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

Federal RegisterMar 19, 2024

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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.

SUMMARY:

The Commodity Futures Trading Commission (“Commission” or “CFTC”) is proposing new rules and amendments to its existing regulations for designated contract markets (“DCMs”) and swap execution facilities (“SEFs”) that would establish governance and fitness requirements with respect to market regulation functions, as well as related conflict of interest standards. The proposed new rules and amendments include minimum fitness standards, requirements for identifying, managing, and resolving conflicts of interest, and structural governance requirements to ensure that SEF and DCM governing bodies adequately incorporate an independent perspective. The proposal also address requirements relating to the following: composition requirements for board of directors and disciplinary panels; limitations on the use and disclosure by employees and certain others of material non-public information; requirements relating to Chief Regulatory Officers, Chief Compliance Officers, and Regulatory Oversight Committees; and notification of certain changes in the ownership or corporate or organizational structure of a SEF or DCM.

DATES:

Comments must be received on or before April 22, 2024.

ADDRESSES:

You may submit comments, identified by “Requirements for Designated Contract Markets and Swap Execution Facilities Regarding Governance and the Mitigation of Conflicts of Interest” and RIN 3038-AF29, by any of the following methods:

•

CFTC Comments Portal: https://comments.cftc.gov

. Select the “Submit Comments” link for this rulemaking and follow the instructions on the Public Comment Form.

•

Mail:

Send to Christopher Kirkpatrick, Secretary of the Commission, Commodity Futures Trading Commission, Three Lafayette Centre, 1155 21st Street NW, Washington, DC 20581.

•

Hand Delivery/Courier:

Follow the same instructions as for Mail, above.

Please submit your comments using only one of these methods. Submissions through the CFTC Comments Portal are encouraged.

All comments must be submitted in English, or if not, accompanied by an English translation. Comments will be posted as received to

https://comments.cftc.gov

. You should submit only information that you wish to make available publicly. If you wish the Commission to consider information that you believe is exempt from disclosure under the Freedom of Information Act (“FOIA”), a petition for confidential treatment of the exempt information may be submitted according to the procedures established in § 145.9 of the Commission's regulations.

17 CFR 145.9.

The Commission reserves the right, but shall have no obligation, to review, pre-screen, filter, redact, refuse, or remove any or all of your submission from

https://www.comments.cftc.gov

that it may deem to be inappropriate for publication, such as obscene language. All submissions that have been redacted or removed that contain comments on the merits of the rulemaking will be retained in the public comment file and will be considered as required under the Administrative Procedure Act and other applicable laws, and may be accessible under FOIA.

FOR FURTHER INFORMATION CONTACT:

Rachel Berdansky, Deputy Director,

rberdansky@cftc.gov,

202-418-5429; Swati Shah, Associate Director,

sshah@cftc.gov,

202-418-5042; Marilee Dahlman, Special Counsel,

mdahlman@cftc.gov,

202-418-5264; Jennifer L. Tveiten-Rifman, Special Counsel,

jtveitenrifman@cftc.gov,

312-802-3848; Lillian Cardona,

lcardona@cftc.gov,

Assistant Chief Counsel, 202-418-5012.

SUPPLEMENTARY INFORMATION:

Table of Contents

I. Introduction

II. Background

a. Statutory Requirements for SEFs and DCMs

b. Proposed and Final Rules Addressing SEF and DCM Governance and Conflicts of Interest

1. 2001 Regulatory Framework

2. 2007 Final Release, Conflicts of Interest Acceptable Practices for DCMs

3. 2009 Final Release, Definition of Public Director

4. 2010 Conflicts of Interest Rule Proposal

5. 2011 Governance and Conflicts of Interest NPRM

6. 2012 Part 38 Final Rule

7. 2013 Part 37 Final Rule

8. 2021 Part 37 Amendments—CCO Duties and Annual Compliance Report

c. Industry Changes and Impact on Regulatory Developments

d. Conflicts of Interest Relating to Market Regulation Functions

1. Market Regulation Functions

2. Questions for Comment

3. Conflicts of Interest Between Market Regulation Functions and Commercial Interests

III. Proposed Governance Fitness Requirements

a. Overview

b. Minimum Fitness Standards—Proposed §§ 37.207 and 38.801

1. Existing Regulatory Framework

2. Proposed Rules

3. Questions for Comment

IV. Proposed Substantive Requirements for Identifying, Managing and Resolving Actual and Potential Conflicts of Interest

a. General Requirements for Conflicts of Interest and Definitions—Proposed §§ 37.1201 and 38.851

1. Existing Regulatory Framework and Definitions

2. Proposed Rules

b. Conflicts of Interest in Decision-Making—Proposed §§ 37.1202 and 38.852

1. Background

2. Existing Regulatory Framework

3. Proposed Rules

4. Questions for Comment

c. Limitations on the Use and Disclosure of Material Non-Public Information—Proposed §§ 37.1203 and 38.853

1. Background

2. Existing Regulatory Framework

3. Proposed Rules

4. Questions for Comment

V. Proposed Structural Governance Requirements for Identifying, Managing and Resolving Actual and Potential Conflicts of Interest

a. Composition and Related Requirements for Board of Directors—Proposed §§ 37.1204 and 38.854

1. Background

2. Existing Regulatory Framework

3. Proposed Rules

4. Questions for Comment

b. Public Director Definition—Proposed §§ 37.1201(b)(12) and 38.851(b)(12)

1. Background

2. Existing Regulatory Framework

3. Proposed Rules

4. Questions for Comment

c. Nominating Committee and Diverse Representation—Proposed §§ 37.1205 and 38.855

1. Background

2. Existing Regulatory Framework

3. Proposed Rules

4. Questions for Comment

d. Regulatory Oversight Committee—Proposed §§ 37.1206 and 38.857

1. Background

2. Existing Regulatory Framework

3. Proposed Rules

4. Questions for Comment

e. Disciplinary Panel Composition—Proposed §§ 37.1207 and 38.858

1. Background

2. Existing Regulatory Framework

3. Proposed Rules

4. Questions for Comment

f. DCM Chief Regulatory Officer—Proposed § 38.856

1. Background

2. Existing Regulatory Framework

3. Proposed Rules

4. Questions for Comment

g. Staffing and Investigations—Proposed Changes to §§ 38.155, 38.158, and 37.203

1. Background

2. Existing Regulatory Framework

3. Proposed Rules

4. Questions for Comment

h. SEF Chief Compliance Officer—Proposed Changes to § 37.1501

1. Background

2. Existing Regulatory Framework

3. Proposed Rules

4. Questions for Comment

VI. Conforming Changes

a. Commission Regulations §§ 37.2, 38.2, and Part 1

b. Transfer of Equity Interest—Commission Regulations §§ 37.5(c) and 38.5(c)

1. Background

2. Existing Regulatory Framework

3. Proposed Rules

4. Questions for Comment

VII. Effective and Compliance Dates

VIII. Related Matters

a. Cost-Benefit Considerations

1. Introduction

2. Baseline

3. Proposed Rules

4. Question for Comment

b. Regulatory Flexibility Act

c. Paperwork Reduction Act

d. Antitrust Considerations

IX. Proposed Rule Text

I. Introduction

The Commission proposes to establish governance fitness regulations related to market regulation functions,

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.

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,

while SEFs do not have parallel core principle requirements. Additionally, SEFs and DCMs currently have different regulatory obligations with respect to governance fitness standards.

Further, while both SEFs and DCMs are subject to equity transfer requirements,

the applicable regulatory provisions currently have different notification thresholds and obligations.

As discussed further below, the Commission is proposing to define “market regulation functions” to include the SEF functions required by SEF Core Principles 2 (Compliance with Rules), 4 (Monitoring of Trading and Trade Processing), and 6 (Position Limits or Accountability), the DCM functions required by DCM Core Principles 2 (Compliance with Rules), 4 (Prevention of Market Disruption), 5 (Position Limitations or Accountability), 10 (Trade Information), 12 (Protection of Markets and Market Participants), and 13 (Disciplinary Procedures), and regulations thereunder. These responsibilities include, but are not limited to, the responsibilities of SEFs and DCMs to conduct trade practice surveillance, market surveillance, real-time market monitoring, audit trail enforcement, investigations of possible SEF or DCM rule violations, and disciplinary actions.

See

proposed §§ 37.1201(b)(9) and 38.851(b)(9).

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).

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.

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.

Commission regulation § 37.5(c) (SEFs) and Commission regulation § 38.5(c) (DCMs).

In this proposal, the Commission is drawing on staff experience in conducting its routine oversight of SEF and DCM “market regulation functions,” which include responsibilities related to trade practice surveillance, market surveillance, real-time market monitoring, audit trail data and recordkeeping enforcement, investigations of possible SEF or DCM rule violations, and disciplinary actions. Commission staff conducts oversight of these market regulation functions in a number of ways, including rule enforcement reviews,

SEF regulatory consultations and registration application reviews, DCM designation application reviews, and regular engagement with SEFs and DCMs.

See

Rule Enforcement Reviews of Designated Contract Markets,

https://www.cftc.gov/IndustryOversight/TradingOrganizations/DCMs/dcmruleenf.html.

As explained below, this proposal is not addressing SEF and DCM obligations relating to core principles that specifically address the financial integrity of transactions under SEF Core Principle 7 and DCM Core Principle 11.

Through its oversight, Commission staff has identified areas where it preliminarily believes that SEF and DCM regulations should be enacted, in lieu of existing guidance and acceptable practices, to further support the statutory objective of ensuring that conflicts of interest are appropriately mitigated. The Commission is proposing enhanced substantive requirements for identifying, managing, and resolving conflicts of interest related to a SEF's or DCM's market regulation functions, and structural governance requirements to ensure that SEF and DCM governing bodies adequately incorporate an independent perspective. The Commission is also proposing additional amendments to address governance standards as they relate to the performance of the market regulation function. The Commission is further proposing enhanced notification requirements with respect to changes in the ownership or corporate or organizational structure of a SEF or DCM.

More specifically, the Commission proposes: (1) new rules to implement DCM Core Principle 15 (Governance Fitness Standards) that are consistent with the existing guidance on compliance with DCM Core Principle 15;

(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;

(3) new rules to implement SEF Core Principle 2 (Compliance With Rules) that are consistent with the DCM Core Principle 15 Guidance;

(4) new rules to implement SEF Core Principle 12 (Conflicts of Interest) that are consistent with the DCM Core Principle 16 Guidance and Acceptable Practices; (5) new rules under part 37 of the Commission's regulations for SEFs and part 38 of the Commission's regulations for DCMs that are consistent with existing conflicts of interest and governance requirements under Commission regulations §§ 1.59 and 1.63;

(6) new rules for DCM Chief Regulatory Officers (“CROs”); (7) amendments to certain requirements relating to SEF Chief Compliance Officers (“CCOs”); and (8) new rules for SEFs and DCMs relating to the establishment and operation of a Regulatory Oversight Committee (“ROC”). The Commission also is proposing to remove the guidance on

compliance with DCM Core Principle 15, as well as the guidance on, and acceptable practices in, compliance with DCM Core Principle 16.

Part 38, Appendix B, Core Principle 15 Guidance.

Part 38, Appendix B, Core Principle 16 Acceptable Practices.

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.

The Commission is also proposing conforming amendments to remove SEFs and DCMs from the scope of these part 1 requirements.

See

Section V(a) herein.

The Commission also proposes amendments to existing rules in part 37 and part 38 of its regulations regarding the notification of a transfer of equity interest in a SEF or DCM. The proposal would harmonize and enhance the rules for SEFs and DCMs, and would also harmonize these SEF and DCM rules with the corollary rules for derivatives clearing organizations (“DCOs”) under part 39 of the Commission's regulations.

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.

See, e.g.,

part 39 of the Commission's regulations, adopted pursuant to Derivatives Clearing Organization General Provisions and Core Principles, 76 FR 39333 (Nov. 8, 2011).

Finally, the Commission is proposing certain technical and conforming changes to SEF and DCM rules relating to disciplinary panels, staffing, and investigations.

See

Section V(e)-(g) herein.

In developing the rules proposed in this NPRM, the Commission has consulted with the Securities and Exchange Commission (“SEC”), pursuant to section 712(a)(1) of the Dodd-Frank Act.

15 U.S.C. 8302 (Providing that before commencing any rulemaking or issuing an order regarding swaps, swap dealers, major swap participants, swap data repositories, derivative clearing organizations with regard to swaps, persons associated with a swap dealer or major swap participant, eligible contract participants, or swap execution facilities pursuant to the applicable subtitle, the CFTC must consult and coordinate to the extent possible with the SEC and the prudential regulators for the purposes of assuring regulatory consistency and comparability, to the extent possible).

II. Background

a. Statutory Requirements for SEFs and DCMs

Section 5h

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.

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.

7 U.S.C. 7b-3.

7 U.S.C. 7b-3(f).

Similarly, Section 5 of the CEA sets forth requirements for DCMs. CEA section 5(d)(1)(A) requires that to be designated, and to maintain designation, by the Commission, a DCM must comply with (1) 23 core principles, and (2) any requirement that the Commission may impose by rule or regulation pursuant to section 8a(5) of the CEA.

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.

As of January 2024, there were 17 registered DCMs.

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.

CEA section 5(d)(1)(B), 7 U.S.C. 7(d)(1)(B).

Both SEFs and DCMs are subject to a respective core principle addressing conflicts of interest. Pursuant to SEF Core Principle 12 and DCM Core Principle 16, both SEFs and DCMs must establish and enforce rules to minimize conflicts of interest in their decision-making processes, and must establish a process for resolving such conflicts.

CEA sections 5(d)(16), 5h(f)(12). DCM Core Principle 16 and SEF Core Principle 12 are substantively identical in the statute.

SEFs are also subject to a Chief Compliance Officer core principle. SEF Core Principle 15 requires SEFs to designate an individual to serve as a CCO, sets forth CCO duties,

including a duty to resolve conflicts of interest,

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.

There is no equivalent statutory core principle for DCMs.

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).

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).

CEA section 5h(f)(15)(D), 7 U.S.C. 7b-3(f)(15)(D).

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.

DCMs are additionally subject to three core principles addressing governance.

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.”

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.

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.

Related governance requirements for SEFs exist in part 1 of the Commission's regulations. Commission regulation § 1.69(b) requires SEFs to adopt rules requiring any member of the board of directors, disciplinary committee or oversight panel to abstain from deliberating and voting on any matter involving a conflict of interest. Commission regulation § 1.69 applies to “self-regulatory organizations” (“SRO”), as defined in Commission regulation § 1.3, which includes SEFs and DCMs. However, pursuant to Commission regulation § 38.2, DCMs are exempt from the requirements of Commission regulation § 1.69.

Commission regulation § 38.900, DCM Core Principle 17, Composition of Governing Boards of Contract Markets.

This proposal is not addressing the requirements identified in DCM Core Principles 17 and 22.

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

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.

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.

A New Regulatory Framework for Trading Facilities, Intermediaries and Clearing Organizations, 66 FR 42256 (Aug. 10, 2001) (“2001 Regulatory Framework”).

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)

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).

DCM Core Principle 15 (Conflicts of Interest)

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.

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).

See

CFMA section 110, codified at CEA section 5(d)(14).

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).

See

CFMA section 110, codified at CEA section 5(d)(15).

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.

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.

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.

Part 38, Appendix B, sec 1.

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.

Additionally, the guidance states that persons who have governing obligations or responsibilities, or who exercise disciplinary authority, should not have a significant history of serious disciplinary offenses, such as those that would be disqualifying under Commission regulation § 1.63.

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.

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.

See

2001 Regulatory Framework, 66 FR 42256 at 42283.

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.”

2001 Regulatory Framework, 66 FR 42256 at 42283.

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.

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.

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 § 38.2, which exempted “agreements, contracts, or transactions” traded on a DCM, as well as the “contract market” itself, and the “contract market's operator” from all Commission regulations for such activity, except for the requirements of part 38 and §§thnsp;1.3, 1.12(e), 1.31, 1.38, 1.52, 1.59(d), 1.63(c), 1.67, 33.10, part 9, parts 15 through 21, part 40, and part 190.

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.

See

2001 Regulatory Framework, 66 FR 42256 at 42277.

See also

2009 Final Release, 74 FR 18982 (which defined “public director”); 2007 Final Release, 72 FR 6936 (Feb. 14, 2007) (which adopted final acceptable practices for the DCM core principle on conflicts of interest); 71 FR 38740 (July 7, 2006) (which proposed acceptable practices for such DCM core principle).

• a board of directors with at least 35 percent, but no less than two, public directors;

• a nominating committee with at least 51 percent public directors, and with a public director as chair;

• one or more disciplinary panels, with a public participant as chair;

• a ROC with all public directors; and

• a membership or participation committee, with 35 percent public directors.

The Commission also proposed, as rules, certain limitations with respect to the ownership of voting equity in the SEF or DCM and the exercise of voting rights. These proposals limited SEF participants or DCM members (and related persons) to: (1) beneficially

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.

The proposal was withdrawn on the Fall 2020 Unified Agenda and Regulatory Plan. The withdrawal entry is available at:

https://www.reginfo.gov/public/do/eAgendaViewRule?pubId=202010&RIN=3038-AD37

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.

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.

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

and the composition of governing bodies,

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.

The Commission never adopted the 2011 Governance and Conflicts of Interest NPRM as final rules.

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).

Id.

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.

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.

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.

The proposal was withdrawn on the Fall 2019 Unified Agenda and Regulatory Plan. The withdrawal entry that appeared in the Fall 2019 Agenda is available at:

https://www.reginfo.gov/public/do/eAgendaViewRule?pubId=201910&RIN=3038-AD36

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.

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”).

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.

See

CEA section 5(d)(1)(B) (emphasis added).

Core Principles and Other Requirements for Designated Contract Markets, 77 FR 36612 (June 19, 2012) (the “2012 Part 38 Final Rule”).

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

on compliance with the DCM core principle on governance fitness standards, and to maintain the existing guidance on,

and acceptable practices in, compliance with the DCM conflicts of interest core principle.

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 § 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.

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.

See

section II(b)(1) herein for a description of the guidance adopted in 2001 relating to governance fitness standards.

See

section II(b)(1) herein for a description of the guidance adopted in 2001 relating to conflicts of interest.

2012 Part 38 Final Rule, 77 FR 36612 at 36655-56. The Commission added Commission regulation § 38.851 to permit DCMs to continue to rely on the conflicts of interest guidance in Appendix B to part 38. See section II(b)(2)-(3) herein for a description of acceptable practices adopted in 2007 and 2009 relating to conflicts of interest.

2012 Part 38 Final Rule, 77 FR 36612 at 36628.

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 § 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.

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.

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.

See

Commission regulation § 38.5(c).

See id.

2012 Part 38 Final Rule, 77 FR 36612 at 36619.

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

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

See

Commission regulation § 38.5(a).

The Commission notes that in the 2012 Part 38 Final Rule, pursuant to § 38.5(d), the Commission delegated “the authority set forth in paragraph (b) of this section” (demonstration of compliance) to the Director of the Division of Market Oversight.

This differs from the corresponding regulation for SEFs.

Existing Commission regulation § 37.5(d) provides that the Commission delegates “the authority set forth in this section” to the Director of the Division of Market Oversight, which is a broader delegation compared to the Part 38 regulation. In particular, the delegation provision in § 37.5(d) includes the authority to request information pursuant to both regulations §§ 37.5(a) (requests for information) and (b) (demonstration of compliance).

The delegation provision in § 38.5(d) does not apply to § 38.5(a) (requests for information).

See

Commission regulation § 38.5(d).

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.

See

Commission regulation § 37.5(d).

Finally, in the 2012 Part 38 Final Rule, the Commission adopted a revised version of § 38.2 that specified “the Commission regulations from which DCMs will be exempt” as opposed to listing the regulations that DCMs were obligated to comply with.

The Commission made this change to add clarity and to eliminate the need for the Commission to continually update § 38.2 when new regulations with which DCMs must comply are codified.

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:

See

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

Id.

• Commission regulation § 1.59, which addresses limitations on the use and disclosure of non-public information;

Commission regulation § 38.2 exempts DCMs from Commission regulation § 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 § 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 §§ 1.59(a) (definitions) and 1.59(d) (prohibiting self-regulatory organization employees, governing board members, committee members, and consultants from trading on or disclosing material non-public information).

• Commission regulation § 1.63, which restricts persons with certain disciplinary histories from serving on governing boards or committees;

Commission regulation § 38.2 exempts DCMs from all paragraphs of Commission regulation § 1.63 except for Commission regulation § 1.63(c), which states that no person may serve on a disciplinary committee, arbitration panel, oversight panel or governing board of a self-regulatory organization if such person is subject to any of the conditions listed in Commission regulation § 1.63(b)(1) through (6), which lists certain disqualifying offenses, suspensions, settlements, revocations, bars, and denials.

• Commission regulation § 1.64, which addresses composition of governing boards and disciplinary committees;

and

Commission regulation § 38.2 exempts DCMs from the entirety of Commission regulation § 1.64.

• Commission regulation § 1.69, which addresses voting by conflicted members of governing boards and committees.

Commission regulation § 38.2 exempts DCMs from the entirely of Commission regulation § 1.69.

In exempting DCMs from the provisions listed above, the Commission noted that Commission regulation § 38.2 will likely be amended if and when the referenced rules are eliminated from the regulations or modified.

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.

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 § 37.100.

See

Core Principles and Other Requirements for Swap Execution Facilities, 78 FR 33476 (June 4, 2013) (the “Part 37 Final Rule”).

Id.

at 33538.

As discussed above, the Commission never adopted the Mitigation of Conflicts of Interest NPRM as final rules.

Pursuant to Commission regulation § 37.2, adopted in the Part 37 Final Rule, SEFs are subject, in their entirety, to Commission regulations §§ 1.59, 1.63, 1.64 and 1.69 which, as discussed above, address conflicts of interest and governance for self-regulatory organizations. Therefore, SEFs are currently subject to a different set of conflicts of interest and governance requirements than DCMs.

In the Part 37 Final Rule, the Commission adopted rules to implement the Chief Compliance Officer core principle for SEFs that, among other things, addressed the CCO's duties and the annual compliance report requirement, provided that the CCO's duties include supervising the SEF's self-regulatory program with respect to, among other regulatory responsibilities, trade practice surveillance, market surveillance, real-time market monitoring, compliance with audit trail requirements, enforcement and disciplinary proceedings, audits, and examinations.

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

regulatory service provider.

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.

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.

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 § 37.204.

Id.

at 33594. Commission regulation § 37.204(a) permits a SEF to utilize another registered entity, a registered futures association, and, in the case of SEFs, the Financial Industry Regulatory Authority, for the provision of services to assist in complying with the CEA and Commission regulations. Commission regulation § 37.204(b) provides that a SEF that chooses to use a regulatory service provider shall retain sufficient staff to supervise the regulatory services, that SEF compliance staff shall hold regular meetings with the regulatory service provider to discuss matters of regulatory concern, and that the SEF must conduct periodic reviews of the services provided. Further, Commission regulation § 37.204(b) requires that the SEF carefully document such periodic reviews and provide them to the Commission upon request. Commission regulation § 37.204(c) states that a SEF that chooses to use a regulatory service provider shall retain exclusive authority in all substantive decisions made by the regulatory service provider, and that the SEF must document any instances where its actions differ from those recommended by the regulatory service provider.

See

Commission regulation § 37.1501(e)(1).

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 § 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.

This is a higher percentage than the 10 percent or more percentage that applies with respect to DCM equity interest transfers, and is therefore effectively a lower notification standard. Second, Commission regulation § 37.5(c) specifically authorizes the Commission, upon receipt of notification from a SEF of an equity interest transfer, to request supporting documentation regarding the transaction; this authority also is delegated to the Director of the Division of Market Oversight or such other employee(s) as the Director may designate from time to time. Finally, upon an equity interest transfer, SEFs are affirmatively required to certify to the Commission, no later than two business days after the transfer takes place, that the SEF meets all of the requirements of section 5h of the CEA (which includes the statutory SEF core principles) and the Commission's regulations thereunder.

There is currently no analogous certification requirement that applies to a DCM under Commission regulation § 38.5(c).

See

Commission regulation § 37.5(c).

See

Commission regulation § 37.5(c)(4).

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 § 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).

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”).

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.

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.”

Swap Execution Facilities, 86 FR 9224 (Feb. 11, 2021) (the “Part 37 Updates”).

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;

(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

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 § 37.1206 in this proposed rulemaking, the Commission now seeks to establish explicit requirements for a SEF ROC.

101

See

Commission regulation § 37.1500(b)(1).

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

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,

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.

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.

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,

https://www.cftc.gov/sites/default/files/opa/press00/opa4407-00.htm

110

See

Commission Release #4427-00,

https://www.cftc.gov/sites/default/files/opa/press00/opa4427-00.htm

111

See

Commission Release #4434-00,

https://www.cftc.gov/sites/default/files/opa/press00/opa4434-00.htm

112

The process continued through 2020, when MGEX went through demutualization.

https://www.cftc.gov/sites/default/files/filings/documents/2020/orgdcmmgexordertransfer201124.pdf

;

https://www.mgex.com/documents/MIAX_MGEX_SeatVote_PressRelease_000.pdf

113

On July 7, 2006, the Commission proposed the acceptable practices that it finalized in the 2007 Final Release. Conflicts of Interest in Self-Regulation and Self-Regulatory Organizations, 71 FR 38739 (July 7, 2006). In that proposal, the Commission acknowledged that the U.S. futures industry was being transformed by, among other things, the demutualization of member-owned exchanges and their conversion to publicly traded stock corporations.

Id.

at 38740-38741. The Commission noted that the acceptable practices would, among other things, ensure that industry expertise, experience, and knowledge continue to play a vital role in self-regulatory organization governance and administration and thus, preserve the “self” in self-regulation.

Id.

at 38741-38742. In the 2007 Final Release, the Commission reiterated that the acceptable practices were being adopted in response to, among other things, demutualization. The Commission observed that it did identify industry changes that it believed create new structural conflicts of interest within self-regulation, increase the risk of customer harm, could lead to an abuse of self-regulatory authority, and threaten the integrity of, and public confidence in, self-regulation in the U.S. futures industry. The Commission further noted that increased competition, demutualization and other new ownership structures, for-profit business models, and other factors are highly relevant to the impartiality, vigor, and effectiveness with which DCMs exercise their self-regulatory responsibilities. 2007 Final Release, 72 FR 6936 at 6944.

114

Through its acceptable practices, the Commission provides exchanges with specific practices that DCMs may adopt to demonstrate a safe harbor for compliance with selected requirements aspects of a core principle, but such acceptable practices were not intended as the exclusive means of compliance.

See

CEA section 5c(a)(1), 7 U.S.C. 7a-2(a)(1).

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

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 § 38.152 requires DCMs that allow intermediation to prohibit customer-related abuses such as trading ahead of customer orders, trading against customer orders, accommodation trading, and improper cross trading. Commission regulation § 37.203 imposes a similar requirement on SEFs.

116

In contrast to situations in which a DCM and DCO are in the same corporate family—which the Commission has observed over the past two decades—a SEF or DCM being in the same corporate family as an intermediary registrant raises unique issues. Rena S. Miller, Congressional Research Service, Conflicts of Interest in Derivatives Clearing (2011),

https://crsreports.congress.gov/product/pdf/R/R41715/4

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.

https://www.cftc.gov/PressRoom/PressReleases/8734-23

118

The Commission received a number of comments raising concerns about the impact of affiliation, and anticipates proposing regulations that will address issues identified as a result of the RFC, including additional concerns raised by commenters about the conflicts of interest, specifically relating to market regulation functions, posed by affiliations. This rulemaking does not reflect the comments submitted in response to the Commission staff's RFC. Those comments will not be made part of the administrative record before the Commission in connection with this proposal.

119

Staff Advisory on Affiliations Among CFTC-Regulated Entities, CFTC Release 8839-23, Dec. 18, 2023.

https://www.cftc.gov/PressRoom/PressReleases/8839-23.

In addition to the increased focus on affiliate relationships, another market structure development relates to the participation of intermediaries on SEF and DCM markets. With limited exceptions, derivatives trading today is conducted through regulated intermediaries who perform many important functions, such as providing customers with access to exchanges and clearinghouses, processing transactions, ensuring compliance with federal regulations, and guaranteeing performance of the derivatives contract to the clearinghouse. Recently, the Commission has observed a trend in which registered entities pursue a “non-intermediated” model, or direct trading and clearing of margined products to retail customers.

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 §§ 38.851(b)(9) and 37.1201(b)(9).

Proposed § 37.1201(b)(9) defines “market regulation functions” as the SEF functions required by SEF Core Principle 2 (Compliance with Rules), SEF Core Principle 4 (Monitoring of Trading and Trade Processing), SEF Core Principle 6 (Position Limits or Accountability), SEF Core Principle 10 (Recordkeeping) and the Commission's regulations thereunder. Proposed § 38.851(b)(9) defines “market regulation functions” as the DCM functions required by DCM Core Principle 2 (Compliance with Rules), DCM Core Principle 4 (Monitoring of Trading), DCM Core Principle 5 (Position Limits or Accountability), DCM Core Principle 10 (Trade Information), DCM Core Principle 12 (Protection of Markets and Market Participants), DCM Core Principle 13 (Disciplinary Procedures), DCM Core Principle 18 (Recordkeeping) and the Commission's regulations thereunder.

The Commission's proposed definition of “market regulation functions” does not include certain other SEF or DCM obligations. For example, the proposed definition does not include DCM Core Principle 11 (Financial Integrity of Transactions), the related financial surveillance requirements for DCMs under Commission regulation § 1.52, or a SEF's obligations under Core Principle 7 (Financial Integrity of Transactions).

As noted above, the Commission staff's RFC sought public comment on a range of potential issues that may arise if a DCM, DCO or SEF is affiliated with an intermediary, such as an FCM or IB, or other market participant such as a trading entity. While the scope of the proposed term “market regulation functions” in this rulemaking is limited to SEF and DCM functions under specific core principles, the Commission notes that public comment in response to the RFC may inform future Commission action. The Commission may further address SEF or DCM conflicts of interest obligations that may impact broader self-regulation functions of SEFs and DCMs, including their obligations under SEF Core Principle 7 and DCM Core Principle 11. The Commission notes that any future action impacting broader self-regulatory functions may consider whether those self-regulatory functions should be subject to requirements that are similar or different to the requirements being proposed in this rulemaking. As discussed further below, the main objective of this rulemaking is to establish requirements to mitigate certain conflicts of interest that may impact those SEF and DCM functions most closely tied to the SEF's or DCM's market regulation function.

2. Questions for Comment

The Commission seeks comment on the questions set forth below regarding the proposed definition of “market regulation functions.”

1. Has the Commission appropriately defined “market regulation functions” for purposes of this rule proposal? Are there additional functions that should be included in the proposed definition?

2. In this rule proposal, and for purposes of the conflicts of interest that it is intended to address, has the Commission appropriately distinguished “market regulation functions” from the broader self-regulatory functions of a SEF or DCM?

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

121

See

Commission regulations §§ 38.155 (DCM) and 37.203(c) (SEF).

122

Proposed Acceptable Practices for compliance with section 5(d)(15) of the Commodity Exchange Act, 71 FR 38740, 38741 n.10 (July 7, 2006) (citing five separate domestic and international studies reaching the same conclusion);

See also

Kristin N. Johnson, Governing Financial Markets: Regulating Conflicts, 88 Wash. L.Rev. 185, 221 (2013) (“While clearinghouses and exchanges are private businesses, these institutions provide a critical, public, infrastructure resource within financial markets. The self-regulatory approach adopted in financial markets presumes that clearinghouses and exchanges will provide a public service and engage in market oversight. The owners of exchanges and clearinghouses may, however, prioritize 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 §§ 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.

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Additionally, the DCM Core Principle 15 Guidance states that persons who have governing obligations or responsibilities, or who exercise disciplinary authority, should not have a significant history of serious disciplinary offenses, such as those that would be disqualifying under Commission regulation § 1.63

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The DCM Core Principle 15 Guidance also states that DCMs should have standards for the collection and verification of information supporting compliance with the DCM's fitness standards. Pursuant to Commission regulation § 38.2, DCMs are exempt from some of the provisions of Commission regulation § 1.63. They are not exempt, however, from Commission regulation § 1.63(c), which prohibits persons that are subject to any of the disciplinary offenses set forth in Commission regulation § 1.63(b) from serving on a disciplinary committee, arbitration panel, oversight panel or governing board of a self-regulatory organization.

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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).

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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.”

SEFs are not subject to a specific core principle requirement to establish fitness standards. However, as authorized by the CEA,

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SEFs must comply with all requirements in Commission regulation § 1.63, which sets forth requirements and procedures to prevent persons with certain disciplinary histories from serving in certain governing or oversight capacities at a self-regulatory organization.

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Commission Regulation § 1.63 was adopted pursuant to the following statutory authority: 7 U.S.C. 2, 2a, 4, 4a, 6, 6a, 6b, 6c, 6d, 6e, 6f, 6g, 6h, 6i, 6j, 6k, 6l, 6m, 6n, 6o, 7, 7a, 8, 9, 12, 12a, 12c, 13a, 13a-l, 16,19, 21, 23, and 24, Service on Self-Regulatory Organization Governing Boards or Committees by Persons with Disciplinary Histories, 55 FR 7884, 7890 (March 6, 1990, Final Rule).

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

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.

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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.

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CEA section 5h(f)(2); 7 U.S.C. 7b-3(f)(2).

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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 §§ 37.207(a) and 38.801(a), the Commission is requiring that SEFs and DCMs establish and enforce appropriate fitness standards for officers; for members of its board of directors, committees, disciplinary panels, and dispute resolution panels (or anyone performing functions similar to the foregoing); for members of the SEF or DCM; for any other person with direct access to the SEF or DCM; and for any person who owns 10 percent or more of a SEF or DCM and who, either directly or indirectly, through agreement or otherwise, in any other manner, may control or direct the management or policies of the SEF or DCM, and any party affiliated with any of those persons.

Specifically, the Commission notes that proposed §§ 37.207(a) and 38.801(a) would extend minimum fitness requirements to certain individuals, including officers and owners of 10 percent or more of a SEF or DCM, and SEF and DCM members with voting privileges, who were not historically subject to DCM fitness requirements under DCM Core Principle 15, or SEF and DCM fitness requirements under Commission regulation § 1.63(c). However, as discussed below, the Commission believes applying consistent minimum fitness standards to classes of individuals enumerated in proposed §§ 37.207(a) and 38.801(a) is reasonably necessary given that these individuals have: (1) obligations with respect to a SEF's or DCM's governance or disciplinary process; or (2) the ability to exercise control over a SEF or DCM.

First, officers of a SEF or DCM would be subject to the minimum fitness requirements in proposed §§ 37.207(a) and 38.801(a).

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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

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—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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Officers are also subject to the 8a(2) and 8a(3) minimum fitness requirements in proposed §§ 37.207(b) and 38.801(b), and the disqualifying offenses in proposed §§ 37.207(c) and 38.801(c).

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In addition to the three categories of individuals highlighted in this section, members of its board of directors, committees, disciplinary panels, and dispute resolution panels, all members of the SEF or DCM, and any other person with direct access to the SEF, are subject to the requirement to have appropriate fitness requirements in §§ 37.207(a) and 38.801(a).

Second, members with voting privileges would also be subject to the minimum fitness requirements in proposed §§ 37.207(a) and 38.801(a).

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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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Members with voting privileges are also subject to the 8a(2) and 8a(3) minimum fitness requirements in proposed §§ 37.207(b) and 38.801(b).

Third, certain owners of 10 percent or more of a SEF or DCM would also be subject to the minimum fitness requirements in proposed §§ 37.207(a) and 38.801(a).

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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.

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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

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be subject to certain minimum fitness requirements, as described below.

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Owners of 10 percent or more of a SEF or DCM, who also may control or direct the management or policies of a SEF or DCM, are also subject to the 8a(2) and 8a(3) minimum fitness requirements in proposed §§ 37.207(b) and 38.801(b).

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As noted below concerning the proposed changes to Commission regulations § 37.5(c), if one entity holds a 10 percent equity share in a SEF it may have a significant voice in the operation and/or decision-making of the SEF.

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The language of the proposed fitness standards for owners of 10 percent or more of a SEF or DCM intentionally generally mirrors the language from the Appendices to Part 37 and 38, Form SEF and Form DCM, Exhibit A. Exhibit A to Form SEF and Form DCM require disclosure of owners of 10 percent or more of the applicant's stock as part of the application for registration or designation. A similar 10 percent or more ownership threshold is found in other Commission regulations,

e.g.,

the definition of Principal in Commission regulation § 3.1 and section 8a(2)(H) of the CEA, which effectively prevent individuals subject to the grounds for refusal to register in CEA section 8a(2) or section 8a(3) from owning 10 percent of voting stock in an intermediary subject to registration requirements. The 10 percent ownership interest threshold is similarly found in the reporting requirements for “insiders” in section 16 of the Securities Exchange Act of 1934.

See also

17 CFR 240.16a-2.

ii. Minimum Fitness Standards

Proposed §§ 37.207(b) and 38.801(b) would set forth minimum standards of fitness SEFs and DCMs must establish and enforce for officers and members of its board of directors,

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committees,

disciplinary panels, and dispute resolution panels (or anyone performing functions similar to the foregoing), for members with voting privileges,

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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,

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to include the bases for refusal to register a person under sections 8a(2) and 8a(3) of the CEA.

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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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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 §§ 37.1201(b)(2) and 38.851(b)(2).

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Consistent with current Core Principle 15 Guidance, members with voting privileges have the same minimum fitness standards as other individuals with the ability to directly affect the operations or governance of the Exchange, whereas members without voting privileges are subject only to the requirement that the DCM or SEF set appropriate fitness standards for them, as set out in proposed regulations §§ 37.207(a) and 38.801(a). In light of industry changes, the Commission is requesting comment on whether “members with voting privileges” remains a relevant category that should be subject to this distinction.

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These categories of individuals are similar to those subject to the 8a(2) standards in the DCM Core Principle 15 Guidance.

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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.”

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.

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In proposing to extend the sections 8a(2) and 8a(3) minimum fitness standards to individuals subject to the fitness requirements in proposed §§ 37.207(a) and 38.801(a), the Commission is extending the same consistent, minimum industry framework

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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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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.

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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.

Proposed §§ 37.207(c) and 38.801(c) would require SEFs and DCMs to establish and enforce additional minimum fitness standards for certain individuals—officers and for members of its board of directors, committees, disciplinary panels, and dispute resolution panels (or anyone performing functions similar to the foregoing). These additional fitness requirements include ineligibility based on six types of disciplinary offenses that generally track the disciplinary offenses listed in §§ 1.63(b)(1)-(6), with certain modifications. In effect, the proposed rules would apply the fitness requirements of Commission regulation § 1.63 consistently to both SEFs and DCMs, subject to certain enhancements as further described below.

The six disciplinary offenses in proposed §§ 37.207(c)(1)-(6) and 38.801(c)(1)-(6) are substantially similar to the existing ineligibility requirements in § 1.63(b).

• Proposed §§ 37.207(c)(1) and 38.801(c)(1), require that an individual would be ineligible if they were found, in a final, non-appealable

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order by a court of competent jurisdiction, an administrative law judge, the Commission, a self-regulatory organization,

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or the SEC, to have committed any of four offenses described in proposed §§ 37.207(c)(1)(i)-(iv) and 38.801(c)(1)(i)-(iv) within the previous three years.

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This requirement is substantially the same as the ineligibility requirement found in § 1.63(b)(1), except for the addition of findings by the SEC.

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The final, non-appealable order language comes from the definition of “final decision” found in Commission regulation § 1.63(a)(5).

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With the exception of the addition of the SEC, these are the same categories as in the definition of “final decision” found in Commission regulation § 1.63(a)(5).

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Pursuant to Commission regulation § 1.63(b)(1), an individual is ineligible to serve on disciplinary committees, arbitration panels, oversight panels or governing board if, within the past three years, that individual was found to have committed a “disciplinary offense.”

• Proposed §§ 37.207(c)(1)(i)-(iv) and 38.801(c)(1)(i)-(iv), include, in substance, the same four disciplinary offenses listed in § 1.63(a)(6)(i)-(iv).

• Proposed §§ 37.207(c)(2)-(6) and 38.801(c)(2)-(6) mirror, in substance, the disciplinary offenses found in § 1.63(b)(6)(2)-(6), with minor enhancements to expressly include both SEFs and DCMs when referencing suspensions from trading on a contract market.

Proposed §§ 37.207(c) and 38.801(c) also enhance the existing minimum fitness requirements in several ways, compared to the requirements in Commission regulation § 1.63. The language in proposed §§ 37.207(c) and 38.801(c) does not use the limiters “significant history” or “serious disciplinary offenses” in setting forth disqualifying offenses. These terms appear in DCM Core Principle 15 Guidance

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and the Commission proposes to clarify which disciplinary offenses are included by specifying which offenses would automatically be

disqualifying. As described above, the list of disciplinary offenses in proposed §§ 37.207(c) and 38.801(c) includes, in substance, the same offenses identified in Commission regulation § 1.63,

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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”).

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DCM Core Principle 15 Guidance provides that, among other things, persons who have governing obligations or responsibilities, or who exercise disciplinary authority, should not have a significant history of serious disciplinary offenses, such as those that would be disqualifying under Commission regulation § 1.63.

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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.

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Commission regulation § 1.63(b)(6) provides as disqualifying anyone who is currently subject to a denial, suspension or disqualification from serving on the disciplinary committee, arbitration panel or governing board of any self-regulatory organization as that term is defined in section 3(a)(26) of the Securities Exchange Act of 1934.

iii. Verification and Documentation of Minimum Fitness Standards

Proposed §§ 37.207(d) and 38.801(d) would require each SEF and DCM to establish appropriate procedures for the collection and verification of information supporting compliance with appropriate fitness standards. The Commission believes that, to be effective, such procedures must be written, must be in a location where people who would use them can find them, and must be preserved and ready for the Commission to review.

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The Commission anticipates staff will review the procedures and fitness determinations as part of its routine oversight.

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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.

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.

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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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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.”

Commission staff also discovered during the course of its oversight that some SEFs and DCMs did not have a practice to verify an individual's compliance with applicable fitness standards prior to the individual starting to serve in the capacity requiring the fitness standard. Additionally, some SEFs and DCMs lacked practices for regular verification of fitness standards, allowing fitness information to become stale. Without these practices for verifying and documenting fitness information, the Commission believes there is an increased risk that individuals will serve in a capacity for which they are not fit. Proposed §§ 37.207(d)(1)(i)-(iv) and 38.801(d)(1)(i)-(iv) would address these practices by requiring: (i) fitness information be verified at least annually, (ii) the SEF or DCM have procedures providing for immediate notice to the SEF or DCM if an individual no longer meets the minimum fitness standards to serve in their role, (iii) the initial verification of information supporting an individual's compliance with relevant fitness standard be completed prior to the individual serving in the capacity with fitness standards, and (iv) the SEF and DCM to document their findings with respect to the verification of fitness information.

The Commission further proposes to clarify the applicability of the governance fitness requirements to SEFs and DCMs by locating them, respectively, within parts 37 and 38 of the Commission's regulations, rather than within part 1 of the Commission's regulations. The Commission also proposes to make conforming amendments to Commission regulations §§ 37.2 and 38.2 to exempt SEFs and DCMs from Commission regulation § 1.63 in its entirety.

iv. Additional Considerations for Minimum Fitness Requirements

The Commission is considering whether additional fitness requirements would enhance the performance and accountability of the individuals who are charged with governing a SEF or DCM or its operations, or have the ability to influence such functions. Therefore, the Commission is seeking comment on whether SEFs and DCMs should consider additional eligibility criteria to prevent individuals from serving as an officer or member of the board of directors if their background, although not automatically disqualifying under proposed §§ 38.801(c) or 37.207(c), raises concerns about the individual's ability to effectively govern, manage, or influence the operations or 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,

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and the same requirement exists for members of the management body of regulated markets in the European Union.

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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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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.”

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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, 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.

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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

a foreign regulator or court in foreign jurisdiction.

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The Form U4 includes information such as criminal charges, pending regulatory cases, license suspensions or revocations, and decisions by foreign courts.

3. Questions for Comment

The Commission requests comment on all aspects of the proposed fitness standards for SEFs and DCMs. The Commission further requests comment on the questions set forth below.

1. Should SEFs and DCMs be required to establish additional fitness standards for officers or members of the board of directors whose background, although not automatically disqualifying under proposed §§ 37.207 or 38.801, raises concerns about the individual's ability to effectively govern, manage, or influence the operations or 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 §§ 37.207(c) and 38.801(c)?

5. Proposed §§ 37.207(b) and 38.801(b) apply to “members of the designated contract market with voting privileges” and “members of the swap execution facility with voting privileges,” respectively. Is this an appropriate category of persons to subject to the proposed minimum fitness standard requirements? Does this category remain relevant to current SEF and DCM governance and business structures, or is it no longer applicable?

IV. Proposed Substantive Requirements for Identifying, Managing and Resolving Actual and Potential Conflicts of Interest

a. General Requirements for Conflicts of Interest and Definitions—Proposed §§ 37.1201 and 38.851

1. Existing Regulatory Framework and Definitions

As described above, SEFs and DCMs must establish and enforce rules to minimize conflicts of interest in their decision-making processes and establish a process for resolving such conflicts, pursuant to SEF Core Principle 12 and DCM Core Principle 16. SEFs and DCMs have different standards for addressing conflicts of interest. The DCM Core Principle 16 Acceptable Practices provide specific practices that DCMs may adopt to demonstrate compliance with aspects of DCM Core Principle 16. The Commission has not adopted guidance on, or acceptable practices in, compliance with the conflicts of interest requirements under SEF Core Principle 12. Commission regulation § 1.59, however, addresses the management of conflicts of interest for SEFs in connection with protecting material non-public information from misuse and disclosure.

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Commission regulation § 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 § 38.2, DCMs are exempt from § 1.59(b) and (c), but must comply with § 1.59(a) and (d); SEFs must comply with all subparts of § 1.59.

There are several terms defined in the DCM Core Principle 16 Acceptable Practices and Commission regulation § 1.59(a) which the Commission believes are relevant to identifying and resolving conflicts of interest that may impact a SEF's or DCM's market regulation functions, and which the Commission is proposing to adopt in these proposed new conflict of interest rules with certain minor modifications as discussed below. The DCM Core Principle 16 Acceptable Practices defines a “public director” as an individual with no material relationship to the DCM and describes the term “immediate family” to include spouse, parents, children, and siblings. The terms “material information,” “non-public information,” “commodity interest,” “related commodity interest,” and “linked exchange” are defined in Commission regulation § 1.59. “Material information” is defined in § 1.59(a)(5) to mean information which, if such information were 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.

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“Non-public information” is defined in § 1.59(a)(6), as information which has not been disseminated in a manner which makes it generally available to the trading public. Commission regulations §§ 1.59(a)(8) and (9) define “commodity interest,” to include all futures, swaps, and options traded on or subject to the rules of a SEF or DCM

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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

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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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The definition of material information in Commission regulation § 1.59(a)(5) also provides that as used in that section, “material information” includes, but is not limited to, information relating to present or anticipated cash positions, commodity interests, trading strategies, the financial condition of members of self-regulatory organizations or members of linked exchanges or their customers, or the regulatory actions or proposed regulatory actions of a self-regulatory organization or a linked exchange.

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The definition of commodity interest also includes futures or swaps cleared by a Designated Clearing Organization. Commission regulation § 1.59(a)(8).

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Commission regulation § 1.3 defines this term as a contract market (as defined in § 1.3(h)), a swap execution facility (as defined in § 1.3(rrrr)), or a registered futures association under section 17 of the CEA.

2. Proposed Rules

Proposed §§ 37.1201(a) and 38.851(a) would set forth the foundational requirement that SEFs and DCMs, respectively, must establish a process for identifying, minimizing, and resolving actual and potential conflicts of interest that may arise, including, but not limited to, conflicts between and among any of the SEF's or DCM's market regulation functions; its commercial interests; and the several interests of its management, members, owners, customers and market participants, other industry participants, and other constituencies. These proposed rules would largely codify existing language from the DCM Core Principle 16 Acceptable Practices.

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Part 38, Appendix B, Core Principle 16.

Proposed §§ 37.1201(b) and 38.851(b) would establish definitions. As discussed above, many of the terms are already defined in existing Commission regulations, and in the acceptable

practices for compliance with the DCM conflicts of interest core principle, and would be duplicated with minor modifications. The Commission believes that specifically defining these terms in parts 37 and 38 of its regulations would provide greater clarity to SEFs and DCMs, and to the public, regarding regulatory requirements applicable to these entities. Additional reasons for proposing these defined terms are discussed below.

First, the terms “material information,” “non-public information,” “commodity interest,” “related commodity interest,” and “linked exchange” would be defined in proposed §§ 37.1202(b) and 38.851(b) as they are in § 1.59(a), but modified specifically to reference SEFs and DCMs, respectively. Additionally, as addressed below, proposed §§ 37.1202(b) and 38.851(b) would define “public director” and “family relationship.”

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“Family relationship” would replace the term “immediate family” that is currently used in the DCM Core Principle 16 Acceptable Practices.

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As discussed above,

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proposed §§ 37.1201 and 38.851 focus on conflicts of interests involving a subset of a SEF or DCM's self-regulatory functions—those that are generally related to the SEF's or DCM's obligations to ensure market integrity and proper and orderly conduct in its markets, and to deter abusive trading practices. Those functions include trade practice surveillance, market surveillance, real-time market monitoring, audit trail and recordkeeping enforcement, investigations of possible rule violations, and disciplinary actions. As discussed above, the Commission is proposing to define “market regulation functions” in §§ 37.1201(b)(9) and 38.851(b)(9) to describe the self-regulatory functions addressed in this rule proposal.

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See

Section V(b)(3) (addressing the term public director) and Section IV(b)(3) (addressing the term family relationship).

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Section IV(c)(3) herein provides details regarding the proposed definitions for public director and family relationship.

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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.

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For the limited purpose of this rule proposal, the Commission proposes defining “affiliate” in proposed §§ 37.1201(b)(1) and 38.851(b)(1), to mean a person that directly or indirectly controls, or is controlled by, or is under common control with, the SEF or DCM (as applicable). The definition of affiliate in proposed §§ 37.1201(b)(1) and 38.851(b)(1) would establish that, for purposes of this rule proposal, “affiliate” broadly includes direct or indirect common ownership or control.

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For example, § 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.

b. Conflicts of Interest in Decision-Making—Proposed §§ 37.1202 and 38.852

1. Background

Officers, members of the board of directors, committees, and disciplinary panels, are the key decision-makers at a SEF or DCM that can directly affect the day-to-day execution of market regulation functions. Therefore, the Commission believes individuals fulfilling these roles must have the ability to make informed and impartial decisions. If any of these 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 §§ 37.1202 and 38.852, respectively, certain elements of Commission regulation § 1.69 that require a self-regulatory organization to address the avoidance of conflicts of interest in the execution of its self-regulatory functions. As noted above, SEFs are currently subject to the requirements of Commission regulation § 1.69; however, DCMs are exempt from these requirements pursuant to Commission regulation § 38.2. Nonetheless, Commission staff has found that as a matter of practice, most DCMs have adopted rules that voluntarily implement these requirements.

2. Existing Regulatory Framework

Commission regulation § 1.69 generally requires self-regulatory organizations to have rules requiring any member of the board of directors, disciplinary committee, or oversight panel, to abstain from deliberating and voting on certain matters that may raise conflicts of interest. Commission regulation § 1.69(a) includes a list of definitions relevant to the section, including the definition of “named party in interest,” which means a person or entity that is identified by name as a subject of any matter being considered by a governing board, disciplinary committee, or oversight panel. Commission regulation § 1.69(b)(1)(i)(A)-(E) enumerates a list of relationships. If a member of the board of directors, disciplinary committee, or oversight panel, has such a relationship with a named party in interest, then this would require the member to abstain from deliberating and voting on that matter. Prior to the consideration of any matter involving a named party in interest, Commission regulation § 1.69(b)(1)(ii) requires members of a governing board, disciplinary committee or oversight panel to disclose their relationships with the named party in interest. Commission regulation § 1.69(b)(1)(iii) requires self-regulatory organizations to establish procedures for determining whether any members of governing boards, disciplinary committees or oversight panels are subject to a conflicts restriction in any matter involving a named party in interest, and specifies certain requirements for making such determinations.

Commission regulation § 1.69(b)(2) requires members of governing boards, disciplinary committees or oversight panels to abstain from deliberating and voting in any significant action if the member knowingly has a direct and substantial financial interest in the result of the vote. Additional requirements for disclosure of interest and the procedures for making a conflicts determination are addressed in Commission regulations §§ 1.69(b)(2)(ii) and (iii), respectively. Commission regulation § 1.69(b)(3) permits members of governing boards, disciplinary committees or oversight panels, who otherwise would be required to abstain from deliberations and voting on a matter because of a conflict under Commission regulation § 1.69(b)(2), to deliberate but not vote on the matter under certain circumstances.

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Finally, Commission regulation § 1.69(b)(4) requires self-regulatory organizations to document certain conflicts determination requirements.

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Commission regulation § 1.64(b)(3)(ii) lists the following factors for the deliberating body to consider in determining whether to allow such member to participate in deliberations: (1) if the member's participation is necessary to achieve a quorum; and (2) whether the member has unique or special expertise, knowledge or experience in the matter under consideration.

3. Proposed Rules

The Commission proposes to include certain elements of Commission regulation § 1.69 in proposed §§ 37.1202 and 38.852, and to make a conforming amendment to Commission regulation

§ 37.2 to exempt SEFs from Commission regulation § 1.69. While the intent behind Commission regulation § 1.69 remains relevant, the Commission believes that certain modifications and enhancements are necessary to reflect the current state of the futures and swaps markets. For example, Commission regulation § 1.69(b)(1)(i)(C) describes a relationship with a named party in interest through a “broker association” as defined in § 156.1. While this relationship may have been significant at the time Commission regulation § 1.69 was adopted, the Commission does not believe it is necessary to include it in proposed §§ 37.1202 and 38.852 given the decline of open outcry trading. Furthermore, the scope of proposed §§ 37.1202 and 38.852 would require a relationship with an individual as part of a broker association, as well as other professional associations, to be disclosed regardless of whether it is an enumerated relationship. The scope of proposed §§ 37.1202 and 38.852 expressly covers officers, as well as members of boards of directors, committees, and disciplinary panels,

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to accurately reflect the individuals and governing bodies that are involved in the decision-making processes of a SEF or DCM and that may therefore be subject to the same conflicts of interest.

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Commission regulation § 1.69(a) defines “disciplinary committee(s),” “governing board(s),” and “oversight panel(s).”

The Commission notes that Commission regulation § 1.69(a)(2) currently includes “family relationship” as one of the enumerated relationships, which is defined as a person's spouse, parent, stepparent, child, stepchild, sibling, stepbrother, stepsister, or 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 §§ 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 §§ 37.1202(a) and 38.852(a) require SEFs and DCMs, respectively, to establish policies and procedures requiring any officer or member of its board of directors, committees, or disciplinary panels to disclose any actual or potential conflicts of interest that may be present prior to considering any matter. The proposed language is a modernized version of the requirement in Commission regulation § 1.69(b). Although not exhaustive, proposed §§ 37.1202(a)(1) and 38.852(a)(1) enumerate certain conflicts in which the member or officer: (1) is the subject of any matter being considered; (2) is an employer, employee, or colleague

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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.

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The Commission is proposing §§ 37.1202(a)(2) and 38.852(a)(2) to extend the conflicts of interest enumerated in proposed §§ 37.1202(a)(1) and 38.852(a)(1) to also apply to relationships that an officer or member of its board of directors, committees, or disciplinary panels has with an affiliate of the subject of any matter being considered.

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The Commission proposes replacing the current term “fellow employee” with “colleague” to include individuals with whom the officer or director may have a collegial relationship, but may not be employed by the same employer. As an example, two individuals who worked in the same office, where the first is a full-time employee of the organization, and the other works alongside the first but is employed by an outside contractor, would be considered colleagues for purposes of proposed §§ 37.1202 and 38.852.

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The Commission believes that this relationship, along with the overarching requirement in proposed §§ 37.1202(a) and 38.852(a) requiring an officer or member of its board of directors, committees, or disciplinary panels to disclose any actual or potential conflicts of interest that may be present prior to considering any matter, are sufficient for addressing conflicts of interest involving financial interest. Accordingly, the Commission is not proposing to include in proposed §§ 37.1202 or 38.852 a parallel to existing Commission regulation § 1.69(b)(2)'s requirements concerning financial interests in significant actions.

As discussed above, the evolution of market structures has increased the interconnectedness between SEFs, DCMs, and their affiliates. This relationship between a SEF or DCM and its affiliates—and by extension, the officers, members of the board of directors, committees, or disciplinary panels—could create, in the Commission's view, an actual or potential conflict of interest. Accordingly, the Commission believes proposed §§ 37.1202(a)(2) and 38.852(a)(2) is necessary to mitigate conflicts of interest in a SEF's or DCM's decision-making.

Proposed §§ 37.1202(b) and 38.852(b) largely track existing requirements in Commission regulation § 1.69(b)(4) and require the board of directors, committee, or disciplinary panel to document its processes for complying with the requirements of the proposed rules, and such documentation must include: (1) the names of all members and officers who attended the relevant meeting in person or who otherwise were present by electronic means; and (2) the names of any members and officers who voluntarily recused themselves or were required to abstain from deliberations or voting on a matter and the reason for the recusal or abstention. To ensure the intent of proposed §§ 37.1202 and 38.852 is captured, the Commission continues to require voluntary recusals to be documented, in addition to the instances in which a determination was made to require the abstention of an officer or member of a board of directors, committee, or disciplinary panel.

In a limited number of circumstances, Commission regulation § 1.69(b)(3) permits members of governing boards, disciplinary committee, or oversight panel, who otherwise would be required to abstain from deliberations and voting on a matter because of a conflict under Commission regulation § 1.69(b)(2), to deliberate but not vote on the matter. The Commission is not proposing to adopt this exemption. If a board of directors, committee or panel believes that it has insufficient expertise to consider a matter, the Commission encourages the committee to seek information from an expert or consultant that is not subject to a conflicts restriction. The Commission believes it is imperative for boards of directors, committees, and disciplinary panels to have access to unbiased, conflict-free information to assist in decision-making.

4. Questions for Comment

The Commission requests comment on all aspects of the proposed conflicts of interest in decision-making rules. The Commission further requests comment on the questions set forth below.

1. Should the Commission enumerate certain other relationships or circumstances that may give rise to an actual or potential conflict of interest? If so, which relationships or circumstances?

2. Does the proposed definition of “family relationship” cover the appropriate types of relationships?

Should any relationships be added or removed from the proposed definition?

c. Limitations on the Use and Disclosure of Material Non-public Information—Proposed §§ 37.1203 and 38.853

1. Background

Preventing the misuse and disclosure of material non-public information at SEFs and DCMs further the objectives of promoting self-regulation of exchanges and maintaining public confidence in SEF and DCM markets. The CEA includes prohibitions on the misuse and disclosure of material non-public information. It is unlawful for any person who is an employee, member of the governing board, or member of any committee of a board of trade, to willfully and knowingly (1) trade for such person's own account, or for or on behalf of any other account, in contracts for future delivery or option thereon on the basis of any material non-public information obtained through special access related to the performance of such person's official duties as an employee or member; or (2) to disclose for any purpose inconsistent with the performance of such person's official duties as an employee or member, any material non-public information obtained through special access related to the performance of such duties.

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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 § 1.59, which establishes limitations on the use and disclosure of material non-public information. The proposed rules would establish prohibitions on the use or disclosure of material non-public information by: (1) employees of the SEF or DCM; and (2) members of the board of directors, committee members, consultants and those with an ownership interest of 10 percent or more in the SEF or DCM.

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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 §§ 37.1203 and 38.853, and to make conforming amendments to Commission regulation § 37.2 to exempt SEFs from Commission regulation § 1.59. As discussed in more detail below, the proposal would establish consistent rules for SEFs and DCMs related to the use and disclosure of material non-public information.

2. Existing Regulatory Framework

Commission regulation § 1.59 generally requires self-regulatory organizations to adopt rules prohibiting employees, governing board members, committee members or consultants from trading commodity interests on the basis of material non-public information obtained in the course of their official duties. Under Commission regulation § 1.59, employees of self-regulatory organizations are subject to stricter trading prohibitions than governing board members, committee members or consultants. Specifically, employees are prohibited from trading in any commodity interest traded on or cleared by the employing SEF, DCM or DCO, or from trading in any related commodity interest. Additionally, employees having access to material non-public information concerning a commodity interest are prohibited from trading in any such commodity interest that is traded on or cleared by any SEF, DCM or DCO, or any linked exchange.

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Commission regulation § 1.59(a)(7) defines linked exchange to include any exchange or board of trade outside of the United States that lists products traded on the SEF or DCM, or that has an agreement with a SEF or DCM to permit positions in one commodity interest to be liquidated on the other market, or any clearing organizations that clears the products in any of the foregoing markets.

Members of the board of directors, committee members, and consultants of a self-regulatory organization, on the other hand, are prohibited from using material non-public information for any purpose other than the performance of their official duties. The possession of material non-public information, therefore, does not absolutely bar these individuals from trading commodity interests. Rather, under Commission regulation § 1.59(d), members of the board of directors, committee members, or consultants of a self-regulatory organization are directly prohibited from trading for their own account, or for or on behalf of any other account, based on this material non-public information.

The direct prohibitions under Commission regulation § 1.59(d) were adopted in 1993 to effectuate section 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.

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Historically, the Commission has adopted a more lenient standard for governing board members and committee members.

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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).

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When Commission regulation § 1.59 was first proposed, it proposed to apply the same standard to employees and governing board members and committee members. Activities of Self-Regulatory Organization Employees and Governing Members Who Possess Material, Nonpublic Information, 50 FR 24533 (June 11, 1985). In response to public comment, however, the Commission initially finalized § 1.59 without addressing what obligations applied to members of the governing board of committee members. Instead, the Commission adopted the more lenient standard in a separate rulemaking. Activities of Self-Regulatory Organization Employees Who Possess Material, Non-Public Information, 51 FR 44866 (Dec. 12, 1986).

While § 1.59(b) prohibits trading in commodity interests or related commodity interests by employees, the rule also provides that exemptions may be granted. Under current § 1.59(b)(2)(ii)(b), a self-regulatory organization may adopt rules setting forth circumstances under which exemptions may be granted, as long as those exemptions are consistent with the CEA, the purposes of § 1.59, just and equitable principles of trade, and the public interest. Exemptions also may be granted, under rules adopted by a self-regulatory organization, in situations where an employee participates in a pooled investment vehicle without direct or indirect control of such vehicle.

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Commission regulation § 1.59(b)(ii)(b).

The prohibitions and requirements under § 1.59 apply differently to SEFs and DCMs. As a result of the core principles framework promulgated under the Commodity Futures Modernization Act of 2000, DCMs were relieved from many rule-based requirements in favor of core principles. Consequently, DCMs were exempted from § 1.59(b) and (c). However, employees, governing board members, committee members, and consultants at DCMs are not exempted from

§ 1.59(d).

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In addition to the Commission's statutory authority on insider trading,

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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.

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Under the provisions of Commission regulation § 1.59(d), no employee, governing board member, committee member, or consultant shall trade for such person's own account, or for or on behalf of any other account, in any commodity interest, on the basis of any material, non-public information obtained through special access related to the performance of such person's official duties as an employee, governing board member, committee member, or consultant. Furthermore, such persons must not disclose for any purpose inconsistent with the performance of their official duties as an employee, governing board member, committee member, or consultant any material, non-public information obtained through special access related to the performance of such duties. In addition, no person shall trade for their own account, or for or on behalf of any other account, in any commodity interest, on the basis of any material, non-public information that such person knows was obtained in violation of paragraph (d)(1) of § 1.59 from an employee, governing board member, committee member, or consultant.

170

CEA section 9(e).

171

Part 38, Appendix B, Core Principle 16.

In contrast, Commission regulation § 1.59 applies in its entirety to SEFs. Unlike for DCMs, the Commission did not adopt any guidance or acceptable practices addressing how a SEF may demonstrate compliance with SEF Core Principle 12 related to appropriate limitations on the use and disclosure of material non-public information.

3. Proposed Rules

The Commission is proposing harmonized rules for SEFs and DCMs related to the use and disclosure of material non-public information from § 1.59.

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Proposed §§ 37.1203(a) and 38.853(a) require SEFs and DCMs to establish and enforce policies and procedures on safeguarding the use and disclosure of material non-public information. These policies and procedures must, at a minimum, prohibit a SEF or DCM employee, member of the board of directors, committee member, consultant, or owner with a 10 percent or more interest in the SEF or DCM, from trading commodity interests or related commodity interests based on, or disclosing, any non-public information obtained through the performance of their official duties. As discussed in more detail below, the scope of individuals subject to trading limitations under this proposed rule is consistent with those individuals subject to the trading limitations under both existing § 1.59 and existing Core Principle 16 Guidance. The proposal codifies existing Core Principle 16 Guidance which considers appropriate limitations on those with an ownership interest in the exchange. The proposal clarifies that the limitation would apply to those with an ownership interest of 10 percent or more in the SEF or DCM.

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This rule proposal would not amend Commission regulation § 1.59, which will remain unchanged and continue to be applicable to registered futures associations.

Proposed §§ 37.1203(b) and 38.853(b) require SEFs and DCMs, respectively, to prohibit employees from certain types of trading

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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.

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Proposed §§ 37.1203(c) and 38.853(c) would allow SEFs and DCMs, respectively, to grant exemptions that are (1) approved by the SEF or DCM ROC; (2) granted only in limited circumstances in which the employee requesting the exemption can demonstrate that the trading is not being conducted on the basis of material 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 §§ 37.1000 and 37.1001 or §§ 38.950 and 38.951, respectively.

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Proposed §§ 37.1203(b)(1) and 38.853(b)(1) restrict trading directly or indirectly, in the following: (1) Any commodity interest traded on the employing designated contract market; (2) Any related commodity interest; (3) A commodity interest traded on designated contract markets or swap execution facilities or cleared by derivatives clearing organizations other than the employing designated contract market if the employee has access to material non-public information concerning such commodity interest; or (4) A commodity interest traded on or cleared by a linked exchange if the employee has access to material non-public information concerning such commodity interest.

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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 §§ 37.1203(d) and 38.853(d) to require SEFs and DCMs, respectively, to establish and enforce policies and procedures to diligently monitor the trading activity conducted under any exemptions granted to ensure compliance with any applicable conditions of the exemptions and the SEF's or DCM's policies and procedures on the use and disclosure of material non-public information. The Commission believes that SEFs and DCMs have an obligation to monitor and ensure compliance with any applicable conditions of the exemptions that may be granted by the exchange. Moreover, SEFs and DCMs must ensure that any granted exemptions are in accordance with the exchange's policies and procedures governing employees' use and disclosure of material non-public information, as well as the CEA and Commission regulations. The Commission believes that SEFs and DCMs should already have existing programs to monitor, detect, and deter abuses that may arise from trading conducted pursuant to an exemption from the employee trading prohibition. Accordingly, a SEF or DCM should utilize its existing surveillance program to monitor trading by employees or other insiders who are granted trading exemptions pursuant to proposed §§ 37.1203(c) and 38.853(c). Such surveillance should focus on the commodity interests or related commodity interests to which the 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

of any other account, based on this material non-public information. Accordingly, proposed §§ 37.1203(e) and 38.853(e) require SEFs and DCMs, respectively, to establish and enforce policies and procedures that, at a minimum, prohibit members of the board of directors, committee members, employees, consultants, and those with an ownership interest of 10 percent or more from: (1) trading in any commodity interest or related commodity interest on the basis of any material non-public information obtained through the performance of such person's official duties; (2) trading in any commodity interest or related commodity interest on the basis of any material non-public information that such person knows was obtained in violation of this section; or (3) disclosing for any purpose inconsistent with the performance of the person's official duties any material non-public information obtained as a result of their official duties.

The Commission is expanding the scope of the direct prohibition on trading based on material non-public information under proposed §§ 37.1203(e) and 38.853(e) as compared to existing Commission regulation § 1.59 in three ways. First, the Commission is proposing to apply the prohibitions already applicable to employees in § 1.59(b), regarding trading in “related commodity interests,” to governing board members, committee members, and consultants who are in possession of material non-public information.

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Consistent with the definition of “related commodity interests,” in § 1.59(a)(9), the Commission believes that the direct prohibitions on trading while in the possession of material 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.

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Second, the Commission is proposing to codify existing DCM Core Principle 16 Guidance related to those with an ownership interest in §§ 37.1203(e)(3) and 38.853(e)(3). While this expands the scope of individuals subject to trading limitations as compared to existing Commission regulation § 1.59, it is codifying existing Core Principle 16 Guidance, with one clarification. Specifically, with regards to owners, the Commission is clarifying that the direct prohibition under §§ 37.1203(e) and 38.853(e) would only apply to those with an ownership interest of 10 percent or more in the SEF or DCM.

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Third, while the proposed rules continue to maintain a restriction on the disclosure of material non-public information, the proposal would address differences in the existing language between §§ 1.59(b)(1)(D)(ii) and 1.59(d)(ii) regarding the restrictions on the disclosure of material non-public information. The Commission is proposing the same restriction on disclosure for both employees under §§ 37.1203(b)(2) and 38.853(b)(3) and members of the board of directors, committee members, consultants, and those with an ownership interest of 10 percent or more under §§ 37.1203(e)(3) and 38.853(e)(3), to make clear that these “insiders” would be subject to the same restriction from disclosing material non-public information obtained as a result of their official duties at a SEF or DCM.

175

Proposed §§ 37.1203(e)(1) and 38.853(e)(1).

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See

proposed §§ 37.1201(b)(15) and 38.851(b)(15) (defining “related commodity interests”).

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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.

As mentioned in Section IV.b, the Commission is proposing to include substantial sections of existing definitions from Commission regulation § 1.59 in proposed parts 37 and 38. For example, the proposal includes, for purposes of §§ 37.1203 and 38.853, the same historical definitions of (1) “commodity interest,” (2) “linked exchange,” (3) “material information,” (4) “non-public information,” and (5) “pooled investment vehicle.” The Commission is proposing 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.

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In particular, that it would be appropriate to grant an employee an exemption to trade in a pooled investment vehicle organized and operated as a commodity pool within the meaning of § 4.10(d) of the Commission regulations, and whose units of participation have been registered under the Securities Act of 1933, or a trading vehicle for which Commission regulation § 4.5 makes available relief from registration as a commodity pool operation.

4. Questions for Comment

The Commission requests comm

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