Fair Administration and Governance of Self-Regulatory Organizations; Disclosure and Regulatory Reporting by Self-Regulatory Organizations; Recordkeeping Requirements for Self-Regulatory Organizations; Ownership and Voting Limitations for Members of Self-Regulatory Organizations; Ownership Reporting Requirements for Members of Self-Regulatory Organizations; Listing and Trading of Affiliated Securities by a Self-Regulatory Organization

Federal RegisterDec 8, 2004

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SECURITIES AND EXCHANGE COMMISSION

17 CFR Parts 240, 242, and 249

[Release No. 34-50699; File No. S7-39-04]

RIN 3235-AJ33

Fair Administration and Governance of Self-Regulatory Organizations; Disclosure and Regulatory Reporting by Self-Regulatory Organizations; Recordkeeping Requirements for Self-Regulatory Organizations; Ownership and Voting Limitations for Members of Self-Regulatory Organizations; Ownership Reporting Requirements for Members of Self-Regulatory Organizations; Listing and Trading of Affiliated Securities by a Self-Regulatory Organization

AGENCY:

Securities and Exchange Commission.

ACTION:

Proposed rule.

SUMMARY:

The Securities and Exchange Commission (“Commission”) is proposing to adopt new rules and amend existing rules and forms under the Securities Exchange Act of 1934 (“Exchange Act”). The proposals pertain to the governance, administration, transparency and ownership of self-regulatory organizations (“SROs”) that are national securities exchanges or registered securities associations and the periodic reporting of information by these SROs regarding their regulatory programs. The proposals also relate to the listing and trading by SROs of their own or affiliated securities.

First, the proposals would impose new governance standards on national securities exchanges and registered securities associations by requiring a majority of the members of the exchange's or association's board of directors to be independent. In addition, key committees of the board would be required to be composed solely of independent directors. The proposals would define the term “independent director.” The proposals also would require exchanges and associations to establish policies and procedures to maintain a separation between their regulatory functions and their market operations and other commercial interests, and require that funds received from regulatory fines, fees, and penalties be used for regulatory purposes.

Further, the proposals would require national securities exchanges and registered securities associations to prohibit any member that is a broker or dealer from owning and voting more than 20% of the ownership interest in the exchange or the association, or a facility of the exchange or association. To supplement these ownership and voting provisions, the proposals also would require each member of an exchange or association that is a broker or dealer to file a report with the Commission when the member acquires ownership of more than 5% of any interest in the exchange or association, or any facility thereof. Also, the Commission proposes to require national securities exchanges and national securities associations to maintain their books and records in the United States. Together, these proposals are designed to strengthen the governance and administration of SROs and address the possible concentration of ownership by member firms.

In addition, the Commission proposes to amend its forms for registration as a national securities exchange or registered securities association to require that these SROs file with the Commission and publicly disclose enhanced information relating to their governance, regulatory programs, finances, ownership structure, and other matters. Further, the Commission's rules governing the procedures for filing amendments to these registration forms would be revised to require more frequent updating of the required information and the posting of the required information on the SROs' Internet Web sites. These proposals are designed to provide greater transparency to key aspects of the governance, ownership structure, and regulatory operations of national securities exchanges and registered securities associations.

The Commission also proposes to require national securities exchanges and registered securities associations to file with the Commission, in an electronic format, quarterly and annual reports on particular aspects of their regulatory programs. This proposal is intended to enhance the Commission's oversight and surveillance of exchanges and associations by requiring them to provide the Commission with detailed regulatory information on a regular basis, thereby assisting the Commission to oversee more effectively the SROs' regulatory programs and better identify any trends or issues that may arise.

Finally, the Commission proposes to impose requirements on a national securities exchange or registered securities association that chooses to list or trade its own security, the security of any trading facility, or the security of an affiliate of itself or a facility. The proposed requirements are designed to assure that these SROs are able to enforce effectively their listing standards with respect to, and supervise trading in, their own or a facility's securities, or the securities of affiliates of the SRO or a facility.

DATES:

Comments should be submitted on or before January 24, 2005.

ADDRESSES:

Comments may be submitted by any of the following methods:

Electronic Comments

• Use the Commission's Internet comment form (

http://www.sec.gov/rules/proposed.shtml

); or

• Send an e-mail to

rule-comments@sec.gov.

Please include File Number S7-39-04 on the subject line; or

• Use the Federal eRulemaking Portal (

http://www.regulations.gov

). Follow the instructions for submitting comments.

Paper Comments

• Send paper comments in triplicate to Jonathan G. Katz, Secretary, Securities and Exchange Commission, 450 Fifth Street, NW., Washington, DC 20549-0609.

All submissions should refer to File Number S7-39-04. This file number should be included on the subject line if e-mail is used. To help us process and review your comments more efficiently, please use only one method. The Commission will post all comments on the Commission's Internet Web site (

http://www.sec.gov/rules/proposed.shtml

). Comments are also available for public inspection and copying in the Commission's Public Reference Room, 450 Fifth Street, NW., Washington, DC 20549. All comments received will be posted without change; we do not edit personal identifying information from submissions. You should submit only information that you wish to make available publicly.

FOR FURTHER INFORMATION CONTACT:

SRO Governance and Disclosure:

Nancy J. Sanow, Assistant Director, at (202) 942-0796, Susie Cho, Special Counsel, at (202) 942-0748, Leah Mesfin, Special Counsel, at (202) 942-0196, Geraldine Idrizi, Attorney, at (202) 942-7317, and A. Michael Pierson, Attorney, at (202) 942-0192;

Reporting Requirements for SROs:

Nancy J. Sanow, Assistant Director, at (202) 942-0796, and Richard Holley III, Attorney, at (202) 942-8086; and

SRO Ownership and Voting Restrictions, SRO Self-Listing, and Reporting Requirements for Members:

Heather Seidel, Attorney Fellow, at (202) 942-0788, Sonia Trocchio, Special Counsel, at (202) 942-0753, David Hsu, Special Counsel, at (202) 942-0731, and Jennifer Dodd, Attorney, at (202) 824-5471; all of whom are in the Division of

Market Regulation, Securities and Exchange Commission, 450 Fifth Street NW, Washington DC 20549-1001.

SUPPLEMENTARY INFORMATION:

We are proposing to add new Rules 3b-19, 6a-5, 17a-26, 17a-27, and Regulation AL under the Exchange Act; amend Rules 6a-2, 15Aa-1, and 17a-1 under the Exchange Act; redesignate Rule 15Aj-1 under the Exchange Act as Rule 15Aa-2 and amend redesignated Rule 15Aa-2; amend Form 1 under the Exchange Act; redesignate Form X-15AA-1 under the Exchange Act as Form 2 and amend redesignated Form 2; and remove Forms X-15AJ-1 and X-15AJ-2 under the Exchange Act.

Table of Contents

I. Background

A. Self-Regulation under the Exchange Act

B. Overview of Recent Developments

1. Governance Concerns

2. Concerns Relating to Weaknesses of SRO Regulatory Programs

3. Competitive Concerns

4. Concerns Relating to New Ownership Structures

II. Fair Administration and Governance of National Securities Exchanges and Registered Securities Associations

A. Background and Need for Proposed Rules 6a-5 and 15Aa-3

B. Description of Proposed Rules 6a-5 and 15Aa-3

1. Scope of Proposed Rules 6a-5 and 15Aa-3

2. Board Consisting of a Majority of Independent Directors

a. Determination of Independence

b. Independent Board Requirements

c. Fair Representation

3. Standing Committees

4. Other Committees of the Board

5. Other Requirements Applicable to Directors and Officers

6. Executive Sessions of the Board

7. Separation of Chairman of the Board and CEO Positions

8. Separation of Regulatory and Market Operations

a. Independence of Regulatory Program

b. Use of Regulatory Fees, Fines, and Penalties

c. Confidentiality of Regulatory and Trading Information

9. Member Voting and Ownership Limitations

a. Members' Interests Aggregated with Their Related Persons

b. Solicitation of Revocable Proxies

c. Requirement to Divest Ownership Interest and Restrict Voting

d. Ability to Obtain Information

10. Code of Conduct and Ethics and Governance Guidelines

11. Exemption Provision

12. Implementation

C. Request for Comment

III. Proposed Regulation AL—National Securities Exchanges and Registered Securities Associations Listing Affiliated Securities

A. Background and Need for Proposed Regulation AL

B. Description of Proposed Regulation AL

1. Definition of Affiliated Security

2. Initial Listing

3. Continued Listing and Trading

4. Parity in Application of Listing and Trading Rules

5. Exemption Provision

C. Request for Comment

IV. Disclosure by Eros

A. Overview of Proposed Amendments to Registration Forms for Exchanges and Associations

B. Description of Registration Processes

1. Registration as a National Securities Exchange or Exemption from Such Registration Based on Limited Volume

2. Registration as a Registered Securities Association or Affiliated Securities Association

C. Proposed Revisions to Form 1 and New Form 2

1. Scope of Disclosures Required by Revised Form 1 and New Form 2

2. Composition, Structure, and Responsibilities of the Board

3. Composition, Structure, and Responsibilities of Committees and Executive Boards

4. Governance

a. Governance Guidelines

b. Code of Conduct and Ethics

5. Organizational Charts

6. Regulatory Program

7. Audited Financial Statements and Other Financial Information

a. Budget and Revenues Devoted to Regulatory Activities

b. Revenues and Expenses

c. Other Financial Disclosures

8. Relationship between SROs, Facilities, and Their Affiliates

9. Ownership

10. Listing and Trading of Affiliated Securities

11. Location of Books and Records

12. Miscellaneous Matters Specific to New Form 2

13. Current Disclosures to be Retained in Revised Form 1 and Added to New Form 2

a. Constitution, Articles of Incorporation, Bylaws, and Rules

b. Rulings and Interpretations

c. Officers

d. Financial Statements of Affiliates

e. General Information Relating to Affiliates and SRO Trading Facilities

f. Operation of SRO Trading Facilities

g. Membership Forms

h. Financial Responsibility and Minimum Capital Requirements of Members

i. Listing Applications

j. Criteria for Membership

k. List of Members

l. Securities Listed and Traded

D. Timing and Format of Revised Form 1 and New Form 2

E. Proposed Changes to Rule 15Aa-1

F. Proposed Repeal of Forms X-15AJ-1 and X-15AJ-2

G. Request for Comment

V. Periodic Reporting Obligations of Exchanges and Associations

A. Background and Need for Proposed Rule 17a-26

B. Scope and Timing of Reports Required by Proposed Rule 17a-26

1. Quarterly Reports

2. Annual Reports

C. Format of Reports

D. Quarterly Reporting of Regulatory Information

1. Information on the SRO's Surveillance Program

2. Information on Complaints Received

3. Investigations, Examinations, and Enforcement Actions

4. Information on Listings Programs

5. Copies of Board and Committee Meeting Agenda

E. Annual Reporting of Regulatory Information

1. Cumulative Summary of Quarterly Information

2. Processes for Carrying Out Regulatory Responsibilities

3. Evaluation of the Regulatory Program

4. Internal Controls

5. Employment Arrangements with Regulatory Personnel

6. Copies of Standing Committee Evaluations

7. Compliance with Regulatory Plans

F. Audit Report of Electronic SRO Trading Facilities

G. Certifications

H. Interim Changes

I. Confidentiality of Reports

J. Compliance Date

K. Exemptions and Extensions of Time for Filing Reports

L. Filing of Reports

M. Request for Comment

VI. Proposed Rule 17a-27

A. Background and Need for Proposed Rule 17a-27

B. Description of Proposed Rule 17a-27

1. Brokers and Dealers Subject to the Rule

2. Information Required to be Filed

3. Timing of Filing

4. Filings with the Exchange or Association

5. Exemptions

C. Request for Comment

VII. Implementation

VIII. General Request for Comment

IX. Paperwork Reduction Act Analysis

A. Proposed Rule 3b-19

B. Proposed Amendments to Rule 6a-2, Revised Form 1, Rule 15Aa-2, and New Form 2

1. Summary of Collections of Information

2. Proposed Use of Information

3. Respondents

4. Reporting and Recordkeeping Burden

5. Collections of Information are Mandatory

6. Record Retention Period

C. Proposed Rules 6a-5 and 15Aa-3

1. Summary of Collection of Information

2. Proposed Use of Information

3. Respondents

4. Reporting and Recordkeeping Burden

5. Collection of Information is Mandatory

6. Record Retention Period

D. Proposed Regulation AL

1. Summary of Collection of Information

2. Proposed Use of Information

3. Respondents

4. Reporting and Recordkeeping Burden

5. Collection of Information is Mandatory

6. Record Retention Period

E. Proposed Amendments to Rule 17a-1

F. Proposed Rule 17a-26

1. Summary of Collection of Information

2. Proposed Use of Information

3. Respondents

4. Reporting and Recordkeeping Burden

5. Collection of Information is Mandatory

6. Record Retention Period

G. Proposed Rule 17a-27

1. Summary of Collection of Information

2. Proposed Use of Information

3. Respondents

4. Reporting and Recordkeeping Burden

5. Collection of Information is Mandatory

6. Record Retention Period

H. Request for Comment

X. Consideration of Costs and Benefits

A. Costs and Benefits of Proposed Rules 6a-5 and 15Aa-3

1. Benefits

2. Costs

3. Request for Comment

B. Costs and Benefits of Proposed Regulation AL

1. Benefits

2. Costs

3. Request for Comment

C. Costs and Benefits of Proposed Rule 6a-2 and Revised Form 1, and Rule 15Aa-2 and New Form 2

1. Benefits

2. Costs

3. Request for Comment

D. Costs and Benefits of Proposed Amendments to Rule 17a-1

1. Benefits

2. Costs

3. Request for Comment

E. Costs and Benefits of Proposed Rule 17a-26

1. Benefits

2. Costs

3. Request for Comment

F. Costs and Benefits of Proposed Rule 17a-27

1. Benefits

2. Costs

3. Request for Comment

XI. Consideration of Burden on Competition, and Promotion of Efficiency, Competition, and Capital Formation

XII. Consideration of Impact on the Economy

XIII. Regulatory Flexibility Act Certification

XIV. Statutory Authority and Text of Proposed Rules

I. Background

A. Self-Regulation Under the Exchange Act

The system of regulation for our Nation's securities markets and market participants is grounded on the principle of self-regulation. Thus, the Exchange Act

sets forth a regulatory model that combines both industry and government responsibility, based on the notion that regulation is most effective when it is done as closely as possible to the regulated activity. Congress enhanced this framework for the regulation of securities markets and market participants since the adoption of the Exchange Act, most notably in the Securities Acts Amendments of 1975.

While Congress at that time again weighed the risks of permitting the securities industry to regulate itself against the burdens of attempting to assure regulation directly through the government on a wide scale,

it refrained from changing the underlying principle of self-regulation. Thus, although the Commission has ultimate responsibility for oversight of the U.S. securities markets and their participants, the SROs continue to have “front-line” responsibility for overseeing trading on their markets and their members' compliance with applicable statutory and regulatory provisions.

15 U.S.C. 78a,

et seq.

Securities Acts Amendments of 1975, Pub. L. 94-29, 89 Stat. 97 (1975).

S. Rep. No. 75, 94th Cong., 1st Sess. (1975) at 201.

Section 3(a)(26) of the Exchange Act, 15 U.S.C. 78c(a)(26), defines a self-regulatory organization as any national securities exchange, registered securities association, or registered clearing agency, or (solely for purposes of Sections 19(b), 19(c), and 23(b) of the Exchange Act, 15 U.S.C. 78s(b), 78s(c), and 78w(b)), the Municipal Securities Rulemaking Board. The proposed rulemaking would apply only to those SROs that are national securities exchanges registered under Section 6(a) of the Exchange Act, 15 U.S.C. 78f(a), and securities associations registered under Section 15A(a) of the Exchange Act, 15 U.S.C. 78

-3(a).

Congress, however, gave the Commission a wide range of tools to oversee this self-regulatory system and to compel SROs to act when they fail to provide adequate protection to investors.

For example, the Commission is empowered to approve SRO rules

and to abrogate, add to, or delete from SRO rules.

The Commission also is authorized to review disciplinary actions taken by SROs against their members.

In addition, the Commission has the authority to require exchanges and associations to keep records and to file reports with the Commission.

All records of exchanges and associations are subject, at any time, or from time to time, to reasonable periodic, special, or other examinations by the Commission.

If the Commission identifies deficiencies, it will bring them to the attention of the SRO and can inspect the SRO to ascertain whether corrective action has been taken. Moreover, the Commission has the authority to impose limitations on the operations of an SRO if it finds that the SRO has violated or is unable to comply with any provisions of the Exchange Act or rules or regulations thereunder, or with any of the SRO's own rules, or has failed to enforce compliance with any such provision by its members.

Further, the Commission has the authority to suspend or revoke the registration of an SRO,

and remove from office or censure any officer or director of an SRO.

See supra

note 2.

Section 19(b)(1) of the Exchange Act, 15 U.S.C. 78s(b)(1), requires an SRO to file with the Commission copies of any proposed rule or any proposed change in, addition to, or deletion from the rules of such SRO, accompanied by a concise general statement of the basis and purpose of such proposed rule change, for Commission approval. This filing requirement is supplemented by Rule 19b-4 under the Exchange Act, 17 CFR 240.19b-4.

Section 19(c) of the Exchange Act, 15 U.S.C. 78s(c), permits the Commission, by rule, to abrogate, add to, or delete from the rules of an SRO as the Commission deems necessary or appropriate to insure the fair administration of the SRO, to conform its rules to requirements of the Exchange Act and the rules and regulations thereunder applicable, or otherwise in furtherance of the purposes of the Exchange Act.

Section 19(d)(2) of the Exchange Act, 15 U.S.C. 78s(d)(2), states that notice of any final disciplinary sanction, denial of membership or participation, or limitation of access to services to a person, member, or person associated with a member shall be subject to review by the appropriate regulatory agency for such member, participant, applicant, or other person. Section 3(a)(34)(E) of the Exchange Act, 15 U.S.C. 78c(a)(34)(E), states that when used with respect to a member of a national securities exchange or registered securities association, the appropriate regulatory authority is the Commission.

Section 17(a)(1) of the Exchange Act, 15 U.S.C. 78q(a)(1), states that exchanges and associations, among others, are required to make, keep and furnish any records, and make and disseminate any reports, that the Commission, by rule, prescribes as necessary or appropriate in the public interest, for the protection of investors, or otherwise in furtherance of the purposes of the Exchange Act.

Section 17(b) of the Exchange Act, 15 U.S.C. 78q(b), states that all records of a national securities exchange or registered securities association, among others, are subject at any time, or from time to time, to such reasonable periodic, special, or other examinations by representatives of the Commission, as the Commission deems necessary or appropriate in the public interest, for the protection of investors, or otherwise in furtherance of the purposes of the Exchange Act.

Section 19(h)(1) of the Exchange Act, 15 U.S.C. 78s(h)(1).

Id.

Section 19(h)(4) of the Exchange Act, 15 U.S.C. 78s(h)(4).

As part of its duties, an SRO must conduct surveillance of trading in its markets and examine the operations of its members. In addition, an exchange or association may not be registered with the Commission unless it is so organized and has the capacity to carry out the purposes of the Exchange Act and to comply with, and enforce its members' compliance with, the federal securities laws and rules thereunder, as well as its own rules.

An exchange or association also may not be registered unless the rules of the exchange or association, among other things: (1) Provide for a fair representation of its members on the board of directors;

(2) provide for an equitable allocation of

dues, fees, and charges among its members;

(3) are designed to prevent fraudulent and manipulative acts and practices;

(4) are designed to promote just and equitable principles of trade;

(5) are designed to perfect the mechanism of a free and open market and a national market system;

(6) protect investors and the public interest;

and (7) provide a process for disciplining its members.

Accordingly, the Exchange Act makes clear that SROs are charged with an important public trust to carry out their self-regulatory responsibilities effectively and fairly, while fostering free and open markets, protecting investors, and promoting the public trust.

Sections 6(b)(1) and 15A(b)(2) of the Exchange Act, 15 U.S.C. 78f(b)(1) and 78

-3(b)(2).

Sections 6(b)(3) and 15A(b)(4) of the Exchange Act, 15 U.S.C. 78f(b)(3) and 78

-3(b)(4).

Sections 6(b)(4) and 15A(b)(5) of the Exchange Act, 15 U.S.C. 78f(b)(4) and 78

-3(b)(5).

Sections 6(b)(5) and 15A(b)(6) of the Exchange Act, 15 U.S.C. 78f(b)(5) and 78

-3(b)(6).

Id.

Sections 6(b)(7) and 15A(b)(7) of the Exchange Act, 15 U.S.C. 78f(b)(7) and 78

-(b)(7).

See

Sections 6(b)(5) and 15A(b)(6) of the Exchange Act, 15 U.S.C. 78f(b)(5) and 78

-3(b)(6).

B. Overview of Recent Developments

Recent developments have prompted the Commission to review aspects of its oversight and regulation of national securities exchanges and registered securities associations and to consider whether changes are necessary to respond to those developments.

1. Governance Concerns

In the wake of corporate scandals that threatened investor confidence in the securities markets,

the governance of companies listed on securities exchanges and The Nasdaq Stock Market (“Nasdaq”) became the focus of attention.

After allegations of improprieties by several issuers and their executives, Congress enacted the Sarbanes-Oxley Act of 2002 (“Sarbanes-Oxley Act”)

to improve the accuracy and reliability of corporate disclosures and the effective oversight of the financial reporting process.

During this period, the New York Stock Exchange, Inc. (“NYSE”) and Nasdaq each undertook a review of its own corporate governance listing standards and proposed changes to strengthen those standards.

The new NYSE and Nasdaq corporate governance listing rules, which were approved by the Commission in November 2003, establish a more comprehensive definition of “independence” for directors and require the majority of members on listed companies' boards to satisfy the new independence standard.

In addition, the new NYSE and Nasdaq rules include a number of provisions that mandate and facilitate independent director oversight of functions relating to corporate governance, auditing, director nominations, and compensation.

See

e.g.

, John Waggoner and Thomas A. Fogarty,

Scandals Shred Investors' Faith: Because of Enron, Andersen, and Rising Gas Prices, the Public Is More Wary Than Ever of Corporate America

, USA Today, May 5, 2002, and Louis Aguilar,

Scandals Jolting Faith of Investors

, Denver Post, June 27, 2002.

Nasdaq is a facility of the National Association of Securities Dealers, Inc. (“NASD”). Pursuant to proposed Rule 15Aa-3(b)(11), which would define the term “facility” with regard to a registered securities association, Nasdaq would continue to be a facility of the NASD.

Sarbanes-Oxley Act of 2002, Pub. L. 107-204, 116 Stat. 745 (2002).

H.R. Conf. Rep. No. 610, 107th Cong., 2nd Sess. (2002).

See

Securities Exchange Act Release Nos. 47672 (April 11, 2003), 68 FR 19051 (April 17, 2003) (publishing for comment File No. SR-NYSE-2002-23); 48137 (July 8, 2003), 68 FR 42152 (July 16, 2003) (publishing for comment File No. SR-NASD-2002-80); 48123 (July 2, 2003), 68 FR 41191 (July 10, 2003) (publishing for comment File No. SR-NASD-2002-77); 48124 (July 2, 2003), 68 FR 41193 (July 10, 2003) (publishing for comment File No. SR-NASD-2002-138); 48125 (July 2, 2003), 68 FR 41194 (July 10, 2003) (publishing for comment File No. SR-NASD-2002-139); and 47516 (March 17, 2003), 68 FR 14451 (March 25, 2003) (publishing for comment File No. SR-NASD-2002-141).

See

Securities Exchange Act Release No. 48745 (November 4, 2003), 68 FR 64154 (November 12, 2003) (order approving File Nos. SR-NYSE-2002-33, SR-NASD-2002-77, SR-NASD-2002-80, SR-NASD-2002-138, SR-NASD-2002-139, and SR-NASD-2002-141).

See id.

In light of the governance changes proposed by the NYSE and Nasdaq for their listed issuers, in March 2003, the Commission's Chairman requested that the SROs review the adequacy of their own governance practices.

In his letter to each SRO, the Chairman noted that the SROs play a critical role in our securities markets as standard setters for listed companies, operators of trading markets, and front-line regulators of securities firms.

Further, the Chairman referred to the enhanced corporate governance listing standards proposed by the NYSE and Nasdaq as a high standard that the SROs should demand not only of listed issuers, but also of themselves.

See

Letters from William H. Donaldson, Chairman, Commission, to Salvatore F. Sodano, Chairman & CEO, American Stock Exchange LLC (“Amex”); Kenneth R. Leibler, Chairman & CEO, Boston Stock Exchange, Inc. (“BSE”); William J. Brodsky, Chairman & CEO, Chicago Board Options Exchange, Inc. (“CBOE”); David A. Herron, CEO, Chicago Stock Exchange, Inc. (“CHX”); David Colker, President & CEO, Cincinnati Stock Exchange, Inc. (“CSE”); David Krell, CEO, International Securities Exchange, Inc. (“ISE”); Philip D. DeFeo, Chairman & CEO, Pacific Exchange, Inc. (“PCX”); Meyer S. Frucher, Chairman & CEO, Philadelphia Stock Exchange, Inc. (“Phlx”); Robert R. Glauber, Chairman & CEO, NASD; Richard G. Ketchum, President & Deputy Chairman, Nasdaq; and Richard A. Grasso, Chairman & CEO, NYSE (March 26, 2003). Copies of these letters are available in the Commission's Public Reference Room under File No. S7-39-04.

See id.

Several months later, while the NYSE was reviewing its own governance practices, the media published reports of the proposed extension of the employment agreement of its then Chairman and Chief Executive Officer (“CEO”), as well as an anticipated substantial payout of his accrued compensation. In response, the Commission's Chairman sent a letter to the Chairman of the NYSE's Compensation and Human Resources Committee and Special Governance Committee requesting information regarding the compensation of the NYSE Chairman and CEO and the decision-making processes at the NYSE that led to the pay package.

Shortly thereafter, the Commission's Chairman sent letters to the other SROs requesting that they provide details about the extent of public representation on their boards and key committees (including the Compensation Committee); the decision-making processes with respect to the nomination of directors, their assignment to committees, and the compensation of executives; and the SROs' past practices and current plans for public disclosure of these processes and the compensation arrangements of key executives.

See

Letter from William H. Donaldson, Chairman, Commission, to The Honorable H. Carl McCall, Chairman, Human Resources and Compensation Committee, Chairman, Special Committee on Governance of the NYSE, NYSE, dated September 2, 2003. A copy of this letter is available in the Commission's Public Reference Room under File No. S7-39-04.

See

Letters from William H. Donaldson, Chairman, Commission, to Salvatore F. Sodano, Chairman & CEO, Amex; Kenneth R. Leibler, Chairman & CEO, BSE; William J. Brodsky, Chairman & CEO, CBOE; Robert; David A. Herron, CEO, CHX; David Colker, President & CEO, CSE; David Krell, President & CEO, ISE; Philip D. DeFeo, Chairman & CEO, PCX; Meyer S. Frucher, Chairman & CEO, Phlx; Robert R. Glauber, Chairman & CEO, NASD; and Robert Greifeld, President & CEO, Nasdaq (September 23, 2003). Copies of these letters are available in the Commission's Public Reference Room under File No. S7-39-04.

During this period, the NYSE announced the resignation of its Chairman and CEO and shortly thereafter named an interim Chairman. In November 2003, the NYSE filed with the Commission a proposal to amend the NYSE Constitution to implement a series of governance changes at the NYSE.

The proposal called for the

establishment of a new board of directors composed wholly of independent directors; an advisory board of executives that would be representative of the exchange's various constituencies; independent board committees with specific oversight authority for compensation, audit functions, the nominations process and regulatory matters; and an autonomous regulatory unit that would report directly to the regulatory oversight committee. The Commission approved the NYSE's governance revisions in December 2003.

See

Securities Exchange Act Release No. 48764 (November 7, 2003), 68 FR 64380 (November 13, 2003).

See

Securities Exchange Act Release No. 48946 (December 17, 2003), 68 FR 74678 (December 24, 2003).

2. Concerns Relating to Weaknesses of SRO Regulatory Programs

In addition to the enhanced focus on SRO governance, recent Commission enforcement actions involving SROs have highlighted weaknesses in the effectiveness of certain SRO regulatory programs. In September 2003, for example, the Commission settled an administrative enforcement action against the CHX for failure to enforce its trading rules.

The Commission's order, among other things, included findings that the CHX's surveillance program failed adequately to detect violations by its members of the firm quote rule,

trading ahead prohibitions,

and the limit order display rule

from 1998 through 2001. As part of the undertakings imposed by the settlement, the CHX was required, among other things, to create a regulatory oversight committee comprised almost exclusively of individuals with no material business relationship with the exchange.

In addition, the CHX was required to file with the Commission various certifications by its officials confirming its ongoing compliance with its statutory obligations.

See In the Matter of Chicago Stock Exchange,

Securities Exchange Act Release No. 48566 (September 30, 2003) (“CHX Order”).

See

CHX Article XX, Rule 7.01;

See also

infra note 230 (for a definition of “affiliate”).

111

15 U.S.C. 78f(b)(1) and 78

-3(b)(2).

See generally

Sections 6(b) and 15A(b) of the Exchange Act, 15 U.S.C. 78f(b) and 78

-3(b).

In addition to the general criteria of no material relationship, the proposed rules would identify certain specific circumstances when a director would not be considered independent.

112

A director would not be considered independent if any of the following circumstances existed:

112

See

proposed Rules 6a-5(b)(12) and 15Aa-3(b)(13).

• The director, or an immediate family member,

113

is, or within the past three years was, employed by or otherwise has or had a material relationship with the exchange or association or any affiliate of the exchange or association;

114

113

The term “immediate family member” would be defined in the proposed rules as a person's spouse, parents, children, and siblings, whether by blood, marriage, or adoption, or anyone residing in such person's house.

See

proposed Rules 6a-5(b)(11) and 15Aa-3(b)(12).

114

See

proposed Rules 6a-5(b)(12)(i) and 15Aa-3(b)(13)(i).

• The director is, or within the past three years was, a member or employed by or affiliated with a member or any affiliate of a member, or the director has an immediate family member that is, or within the past three years was, an executive officer of a member or any affiliate of a member;

115

See

proposed Rules 6a-5(b)(12)(ii) and 15Aa-3(b)(13)(ii).

• The director, or an immediate family member, has received during any twelve month period within the past three years more than $60,000 in payments from the exchange or association, any affiliate of the exchange or association or from a member or any affiliate of a member; however, payments received in the form of compensation

116

for board or board committee services, compensation to an immediate family member who is not an executive officer of the exchange or association, any affiliate of the exchange or association or of a member or any affiliate of a member, and pension and other forms of deferred compensation for prior services, not contingent on

continued service, would not disqualify a director as independent;

117

116

See

proposed Rules 6a-5(b)(6) and 15Aa-3(b)(7) for the definition of the term “compensation.”

117

See

proposed Rules 6a-5(b)(12)(iii) and 15Aa-3(b)(13)(iii). The Commission believes that compensation received as deferred compensation for prior service should not by itself exclude a director from being considered independent. However, the director would still need to satisfy the core definition of independence contained in the proposed rules.

• The director, or an immediate family member, is a partner in, or controlling

118

shareholder or executive officer of, any organization to which, or from which, the exchange or association or any affiliate of the exchange or association made or received payments for property or services in the current or any of the past three full fiscal years that exceed 2% of the recipient's consolidated gross revenues for that year, or $200,000, whichever is more, other than certain payments arising solely from investments in the securities of the exchange or association or any facility or affiliate of the exchange or association or payments under non-discretionary charitable contribution matching programs;

119

118

See

proposed Rules 6a-5(b)(7) and 15Aa-3(b)(8) for the definition of the term “control.”

119

See

proposed Rules 6a-5(b)(12)(iv) and 15Aa-3(b)(13)(iv).

• The director, or an immediate family member, is, or within the past three years was, an executive officer of an issuer of securities listed or primarily traded on the exchange or a facility of the exchange or association;

120

See

proposed Rules 6a-5(b)(12)(v) and 15Aa-3(b)(13)(v).

• The director, or an immediate family member, is, or within the past three years was, employed as an executive officer of another entity where any of the exchange's or association's executive officers serve on that entity's compensation committee;

121

See

proposed Rules 6a-5(b)(12)(vi) and 15Aa-3(b)(13)(vi).

• The director, or an immediate family member, is a current partner of the outside auditor of the exchange or association or any affiliate of the exchange or association, or was a partner or employee of the outside auditor of the exchange or association or any affiliate of the exchange or association who worked on the audit of the exchange or association or any affiliate of the exchange or association, at any time within the past three years;

122

See

proposed Rules 6a-5(b)(12)(vii) and 15Aa-3(b)(13)(vii).

• In the case of a director that is a member of the Audit Committee,

123

such director (other than in his or her capacity as a member of the Audit Committee, the board, or any other board committee), accepts, directly or indirectly, any consulting, advisory, or other compensatory fee from the exchange or association, any affiliate of the exchange or association, or a member or any affiliate of a member, other than fixed amounts of pension and other forms of deferred compensation for prior service, provided such compensation is not contingent in any way on continued service.

124

123

See infra

Section II.B.3. for a discussion of the Audit Committee.

124

See

proposed Rules 6a-5(b)(12)(viii) and 15Aa-3(b)(13)(viii). This requirement is commensurate with an independence requirement for non-investment company issuers contained in Rule 10A-3(b)(1)(ii) under the Exchange Act, 17 CFR 240.10A-3(b)(1)(ii), which pertains to listing standards relating to audit committees. The proposed requirement is designed to help assure that there are no fee arrangements between the exchange or association or any of its affiliates and the Audit Committee member that would impair the independence of the Audit Committee member.

The Commission believes that the proposed circumstances that would preclude a determination of a director's independence—in effect, concluding that a “material relationship” exists under certain circumstances—should better assure that a majority of an SRO's board is truly independent, and thus should promote the statutory requirement that SROs be so organized and have the capacity to carry out the Exchange Act's purposes.

125

The proposed circumstances that would preclude a director from being considered independent are similar to criteria that are contained in SRO listing standards, which recently were approved by the Commission and are designed to address similar governance concerns and the conflicts of interest that can arise between a company's management and its public shareholders.

126

For example, the three-year look-back provision

127

is a feature of NYSE, NASD, and Amex rules for listed issuers;

128

the $60,000 restriction on payments received and the 2%/$200,000 threshold for payments received or made for property or services

129

are similar to factors contained in NASD and Amex listing rules;

130

and the definition of “immediate family member

131

is substantially the same as the definition of the term “family member” in the NASD's listing rules.

132

The Commission further notes that because SROs are member organizations and operate markets with listing requirements, the proposed rules would take into account specific relationships between the director and a member or listed company that could challenge the impartiality of the director.

133

125

See

Sections 6(b)(1) and 15A(b)(2) of the Exchange Act, 15 U.S.C. 78f(b)(1) and 78o-3(b)(2).

126

See, e.g.

, Securities Exchange Act Release Nos. 48745,

supra

note 28 and 48863 (December 1, 2003), 68 FR 68432 (December 8, 2003) (order approving governance standards for issuers of securities listed on Amex).

127

See

proposed Rules 6a-5(b)(12)(i) through (vii) and 15Aa-3(b)(13)(i) through (vii).

128

See

NYSE

Listed Company Manual

Section 303A.02(b); NASD Rules 4350, 4200(a)(15), and IM-4200; and Amex

Company Guide,

Part I, Section 121A.

129

See

proposed Rules 6a-5(b)(12)(iii) and (iv) and 15Aa-3(b)(13)(iii) and (iv).

130

See

NASD Rules 4350, 4200(a)(15), and IM-4200 and Amex

Company Guide,

Part I, Section 121A.

131

See

proposed Rules 6a-5(b)(11) and 15Aa-3(b)(12).

132

See

NASD Rule 4200(a)(14).

133

For example, the proposed governance rules state that a director would not be considered independent in the circumstance where a director is, or within the past three years was, a member or employed by or affiliated with a member, or the director has an immediate family member that is, or within the past three years was, an executive officer of a member or any affiliate of a member. Similarly, a director would not be considered independent in the circumstance where a director, or an immediate family member, is or within the past three years was an executive officer of an issuer of securities listed or primarily traded on the exchange or a facility of the association.

See

proposed Rules 6a-5(b)(12)(ii) and (iv) and 15Aa-3(b)(13)(ii) and (iv).

In the Commission's view, the proposed relationship tests that would preclude a determination that a director is independent strike an appropriate balance and promote the goal of providing clear standards regarding the determination of independence.

134

The Commission believes that these criteria are indicative of whether directors can reach independent decisions that affect the SRO without competing pressures or conflicts of interest. For example, the fact that a director was an executive officer of a listed issuer more than three years prior to his or her nomination to the board is unlikely to have an influence on his or her decisions as a board member. On the other hand, a director's recent employment with a member does raise such concerns and would preclude a finding that he or she is independent. The Commission believes that these specific circumstances appropriately identify those relationships, such as recent employment, a business or financial relationship, or family ties, that are likely to impair the independence of a director. Further, there are practical reasons for relying on criteria that are similar to factors currently in place at the SROs for their listed issuers, as the SROs already are experienced in

interpreting and applying those standards. The Commission emphasizes that the absence of any of the proposed relationship tests, of course, would not necessarily result in a determination of independence, as the board must still affirmatively determine that the director has no material relationship with the SRO.

134

See, e.g.

, Higgs Report,

supra

note 91, at 37 and Richard C. Breeden,

Restoring Trust: Report on Corporate Governance for the Future of MCI, Inc.

(August 2002) (“Breeden Report”), at 61.

b. Independent Board Requirements. The proposed governance rules would require exchanges and associations to establish policies and procedures to require each director, on his or her own initiative and upon request of the exchange or association, to inform the exchange or association of the existence or establishment of any relationship or interest that may reasonably be considered to bear on whether such director is an independent director.

135

Exchanges and associations also would be required to establish procedures for interested persons to communicate their concerns relating to any matter within the authority or jurisdiction of a Standing Committee directly to the independent directors.

136

135

See

proposed Rules 6a-5(c)(3) and 15Aa-3(c)(3).

136

See

proposed Rules 6a-5(c)(9) and 15Aa-3(c)(9).

The proposed governance rules also would require that at least 20% of the total number of directors be selected by members.

137

In addition, the proposed governance rules would require that at least one director be representative of issuers and at least one director be representative of investors and, in each case, such director must not be associated with a member or broker or dealer.

138

The Commission believes that these provisions are consistent with the “fair representation” and “issuer and investor representation” requirements of the Exchange Act, which are discussed below.

139

137

See

proposed Rules 6a-5(c)(4) and 15Aa-3(c)(4).

See infra

Section II.B.2.c. for a discussion of the statutory “fair representation” requirement.

138

See

proposed Rules 6a-5(c)(5) and 15Aa-3(c)(5).

139

See infra

Section II.B.2.c.

Further, the proposed governance rules would require that when the board of an exchange or association considers any matter that is recommended by or otherwise is within the authority or jurisdiction of a Standing Committee, a majority of the directors who vote on the matter must be independent directors.

140

For example, assume an exchange has a board composed of nine independent directors and eight non-independent directors. If two independent directors do not participate in a board meeting but all the non-independent directors participate in such meeting, the matter could be voted upon only by the seven independent directors present and six of the eight non-independent directors present.

141

This proposal is intended to preserve and bolster the requirement that the majority of the board be independent, and is designed to assure that matters before the board that are within the authority or jurisdiction of the fully-independent Standing Committees are considered by and voted on by a majority of independent directors.

140

See

proposed Rules 6a-5(c)(6) and 15Aa-3(c)(6).

See infra

Section II.B.3. for a discussion of the Standing Committees of the board.

141

Each SRO with non-independent directors would have to establish procedures for determining which non-independent directors would vote under such circumstances, consistent with the “fair representation” requirements discussed below.

In addition, the proposed governance rules would require that if the exchange or association fails to comply with the requirement that the board be composed of a majority of independent directors because there is a vacancy on the board or a director ceases to be independent, the exchange or association must remedy such non-compliance by the earlier of the exchange's or association's next annual meeting or one year from the date of the occurrence of the event that caused the non-compliance.

142

This provision is consistent with the standard imposed on listed issuers and, in our view, should assure prompt remediation, yet provide exchanges and associations with a reasonable period of time, consistent with their governance procedures, to cure any failure to satisfy the majority independence requirement.

142

See

proposed Rules 6a-5(c)(8) and 15Aa-3(c)(8).

c. Fair Representation. Section 6(b)(3) of the Exchange Act requires that the rules of an exchange assure a fair representation of its members in the selection of its directors and administration of its affairs (“fair representation requirement”), and must provide that one or more directors be representative of issuers and investors and not be associated with a member of the exchange, broker or dealer (“issuer and investor representation requirements”).

143

Section 15A(b)(4) of the Exchange Act contains an identical requirement with respect to the rules of an association.

144

143

15 U.S.C. 78f(b)(3).

144

15 U.S.C. 78

-3(b)(4).

Consistent with the fair representation requirement, the proposed governance rules would require that the Nominating Committee

145

administer a fair process that provides members

146

with the opportunity to select at least 20% of the total number of directors (“member candidates”).

147

This requirement is not intended to prohibit exchanges and associations from having boards composed solely of independent directors. If an exchange's or association's board is composed wholly of independent directors, the candidate or candidates selected by members would have to be independent. This “20% standard” for member candidates comports with previously-approved SRO rule changes that raised the issue of fair representation.

148

The Commission preliminarily believes that the proposed 20% requirement strikes a proper balance by giving members a practical voice in the governance of the exchange or association and the administration of its affairs, without jeopardizing the overall independence of the board.

145

See infra

Section II.B.3. for a discussion of the fully-independent Nominating Committee.

146

See supra

note 109 for the definition of the term “member.”

147

See

proposed Rules 6a-5(f)(3) and 15Aa-3(f)(3).

148

See

Securities Exchange Act Release Nos. 48946,

supra

note 36 and 49718,

supra

note 61. The Commission notes that it previously has taken the position that the fair representation requirement could be satisfied if the exchange's or association's rules provided that members constitute at least 20% of the individuals serving on the Nominating Committee.

See, e.g.

, Securities Exchange Act Release Nos. 49098 and 49718,

supra

note 61. Because the proposed governance rules would mandate that the Nominating Committee consist solely of independent directors, an exchange or association no longer would have the option of satisfying the fair representation requirement by having at least 20% member representation on its Nominating Committee. Although the Commission previously approved SRO proposals that allowed members to constitute at least 20% of the exchange's or association's Nominating Committee, the Commission now believes that the governance of exchanges and associations would be strengthened by requiring a fully independent Nominating Committee.

An exchange or association would have some leeway in implementing the fair process for members to select board candidates. For example, the Commission believes that the exchange or association would have a fair process if it established an advisory panel of members that reports to the Nominating Committee, and that is directly responsible for nominating member candidates for the board. Another type of fair process would be for the member advisory panel to make recommendations to the Nominating Committee, with the Nominating Committee required to nominate the member candidates identified by the member advisory panel. The member candidates, of course, would be required to satisfy all relevant eligibility criteria for directors (including independence requirements, if applicable). The fair process must also ensure that the member candidates actually are provided seats on the board.

To further address the fair representation requirement, proposed Rules 6a-5(c)(7) and 15Aa-3(c)(7) would require exchanges and associations to adopt rules to establish a fair process for the nomination of alternative candidates by members through a petition process. This requirement would provide members with the means to nominate one or more alternative candidates representative of members. The percentage of members that is necessary to put forth such alternative member candidate or candidates would be required to be specified in the exchange's or association's rules, and could not exceed 10% of the total number of members.

149

The Commission believes that this 10% requirement strikes an appropriate balance in that it provides members a practical mechanism to put forth alternative candidates, without jeopardizing the overall integrity of the nominating process. The Nominating Committee would be required to administer the petition process established by the exchange's or association's rules.

150

149

See

proposed Rules 6a-5(c)(7) and 15Aa-3(c)(7). SROs currently have rules that permit members to engage in a petition process to nominate candidates. For example, pursuant to Phlx rules, members representing not less than 50 votes may, by written petition, independently nominate an individual for the position of on-floor governor, and members representing not less than 75 votes may propose an entire ticket, or any portion thereof, for on-floor governor positions which are vacant.

See

Phlx Bylaws, Article III, Section 3-7. A similar process is employed at the NYSE where members may propose by written petition potential nominees for positions to be filled at elections. Any such nominee must be endorsed by not less than 40 members, and not less than 100 members may petition for an entire ticket, or any portion thereof.

See

NYSE Constitution, Article III, Section 1.

150

See

proposed Rules 6a-5(f)(3) and 15Aa-3(f)(3).

To address the issuer and investor representation requirement, the Nominating Committee would be required to nominate at least one director who is representative of issuers and at least one director who is representative of investors and who, in each case, is not associated with a member or broker or dealer.

151

This provision simply would codify in Commission rules the requirements set forth in Sections 6(b)(3) and 15A(b)(4) of the Exchange Act.

152

151

See

proposed Rules 6a-5(f)(4) and 15Aa-3(f)(4). For example, the Nominating and Governance Committee of the NYSE currently is required to recommend to the board at least one individual who is representative of issuers and at least one individual who is representative of investors.

See

NYSE Constitution, Article IV, Sections 2 and 12.

152

15 U.S.C. 78f(b)(3) and 78

-3(b)(4).

The Commission notes that it recently approved the NYSE's proposal to establish a fully independent board, finding that such a board could be consistent with the Exchange Act and the fair representation and issuer and investor representation requirements.

153

As discussed above, the Commission only is proposing to require exchanges and associations to elect majority-independent boards, although an SRO may elect to impose a more rigorous requirement. The Commission believes that an exchange's or association's board could be wholly-independent based on the independence criteria contained in the proposed governance rules, provided that its rules satisfy the fair representation requirement and issuer and investor representation requirements (

i.e.

, by requiring that at least 20% of the independent directors are selected by members, that at least one independent director is representative of issuers, and at least one independent director is representative of investors).

153

See

Securities Exchange Act Release No. 48946,

supra

note 36.

3. Standing Committees

Recent developments have highlighted the critical role that board committees play in the governance of exchanges and associations and the importance of having key committees function independently of the pressures that otherwise could be exerted on them by management, members or other interested parties.

154

The Commission is proposing that each exchange and association, at a minimum, have the following standing committees, or their equivalent: Nominating Committee; Governance Committee; Compensation Committee; Audit Committee; and Regulatory Oversight Committee (collectively, “Standing Committees”).

155

The proposed governance rules also would require that each Standing Committee be composed solely of independent directors.

156

The Commission preliminarily believes that the functions to be performed by these committees are important to the effective administration of an exchange or association. Moreover, these are the committees that generally are charged with overseeing the SRO's regulatory responsibilities, including the SRO's commitment of financial resources to fund those responsibilities. Thus, the Commission believes that requiring all of the members of these Standing Committees to be independent would result in a greater degree of objective decision-making with respect to the exchange's or association's core responsibilities and would further the Exchange Act's goal that SROs be so organized and have the capacity to carry out their self-regulatory obligations.

157

154

See supra

Section I.B.

155

See

proposed Rules 6a-5(b)(21) and (e)(1) and 15Aa-3(b)(22) and (e)(1). An SRO would not be precluded from allowing a single committee to carry out the functions of two Standing Committees as long as the committee consisted solely of independent directors,

e.g.

, the functions of the Nominating Committee and the Governance Committee could be carried out by a single committee. Also, to the extent that a Standing Committee of the exchange or association carries out responsibilities on behalf of a regulatory subsidiary, the regulatory subsidiary would not be required to have a Standing Committee that performs the same functions.

See

proposed Rules 6a-5(a) and 15Aa-3(a).

156

See

proposed Rules 6a-5(f)(1), (g)(1), (h)(1), (i)(1), and (j)(1) and 15Aa-3(f)(1), (g)(1), (h)(1), (i)(1), and (j)(1). This provision is consistent with the recommendations in the Higgs Report, ABA Task Force Report and the Breeden Report.

See

Higgs Report,

supra

note 91, at 60-61; ABA Task Force Report,

supra

note 91, at 63-67; and Breeden Report,

supra

note 134, at 103.

157

See

Sections 6(b)(1) and 15A(b)(2) of the Exchange Act, 15 U.S.C. 78f(b)(1) and 78

-3(b)(2).

The proposed governance rules would require each Standing Committee to have the authority to direct and supervise inquiries into any matter brought to its attention within the scope of its duties and to obtain advice and assistance from independent legal counsel and other advisors as it determines necessary to carry out its duties.

158

In addition, each Standing Committee, other than the Governance Committee, would be required to conduct an annual performance self-evaluation.

159

Rather than conduct an annual self-evaluation of the committee's performance, the Governance Committee would be required to conduct an annual performance evaluation of the governance of the exchange or association as a whole, including the effectiveness of the board and its committees.

160

The Commission believes that these self-evaluations should assist the exchange or association in identifying strengths and deficiencies in the governance, administration, regulatory programs,

and financial matters of the exchange or association.

161

158

See

proposed Rules 6a-5(e)(2) and 15Aa-3(e)(2). The Business Roundtable Report noted that it may be appropriate for boards and committees to seek advice from outside advisors and that board and committee access to outside advisors is an important element of corporate governance.

See

Business Roundtable Report,

supra

note 91, at 27-28.

159

See

proposed Rules 6a-5(f)(5), (h)(3), (i)(3) and (j)(6) and 15Aa-3(f)(5), (h)(3), (i)(3) and (j)(6). The proposed rules would require each exchange and association to provide sufficient funding and other resources, as determined by each Standing Committee, to permit the Standing Committees to fulfill their responsibilities and to retain independent legal counsel and other advisors.

See

proposed Rules 6a-5(e)(3) and 15Aa-3(e)(3).

160

See

proposed Rules 6a-5(g)(3) and 15Aa-3(g)(3).

161

The ABA Task Force Report recommended periodic evaluations by the directors of the effectiveness and adequacy of meetings of the board and its committees.

See

ABA Task Force Report,

supra

note 91, at 72. The Business Roundtable Report similarly recommended that the “performance of the full board should be evaluated annually, as should the performance of its committees,” to allow the board to determine whether it and its committees were following the procedures necessary to function effectively.

See

Business Roundtable Report,

supra

note 91, at 28.

In order to function effectively, each Standing Committee would need to be clear as to its role. Accordingly, the proposed rules would require that each Standing Committee have a written charter that addresses such committee's purpose and responsibilities, which, at a minimum, must be as follows:

• Nominating Committee: to identify individuals qualified to become board members, consistent with criteria approved by the board and administer a process for the nomination of individuals to the board.

162

See

proposed Rules 6a-5(f)(2) and 15Aa-3(f)(2).

• Governance Committee: to develop and recommend to the board a set of governance principles applicable to the exchange or association and to oversee the evaluation of the board and management.

163

See

proposed Rules 6a-5(g)(2) and 15Aa-3(g)(2).

• Compensation Committee: to have direct responsibility to review and approve corporate goals and objectives relevant to the compensation of the executive officers of the exchange or association; evaluate the performance of the executive officers in light of those goals and objectives; and consider and approve recommendations with respect to the compensation level of the executive officers, based on this evaluation.

164

See

proposed Rules 6a-5(h)(2) and 15Aa-3(h)(2).

• Audit Committee: to assist the board in oversight of the integrity of the exchange's or association's financial statements; the exchange's or association's compliance with related legal and regulatory requirements; the qualifications and independence of the exchange's or association's auditor, including direct responsibility for the hiring, firing, and compensation of the auditor, overseeing the auditor's engagement, meeting regularly in executive session with the auditor, reviewing the auditor's reports with respect to the exchange's or association's internal controls, and pre-approving all audit and non-audit services performed by the auditor; determining the budget and staffing of the exchange's or association's internal audit department; and establishing procedures for the receipt of complaints regarding accounting, internal accounting controls, or auditing matters of the exchange or association and the confidential submission by employees of the exchange or association of concerns regarding questionable accounting or auditing matters.

165

See

proposed Rules 6a-5(i)(2) and 15Aa-3(i)(2). The complaint procedures for the Audit Committee are commensurate with the complaint procedures contained in Rule 10A-3(b)(3) under the Exchange Act, 17 CFR 240.10A-3(b)(3), which pertain to audit committees of listed issuers.

• Regulatory Oversight Committee: to assure the adequacy and effectiveness of the exchange's or association's regulatory program; assess the exchange's or association's regulatory performance; determine the regulatory plan, programs, budget, and staffing for the regulatory functions of the exchange or association; assess the performance of, and recommend compensation and personnel actions involving, the Chief Regulatory Officer

166

and other senior regulatory personnel

167

to the Compensation Committee; monitor and review regularly with the Chief Regulatory Officer matters relating to the exchange's or association's surveillance, examination, and enforcement units; assure that the exchange's or association's disciplinary and arbitration proceedings are conducted in accordance with the exchange's or association's rules and policies and any other applicable laws or rules, including those of the Commission; prior to the exchange's or association's approval of an affiliated security

168

for listing, certify that such security meets the exchange's or association's rules for listing; and approve any reports filed with the Commission as required by proposed Regulation AL (§ 242.800).

169

166

See

proposed Rules 6a-5(n)(3) and 15Aa-3(n)(3), which would require exchanges and associations to appoint a Chief Regulatory Officer.