Requirements for Designated Contract Markets and Swap Execution Facilities Regarding Governance and the Mitigation of Conflicts of Interest Impacting Market Regulation Functions
| Published date | 19 March 2024 |
| Record Number | 2024-04938 |
| Citation | 89 FR 19646 |
| Court | Commodity Futures Trading Commission |
| Section | Proposed rules |
Federal Register, Volume 89 Issue 54 (Tuesday, March 19, 2024)
[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 IICommodity Futures Trading Commission-----------------------------------------------------------------------17 CFR Parts 37 and 38Requirements 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]]
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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.
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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\
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\1\ 17 CFR 145.9.
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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.
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\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).
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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\
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\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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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.
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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.
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\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).
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Finally, the Commission is proposing certain technical and
conforming changes to SEF and DCM rules relating to disciplinary
panels, staffing, and investigations.\14\
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\14\ See Section V(e)-(g) herein.
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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\
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\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).
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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.
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\16\ 7 U.S.C. 7b-3.
\17\ 7 U.S.C. 7b-3(f).
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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.
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\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).
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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\
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\20\ CEA sections 5(d)(16), 5h(f)(12). DCM Core Principle 16 and
SEF Core Principle 12 are substantively identical in the statute.
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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\
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\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
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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.
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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).
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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\
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\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\
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\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).
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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\
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\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\
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\77\ See Commission regulation Sec. 38.5(a).
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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:
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\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.
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Commission regulation Sec. 1.59, which addresses
limitations on the use and disclosure of non-public information; \83\
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\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).
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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.
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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.
---------------------------------------------------------------------------
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.
---------------------------------------------------------------------------
\288\ See proposed Sec. 37.1204(a)(1), herein.
---------------------------------------------------------------------------
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).
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\289\ See supra, Section V(b), ``public director'' definition--
proposed Sec. Sec. 37.1201(b)(12) and 38.851(b)(12).
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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.
---------------------------------------------------------------------------
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).
---------------------------------------------------------------------------
\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).
---------------------------------------------------------------------------
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.
---------------------------------------------------------------------------
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\
---------------------------------------------------------------------------
\18\ Proposed 17 CFR 37.1202, 38.852.
---------------------------------------------------------------------------
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\
---------------------------------------------------------------------------
\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.
---------------------------------------------------------------------------
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\
---------------------------------------------------------------------------
\20\ Opening Statement Regarding the Open Commission Meeting on
December 13, 2023, supra note 1.
---------------------------------------------------------------------------
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\
---------------------------------------------------------------------------
\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.
---------------------------------------------------------------------------
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\
---------------------------------------------------------------------------
\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.
---------------------------------------------------------------------------
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.
---------------------------------------------------------------------------
\25\ A Call for the CFTC to Begin a Formal Rulemaking to Address
Vertical Integration, supra note 1.
---------------------------------------------------------------------------
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.
---------------------------------------------------------------------------
\26\ 17 CFR 38.5(c).
\27\ 17 CFR 37.5(c).
---------------------------------------------------------------------------
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.
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\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.
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\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
