforcement reviews. To the extent that SEFs
and DCMs already conduct self-assessments of their boards of directors,
these benefits will be limited or may already have been realized.
B. Costs
The requirements in proposed Sec. Sec. 37.1204(a)(1) and (3) and
38.854(a)(1) and (3) requiring SEF and DCM board of directors and
executive committees to be composed of 35 percent public directors
could cause SEFs and DCMs to incur higher costs, compared to non-public
directors, because public directors must meet additional qualifications
and therefore it may take SEF and DCM staff additional time to identify
such persons. Similarly, requiring members of the board of directors to
have relevant expertise, under proposed Sec. Sec. 37.1204(b) and
38.854(b) and will impose costs in terms of SEF and DCM staff time.
When the composition requirements are first established, some SEFs and
DCMs will incur initial costs to identify and appoint new members for
their boards of directors that satisfy the composition requirements of
proposed Sec. Sec. 37.1204(b) and 38.854(b). Time requirements will
vary based on SEFs and DCMs current composition of the board of
directors.
Proposed Sec. Sec. 37.1204(a)(2) and 38.854(a)(2) will require
SEFs and DCMs to draft policies and procedures setting forth the
requirements of the board of directors, including how the board
oversees the entity's compliance with statutory, regulatory, and self-
regulatory responsibilities. At a minimum, existing board of directors'
policies would need to be reviewed, and, as necessary, such policies
would need to be revised. To the extent that such policies are approved
by the board of directors, the board of directors would need to devote
additional meeting time to approve such policies.
Prohibiting compensation being directly linked to business
performance, for public directors and other non-executive members, as
required by proposed Sec. Sec. 37.1204(c) and 38.854(c) will impose
costs in terms of time necessary to review existing compensation plans,
and revise such plans if they are not in compliance.
The requirements under proposed Sec. Sec. 37.1204(d) and 38.854(d)
for a SEF's and DCM's board of directors to conduct an annual self-
assessment will impose costs in terms of conducting such a review,
including reviewing policies and procedures and interviewing SEF or DCM
staff. Additionally, there will be costs of the time of the board of
directors evaluating and approving the self-assessment at board
meetings.
Proposed Sec. Sec. 37.1204(e) and 38.854(e) require procedures for
removing members of the board of directors, when the conduct of a
member is likely to be prejudicial to the sound and prudent management
of the SEF or DCM. The proposed requirements will impose costs relating
to reviewing existing procedures, drafting new procedures if necessary,
and board of director's time in assessing situations where a member's
conduct may be problematic.
The requirements in proposed Sec. Sec. 37.1204(f) and 38.854(f)
relating to reporting to the Commission within five business days of
any change in board membership or any of its committees will require
SEF and DCM staff time in notifying the Commission, as applicable, when
changes to the membership of the board of directors or any of its
committees occur.
Generally, costs associated with complying with proposed Sec. Sec.
37.1204 and 38.854 may further vary based on the size of the SEF or
DCM, available resources, and existing practices, rules, and
procedures. Accordingly, those costs would be impracticable to
reasonably quantify. Further, rules and procedures required for
implementing the proposed board of director requirements would likely
not change significantly from year to year, so after the initial
creation of the rules and procedures, the time required to maintain
those procedures would be negligible. To the extent that SEFs and DCMs
have adopted existing board of director composition standards under DCM
Core Principle 16 Acceptable Practices, some of the costs identified
above will have already been realized.
The Commission requests comments on the potential costs of proposed
Sec. Sec. 37.1204 and 38.854, including any costs that would be
imposed on SEFs, DCMs, other market participants, or the financial
system more broadly.
C. Section 15(a) Factors
In addition to the discussion above, the Commission has evaluated
the costs and benefits of proposed Sec. Sec. 37.1204 and 38.854 in
light of the specific considerations identified in Section 15(a) of the
CEA. The Commission believes that proposed Sec. Sec. 37.1204 and
38.854 may have a beneficial effect on protection of market
participants and the public, as well as on the financial integrity of
the markets. Public directors, with their independent perspective,
might consider and advocate for stakeholders that non-public directors
do not consider. As a result, this might lead to greater protection of
the wider public. The Commission has considered the other Section 15(a)
Factors and believes that they are not implicated by proposed
Sec. Sec. 37.1204 and 38.854.
[[Page 19691]]
vi. Public Director Definition--Proposed Sec. Sec. 37.1201(b)(12) and
38.851(b)(12)
The definition of ``public director'' in proposed Sec. Sec.
37.1201(b)(12) and 38.851(b)(12) excludes a person who has a ``material
relationship'' with the SEF or DCM from serving as a public director,
and defines a ``material relationship'' as one that could affect the
independent judgment or decision-making ability of the director. The
public director definition enumerates certain relationships that are
deemed to be material: (1) the director is an officer or an employee of
the SEF or DCM, or an officer or an employee of its affiliate; (2) the
director is a member of the DCM or is a director, officer, or an
employee of either a member or an affiliate of a member; (3) the
director directly or indirectly owns more than 10 percent of the SEF or
DCM or an affiliate of the SEF or DCM, or is an officer or employee of
an entity that directly or indirectly owns more than 10 percent of SEF
or DCM; (4) the director, or an entity in which the director is a
partner, an officer, an employee, or a director receives more than
$100,000 in aggregate annual payments from the SEF or DCM, or an
affiliate of the SEF or DCM. A material relationship disqualifies a
person from being a public director. The material relationship
disqualifier also applies to any person with whom the director has a
``family relationship,'' as set forth in proposed Sec. Sec.
37.1201(b)(7) and 38.851(b)(7), and is subject to a one-year look-back
period.
A. Benefits
The Commission believes that codifying the public director
definition for both SEFs and DCMs in proposed Sec. Sec. 37.1201(b)(12)
and 38.851(b)(12) will provide several benefits. First, expanding the
disqualifying factors to prohibit individuals who, directly or
indirectly, own more than 10 percent of either the SEF or DCM or an
affiliate will further prevent individuals with specific conflicts of
interests, including personal financial interests, from serving as
public directors and makes it more likely that decision-makers will
remain independent. Second, applying the disqualifying factors to
family relationships ensures that public directors are not influenced
by familial connections. Third, requiring both an initial and annual
review of the qualifications of public directors should reduce the risk
that existing public directors may become disqualified in the course of
the service on the board of directors and become conflicted in the
SEFs' or DCMs' decision-making process.
B. Costs
The Commission does not believe that there are costs associated
with the definition of ``public director'' in proposed Sec. Sec.
37.1201(b)(12) and 38.851(b)(12). However, SEFs and DCMs will incur
costs associated with making determinations on whether an individual is
qualified to serve as a public director. Those costs include the
process to identify, minimize, and resolve conflicts of interests as
proposed by Sec. Sec. 37.1201(a) and 38.851(a), and to determine
whether a person meets fitness standards under proposed Sec. Sec.
37.207 and 38.801, discussed above. Finally, the Commission notes that
if an individual is found not to be eligible to serve, the SEF or DCM
can mitigate the costs incurred with making such determination if it
chooses to nominate the individual as a non-public director. Costs
associated with complying with the proposed Sec. Sec. 37.1201(b)(12)
and 38.851(b)(12) may vary based on the size of the SEF and DCM, its
available resources, and its existing practices and policies. To the
extent that SEFs and DCMs have voluntarily adopted existing public
director standards under the DCM Core Principle 16 Acceptable
Practices, some of the costs identified above will have already been
realized.
The Commission requests comments on the potential costs of proposed
Sec. Sec. 37.1201(b)(12) and 38.851(b)(12), including any costs that
would be imposed on SEFs, DCMs, other market participants, or the
financial system more broadly.
C. Section 15(a) Factors
In addition to the discussion above, the Commission has evaluated
the costs and benefits of proposed Sec. Sec. 37.1201(b)(12) and
38.851(b)(12) in light of the specific considerations identified in
Section 15(a) of the CEA. The Commission believes that the public
director definition under proposed Sec. Sec. 37.1201(b)(12) and
38.851(b)(12) may have a beneficial effect on the protection of market
participants and the public, as well as on the financial integrity of
the markets.\289\ Ensuring sufficient independent judgment through the
inclusion of public directors will improve the overall decision-making
of a SEF or DCM and protect the market regulation functions. The
Commission has considered the other Section 15(a) Factors and believes
that they are not implicated by proposed Sec. Sec. 37.1201(b)(12) and
38.851(b)(12).
---------------------------------------------------------------------------
\289\ See supra, Section V(b), ``public director'' definition--
proposed Sec. Sec. 37.1201(b)(12) and 38.851(b)(12).
---------------------------------------------------------------------------
vii. Nominating Committee--Proposed Sec. Sec. 37.1205 and 38.855
Currently, neither SEFs nor DCMs are obligated by Commission
regulations to have a nominating committee to identify or manage the
process for nominating potential members of the board of directors. DCM
Core Principle 17 requires the governance arrangements of a board of
directors of a DCM to permit consideration of the views of market
participants. Similarly, pursuant to Commission regulation Sec.
1.64(b)(3), an SRO, such as a SEF, must include a diversity of
membership interests on their governing boards.
The Commission is proposing Sec. Sec. 37.1205 and 38.855 to
require SEFs and DCMs to have a nominating committee. The role of the
nominating committee would be to identify a pool of candidates who are
qualified to serve on the board of directors who represent diverse
interests, including the interests of the participants and members of
the SEF or DCM. Furthermore, proposed Sec. Sec. 37.1205 and 38.855
would require: at least 51 percent of the nominating committee be
comprised of public directors, the nominating committee be chaired by a
public director, and the nominating committee report directly to the
board of directors.
A. Benefits
The Commission believes that proposed Sec. Sec. 37.1205 and 38.855
establishing SEF and DCM nominating committees will help protect the
integrity of selecting members for the board of directors and assist
SEFs and DCMs in identifying qualified candidates. The Commission
believes that requiring 51 percent of the nominating committee to be
public directors will help maintain independence and objectivity in
selecting nominees for the board of directors. Additionally, the
requirement in proposed Sec. Sec. 37.1205 and 38.855 that the
nominating committee identify individuals that reflect the views of
market participants will help ensure that a broader pool of candidates
with more diverse viewpoints are considered to serve on the board of
directors. The Commission believes that these diverse viewpoints may
improve the decision-making of the SEF or DCM. These benefits, in turn,
will improve the governance and public perception of the SEF or DCM.
[[Page 19692]]
B. Costs
Since SEFs and DCMs are not currently required to have nominating
committees, some entities would need to revise their existing policies
and procedures to create a nominating committee in accordance with
proposed Sec. Sec. 37.1205 and 38.855. Accordingly, proposed
Sec. Sec. 37.1205 and 38.855 would impose some costs on these SEFs and
DCMs, including costs that could arise from additional hours SEF and
DCM employees might need to spend time reviewing existing SEF and DCM
policies and procedures, and designing and implementing new or amended
rules and procedures, as necessary.
Specifically, drafting new policies and procedures to form a
nominating committee would cost administrative time. Those
administrative costs associated with complying with proposed Sec. Sec.
37.1205 and 38.855 may vary based on the size of the SEF or DCM,
available resources, and existing practices, rules, and procedures.
Accordingly, those costs would be impracticable to reasonably quantify.
Further, rules and procedures required to administer a nominating
committee would likely not change significantly from year to year, so
after the initial creation of the rules and procedures, the time
required to maintain those procedures would be negligible.
When the nominating committee is first established, the SEF and DCM
will incur initial costs related to identifying potential members for
the nominating committee, including public directors that must comprise
51 percent of the committee. Ongoing implementation of proposed
Sec. Sec. 37.1205 and 38.855 would also impose costs whenever the
nominating committee meets to identify new candidates for the board of
directors, nominates individuals to the board of directors, and reports
their decisions to the SEF or DCM board of directors.
The Commission requests comments on the potential costs of proposed
Sec. Sec. 37.1205 and 38.855, including any costs that would be
imposed on SEFs, DCMs, other market participants, or the financial
system more broadly.
C. Section 15(a) Factors
In addition to the discussion above, the Commission has evaluated
the costs and benefits of proposed Sec. Sec. 37.1205 and 38.855 in
light of the specific considerations identified in Section 15(a) of the
CEA. The Commission believes that proposed Sec. Sec. 37.1205 and
38.855 may have a beneficial effect on protection of market
participants and the public, as well as on the financial integrity of
the markets. The Commission believes that the proposed rules requiring
SEF and DCM nominating committees will have a beneficial effect on the
identification of nominees for the board of directors who have
independent and diverse experiences. Such characteristics, the
Commission believes, will aid in recruiting members for the board of
directors who will contribute to making sound decisions for SEFs and
DCMs, and, ultimately, for the markets. The Commission has considered
the other Section 15(a) Factors and believes that they are not
implicated by proposed Sec. Sec. 37.1205 and 38.855.
viii. Regulatory Oversight Committee--Proposed Sec. Sec. 37.1206 and
38.857
Currently, the DCM Core Principle 16 Acceptable Practices provide
that DCMs establish a ROC, consisting of only public directors, to
assist in minimizing actual and potential conflicts of interest. The
purpose of the ROC is to oversee the DCM's regulatory program on behalf
of the board of directors, which in turn, delegates the necessary
authority, resources, and time for the ROC to fulfill its mandate. The
ROC is responsible for: (1) monitoring the DCM's regulatory program for
sufficiency, effectiveness, and independence; (2) overseeing all facets
of the regulatory program; (3) reviewing the size and allocation of the
regulatory budget and resources; and the number, hiring and
termination, and compensation of regulatory personnel; (4) supervising
the DCM's CRO, who reports directly to the ROC; (5) preparing an annual
report assessing the DCM's self-regulatory program for the board of
directors and the Commission; (6) recommending changes that would
ensure fair, vigorous, and effective regulation; and (7) reviewing
regulatory proposals and advising the board as to whether and how such
changes may impact regulation. In performing these functions, the ROC
plays a critical role in insulating the CRO and the DCM's self-
regulatory function from undue influence.
Currently, SEFs do not have any requirements for establishing a ROC
but they are subject to Core Principle 15, which requires SEFs to
designate a CCO to monitor its adherence to statutory, regulatory, and
self-regulatory requirements and to resolve conflicts of interest that
may impede such adherence. The CCO is required to report to the SEF
board of directors (or similar governing body) or the senior SEF
officer.
The Commission is proposing to codify the ROC component of the DCM
Core Principle 16 Acceptable Practices for both SEFs and DCMs. Proposed
Sec. Sec. 37.1206(a) and 38.857(a), respectively, require SEFs and
DCMs to establish a ROC composed of only public directors. In addition,
the Commission is proposing Sec. Sec. 37.1206(c) and 38.857(c), which
require the board of directors to delegate sufficient authority,
dedicate sufficient resources, and allow sufficient time to perform its
functions to ensure that the ROC can fulfill its mandate and duties.
Furthermore, proposed Sec. Sec. 37.1206(d) and 38.857(d) would require
SEF and DCM ROCs, respectively, to have oversight duties over the
market regulation functions, including: (1) monitoring the SEF's or
DCM's market regulation functions for sufficiency, effectiveness, and
independence; (2) overseeing all facets of the market regulation
functions; (3) approving the size and allocation of the regulatory
budget and resources; and the number, hiring and termination, and
compensation of staff; (4) recommending changes that would promote
fair, vigorous, and effective self-regulation; and (5) reviewing all
regulatory proposals prior to implementation and advising the board of
directors as to whether and how such proposals may impact market
regulation functions.
The Commission also is proposing several new requirements related
to procedures and documentation for ROC meetings that reflect the best
practices that have been identified during the Commission's oversight
of DCMs. Proposed Sec. Sec. 37.1206(f) and 38.857(f) would require SEF
and DCM ROCs to meet quarterly. In addition, proposed Sec. Sec.
37.1206(f)(1)(iii) and 38.857(f)(1)(iii) would require that ROC meeting
minutes include: (a) list of the attendees; (b) their titles; (c)
whether they were present for the entirety of the meeting or a portion
thereof (and if so, what portion); and (d) a summary of all meeting
discussions. Proposed Sec. Sec. 37.1206(f)(2) and 38.857(f)(2) would
require the ROC to maintain documentation of the committee's findings,
recommendations, and any other discussions or deliberations related to
the performance of its duties. The Commission also is proposing rules
to require an annual ROC report, which would enhance the ROC report
procedures currently set forth in the DCM Core Principle 16 Acceptable
Practices. Specifically, the Commission is proposing Sec. Sec.
37.1206(g)(1) and 38.857(g)(1) to require that ROC annual reports
include a list of any actual or potential conflicts of interest that
were reported to the ROC and a description
[[Page 19693]]
of how such conflicts of interest were managed and resolved and an
assessment of the impact of any conflicts of interest on the SEF's or
DCM's ability to perform its market regulation functions. In addition,
proposed Sec. Sec. 37.1206(g)(2) and 38.857(g)(2) would establish a
process for filing the ROC annual report which mirrors the existing SEF
annual compliance report requirements in Commission regulation Sec.
37.1501(e). These proposed requirements would establish the following:
(1) a filing deadline no later than 90 days after the end of the fiscal
year; (2) a process for amendments and extension requests; (3)
recordkeeping requirements; and (4) delegated authority to the Division
of Market Oversight to grant or deny extensions. Finally, proposed
Sec. Sec. 37.1206(g)(3) and 38.857(g)(3) require SEFs and DCMs to
maintain all records demonstrating compliance with the duties of the
ROC and the preparation and submission of its annual report.
A. Benefits
Proposed Sec. Sec. 37.1206 and 38.857 establish the creation and
duties for SEF and DCM ROCs. These proposed rules will generate
benefits by establishing effective structural governance protections to
assist SEFs and DCMs in minimizing conflicts of interest that may
impact their market regulation functions. The ROC will help to ensure
that improper influences and pressures from a SEF's or DCM's commercial
interest do not denigrate the integrity of the market regulation
functions. Because both SEFs and DCMs are SROs, these benefits extend
well beyond the internal functioning of a SEF or DCM. Since SEFs and
DCMs have similar commercial interests that may conflict with their
market regulation functions, the Commission believes that applying
similar ROC structures across SEFs and DCMs will result in a more level
and resilient marketplace, which in turn will promote competition in
the derivatives markets.
The proposed rules address the types of conflicts of interest
Commission staff has identified through its SEF and DCM oversight
activities. Accordingly, the proposed rules are based on existing,
identifiable solutions that have already benefitted SEFs and DCMs. To
the extent that the existing SEF and DCM practices are similar to the
proposed requirements, the benefits will be limited or already have
been realized.
The requirements under proposed Sec. Sec. 37.1206(f) and 38.857(f)
relating to ROC meetings and documentation should provide a number of
benefits. First, the quarterly meeting requirement facilitates the
free-flow of information between the ROC and the SEF's CCO or the DCM's
CRO. This is an opportunity to share information, discuss matters of
mutual concern, and speak freely about potentially sensitive issues
that may relate to the SEF's or DCM's management. Such communication
may enable the SEF or DCM to more effectively fulfill its market
regulation function. Similarly, restricting individuals with actual or
potential conflicts of interest from attending ROC meetings ensures
that sensitive information related to the market regulation function is
not broadly disseminated. The documentation requirements, such as
requiring ROC meeting minutes under proposed Sec. Sec.
37.1206(f)(1)(iii) and 38.857(f)(1)(iii), and the ROC annual reporting
requirements under proposed Sec. Sec. 37.1206(g)(1) and 38.857(g)(1),
are mechanisms to enhance the accountability of the ROC and promote
transparency for all stakeholders. Ultimately, market participants will
benefit from the improvements in SEF and DCM governance operations.
B. Costs
The proposed rules would impose some costs on SEFs and DCMs. To the
extent that DCMs and some SEFs already have established a ROC, they may
incur some costs related to updating their ROC policies and procedures
to comply with proposed Sec. Sec. 37.1204 and 38.854. Costs could
arise from additional hours SEF and DCM employees might need to spend
analyzing the compliance of their rules and procedures with these
requirements, drafting and implementing new or amended rules and
procedures, when necessary. While some SEFs have chosen to create ROCs,
those SEFs that do not current have ROCs may incur additional costs
associated with establishing the committee and identifying the public
directors that will serve on the committee. Specifically, drafting new
policies to form this committee would cost administrative time. The
amount of time required to establish this committee would vary based on
a number of factors, including whether the SEF's or DCM's existing
policies complying with the proposed rules, and the amount of time
necessary for each SEF and DCM to draft and implement new or amended
polices, where necessary. Further, policies required for implementing
the proposed rules would likely not change significantly from year to
year, so after the initial creation of the policies, the time required
to create rules and procedures would be negligible.
When the ROC is initially established, the SEF or DCM will incur
costs for the time spent to identify potential members that meet public
director composition requirement. Ongoing implementation of the
proposed rules also would impose costs. For example, there may be costs
associated with providing necessary information to the ROC for its
consideration, and time spent by the members of a SEF's or DCM's board
of directors or senior officer to meet and consult with the ROC, and
consider and respond to any information requested by the ROC. A ROC's
operation also would require time from its members to meet at least on
a quarterly basis, as required by proposed Sec. Sec. 37.1206(f) and
38.857(f). ROC members also will spend time on the duties outlined in
proposed Sec. Sec. 37.1206(d) and 38.857(d).
There may be additional costs related to ROC meetings, reporting,
and recordkeeping. Proposed Sec. Sec. 37.1206(f)(1)(iii) and
38.857(f)(1)(iii) require ROCs to keep minutes of their meetings and
proposed Sec. Sec. 37.1206(f)(2) and 38.857(f)(2) require ROCs to
maintain documentation of findings, recommendations, and any other
discussions or deliberations. Proposed Sec. Sec. 37.1206(g)(1) and
38.857(g)(1) require ROCs to prepare an annual report for the board of
directors and the Commission. The time spent drafting the annual report
will include time spent assessing the SEF's or DCM's self-regulatory
program and preparing the report with the information required in
proposed Sec. Sec. 37.1206(g)(1)(i)-(vi) and 38.857(g)(1)(i)-(vi).
Finally, SEFs and DCMs may incur some initial costs associated with
establishing a process to maintain all records demonstrating compliance
with the duties of the ROC and the preparation and submission of annual
reports, as required by proposed Sec. Sec. 37.1206(g)(3) and
38.857(g)(3).
Costs associated with complying with proposed Sec. Sec. 37.1206(f)
and 38.857(f) may vary based on the size of the SEF and DCM, available
resources, and existing practices and policies. To the extent that SEFs
and DCMs have adopted existing ROC standards under the DCM Core
Principle 16 Acceptable Practices, some of the costs identified above
will have already been realized.
The Commission requests comments on the potential costs of proposed
Sec. Sec. 37.1206 and 38.857, including any costs that would be
imposed on SEFs, DCMs, other market participants, or the financial
system more broadly. In particular, for those SEFs and DCMs that
already have ROCs in place, the
[[Page 19694]]
Commission requests comment on the extent to which the proposed rules
would require changes to existing ROC policies and procedures.
C. Section 15(a) Factors
In addition to the discussion above, the Commission has evaluated
the costs and benefits of proposed Sec. Sec. 37.1206 and 38.857 in
light of the specific considerations identified in Section 15(a) of the
CEA. The Commission believes that proposed Sec. Sec. 37.1206 and
38.857 may have a beneficial effect on protection of market
participants and the public, as well as on the financial integrity of
the markets by strengthening the boards oversight of the market
regulation functions of SEFs and DCMs. The Commission has considered
the other Section 15(a) Factors and believes that they are not
implicated by proposed Sec. Sec. 37.1206 and 38.857.
ix. Disciplinary Panel Composition--Proposed Sec. Sec. 37.1207 and
38.858
Currently, the DCM Core Principle 16 Acceptable Practices provide
that DCMs establish disciplinary panel composition standards. Those
acceptable practices state that no group or class of industry
participants may dominate or exercise disproportionate influence on
such panels. Furthermore, the DCM Core Principle 16 Acceptable
Practices provide that all disciplinary panels (and appellate bodies)
include at least one person who would qualify as a public director,
except in cases limited to decorum, attire, or the timely submission of
accurate records required for clearing or verifying each day's
transactions. Currently, Commission regulation Sec. 1.64(c) requires
SEF major disciplinary committees to include: (1) at least one member
who is not a member of the SEF; and (2) sufficient different membership
interests to ensure fairness and to prevent special treatment or
preference for any person in the conduct of a committee's or the
panel's responsibility.
The Commission is proposing Sec. Sec. 37.1207 and 38.858 for both
SEFs and DCMs, respectively, to adopt disciplinary panel composition
requirements which prohibit any member of a disciplinary panel from
participating in deliberations or voting on any matter in which the
member has an actual or potential conflict of interest. With this
proposed rulemaking, SEFs will be exempt from complying with Commission
regulation Sec. 1.64(c) since they will be subject to this new rule.
In addition, the Commission is proposing Sec. Sec. 37.1207(a) and
(b) and 38.858(a) and (b) to clarify that SEF and DCM disciplinary
panels and appellate panels must consist of two or more persons. The
Commission is also proposing Sec. Sec. 37.1207(b) and 38.858(b) to
extend the public participant requirement to any SEF and DCM committee
to which disciplinary panel decisions may be appealed. Finally, the
Commission is proposing technical amendments to Commission regulations
Sec. Sec. 37.206(b) and 38.702 to remove the references that
disciplinary panels must meet the composition requirements of part 40
and replace these references with references to proposed regulations
Sec. Sec. 37.1207 and 38.858, respectively. The Commission also
proposes changing the reference to ``compliance'' staff to ``market
regulation'' staff. This is intended for clarity and is consistent with
proposed changes to Sec. Sec. 38.155(a) and 37.203(c).
A. Benefits
The requirement under proposed Sec. Sec. 37.1207 and 38.858 for
SEFs and DCMs to establish disciplinary panel requirements is likely to
provide a number of benefits. The composition requirements of
Sec. Sec. 37.1207(a) and 38.858(a) instill fairness in the
disciplinary process by requiring a minimum of two members, one of whom
must be a public participant. This ensures that the disciplinary panels
have a degree of independence from outside influences, and are capable
of functioning impartially. Proposed Sec. Sec. 37.1207(a)(1) and (2)
and 38.858(a)(1) and (2) further these goals by precluding any group or
class of participants from dominating or exercising disproportionate
influence on a disciplinary panel, and prohibiting any member of a
disciplinary panel from participating in deliberations or voting on any
matter in which the member has an actual or potential conflict of
interest. These safeguards increase the likelihood that disciplinary
proceedings are handled by competent individuals that represent a
diversity of perspectives, and are free of conflicts of interest. This,
in turn, may benefit the overall integrity of the derivatives markets.
B. Costs
SEFs and DCMs are already required to establish disciplinary panels
pursuant to Commission regulations Sec. Sec. 37.206(b) and 38.702.
Accordingly, the potential cost is limited to the changes necessary to
comply with proposed Sec. Sec. 37.1207 and 38.858. Initial costs could
arise from additional administrative hours SEF and DCM employees might
need to spend analyzing the compliance of their rules and procedures
with these requirements, and drafting and implementing new or amended
rules, as necessary. Once these rules and policies are established,
they would likely not change significantly from year to year.
SEFs and DCMs may need to change the composition of their
disciplinary panels to satisfy the requirements of proposed Sec. Sec.
37.1207(a) and 38.858(a), and ensure that these requirements are
extended to appellate panels, as required by proposed Sec. Sec.
37.1207(b) and 38.858(b). Additionally, proposed Sec. Sec. 37.1207 and
38.858 prohibit any member of the panel from voting on issues in which
they have a conflict of interest, which may reduce the number of
potential suitable individuals who may serve on the disciplinary panel.
Costs associated with complying with the proposed Sec. Sec.
37.1207(b) and 38.858(b) may further vary based on the size of the SEF
and DCM, its available resources, its existing practices and policies.
To the extent that SEFs and DCMs have adopted existing disciplinary
panel standards under the Acceptable Practices for DCM Core Principle
16, some of the costs identified above will have already been realized.
The Commission requests comments on the potential costs of proposed
Sec. Sec. 37.1207 and 38.858, including any costs that would be
imposed on SEFs, DCMs, other market participants, or the financial
system more broadly. In particular, for those SEFs and DCMs that
already have disciplinary panels in place, the Commission requests
comment on the extent to which the proposed rules would require changes
to existing policies and procedures regarding their disciplinary
panels.
C. Section 15(a) Factors
In addition to the discussion above, the Commission has evaluated
the costs and benefits of the proposed amendments to Sec. Sec. 37.1207
and 38.858 in light of the specific considerations identified in
Section 15(a) of the CEA. The Commission believes that proposed
Sec. Sec. 37.1207 and 38.858 may have a beneficial effect on
protection of market participants and the public, as well as on the
financial integrity of the markets. The Commission believes that by
better ensuring the fairness of the disciplinary process, market
participants can have greater trust in the oversight process of SEF and
DCM rules. The Commission has considered the other Section 15(a)
Factors and believes that they are not implicated by proposed
Sec. Sec. 37.1207 and 38.858.
[[Page 19695]]
x. DCM Chief Regulatory Officer--Proposed Sec. 38.856
Commission regulations do not currently require DCMs to have a CRO.
However, the framework created under the DCM Core Principle 16
Acceptable Practices includes a reference to a CRO, who reports
directly to the ROC.
The Commission is proposing Sec. 38.856(a)(1) to require DCMs to
establish the position of a CRO to administer a DCM's market regulation
functions. The proposed rules would require that (i) the position of
CRO must carry with it the authority and resources necessary to fulfill
the duties set forth in this section for CROs; and (ii) the CRO must
have supervisory authority over all staff performing the DCM's market
regulation functions.
In addition, the Commission is proposing Sec. 38.856(a)(2) to
require that the individual designated to serve as CRO must have the
background and skills appropriate for fulfilling the duties of the
position. A DCM, therefore, is expected to identify the needs of its
own market regulation functions and ensure that the CRO has the
requisite surveillance and investigatory experience necessary to
perform the role. Moreover, individuals disqualified from registration
pursuant to sections 8a(2) or 8a(3) of the CEA are ineligible to serve
as a CRO.
Proposed Sec. 38.856(b) requires the CRO to report directly to the
DCM's board of directors or senior officer. The Commission is also
proposing Sec. 38.856(c) to require (1) the appointment or removal of
a DCM's CRO to occur only with the approval of the DCM's ROC; (2) the
DCM to notify the Commission within two business days of the
appointment of any new CRO, whether interim or permanent; and (3) the
DCM to notify the Commission within two business days of removal of the
CRO. The Commission is proposing Sec. 38.856(d) to require the board
of directors or the senior officer of the DCM, in consultation with the
DCM's ROC, to approve the compensation of the CRO.
The Commission is proposing Sec. 38.856(e) to establish the duties
of the CRO, which include: (1) supervising the DCM's market regulation
functions; (2) establishing and administering policies and procedures
related to the DCM's market regulation functions; (3) supervising the
effectiveness and sufficiency of any regulatory services provided to
the DCM by a regulatory service provider in accordance with existing
Sec. 38.154; (4) reviewing any proposed rule or programmatic changes
that may have a significant regulatory impact and advising the ROC on
such matters; and (5) in consultation with the DCM's ROC, identifying,
minimizing, managing, and resolving conflicts of interest involving the
DCM's market regulation functions.
Finally, proposedSec. 38.856(f) requires DCMs to establish
procedures for the CRO's disclosure of actual or potential conflicts of
interest to the ROC, and designation of a qualified person to serve in
the place of the CRO if the CRO has such a conflict of interest. The
proposed rules also require documentation of any such disclosure
regarding conflicts of interest.
A. Benefits
The Commission preliminarily believes that establishing a position
of a CRO under proposed Sec. 38.856(a)(1) will enable DCMs to comply
with their statutory and regulatory obligation to fulfill their market
regulation functions. Proposed Sec. 38.856(a)(2) provides that the CRO
must have the necessary background and skills appropriate for
fulfilling the responsibilities of the position. This requirement will
benefit DCMs by ensuring CROs have the requisite experience necessary
to oversee the DCM's market regulation functions. CROs who lack
appropriate background and skills for their position would have a
harder time effectively fulfilling their duties, which could be
detrimental to the DCM's role as a SRO.
Furthermore, proposed Sec. 38.856(b), which requires the CRO to
directly report to the board of directors or to the senior officer,
would make it easier for the CRO to fulfill the duties critical to the
DCM's market regulation functions. For example, having a direct line to
the board of directors or the senior officer would allow the CRO to
more easily gain approval for any new policies related to the DCM's
market regulation functions that the CRO needed to implement, to the
extent that they required approval of a senior officer or the board of
directors. Since DCM rule changes often need to be approved by the
board of directors, having the CRO report to the board of directors or
to the senior officer (who likely regularly communicates with the board
of directors) would allow the CRO to more easily explain the need for
rule changes, and to answer questions from the board of directors or
the senior officer about such changes.
Proposed Sec. Sec. 38.856(c) and (d) require the ROC to (1)
approve the appointment or removal of the CRO, and (2) consult with the
board of directors or senior officer regarding the compensation of the
CRO. The ROC is composed of exclusively public directors who have no
material relationship with the exchange, and therefore, is well-
positioned to protect the CRO from interference from commercial
interests. If the senior officer or the board of directors sought to
terminate the CRO or decrease the CRO's compensation, as retaliation
for not advancing the DCM's commercial interests ahead of the interests
of the market regulation function, the ROC could step in to protect the
CRO. By requiring the DCM to notify the Commission upon the appointment
of a new CRO, the proposed rule will facilitate Commission staff being
able to contact the new CRO to discuss regulatory concerns.
Additionally, Commission staff can ask questions about the removal of
the old CRO, and identify whether the ROC was involved.
Additionally, proposed Sec. 38.856(e), which establishes the
duties of a CRO, will provide benefits by establishing clear and
transparent standards for the CRO duties, and may prevent the board of
directors or senior officer from unreasonably limiting the CRO's role.
For example, a board of directors or senior officer would be prohibited
from taking over the market regulation functions in order to prioritize
commercial interests.
Finally, proposed Sec. 38.856(f), which requires the CRO to
disclose to the ROC and document any actual or potential conflicts of
interest identified by the CRO, is likely to provide benefits by
promoting integrity and further allowing CROs to fulfill their duties.
If the CRO did not have to disclose their own conflicts, the CRO's
involvement in resolving conflicts of interest could exacerbate, rather
than mitigate, conflicts of interest in the critical market regulation
functions of the DCM. Therefore, proposed Sec. 38.856(f) may further
mitigate potential conflicts of interests in the DCM's role as an SRO.
B. Costs
Commission regulations do not currently require a DCM to appoint a
CRO. However, the Commission noted that current industry practice is
for DCMs to designate an individual to serve as CRO, and it would be
difficult for a DCM to meet the staffing and resource requirements of
Sec. 38.155 without a CRO. However, even if all DCMs currently have a
CRO, it is possible that some DCMs may incur costs by having to adjust
their existing staffing structure to ensure it complies with the
specific regulatory requirements of proposed Sec. 38.856(a)(1). These
costs could arise from additional hours DCM employees might need to
spend analyzing their rules, policies,
[[Page 19696]]
and procedures for compliance with these requirements, and drafting and
implementing new or amended rules, policies, and procedures, when
necessary. Additionally, there may be costs incurred in implementing
the appropriate policies and procedures to ensure that the CRO has the
resources required to perform the duties set forth in proposed Sec.
38.856(a)(1).
DCMs may also expend administrative time finding a suitable
candidate for the CRO position if the DCM either does not have a CRO,
or does not have a CRO that meets the requirements of proposed Sec.
38.856(a)(2). If a DCM does not already have a CRO, the costs to
identify and hire a new CRO could be significant. Where DCMs have
existing CROs, the cost of implementing the proposed rules may be
lower. Nevertheless, there may costs related to ensuring the existing
CRO role satisfies all of the requirements set forth in proposed Sec.
38.856. Ongoing costs may include employment costs for the position
itself, as well as time spent by the board of directors or senior
officer to supervise the CRO and the administrative costs associated
with notifying the Commission of the appointment of a new CRO or the
removal of an existing CRO. The Commission requests comments on the
potential costs of proposed Sec. 38.856, including any costs that
would be imposed on DCMs, other market participants, or the financial
system more broadly. In particular, for those DCMs that already have
CROs, the Commission requests comment on the extent to which the
proposed rules would require changes to existing policies and
procedures regarding the CRO position.
C. Section 15(a) Factors
In addition to the discussion above, the Commission has evaluated
the costs and benefits of proposed Sec. 38.856 in light of the
specific considerations identified in Section 15(a) of the CEA. The
Commission believes that proposed Sec. 38.856 may have a beneficial
effect on protection of market participants and the public, as well as
on the financial integrity of the markets. The Commission believes that
designating a CRO to administer the market regulation functions of the
DCM will promote compliance with the proposed rules related to
identifying and minimizing DCM conflicts of interest, which, in turn,
will allow the DCMs to better provide services as an exchange. The
Commission has considered the other Section 15(a) Factors and believes
that they are not implicated by proposed Sec. 38.856.
xi. Staffing and Investigations--Proposed Changes to Commission
Regulations Sec. Sec. 38.155, 38.158, and 37.203
Commission regulation Sec. 38.155(a) requires a DCM to: (1)
establish and maintain sufficient compliance department resources and
staff to ensure that it can conduct effective audit trail reviews,
trade practice surveillance, market surveillance, and real-time market
monitoring; (2) maintain sufficient compliance staff to address unusual
market or trading events as they arise; and (3) conduct and complete
investigations in a timely manner. Furthermore, Commission regulation
Sec. 38.155(b) requires a DCM to: (1) monitor the size and workload of
its compliance staff annually and ensure that its compliance resources
and staff are at appropriate levels; and (2) consider trading volume
increases, the number of new products or contracts to be listed for
trading, any new responsibilities to be assigned to compliance staff,
the results of any internal review demonstrating that work is not
completed in an effective or timely manner, and any other factors
suggesting the need for increased resources and staff.
Similarly, existing Commission regulation Sec. 37.203(c) requires
SEFs to have sufficient compliance staff and resources to ensure it can
conduct effective audit trail reviews, trade practice surveillance,
market surveillance, and real-time market monitoring. Currently, SEFs
are not subject to a regulation parallel to Commission regulation Sec.
38.155(b) where DCMs are required to annually monitor the sufficiency
of staff and resources.
Finally, existing regulations Sec. Sec. 37.203(f) and 38.158,
respectively, relate to SEF and DCM obligations regarding
investigations and investigation reports. These provisions generally
address investigation timeliness, substance of investigation reports,
and the issuance of warning letters.
The Commission is proposing amendments to existing Sec. Sec.
37.203(c) and 38.155(a). First, the Commission proposes to replace
references to ``compliance staff'' with ``staff.'' Second, proposed
Sec. Sec. 37.203(c) and 38.155(a) would amend the first sentence of
the existing regulations to provide that SEFs and DCMs must establish
and maintain sufficient staff and resources to ``effectively perform
market regulation functions'' rather than listing the individual
functions. The Commission does not view these as substantive changes.
References to ``staff'' rather than ``compliance staff'' are intended
for clarity. As noted, Commission regulations Sec. Sec. 37.203(c) and
38.155(a) are solely focused on staff dedicated to performing market
regulation functions.
The Commission also proposes to amend Sec. 37.203 to add a new
paragraph (d). The proposed provision would require SEFs to annually
monitor the size and workload of their staff, and ensure its resources
and staff effectively perform market regulation functions at
appropriate levels. In addition, paragraph (d) would include a
reference to paragraph (c) to clarify that it applies to staff
responsible for conducting market regulation functions. In addition,
with respect to both proposed Sec. 37.203(d) and amended Sec.
38.155(b), the Commission is proposing to add to the list of factors
that a SEF or DCM should consider in determining the appropriate level
of resources and staff: (1) any responsibilities that staff have at
affiliated entities; and (2) any conflicts of interest that prevent
staff from working on certain matters.
Additionally, the Commission proposes certain non-substantive
changes to existing Commission regulations Sec. Sec. 38.155 and
38.158. Proposed Sec. 38.155 would rename the regulation ``Sufficient
staff and resources.'' Proposed Sec. 38.155(b) would add an internal
reference to paragraph (a). This change is intended to clarify that the
annual staff and resource monitoring requirement pertains to staff
performing market regulation functions required under Sec. 38.155(a).
Proposed Sec. 38.158(a) would replace the reference to ``compliance
staff'' with ``staff responsible for conducting market regulation
functions.'' Proposed Sec. 38.158(b) would delete the reference to
``compliance staff investigation'' being required to be completed in a
timely manner, and instead provide, more simply, that ``[e]ach
investigation must be completed in a timely manner.'' Finally, proposed
Sec. Sec. 38.158(c) and (d) would delete the modifier ``compliance''
when referencing to staff.
Finally, the Commission also proposes certain non-substantive
changes to existing Commission regulation Sec. 37.203. Proposed Sec.
37.203(c) would rename the paragraph ``Sufficient staff and
resources.'' The addition of proposed Sec. 37.203(d) would result in
redesignating the remaining paragraphs of Sec. 37.203. Proposed Sec.
37.203(g)(1), which would replace existing Commission regulation Sec.
37.203(f)(1), and adds a reference to ``market regulation functions,''
consistent with the new proposed defined term. Proposed Sec.
37.203(g)(1),
[[Page 19697]]
which would replace existing Commission regulation Sec. 37.203(f)(1),
adds a reference to ``market regulation functions,'' consistent with
the new proposed defined term. Proposed Sec. 37.203(g)(2)-(4) deletes
the modifier ``compliance'' when referencing staff.
A. Benefits
As explained above, the Commission is proposing certain non-
substantive changes to existing Sec. Sec. 37.203(c) and 38.155(a).
These changes include replacing references to ``compliance staff'' with
``staff.'' Proposed Sec. Sec. 37.203(c) and 38.155(a) would also amend
the first sentence of the existing regulations to provide that SEFs and
DCMs must establish and maintain sufficient staff and resources to
``effectively perform market regulation functions'' rather than listing
the individual functions. Additionally, as noted above, the Commission
proposes non-substantive changes to existing Commission regulations
Sec. Sec. 38.155, 38.158 and Sec. 37.203. Proposed Sec. 37.203(c)
and Sec. 38.155 would both be renamed as ``Sufficient staff and
resources.'' Proposed Sec. 37.203(g)(1) would add reference to
``market regulation functions,'' and 38.155(b) would add an internal
reference to paragraph (a) to achieve the same result. Proposed Sec.
38.158(a) would replace the reference to ``compliance staff'' with
``staff responsible for conducting market regulation functions.''
Proposed Sec. 38.158(b) would delete the reference to ``compliance
staff investigation'' being required to be completed in a timely
manner, and instead provide, more simply, that ``[e]ach investigation
must be completed in a timely manner.'' Finally, proposed Sec. Sec.
Sec. 37.203(g)(2)-(4) and 38.158(c) and (d) would delete the modifier
``compliance'' when referencing to staff. These amendments provide
additional clarity to those regulations. Such changes may provide
benefits through enhanced regulatory clarity for SEFs and DCMs.
However, as they are non-substantive changes, benefits will not be
significant.
The Commission also proposes to amend Sec. 37.203 to add a new
paragraph (d). The proposed rule would require SEFs to annually monitor
the size and workload of its staff, and ensure its resources and staff
effectively perform market regulation functions at appropriate levels.
In addition, paragraph (d) would include a reference to paragraph (c)
to clarify that it applies to staff responsible for conducting market
regulation functions. In addition, as noted above, with respect to both
proposed Sec. 37.203(d) and amended Sec. 38.155(b), the Commission is
proposing to add to the list of factors that a SEF or DCM should
consider in determining the appropriate level of resources and staff:
(1) any responsibilities that staff have at affiliated entities; and
(2) any conflicts of interest that prevent staff from working on
certain matters. Market regulation functions are critical for the
performance of a SEF's self-regulatory obligations. This amendment is
beneficial because it will help ensure sufficiency of SEF staff
responsible for performing market regulation functions and identify in
a timely way any potential conflicts of interest relating to market
regulations staff, particularly regarding a SEF's or DCM's affiliates.
B. Costs
The Commission also proposes to amend Sec. 37.203 to add a new
paragraph (d). The proposed provision would require SEFs to annually
monitor the size and workload of its staff, and ensure its resources
and staff effectively perform market regulation functions at
appropriate levels. SEFs may need to adjust their policies and
procedures to comply with this new monitoring requirement. Costs could
arise from additional hours SEF employees might need to spend analyzing
the compliance of their rules and procedures with these requirements,
drafting new or amended rules and procedures when necessary, and
implementing these new or amended rules and procedures. Costs may
further vary based on the size of the SEF, available resources the SEF
may have, and with existing practices and policies the SEF may have in
place. If a SEF has insufficient staff, it will need to find suitable
candidates and hire staff as necessary. As noted above, the Commission
proposes to amend Sec. 38.155(b), to add to the list of factors that a
DCM should consider in determining the appropriate level of resources
and staff: (1) any responsibilities that staff have at affiliated
entities; and (2) any conflicts of interest that prevent staff from
working on certain matters. The Commission believes that any costs
imposed by such additional two factors will be negligible, as DCMs are
currently obligated under existing Commission regulation Sec.
38.155(b) to monitor the size and workload of its compliance staff
annually, and already lists various factors they should consider in
making that determination of sufficiency of resources.
Finally, as noted above, the Commission proposes various non-
substantive changes to Commission regulations Sec. Sec. 37.203,
38.155, and 38.158. These will provide additional clarity to SEFs and
DCMs, and any costs associated with such changes will be negligible.
The Commission requests comments on the potential costs of the
proposed amendments to Sec. Sec. 37.203, 38.155, and 38.158, including
any costs that would be imposed on SEFs, DCMs, other market
participants, or the financial system more broadly. In particular, for
those SEFs and DCMs that already have these requirements in place, the
Commission requests comment on the extent to which the proposed rules
would require changes to existing policies and procedures.
C. Section 15(a) Factors
In addition to the discussion above, the Commission has evaluated
the costs and benefits of the proposed amendments to Sec. Sec. 38.155,
38.158, and 37.203 in light of the specific considerations identified
in Section 15(a) of the CEA. The Commission believes that the proposed
amendments to Sec. Sec. 38.155, 38.158, and 37.203 may have a
beneficial effect on protection of market participants and the public,
as well as on the financial integrity of the markets by requiring a
more direct link between exchange management and the staff performing
market regulation functions, hence providing a more direct way of
effectuating compliance with Commission rules. The Commission has
considered the other Section 15(a) Factors and believes that they are
not implicated by the proposed amendments to Sec. Sec. 38.155, 38.158,
and 37.203.
xii. SEF Chief Compliance Officer--Proposed Changes to Commission
Regulation Sec. 37.1501
In general, the statutory framework provided in SEF Core Principle
15 requires each SEF to designate an individual to serve as a CCO.\290\
SEF Core Principle 15 also provides requirements relating to the CCO's
reporting structure and duties.\291\
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\290\ CEA section 5h(f)(15); 7 U.S.C. 7b-3(f)(15)(A).
\291\ See id.
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Commission regulation Sec. 37.1501 further implements the
statutory CCO requirements. In particular, Commission regulation Sec.
37.1501 currently establishes definitions for the terms ``board of
directors'' and ``senior officer;'' addresses the authority of the CCO;
establishes qualifications for the CCO; outlines the appointment and
removal procedures for the CCO; requires the SEF's board of directors
or senior officer to approve the CCO's compensation; and requires the
CCO to
[[Page 19698]]
meet with the SEF's board of directors or senior officer at least
annually.\292\
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\292\ See Commission regulation Sec. 37.1501(a)-(b).
---------------------------------------------------------------------------
Commission regulation Sec. 37.1501(c) further outlines the duties
of the CCO. For example, Commission regulation Sec. 37.1501(c)(2)
details that the CCO must take reasonable steps, in consultation with
the board of directors or the senior officer of the SEF, to resolve any
material conflicts of interest that may arise, including, but not
limited to: (1) conflicts between business considerations and
compliance requirements; (2) conflicts between business considerations
and implementation of the requirement that the SEF provide fair, open,
and impartial access as set forth in Sec. 37.202; and (3) conflicts
between a SEF's management and members of the board of directors.
Commission regulation Sec. 37.1501(c)(6) specifies that the SEF's CCO
must establish and administer a compliance manual designed to promote
compliance with the applicable laws, rules, and regulations and a
written code of ethics for the SEF designed to prevent ethical
violations and to promote honesty and ethical conduct by SEF personnel.
Finally, Commission regulation Sec. Sec. 37.1501(c)(7) and (c)(8)
detail the requirement that the CCO supervise the SEF's self-regulatory
program as well as the effectiveness and sufficiency of any regulatory
service provider, respectively.
Commission regulation Sec. 37.1501(d) addresses the statutory
requirement under SEF Core Principle 15 requiring a CCO to prepare an
annual compliance report. Commission regulation Sec. 37.1501(d)
details the information the report must contain.\293\ Commission
regulation Sec. 37.1501(e) addresses the submission of the annual
compliance report; Commission regulation Sec. 37.1501(f) requires the
SEF to maintain all records demonstrating compliance with the duties of
the CCO and the preparation and submission of annual compliance reports
consistent with Commission regulations Sec. Sec. 37.1000 and 37.1001.
Finally, Commission regulation Sec. 37.1501(g) delegates to the
Director of the Division of Market Oversight the authority to grant or
deny a request for an extension of time for a SEF to file its annual
compliance report under Commission regulation Sec. 37.1501(e).
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\293\ Commission regulation Sec. 37.1500(d)(1)-(5).
---------------------------------------------------------------------------
The Commission is proposing several amendments to Sec. 37.1501.
First, the Commission proposes amendments to the existing SEF CCO
requirements to ensure that, to the extent applicable, these
requirements are consistent with the proposed DCM CRO requirements.
Second, the Commission is proposing additional SEF CCO requirements to
harmonize the language with other aspects of this proposal, namely
proposed amendments that pertain to the board of directors and
conflicts of interest procedures. Third, the Commission is proposing
amendments that will more closely align Sec. 37.1501 with the language
of SEF Core Principle 15.
The Commission is proposing to move the terms ``board of
directors'' and ``senior officer'' from existing regulation Sec.
37.1501(a) to proposed Sec. 37.1201(b). The meaning of each term would
remain unchanged, with one exception. Specifically, the Commission
seeks to clarify the existing definition of ``board of directors'' by
including the introductory language ``a group of people'' serving as
the governing body of the SEF.
The Commission also is proposing a new Sec. 37.1501(a)(3) that
would require the CCO to report directly to the board of directors or
to the senior officer of the SEF. This would be a new provision in
Sec. 37.1501, but it is consistent with the language of SEF Core
Principle 15, as set out in Sec. 37.1500. Proposed Sec.
37.1501(a)(4)(i) would amend the language in existing Commission
regulation Sec. 37.1501(b)(3)(i) to provide that the board of
directors or senior officer may appoint or remove the CCO ``with the
approval of the [SEF's] regulatory oversight committee.'' \294\
Finally, proposed Sec. 37.1501(a)(5) would amend the existing
requirement in Commission regulation Sec. 37.1501(b)(4) that the board
of directors or the senior officer of the SEF shall approve the
compensation of the CCO, to now require this approval to occur ``in
consultation with the [SEF's ROC].'' \295\
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\294\ Proposed Sec. 37.1501(a)(4)(i).
\295\ Proposed Sec. 37.1501(a)(5).
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The duties of the CCO under proposed Sec. 37.1501(b) are
substantively similar to existing Commission regulation Sec.
37.1501(c), with two exceptions. First, proposed Sec. 37.1501(b)(2)
provides that the CCO must take reasonable steps in consultation with
the SEF's board of directors ``or a committee thereof'' to manage and
resolve material conflicts of interest. The added reference to
``committee'' accounts for the ROC's role in resolving conflicts of
interest, which is provided in proposed Sec. 37.1206(d)(4). Second,
proposed Sec. 37.1501(b)(2)(i) specifies that conflicts of interest
between business considerations and compliance requirements includes,
with respect to compliance requirements, the SEF's ``market regulation
functions.''
Existing Commission regulation Sec. 37.1501(c)(7) provides that
the CCO must supervise the SEF's ``self-regulatory program,'' which
includes trade practice surveillance; market surveillance; real time
market monitoring; compliance with audit trail requirements;
enforcement and disciplinary proceedings; audits, examinations, and
other regulatory responsibilities (including taking reasonable steps to
ensure compliance with, if applicable, financial integrity, financial
reporting, sales practice, recordkeeping, and other requirements).
Proposed Sec. 37.1501(b)(7) would amend this provision to state that
the CCO is responsible for supervising the SEF's self-regulatory
program, including the market regulation functions set forth in Sec.
37.1201(b)(9).
Proposed Sec. 37.1501(c) is an entirely new rule that addresses
conflicts of interest involving the CCO. The proposed rules requires
the SEF to establish procedures for the disclosure of actual or
potential conflicts of interest to the ROC. In addition, the SEF must
designate a qualified person to serve in the place of the CCO for any
matter for which the CCO has such a conflict, and maintain
documentation of such disclosure and designation.
Proposed Sec. 37.1501(d)(5) amends the existing annual compliance
report requirement under Commission regulation Sec. 37.1501(d) to
require the annual report to include any actual or potential conflicts
of interests that were identified to the CCO during the coverage period
for the report, including a description of how such conflicts of
interest were managed or resolved, and an assessment of the impact of
any conflicts of interest on the swap execution facility's ability to
perform its market regulation functions.
A. Benefits
The Commission believes that proposed Sec. 37.1201(b) and the
proposed amendments to Sec. 37.1501(a) are likely to provide benefits
as they enhance the existing definition for the board of directors to
include the introductory language ``a group of people,'' which provides
clarity and ease of reference. This, in turn, should enhance the SEF's
ability to comply with the regulation. Proposed Sec. 37.1501(a)(3),
which requires the CCO to directly report to the SEF's board of
directors or to the senior officer of the SEF, is likely to provide
benefits by allowing the CCO to report directly to the ROC, which
insulates the CCO's role from commercial interests and allows that
[[Page 19699]]
person to more effectively fulfill its critical market regulations
functions and other self-regulatory obligations. This may result in
improved overall SEF compliance with Commission regulations. It is,
however, important to note that providing the SEF an option to have its
CCO to report to a senior officer may introduce a possibility of
interference by the management team, as senior officers are likely to
have incentives that conflict with that of a CCO. For example, senior
officers are sometimes responsible for performance evaluations and
approving administrative requests, which might compromise the
effectiveness of the CCO and may limit the benefits of the proposed
rule.
Proposed Sec. 37.1501(a)(4)(i), which will allow the board of
directors or a senior officer to appoint or remove the CCO with the
approval of the SEF's ROC, is likely to generate benefits as it further
insulates the CCO from improper or undue influence from the commercial
interests of the SEF. These benefits, however, are likely to be limited
as SEFs have been operating under an existing similar standard.
Furthermore, by requiring the board of directors or the senior officer
to consult with the ROC in approving the compensation of the CCO,
proposed Sec. 37.1501(a)(5) is likely to provide benefits as it may
further insulate the CCO from interference from the commercial
interests of the SEF.
In addition, by requiring the ROC's involvement in resolving
conflicts of interest and by explicitly including the SEF's market
regulation function in the list of conflicts considered for compliance
requirements, proposed Sec. 37.1501(b) will allow the CCO to be in a
better position to resolve conflicts of interest that relate to
surveillance, investigations, and disciplinary functions which, in
turn, will enhance the SEF's important role as an SRO.
The proposed amendment to Sec. 37.1501(b)(7) will explicitly refer
to a SEF's market regulation function in referring to the CCO's
supervision responsibility. The term ``market regulation functions'' is
defined in proposed Sec. 37.1201(b)(9), and will provide clarity and
ease of reference to compliance standards. Such clarity and ease of
reference should enhance a SEF's ability to comply with core principle
and regulatory requirements. To the extent that a SEF's CCO is already
carrying out such responsibilities, the benefits may be less
significant.
Proposed Sec. 37.1501(c), requires SEFs to establish procedures
for disclosing conflicts of interest to the ROC, designate a qualified
person to serve in the place of the CCO for any matter in which the CCO
has a conflict, and maintain documentation of such designation. These
requirements are likely to provide benefits by better facilitating the
ROC's assistance in managing and resolving conflicts of interest. This
will allow the SEF to effectively perform its market regulation
functions and maintain regulatory compliance. In addition, the
requirement in proposed regulation Sec. 37.1501(c) that the SEF have
procedures to designate a qualified person to serve in the place of the
CCO for any matter in which the CCO is conflicted is likely to provide
benefits as it will increase the likelihood that the conflict of
interest is managed and resolved by a person with sufficient
independence, expertise and authority, which, in turn, will allow the
SEF to effectively perform its market regulation functions.
In addition, proposed Sec. 37.1501(d)(5), which amends the annual
compliance report requirements to include a report of any actual or
potential conflicts of interests and how such conflicts of interests
were managed or resolved, will increase the chances that the Commission
has timely notice and sufficient knowledge of conflicts of interest and
how they are resolved. Such disclosures allow the Commission to have
effective oversight over SEFs and enhances SEF governance transparency
and accountability.
B. Costs
In order to comply with the proposed amendments to Sec. 37.1501,
SEFs may need to adjust their policies and procedures regarding CCOs.
This may impose some administrative costs on SEFs. Costs could arise
from additional hours SEF employees might need to spend analyzing the
compliance of their rules and procedures with the proposed
requirements, drafting new or amended rules and procedures when
necessary, and implementing these new or amended rules and procedures.
More specifically, SEFs may have additional costs associated with
the CCO position resulting from the time requirements on the board of
directors or senior officer meeting with the CCO, and administrative
costs associated with the ROC actions being required to hire or remove
a CCO and to approve CCO compensation. To the extent that SEFs already
have such rules and procedures in place, costs may have been already
realized.
The Commission requests comment on the potential costs of the
proposed amendments to Sec. 37.1501, including any costs that would be
imposed on SEFs, other market participants, or the financial system
more broadly.
C. Section 15(a) Factors
In addition to the discussion above, the Commission has evaluated
the costs and benefits of the proposed amendments to Sec. 37.1501 in
light of the specific considerations identified in Section 15(a) of the
CEA. The Commission believes that the proposed amendments to Sec.
37.1501 may have a beneficial effect on protection of market
participants and the public, as well as on the financial integrity of
the markets because the proposed amendments should support and
effectuate better compliance with core principles. Increased
independence of the CCO position and additional requirements pertaining
to the resolution and documentation of conflicts of interest will
enhance SEF governance, accountability, and promote transparency, which
is an essential factor for establishing the integrity of derivatives
markets. The Commission has considered the other Section 15(a) Factors
and believes that they are not implicated by the proposed amendments to
Sec. 37.1501.
xiii. Transfer of Equity Interest--Proposed Changes to Commission
Regulations Sec. Sec. 37.5(c) and 38.5(c)
Currently, Commission regulations Sec. Sec. 37.5(c)(1) and
38.5(c)(1) require SEFs and DCMs, respectively, to notify the
Commission in the event of an equity interest transfer. The threshold
that triggers the notification requirement when a DCM enters a
transaction is the transfer of 10 percent or more of the DCM's equity.
In comparison, a SEF is required to notify the Commission when it
enters a transaction to transfer 50 percent or more of the SEF's
equity. Commission regulation Sec. 37.5(c)(1) provides that the
Commission may ``upon receiving such notification, request supporting
documentation of the transaction.'' Commission regulation Sec.
38.5(c)(1) does not include a similar provision for DCMs.
Commission regulations Sec. Sec. 37.5(c)(2) and 38.5(c)(2) govern
the timing of the equity interest transfer notification to the
Commission. These provisions require notification at the earliest
possible time, but in no event later than the open of business 10
business days following the date upon which the SEF or DCM enters a
firm obligation to transfer the equity interest. Commission regulations
Sec. Sec. 37.5(c)(3) and 38.5(c)(3) govern rule filing obligations
that may be prompted by the equity interest transfer. Commission
regulation Sec. 37.5(c)(4) requires a SEF to certify to
[[Page 19700]]
the Commission no later than two days after an equity transfer takes
place that the SEF meets all of the requirements of section 5h of the
CEA and applicable Commission regulations. Commission regulation Sec.
38.5(c) does not have an analogous certification requirement for DCMs.
Commission regulations Sec. Sec. 37.5(d) and 38.5(d) establish
Commission delegation of authority provisions to the Director of the
Division of Market Oversight. The delegation authority under Sec.
37.5(d) permits the Director to request any of the information
specified in Sec. 37.5, including information relating to the business
of the SEF, information demonstrating compliance with the core
principles, or with the SEF's other obligations under the CEA or the
Commission's regulations, and information relating to an equity
interest transfer. In contrast, the scope of the delegation of
authority in Commission regulation 38.5(d) limits the Director to
requesting information from a DCM pursuant to Commission regulation
Sec. 38.5(b) demonstrating compliance with the DCM core principles and
the CEA. The Director's delegation authority does not extend to
requests for information related to the business of the DCM or to
equity interest transfers.
The Commission proposes to amend regulations Sec. Sec. 37.5(c) and
38.5(c) to: (1) ensure the Commission receives timely and sufficient
information in the event of certain changes in the ownership or
corporate or organizational structure of a SEF or DCM; (2) clarify what
information is required to be provided and the relevant deadlines; and
(3) conform to similar requirements applicable to DCOs.
The Commission proposes to amend regulation Sec. 37.5(c)(1) to
require SEFs to file with the Commission notification of transactions
involving the transfer of at least 10 percent of the equity interest in
the SEF. The Commission also is proposing to amend regulations
Sec. Sec. 37.5(c)(1) and 38.5(c)(1) to expand the types of changes of
ownership or corporate or organizational structure that would trigger a
notification obligation to the Commission. The proposed amendments
would require SEFs and DCMs to report any anticipated change in the
ownership or corporate or organizational structure of the SEF or DCM,
or its respective parent(s) that would: (1) result in at least a 10
percent change of ownership of the SEF or DCM, or a change to the
entity or person holding a controlling interest in the SEF or DCM,
whether through an increase in direct ownership or voting interest in
the SEF or DCM, or in a direct or indirect corporate parent entity of
the SEF or DCM; (2) create a new subsidiary or eliminate a current
subsidiary of the SEF or DCM; or (3) result in the transfer of all or
substantially all of the assets of the SEF or DCM to another legal
entity.
The Commission also is proposing to amend regulations Sec. Sec.
37.5(c)(2) and 38.5(c)(2) to clarify what information must be submitted
to the Commission as part of a notification pursuant to Commission
regulations Sec. Sec. 37.5(c)(1) and 38.5(c)(1), as proposed to be
amended. The Commission proposes to harmonize and enhance the
requirements between SEFs and DCMs by amending regulations Sec. Sec.
37.5(c)(2) and 38.5(c)(2) to state that, as part of a notification
pursuant to Commission regulations Sec. Sec. 37.5(c)(1) or 38.5(c)(1),
a SEF or DCM must provide ``required information'' including: a chart
outlining the new ownership or corporate or organizational structure, a
brief description of the purpose or the impact of the change, and any
relevant agreement effecting the change and corporate documents such as
articles of incorporation and bylaws. As proposed, the Commission may,
after receiving such information, request additional supporting
documentation related to the change in ownership or corporate or
organizational structure, such as amended Form SEF or Form DCM
exhibits, to demonstrate that the SEF or DCM will, following the
change, continue to meet all the requirements in section 5 or 5h of the
CEA (as applicable) and applicable Commission regulations.
Proposed Sec. Sec. 37.5(c)(3) and 38.5(c)(3) will require a
notification pursuant to Commission regulations Sec. Sec. 37.5(c)(1)
or 38.5(c)(1) to be submitted no later than three months prior to the
anticipated change, provided that the SEF or DCM may report the
anticipated change later than three months prior to the anticipated
change if it does not know and reasonably could not have known of the
anticipated change three months prior to the anticipated change. In
such event, the SEF or DCM shall immediately report such change to the
Commission as soon as it knows of such change.
In addition to the new reporting requirements, the proposal
includes a new certification requirement for DCMs. The Commission is
proposing to amend Commission regulation Sec. 38.5(c) by adding a
certification requirement in regulation Sec. 38.5(c)(5). The
certification will require a DCM, upon a change in ownership or
corporate organizational structure described in Commission regulation
Sec. 38.5(c)(1), file with the Commission a certification that the DCM
meets all of the requirements of section 5 of the CEA and applicable
Commission regulations. The certification must be filed no later than
two business days following the date on which the change in ownership
or corporate or organizational structure takes effect.
The Commission proposes a new Sec. Sec. 37.5(c)(6) and 38.5(c)(6),
which provide that a change in the ownership or corporate or
organizational structure of a SEF or DCM that results in the failure of
the SEF or DCM to comply with any provision of the Act, or any
regulation or order of the Commission thereunder, shall be cause for
the suspension of the registration or designation of the SEF or DCM, or
the revocation of registration or designation as a SEF or DCM, in
accordance with sections 5e and 6(b) of the CEA. The proposed rule
further provides that the Commission may make and enter an order
directing that the SEF or DCM cease and desist from such violation, in
accordance with sections 6b and 6(b) of the CEA. Section 6(b) of the
CEA authorizes the Commission to suspend or revoke registration or
designation of a SEF or DCM if the exchange has violated the CEA or
Commission orders or regulations. Section 6(b) includes a number of
procedural safeguards, including that it requires notice to the SEF or
DCM, a hearing on the record, and appeal rights to the court of appeals
for the circuit in which the SEF or DCM has its principal place of
business. It is imperative that SEFs and DCMs, regardless of ownership
or control changes, continue to comply with the CEA and all Commission
regulations to promote market integrity and protect market
participants.
Finally, the Commission proposes to amend existing regulation Sec.
38.5(d) by extending the delegation of authority provisions to the
Director of the Division of Market Oversight to include information
requests related to the business of the DCM in Sec. 38.5(a) and
changes in ownership or corporate or organizational structure in Sec.
38.5(c).
A. Benefits
The proposed change to revise the reporting threshold for SEFs from
50 percent to 10 percent would harmonize the regulatory standard
currently in place for DCMs and DCOs. In addition, lowering the
notification standard for SEFs may better allow the Commission to
fulfill its oversight obligations. The Commission recognizes that a
notification based on a percentage of ownership change that is set too
low will result in notifications of changes that do not have a
consequential change
[[Page 19701]]
in who has control over the exchange or impact on SEF operations. In
contrast, a threshold set too high will reduce the instances of
notification of changes in ownership or corporate or organizational
structure to the Commission that are consequential to the operations of
a SEF. The Commission believes that lowering the threshold to 10
percent results in an appropriate balance. In this connection, the 10
percent threshold represents a level where the Commission would receive
notice of a SEF's ownership or corporate or organizational structure
changes, when such changes actually reflect meaningful changes in who
potentially could impact a SEF's compliance with the CEA and Commission
regulations. Therefore, the proposed amendment will benefit SEF market
participants and the public given the increased transparency to the
Commission in terms of who potentially controls the SEF.
As discussed in the preamble above, under the existing regulations,
an increase in equity interest of less than 10 percent could still
result in change of control of the exchange. Proposed Sec. Sec.
37.5(c)(1) and 38.5(c)(1) expand the scope of corporate changes that
require notification to include changes not only in ownership, but also
corporate and organizational structural changes. These proposed changes
will help ensure that the Commission has accurate knowledge of the
individuals or entities that control a SEF or DCM and its activities,
thereby promoting market integrity. The Commission believes that
proposed Sec. Sec. 37.5(c)(2) and 38.5(c)(2) will encourage SEFs and
DCMs to remain mindful of their self-regulatory responsibilities when
negotiating the terms of significant equity interest transfers or other
changes in ownership or corporate or organizational structure. In
addition, the proposed rules help maintain an orderly marketplace
despite changes in the ownership or corporate or organizational
structure of the exchange. The proposed amendments will enhance
Commission staff's ability to undertake a timely and effective due
diligence review of the impact, if any, of such changes. These enhanced
requirements will allow Commission staff to seek updated copies of
exhibits and other documents that provide valuable and timely
information regarding the professional staff, legal proceedings,
rulebook changes, third party service provider agreements, member and
user agreements, and compliance manual changes. Those documents are
important to confirm that the registrant will continue to be able to
meet its regulatory obligations.
The Commission believes that new provisions Sec. Sec. 37.5(c)(3)
and 38.5(c)(3) that require the SEF or the DCM notification three
months prior to the anticipated change or immediately as soon as it
knows of such a change, will allow the Commission staff sufficient time
to review the change and confirm compliance with applicable statutory
and regulatory requirements. The new rules will also provide
flexibility to the SEF or DCM if the anticipated change occurs more
quickly than within three months.
Given their roles as SROs, the proposed amendments to Sec. 38.5(c)
are likely to provide benefits by establishing consistent regulations
among SEFs and DCMs in the manner they certify their compliance with
the CEA and Commission regulations. Furthermore, to the extent that the
certification requirement will help ensure any changes to ownership or
corporate or organizational structure do not result in non-compliance,
the certification requirement will improve confidence in the
marketplace and promote market integrity.
Finally, the proposal extends the delegation of authority
provisions to the Director of the Division of Market Oversight
regarding DCMs to include information requests related to the business
and changes to ownership or corporate or organizational structure of a
DCM. Proposed Sec. 38.5(d) provides a standard for DCMs that conforms
to the existing standard for SEFs and establishes a consistent
regulatory framework. Furthermore, since changes to ownership or
corporate or organizational structure of a DCM can occur relatively
quickly with significant consequences, the amendments are likely to
provide benefits by providing the Director of the Division of Market
Oversight with the authority to immediately request information and
documents to confirm continued compliance with the CEA and relevant
regulations, which in turn should result in more effective DCM
oversight.
B. Costs
As described above, the Commission proposes to amend regulations
Sec. Sec. 37.5(c) and 38.5(c) to ensure the Commission receives timely
and sufficient information in the event of certain changes in the
ownership or corporate or organizational structure of a SEF or DCM.
To comply with the proposed rules, SEFs and DCMs may need to adjust
their policies and procedures, which would impose some costs. SEF and
DCM costs could arise from additional hours employees might need to
spend analyzing the compliance of their rules and procedures with these
requirements, drafting new or amended rules and procedures when
necessary, and implementing these new or amended rules and procedures.
Costs associated with complying with the proposed Sec. Sec. 37.5(c)
and 38.5(c) may further vary based on the size of the SEF and DCM,
available resources, and the existing practices and policies they may
already have in place. Finally, costs will depend significantly on how
often a change in ownership or corporate or ownership structure occurs.
More specifically, while DCMs are already required to notify the
Commission in the event of a 10 percent change in ownership interest,
this 10 percent threshold requirement is being extended to SEFs, which
will impose additional costs whenever such a transfer occurs.
Additionally, the proposed rules also require both SEFs and DCMs to
report any anticipated change in the ownership or corporate or
organizational structure of the SEF or DCM, or its respective parent(s)
that would result in at least a 10 percent change of ownership of the
SEF or DCM, or a change to the entity or person holding a controlling
interest in the SEF or DCM. This additional reporting in the event of
anticipated change will generate additional costs for both SEFs and
DCMs. Under proposed Sec. Sec. 37.5(c)(3) and 38.5(c)(3), this
additional reporting is required to be submitted to the Commission no
later than three months prior to the anticipated change which will add
additional employee time and costs to any anticipated change in
ownership or organizational structure event that requires notification
under the proposed rules.
With respect to DCMs, proposed Sec. 38.5(c)(5) will add a
certification requirement in the event of a change in ownership or
organizational structure similar to the existing requirements for SEFs.
This certification must be no later than two business days following
the date on which the change in ownership or corporate or
organizational structure took effect, and will add direct costs to any
such change event.
Finally, the Commission proposes to amend existing Commission
regulation Sec. 38.5(d) to delegate to the Director of the Division of
Market Oversight the authority to request information related to the
DCM's business and changes in ownership or corporate or organizational
structure. Information or document requests initiated by the Director,
as opposed to the Commission, should not, on its own, impose
[[Page 19702]]
additional costs on DCMs. Therefore, costs to DCMs relating to this
change should be negligible. The Commission acknowledges that a
streamlined process for requesting information and documents may result
in more frequent information or document requests under Sec. 38.5. In
that respect, direct costs to DCMs could increase.
The Commission requests comments on the potential costs of the
proposed amendments to Sec. Sec. 37.5(c) and 38.5(c) and (d),
including any costs that would be imposed on SEFs, DCMs, other market
participants, or the financial system more broadly.
C. Section 15(a) Factors
In addition to the discussion above, the Commission has evaluated
the costs and benefits of the proposed amendments to Sec. Sec. 37.5(c)
and 38.5(c) and (d) in light of the specific considerations identified
in Section 15(a) of the CEA. The Commission believes that the proposed
amendments may have a beneficial effect on protection of market
participants and the public, as well as on the integrity of the markets
through improved Commission awareness and oversight of significant
changes to ownership or corporate or organizational structure of SEFs.
The Commission has considered the other Section 15(a) Factors and
believes that they are not implicated by the proposed amendments to
Sec. Sec. 37.5(c) and 38.5(c)-(d).
Summary 15(a) Factors
In addition to the discussion above, the Commission has evaluated
the costs and benefits of the proposed rules in light of the following
five broad areas of market and public concern identified in Section
15(a) of the CEA: (1) protection of market participants and the public;
(2) efficiency, competitiveness, and financial integrity of markets;
(3) price discovery; (4) sound risk management practices; and (5) other
public interest considerations. The Commission believes that the
proposed rules will have a beneficial effect on sound risk management
practices and on the protection of market participants and the public.
1. Protection of Market Participants and the Public
The Commission believes that the proposed rules will enhance the
protection of market participants and the public by improving the
ability of SEFs and DCMs to identify, manage and resolve conflicts of
interest. The proposed rules will allow the exchanges to properly and
orderly perform their function in facilitating markets, which in turn
will reduce the likelihood that market participants and the public face
unanticipated costs. The proposed rules will enhance the transparency
and consistency of governance fitness standards, which in turn
increases the likelihood that exchanges provide reliable services to
the market participants. Finally, the proposed rules will provide the
public and the Commission with transparent information regarding
changes in ownership of SEFs or DCMs, which enhances the protection of
the public.
2. Efficiency, Competitiveness, and Financial Integrity
The proposed rules will benefit the financial integrity of the
derivatives markets by promoting the transparency and the integrity of
the governance practices and proper identification and handling of
conflicts of interest through the adoption of the proposed rules. The
proposed rules will also benefit the marketplace by allowing a
consistent approach on managing conflicts of interest and
implementation of governance fitness standards. Additionally, the
proposed rules will promote SEF's and DCM's ability to complete their
self-regulatory obligations by promoting the resources necessary to
effectively complete those obligations.
3. Price Discovery
Price discovery is the process of determining the price level for
an asset through the interaction of buyers and sellers and based on
supply and demand conditions. The Commission has not identified any
effect of the proposed rules on the price discovery process.
4. Sound Risk Management Practices
The proposed rules seek to establish transparent and consistent
governance fitness standards and proposes rules for proper
identification and handling of conflicts of interest, which will
support sound risk management practices at SEFs and DCMs. Nevertheless,
the proposed rules will not necessarily impact the sound risk
management practices by other market participants per se.
5. Other Public Interest Considerations
The Commission has not identified any effect of the proposed rule
on other public interest considerations.
4. Question for Comment
As noted above regarding the regulatory baseline, the Commission's
understanding is that all of the DCMs that are currently designated by
the Commission rely on the acceptable practices to comply with Core
Principle 16, and therefore the actual costs and benefits of the
codification of those acceptable practices with respect to DCMs may not
be as significant. Is this understanding correct in all cases or are
there situations where DCMs using other means to satisfy the core
principles? If so, what are these means?
b. Regulatory Flexibility Act
The Regulatory Flexibility Act (``RFA'') requires Federal agencies
to consider whether the regulations they propose will have a
significant economic impact on a substantial number of small entities
and, if so, provide a regulatory flexibility analysis with respect to
such impact.\296\ The regulations proposed herein will directly affect
SEFs, DCMs, and their market participants. The Commission has
previously established certain definitions of ``small entities'' to be
used by the Commission in evaluating the impact of its regulations on
small entities in accordance with the RFA.\297\ The Commission
previously concluded that SEFs are not small entities for the purpose
of the RFA.\298\ The Commission has also previously stated its belief
in the context of relevant rulemakings that SEFs' market participants,
which are all required to be eligible contract participants (``ECPs'')
\299\ as defined in section 1a(18) of the CEA,\300\ are not small
entities for purposes of the RFA.\301\ Similarly, Commission previously
determined that DCMs are not small entities for purposes of the RFA
because DCMs are required to demonstrate compliance with a number of
core principles, including principles concerning the expenditure of
sufficient financial resources to establish and maintain an adequate
self-regulatory program.\302\ Therefore, the Chairman, on behalf of the
Commission, hereby certifies, pursuant to 5 U.S.C. 605(b), that the
proposed rules will not have a significant economic impact on a
substantial number of small entities.
[[Page 19703]]
The Commission invites the public and other federal agencies to comment
on the above determination.
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\296\ 5 U.S.C. 601 et seq.
\297\ 47 FR at 18618-21 (Apr. 30, 1982).
\298\ See Part 37 Final Rule, 78 FR 33476 at 33548 (citing 47 FR
18618, 18621 (Apr. 30, 1982) (discussing DCMs)).
\299\ Commission regulation 37.703.
\300\ 7 U.S.C. 1(a)(18).
\301\ Opting Out of Segregation, 66 FR 20740 at 20743 (Apr. 25,
2001) (stating that ECPs by the nature of their definition in the
CEA should not be considered small entities).
\302\ See Policy Statement and Establishment of Definitions of
``Small Entities'' for Purposes of the Regulatory Flexibility Act,
47 FR 18618, 18619 (Apr. 30, 1982); See also, e.g., DCM Core
Principle 21 applicable to DCMs under section 735 of the Dodd-Frank
Act.
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c. Paperwork Reduction Act
The Paperwork Reduction Act of 1995 (``PRA'') \303\ imposes certain
requirements on federal agencies, including the Commission, in
connection with their conducting or sponsoring any ``collection of
information,'' as defined by the PRA. Under the PRA, an agency may not
conduct or sponsor, and a person is not required to respond to, a
collection of information unless it displays a valid control number
from the Office of Management and Budget (``OMB'').\304\ The PRA is
intended, in part, to minimize the paperwork burden created for
individuals, businesses, and other persons as a result of the
collection of information by federal agencies, and to ensure the
greatest possible benefit and utility of information created,
collected, maintained, sued, shared, and disseminated by or for the
Federal Government.\305\ The PRA applies to all information, regardless
of form or format, whenever the Federal Government is obtaining,
causing to be obtained, or soliciting information, and includes
required disclosure to third parties or the public, of facts or
opinions, when the information collection calls for answers to
identical questions posed to, or identical reporting or recordkeeping
requirements imposed on, 10 or more persons.\306\
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\303\ 5 U.S.C. 601, et seq.
\304\ See 44 U.S.C. 3507(a)(3); 5 CFR 1320.5(a)(3).
\305\ See 44 U.S.C. 3501.
\306\ See 44 U.S.C. 3502(3).
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This NPRM, if adopted, would result in a collection of information
within the meaning of the PRA, as discussed below. The proposal affects
three collections of information for which the Commission has
previously received a control number from OMB: OMB Control No. 3038-
0052, ``Core Principles & Other Requirements for DCMs;'' \307\ OMB
Control No. 3038-0074, ``Core Principles and Other Requirements for
Swap Execution Facilities;'' \308\ and OMB Control No. 3038-0093,
``Part 40, Provisions Common to Registered Entities.'' \309\
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\307\ For the previously approved PRA estimates for DCMs under
OMB Control No. 3038-0052, see ICR Reference No. 202207-3038-003,
Conclusion Date Aug. 24, 2022, at https://www.reginfo.gov/public/do/PRAViewICR?ref_nbr=202207-3038-003. The PRA analysis uses a count of
16 DCMs based on Commission data accurate as of Sept. 29, 2023.
\308\ For the previously approved estimates for SEFs under OMB
Control No. 3038-0074, see ICR Reference No. 202201-3038-002,
Conclusion Date Apr. 30, 2022, at https://www.reginfo.gov/public/do/PRAViewICR?ref_nbr=202201-3038-002. The PRA analysis uses a count of
23 SEFs based on Commission data accurate as of Sept. 29, 2023.
\309\ OMB Control Number 3038-0093 has two Information
Collections: Part 40, Provisions Common to Registered Entities; and
Part 150, Position Limits. See https://www.reginfo.gov/public/do/PRAViewICR?ref_nbr=202102-3038-001.
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The Commission is therefore submitting this NPRM to OMB for
review.\310\ Responses to this collection of information would be
mandatory. The Commission will protect any proprietary information
according to the Freedom of Information Act and part 145 of the
Commission's regulations.\311\ In addition, CEA section 8(a)(1)
strictly prohibits the Commission, unless specifically authorized by
the CEA, from making public any data and information that would
separately disclose the business transactions or market positions of
any person and trade secrets or names of customers.\312\ Finally, the
Commission is also required to protect certain information contained in
a government system of records according to the Privacy Act of
1974.\313\
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\310\ See 44 U.S.C. 3507(d) and 5 CFR 1320.11.
\311\ See 5 U.S.C. 552; see also 17 CFR part 145 (Commission
Records and Information).
\312\ 7 U.S.C. 12(a)(1).
\313\ 5 U.S.C. 552a.
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1. Burden Estimates
For PRA purposes, there are 23 registered SEFs and 16 designated
DCMs. The proposed amendments would impose new one-time and ongoing
reporting and recordkeeping requirements on SEFs and DCMs related to
conflict of interest requirements and associated governance
requirements under parts 37 and 38, along with associated rule
submissions under part 40. The estimated aggregate burden imposed by
the proposed amendments is set out below.
2. Fitness Documentation and Written Procedures (Sec. Sec.
37.207(d) and 38.801(d))
The proposed amendments would add requirements that SEFs and DCMs
establish appropriate procedures for the collection of information
supporting compliance with appropriate fitness standards, including the
creation of written procedures that are preserved for Commission
review. The new provisions would codify and enhance existing guidance
covering DCMs (Core Principle 15 Guidance) and Commission regulation
Sec. 1.63 covering SEFs and DCMs.
The Commission estimates that each SEF and DCM will spend an
additional 10 hours annually on recordkeeping for Sec. Sec. 37.207(d)
and 38.801(d), plus a 40-hour one-time start-up cost for the initial
written procedures. Accordingly, the aggregate annual estimate for the
recordkeeping and reporting burden associated as with the proposal, is
as follows:
DCMs--Recordkeeping Sec. 38.801(d)
Estimated number of respondents: 16.
Estimated number of reports per respondent: 1.
Average number of hours per report: 10.
Estimated gross annual recordkeeping burden (hours): 160.
One-time start-up burden (hours): 40.
Estimated gross one-time start-up burden (hours): 640.
SEFs--Recordkeeping Sec. 37.207(d)
Estimated number of respondents: 23.
Estimated number of reports per respondent: 1.
Average number of hours per report: 10.
Estimated gross annual recordkeeping burden (hours): 230.
One-time start-up burden (hours): 40.
Estimated gross one-time start-up burden (hours): 920.
3. Documentation of Conflict-of-Interest Provisions (Sec. Sec.
37.1202(b) and 38.852(b))
Proposed Sec. Sec. 37.1202(b) and 38.852(b) require the board of
directors, committee, or disciplinary panel to document its processes
for complying with the requirements of the conflict-of-interest rules,
and such documentation must include: (1) the names of all members and
officers who attended the relevant meeting in person where a conflict
of interest was raised; and (2) the names of any members and officers
who voluntarily recused themselves or were required to abstain from
deliberations or voting on a matter and the reason for the recusal or
abstention. Although these provisions currently exist for SEFs in Sec.
1.69, they are new for DCMs.
The Commission estimates that each SEF and DCM will spend an
additional one hour four times a year on recordkeeping associated with
the proposal. Accordingly, the aggregate annual estimate for the
reporting burden associated with proposed new Sec. Sec. 37.1202(b) and
38.852(b) is as follows:
DCMs--Recordkeeping Sec. 38.852(b)
Estimated number of respondents: 16.
Estimated number of reports per respondent: 4.
Average number of hours per report: 1.
Estimated gross annual recordkeeping burden (hours): 64.
SEFs--Recordkeeping Sec. 37.1202(b)
Estimated number of respondents: 23.
Estimated number of reports per respondent: 4.
[[Page 19704]]
Average number of hours per report: 1.
Estimated gross annual recordkeeping burden (hours): 92.
4. Trading on Material Non-Public Information (Sec. Sec. 37.1203 and
38.853)
The amendments include documentation and recordkeeping requirements
connected to a new requirement that SEFs and DCMs take certain steps to
prevent an employee, member of the board of directors, committee
member, consultant, or owner with more than a 10 percent interest in
the SEF or DCM, from trading commodity interests or related commodity
interests based on, or disclosing, any non-public information obtained
through the performance of their official duties. The proposal would
replace an existing regulation applicable to SEFs and partially to DCMs
(Sec. 1.59), and guidance applicable to DCMs (Core Principle 16
Guidance). Under the proposed amendments, SEFs and DCMs must continue
to document any exemptions from trading restrictions, in accordance
with requirements in existing Commission regulations Sec. Sec. 37.1000
and 37.1001 or 38.950 and 38.951, respectively.
The Commission estimates that each SEF and DCM will spend an
estimated additional 10 hours annually on recordkeeping associated with
this proposal, with a one-time burden of 10 hours to review and update
existing policies and procedures. Accordingly, the aggregate annual
estimate for the reporting burden associated with proposed new
Sec. Sec. 37.1203 and 38.853, is as follows:
DCMs--Recordkeeping Sec. 38.853
Estimated number of respondents: 16.
Estimated number of reports per respondent: 1.
Average number of hours per report: 10.
Estimated gross annual reporting burden (hours): 160.
One-time start-up burden (hours): 10.
Estimated gross one-time start-up burden (hours): 160.
SEFs--Recordkeeping Sec. 37.1203
Estimated number of respondents: 23.
Estimated number of reports per respondent: 1.
Average number of hours per report: 10.
Estimated gross annual reporting burden (hours): 230.
One-time start-up burden (hours): 10.
Estimated gross one-time start-up burden (hours): 230.
5. Annual Self-Assessment Sec. Sec. 37.1204(d) and 38.854(d)
Proposed Sec. Sec. 37.1204(d) and 38.854(d) are new requirements
that SEF and DCM Boards perform an annual self-assessment and
performance review, and document the results for possible Commission
review.
The Commission estimates that the documentation and recordkeeping
for the annual review will take 25 hours. Accordingly, the aggregate
annual estimate for the recordkeeping burden associated with Sec. Sec.
37.1204(d) and 38.854(d) is as follows:
DCMs--Sec. 38.854(d)
Estimated number of respondents: 16.
Estimated number of reports per respondent: 1.
Average number of hours per report: 25.
Estimated gross annual reporting burden (hours): 400.
SEFs--Sec. 37.1204(d)
Estimated number of respondents: 23.
Estimated number of reports per respondent: 1.
Average number of hours per report: 25.
Estimated gross annual reporting burden (hours): 575.
6. Commission Notice of Membership Changes of the Board of Directors
(Sec. Sec. 37.1204(f) and 38.854(f))
This new proposed provision would require SEFs and DCMs to notify
the Commission within five business days of any changes to the
membership of the board of directors or its committees.
The Commission believes that although the ongoing burden will be
low, it constitutes a burden for PRA purposes. Each notification will
take an estimated one hour, and each SEF and DCM will on average change
two board or committee members a year (in total). Accordingly, the
aggregate annual estimate for the reporting burden associated with
proposed Sec. Sec. 37.1204(f) and 38.854(f) is as follows:
DCMs--Sec. 38.854(f) Reporting
Estimated number of respondents: 16.
Estimated number of reports per respondent: 2.
Average number of hours per report: 1.
Estimated gross annual reporting burden (hours): 32.
SEF--Sec. 37.1204(f) Reporting
Estimated number of respondents: 23.
Estimated number of reports per respondent: 2.
Average number of hours per report: 1.
Estimated gross annual reporting burden (hours): 46.
7. ROC Meeting Minutes and Documentation (Sec. Sec. 37.1206(f)(1)(iii)
and 38.857(f)(1)(iii); Sec. Sec. 37.1206(f)(2) and 38.857(f)(2))
The proposed provisions in Sec. Sec. 37.1206(f)(1)(iii) and
38.857(f)(1)(iii) would require that SEF and DCM ROC meeting minutes
include the following specific information: (a) list of the attendees;
(b) their titles; and (c) whether they were present for the entirety of
the meeting or a portion thereof (and if so, what portion); and (d) a
summary of all meeting discussions. In addition, new Sec. Sec.
37.1206(f)(2) and 38.857(f)(2) would require the ROCs to maintain
documentation of the committee's findings, recommendations, and any
other discussions or deliberations related to the performance of its
duties.
The Commission estimates that these new requirements will add an
additional four hours of recordkeeping for an estimated four quarterly
ROC meetings for each SEF and DCM. Accordingly, the aggregate annual
estimate for the reporting burden associated with the proposal is as
follows:
DCMs--Sec. 38.857(f)(1)(iii) and 38.857(f)(2) Recordkeeping
Estimated number of respondents: 16.
Estimated number of reports per respondent: 4.
Average number of hours per report: 4.
Estimated gross annual reporting burden (hours): 256.
SEFs--Sec. Sec. 37.1206(f)(1)(iii) and 37.1206(f)(2) Recordkeeping
Estimated number of respondents: 23.
Estimated number of reports per respondent: 4.
Average number of hours per report: 4.
Estimated gross annual reporting burden (hours): 368.
8. ROC Annual Report ((Sec. Sec. 37.1206(g)(1) and (g)(2) and
38.857(g)(1) and (g)(2))
Currently, DCMs prepare annual ROC reports pursuant to the
Acceptable Practices for DCM Core Principle 16, but SEFs do not have a
similar requirement. Proposed Sec. Sec. 37.1206(g)(1) and 38.857(g)(1)
would codify annual report requirements for SEFs and DCMs. Proposed
Sec. Sec. 37.1206(g)(2) and 38.857(g)(2) would set out the filing
requirements for the reports.
The current PRA estimated burden for the DCM ROC reports is 70
hours for one annual report. The Commission has
[[Page 19705]]
reevaluated the ROC report burden and now revises its estimate down to
40 hours, including the new requirements. In the Commission's recent
experience, the ROC report is less extensive and burdensome to prepare
than the SEF Annual Compliance Report, which has a burden of 52 hours.
40 hours more accurately reflects the preparation required for the ROC
report, including the new reporting requirements added by the proposal.
The proposal would add a new burden of 40 hours for one annual SEF ROC
report.
Accordingly, the aggregate annual estimate for the reporting burden
associated the proposal is as follows:
DCMs--Sec. 38.857(g)(1) and (g)(2) Reporting
Estimated number of respondents: 16.
Estimated number of reports per respondent: 1.
Average number of hours per report: 40.
Estimated gross annual reporting burden (hours): 640.
SEFs--Sec. 37.1206(g)(1) and (g)(2) Reporting
Estimated number of respondents: 23.
Estimated number of reports per respondent: 1.
Average number of hours per report: 40.
Estimated gross annual reporting burden (hours): 920.
9. ROC Recordkeeping (Sec. Sec. 37.1206(g)(3) and 38.857(g)(3))
Proposed Sec. Sec. 37.1206(g)(3) and 38.857(g)(3) establish a
recordkeeping requirement to maintain all records demonstrating
compliance with the duties of the ROC and the preparation and
submission of the annual report.
The Commission estimates that the proposal will add an additional
two hours of burden per an estimated four quarterly ROC meetings.
Accordingly, the aggregate annual estimate for the reporting burden
associated with the proposal is as follows:
DCMs--Sec. 38.857(g)(3) Recordkeeping
Estimated number of respondents: 16.
Estimated number of reports per respondent: 4.
Average number of hours per report: 2.
Estimated gross annual reporting burden (hours): 128.
SEFs--Sec. 37.1206(g)(3) Recordkeeping
Estimated number of respondents: 23.
Estimated number of reports per respondent: 4.
Average number of hours per report: 2.
Estimated gross annual reporting burden (hours): 184.
10. DCM CRO Appointment and Removal Notification (Sec. 38.856(c))
Under proposed new Sec. 38.856(c), DCMs must notify the Commission
when a CRO is appointed or removed. A similar requirement for SEFs is
proposed in Sec. 37.1501(a)(4)(ii), but does not add a reporting
burden since the requirement already exists in Commission regulation
Sec. 37.1501(b)(3)(ii) for SEF CCOs.
The Commission estimates that a CRO would be replaced on average
every two years at a maximum, and the required notice would require 0.5
hours. Accordingly, the aggregate annual estimate for the reporting
burden associated with the proposal is as follows:
DCMs--Sec. 38.856(c) Reporting
Estimated number of respondents: 16.
Estimated number of reports per respondent: 0.5.
Average number of hours per report: 0.5.
Estimated gross annual reporting burden (hours): 4.
11. Documentation of CCO/CRO Conflicts of Interest (Sec. Sec.
37.1501(c) and 38.856(f))
Proposed Sec. Sec. 37.1501(c) and 38.856(f) require SEFs and DCMs
to maintain documentation when a CCO (SEF) or CRO (DCM) discloses a
conflict of interest to the ROC.
The Commission estimates that the proposal would require an
additional four hours of recordkeeping for each SEF and DCM once per
year. Accordingly, the aggregate annual estimate for the reporting
burden associated with is as follows:
DCMs--Sec. 38.856(f) Recordkeeping
Estimated number of respondents: 16.
Estimated number of reports per respondent: 1.
Average number of hours per report: 4.
Estimated gross annual reporting burden (hours): 64.
SEFs--Sec. 37.1501(c) Recordkeeping
Estimated number of respondents: 23.
Estimated number of reports per respondent: 1.
Average number of hours per report: 4.
Estimated gross annual reporting burden (hours): 92.
12. Conflicts of Interests Reported in SEF Annual Compliance Report
(Sec. 37.1501(d)(5))
Proposed Sec. 37.1501(d)(5) requires any actual or potential
conflicts reported to the CCO to be included in the SEF Annual
Compliance Report (ACR) to the Commission. The Commission estimates
that this new requirement would add one hour to the existing 52 hours
burden associated with the SEF ACR, for a total of 53 hours.
Accordingly, the aggregate annual estimate for the reporting burden
associated with the proposal is as follows:
SEFs--Reporting
Estimated number of respondents: 23.
Estimated number of reports per respondent: 1.
Average number of hours per report: 53.
Estimated gross annual reporting burden (hours): 1,219.
13. Reports of Anticipated Changes in Ownership or Corporate Structure
(Sec. Sec. 37.5(c)(1) and 38.5(c)(1)); Sec. Sec. 37.5(c)(2) and
38.5(c)(2)
The proposal would amend Sec. Sec. 37.5(c)(1) and 38.5(c)(1) to
require that SEFs and DCMs report anticipated changes of corporate
structure or ownership that would result in certain significant changes
to ownership, subsidiaries, or transfer of assets to another legal
entity. The amendments to Sec. Sec. 37.5(c)(1) and 38.5(c)(1) would
require SEFs and DCMs to file with the Commission reports of
anticipated changes in ownership or corporate structure that would (i)
result in at least a 10 percent change of ownership of the SEF or DCM
or a change to the entity or person holding a controlling interest in
the SEF or DCM; (ii) create a new subsidiary or eliminate a current
subsidiary of the SEF or DCM; or (iii) result in the transfer of all or
substantially all of the assets of the SEF or DCM to another legal
entity.
The proposed amendments to Sec. Sec. 37.5(c)(2) and 38.5(c)(2)
would set out the documents that must be submitted to the Commission in
such reports, including a chart outlining the new ownership or
corporate or organizational structure; a brief description of the
purpose and impact of the change; and any relevant agreements effecting
the change and corporate documents such as articles of incorporation
and bylaws; and any additional supporting documents requested by the
Commission.
The Commission estimates that each SEF and DCM would file one
report every four years, which would require
[[Page 19706]]
40 hours of burden. Accordingly, the aggregate annual estimate for the
reporting burden associated with the proposal is as follows:
DCMs--Sec. 38.5(c)(1) and (c)(2) Reporting
Estimated number of respondents: 16.
Estimated number of reports per respondent: 0.25.
Average number of hours per report: 40.
Estimated gross annual reporting burden (hours): 160.
SEFs--Sec. 38.5(c)(1) and (c)(2)
Estimated number of respondents: 23.
Estimated number of reports per respondent: 0.25.
Average number of hours per report: 40.
Estimated gross annual reporting burden (hours): 230.
14. Change in Ownership/Structure Certification Requirement (Sec. Sec.
37.4(c)(4) and 38.5(c)(5))
The Commission is proposing to amend Sec. 38.5(c) by adding a
certification requirement that will require a DCM, upon a change in
ownership or corporate organizational structure, to certify that the
DCM meets all of the requirements of section 5h of the Act and
applicable Commission regulations. SEFs have an existing similar
requirement in Sec. 37.4(c)(4) with no new increase in burden from the
proposed rule. However, the SEF burden will be listed here for clarity,
since it is not separately accounted for in the current PRA approval.
The Commission estimates that each SEF and DCM would file one
report under the proposed amendments every four years, and each report
would require an additional two hours of burden. Accordingly, the
aggregate annual estimate for the reporting burden associated with the
proposed amendments is as follows:
DCMs--Sec. 38.5(c)(5) Reporting
Estimated number of respondents: 16.
Estimated number of reports per respondent: 0.25.
Average number of hours per report: 2.
Estimated gross annual reporting burden (hours): 8.
SEFs--Sec. 37.4(c)(4)--Reporting
Estimated number of respondents: 23.
Estimated number of reports per respondent: 0.25.
Average number of hours per report: 2.
Estimated gross annual reporting burden (hours): 11.5.
15. SEF and DCM Updates to Rulebooks and Internal Procedures
(Sec. Sec. 40.5 and 40.6; Parts 37 and 38)
The proposal would institute organizational changes that may
require one-time updates to SEF and DCM rulebooks and internal
procedures, such as compliance manuals, or require submissions to the
Commission under part 40.
Under Sec. Sec. 40.5 and 40.6, registered entities must submit a
written certification to the Commission in connection with a new or
amended rule. However, this burden is already covered in the existing
part 40 PRA collection.\314\
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\314\ The Commission accounts for the burden associated with the
part 40 filings under Collection No. 3038-0093, ``Part 40,
Provisions Common to Registered Entities,'' which includes updates
to rulebooks in response to new Commission regulations and other
actions. The CFTC bases its burden estimates under this clearance on
the number of annual rule filings with the Commission. Based on
those numbers, the Commission has estimated that these reporting
requirements entail a burden of approximately 2,800 hours annually
for covered entities (70 respondents x 20 reports per respondent x 2
hours per report = 2,800 hours annually). The Commission is
retaining its existing burden estimates under the existing
clearance. The Commission believes that these estimates are adequate
to account for any incremental burden associated with part 40
filings that may result from the proposed organizational changes.
---------------------------------------------------------------------------
To comply with parts 37 and 38, SEFs and DCMs must maintain
policies and procedures for ensuring compliance with regulatory
requirements, such as compliance manuals. The Commission estimates that
the proposed rules would require one-time updates to SEF and DCM
internal procedures, with an estimated burden of 20 hours. Accordingly,
the aggregate annual estimate for the recordkeeping and reporting
burden associated with the proposed amendments is as follows:
DCMs--Internal Procedures Recordkeeping and Reporting (Part 38)
Estimated number of respondents: 16.
Estimated number of reports per respondent: 1.
Average number of hours per report: 20.
Estimated gross one-time reporting and recordkeeping burden
(hours): 320.
SEFs--Internal Procedures Manual Recordkeeping and Reporting (Part 37)
Estimated number of respondents: 23.
Estimated number of reports per respondent: 1.
Average number of hours per report: 20.
Estimated gross one-time reporting and recordkeeping burden
(hours): 460.
16. Request for Comment
The Commission invites the public and other Federal agencies to
comment on any aspect of the proposed information collection
requirements discussed above. Pursuant to 44 U.S.C. 3506(c)(2)(B), the
Commission will consider public comments on this proposed collection of
information in:
(1) Evaluating whether the proposed collection of information is
necessary for the proper performance of the functions of the
Commission, including whether the information will have a practical
use;
(2) Evaluating the accuracy of the estimated burden of the proposed
collection of information, including the degree to which the
methodology and the assumptions that the Commission employed were
valid;
(3) Enhancing the quality, utility, and clarity of the information
proposed to be collected; and
(4) Minimizing the burden of the proposed information collection
requirements on registered entities, including through the use of
appropriate automated, electronic, mechanical, or other technological
information collection techniques, e.g., permitting electronic
submission of responses.
Copies of the submission from the Commission to OMB are available
from the CFTC Clearance Officer, 1155 21st Street NW, Washington, DC
20581, (202) 418-5160 or from https://RegInfo.gov. Organizations and
individuals desiring to submit comments on the proposed information
collection requirements should send those comments to:
The Office of Information and Regulatory Affairs, Office
of Management and Budget, Room 10235, New Executive Office Building,
Washington, DC 20503, Attn: Desk Officer of the Commodity Futures
Trading Commission;
(202) 395-6566 (fax); or
[email protected] (email).
Please provide the Commission with a copy of submitted comments so
that comments can be summarized and addressed in the final rulemaking,
and please refer to the ADDRESSES section of this rulemaking for
instructions on submitting comments to the Commission. OMB is required
to make a decision concerning the proposed information collection
requirements between 30 and 60 days after publication of this release
in the Federal Register. Therefore, a comment to OMB is best assured of
receiving full consideration if OMB receives it within 30 calendar days
of publication of this release. Nothing in the foregoing affects
[[Page 19707]]
the deadline enumerated above for public comment to the Commission on
the proposed rules.
d. Antitrust Considerations
Section 15(b) of the CEA requires the Commission to take into
consideration the public interest to be protected by the antitrust laws
and endeavor to take the least anticompetitive means of achieving the
purposes of the CEA, in issuing any order or adopting any Commission
rule or regulation.\315\
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\315\ 7 U.S.C. 19(b).
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The Commission believes that the public interest to be protected by
the antitrust laws is the promotion of competition. The Commission
requests comment on whether the proposed amendments implicate any other
specific public interest to be protected by the antitrust laws. The
Commission has considered the proposed rulemaking to determine whether
it is anticompetitive and has identified no anticompetitive effects.
The Commission requests comment on whether the proposed rulemaking is
anticompetitive and, if it is, what the anticompetitive effects are.
Because the Commission has determined that the proposed rule
amendments are not anticompetitive and have no anticompetitive effects,
the Commission has not identified any less anticompetitive means of
achieving the purposes of the CEA. The Commission requests comment on
whether there are less anticompetitive means of achieving the relevant
purposes of the CEA that would otherwise be served by adopting the
proposed rule amendments.
List of Subjects
17 CFR Part 37
Compliance with rules, Conflicts of interest, Designation of Chief
Compliance Officer, General Provisions.
17 CFR Part 38
Compliance with rules, Conflicts of Interest, Disciplinary
procedures, General provisions.
For the reasons stated in the preamble, the Commodity Futures
Trading Commission proposes to amend 17 CFR chapter I as follows:
PART 37--SWAP EXECUTION FACILITIES
0
1. The authority citation for part 37 continues to read as follows:
Authority: 7 U.S.C. 1a, 2, 5, 6, 6c, 7, 7a-2, 7b-3, and 12a, as
amended by Titles VII and VIII of the Dodd-Frank Wall Street Reform
and Consumer Protection Act, Pub. L. 111-203, 124 Stat. 1376.
0
2. Revise Sec. 37.2 to read as follows:
Sec. 37.2 Exempt provisions.
A swap execution facility, the swap execution facility's operator
and transactions executed on or pursuant to the rules of a swap
execution facility must comply with all applicable requirements under
Title 17 of the Code of Federal Regulations, except for the
requirements of Sec. Sec. 1.59(b) and (c), 1.63, 1.64, and 1.69.
0
3. In Sec. 37.5, revise paragraph (c) to read as follows:
Sec. 37.5 Information relating to swap execution facility compliance.
* * * * *
(c) Change in ownership or corporate or organizational structure--
(1) Reporting requirement. A swap execution facility must report to the
Commission any anticipated change in the ownership or corporate or
organizational structure of the swap execution facility or its
parent(s) that would:
(i) Result in at least a ten percent change of ownership of the
swap execution facility or a change to the entity or person holding a
controlling interest in the swap execution facility, whether through an
increase in direct ownership or voting interest in the swap execution
facility or in a direct or indirect corporate parent entity of the swap
execution facility;
(ii) Create a new subsidiary or eliminate a current subsidiary of
the swap execution facility; or
(iii) Result in the transfer of all or substantially all of the
assets of the swap execution facility to another legal entity.
(2) Required information. The information reported under paragraph
(c)(1) of this section must include: A chart outlining the new
ownership or corporate or organizational structure; a brief description
of the purpose and impact of the change; and any relevant agreements
effecting the change and corporate documents such as articles of
incorporation and bylaws.
(i) The Commission may, after receiving such report, request
additional supporting documentation relating to the anticipated change
in the ownership or corporate or organizational structure of the swap
execution facility, including amended Form SEF exhibits, to demonstrate
that the swap execution facility will continue to meet all of the
requirements of section 5h of the Act and applicable Commission
regulations following such change.
(ii) [Reserved]
(3) Time of report. The report under paragraph (c)(1) of this
section must be submitted to the Commission no later than three months
prior to the anticipated change, provided that the swap execution
facility may report the anticipated change to the Commission later than
three months prior to the anticipated change if the swap execution
facility does not know and reasonably could not have known of the
anticipated change three months prior to the anticipated change. In
such event, the swap execution facility must immediately report such
change to the Commission as soon as it knows of such change. The report
must be filed electronically with the Secretary of the Commission at
[email protected] and with the Division of Market Oversight at
[email protected].
(4) Rule filing. Notwithstanding the provisions of paragraphs
(c)(1) through (3) of this section, if any aspect of a change in
ownership or corporate or organizational structure described in
paragraph (c)(1) of this section requires a swap execution facility to
file a rule as defined in Sec. 40.1(i) of this chapter, then the swap
execution facility must comply with the rule filing requirements of
section 5c(c) of the Act and part 40 of this chapter, and all other
applicable Commission regulations.
(5) Certification. Upon a change in ownership or corporate or
organizational structure described in paragraph (c)(1) of this section,
a swap execution facility must file electronically with the Secretary
of the Commission at [email protected] and with the Division of
Market Oversight at [email protected], a certification that the
swap execution facility meets all of the requirements of section 5h of
the Act and applicable Commission regulations, no later than two
business days following the date on which the change in ownership or
corporate or organizational structure described in paragraph (c)(1) of
this section takes effect.
(6) Failure to comply. A change in the ownership or corporate or
organizational structure of a swap execution facility that results in
the failure of the swap execution facility to comply with any provision
of the Act, or any regulation or order of the Commission thereunder--
(i) Shall be cause for the suspension of the registration of the
swap execution facility or the revocation of registration as a swap
execution facility, in accordance with the procedures provided in
sections 5e and 6(b) of the Act, including notice and a hearing on the
record; or
(ii) May be cause for the Commission to make and enter an order
directing that the swap execution facility cease
[[Page 19708]]
and desist from such violation, in accordance with the procedures
provided in sections 6b and 6(b) of the Act, including notice and a
hearing on the record.
* * * * *
0
4. Amend Sec. 37.203 as follows:
0
a. Revise paragraph (c);
0
b. Redesignate paragraphs (d), (e), (f), and (g) as paragraphs (e),
(f), (g), and (h);
0
c. Add a new paragraph (d); and
0
d. Revise newly redesignated paragraph (g).
The revisions and addition read as follows:
Sec. 37.203 Rule enforcement program.
* * * * *
(c) Sufficient staff and resources. A swap execution facility must
establish and maintain sufficient staff and resources to effectively
perform market regulation functions, as defined in Sec. 37.1201(b)(9).
Such staff must be sufficient to address unusual market or trading
events as they arise, and to conduct and complete investigations in a
timely manner, as set forth in Sec. 37.203(g).
(d) Ongoing monitoring of staff and resources. A swap execution
facility must monitor the size and workload of its staff required under
paragraph (c) of this section annually and ensure that its staff and
resources are at appropriate levels. In determining the appropriate
level of staff and resources, the swap execution facility should
consider trading volume increases, the number of new products or
contracts to be listed for trading, any new responsibilities to be
assigned to staff, any responsibilities that staff have at affiliated
entities, the results of any internal review demonstrating that work is
not completed in an effective or timely manner, any conflicts of
interest that prevent staff from working on certain matters, and any
other factors suggesting the need for increased staff and resources.
* * * * *
(g) Investigations and investigation reports--(1) Procedures. A
swap execution facility shall establish and maintain procedures that
require its staff responsible for market regulation functions to
conduct investigations of possible rule violations. An investigation
shall be commenced upon the receipt of a request from Commission staff
or upon the discovery or receipt of information by the swap execution
facility that indicates a reasonable basis for finding that a violation
may have occurred or will occur.
(2) Timeliness. Each investigation shall be completed in a timely
manner. Absent mitigating factors, a timely manner is no later than 12
months after the date that an investigation is opened. Mitigating
factors that may reasonably justify an investigation taking longer than
12 months to complete include the complexity of the investigation, the
number of firms or individuals involved as potential wrongdoers, the
number of potential violations to be investigated, and the volume of
documents and data to be examined and analyzed by staff.
(3) Investigation reports when a reasonable basis exists for
finding a violation. Staff shall submit a written investigation report
for disciplinary action in every instance in which staff determines
from surveillance or from an investigation that a reasonable basis
exists for finding a rule violation. The investigation report shall
include the reason the investigation was initiated; a summary of the
complaint, if any; the relevant facts; staff's analysis and
conclusions; and a recommendation as to whether disciplinary action
should be pursued.
(4) Investigation reports when no reasonable basis exists for
finding a violation. If after conducting an investigation, staff
determines that no reasonable basis exists for finding a rule
violation, it shall prepare a written report including the reason the
investigation was initiated; a summary of the complaint, if any; the
relevant facts; and staff's analysis and conclusions.
(5) Warning letters. No more than one warning letter may be issued
to the same person or entity found to have committed the same rule
violation within a rolling twelve month period.
* * * * *
0
5. In Sec. 37.206, revise paragraph (b) to read as follows:
Sec. 37.206 Disciplinary procedures and sanctions.
* * * * *
(b) Disciplinary panels. A swap execution facility must establish
one or more disciplinary panels that are authorized to fulfill their
obligations under the rules of this subpart. Disciplinary panels must
meet the composition requirements of Sec. 37.1207, and must not
include any members of the swap execution facility's market regulation
staff or any person involved in adjudicating any other stage of the
same proceeding.
* * * * *
0
6. Add Sec. 37.207 in subpart C to read as follows:
Sec. 37.207 Minimum fitness standards.
(a) In general. A swap execution facility must establish and
enforce appropriate fitness standards for its officers and for members
of its board of directors, committees, disciplinary panels, and dispute
resolution panels (or anyone performing functions similar to the
foregoing), for members of the swap execution facility, for any other
person with direct access to the swap execution facility, any person
who owns 10 percent or more of the SEF and who, either directly or
indirectly, through agreement or otherwise, in any other manner, may
control or direct the management or policies of the SEF, and for any
party affiliated with any person described in this paragraph.
(b) Minimum standards for certain persons--bases for refusal to
register. Minimum standards of fitness for the swap execution
facility's officers and for members of its board of directors,
committees, disciplinary panels, and dispute resolution panels (or
anyone performing functions similar to the foregoing), for members of
the swap execution facility with voting privileges, and any person who
owns 10 percent or more of the SEF and who, either directly or
indirectly, through agreement or otherwise, in any other manner, may
control or direct the management or policies of the SEF, must include
the bases for refusal to register a person under sections 8a(2) and
8a(3) of the Act.
(c) Additional minimum fitness standards for certain persons--
history of disciplinary offenses. Minimum standards of fitness for the
swap execution facility's officers and for members of its board of
directors, committees, disciplinary panels, and dispute resolution
panels (or anyone performing functions similar to the foregoing), must
include ineligibility based on the disciplinary offenses listed in the
following paragraphs (c)(1) through (6):
(1) Was found within the prior three years by a final, non-
appealable decision of a self-regulatory organization, an
administrative law judge, a court of competent jurisdiction, the
Securities Exchange Commission, or the Commission to have committed:
(i) A violation of the rules of a self-regulatory organization,
except rules related to decorum or attire, financial requirements, or
reporting or recordkeeping resulting in fines aggregating $5,000 or
less within a calendar year; or
(ii) A violation of any rule of a self-regulatory organization if
the violation involved fraud, deceit, or conversion, or resulted in
suspension or expulsion; or
(iii) Any violation of the Act or the regulations promulgated
thereunder; or
[[Page 19709]]
(iv) Any failure to exercise supervisory responsibility in
violation of the rules of a self-regulatory organization, or the Act,
or regulations promulgated thereunder.
(2) Entered into a settlement agreement within the prior three
years in which the acts charged, or findings included any of the
violations described in paragraph (c)(1) of this section;
(3) Currently is suspended from trading on any designated contract
market or swap execution facility, is suspended or expelled from
membership with any self-regulatory organization, is serving any
sentence of probation, or owes any portion of a fine imposed due to a
finding or settlement described in paragraphs (c)(1) or (2) of this
section;
(4) Currently is subject to an agreement with the Commission, the
Securities Exchange Commission, or any self-regulatory organization,
not to apply for registration with the Securities Exchange Commission,
Commission or membership in any self-regulatory organization;
(5) Currently is subject to or has had imposed on him or her within
the prior three years a Commission registration revocation or
suspension in any capacity for any reason, or has been convicted within
the prior three years of any of the felonies listed in section
8a(2)(D)(ii) through (iv) of the Act; or
(6) Currently is subject to a denial, suspension or
disqualification from serving on the disciplinary panel, arbitration
panel or governing board of any self-regulatory organization as that
term is defined in section 3(a)(26) of the Securities Exchange Act of
1934.
(d) Collection and verification of fitness information. (1) A swap
execution facility must have appropriate procedures for the collection
and verification of information supporting compliance with appropriate
fitness standards, including, at a minimum, the following:
(i) A swap execution facility must, on at least an annual basis,
collect and verify fitness information for each person acting in the
capacity subject to the fitness standards;
(ii) A swap execution facility must require each person acting in
any capacity subject to the fitness standards to provide immediate
notice if that person no longer meets the minimum fitness standards to
act in that capacity;
(iii) An initial verification of fitness information must be
completed prior to the person commencing to act in the capacity for
which the person is subject to fitness standards; and
(iv) A swap execution facility must document its findings with
respect to the verification of fitness information for each person
acting in the capacity subject to the fitness standards.
(2) [Reserved]
0
7. Add Sec. 37.1201 in subpart M to read as follows:
Sec. 37.1201 General requirements.
(a) Establishment of process. A swap execution facility must
establish a process for identifying, minimizing, and resolving actual
or potential conflicts of interest that may arise, including, but not
limited to, conflicts between and among any of the swap execution
facility's market regulation functions; its commercial interests; and
the several interests of its management, members, owners, customers and
market participants, other industry participants, and other
constituencies.
(b) Definitions. For purposes of this section:
(1) Affiliate means a person that directly or indirectly controls,
is controlled by, or is under common control with, the swap execution
facility.
(2) Board of directors means a group of people serving as the
governing body of a swap execution facility, or for a swap execution
facility whose organizational structure does not include a board of
directors, a body performing a function similar to a board of
directors.
(3) Commodity interest means any commodity futures, commodity
option or swap contract traded on or subject to the rules of a
designated contract market, a swap execution facility or linked
exchange, or cleared by a derivatives clearing organization, or cash
commodities traded on or subject to the rules of a designated contract
market.
(4) Disciplinary panel means a panel of two or more persons
authorized to conduct hearings, render decisions, approve settlements,
and impose sanctions with respect to disciplinary matters.
(5) Dispute resolution panel means a panel of two or more persons
authorized to resolve disputes involving a swap execution facility's
members, market participants, and any intermediaries.
(6) Executive committee means a committee of the board of directors
that may exercise the authority delegated to it by the board of
directors with respect to the decision-making of the company or
organization.
(7) Family relationship means a person's relationship with a
spouse, parents, children, or siblings, in each case, whether by blood,
marriage, or adoption, or the person's relationship with any person
residing in the home of the person.
(8) Linked exchange means:
(i) Any board of trade, exchange or market outside the United
States, its territories or possessions, which has an agreement with a
designated contract market or swap execution facility in the United
States that permits positions in a commodity interest which have been
established on one of the two markets to be liquidated on the other
market;
(ii) Any board of trade, exchange or market outside the United
States, its territories or possessions, the products of which are
listed on a United States designated contract market, swap execution
facility, or a trading facility thereof;
(iii) Any securities exchange, the products of which are held as
margin in a commodity account or cleared by a securities clearing
organization pursuant to a cross-margining arrangement with a futures
clearing organization; or
(iv) Any clearing organization which clears the products of any of
the foregoing markets.
(9) Market regulation functions means SEF functions required by SEF
Core Principle 2, SEF Core Principle 4, SEF Core Principle 6, SEF Core
Principle 10 and the applicable Commission regulations thereunder.
(10) Material information means information which, if such
information were publicly known, would be considered important by a
reasonable person in deciding whether to trade a particular commodity
interest on a designated contract market or a swap execution facility,
or to clear a swap contract through a derivatives clearing
organization. As used in this section, ``material information''
includes, but is not limited to, information relating to present or
anticipated cash positions, commodity interests, trading strategies,
the financial condition of members of self-regulatory organizations or
members of linked exchanges or their customers, or the regulatory
actions or proposed regulatory actions of a swap execution facility or
a linked exchange.
(11) Non-public information means information which has not been
disseminated in a manner which makes it generally available to the
trading public.
(12) Pooled investment vehicle means a trading vehicle organized
and operated as a commodity pool within the meaning of Sec. 4.10(d) of
this chapter, and whose units of participation have been registered
under the Securities Act of 1933, or a trading vehicle for which Sec.
4.5 of this chapter makes available relief from regulation as a
commodity
[[Page 19710]]
pool operator, i.e., registered investment companies, insurance company
separate accounts, bank trust funds, and certain pension plans.
(13) Public director means a member of the board of directors who
has been found, by the board of directors of the swap execution
facility, on the record, to have no material relationship with the swap
execution facility. The board of directors must make such finding upon
the nomination of the director and at least on an annual basis
thereafter.
(i) For purposes of this definition, a ``material relationship'' is
one that reasonably could affect the independent judgment or decision-
making of the member of the board of directors. Circumstances in which
a member of the board of directors shall be considered to have a
``material relationship'' with the swap execution facility include, but
are not limited to, the following:
(A) Such director is an officer or an employee of the swap
execution facility or an officer or an employee of its affiliate;
(B) Such director is a member of the swap execution facility, or a
director, an officer, or an employee of either a member or an affiliate
of a member. In this context, ``member'' shall have the meaning set
forth in Sec. 1.3 of this chapter;
(C) Such director directly or indirectly owns more than 10 percent
of the swap execution facility or an affiliate of the swap execution
facility, or is an officer or employee of an entity that directly or
indirectly owns more than 10 percent of the swap execution facility;
(D) Such director, or an entity in which the director is a partner,
an officer, an employee, or a director, receives more than $100,000 in
aggregate annual payments from the swap execution facility, or an
affiliate of the swap execution facility. Compensation for services as
a director of the swap execution facility or as a director of an
affiliate of the swap execution facility does not count toward the
$100,000 payment limit, nor does deferred compensation for services
rendered prior to becoming a director of the swap execution facility,
so long as such compensation is in no way contingent, conditioned, or
revocable; or
(E) The director shall be considered to have a ``material
relationship'' with the swap execution facility when any of the
circumstances described in paragraphs (b)(13)(i)(A) through (D) of this
section apply to any person with whom the director has a family
relationship.
(ii) All of the circumstances described in paragraph (b)(13)(i) of
this section shall be subject to a one-year look back.
(iii) A public director of the swap execution facility may also
serve as a public director of an affiliate of the swap execution
facility if they otherwise meet the requirements of this section.
(iv) A swap execution facility must disclose to the Commission
which members of its board are public directors, and the basis for
those determinations.
(14) Related commodity interest means any commodity interest which
is traded on or subject to the rules of a designated contract market,
swap execution facility, linked exchange, or other board of trade,
exchange, or market, or cleared by a derivatives clearing organization,
other than the swap execution facility by which a person is employed,
and with respect to which:
(i) Such employing swap execution facility has recognized or
established intermarket spread margins or other special margin
treatment between that other commodity interest and a commodity
interest which is traded on or subject to the rules of the employing
swap execution facility; or
(ii) Such other swap execution facility has recognized or
established intermarket spread margins or other special margin
treatment with another commodity interest as to which the person has
access to material nonpublic information.
(15) Self-regulatory organization shall have the meaning set forth
in Sec. 1.3 of this chapter.
(16) Senior officer means the chief executive officer or other
equivalent officer of the swap execution facility.
0
8. Add Sec. 37.1202 in subpart M to read as follows:
Sec. 37.1202 Conflicts of interest.
(a) Conflicts of interest in the decision-making of a swap
execution facility. (1) A swap execution facility must establish
policies and procedures that require any officer or member of its board
of directors, committees, or disciplinary panels to disclose any actual
or potential conflicts of interest that may be present prior to
considering any matter. Such conflicts of interests include, but are
not limited to, conflicts of interest that may arise when such member
or officer:
(i) Is the subject of any matter being considered;
(ii) Is an employer, employee, or colleague of the subject of any
matter being considered;
(iii) Has a family relationship with the subject of any matter
being considered; or
(iv) Has any ongoing business relationship with or a financial
interest in the subject of any matter being considered.
(2) Any relationship of the type listed in paragraphs (a)(1)(i)
through (iv) of this section that is with an affiliate of the subject
of any matter being considered would be deemed an actual or potential
conflict of interest for purposes of this section.
(3) The swap execution facility must establish policies and
procedures that require any officer or member of a board of directors,
committee, or disciplinary panel of a swap execution facility that has
an actual or potential conflict of interest, including any of the
relationships listed in paragraphs (a)(1) and (2) of this section, to
abstain from deliberating or voting on such matter.
(b) Documentation of conflicts of interest determinations. The
board of directors, committees, and disciplinary panels of a swap
execution facility must document in meeting minutes, or otherwise
document in a comparable manner, compliance with the applicable
requirements of this section. Such documentation demonstrating
compliance must also include:
(1) The names of all members and officers who attended the relevant
meeting in person or who otherwise were present by electronic means;
and
(2) The names of any members and officers who voluntarily recused
themselves or were required to abstain from deliberations or voting on
a matter and the reason for the recusal or abstention.
0
9. Add Sec. 37.1203 in subpart M to read as follows:
Sec. 37.1203 Limitations on the use and disclosure of material non-
public information.
(a) In general. A swap execution facility must establish and
enforce policies and procedures on safeguarding the use and disclosure
of material non-public information. Such policies and procedures must
provide for appropriate limitations on the use or disclosure of
material non-public information gained through the performance of
official duties by members of the board of directors, committee
members, and employees, or through an ownership interest in the swap
execution facility.
(b) Prohibited conduct by employees. A swap execution facility must
establish and enforce policies and procedures that, at a minimum,
prohibit employees of the swap execution facility from the following:
(1) Trading directly or indirectly, in the following:
(i) Any commodity interest traded on the employing swap execution
facility;
(ii) Any related commodity interest;
[[Page 19711]]
(iii) A commodity interest traded on designated contract markets or
swap execution facilities or cleared by derivatives clearing
organizations other than the employing swap execution facility if the
employee has access to material non-public information concerning such
commodity interest; or
(iv) A commodity interest traded on or cleared by a linked exchange
if the employee has access to material non-public information
concerning such commodity interest.
(2) Disclosing for any purpose inconsistent with the performance of
the person's official duties as an employee any material non-public
information obtained as a result of such person's employment at the
swap execution facility; provided, however, that such policies and
procedures shall not prohibit disclosures made in the performance by
the employee, acting in the employee's official capacity or the
employee's official duties, including to another self-regulatory
organization, linked exchange, court of competent jurisdiction or
representative of any agency or department of the federal or a state
government.
(c) Permitted exemptions. A swap execution facility may grant
exemptions from the trading prohibitions contained in paragraph (b)(1)
of this section. Such exemptions must be:
(1) Consistent with policies and procedures established by the swap
execution facility that set forth the circumstances under which such
exemptions may be granted;
(2) Administered by the swap execution facility on a case-by-case
basis;
(3) Approved by the swap execution facility's regulatory oversight
committee;
(4) Granted only in limited circumstances in which the employee
requesting the exemption can demonstrate that the trading is not being
conducted on the basis of material non-public information gained
through the performance of official duties, which limited circumstances
may include participation by an employee in pooled investment vehicles
where the employee has no direct or indirect control with respect to
transactions executed for or on behalf of such vehicles; and
(5) Individually documented by the swap execution facility, with
the documentation maintained by the swap execution facility in
accordance with Sec. Sec. 37.1000 and 37.1001.
(d) Monitoring for Permitted Exemptions. A swap execution facility
must establish and enforce policies and procedures to diligently
monitor the trading activity conducted under any exemptions granted
under paragraph (c) of this section to ensure compliance with any
applicable conditions of the exemptions and the swap execution
facility's policies and procedures on the use and disclosure of
material non-public information that are required pursuant to this
section.
(e) Prohibited conduct by members of the board of directors,
committee members, employees, consultants, or owners. A swap execution
facility must establish and enforce policies and procedures that, at a
minimum, prohibit members of the board of directors, committee members,
employees, consultants, and those with an ownership interest of 10
percent or more in the swap execution facility, from the following:
(1) Trading for such person's own account, or for or on behalf of
any other account, in any commodity interest or related commodity
interest, on the basis of any material non-public information obtained
through the performance of such person's official duties as a member of
the board of directors, committee member, employee, consultant, or
those with an ownership interest of 10 percent or more in the swap
execution facility;
(2) Trading for such person's own account, or for or on behalf of
any other account, in any commodity interest or related commodity
interest, on the basis of any material non-public information that such
person knows was obtained in violation of this section from a member of
the board of directors, committee member, employee, consultant, or
those with an ownership interest of 10 percent or more in the swap
execution facility; or
(3) Disclosing for any purpose inconsistent with the performance of
the person's official duties any material non-public information
obtained as a result of their official duties at the swap execution
facility; provided, however, that such policies and procedures shall
not prohibit disclosures made in the performance of such person's
official duties, including to another self-regulatory organization,
linked exchange, court of competent jurisdiction or representative of
any agency or department of the federal or state government acting in
their official capacity.
0
10. Add Sec. 37.1204 in subpart M to read as follows:
Sec. 37.1204 Board of directors.
(a) In general. (1) The board of directors of a swap execution
facility must be composed of at least thirty-five percent public
directors.
(2) A swap execution facility must establish and enforce policies
and procedures outlining the roles and responsibilities of the board of
directors, including the manner in which the board of directors
oversees the swap execution facility's compliance with all statutory,
regulatory, and self-regulatory responsibilities of the swap execution
facility under the Act and the regulations promulgated thereunder.
(3) Any executive committee (or any similarly empowered body) must
be composed of at least thirty-five percent public directors.
(b) Expertise. Each member of the board of directors, including
public directors, of the swap execution facility, must have relevant
expertise to fulfill the roles and responsibilities of such member.
(c) Compensation. The compensation of public directors and other
non-executive members of the board of directors of a swap execution
facility must not be directly dependent on the business performance of
such swap execution facility or any affiliate of the swap execution
facility.
(d) Annual self-assessment. The board of directors of a swap
execution facility must annually conduct a self-assessment of its
performance and that of its committees. Such self-assessments must be
documented and made available to the Commission for inspection.
(e) Removal of a member of the board of directors. A swap execution
facility must have procedures to remove a member from the board of
directors, where the conduct of such member is likely to be prejudicial
to the sound and prudent management of the swap execution facility.
(f) Reporting to the Commission. A swap execution facility must
notify the Commission within five business days of any changes to the
membership of the board of directors or any of its committees.
0
11. Add Sec. 37.1205 in subpart M to read as follows:
Sec. 37.1205 Nominating committee.
(a) In general. A swap execution facility must have a board-level
nominating committee, which must, at a minimum:
(1) Identify a diverse panel of individuals qualified to serve on
the board of directors, consistent with the fitness requirements set
forth in Sec. 37.207, the composition requirements set forth in Sec.
37.1204, and that reflect the views of market participants; and
(2) Administer a process for the nomination of individuals to the
board of directors.
[[Page 19712]]
(b) Applicability. The requirements in paragraphs (a)(1) and (2) of
this section apply to all nominations that occur after the initial
establishment of the nominating committee and the appointment of
members to the nominating committee.
(c) Reporting. The nominating committee must report to the board of
directors of the swap execution facility.
(d) Composition. The nominating committee must be composed of at
least fifty-one percent public directors. The chair of the nominating
committee must be a public director.
0
12. Add Sec. 37.1206 in subpart M to read as follows:
Sec. 37.1206 Regulatory oversight committee.
(a) In general. Each swap execution facility must establish a
regulatory oversight committee, as a standing committee of the board of
directors, to oversee the swap execution facility's market regulation
functions on behalf of the board of directors.
(b) Composition. The regulatory oversight committee must be
composed entirely of public directors, and must include no less than
two directors.
(c) Delegation. The board of directors must delegate sufficient
authority, dedicate sufficient resources, and allow sufficient time for
the regulatory oversight committee to fulfill its mandate and duties.
(d) Duties. The regulatory oversight committee must:
(1) Monitor the sufficiency, effectiveness, and independence of the
swap execution facility's market regulation functions;
(2) Oversee all facets of the swap execution facility's market
regulation functions;
(3) Approve the size and allocation of the regulatory budget and
resources, and the number, hiring, termination, and compensation of
staff required pursuant to Sec. 37.203(c);
(4) Consult with the chief compliance officer in managing and
resolving any actual or potential conflicts of interest involving the
swap execution facility's market regulation functions;
(5) Recommend changes that would promote fair, vigorous, and
effective self-regulation; and
(6) Review all regulatory proposals prior to implementation and
advising the board of directors as to whether and how such proposals
may impact the swap execution facility's market regulation functions.
(e) Reporting. The regulatory oversight committee must periodically
report to the board of directors of the swap execution facility.
(f) Meetings and documentation. (1) The regulatory oversight
committee must have processes related to the conducting of meetings,
including, but not limited to, the following:
(i) The regulatory oversight committee must meet no less than on a
quarterly basis;
(ii) The regulatory oversight committee must not permit any
individuals with actual or potential conflicts of interest to attend
any discussions or deliberations in its meetings that relate to the
swap execution facility's market regulation functions; and
(iii) The regulatory oversight committee must maintain minutes of
its meetings. Such minutes must include a list of the attendees; their
titles; whether they were present for the entirety of the meeting or a
portion thereof (and if so, what portion); and a summary of all meeting
discussions.
(2) The regulatory oversight committee must maintain documentation
of the committee's findings, recommendations, deliberations, or other
communications related to the performance of its duties.
(g) Annual report--(1) Preparation. The regulatory oversight
committee must prepare an annual report of the swap execution
facility's market regulation functions for the board of directors and
the Commission, which includes an assessment, at a minimum, of the
following:
(i) Details of all market regulation function expenses;
(ii) A description of staffing, structure, and resources for the
swap execution facility's market regulation functions;
(iii) A description of disciplinary actions taken during the year;
(iv) A review of the performance of the swap execution facility's
disciplinary panels;
(v) A list of any actual or potential conflicts of interests
reported to the regulatory oversight committee, including a description
of how such conflicts of interest were managed or resolved, and an
assessment of the impact of any conflicts of interest on the swap
execution facility's ability to perform its market regulation
functions; and
(vi) Details related to all actions taken by the board of directors
of a swap execution facility pursuant to a recommendation of the
regulatory oversight committee, which details must include the
following:
(A) The recommendation or action of the regulatory oversight
committee;
(B) The rationale for such recommendation or action of the
regulatory oversight committee;
(C) The rationale of the board of directors for rejecting such
recommendation or superseding such action of the regulatory oversight
committee, if applicable; and
(D) The course of action that the board of directors decided to
take that differs from such recommendation or action of the regulatory
oversight committee, if applicable.
(2) Submission of the annual report to the Commission--(i) Timing.
The annual report must be submitted electronically to the Commission no
later than 90 days after the end of the swap execution facility's
fiscal year.
(ii) Request for extension. A swap execution facility may request
an extension of time to file its annual report from the Commission.
Reasonable and valid requests for extensions of the filing deadline may
be granted at the discretion of the Commission.
(iii) Delegation of authority. The Commission hereby delegates,
until it orders otherwise, to the Director of the Division of Market
Oversight or such other employee or employees as the Director may
designate from time to time, the authority to grant or deny a request
for an extension of time for a swap execution facility to file its
annual report under paragraph (g)(2)(ii) of this section. The Director
may submit to the Commission for its consideration any matter that has
been delegated in this paragraph. Nothing in this paragraph prohibits
the Commission, at its election, from exercising the authority
delegated in this paragraph.
(3) Records. The swap execution facility must maintain all records
demonstrating compliance with the duties of the regulatory oversight
committee and the preparation and submission of annual reports
consistent with Sec. Sec. 37.1000 and 37.1001.
0
13. Add Sec. 37.1207 in subpart M to read as follows:
Sec. 37.1207 Disciplinary panel composition.
(a) Composition. Each disciplinary panel must include at least two
persons, including one public participant. A public participant is a
person who would meet the eligibility requirements of a public director
in Sec. 37.1201(b)(12), provided that such person need not be a member
of the board of directors of the swap execution facility. A public
participant must chair each disciplinary panel. In addition, a swap
execution facility must adopt rules that would, at a minimum:
(1) Preclude any group or class of participants from dominating or
exercising disproportionate influence on a disciplinary panel; and
(2) Prohibit any member of a disciplinary panel from participating
in deliberations or voting on any matter in
[[Page 19713]]
which the member has an actual or potential conflict of interest as set
forth in Sec. 37.1202(a).
(b) Appeals. If the rules of the swap execution facility provide
that the decision of a disciplinary panel may be appealed to another
committee of the board of directors, then such committee must also
include at least two persons, including one public participant, and
such public participant must chair the committee.
(c) Exception. Paragraphs (a) and (b) of this section do not apply
to a disciplinary panel convened for cases solely involving decorum or
attire.
* * * * *
0
14. In Sec. 37.1501, revise paragraphs (a) through (d) to read as
follows:
Sec. 37.1501 Chief compliance officer.
(a) Chief compliance officer--(1) Authority of chief compliance
officer. (i) The position of chief compliance officer must carry with
it the authority and resources to develop, in consultation with the
board of directors or senior officer, the policies and procedures of
the swap execution facility and enforce such policies and procedures to
fulfill the duties set forth for chief compliance officers in the Act
and Commission regulations.
(ii) The chief compliance officer must have supervisory authority
over all staff acting at the direction of the chief compliance officer.
(2) Qualifications of chief compliance officer. (i) The individual
designated to serve as chief compliance officer must have the
background and skills appropriate for fulfilling the responsibilities
of the position.
(ii) No individual disqualified from registration pursuant to
sections 8a(2) or 8a(3) of the Act may serve as a chief compliance
officer.
(3) Reporting line of the chief compliance officer. The chief
compliance officer must report directly to the board of directors or to
the senior officer of the swap execution facility.
(4) Appointment and removal of chief compliance officer. (i) Only
the board of directors or the senior officer, with the approval of the
swap execution facility's regulatory oversight committee, may appoint
or remove the chief compliance officer.
(ii) The swap execution facility must notify the Commission within
two business days of the appointment or removal, whether interim or
permanent, of a chief compliance officer.
(5) Compensation of the chief compliance officer. The board of
directors or the senior officer, in consultation with the swap
execution facility's regulatory oversight committee, must approve the
compensation of the chief compliance officer.
(6) Annual meeting with the chief compliance officer. The chief
compliance officer must meet with the board of directors or senior
officer of the swap execution facility at least annually.
(7) Information requested of the chief compliance officer. The
chief compliance officer must provide any information regarding the
self-regulatory program of the swap execution facility as requested by
the board of directors or the senior officer.
(b) Duties of chief compliance officer. The duties of the chief
compliance officer must include, but are not limited to, the following:
(1) Overseeing and reviewing compliance of the swap execution
facility with section 5h of the Act and any related rules adopted by
the Commission;
(2) Taking reasonable steps, in consultation with the swap
execution facility's board of directors, or a committee thereof, or the
senior officer of the swap execution facility, to manage and resolve
any material conflicts of interest that may arise relating to:
(i) Conflicts between business considerations and compliance
requirements, including the swap execution facility's market regulation
functions;
(ii) Conflicts between business considerations and implementation
of the requirement that the swap execution facility provide fair, open,
and impartial access as set forth in Sec. 37.202; and
(iii) Conflicts between a swap execution facility's management and
members of the board of directors.
(3) Establishing and administering written policies and procedures
reasonably designed to prevent violations of the Act and the rules of
the Commission;
(4) Taking reasonable steps to ensure compliance with the Act and
the rules of the Commission;
(5) Establishing procedures reasonably designed to handle, respond,
remediate, retest, and resolve noncompliance issues identified by the
chief compliance officer through any means, including any compliance
office review, look-back, internal or external audit finding, self-
reported error, or validated complaint; and
(6) Establishing and administering a compliance manual designed to
promote compliance with the applicable laws, rules, and regulations and
a written code of ethics for the swap execution facility designed to
prevent ethical violations and to promote honesty and ethical conduct
by personnel of the swap execution facility.
(7) Supervising the swap execution facility's self-regulatory
program, including the market regulation functions set forth in Sec.
37.1201(b)(9); and
(8) If applicable, supervising the effectiveness and sufficiency of
any regulatory services provided to the swap execution facility by a
regulatory service provider in accordance with Sec. 37.204.
(c) Conflicts of interest involving the chief compliance officer.
Each swap execution facility must establish procedures for the chief
compliance officer's disclosure of actual or potential conflicts of
interest involving the chief compliance officer to the regulatory
oversight committee and designation of a qualified person to serve in
the place of the chief compliance officer for any matter in which the
chief compliance officer has such a conflict, and documentation of such
disclosure and designation.
(d) Preparation of annual compliance report. The chief compliance
officer must, not less than annually, prepare and sign an annual
compliance report that covers the prior fiscal year. The report must,
at a minimum, contain:
(1) A description and self-assessment of the effectiveness of the
written policies and procedures of the swap execution facility,
including the code of ethics and conflict of interest policies, to
reasonably ensure compliance with the Act and applicable Commission
regulations;
(2) Any material changes made to policies and procedures related to
the swap execution facility's self-regulatory functions during the
coverage period for the report and any areas of improvement or
recommended changes such policies and procedures;
(3) A description of the financial, managerial, and operational
resources set aside for compliance with the Act and applicable
Commission regulations;
(4) Any material non-compliance matters identified and an
explanation of the corresponding action taken to resolve such non-
compliance matters;
(5) Any actual or potential conflicts of interests that were
identified to the chief compliance officer during the coverage period
for the report, including a description of how such conflicts of
interest were managed or resolved, and an assessment of the impact of
any conflicts of interest on the swap execution facility's ability to
perform its market regulation functions; and
(6) A certification by the chief compliance officer that, to the
best of his or her knowledge and reasonable
[[Page 19714]]
belief, and under penalty of law, the annual compliance report is
accurate and complete in all material respects.
* * * * *
PART 38--DESIGNATED CONTRACT MARKETS
0
15. The authority citation for part 38 continues to read as follows:
Authority: 7 U.S.C. 1a, 2, 6, 6a, 6c, 6d, 6e, 6f, 6g, 6i, 6j,
6k, 6l, 6m, 6n, 7, 7a-2, 7b, 7b-1, 7b-3, 8, 9, 15, and 21, as
amended by the Dodd-Frank Wall Street Reform and Consumer Protection
Act, Pub. L. 111-203, 124 Stat. 1376.
0
16. Revise Sec. 38.2 to read as follows:
Sec. 38.2 Exempt provisions.
A designated contract market, the designated contract market's
operator and transactions traded on or through a designated contract
market under section 5 of the Act shall comply with all applicable
regulations under Title 17 of the Code of Federal Regulations, except
for the requirements of Sec. Sec. 1.39(b), 1.54, 1.59(b) and (c),
1.63, 1.64, 1.69, 100.1, 155.2, and part 156 of this chapter.
0
17. In Sec. 38.5, revise paragraphs (c) and (d) to read as follows:
Sec. 38.5 Information relating to contract market compliance.
* * * * *
(c) Change in ownership or corporate or organizational structure--
(1) Reporting requirement. A designated contract market must report to
the Commission any anticipated change in the ownership or corporate or
organizational structure of the designated contract market or its
parent(s) that would:
(i) Result in at least a ten percent change of ownership of the
designated contract market or a change to the entity or person holding
a controlling interest in the designated contract market, whether
through an increase in direct ownership or voting interest in the
designated contract market or in a direct or indirect corporate parent
entity of the designated contract market;
(ii) Create a new subsidiary or eliminate a current subsidiary of
the designated contract market; or
(iii) Result in the transfer of all or substantially all of the
assets of the designated contract market to another legal entity.
(2) Required information. The information reported under paragraph
(c)(1) of this section must include: A chart outlining the new
ownership or corporate or organizational structure; a brief description
of the purpose and impact of the change; and any relevant agreements
effecting the change and corporate documents such as articles of
incorporation and bylaws.
(i) The Commission may, after receiving such report, request
additional supporting documentation relating to the anticipated change
in the ownership or corporate or organizational structure of the
designated contract market, including amended Form DCM exhibits, to
demonstrate that the designated contract market will continue to meet
all of the requirements of section 5 of the Act and applicable
Commission regulations following such change.
(ii) [Reserved]
(3) Time of report. The report under paragraph (c)(1) of this
section must be submitted to the Commission no later than three months
prior to the anticipated change, provided that the designated contract
market may report the anticipated change to the Commission later than
three months prior to the anticipated change if the designated contract
market does not know and reasonably could not have known of the
anticipated change three months prior to the anticipated change. In
such event, the designated contract market must immediately report such
change to the Commission as soon as it knows of such change. The report
must be filed electronically with the Secretary of the Commission at
[email protected] and with the Division of Market Oversight at
[email protected].
(4) Rule filing. Notwithstanding the provisions of paragraphs
(c)(1) through (3) of this section, if any aspect of a change in
ownership or corporate or organizational structure described in
paragraph (c)(1) of this section requires a designated contract market
to file a rule as defined in Sec. 40.1(i) of this chapter, then the
designated contract market must comply with the rule filing
requirements of section 5c(c) of the Act and part 40 of this chapter,
and all other applicable Commission regulations.
(5) Certification. Upon a change in ownership or corporate or
organizational structure described in paragraph (c)(1) of this section,
a designated contract market must file electronically with the
Secretary of the Commission at [email protected] and with the
Division of Market Oversight at [email protected], a
certification that the designated contract market meets all of the
requirements of section 5 of the Act and applicable Commission
regulations, no later than two business days following the date on
which the change in ownership or corporate or organizational structure
described in paragraph (c)(1) of this section takes effect.
(6) Failure to comply. A change in the ownership or corporate or
organizational structure of a designated contract market that results
in the failure of the designated contract market to comply with any
provision of the Act, or any regulation or order of the Commission
thereunder--
(i) Shall be cause for the suspension of the designation of the
designated contract market or the revocation of designation as a
designated contract market, in accordance with the procedures provided
in sections 5e and 6(b) of the Act, including notice and a hearing on
the record; or
(ii) May be cause for the Commission to make and enter an order
directing that the designated contract market cease and desist from
such violation, in accordance with the procedures provided in sections
6b and 6(b) of the Act, including notice and a hearing on the record.
(d) Delegation of authority. The Commission hereby delegates, until
it orders otherwise, the authority set forth in this section to the
Director of the Division of Market Oversight or such other employee or
employees as the Director may designate from time to time. The Director
may submit to the Commission for its consideration any matter that has
been delegated in this paragraph. Nothing in this paragraph prohibits
the Commission, at its election, from exercising the authority
delegated in this paragraph.
0
18. Revise Sec. 38.155 to read as follows:
Sec. 38.155 Sufficient staff and resources.
(a) Sufficient staff and resources. A designated contract market
must establish and maintain sufficient staff and resources to
effectively perform market regulation functions, as defined in Sec.
38.851(b)(9). Such staff must be sufficient to address unusual market
or trading events as they arise, and to conduct and complete
investigations in a timely manner, as set forth in Sec. 38.158(b).
(b) Ongoing monitoring of staff and resources. A designated
contract market must monitor the size and workload of its staff
required under paragraph (a) of this section annually and ensure that
its staff and resources are at appropriate levels. In determining the
appropriate level of staff and resources, the designated contract
market should consider trading volume increases, the number of new
products or contracts to be listed for trading, any new
responsibilities to be assigned to staff, any responsibilities that
staff have at affiliated entities, the results of any internal review
demonstrating that work is not completed in an effective or
[[Page 19715]]
timely manner, any conflicts of interest that prevent staff from
working on certain matters, and any other factors suggesting the need
for increased staff and resources.
0
19. In Sec. 38.158, revise paragraphs (a) through (d) to read as
follows:
Sec. 38.158 Investigations and investigation reports.
(a) Procedures. A designated contract market must establish and
maintain procedures that require staff responsible for market
regulation functions to conduct investigations of possible rule
violations. An investigation must be commenced upon the receipt of a
request from Commission staff or upon the discovery or receipt of
information by the designated contract market that indicates a
reasonable basis for finding that a violation may have occurred or will
occur.
(b) Timeliness. Each investigation must be completed in a timely
manner. Absent mitigating factors, a timely manner is no later than 12
months after the date that an investigation is opened. Mitigating
factors that may reasonably justify an investigation taking longer than
12 months to complete include the complexity of the investigation, the
number of firms or individuals involved as potential wrongdoers, the
number of potential violations to be investigated, and the volume of
documents and data to be examined and analyzed by staff.
(c) Investigation reports when a reasonable basis exists for
finding a violation. Staff must submit a written investigation report
for disciplinary action in every instance in which such staff
determines from surveillance or from an investigation that a reasonable
basis exists for finding a rule violation. The investigation report
must include the reason the investigation was initiated; a summary of
the complaint, if any; the relevant facts; staff's analysis and
conclusions; and a recommendation as to whether disciplinary action
should be pursued.
(d) Investigation reports when no reasonable basis exists for
finding a violation. If after conducting an investigation, staff
determines that no reasonable basis exists for finding a violation, it
must prepare a written report including the reason(s) the investigation
was initiated; a summary of the complaint, if any; the relevant facts;
and staff's analysis and conclusions.
* * * * *
0
20. Revise Sec. 38.702 to read as follows:
Sec. 38.702 Disciplinary panels.
A designated contract market must establish one or more
disciplinary panels that are authorized to fulfill their obligations
under the rules of this subpart. Disciplinary panels must meet the
composition requirements of Sec. 38.858, and must not include any
members of the designated contract market's market regulation staff or
any person involved in adjudicating any other stage of the same
proceeding.
0
21. Revise Sec. 38.801 to read as follows:
Sec. 38.801 Minimum fitness standards.
(a) In general. A designated contract market must establish and
enforce appropriate fitness standards for its officers and for members
of its board of directors, committees, disciplinary panels, and dispute
resolution panels (or anyone performing functions similar to the
foregoing), for members of the designated contract market, for any
other person with direct access to the contract market, any person who
owns 10 percent or more of the DCM and who, either directly or
indirectly, through agreement or otherwise, in any other manner, may
control or direct the management or policies of the DCM, and for any
party affiliated with any person described in this paragraph.
(b) Minimum standards for certain persons--bases for refusal to
register. Minimum standards of fitness for the designated contract
market's officers and for members of its board of directors,
committees, disciplinary panels, and dispute resolution panels (or
anyone performing functions similar to the foregoing), for members of
the designated contract market with voting privileges, and any person
who owns 10 percent or more of the DCM and who, either directly or
indirectly, through agreement or otherwise, in any other manner, may
control or direct the management or policies of the DCM, must include
the bases for refusal to register a person under sections 8a(2) and
8a(3) of the Act.
(c) Additional minimum fitness standards for certain persons--
history of disciplinary offenses. Minimum standards of fitness for the
designated contract market's officers and for members of its board of
directors, committees, disciplinary panels, and dispute resolution
panels (or anyone performing functions similar to the foregoing), must
include ineligibility based on the disciplinary offenses listed in the
following paragraphs (c)(1) through (6):
(1) Was found within the prior three years by a final, non-
appealable decision of a self-regulatory organization, an
administrative law judge, a court of competent jurisdiction, the
Securities Exchange Commission, or the Commission to have committed:
(i) A violation of the rules of a self-regulatory organization,
except rules related to decorum or attire, financial requirements, or
reporting or recordkeeping resulting in fines aggregating $5,000 or
less within a calendar year; or
(ii) A violation of any rule of a self-regulatory organization if
the violation involved fraud, deceit, or conversion, or resulted in
suspension or expulsion; or
(iii) Any violation of the Act or the regulations promulgated
thereunder; or
(iv) Any failure to exercise supervisory responsibility in
violation of the rules of a self-regulatory organization, or the Act,
or regulations promulgated thereunder.
(2) Entered into a settlement agreement within the prior three
years in which the acts charged, or findings included any of the
violations described in paragraph (c)(1) of this section;
(3) Currently is suspended from trading on any designated contract
market or swap execution facility, is suspended or expelled from
membership with any self-regulatory organization, is serving any
sentence of probation, or owes any portion of a fine imposed due to a
finding or settlement described in paragraphs (c)(1) or (2) of this
section;
(4) Currently is subject to an agreement with the Commission, the
Securities Exchange Commission, or any self-regulatory organization,
not to apply for registration with the Securities Exchange Commission,
Commission or membership in any self-regulatory organization;
(5) Currently is subject to or has had imposed on him or her within
the prior three years a Commission registration revocation or
suspension in any capacity for any reason, or has been convicted within
the prior three years of any of the felonies listed in section 8a(2)(D)
(ii) through (iv) of the Act; or
(6) Currently is subject to a denial, suspension or
disqualification from serving on the disciplinary panel, arbitration
panel or governing board of any self-regulatory organization as that
term is defined in section 3(a)(26) of the Securities Exchange Act of
1934.
(d) Collection and verification of fitness information. (1) A
designated contract market must have appropriate procedures for the
collection and verification of information supporting compliance with
appropriate fitness standards, including, at a minimum, the following:
(i) A designated contract market must, on at least an annual basis,
collect and verify fitness information for each person acting in the
capacity subject to the fitness standards;
[[Page 19716]]
(ii) A designated contract market must require each person acting
in any capacity subject to the fitness standards to provide immediate
notice if that person no longer meets the minimum fitness standards to
act in that capacity;
(iii) An initial verification of fitness information must be
completed prior to the person commencing to act in the capacity for
which the person is subject to fitness standards; and
(iv) A designated contract market must document its findings with
respect to the verification of fitness information for each person
acting in the capacity subject to the fitness standards.
(2) [Reserved]
0
22. Revise Sec. 38.851 to read as follows:
Sec. 38.851 General requirements.
(a) Establishment of process. A designated contract market must
establish a process for identifying, minimizing, and resolving actual
or potential conflicts of interest that may arise, including, but not
limited to, conflicts between and among any of the designated contract
market's market regulation functions; its commercial interests; and the
several interests of its management, members, owners, customers and
market participants, other industry participants, and other
constituencies.
(b) Definitions. For purposes of this section:
(1) Affiliate means a person that directly or indirectly controls,
is controlled by, or is under common control with, the designated
contract market.
(2) Board of directors means a group of people serving as the
governing body of a designated contract market, or for a designated
contract market whose organizational structure does not include a board
of directors, a body performing a function similar to a board of
directors.
(3) Commodity interest means any commodity futures, commodity
option or swap contract traded on or subject to the rules of a
designated contract market, a swap execution facility or linked
exchange, or cleared by a derivatives clearing organization, or cash
commodities traded on or subject to the rules of a designated contract
market.
(4) Disciplinary panel means a panel of two or more persons
authorized to conduct hearings, render decisions, approve settlements,
and impose sanctions with respect to disciplinary matters.
(5) Dispute resolution panel means a panel of two or more persons
authorized to resolve disputes involving a designated contract market's
members, market participants, and any intermediaries.
(6) Executive committee means a committee of the board of directors
that may exercise the authority delegated to it by the board of
directors with respect to the decision-making of the company or
organization.
(7) Family relationship means a person's relationship with a
spouse, parents, children, or siblings, in each case, whether by blood,
marriage, or adoption, or the person's relationship with any person
residing in the home of the person.
(8) Linked exchange means:
(i) Any board of trade, exchange or market outside the United
States, its territories or possessions, which has an agreement with a
designated contract market or swap execution facility in the United
States that permits positions in a commodity interest which have been
established on one of the two markets to be liquidated on the other
market;
(ii) Any board of trade, exchange or market outside the United
States, its territories or possessions, the products of which are
listed on a United States designated contract market, swap execution
facility, or a trading facility thereof;
(iii) Any securities exchange, the products of which are held as
margin in a commodity account or cleared by a securities clearing
organization pursuant to a cross-margining arrangement with a futures
clearing organization; or
(iv) Any clearing organization which clears the products of any of
the foregoing markets.
(9) Market regulation functions means DCM functions required by DCM
Core Principle 2, DCM Core Principle 4, DCM Core Principle 5, DCM Core
Principle 10, DCM Core Principle 12, DCM Core Principle 13, DCM Core
Principle 17 and the applicable Commission regulations thereunder.
(10) Material information means information which, if such
information were publicly known, would be considered important by a
reasonable person in deciding whether to trade a particular commodity
interest on a designated contract market or a swap execution facility,
or to clear a swap contract through a derivatives clearing
organization. As used in this section, ``material information''
includes, but is not limited to, information relating to present or
anticipated cash positions, commodity interests, trading strategies,
the financial condition of members of self-regulatory organizations or
members of linked exchanges or their customers, or the regulatory
actions or proposed regulatory actions of a designated contract market
or a linked exchange.
(11) Non-public information means information which has not been
disseminated in a manner which makes it generally available to the
trading public.
(12) Pooled investment vehicle means a trading vehicle organized
and operated as a commodity pool within the meaning of Sec. 4.10(d) of
this chapter, and whose units of participation have been registered
under the Securities Act of 1933, or a trading vehicle for which Sec.
4.5 of this chapter makes available relief from regulation as a
commodity pool operator, i.e., registered investment companies,
insurance company separate accounts, bank trust funds, and certain
pension plans.
(13) Public director means a member of the board of directors who
has been found, by the board of directors of the designated contract
market, on the record, to have no material relationship with the
designated contract market. The board of directors must make such
finding upon the nomination of the director and at least on an annual
basis thereafter.
(i) For purposes of this definition, a ``material relationship'' is
one that reasonably could affect the independent judgment or decision-
making of the member of the board of directors. Circumstances in which
a member of the board of directors shall be considered to have a
``material relationship'' with the designated contract market include,
but are not limited to, the following:
(A) Such director is an officer or an employee of the designated
contract market or an officer or an employee of its affiliate;
(B) Such director is a member of the designated contract market, or
a director, an officer, or an employee of either a member or an
affiliate of the member. In this context, ``member'' shall have the
meaning set forth in Sec. 1.3 of this chapter;
(C) Such director directly or indirectly owns more than 10 percent
of the designated contract market or an affiliate of the designated
contract market, or is an officer or employee of an entity that
directly or indirectly owns more than 10 percent of the designated
contract market;
(D) Such director, or an entity in which the director is a partner,
an officer, an employee, or a director, receives more than $100,000 in
aggregate annual payments from the designated contract market, or an
affiliate of the designated contract market. Compensation for services
as a director of the designated contract
[[Page 19717]]
market or as a director of an affiliate of the designated contract
market does not count toward the $100,000 payment limit, nor does
deferred compensation for services rendered prior to becoming a
director of the designated contract market, so long as such
compensation is in no way contingent, conditioned, or revocable; or
(E) The director shall be considered to have a ``material
relationship'' with the designated contract market when any of the
circumstances described in paragraphs (b)(13)(i)(A) through (D) of this
section apply to any person with whom the director has a family
relationship.
(ii) All of the circumstances described in paragraph (b)(13)(i) of
this section shall be subject to a one-year look back.
(iii) A public director of the designated contract market may also
serve as a public director of an affiliate of the designated contract
market if they otherwise meet the requirements of this section.
(iv) A designated contract market must disclose to the Commission
which members of its board are public directors, and the basis for
those determinations.
(14) Related commodity interest means any commodity interest which
is traded on or subject to the rules of a designated contract market,
swap execution facility, linked exchange, or other board of trade,
exchange, or market, or cleared by a derivatives clearing organization,
other than the designated contract market by which a person is
employed, and with respect to which:
(i) Such employing designated contract market has recognized or
established intermarket spread margins or other special margin
treatment between that other commodity interest and a commodity
interest which is traded on or subject to the rules of the employing
designated contract market; or
(ii) Such other designated contract market has recognized or
established intermarket spread margins or other special margin
treatment with another commodity interest as to which the person has
access to material nonpublic information.
(15) Self-regulatory organization shall have the meaning set forth
in Sec. 1.3 of this chapter.
(16) Senior officer means the chief executive officer or other
equivalent officer of the designated contract market.
0
23. Add Sec. 38.852 in subpart Q to read as follows:
Sec. 38.852 Conflicts of interest.
(a) Conflicts of interest in the decision-making of a designated
contract market. (1) A designated contract market must establish
policies and procedures that require any officer or member of its board
of directors, committees, or disciplinary panels to disclose any actual
or potential conflicts of interest that may be present prior to
considering any matter. Such conflicts of interests include, but are
not limited to, conflicts of interest that may arise when such member
or officer:
(i) Is the subject of any matter being considered;
(ii) Is an employer, employee, or colleague of the subject of any
matter being considered;
(iii) Has a family relationship with the subject of any matter
being considered; or
(iv) Has any ongoing business relationship with or a financial
interest in the subject of any matter being considered.
(2) Any relationship of the type listed in paragraphs (a)(1)(i)
through (iv) of this section that is with an affiliate of the subject
of any matter being considered would be deemed an actual or potential
conflict of interest for purposes of this section.
(3) The designated contract market must establish policies and
procedures that require any officer or member of a board of directors,
committee, or disciplinary panel of a designated contract market that
has an actual or potential conflict of interest, including any of the
relationships listed in paragraphs (a)(1) and (2) of this section, to
abstain from deliberating or voting on such matter.
(b) Documentation of conflicts of interest determinations. The
board of directors, committees, and disciplinary panels of a designated
contract market must document in meeting minutes, or otherwise document
in a comparable manner, compliance with the applicable requirements of
this section. Such documentation demonstrating compliance must also
include:
(1) The names of all members and officers who attended the relevant
meeting in person or who otherwise were present by electronic means;
and
(2) The names of any members and officers who voluntarily recused
themselves or were required to abstain from deliberations or voting on
a matter and the reason for the recusal or abstention.
0
24. Add Sec. 38.853 in subpart Q to read as follows:
Sec. 38.853 Limitations on the use and disclosure of material non-
public information.
(a) In general. A designated contract market must establish and
enforce policies and procedures on safeguarding the use and disclosure
of material non-public information. Such policies and procedures must
provide for appropriate limitations on the use or disclosure of
material non-public information gained through the performance of
official duties by members of the board of directors, committee
members, and employees, or through an ownership interest in the
designated contract market.
(b) Prohibited conduct by employees. A designated contract market
must establish and enforce policies and procedures that, at a minimum,
prohibit employees of the designated contract market from the
following:
(1) Trading directly or indirectly, in the following:
(i) Any commodity interest traded on the employing designated
contract market;
(ii) Any related commodity interest;
(iii) A commodity interest traded on designated contract markets or
swap execution facilities or cleared by derivatives clearing
organizations other than the employing designated contract market if
the employee has access to material non-public information concerning
such commodity interest; or
(iv) A commodity interest traded on or cleared by a linked exchange
if the employee has access to material non-public information
concerning such commodity interest.
(2) Disclosing for any purpose inconsistent with the performance of
the person's official duties as an employee any material non-public
information obtained as a result of such person's employment at the
designated contract market; provided, however, that such policies and
procedures shall not prohibit disclosures made in the performance by
the employee, acting in the employee's official capacity or the
employee's official duties, including to another self-regulatory
organization, linked exchange, court of competent jurisdiction or
representative of any agency or department of the federal or a state
government.
(c) Permitted exemptions. A designated contract market may grant
exemptions from the trading prohibitions contained in paragraph (b)(1)
of this section. Such exemptions must be:
(1) Consistent with policies and procedures established by the
designated contract market that set forth
[[Page 19718]]
the circumstances under which such exemptions may be granted;
(2) Administered by the designated contract market on a case-by-
case basis;
(3) Approved by the designated contract market's regulatory
oversight committee;
(4) Granted only in limited circumstances in which the employee
requesting the exemption can demonstrate that the trading is not being
conducted on the basis of material non-public information gained
through the performance of official duties, which limited circumstances
may include participation by an employee in pooled investment vehicles
where the employee has no direct or indirect control with respect to
transactions executed for or on behalf of such vehicles; and
(5) Individually documented by the designated contract market, with
the documentation maintained by the designated contract market in
accordance with Sec. Sec. 38.950 and 38.951.
(d) Monitoring for Permitted Exemptions. A designated contract
market must establish and enforce policies and procedures to diligently
monitor the trading activity conducted under any exemptions granted
under paragraph (c) of this section to ensure compliance with any
applicable conditions of the exemptions and the designated contract
market's policies and procedures on the use and disclosure of material
non-public information that are required pursuant to this section.
(e) Prohibited conduct by members of the board of directors,
committee members, employees, consultants, or owners. A designated
contract market must establish and enforce policies and procedures
that, at a minimum, prohibit members of the board of directors,
committee members, employees, consultants, and those with an ownership
interest of 10 percent or more in the designated contract market, from
the following:
(1) Trading for such person's own account, or for or on behalf of
any other account, in any commodity interest or related commodity
interest, on the basis of any material non-public information obtained
through the performance of such person's official duties as a member of
the board of directors, committee member, employee, consultant, or
those with an ownership interest of 10 percent or more in the
designated contract market;
(2) Trading for such person's own account, or for or on behalf of
any other account, in any commodity interest or related commodity
interest, on the basis of any material non-public information that such
person knows was obtained in violation of this section from a member of
the board of directors, committee member, employee, consultant, or
those with an ownership interest of 10 percent or more in the
designated contract market; or
(3) Disclosing for any purpose inconsistent with the performance of
the person's official duties any material non-public information
obtained as a result of their official duties at the designated
contract market; provided, however, that such policies and procedures
shall not prohibit disclosures made in the performance of such person's
official duties, including to another self-regulatory organization,
linked exchange, court of competent jurisdiction or representative of
any agency or department of the federal or state government acting in
their official capacity.
0
25. Add Sec. 38.854 in subpart Q to read as follows:
Sec. 38.854 Board of directors.
(a) In general. (1) The board of directors of a designated contract
market must be composed of at least thirty-five percent public
directors.
(2) A designated contract market must establish and enforce
policies and procedures outlining the roles and responsibilities of the
board of directors, including the manner in which the board of
directors oversees the designated contract market's compliance with all
statutory, regulatory, and self-regulatory responsibilities of the
designated contract market under the Act and the regulations
promulgated thereunder.
(3) Any executive committee (or any similarly empowered body) must
be composed of at least thirty-five percent public directors.
(b) Expertise. Each member of the board of directors, including
public directors, of the designated contract market, must have relevant
expertise to fulfill the roles and responsibilities of such member.
(c) Compensation. The compensation of public directors and other
non-executive members of the board of directors of a designated
contract market must not be directly dependent on the business
performance of such designated contract market or any affiliate of the
designated contract market.
(d) Annual self-assessment. The board of directors of a designated
contract market must annually conduct a self-assessment of its
performance and that of its committees. Such self-assessments must be
documented and made available to the Commission for inspection.
(e) Removal of a member of the board of directors. A designated
contract market must have procedures to remove a member from the board
of directors, where the conduct of such member is likely to be
prejudicial to the sound and prudent management of the designated
contract market.
(f) Reporting to the Commission. A designated contract market must
notify the Commission within five business days of any changes to the
membership of the board of directors or any of its committees.
0
26. Add Sec. 38.855 in subpart Q to read as follows:
Sec. 38.855 Nominating committee.
(a) In general. A designated contract market must have a board-
level nominating committee, which must, at a minimum:
(1) Identify a diverse panel of individuals qualified to serve on
the board of directors, consistent with the fitness requirements set
forth in Sec. 38.801, the composition requirements set forth in Sec.
38.853, and that reflect the views of market participants; and
(2) Administer a process for the nomination of individuals to the
board of directors.
(b) Applicability. The requirements in paragraphs (a)(1) and (2) of
this section apply to all nominations that occur after the initial
establishment of the nominating committee and the appointment of
members to the nominating committee.
(c) Reporting. The nominating committee must report to the board of
directors of the designated contract market.
(d) Composition. The nominating committee must be composed of at
least fifty-one percent public directors. The chair of the nominating
committee must be a public director.
0
27. Add Sec. 38.856 in subpart Q to read as follows:
Sec. 38.856 Chief regulatory officer.
(a) Designation and qualifications of chief regulatory officer. (1)
Each designated contract market must establish the position of chief
regulatory officer, and designate an individual to serve in that
capacity, to administer the designated contract market's market
regulation functions.
(i) The position of chief regulatory officer must carry with it the
authority and resources necessary to fulfill the duties set forth in
this section for chief regulatory officers.
(ii) The chief regulatory officer must have supervisory authority
over all staff
[[Page 19719]]
performing the designated contract market's market regulation
functions.
(2) The individual designated to serve as chief regulatory officer
must have the background and skills appropriate for fulfilling the
duties of the position. No individual disqualified from registration
pursuant to sections 8a(2) or 8a(3) of the Act may serve as a chief
regulatory officer.
(b) Reporting line of the chief regulatory officer. (1) The chief
regulatory officer must report directly to the board of directors or to
the senior officer of the designated contract market.
(2) The designated contract market's regulatory oversight committee
must oversee the chief regulatory officer to minimize any actual or
potential conflicts of interest, including conflicts of interest
between the duties of the chief regulatory officer and the designated
contract market's commercial interests.
(c) Appointment and removal of the chief regulatory officer. (1)
The appointment or removal of a designated contract market's chief
regulatory officer must occur only with the approval of the designated
contract market's regulatory oversight committee.
(2) The designated contract market must notify the Commission
within two business days of the appointment of any new chief regulatory
officer, whether interim or permanent.
(3) The designated contract market must notify the Commission
within two business days of removal of the chief regulatory officer.
(d) Compensation of the chief regulatory officer. The board of
directors or the senior officer of the designated contract market, in
consultation with the designated contract market's regulatory oversight
committee, must approve the compensation of the chief regulatory
officer.
(e) Duties of the chief regulatory officer. The chief regulatory
officer's duties must include, but are not limited to, the following:
(1) Supervising the designated contract market's market regulation
functions;
(2) Establishing and administering policies and procedures related
to the designated contract market's market regulation functions.
(3) Supervising the effectiveness and sufficiency of any regulatory
services provided to the designated contract market by a regulatory
service provider in accordance with Sec. 38.154;
(4) Reviewing any proposed rule or programmatic changes that may
have a significant regulatory impact on the designated contract
market's market regulation functions and advising the regulatory
oversight committee on such matters; and
(5) In consultation with the designated contract market's
regulatory oversight committee, identifying, minimizing, managing, and
resolving conflicts of interest involving the designated contract
market's market regulation functions.
(f) Conflicts of interest involving the chief regulatory officer.
Each designated contract market must establish procedures for the chief
regulatory officer's disclosure of actual or potential conflicts of
interest involving the chief regulatory officer to the regulatory
oversight committee and designation of a qualified person to serve in
the place of the chief regulatory officer for any matter in which the
chief regulatory officer has such a conflict, and documentation of such
disclosure and designation.
0
28. Add Sec. 38.857 in subpart Q to read as follows:
Sec. 38.857 Regulatory oversight committee.
(a) In general. Each designated contract market must establish a
regulatory oversight committee, as a standing committee of the board of
directors, to oversee the designated contract market's market
regulation functions on behalf of the board of directors.
(b) Composition. The regulatory oversight committee must be
composed entirely of public directors, and must include no less than
two directors.
(c) Delegation. The board of directors must delegate sufficient
authority, dedicate sufficient resources, and allow sufficient time for
the regulatory oversight committee to fulfill its mandate and duties.
(d) Duties. The regulatory oversight committee must:
(1) Monitor the sufficiency, effectiveness, and independence of the
designated contract market's market regulation functions;
(2) Oversee all facets of the designated contract market's market
regulation functions;
(3) Approve the size and allocation of the regulatory budget and
resources, and the number, hiring, termination, and compensation of
staff required pursuant to Sec. 38.155(a);
(4) Consult with the chief regulatory officer in managing and
resolving any actual or potential conflicts of interest involving the
designated contract market's market regulation functions;
(5) Recommend changes that would promote fair, vigorous, and
effective self-regulation; and
(6) Review all regulatory proposals prior to implementation and
advising the board of directors as to whether and how such proposals
may impact the designated contract market's market regulation
functions.
(e) Reporting. The regulatory oversight committee must periodically
report to the board of directors of the designated contract market.
(f) Meetings and documentation. (1) The regulatory oversight
committee must have processes related to the conducting of meetings,
including, but not limited to, the following:
(i) The regulatory oversight committee must meet no less than on a
quarterly basis;
(ii) The regulatory oversight committee must not permit any
individuals with actual or potential conflicts of interest to attend
any discussions or deliberations in its meetings that relate to the
designated contract market's market regulation functions; and
(iii) The regulatory oversight committee must maintain minutes of
its meetings. Such minutes must include a list of the attendees; their
titles; whether they were present for the entirety of the meeting or a
portion thereof (and if so, what portion); and a summary of all meeting
discussions.
(2) The regulatory oversight committee must maintain documentation
of the committee's findings, recommendations, deliberations, or other
communications related to the performance of its duties.
(g) Annual report--(1) Preparation. The regulatory oversight
committee must prepare an annual report of the designated contract
market's market regulation functions for the board of directors and the
Commission, which includes an assessment, at a minimum, of the
following:
(i) Details of all market regulation function expenses;
(ii) A description of staffing, structure, and resources for the
designated contract market's market regulation functions;
(iii) A description of disciplinary actions taken during the year;
(iv) A review of the performance of the designated contract
market's disciplinary panels; and
(v) A list of any actual or potential conflicts of interests
reported to the regulatory oversight committee, including a description
of how such conflicts of interest were managed or resolved, and an
assessment of the impact of any conflicts of interest on the swap
execution facility's ability to perform its market regulation
functions; and
(vi) Details related to all actions taken by the board of directors
of a designated
[[Page 19720]]
contract market pursuant to a recommendation of the regulatory
oversight committee, which details must include the following:
(A) The recommendation or action of the regulatory oversight
committee;
(B) The rationale for such recommendation or action of the
regulatory oversight committee;
(C) The rationale of the board of directors for rejecting such
recommendation or superseding such action of the regulatory oversight
committee, if applicable; and
(D) The course of action that the board of directors decided to
take that differs from such recommendation or action of the regulatory
oversight committee, if applicable.
(2) Submission of the annual report to the Commission--(i) Timing.
The annual report must be submitted electronically to the Commission no
later than 90 days after the end of the designated contract market's
fiscal year.
(ii) Request for extension. A designated contract market may
request an extension of time to file its annual report from the
Commission. Reasonable and valid requests for extensions of the filing
deadline may be granted at the discretion of the Commission.
(iii) Delegation of authority. The Commission hereby delegates,
until it orders otherwise, to the Director of the Division of Market
Oversight or such other employee or employees as the Director may
designate from time to time, the authority to grant or deny a request
for an extension of time for a designated contract market to file its
annual report under paragraph (g)(2)(ii) of this section. The Director
may submit to the Commission for its consideration any matter that has
been delegated in this paragraph. Nothing in this paragraph prohibits
the Commission, at its election, from exercising the authority
delegated in this paragraph.
(3) Records. The designated contract market must maintain all
records demonstrating compliance with the duties of the regulatory
oversight committee and the preparation and submission of annual
reports consistent with Sec. Sec. 38.950 and 38.951.
0
29. Add Sec. 38.858 in subpart Q to read as follows:
Sec. 38.858 Disciplinary panel composition.
(a) Composition. Each disciplinary panel must include at least two
persons, including one public participant. A public participant is a
person who would meet the eligibility requirements of a public director
in Sec. 38.851(b)(13), provided that such person need not be a member
of the board of directors of the designated contract market. A public
participant must chair each disciplinary panel. In addition, a
designated contract market must adopt rules that would, at a minimum:
(1) Preclude any group or class of participants from dominating or
exercising disproportionate influence on a disciplinary panel; and
(2) Prohibit any member of a disciplinary panel from participating
in deliberations or voting on any matter in which the member has an
actual or potential conflict of interest as set forth in Sec.
38.852(a).
(b) Appeals. If the rules of the designated contract market provide
that the decision of a disciplinary panel may be appealed to another
committee of the board of directors, then such committee must also
include at least two persons, including one public participant, and
such public participant must chair the committee.
(c) Exception. Paragraphs (a) and (b) of this section do not apply
to a disciplinary panel convened for cases solely involving decorum or
attire.
0
30. Amend Appendix B to part 38 by revising ``Core Principle 15 of
section 5(d) of the Act'' and ``Core Principle 16 of section 5(d) of
the Act'' 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 [Reserved]
Core Principle 16 of section 5(d) of the Act [Reserved]
* * * * *
Issued in Washington, DC, on March 4, 2024, by the Commission.
Christopher Kirkpatrick,
Secretary of the Commission.
NOTE: The following appendices will not appear in the Code of
Federal Regulations.
Appendices to Requirements for Designated Contract Markets and Swap
Execution Facilities Regarding Governance and the Mitigation of
Conflicts of Interest Impacting Market Regulation Functions--Commission
Voting Summary, Chairman's Statement, and Commissioners' Statements
Appendix 1--Commission Voting Summary
On this matter, Chairman Behnam and Commissioners Goldsmith
Romero and Pham voted in the affirmative. Commissioners Johnson and
Mersinger voted in the negative.
Appendix 2--Statement of Support of Chairman Rostin Behnam
I support the proposed rules for designated contract markets
(DCMs) and swap execution facilities (SEFs) that would establish
governance and fitness requirements with respect to market
regulation functions and related conflict of interest standards.
This action continues my commitment to ensure that conflicts of
interest are appropriately mitigated, and that SEF and DCM governing
bodies adequately incorporate an independent perspective.
Advancements in technology, coupled with demand for ever greater
efficiency and speed, are pushing markets and market structure in
new directions. This new disruption raises new and novel policy
issues in all aspects of markets, including conflicts of interest.
This proposal is just one step towards addressing potential and
existing conflicts of interest in CFTC markets, to ensure markets
remain strong, resilient, and transparent.
The proposed rules would enhance substantive requirements for
identifying, managing, and resolving conflicts of interest related
to market regulation functions. The rules also establish structural
governance requirements regarding the makeup of SEF and DCM
governing bodies. Importantly, these proposed rules would simplify
the CFTC's rules for conflicts and governance fitness standards by
harmonizing the regulatory regimes for SEFs and DCMs. In addition,
these proposed rules would harmonize and enhance rules for SEFs and
DCMs regarding the notification of a transfer of equity interest in
a SEF or DCM, and would confirm the CFTC's authority to obtain
information concerning continued regulatory compliance in the event
of a change in ownership of a SEF or DCM.
I look forward to hearing the public's comments on the proposed
amendments to the regulations for SEFs and DCMs. I thank staff in
the Division of Market Oversight, Office of the General Counsel, and
the Office of the Chief Economist for all of their work on the
proposal.
Appendix 3--Dissenting Statement of Commissioner Kristin N. Johnson
I. Introduction
I dissent from this conflicts of interest and equity ownership
transfer proposal (Proposed Rule). For nearly two years, in
Commodity Futures Trading Commission (Commission or CFTC) public
meetings, speeches, and engaged conversations with my fellow
Commissioners, staff, and diverse market participants, I have
advocated for the Commission to address two critical gaps in our
regulations: incomplete and disparate conflicts of interest rules as
well as Commission rules governing the transfer of ownership
interests in a registered entity.\1\
---------------------------------------------------------------------------
\1\ Commissioner Kristin N. Johnson, Keynote Address at Digital
Assets @Duke Conference (Jan. 26, 2023), https://www.cftc.gov/PressRoom/SpeechesTestimony/opajohnson2; Commissioner Kristin N.
Johnson, Statement Calling for the CFTC to Initiate a Rulemaking
Process for CFTC Registered DCOs Engaged in Crypto or Digital Asset
Clearing Activities (May 30, 2023), https://www.cftc.gov/PressRoom/SpeechesTestimony/johnsonstatement053023; Commissioner Kristin N.
Johnson, Keynote Speech at the Salzburg Global Finance Forum (June
29, 2023), https://www.cftc.gov/PressRoom/SpeechesTestimony/opajohnson4; Commissioner Kristin N. Johnson, Opening Statement
Before the Market Risk Advisory Committee (July 10, 2023), https://www.cftc.gov/PressRoom/SpeechesTestimony/johnsonstatement071023;
Commissioner Kristin N. Johnson, Opening Statement Before the Market
Risk Advisory Committee Meeting (Dec. 11, 2023), https://www.cftc.gov/PressRoom/SpeechesTestimony/johnsonstatement121123;
Commissioner Kristin N. Johnson, Opening Statement Regarding the
Open Commission Meeting on December 13, 2023 (Dec. 13, 2023),
https://www.cftc.gov/PressRoom/SpeechesTestimony/johnsonstatement121323; Commissioner Kristin N. Johnson, A Call for
the CFTC to Begin a Formal Rulemaking to Address Vertical
Integration (Dec. 18, 2023), https://www.cftc.gov/PressRoom/
SpeechesTestimony/
johnsonstatement121823c#:~:text=I%20strongly%20advocate%20for%20the,r
isk%20or%20financial%20stability%20concerns.
---------------------------------------------------------------------------
[[Page 19721]]
In the Commission's December 2023 open meeting, I expressly
stated that I cannot support the Commission in permitting conflicts-
laden market structures without effective regulation.\2\ It is
imperative to note that this Proposed Rule will not address the
conflicts of interest that I and many others have advocated for the
Commission to address.
---------------------------------------------------------------------------
\2\ Opening Statement Regarding the Open Commission Meeting on
December 13, 2023, supra note 1.
---------------------------------------------------------------------------
The Proposed Rule is materially incomplete. The Proposed Rule
ignores conflicts of interest in novel segments of our markets where
the Commission lacks visibility and the market lacks the benefit of
robust regulatory oversight. While the Commission could have used
this rulemaking to address endemic conflicts of interest in emerging
markets such as cryptocurrency or digital asset markets, this
Proposed Rule does not address these deeply concerning, pernicious
conflicts of interest.
The Proposed Rule undermines harmonization of conflicts
regulations across our markets. Over a century ago, in passing the
Grain Futures Act and, later, the Commodity Exchange Act (CEA),
Congress expressly emphasized the necessity of governing conflicts
of interest and registration standards in the oversight of the
derivatives markets.
In 2010, in the wake of the financial crisis, Congress passed
the Dodd-Frank Wall Street Reform and Consumer Protection Act (Dodd-
Frank Act) and expressly tasked the Commission with introducing
clearing infrastructure regulation in the bespoke, bilateral over-
the-counter (OTC) swaps market. In 2011, the Commission adopted a
rule proposal to establish conflicts of interest regulations for
derivatives clearing organizations (DCOs), derivatives contract
markets (DCMs) and swap execution facilities (SEFs).\3\ This
proposal was withdrawn. In an approach that splintered the proposed
rule and may have stymied harmonization, the Commission proceeded
with separate, disparate conflicts of interest final rulemakings. It
adopted conflicts requirements in 2012 for DCMs, in 2013 for SEFs,
and in 2020 for all DCOs.\4\
---------------------------------------------------------------------------
\3\ Governance Requirements for Derivatives Clearing
Organizations, Designated Contract Markets, and Swap Execution
Facilities; Additional Requirements Regarding the Mitigation of
Conflicts of Interest, 76 FR 722 (Jan. 6, 2011).
\4\ Core Principles and Other Requirements for Designated
Contract Markets, 77 FR 36612 (June 19, 2012); Core Principles and
Other Requirements for Swap Execution Facilities, 78 FR 33476 (June
4, 2013); Derivatives Clearing Organization General Provisions and
Core Principles, 85 FR 4800 (Jan. 27, 2020).
---------------------------------------------------------------------------
This fractured approach has led to entrenched challenges and
resulted in different rules for different registered entities.
While some tailoring may be appropriate to acknowledge
differences in market design and the role and obligation of
registered entities, the Commission should not permit weaker
conflicts rules in certain segments of our markets. It is imperative
that any final rule governing conflicts address conflicts of
interest comprehensively across our existing regulatory landscape.
Conflicts of interest have the potential to create governance
risks. Governance plays a critical role in operational, market,
credit and general risk management decision-making. Any post-mortem
of the financial crisis offers dozens of illustrations regarding the
potential for conflicts of interest to trigger the very types of
disruption that may undermine enterprise risk management, market
stability and integrity, and potentially generate risks that may be
antecedents to systemic crises. Because we know well the
consequences of failing to introduce effective risk management and
governance regulation, the Commission must act now.
I have repeatedly called on the Commission to initiate a
rulemaking that addresses the conflicts of interest that may arise
from adopting vertically integrated market structures. This concern
is intimately connected with the previously articulated concern. The
CFTC's enforcement actions filed in the wake of FTX's bankruptcy
detail the potential for a market participant to interface with
retail market participants through a series of affiliated entities
that share a common ownership structure among the exchange, market
maker, broker dealer, and custodian. These concerns should prompt
the Commission to act within our existing authority and as part of
this conflicts rulemaking.
In an increasing number of instances, businesses with no history
of operating in derivatives markets, no track record of compliance
with federal financial market regulations, and limited evidence of
corporate governance and risk management infrastructure have
expressed interest in acquiring or have acquired CFTC-registered
entities. Some may conclude that it is cheaper to purchase a
business licensed to operate in our markets than to engage with the
Commission in the rigorous and extensive licensing application
process.
It is important for the Commission to carefully consider
regulations governing equity interest transfers and ensure that
anyone acquiring a registered entity is prepared to comply with the
entire regulatory regime applicable to CFTC-registered firms.
Similar to the proposed conflicts of interest rules, I am concerned
that the Commission's actions are not commensurate with the risks
presented by emerging market conditions.
For these reasons and as explained below, I dissent from the
Commission's decision to adopt the Proposed Rule.
II. Background of the Proposed Rule
I support the Commission's efforts to enhance the integrity of
the decision-making process of SEFs and DCMs and reduce conflicts of
interest. The Proposed Rule seeks to ensure that conflicts of
interest are mitigated for SEFs and DCMs. The Commission proposes
enhancing conflicts of interest requirements to ensure that SEFs and
DCMs identify, manage, and resolve conflicts related to ``market
regulation functions.'' In the Proposed Rule, the Division of Market
Oversight (DMO) identifies a set of issues that the Commission has
carefully considered addressing for over a decade. I deeply respect
and appreciate the tireless efforts and expertise of the Commission
staff.
I applaud the staff's identification of and focus on addressing
conflicts of interest in certain self-regulatory functions of SEFs
and DCMs. The carefully developed rule text seeks to impose
heightened governance fitness and structural standards to ensure
that a SEF and DCM board of directors and disciplinary panels
incorporate independent and expert perspectives.
For almost two decades, I have advocated for the Commission to
enhance conflicts regulations. The Proposed Rule reflects a
thoughtful commitment to addressing an area of conflicts that has
not received sufficient attention. The Commission is also proposing
to strengthen the notification requirements with respect to changes
in the ownership or corporate or organizational structure of a SEF
or DCM.
The Commission is proposing:
new rules to implement DCM Core Principle 15
(Governance Fitness Standards) that are consistent with the existing
Guidance on compliance with DCM Core Principle 15;
new rules to implement DCM Core Principle 16 (Conflicts
of Interest) that are consistent with the existing Guidance on, and
Acceptable Practices in, compliance with DCM Core Principle 16;
new rules to implement SEF Core Principle 2 (Compliance
with Rules) that are consistent with the existing DCM Core Principle
15 Guidance;
new rules to implement SEF Core Principle 12 (Conflicts
of Interest) that are consistent with the existing DCM Core
Principle 16 Guidance and Acceptable Practices;
new rules under Part 37 of the Commission's regulations
for SEFs and Part 38 of the Commission's regulations for DCMs that
are consistent with existing conflicts of interest and governance
requirements under Commission Regulations 1.59 and 1.63;
new rules for DCM chief regulatory officers (CROs);
amendments to certain requirements relating to SEF
chief compliance officers (CCOs); and
new rules for SEFs and DCMs relating to the
establishment and operation of a Regulatory Oversight Committee
(ROC).
[[Page 19722]]
I thank the staff for their constructive engagement and
cooperation with my office. DMO staff addressed and incorporated my
comments into the Proposed Rule, which materially improve and
strengthen both the conflicts of interest and governance
requirements. Through coordinated efforts with my office, we have
made our markets stronger and safer.
Section 5h of the CEA sets forth requirements for SEFs.\5\ To be
registered and maintain registration with the Commission, a SEF must
comply with 15 core principles and any requirement that the
Commission may impose by rule or regulation pursuant to Section
8a(5) of the CEA.\6\ Similarly, Section 5 of the CEA sets forth
requirements for DCMs.\7\ The CEA requires that to be designated and
maintain designation by the Commission, a DCM must comply with 23
core principles, and any requirement that the Commission may impose
by rule or regulation pursuant to Section 8a(5) of the CEA.\8\
---------------------------------------------------------------------------
\5\ 7 U.S.C. 7b-3.
\6\ 7 U.S.C. 7b-3(f).
\7\ 7 U.S.C. 7.
\8\ 7 U.S.C. 7(d)(1)(A).
---------------------------------------------------------------------------
Section 8a(5) authorizes the Commission to make and promulgate
rules and regulations that, in the judgment of the Commission, are
reasonably necessary to effectuate any of the provisions or to
accomplish any of the purposes of the CEA.\9\ As noted in the
Preamble to the Proposed Rule, the CEA contains a finding that the
transactions subject to the CEA are affected with a ``national
public interest by providing a means for managing and assuming price
risks, discovering prices, or disseminating pricing information
through trading in liquid, fair and financially secure trading
facilities,'' and among the CEA's purposes are to serve the
aforementioned public interests through a system of ``effective
self-regulation of trading facilities.'' \10\
---------------------------------------------------------------------------
\9\ 7 U.S.C. 12a(5).
\10\ 7 U.S.C. 5.
---------------------------------------------------------------------------
A SEF or DCM has reasonable discretion to establish the manner
in which it complies with a particular core principle unless the
Commission adopts more prescriptive requirements by rule or
regulation. In the Proposed Rule, the Commission is prescribing
heightened requirements for SEFs and DCMs.
III. Limitations of the Conflicts Rules
SEFs, DCMs, and DCOs, as self-regulatory organizations, are
tasked with the important responsibility of regulating the
derivatives market and fostering market integrity. The CEA requires
effective self-regulation of trading facilities, clearing systems
(clearinghouses), market participants and market professionals under
the oversight of the Commission.\11\
---------------------------------------------------------------------------
\11\ Id.
---------------------------------------------------------------------------
A SEF's or DCM's decision-making process encompasses a broad
range of regulatory functions, including certain self-regulatory
obligations subject to the influence or capture of interested
decision-makers. Under the existing conflicts of interest framework,
both SEFs and DCMs are subject to a respective core principle (DCM
Core Principle 16 and SEF Core Principle 12) to minimize and have a
process to resolve conflicts of interest in their decision-making
processes.\12\
---------------------------------------------------------------------------
\12\ 7 U.S.C.A. 7, 7b-3.
---------------------------------------------------------------------------
Under the Proposed Rule, SEFs and DCMs will be required, by
regulation, to establish a process for identifying, managing, and
resolving actual and potential conflicts of interest that may arise
between and among any of the SEF's or DCM's ``market regulation
functions'' and its commercial interests as well as the interests of
its management, members, owners, customers, market participants,
other industry participants, and other constituencies.
Specifically, both SEFs and DCMs are required to establish a
ROC, a standing committee of the board consisting of only public
directors tasked with minimizing conflicts of interest, overseeing
the DCM's market regulation functions, and preparing an annual
report assessing the market regulation functions for the Commission
(among other responsibilities). The DCM is required to designate a
CRO responsible for the market regulation function. A SEF is
required to designate a CCO or a similar senior officer. The CRO and
CCO must report to the board or a senior officer. SEFs and DCMs must
also limit the use or disclosure of material non-public information
by certain decision-makers, employees, and owners.
Notwithstanding my general support for the conflicts regulation
that the Proposed Rule advances, I am unable to support the
conflicts provisions in the Proposed Rule for several reasons.
First, the Proposed Rule is incomplete. The Proposed Rule fails
to modernize similar conflicts of interest rules for DCOs. The
Commission should take a comprehensive approach to conflicts of
interest across our various market structures to avoid potential
inconsistencies, contradictions, and inefficiencies.
Second, last year in a series of public statements and speeches,
I clearly and unequivocally signaled to the Commission that we must
adopt comprehensive conflicts rules.\13\ The proposed conflicts
regulation overlooks the need for conflicts regulation for certain
market participants adopting vertically integrated market
structures. I repeat my call for the Commission to commit to engage
in a public rulemaking with formal notice and comment period on
vertically integrated structures.\14\
---------------------------------------------------------------------------
\13\ See supra note 1.
\14\ A Call for the CFTC to Begin a Formal Rulemaking to Address
Vertical Integration, supra note 1 (``I strongly advocate for the
Commission to initiate a rulemaking. More market participants are
adopting a vertically-integrated market structure, and the
Commission must ensure that such structure does not raise systemic
risk or financial stability concerns.'').
---------------------------------------------------------------------------
A. Failure To Address Conflicts of Interest for DCOs
The Commission should adopt enhanced conflicts of interest rules
that parallel today's proposed conflicts rules for DCOs. DCOs play a
central role in derivatives markets. Since the passage of the Dodd-
Frank Act, market participants have cleared significant volumes of
OTC derivatives transactions through DCOs. Clearing OTC derivatives
through registered clearinghouses may lead to greater concentration
of risk.
In the Preamble to the Proposed Rule, DMO cited to an article I
published a decade ago that explores how CCP boards of directors
face persistent and pernicious conflicts of interest that impede
objective risk oversight. The preamble acknowledges my view that:
While clearinghouses and exchanges are private businesses, these
institutions provide a critical, public, infrastructure resource
within financial markets. The self-regulatory approach adopted in
financial markets presumes that clearinghouses and exchanges will
provide a public service and engage in market oversight. The owners
of exchanges and clearinghouses may, however, prioritize profit-
maximizing strategies that de-emphasize or conflict with regulatory
goals.\15\
---------------------------------------------------------------------------
\15\ See also Kristin N. Johnson, Governing Financial Markets:
Regulating Conflicts, 88 Wash. L.Rev. 185, 221 (2013).
---------------------------------------------------------------------------
It is imperative that, to the extent the Commission advances the
Proposed Rule, it also adopts well-tailored governance reforms to
address conflicts and prevent DCO owners' self-interested commercial
incentives or other institutional constraints from triggering
systemic risk concerns.
DCOs are subject to Core Principle P regarding conflicts of
interest.\16\ CFTC Regulation 39.25 implements DCO Core Principle P
and is identical in all material respects to the existing SEF and
DCM core principles and implementing regulations on conflicts of
interest. A DCO is also required ``to establish and enforce rules to
minimize conflicts of interest in the decision-making process,''
``establish a process for resolving conflicts of interest,'' and
``have procedures for identifying, addressing, and managing
conflicts of interest involving their members.'' \17\
---------------------------------------------------------------------------
\16\ 7 U.S.C. 7a-1.
\17\ 17 CFR 39.25.
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The Commission has improved the conflicts requirements for SEFs
and DCMs but did not propose parallel revised rules for DCOs. For
example, the Proposed Rule introduces common scenarios in which a
conflict of interest may arise and imposes requirements to document
conflicts of interest determinations.\18\
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\18\ Proposed 17 CFR 37.1202, 38.852.
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At a minimum, the Commission should advance parallel rules to
assist DCOs in identifying, managing, and resolving conflicts of
interest in their decision-making process.\19\
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\19\ Commissioner Kristin N. Johnson, Statement of Commissioner
Kristin N. Johnson Regarding the CFTC's Notice of Proposed
Rulemaking on Operational Resilience Program for FCMs, SDs, and MSPs
(Dec. 18, 2023); https://www.cftc.gov/PressRoom/SpeechesTestimony/johnsonstatement121823.
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B. Commit to a Conflicts Rulemaking on Vertical Integration
It is essential that the Commission adopt a comprehensive
approach to addressing deep-seated conflicts of interest concerns,
instead of its piece-meal and fragmented approach. I
[[Page 19723]]
have repeatedly called for the Commission to initiate a
comprehensive rulemaking process across all market infrastructures--
DCOs, SEFs, and DCMs--to address inherent conflicts of interest
issues that arise in vertically integrated structures, including,
most recently, in my statement on the Bitnomial DCM application
where I outlined numerous important Commission conflicts of interest
regulations.\20\
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\20\ Opening Statement Regarding the Open Commission Meeting on
December 13, 2023, supra note 1.
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A Rulemaking on Vertical Integration Is Essential
The Preamble to the Proposed Rule notes that in 2021, Commission
staff identified several SEFs and three DCMs that were in the same
corporate family as intermediaries engaged in trading on the
affiliated-SEF or DCM. Such organizational structures increase the
risk of conflicts of interest.
The Commission's request for comment and staff advisory are
helpful initial steps. On June 28, 2023, Commission staff issued a
Request for Comment on the Impact of Affiliations Between Certain
CFTC-Regulated Entities (RFC on Vertical Integration) to better
understand a broad range of potential issues that may arise if a
DCO, DCM, or SEF is affiliated with an intermediary that uses its
platform.\21\ On December 18, 2023, the Commission issued a staff
advisory on affiliations between a DCM, DCO, or a SEF and an
intermediary or other market participant to remind them of their
regulatory obligations.\22\
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\21\ Request for Comment on the Impact of Affiliations of
Certain CFTC-Regulated Entities, CFTC Release 8734-23, June 28,
2023, https://www.cftc.gov/PressRoom/PressReleases/8734-23.
\22\ Staff Advisory on Affiliations Among CFTC-Regulated
Entities, CFTC Release 8839-23, Dec. 18, 2023, https://www.cftc.gov/PressRoom/PressReleases/8839-23.
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The Commission staff indicates that we should anticipate
proposed conflicts regulations addressing vertical integration,
including responses to concerns related to market regulation
functions posed by affiliations. It is, however, unacceptable that
this commitment note appears only in a footnote that fails to
provide a clear and unambiguous commitment to undertake a
rulemaking.
Industry comments related to SEFs and DCMs with affiliated
trading members highlight the urgent need for a regulatory response.
Many of the comments to the RFC on Vertical Integration echo these
concerns. It is particularly disappointing that the Commission is
delaying a resolution of the matter when certain questions in the
RFC on Vertical Integration directly implicate the narrowly-defined
``market regulation functions.''
A Piecemeal Approach Risks Inconsistencies and Contradictions
The Proposed Rule's significant gaps are likely to demand future
rulemakings addressing them. For example, the Proposed Rule is
silent on the sharing of certain key executive functions and other
key personnel, which is not an unusual operating model for
vertically integrated structures.\23\
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\23\ See CME Comment Letter in response to General CFTC Request
for Comment on the Impact of Affiliations of Certain CFTC-Regulated
Entities at 16-17 (Sept. 20, 2023), https://comments.cftc.gov/PublicComments/CommentList.aspx?id=7401; Global Association of
Central Counterparties Comment Letter in response to General CFTC
Request for Comment on the Impact of Affiliations of Certain CFTC-
Regulated Entities at 3 (Sept. 28, 2023), https://comments.cftc.gov/PublicComments/CommentList.aspx?id=7401.
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While the Proposed Rule requires a DCM's CRO and an SEF's CCO to
report to the board of directors or a senior officer of the SEF or
DCM, it does not require that the CCO report to the ROC, which is
comprised of only public directors.\24\ A member of the board,
including a shared officer--e.g., the chief executive officer--may
have supervisory authority over the CRO and CCO. This raises the
question of whether the Commission has adequately insulated the CRO
and CCO from commercial pressures when a CRO or CCO is required to
make decisions about a member that is affiliated with the SEF or
DCM. Compounding this issue, the Commission is allowing the CRO and
CCO to be paid based on the profits of the SEF or DCM, which could
create perverse incentives.
---------------------------------------------------------------------------
\24\ See Futures Industry Association Comment Letter in response
to General CFTC Request for Comment on the Impact of Affiliations of
Certain CFTC-Regulated Entities at 10 (Sept. 28, 2023), https://comments.cftc.gov/PublicComments/CommentList.aspx?id=7401.
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I am disappointed that the Commission has elected to proceed
with the Proposed Rule on conflicts concerns without initiating a
formal rulemaking to establish effective conflicts rules in the
context of vertically integrated structures.\25\ The Commission's
piecemeal approach to regulating the derivatives market leaves key
issues unaddressed.
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\25\ A Call for the CFTC to Begin a Formal Rulemaking to Address
Vertical Integration, supra note 1.
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IV. Failure To Adequately Reinforce the Commission's Right To Take
Regulatory Action Upon a Change of Ownership
Since the early months of my tenure as a Commissioner, I have
raised questions regarding a change of control in the ownership of a
registered entity.
I welcome the Commission's efforts to address the disparate
regulations that govern the two approaches for acquiring access to
our markets. I find, however, that the Proposed Rule advances and
codifies deficiencies and reinforces an antiquated understanding of
markets.
In any instance in which an applicant seeks to register with the
CFTC, transfer a designation, or acquire a controlling percentage of
the equity interest in a licensed registrant, the CFTC must be
confident that the party assuming control over a registrant will
continue to comply with our regulations in a manner consistent with
the Commission's expectations of the registrant at the time of the
approval of the registrant's initial application.
While the Commission retains the authority to suspend or revoke
the registration of or impose a cease and desist order on a SEF or
DCM that fails to comply with the CEA and Commission regulations,
our regulations should clearly state that the Commission will object
to a transfer of ownership in such circumstances or has an outright
approval right.
The efforts of the Commission staff are commendable but not
sufficient. With respect to a change in ownership or corporation or
organizational structure of the SEF or DCM, if a SEF or DCM does not
have the ability to comply with the CEA and Commission regulations
in connection with such a change, the Commission should have the
ability to approve or object to such change.
New Equity Transfer Provisions
Commission Regulation 38.5(c)(1) currently provides that a DCM
must file with the Commission a notification of each transaction it
enters into involving the transfer of ten percent or more of the
equity interest in the DCM.\26\ The regulation does not indicate
that Commission approval is required for the acquisition. Similar
provisions apply to SEFs in CFTC Regulation 37.5(c), but the
threshold that triggers a notice event is fifty percent or more of
the equity interest of the SEF. Under Regulation 37.5(c), a SEF must
also certify as to its compliance with the CEA and Commission
regulations.\27\ DMO staff review the relevant notifications.
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\26\ 17 CFR 38.5(c).
\27\ 17 CFR 37.5(c).
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The Commission proposes to amend CFTC Regulations 37.5(c) and
38.5(c) to:
ensure the Commission receives timely and sufficient
information in the event of certain changes in the ownership or
corporate or organizational structure of a SEF or DCM;
clarify what information is required to be provided and
the relevant deadlines;
conform to similar existing and proposed requirements
applicable to DCOs; and
impose a certification requirement.
The Proposed Rule emphasizes the importance of disclosures
related to the ownership structure of registrants. In our
registration process, staff carefully evaluates significant volumes
of data regarding an entity that seeks to be licensed by and subject
to the Commission's authority. The disclosures enable the Commission
to assess whether the entity demonstrates the requisite ability to
comply with our regulation.
The Proposed Rule acknowledges the significant business
organizational shifts in our markets. For many years market
participants were organized as cooperative structures or private
partnerships. Demutualization and an increase in registrants
choosing to become publicly-traded companies alters the market
landscape. In addition to a transformation in how risks and default
risks are managed, this approach has led to significant
consolidation in some contexts.
A ten percent change in the equity ownership may create a
notable difference in governance and risk management decision-making
authority within a firm. Finally, our regulations note that an asset
purchase may have the same effect as an equity interest
[[Page 19724]]
transfer. The Proposed Rule requires SEFs and DCMs to notify the
CFTC if substantially all of the assets of the SEF or DCM are
transferred to another legal entity.
Limitations of the Equity Transfer Provisions
The Proposed Rule should clearly state that the Commission has
the regulatory authority to take traditional and well-recognized
regulatory action in the context of a change in the ownership or
corporate or organizational structure of a SEF or DCM. From as early
as 2022, I have raised alarms with respect to the Commission's
explicit and express authority under Commission regulations to
engage in a robust dialogue with a registrant planning a significant
equity interest transfer.\28\ The Proposed Rule fails to fully
address my concerns.
---------------------------------------------------------------------------
\28\ Commissioner Kristin N. Johnson, Keynote Address at UC
Berkeley Law Crypto Regulation Virtual Conference (Feb. 8, 2023),
https://www.cftc.gov/PressRoom/SpeechesTestimony/opajohnson3
(``During a more recent speech at Duke University. . . I also called
for Congress to consider including in any legislation expanding the
CFTC's authority a provision that enables the Commission to have
greater authority including, in the least, a robust dialogue in
advance of the acquisition of a controlling equity ownership stake
in any registered market participant.'').
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I am deeply concerned that some may mistakenly interpret the
Proposed Rule to indicate that the Commission has no explicit or
express legal authority to take regulatory action upon disclosure of
an acquisition of our registrant where the Commission believes that
the registrant will no longer comply with the CEA or Commission
regulations.
In addition to this concern, I strongly believe that the
Commission has missed an opportunity to ensure that all entities
entering in our markets are subject to the same rules whether they
are acquiring a significant equity interest in a registered entity
or registering as a registrant. The best method of addressing these
twin concerns is to first clarify the Commission's existing
authority and to ensure that across our markets the equity interest
transfer regulations are similar and that these regulations involve
inquiries as robust and effectively enforced as disclosures provided
at the time that an entity registers with the Commission.
Objecting to a Change in Equity Ownership
As part of the registration process, SEFs and DCMs are required
to demonstrate, prior to registration, compliance with the CEA and
related core principles. An entity seeking designation as a SEF or
DCM must include ownership information in its Form DCM or Form SEF
application. This authority is parallel to the authority the
Commission exercises when a registered entity experiences a change
of control.
The Proposed Rule should clarify that the Commission may object
to a proposed change in ownership or corporate or organizational
structure for SEFs and DCMs if such change could result in a failure
of a registrant to comply with the CEA or Commission regulations. In
parallel to the Commission's authority to grant registration is the
Commission's authority to revoke registration.
Approving a Change in Ownership
The Proposed Rule should state that the Commission has an
approval right in the event of a change in ownership or corporate or
organizational structure. This approval authority parallels the
authority that the Commission exercises at the time of registration.
Rule text that explicitly states the same would clarify the
Commission's authority for market participants.
For example, certain prudential regulations are consistent with
this understanding. The Office of the Comptroller of the Currency
(OCC), for example, requires that any party seeking to acquire
control of a national bank give notice of such change to the OCC.
Upon the filing of such notice, the OCC has the power to disapprove
(i.e., object to) such changes set out in the notice.\29\ Similarly,
under FINRA Rule 1017, a member is required to file an application
with FINRA for approval of a 25% change in equity ownership of the
member.
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\29\ 12 CFR 5.50(f)(3).
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V. Conclusion
I believe the Commission should adopt parallel conflicts
regulations across our markets and must adopt conflicts rules that
effectively govern conflicts among affiliated entities. I believe
that the Commission has notable authority with respect to any entity
seeking to acquire a controlling equity interest in a business in
our markets, including the authority to suspend, revoke, or enter a
cease and desist order, should the ownership change result in a
violation of a statutory or regulatory requirement or a Commission
order. I would like to see the Commission go farther and adopt a
rulemaking that gives the Commission the right to approve or object
to a change in ownership or corporate or organizational structure to
the same extent.
I would like to extend my sincere gratitude to the DMO team,
including Rachel Berdansky, Swati Shah, Marilee Dahlman, Jennifer
Tveiten-Rifman, David Steinberg, Lillian Cardona, Caitlin Holzem,
and Rebecca Mersand.
Appendix 4--Statement of Commissioner Christy Goldsmith Romero
Conflicts of interest at exchanges and swap execution facilities
(SEFs) present serious risk to market fairness, integrity, and
financial stability. The CFTC plays a critical role in implementing
strong rules to prevent conflicts from hurting customers, markets,
market participants, and end users. As designated self-regulatory
organizations, exchanges serve as the front line for market
integrity.\1\ And given the contribution to the financial crisis of
opaque caveat emptor swaps markets,\2\ the Dodd-Frank Act created
SEFs and gave them important regulatory responsibilities to ensure
transparency in the swaps markets.\3\ In order for markets to
function well and fairly, these important regulatory
responsibilities must be performed free of conflicts of interest.
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\1\ Exchanges are responsible for setting financial and
reporting rules, including involving customer funds. Exchanges must
also supervise compliance with exchange rules and Commission
regulations related to capital, customer protection, risk
management, financial reporting, and record keeping. They have a
responsibility to investigate and discipline those who violate those
requirements.
\2\ See Business Conduct Standards for Swap Dealers and Major
Swap Participants with Counterparties, 77 FR 9734, 9805 (Feb. 17,
2012) (Comment of CFA/AFR).
\3\ SEFs have important regulatory responsibilities, including
reporting transactions and maintaining an audit trail. SEFs are
required to establish and enforce rules for trading or processing
swaps, and to have the capacity to investigate violations and
enforce these rules.
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Existing CFTC rules already require exchanges and SEFs to
establish and enforce rules to minimize conflicts of interest, and
we have issued accompanying guidance to exchanges. Though I support
the rule, I consider it to be a baseline minimum, largely codifying
existing guidance,\4\ extending it to swap execution facilities, and
adding a few additional requirements.
---------------------------------------------------------------------------
\4\ See 17 CFR part 38, Appendix B.
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This proposed rule would not create an adequate conflicts of
interest regulatory regime to cover conflicts that come from
affiliated entities serving multiple functions (i.e. broker,
exchange, clearinghouse, etc.)-so called ``vertical integration,''
which the proposal acknowledges.\5\ Therefore, this rule does not
serve as a basis for future approval of additional vertically
integrated structures that break from the traditional structure on
which the Commodity Exchange Act and CFTC rules are based.
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\5\ See Proposal at note 118 (``The Commission received a number
of comments raising concerns about the impact of affiliation, and
anticipates proposing regulations that will address issues
identified as a result of the [request for comment] RFC, including
additional concerns raised by commenters about the conflicts of
interest, specifically relating to market regulation functions,
posed by affiliations. This rulemaking does not reflect the comments
submitted in response to the Commission staff's RFC. Those comments
will not be made part of the administrative record before the
Commission in connection with this proposal'').
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The proposal purposely attempts to carve out vertical
integration from this rulemaking and commits to addressing it in the
future in light of the recently completed request for comment on
affiliated entities. By September, the CFTC received more than 100
comments expressing significant concern over conflicts of interest
with vertically integrated market structures.\6\ Serious concerns
about vertically integrated market structures in digital assets had
already been expressed by the White House in the Economic Report of
the President,\7\ the Financial Stability Oversight
[[Page 19725]]
Council (FSOC),\8\ Treasury Secretary Janet Yellen,\9\ then-Federal
Reserve Vice Chair Lael Brainard,\10\ and Acting Comptroller of the
Currency Michael Hsu before we issued the request for comment.\11\
The CFTC has not issued any new rules or guidance based on those
comments. Last month, the Commission approved a vertically
integrated market structure for the first time (on which I dissented
given that we were in the middle of studying the risks and had not
engaged in rulemaking),\12\ and it was said in the open meeting that
there are other pending applications. As this proposal's record will
not reflect comments submitted in response to the request for
comment on vertical integration, I encourage commenters to resubmit
relevant sections of those comments in response to this proposal.
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\6\ The comments were in response to a request for comment on
the impact of affiliated entities. I have raised concerns about the
risk posed by these arrangements, including the immediately apparent
risk of conflict of interest. See CFTC Commissioner Christy
Goldsmith Romero, https://www.cftc.gov/PressRoom/SpeechesTestimony/romerostatement062823, (June 28, 2023); See also CFTC Commissioner
Christy Goldsmith Romero, https://www.cftc.gov/PressRoom/SpeechesTestimony/oparomero3, (Oct. 26, 2022).
\7\ See The White House, https://www.whitehouse.gov/wp-content/uploads/2023/03/ERP-2023.pdf, (Mar. 2023).
\8\ See Financial Stability Oversight Council, https://home.treasury.gov/system/files/261/FSOC-Digital-Assets-Report-2022.pdf, (Oct. 3, 2022).
\9\ See https://home.treasury.gov/news/featured-stories/remarks-by-secretary-of-the-treasury-janet-l-yellen-at-the-national-association-for-business-economics-39th-annual-economic-policy-conference, (Mar. 30, 2023).
\10\ See Federal Reserve Board Vice-Chair Lael Brainard, https://www.federalreserve.gov/newsevents/speech/brainard20220708a.htm,
(July 8, 2022).
\11\ See Acting Comptroller of the Currency Michael J. Hsu,
https://www.occ.treas.gov/news-issuances/speeches/2022/pub-speech-2022-125.pdf, (Oct. 11, 2022).
\12\ See CFTC Commissioner Christy Goldsmith Romero, https://www.cftc.gov/PressRoom/SpeechesTestimony/romerostatement121823b,
(December 18, 2023).
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Requirements of the Proposed Rule
The rule would require an exchange or SEF to report any change
to the entity or person that holds a controlling interest, either
directly or indirectly, as opposed to the more limited notification
requirements (10% change in ownership of an exchange or 50%
ownership of a SEF). Any owners of exchanges and SEFs may have other
interests (financial or otherwise) that may not align with the
exchange's or SEF's responsibilities.
The rule would require officers or directors with an actual or
potential conflict of interest in the subject of a matter to abstain
from both voting and deliberation. The proposal also creates a
baseline definition of what is a conflict of interest, and requires
documentation of compliance with the rule, which facilitates
oversight.
Officers, directors, those with an ownership interest in the
exchange of at least 10%, and employees would be banned from trading
on or disclosing material non-public information. I would like to
hear from commenters if the 10% ownership threshold is appropriate
or should be lowered. I would also like to hear whether commenters
think the proposed requirements are sufficient to prevent the misuse
of non-public information, especially in cases where employees,
officers, directors or owners are also employed by a company that
trades in contracts for commodities traded on the exchange. I am
especially interested in comments about whether the Commission
should ban use of material non-public information for trades on a
spot exchange by an officer, director, owner or employee of an
affiliated derivatives exchange.\13\
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\13\ The Commission currently requires an exchange to provide
for ``appropriate'' limitations on the use of material non-public
information by employees, officers, and directors, but does not
include a spot exchange trading ban as one of its specific
requirements for such limitations.
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The proposal would codify guidance by requiring establishment of
a regulatory oversight committee, comprised entirely of independent
public directors tasked with monitoring the effectiveness of an
exchange or SEF's regulatory functions and minimizing and resolving
conflicts of interest, and requires every exchange to have a Chief
Regulatory Officer (``CRO'').\14\ Requirements for the regulatory
oversight committee include approving the size and allocation of
resources and the number of market regulation staff.
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\14\ SEFs are required to have a Chief Compliance Officer with
similar duties and responsibilities. The regulatory oversight
committee would be required to minimize any conflicts of interest
involving the CRO or CCO. Compensation of the position would require
consultation with the public directors in the ROC. The exchange
would also be required to disclose and minimize any conflicts of
interest involving the CRO or CCO.
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The proposal does not address the issue of shared resources of
affiliated entities, including for example dual-hatted employees.
Shared resources lead to concerns about whose interest will dominate
when it counts the most, during times of stress. Shared resources
also raise concerns over capacity to fulfill regulatory
responsibilities, including for example, a derivatives exchange's
ability to fulfill its front-line market integrity responsibility
when using shared resources of an affiliated spot exchange.\15\
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\15\ See CFTC Commissioner Christy Goldsmith Romero, https://www.cftc.gov/PressRoom/SpeechesTestimony/romerostatement062823,
(June 28, 2023).
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I want to thank the staff for working with me to strengthen this
proposal, including in the way it incorporates affiliates in certain
areas, particularly given that affiliated entities can raise
conflicts of interest even outside of the vertical integration
structure. I continue to urge further rulemaking to address
conflicts of interest, including those associated with vertically
integrated market structures.
Appendix 5--Statement of Commissioner Caroline D. Pham
I am voting to publish the Notice of Proposed Rulemaking on
Requirements for Designated Contract Markets (DCMs) and Swap
Execution Facilities (SEFs) Regarding Governance and the Mitigation
of Conflicts of Interest Impacting Market Regulation Functions (DCM
and SEF Conflicts of Interest Proposal or NPRM) because the public
must have an opportunity to weigh in on these important issues that
raise serious concerns. I would like to thank Lillian Cardona,
Jennifer Tveiten-Rifman, Marilee Dahlman, Swati Shah, and Rachel
Berdansky in the Division of Market Oversight for their time and
efforts, and I take this opportunity to recognize the importance of
their rule enforcement reviews program for DCMs and SEFs. I
appreciate the staff working with me to make revisions to address my
concerns. Unfortunately, while the NPRM has been improved, it is far
from perfect.
Overall, I believe the public comment process is a critical
component of good government. That is why, although I have serious
concerns about the DCM and SEF Conflicts of Interest Proposal, I am
voting to publish it for transparency and public engagement on this
flawed rulemaking.
The CFTC cannot haphazardly codify guidance as rules. That goes
against the very essence of the statutory framework to regulate
derivatives markets under the Commodity Exchange Act (CEA). Here,
public input will serve as a valuable tool in refining the NPRM by
providing insights that may not have been considered in changing the
CFTC's longstanding principles-based approach to oversight of self-
regulatory organizations (SROs) such as DCMs and SEFs, who establish
their own rule books and bring enforcement actions against market
participants for violations.\1\ In 2012, when the CFTC first adopted
its DCM rules and decided to leave certain areas as guidance on
acceptable best practices, the CFTC thoroughly examined each
regulation and explained where guidance was more appropriate than a
rule in recognition of the need to maintain flexibility for DCMs to
establish rules that are appropriate for their products, markets,
and participants, including associated risks.\2\ I have serious
concerns with the CFTC proceeding down a path to finalizing a rule
that is overly prescriptive and unsupported by data or other
evidence.
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\1\ See Statement of Commissioner Caroline D. Pham Regarding
Request for Comment on the Impact of Affiliations Between Certain
CFTC-Regulated Entities (June 28, 2023), https://www.cftc.gov/PressRoom/SpeechesTestimony/phamstatement062823; Statement of
Commissioner Caroline D. Pham on Effective Self-Regulation and
Notice of Proposed Rulemaking to Amend Part 40 Regulations (July 26,
2023), https://www.cftc.gov/PressRoom/SpeechesTestimony/phamstatement072623b.
\2\ See Core Principles and Other Requirements for Designated
Contract Markets, 77 FR 36612, 36614 (June 19, 2012), https://www.federalregister.gov/documents/2012/06/19/2012-12746/core-principles-and-other-requirements-for-designated-contract-markets
(explaining the process as ``In determining whether to codify a
compliance practice in the form of a rule or guidance/acceptable
practice, the Commission was guided by whether the practice
consisted of a commonly-accepted industry practice. Where there is a
standard industry practice that the Commission has determined to be
an acceptable compliance practice, the Commission believes that the
promulgation of clear-cut regulations will provide greater legal
certainty and transparency to DCMs in determining their compliance
obligations, and to market participants in determining their
obligations as DCM members, and will facilitate the enforcement of
such provisions. Several of the rules adopted in this notice of
final rulemaking largely codify practices that are commonly accepted
in the industry and are currently being undertaken by most, if not
all, DCMs.'').
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Specific Areas for Public Comment
Separately, I am highlighting two additional issues for
commenters:
[[Page 19726]]
Material Non-Public Information
The Commission is refusing to fix the references to ``material
non-public information'' in Parts 37 and 38. Even though the NPRM
cites Regulation 1.59(d) and its use of ``material, non-public
information,'' and that the intent is to copy the requirements in
Regulation 1.59(d) to Parts 37 and 38 purely for housekeeping
purposes, the Commission is potentially creating a loophole by
making a small but very substantive change in using ``material non-
public information'' in Parts 37 and 38. The former--with a comma--
broadly captures information that is material and non-public. The
latter--with no comma--is an incorrect usage of a well-established
term of art under securities laws that is too narrow to address the
potential conflicts in derivatives markets, creates unnecessary
confusion for market participants, and undermines robust compliance
programs by introducing uncertainty.\3\ ``Consistency'' is a goal
repeated throughout the NPRM, and I do not understand why we are
refusing to resolve the inconsistency here.
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\3\ See Dissenting Statement of Commissioner Caroline D. Pham on
Misappropriation Theory in Derivatives Markets (Sept. 27, 2023),
https://www.cftc.gov/PressRoom/SpeechesTestimony/phamstatement092723.
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The Commission must protect all confidential information--not
just material information--in order to effectively mitigate,
prevent, or avoid conflicts of interest. In some circumstances,
there must be a complete information barrier or segregation of
activities between business units or personnel to protect sensitive
and confidential information about customer trades or positions in
order to prevent potential market manipulation or other abusive
trading practices. The Commission's misguided approach is not enough
to protect our markets from misconduct.\4\
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\4\ Id.
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Revocation of Registration
I am deeply concerned about proposed Regulations 37.5(c)(6) and
38.5(c)(6).\5\ This is the first time that the CFTC has decided to
promulgate a rule to revoke the registration of a registered entity
since section 5e of the Commodity Exchange Act was enacted in 1998,
with insufficient explanation to demonstrate a reasonable basis and
reasoned decision-making as required by the Administrative Procedure
Act,\6\ and insufficient procedural safeguards to ensure due process
for DCMs and SEFs. The government must ensure due process under the
Constitution, including judicial review, before taking away the
rights of the public in what may well be a death knell for trading
venues. Anything less is an abuse of power.\7\
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\5\ The language is the same for both SEFs and DCMs, so for
brevity I will only include it for SEFs here: Reg. 37.5(c)(6) A
change in the ownership or corporate or organizational structure of
a SEF that results in the failure of the SEF to comply with any
provision of the CEA, or any regulation or order of the Commission
thereunder--(i) shall be cause for the suspension of the
registration of the SEF or the revocation of registration as a SEF,
in accordance with the procedures provided in sections 5e and 6(b)
of the CEA, including notice and a hearing on the record; or (ii)
may be cause for the Commission to make and enter an order directing
that the SEF cease and desist from such violation, in accordance
with the procedures provided in sections 6b and 6(b) of the CEA,
including notice and a hearing on the record.
\6\ The only justification provided is ``[i]t is imperative that
SEFs and DCMs, regardless of ownership or control changes, continue
to comply with the CEA and all Commission regulations to promote
market integrity and protect market participants.''
\7\ See Statement of Commissioner Caroline D. Pham on Effective
Self-Regulation and Notice of Proposed Rulemaking to Amend Part 40
Regulations (July 26, 2023), https://www.cftc.gov/PressRoom/SpeechesTestimony/phamstatement072623b.
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Further, the rules are clearly overbroad because the CFTC could
revoke registration due to changes ``in the ownership or corporate
or organizational structure'' of a DCM or SEF (emphasis added). This
could include simple changes in headcount and other staffing
reorganizations, making it all too easy for the CFTC to manufacture
a reason to revoke registration. I sincerely hope that this is not
the Commission's intent. What is even more puzzling is that the CFTC
is choosing to propose structural changes as cause to revoke
registration, but not grave misconduct such as fraud, abuse, or
manipulation. This is nonsensical. I urge commenters to pay close
attention to the full import of the revocation of registration
proposed rules.
I look forward to reviewing the comments on the DCM and SEF
Conflicts of Interest Proposal.
[FR Doc. 2024-04938 Filed 3-18-24; 8:45 am]
BILLING CODE 6351-01-P