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Proposed Rule2024-04938

Requirements for Designated Contract Markets and Swap Execution Facilities Regarding Governance and the Mitigation of Conflicts of Interest Impacting Market Regulation Functions

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Published

March 19, 2024

Issuing agencies

Commodity Futures Trading Commission

Abstract

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.

Full Text

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[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 [<a href="http://www.gpo.gov">www.gpo.gov</a>]
[FR Doc No: 2024-04938]

[[Page 19645]]

Vol. 89

Tuesday,

No. 54

March 19, 2024

Part II

Commodity Futures Trading Commission

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17 CFR Parts 37 and 38

Requirements for Designated Contract Markets and Swap Execution
Facilities Regarding Governance and the Mitigation of Conflicts of
Interest Impacting Market Regulation Functions; Proposed Rule

Federal Register / Vol. 89 , No. 54 / Tuesday, March 19, 2024 /
Proposed Rules

[[Page 19646]]

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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:
<bullet> CFTC Comments Portal: <a href="https://comments.cftc.gov">https://comments.cftc.gov</a>. Select
the ``Submit Comments'' link for this rulemaking and follow the
instructions on the Public Comment Form.
<bullet> Mail: Send to Christopher Kirkpatrick, Secretary of the
Commission, Commodity Futures Trading Commission, Three Lafayette
Centre, 1155 21st Street NW, Washington, DC 20581.
<bullet> 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
<a href="https://comments.cftc.gov">https://comments.cftc.gov</a>. 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 <a href="https://www.comments.cftc.gov">https://www.comments.cftc.gov</a> 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,
<a href="/cdn-cgi/l/email-protection#651707001701040b160e1c25060311064b020a13">[email&#160;protected]</a>, 202-418-5429; Swati Shah, Associate Director,
<a href="/cdn-cgi/l/email-protection#6e1d1d060f062e0d081a0d40090118">[email&#160;protected]</a>, 202-418-5042; Marilee Dahlman, Special Counsel,
<a href="/cdn-cgi/l/email-protection#7f121b1e1713121e113f1c190b1c51181009">[email&#160;protected]</a>, 202-418-5264; Jennifer L. Tveiten-Rifman, Special
Counsel, <a href="/cdn-cgi/l/email-protection#8de7f9fbe8e4f9e8e3ffe4ebe0ece3cdeeebf9eea3eae2fb">[email&#160;protected]</a>, 312-802-3848; Lillian Cardona,
<a href="/cdn-cgi/l/email-protection#5539363427313a3b3415363321367b323a23">[email&#160;protected]</a>, 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,
<a href="https://www.cftc.gov/IndustryOversight/TradingOrganizations/DCMs/dcmruleenf.html">https://www.cftc.gov/IndustryOversight/TradingOrganizations/DCMs/dcmruleenf.html</a>.
\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

[[Page 19649]]

of interest and governance standards for SEFs and DCMs.
1. 2001 Regulatory Framework
On August 10, 2001, the Commission adopted a regulatory framework
(``2001 Regulatory Framework'') implementing the Commodity Futures
Modernization Act of 2000 (``CFMA''), effective October 9, 2001.\28\
The CFMA required the Commission to implement a framework of flexible
core principles in lieu of detailed regulatory prescriptions. Section
110 of the CFMA, codified in section 5(d)(1) of the CEA, stated that a
DCM shall have reasonable discretion in establishing the manner in
which it complies with the core principles.
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\28\ A New Regulatory Framework for Trading Facilities,
Intermediaries and Clearing Organizations, 66 FR 42256 (Aug. 10,
2001) (``2001 Regulatory Framework'').
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The CFMA contained core principles, that among other things,
related to governance fitness standards and conflicts of interest. DCM
Core Principle 14 (Governance Fitness Standards) \29\ provided that
boards of trade shall establish and enforce appropriate fitness
standards for directors, members of any disciplinary committee, members
of the contract market, and any other persons with direct access to the
facility (including any parties affiliated with any of the persons
described in this paragraph).\30\ DCM Core Principle 15 (Conflicts of
Interest) \31\ provided that boards of trade shall establish and
enforce rules to minimize conflicts of interest in the decision-making
process of the contract market and shall establish a process for
resolving such conflicts of interest.\32\
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\29\ In 2001, DCM Core Principle 14 addressed governance fitness
standards. In the Dodd-Frank Act, the DCM conflicts of interest core
principle was renumbered to be Core Principle 15. See Dodd-Frank
Act, section 735(b); 7 U.S.C. 7(d)(15).
\30\ See CFMA section 110, codified at CEA section 5(d)(14).
\31\ In 2001, DCM Core Principle 15 addressed conflicts of
interest. In the Dodd-Frank Act, the DCM conflicts of interest core
principle was renumbered to be Core Principle 16. See Dodd-Frank
Act, section 735(b); 7 U.S.C. 7(d)(16).
\32\ See CFMA section 110, codified at CEA section 5(d)(15).
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The 2001 Regulatory Framework implemented guidance for DCM Core
Principles 14 (Governance Fitness Standards) and 15 (Conflicts of
Interest). Guidance provides contextual information regarding the core
principles, including important concerns which the Commission believes
should be taken into account in complying with specific core
principles.\33\ The guidance for a core principle is illustrative only
of the types of matters a DCM may address, and is not intended to be
used as a mandatory checklist.\34\
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\33\ The 2001 Regulatory Framework described the guidance
contained therein as ``application guidance,'' but the concept is
substantively similar to the ``guidance'' in part 38, Appendix B,
sec. 1. See 2001 Regulatory Framework, 66 FR 42256 at 42278.
\34\ Part 38, Appendix B, sec 1.
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The guidance for DCM Core Principle 14 states that minimum fitness
standards for ``persons who have member voting privileges, governing
obligations or responsibilities, or who exercise disciplinary
authority,'' and ``natural persons who directly or indirectly have
greater than a ten percent ownership interest in a designated
contract'' should include those bases for refusal to register a person
under section 8a(2) of the CEA.\35\ Additionally, the guidance states
that persons who have governing obligations or responsibilities, or who
exercise disciplinary authority, should not have a significant history
of serious disciplinary offenses, such as those that would be
disqualifying under Commission regulation Sec. 1.63.\36\ The guidance
further states that fitness standards should include providing the
Commission with fitness information for such persons, whether
registration information, certification to the fitness of such persons,
an affidavit of such persons' fitness by the contract market's counsel
or other information substantiating the fitness of such persons.\37\
Finally, the guidance provides that if a contract market provides
certification of the fitness of such a person, the Commission believes
that such certification should be based on verified information that
the person is fit to be in his or her position.\38\
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\35\ See 2001 Regulatory Framework, 66 FR 42256 at 42283.
\36\ Id. The DCM Core Principle 14 Guidance states that members
with trading privileges but having no or only minimal equity in the
DCM and non-member market participants who are not intermediated
``and do not have these privileges, obligations, or responsibilities
or disciplinary authority'' could satisfy minimum fitness standards
by meeting the standards that they must meet to qualify as a
``market participant.''
\37\ 2001 Regulatory Framework, 66 FR 42256 at 42283.
\38\ Id.
---------------------------------------------------------------------------

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.
---------------------------------------------------------------------------

\39\ Id. In 2001, DCM Core Principle 15 addressed conflicts of
interest. In the Dodd-Frank Act, the DCM conflicts of interest core
principle was renumbered to be Core Principle 16. See Dodd-Frank
Act, section 735(b); 7 U.S.C. 7(d)(16).
---------------------------------------------------------------------------

In the 2001 Regulatory Framework, the Commission adopted Commission
regulation Sec. 38.2, which exempted ``agreements, contracts, or
transactions'' traded on a DCM, as well as the ``contract market''
itself, and the ``contract market's operator'' from all Commission
regulations for such activity, except for the requirements of part 38
and Sec. Sec. thnsp;1.3, 1.12(e), 1.31, 1.38, 1.52, 1.59(d), 1.63(c),
1.67, 33.10, part 9, parts 15 through 21, part 40, and part 190.\40\
The Commission did so in the context of the CFMA, which provided DCMs
with a framework of flexible core principles in lieu of detailed
regulatory prescriptions.\41\
---------------------------------------------------------------------------

\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.
---------------------------------------------------------------------------

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\
---------------------------------------------------------------------------

\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.
---------------------------------------------------------------------------

The DCM Core Principle 16 acceptable practices have several key
provisions. First, the acceptable practices provided that DCM boards of
directors, and any executive committees or similarly empowered bodies,
be comprised of at least 35 percent ``public directors.'' Second, the
acceptable practices also established a definition of who would
constitute a ``public director'' for purposes of the acceptable
practices. Third, the acceptable practices provided that a DCM
establish a ROC comprised exclusively of public directors, which would
have among its duties to supervise the contract market's CRO, who will
report directly to the ROC.\47\ The Commission explained that properly
functioning ROCs should be robust oversight bodies capable of firmly
representing the interests of vigorous, impartial, and effective self-
regulation. ROCs should also represent the interests and needs of
regulatory officers and staff; the resource needs of regulatory
functions; and the independence of regulatory decisions. In this
manner, ROCs will insulate DCM self-regulatory functions, decisions,
and personnel from improper influence, both internal and external.\48\
---------------------------------------------------------------------------

\47\ Id. at 6951 n.80.
\48\ Id. at 6950-51.
---------------------------------------------------------------------------

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\
---------------------------------------------------------------------------

\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) <a href="https://www.cftc.gov/sites/default/files/opa/press00/opa4407-00.htm">https://www.cftc.gov/sites/default/files/opa/press00/opa4407-00.htm</a> and Commission Release #4427-00 (July 28, 2000)
<a href="https://www.cftc.gov/sites/default/files/opa/press00/opa4427-00.htm">https://www.cftc.gov/sites/default/files/opa/press00/opa4427-00.htm</a>,
respectively. The Commission also approved a demutualization plan
for the Chicago Board of Trade (CBOT) on April 18, 2005. See
Certified Rule Submissions, <a href="https://www.cftc.gov/IndustryOversight/IndustryFilings/deaapprovalofrulestable.html">https://www.cftc.gov/IndustryOversight/IndustryFilings/deaapprovalofrulestable.html</a>.
\50\ See 2007 Final Release, 72 FR 6936 at 6951.
---------------------------------------------------------------------------

Fourth, the acceptable practices specified that DCM disciplinary
panels should not be dominated by any group or class of DCM members or
participants, and provided that at least one person who would qualify
as a public director be included on the panel.
The Commission provided existing DCMs with a phase-in period of the
lesser of two years or two regularly scheduled elections of the board
of directors to demonstrate full compliance with the conflicts of
interest core principle for DCMs.\51\ Then, on March 26, 2007, the
Commission proposed certain amendments to the ``public director''
definition.\52\ With the ``public director'' definition in flux, the
Commission stayed the phase-in period for existing DCMs to demonstrate
full compliance with the conflicts of interest core principle.\53\
---------------------------------------------------------------------------

\51\ See id.
\52\ Conflicts of Interest in Self-Regulation and Self-
Regulatory Organizations, 72 FR 14051 (March 26, 2007).
\53\ Id. at 65659.
---------------------------------------------------------------------------

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\
---------------------------------------------------------------------------

\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.
---------------------------------------------------------------------------

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:
---------------------------------------------------------------------------

\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).
---------------------------------------------------------------------------

<bullet> a board of directors with at least 35 percent, but no less
than two, public directors;
<bullet> a nominating committee with at least 51 percent public
directors, and with a public director as chair;
<bullet> one or more disciplinary panels, with a public participant
as chair;
<bullet> a ROC with all public directors; and
<bullet> a membership or participation committee, with 35 percent
public directors.
The Commission also proposed, as rules, certain limitations with
respect to the ownership of voting equity in the SEF or DCM and the
exercise of voting rights. These proposals limited SEF participants or
DCM members (and related persons) to: (1) beneficially

[[Page 19651]]

owning no more than 20 percent of any class of voting equity in the SEF
or DCM; and (2) exercising (whether directly or indirectly) no more
than 20 percent of the voting power of any class of equity interest in
the SEF or DCM.
The Commission never adopted the proposed rules as final rules.\59\
---------------------------------------------------------------------------

\59\ The proposal was withdrawn on the Fall 2020 Unified Agenda
and Regulatory Plan. The withdrawal entry is available at: <a href="https://www.reginfo.gov/public/do/eAgendaViewRule?pubId=202010&RIN=3038-AD37">https://www.reginfo.gov/public/do/eAgendaViewRule?pubId=202010&RIN=3038-AD37</a>.
---------------------------------------------------------------------------

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\
---------------------------------------------------------------------------

\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: <a href="https://www.reginfo.gov/public/do/eAgendaViewRule?pubId=201910&RIN=3038-AD36">https://www.reginfo.gov/public/do/eAgendaViewRule?pubId=201910&RIN=3038-AD36</a>.
---------------------------------------------------------------------------

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\
---------------------------------------------------------------------------

\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\
---------------------------------------------------------------------------

\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.
---------------------------------------------------------------------------

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\
---------------------------------------------------------------------------

\74\ See Commission regulation Sec. 38.5(c).
\75\ See id.
\76\ 2012 Part 38 Final Rule, 77 FR 36612 at 36619.
---------------------------------------------------------------------------

In addition to Commission regulation Sec. 38.5(c)'s equity
interest transfer requirements, the Commission adopted regulations
requiring DCMs to submit certain information to the Commission.

[[Page 19652]]

Pursuant to Commission regulation Sec. 38.5(a), upon request, a DCM
must file with the Commission information related to its business as a
DCM, including information relating to data entry and trade details, in
the form and manner and within the time specified by the Commission in
its request.\77\
---------------------------------------------------------------------------

\77\ See Commission regulation Sec. 38.5(a).
---------------------------------------------------------------------------

The Commission notes that in the 2012 Part 38 Final Rule, pursuant
to Sec. 38.5(d), the Commission delegated ``the authority set forth in
paragraph (b) of this section'' (demonstration of compliance) to the
Director of the Division of Market Oversight.\78\ This differs from the
corresponding regulation for SEFs.\79\ Existing Commission regulation
Sec. 37.5(d) provides that the Commission delegates ``the authority
set forth in this section'' to the Director of the Division of Market
Oversight, which is a broader delegation compared to the Part 38
regulation. In particular, the delegation provision in Sec. 37.5(d)
includes the authority to request information pursuant to both
regulations Sec. Sec. 37.5(a) (requests for information) and (b)
(demonstration of compliance).\80\ The delegation provision in Sec.
38.5(d) does not apply to Sec. 38.5(a) (requests for information).
---------------------------------------------------------------------------

\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).
---------------------------------------------------------------------------

Finally, in the 2012 Part 38 Final Rule, the Commission adopted a
revised version of Sec. 38.2 that specified ``the Commission
regulations from which DCMs will be exempt'' as opposed to listing the
regulations that DCMs were obligated to comply with.\81\ The Commission
made this change to add clarity and to eliminate the need for the
Commission to continually update Sec. 38.2 when new regulations with
which DCMs must comply are codified.\82\ The Commission exempted DCMs
from certain provisions within part 1 of the Commission's regulations
that address conflicts of interest and governance for self-regulatory
organizations (``SROs''). In particular, the Commission exempted DCMs
from all or part of the following provisions:
---------------------------------------------------------------------------

\81\ See 2012 Part 38 Final Rule, 77 FR 36612 at 36615. See
Section II(b)(1) herein for a description of the previous version of
Commission regulation Sec. 38.2.
\82\ Id.
---------------------------------------------------------------------------

<bullet> Commission regulation Sec. 1.59, which addresses
limitations on the use and disclosure of non-public information; \83\
---------------------------------------------------------------------------

\83\ Commission regulation Sec. 38.2 exempts DCMs from
Commission regulation Sec. 1.59(b) (requiring self-regulatory
organizations to, by rule, prohibit employees from trading in
certain contracts traded on or cleared by the self-regulatory
organization or related to those traded on or cleared by the self-
regulatory organization, and from trading on or disclosing material
non-public information), and Commission regulation Sec. 1.59(c)
(requiring self-regulatory organizations to, by rule, prohibit
governing board members, committee members, and consultants from
disclosing material non-public information gained as a result of
official duties). DCMs remain subject to Commission regulations
Sec. Sec. 1.59(a) (definitions) and 1.59(d) (prohibiting self-
regulatory organization employees, governing board members,
committee members, and consultants from trading on or disclosing
material non-public information).
---------------------------------------------------------------------------

<bullet> Commission regulation Sec. 1.63, which restricts persons
with certain disciplinary histories from serving on governing boards or
committees; \84\
---------------------------------------------------------------------------

\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.
---------------------------------------------------------------------------

<bullet> Commission regulation Sec. 1.64, which addresses
composition of governing boards and disciplinary committees; \85\ and
---------------------------------------------------------------------------

\85\ Commission regulation Sec. 38.2 exempts DCMs from the
entirety of Commission regulation Sec. 1.64.
---------------------------------------------------------------------------

<bullet> Commission regulation Sec. 1.69, which addresses voting
by conflicted members of governing boards and committees.\86\
---------------------------------------------------------------------------

\86\ Commission regulation Sec. 38.2 exempts DCMs from the
entirely of Commission regulation Sec. 1.69.
---------------------------------------------------------------------------

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\
---------------------------------------------------------------------------

\87\ See 2012 Part 38 Final Rule, 77 FR 36612 at 36615.
---------------------------------------------------------------------------

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\
---------------------------------------------------------------------------

\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.
---------------------------------------------------------------------------

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\
---------------------------------------------------------------------------

\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.
---------------------------------------------------------------------------

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.''
---------------------------------------------------------------------------

\97\ Swap Execution Facilities, 86 FR 9224 (Feb. 11, 2021) (the
``Part 37 Updates'').
\98\ Id. at 9225.
---------------------------------------------------------------------------

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.
---------------------------------------------------------------------------

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\
---------------------------------------------------------------------------

\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\
---------------------------------------------------------------------------

\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.
---------------------------------------------------------------------------

\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, <a href="https://www.cftc.gov/sites/default/files/opa/press00/opa4407-00.htm">https://www.cftc.gov/sites/default/files/opa/press00/opa4407-00.htm</a>.
\110\ See Commission Release #4427-00, <a href="https://www.cftc.gov/sites/default/files/opa/press00/opa4427-00.htm">https://www.cftc.gov/sites/default/files/opa/press00/opa4427-00.htm</a>.
\111\ See Commission Release #4434-00, <a href="https://www.cftc.gov/sites/default/files/opa/press00/opa4434-00.htm">https://www.cftc.gov/sites/default/files/opa/press00/opa4434-00.htm</a>.
\112\ The process continued through 2020, when MGEX went through
demutualization. <a href="https://www.cftc.gov/sites/default/files/filings/documents/2020/orgdcmmgexordertransfer201124.pdf">https://www.cftc.gov/sites/default/files/filings/documents/2020/orgdcmmgexordertransfer201124.pdf</a>; <a href="https://www.mgex.com/documents/MIAX_MGEX_SeatVote_PressRelease_000.pdf">https://www.mgex.com/documents/MIAX_MGEX_SeatVote_PressRelease_000.pdf</a>.
\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).
---------------------------------------------------------------------------

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.
---------------------------------------------------------------------------

\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), <a href="https://crsreports.congress.gov/product/pdf/R/R41715/4">https://crsreports.congress.gov/product/pdf/R/R41715/4</a>.
---------------------------------------------------------------------------

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\
---------------------------------------------------------------------------

\117\ Request for Comment on the Impact of Affiliations of
Certain CFTC-Regulated Entities, CFTC Release 8734-23, June 28,
2023. <a href="https://www.cftc.gov/PressRoom/PressReleases/8734-23">https://www.cftc.gov/PressRoom/PressReleases/8734-23</a>.
\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. <a href="https://www.cftc.gov/PressRoom/PressReleases/8839-23">https://www.cftc.gov/PressRoom/PressReleases/8839-23</a>. 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.
---------------------------------------------------------------------------

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.
---------------------------------------------------------------------------

\120\ See proposed Sec. Sec. 38.851(b)(9) and 37.1201(b)(9).
---------------------------------------------------------------------------

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.'')
---------------------------------------------------------------------------

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).
---------------------------------------------------------------------------

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).
<bullet> 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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<bullet> 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).
<bullet> 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.
---------------------------------------------------------------------------

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.
---------------------------------------------------------------------------

\161\ Commission regulation Sec. 1.69(a) defines ``disciplinary
committee(s),'' ``governing board(s),'' and ``oversight panel(s).''
---------------------------------------------------------------------------

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.
---------------------------------------------------------------------------

\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.
---------------------------------------------------------------------------

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.
---------------------------------------------------------------------------

\164\ CEA section 9(e), 7 U.S.C. 13(e).
---------------------------------------------------------------------------

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\
---------------------------------------------------------------------------

\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.
---------------------------------------------------------------------------

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.
---------------------------------------------------------------------------

\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).
---------------------------------------------------------------------------

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\
---------------------------------------------------------------------------

\168\ Commission regulation Sec. 1.59(b)(ii)(b).
---------------------------------------------------------------------------

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\
---------------------------------------------------------------------------

\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.
---------------------------------------------------------------------------

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.
---------------------------------------------------------------------------

\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.
---------------------------------------------------------------------------

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.
---------------------------------------------------------------------------

\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.
---------------------------------------------------------------------------

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, <a href="https://www.sec.gov/news/speech/2014-spch062314mjw">https://www.sec.gov/news/speech/2014-spch062314mjw</a> (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.'').
---------------------------------------------------------------------------

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.
---------------------------------------------------------------------------

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.
---------------------------------------------------------------------------

\187\ NYSE American Company Guide Rule 802; Nasdaq Rule 5605(b).
---------------------------------------------------------------------------

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).
---------------------------------------------------------------------------

\188\ Proposed Sec. 38.854(a)(1).
\189\ Proposed Sec. 37.1204(a)(1).
---------------------------------------------------------------------------

In addition to proposing board of director composition
requirements, the Commission proposes the substantive requirements set
forth below, which aim to enhance transparency and the accountability
of the SEF and DCM board of directors regarding the manner in which
such board of directors causes the SEF or DCM to discharge all
statutory, regulatory, or self-regulatory responsibilities under the
CEA, including the market regulation functions.
<bullet> 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).
---------------------------------------------------------------------------

<bullet> 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\
---------------------------------------------------------------------------

\191\ Proposed Sec. Sec. 37.1204(e) and 38.854(e).
---------------------------------------------------------------------------

<bullet> 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).
---------------------------------------------------------------------------

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 cr

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